e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 |
For the quarterly period ended September 30, 2008
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934. |
For the transition period from to
Commission file number 001-33508
LIMELIGHT NETWORKS, INC.
(Exact name of registrant as specified in its charter)
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| Delaware
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20-1677033 |
| (State or other jurisdiction of
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(I.R.S. Employer |
| incorporation or organization)
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Identification No.) |
2220 W. 14th Street
Tempe, AZ 85281
(Address of principal executive offices, including Zip Code)
(602) 850-5000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large
accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
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| Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer þ
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Smaller reporting company o |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The number of shares outstanding of the registrant’s common stock as of November 3, 2008:
83,081,883 shares.
LIMELIGHT NETWORKS, INC.
FORM 10-Q
Quarterly Period Ended September 30, 2008
TABLE OF CONTENTS
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LIMELIGHT NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
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September 30, |
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December 31, |
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2008 |
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2007 |
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(Unaudited) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
123,146 |
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$ |
113,824 |
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Marketable securities |
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53,509 |
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83,273 |
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Accounts receivable, net of reserves of
$5,401 at September 30, 2008 and $4,022 at
December 31, 2007, respectively |
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31,274 |
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21,407 |
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Income taxes receivable |
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1,419 |
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|
1,960 |
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Prepaid expenses and other current assets |
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9,262 |
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4,469 |
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Total current assets |
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218,610 |
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224,933 |
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Property and equipment, net |
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42,355 |
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46,968 |
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Marketable securities, less current portion |
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16 |
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|
87 |
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Other assets |
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656 |
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1,440 |
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Total assets |
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$ |
261,637 |
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$ |
273,428 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
7,560 |
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$ |
8,523 |
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Accounts payable, related parties |
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— |
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|
230 |
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Deferred revenue, current portion |
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7,987 |
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|
4,237 |
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Provision for litigation |
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64,350 |
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|
48,130 |
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Other current liabilities |
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14,043 |
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9,312 |
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Total current liabilities |
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93,940 |
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70,432 |
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Deferred revenue, less current portion |
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8,765 |
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8,189 |
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Other long-term liabilities |
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797 |
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770 |
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Total liabilities |
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103,502 |
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79,391 |
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Commitments and contingencies |
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— |
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— |
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Stockholders’ equity: |
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Convertible preferred stock, $0.001 par
value; 7,500 shares authorized; 0 shares
issued and outstanding |
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— |
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— |
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Common stock, $0.001 par value; 150,000
shares authorized; 83,082 and 82,541 shares
issued and outstanding at September 30, 2008
and December 31, 2007, respectively |
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83 |
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83 |
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Additional paid-in capital |
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285,219 |
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271,586 |
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Accumulated other comprehensive (loss) income |
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(304 |
) |
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|
106 |
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Accumulated deficit |
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(126,863 |
) |
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(77,738 |
) |
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Total stockholders’ equity |
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158,135 |
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194,037 |
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Total liabilities and stockholders’ equity |
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$ |
261,637 |
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$ |
273,428 |
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The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
3
LIMELIGHT NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
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For the |
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For the |
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2008 |
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2007 |
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2008 |
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2007 |
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Revenue |
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$ |
33,116 |
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$ |
29,190 |
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$ |
93,632 |
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$ |
73,979 |
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Cost of revenue: |
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Cost of services |
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14,950 |
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12,171 |
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43,168 |
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31,796 |
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Depreciation — network |
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6,607 |
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5,602 |
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18,812 |
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15,310 |
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Total cost of revenue |
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21,557 |
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17,773 |
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61,980 |
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47,106 |
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Gross margin |
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11,559 |
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11,417 |
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31,652 |
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26,873 |
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Operating expenses: |
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General and administrative |
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15,112 |
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7,849 |
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37,346 |
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24,144 |
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Sales and marketing |
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8,577 |
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7,421 |
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25,684 |
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16,843 |
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Research and development |
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2,008 |
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1,294 |
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5,293 |
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4,119 |
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Depreciation and amortization |
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|
343 |
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268 |
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|
901 |
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|
579 |
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Provision for litigation |
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2,343 |
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— |
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16,220 |
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— |
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Total operating expenses |
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28,383 |
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16,832 |
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85,444 |
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45,685 |
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Operating loss |
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(16,824 |
) |
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(5,415 |
) |
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(53,792 |
) |
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(18,812 |
) |
Other income (expense): |
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Interest expense |
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(11 |
) |
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(18 |
) |
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(43 |
) |
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(1,412 |
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Interest income |
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1,203 |
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2,456 |
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4,428 |
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|
3,118 |
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Other income (expense) |
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|
410 |
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33 |
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|
203 |
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33 |
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Total other income (expense) |
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1,602 |
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2,471 |
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4,588 |
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1,739 |
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Loss before income taxes |
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(15,222 |
) |
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(2,944 |
) |
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(49,204 |
) |
|
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(17,073 |
) |
Income tax
expense (benefit) |
|
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130 |
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|
181 |
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(78 |
) |
|
|
602 |
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Net loss |
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$ |
(15,352 |
) |
|
$ |
(3,125 |
) |
|
$ |
(49,126 |
) |
|
$ |
(17,675 |
) |
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Net loss per weighted average share: |
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Basic |
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$ |
(0.18 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.59 |
) |
|
$ |
(0.35 |
) |
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Diluted |
|
$ |
(0.18 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.59 |
) |
|
$ |
(0.35 |
) |
|
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|
|
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Shares used in per weighted average share calculations: |
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Basic |
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83,022 |
|
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|
82,045 |
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|
82,845 |
|
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|
49,929 |
|
Diluted |
|
|
83,022 |
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|
82,045 |
|
|
|
82,845 |
|
|
|
49,929 |
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
4
LIMELIGHT NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
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For the |
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Nine Months Ended |
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September 30, |
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2008 |
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2007 |
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|
(Unaudited) |
|
Cash flows from operating activities: |
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|
|
|
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Net loss |
|
$ |
(49,126 |
) |
|
$ |
(17,675 |
) |
Adjustments to reconcile net loss to net cash (used in) provided by operating activities: |
|
|
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Depreciation and amortization |
|
|
19,713 |
|
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|
15,889 |
|
Share-based compensation |
|
|
12,549 |
|
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|
15,285 |
|
Deferred income tax (benefit) expense |
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(82 |
) |
|
|
286 |
|
Provision for litigation |
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|
16,220 |
|
|
|
— |
|
Gain on foreign currency exchange |
|
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(18 |
) |
|
|
— |
|
Accounts receivable charges |
|
|
5,289 |
|
|
|
3,536 |
|
Accretion of debt discount |
|
|
— |
|
|
|
424 |
|
Accretion of marketable securities |
|
|
(421 |
) |
|
|
(277 |
) |
Loss on marketable securities |
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|
71 |
|
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|
— |
|
Changes in operating assets and liabilities: |
|
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|
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|
|
|
|
Accounts receivable |
|
|
(15,157 |
) |
|
|
(4,441 |
) |
Prepaid expenses and other current assets |
|
|
(3,948 |
) |
|
|
(2,495 |
) |
Income taxes receivable |
|
|
473 |
|
|
|
(126 |
) |
Other assets |
|
|
784 |
|
|
|
(698 |
) |
Accounts payable |
|
|
(2,359 |
) |
|
|
(5,595 |
) |
Accounts payable, related parties |
|
|
(230 |
) |
|
|
(781 |
) |
Deferred revenue |
|
|
4,326 |
|
|
|
12,094 |
|
Other current liabilities |
|
|
4,733 |
|
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|
8,044 |
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Net cash (used in) provided by operating activities |
|
|
(7,183 |
) |
|
|
23,470 |
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Cash flows from investing activities: |
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Purchase of marketable securities |
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(65,125 |
) |
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(72,001 |
) |
Sale of marketable securities |
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|
95,025 |
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|
7,000 |
|
Purchases of property and equipment |
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(14,536 |
) |
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|
(20,650 |
) |
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|
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Net cash provided by (used in) investing activities |
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|
15,364 |
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|
|
(85,651 |
) |
|
|
|
|
|
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Cash flows from financing activities: |
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|
|
|
|
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Payments on credit facilities |
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|
— |
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|
|
(23,818 |
) |
Borrowings on line of credit |
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|
— |
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|
1,500 |
|
Payments on line of credit |
|
|
— |
|
|
|
(1,500 |
) |
Payments on capital lease obligations |
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— |
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|
(250 |
) |
Escrow funds returned from share repurchase |
|
|
1,070 |
|
|
|
3,418 |
|
Excess tax benefit related to stock option exercises |
|
|
— |
|
|
|
23 |
|
Proceeds from exercise of stock options and warrants |
|
|
191 |
|
|
|
35 |
|
Proceeds from initial public offering, net of issuance costs |
|
|
— |
|
|
|
203,912 |
|
|
|
|
|
|
|
|
Net cash provided by financing activities |
|
|
1,261 |
|
|
|
183,320 |
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash |
|
|
(120 |
) |
|
|
— |
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents |
|
|
9,322 |
|
|
|
121,139 |
|
Cash and cash equivalents at beginning of period |
|
|
113,824 |
|
|
|
7,611 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
123,146 |
|
|
$ |
128,750 |
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
Cash paid for interest |
|
$ |
— |
|
|
$ |
1,020 |
|
|
|
|
|
|
|
|
Cash paid for income taxes |
|
$ |
114 |
|
|
$ |
360 |
|
|
|
|
|
|
|
|
Property and equipment purchases remaining in accounts payable |
|
$ |
1,395 |
|
|
$ |
998 |
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
5
LIMELIGHT NETWORKS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business
Limelight Networks, Inc. (the Company) is a provider of high-performance content delivery
network (CDN) services. The Company delivers content for traditional and emerging media companies,
or content providers, including businesses operating in the television, music, radio, newspaper,
magazine, movie, videogame, software and social media industries as well as enterprises and
government entities doing business online.
2. Summary of Significant Accounting Policies and Use of Estimates
Basis of Presentation
The condensed consolidated financial statements include accounts of the Company and its wholly
owned subsidiaries. All significant intercompany balances and transactions have been eliminated.
The accompanying condensed consolidated financial statements have been prepared in accordance with
U.S. generally accepted accounting principles (GAAP) and pursuant to the rules and regulations of
the Securities and Exchange Commission (SEC). These principles require management to make
estimates, judgments and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses, together with amounts disclosed in the related notes to the condensed
consolidated financial statements. Actual results and outcomes may differ from management’s
estimates, judgments and assumptions. Significant estimates used in these financial statements
include, but are not limited to, revenues, accounts receivable and related reserves, useful lives
and realizability of long-term assets, provision for litigation, income and other taxes and the
fair value of stock-based compensation. Estimates are periodically reviewed in light of changes in
circumstances, facts and experience. The effects of material revisions in estimates are reflected
in the condensed consolidated financial statements prospectively from the date of the change in
estimate. The accompanying interim condensed consolidated balance sheet as of September 30, 2008,
the condensed consolidated statements of operations for the three and nine months ended September
30, 2008 and 2007, and the condensed consolidated statements of cash flows for the nine months
ended September 30, 2008 and 2007, are unaudited. The condensed consolidated balance sheet
information as of December 31, 2007 is derived from the audited consolidated financial statements
which were included in our Annual Report on Form 10-K filed with the SEC on March 25, 2008. The
consolidated financial information contained in this Quarterly Report on Form 10-Q should be read
in conjunction with the audited consolidated financial statements and related notes contained in
the Annual Report on Form 10-K filed on March 25, 2008.
The results of operations presented in this Quarterly Report on Form 10-Q are not necessarily
indicative of the results that may be expected for the year ending December 31, 2008 or for any
future periods. In the opinion of management, these unaudited condensed consolidated financial
statements include all adjustments of a normal recurring nature that are necessary, in the opinion
of management, to present fairly the results of all interim periods reported herein.
As of January 1, 2008 the Company adopted statement No. 157, Fair Value Measurements (SFAS No.
157) for financial instruments. Although the adoption of SFAS No. 157 did not materially impact its
financial condition, results of operations, or cash flow, the Company is now required to provide
additional disclosures as part of its financial statements. See footnote 15 for additional
disclosure regarding SFAS No. 157.
As of January 1, 2008 the Company adopted statement No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities (SFAS No. 159). The adoption of SFAS No. 159 did not
materially impact its financial condition, results of operations, or cash flow.
Revenue Recognition
The Company recognizes service revenues in accordance with the SEC’s Staff Accounting Bulletin
No. 104, Revenue Recognition, and the Financial Accounting Standards Board’s (FASB) Emerging Issues
Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Revenue is recognized
when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service
is performed and collectability of the resulting receivable is reasonably assured.
At the inception of a customer contract for service, the Company makes an assessment as to
that customer’s ability to pay for the services provided. If the Company subsequently determines
that collection from the customer is not reasonably assured, the Company records an allowance for
doubtful accounts and bad debt expense for all of that customer’s unpaid invoices and ceases
recognizing revenue for continued services provided until cash is received.
The Company primarily derives revenue from the sale of content delivery network services to
customers executing contracts having terms of one year or longer. These contracts generally commit
the customer to a minimum monthly level of usage on a calendar month basis and provide the rate at
which the customer must pay for actual usage above the monthly minimum. For these services, the
Company recognizes the monthly minimum as revenue each month provided that an enforceable contract
has been signed
6
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 the Company’s
services exceed the monthly minimum, the Company recognizes revenue for such excess in the period
of the usage. The Company typically charges the customer an installation fee when the services are
first activated. The installation fees are recorded as deferred revenue and recognized as revenue
ratably over the estimated life of the customer arrangement. The Company also derives revenue from
services sold as discrete, non-recurring events or based solely on usage. For these services, the
Company recognizes 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.
The Company has on one occasion entered into a multi-element arrangement. When the Company
enters into such arrangements, each element is accounted for separately over its respective service
period or at the time of delivery, provided that there is objective evidence of fair value for the
separate elements. Objective evidence of fair value includes the price charged for the element when
sold separately. If the fair value of each element cannot be objectively determined, the total
value of the arrangement is recognized ratably over the entire service period to the extent that
all services have begun to be provided, and other revenue recognition criteria has been satisfied.
The multi-element arrangement includes a significant software component. In accounting for
such an arrangement the Company applies the provisions of Statement of Position, 97-2, (SOP 97-2)
Software Revenue Recognition, as amended by SOP 98-9, Modifications of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions. The Company recognizes software license revenue
when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or
determinable and collection of the receivable is probable. If a software license contains 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 are primarily software support and professional services. VSOE of fair value of software
support and professional services is based upon hourly rates or fixed fees charged when those
services are sold separately. If VSOE cannot be established for all elements to be delivered, the
Company defers all amounts received under the arrangement and does not begin to recognize revenue
until the delivery of the last element of the contract has started. Subsequent to commencement of
delivery of the last element, the Company commences revenue recognition. Amounts to be received
under the contract are then included in the amortizable base and then recognized as revenue ratably
over the remaining term of the arrangement until the Company has delivered all elements and has no
additional performance obligations.
The multi-element arrangement provided for consulting services related to the development of a
custom CDN solution, the cross-license of certain technologies, including certain components of the
Company’s CDN software and technology, and post-contract customer support (PCS) for both the custom
CDN solution and the software component (the Multi-Element Arrangement). The agreement also
contains a commitment by the customer to transmit a certain amount of traffic over the Company’s
network during a five-year period from commencement of the agreement or be subject to penalty
payments.
The Company does not have VSOE of fair value to allocate the fee to the separate elements of
the Multi-Element Arrangement as it has not licensed the intellectual property and software
components, nor PCS separately. Accordingly the Company will recognize the revenues related to the
professional services, license and PCS ratably over the four-year period over which the PCS has
been contracted as allowed for by paragraph 12 of SOP 97-2. Because delivery of the license and PCS
elements of this arrangement had not occurred at June 30, 2007, revenue on all services provided to
this customer during the three months ended June 30, 2007, including the ongoing content delivery
services, and the direct incremental costs incurred associated with these revenues, were deferred
until such time as delivery occurs and PCS has commenced. Concurrently with the signing of the
Multi-Element Arrangement, the Company also extended and amended a content delivery contract
entered into originally in 2005. The arrangement for transmitting content is not a required element
of the new software and node development project commencing under the Multi-Element Arrangement.
The Company will continue to receive payments on a usage basis under the content delivery contract.
Given that the services are priced at market rates and subject to regular adjustments and are
cancelable with thirty days’ notice, the amount of revenue and pricing is considered variable and
contingent until services are delivered. As such, the Company has attributed revenue for the
service as one that is contingent and becomes measurable as the services are delivered under the
terms of the content delivery contract. Accordingly, the Company will record revenue on a monthly
basis in an amount based upon usage. Because the content delivery agreement was amended
concurrently with the Multi-Element Arrangement, the Company deferred revenue recognition until
commencement of delivery of the last element of the Multi-Element Arrangement, which was determined
to be July 27, 2007. For the three and nine month periods ended September 30, 2008 the Company
recognized approximately $1.5 million and $3.5 million, respectively, in revenue and approximately
$21,000 and $63,000, respectively, in costs of revenue. During the three and nine month periods
ended September 30, 2007, the Company recognized approximately $2.7 million in revenue and
approximately $0.7 million in costs of revenue. As of September 30, 2008, the Company had remaining
deferred revenue related to the multi-element arrangement of $15.1 million, which is expected to be
recognized ratably over the remaining 29 month contract period and had remaining related deferred
costs of $0.2 million which are amortized over the same period.
The Company also sells 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. The Company
records revenue under these agreements on a net or gross basis depending upon the terms of the
arrangement in accordance with EITF 99-19 Recording Revenue Gross as a Principal Versus Net as an
Agent. The Company typically records revenue gross when it has risk of loss, latitude in
establishing price, credit risk and is the primary obligor in the arrangement.
7
From time to time, the Company enters into contracts to sell services to unrelated companies
at or about the same time the Company enters into contracts to purchase products or services from
the same companies. If the Company concludes that these contracts were negotiated concurrently, the
Company records as revenue only the net cash received from the vendor. For certain non-cash
arrangements whereby the Company provides rack space and bandwidth services to several companies in
exchange for advertising the Company records barter revenue and expense if the services are
objectively measurable. The various types of advertising include radio, website, print and signage.
The Company recorded barter revenue and expense of approximately $138,000, and $196,000, for the
three month period ended September 30, 2008 and 2007, and approximately $435,000 and $648,000 for
the nine month period ended September 30, 2008 and 2007, respectively.
The Company may from time to time resell licenses or services of third parties. Revenue for
these transactions is recorded when the Company has risk of loss related to the amounts purchased
from the third party and the Company adds value to the license or service, such as by providing
maintenance or support for such license or service. If these conditions are present, the Company
recognizes revenue when all other revenue recognition criteria are satisfied.
Cash and Cash Equivalents
The Company holds its cash and cash equivalents in checking, money market, and investment
accounts with a minimum credit rating of at least A1/P1. The Company considers all highly liquid
investments with maturities of three months or less when purchased to be cash equivalents.
Investments in Marketable Securities
The Company accounts for its investments in debt and equity securities under FASB’s Statement
of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and
Equity Securities and FASB Staff Position, or FSP, SFAS No. 115-1, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments. Management determines
the appropriate classification of such securities at the time of purchase and reevaluates such
classification as of each balance sheet date. Realized gains and losses and declines in value
judged to be other than temporary are determined based on the specific identification method and is
reported in the statements of operations.
The Company has classified its investments in equity and debt securities as
available-for-sale. Available-for-sale investments are initially recorded at cost with temporary
changes in fair value periodically adjusted through comprehensive income. The Company periodically
reviews its investments for other-than-temporary declines in fair value based on the specific
identification method and writes down investments to their fair value when an other-than-temporary
decline has occurred.
The following is a summary of available-for-sale securities at September 30, 2008 (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
| |
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
| |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Government agency notes and bonds |
|
$ |
32,141 |
|
|
$ |
20 |
|
|
$ |
(47 |
) |
|
$ |
32,114 |
|
Commercial paper |
|
|
4,253 |
|
|
|
— |
|
|
|
(3 |
) |
|
|
4,250 |
|
Corporate notes and bonds |
|
|
17,204 |
|
|
|
32 |
|
|
|
(91 |
) |
|
|
17,145 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale debt securities |
|
|
53,598 |
|
|
|
52 |
|
|
|
(141 |
) |
|
|
53,509 |
|
Publicly traded common stock |
|
|
16 |
|
|
|
— |
|
|
|
— |
|
|
|
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities |
|
$ |
53,614 |
|
|
$ |
52 |
|
|
$ |
(141 |
) |
|
$ |
53,525 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At September 30, 2008, the Company evaluated its investment portfolio, and noted unrealized
losses of $141,000 were due to market movements and fluctuations in interest rates. Management does
not believe any of the unrealized losses represented an other-than-temporary impairment based on
its evaluation of available evidence as of September 30, 2008. The Company’s intent is to hold
these investments to such time as these assets are no longer impaired.
Expected maturities can differ from contractual maturities because the issuers of the
securities may have the right to prepay obligations without prepayment penalties, and the Company
views its available-for-sale securities as available for current operations.
At September 30, 2008, the Company evaluated its investment portfolio in publicly traded
common stock to determine if there had been decline in market value that was considered to be
other-than-temporary. For the three months and nine months ended September 30, 2008, the Company
concluded that $0, and $71,000, respectively, of the decline associated with a publicly traded
common stock was other than temporary and recorded an impairment charge in interest income.
8
The amortized cost and estimated fair value of the available-for-sale debt securities at
September 30, 2008, by maturity, are shown below (in thousands).
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
| |
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
| |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Available-for-sale debt securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in one year or less |
|
$ |
36,492 |
|
|
$ |
12 |
|
|
$ |
(72 |
) |
|
$ |
36,432 |
|
Due after one year and less than two years |
|
|
17,106 |
|
|
|
40 |
|
|
|
(69 |
) |
|
|
17,077 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
53,598 |
|
|
$ |
52 |
|
|
$ |
(141 |
) |
|
$ |
53,509 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following is a summary of available-for-sale securities at December 31, 2007 (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
| |
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
| |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Government agency bonds |
|
$ |
19,764 |
|
|
$ |
68 |
|
|
$ |
(3 |
) |
|
$ |
19,829 |
|
Commercial paper |
|
|
43,916 |
|
|
|
3 |
|
|
|
(10 |
) |
|
|
43,909 |
|
Corporate notes and bonds |
|
|
19,397 |
|
|
|
141 |
|
|
|
(3 |
) |
|
|
19,535 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale debt securities |
|
|
83,077 |
|
|
|
212 |
|
|
|
(16 |
) |
|
|
83,273 |
|
Publicly traded common stock |
|
|
87 |
|
|
|
— |
|
|
|
— |
|
|
|
87 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total available-for-sale securities |
|
$ |
83,164 |
|
|
$ |
212 |
|
|
$ |
(16 |
) |
|
$ |
83,360 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amortized cost and estimated fair value of the available-for-sale debt securities at
December 31, 2007, by maturity, are shown below (in thousands).
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
| |
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
| |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
Available-for-sale debt securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due in one year or less |
|
$ |
64,092 |
|
|
$ |
16 |
|
|
$ |
(16 |
) |
|
$ |
64,092 |
|
Due after one year and less than two years |
|
|
18,985 |
|
|
|
196 |
|
|
|
— |
|
|
|
19,181 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
83,077 |
|
|
$ |
212 |
|
|
$ |
(16 |
) |
|
$ |
83,273 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recently Issued Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS No.
141(R)). SFAS No. 141(R) replaces SFAS No. 141 and, although it retains certain requirements of
that guidance, it is broader in scope. SFAS No. 141(R) establishes principles and requirements in
the recognition and measurement of the assets acquired, the liabilities assumed and any
non-controlling interests related to a business combination. Among other requirements, direct
acquisition costs and acquisition-related restructuring costs must be accounted for separately from
the business combination. In addition, SFAS No. 141(R) provides guidance in accounting for step
acquisitions, contingent liabilities, goodwill, contingent consideration, and other aspects of
business combinations. SFAS No. 141(R) applies prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting period beginning on or
after December 15, 2008. Accordingly, the Company will adopt SFAS No. 141(R) on January 1, 2009 and
will apply its provisions prospectively. The Company does not believe the adoption of this standard
will have a material impact on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements, an amendment of ARB No. 51 (SFAS No. 160). SFAS No. 160 requires that
ownership interests in subsidiaries held by parties other than the parent be presented separately
within equity in the consolidated balance sheet. SFAS No. 160 also requires that the consolidated
net income attributable to the parent and to the noncontrolling interests be identified and
displayed on the face of the consolidated income statement. Changes in ownership interests,
deconsolidation and additional disclosures regarding noncontrolling interests are also addressed in
the new guidance. SFAS No. 160 is effective for fiscal years, and interim periods within those
fiscal years, beginning on or after December 15, 2008. Accordingly, the Company will adopt SFAS No.
160 on January 1, 2009. As of September 30, 2008, the Company had no noncontrolling interests
recorded in its balance sheet. The Company does not believe the adoption of SFAS No. 160 will have
a material impact on its financial position or results of operations.
9
In February 2008, the FASB issued FASB Staff Position (FSP) No. 157-2 (FSP 157-2). FSP 157-2
delays the effective date of SFAS 157 for non-financial assets and non-financial liabilities,
except those that are recognized or disclosed at fair value in the financial statements on a
recurring basis, to fiscal years beginning after November 15, 2008, and interim periods within
those fiscal years. In February 2008, the FASB also issued FSP No. 157-1 that would exclude leasing
transactions accounted for under SFAS No. 13, Accounting for Leases, and its related interpretive
accounting pronouncements. The Company does not expect the SFAS 157 staff position guidance to have
a material impact on its consolidated financial statements.
In October 2008, the FASB issued Staff Position No. FAS 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active (FSP 157-3) which clarifies the
application of SFAS 157 in an inactive market and illustrates how an entity would determine fair
value when the market for a financial asset is not active. FSP 157-3 is effective immediately and
applies to prior periods for which financial statements have not been issued, including interim or
annual periods ending on or before September 30, 2008. The Company does not expect the
implementation of FAS 157-3 to have a material impact on its consolidated financial statements.
In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and
Hedging Activities—an amendment of FASB Statement No. 133 (SFAS No. 161). SFAS No. 161 requires
entities that utilize derivative instruments to provide qualitative disclosures about their
objectives and strategies for using such instruments, as well as any details of credit-risk-related
contingent features contained within derivatives. SFAS No. 161 also requires entities to disclose
additional information about the amounts and location of derivatives located within the financial
statements, how the provisions of SFAS No. 133 has been applied, and the impact that hedges have on
an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective
for fiscal years and interim periods beginning after November 15, 2008, with early application
encouraged. The Company currently does not utilize any derivative instruments and/or hedging
activities. Since the Company does not have any derivative instruments and/or hedging activities,
the Company does not believe that the adoption of this statement will have a material effect on its
financial position or results of operations.
In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting
Principles. SFAS No. 162 supersedes the existing hierarchy contained in the U.S. auditing
standards. The existing hierarchy was carried over to SFAS No. 162 essentially unchanged. SFAS No.
162 becomes effective 60 days following the SEC’s approval of the Public Company Accounting
Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles. The Company does not expect the adoption of SFAS No. 162
to have a material effect on its consolidated financial statements.
In June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities. This FSP clarifies that invested
share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents,
whether paid or unpaid, are participating securities and requires such awards be included in the
computation of earnings per share (EPS) pursuant to the two-class method. This FSP is effective
for financial statements issued for fiscal years beginning after December 15, 2008, and interim
periods within those years. This FSP requires all prior-period EPS data presented to be adjusted
retrospectively and early application is not permitted. The Company awarded restricted stock and
restricted stock units which included non-forfeitable dividend rights. The Company does not expect
the adoption of FSP No. EITF 03-6-1 to have a material impact on its consolidated financial
statements.
3. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets include (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
As of |
|
|
As of |
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2008 |
|
|
2007 |
|
Prepaid bandwidth services |
|
$ |
3,592 |
|
|
$ |
— |
|
Non-income taxes receivable |
|
|
2,680 |
|
|
|
2,109 |
|
Interest receivable |
|
|
587 |
|
|
|
506 |
|
Employee advances and prepaid recoverable commissions |
|
|
352 |
|
|
|
118 |
|
Prepaid royalties and licenses |
|
|
— |
|
|
|
525 |
|
Other |
|
|
2,051 |
|
|
|
1,211 |
|
|
|
|
|
|
|
|
Total prepaid expenses and other current assets |
|
$ |
9,262 |
|
|
$ |
4,469 |
|
|
|
|
|
|
|
|
10
4. Property and Equipment
Property and equipment include (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
As of |
|
|
As of |
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2008 |
|
|
2007 |
|
Network equipment |
|
$ |
92,365 |
|
|
$ |
79,770 |
|
Computer equipment |
|
|
2,588 |
|
|
|
1,573 |
|
Furniture and fixtures |
|
|
675 |
|
|
|
291 |
|
Leasehold improvements |
|
|
2,126 |
|
|
|
1,411 |
|
Other equipment |
|
|
410 |
|
|
|
207 |
|
|
|
|
|
|
|
|
|
|
|
98,164 |
|
|
|
83,252 |
|
Less: accumulated depreciation |
|
|
(55,809 |
) |
|
|
(36,284 |
) |
|
|
|
|
|
|
|
|
|
$ |
42,355 |
|
|
$ |
46,968 |
|
|
|
|
|
|
|
|
5. Other Current Liabilities
Other current liabilities consist of the following (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
As of |
|
|
As of |
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2008 |
|
|
2007 |
|
Accrued cost of revenue |
|
$ |
3,603 |
|
|
$ |
3,007 |
|
Accrued compensation and benefits |
|
|
2,196 |
|
|
|
1,900 |
|
Accrued legal fees |
|
|
4,665 |
|
|
|
137 |
|
Non income taxes payable |
|
|
1,167 |
|
|
|
3,161 |
|
Other accrued expenses |
|
|
2,412 |
|
|
|
1,107 |
|
|
|
|
|
|
|
|
Total other current liabilities |
|
$ |
14,043 |
|
|
$ |
9,312 |
|
|
|
|
|
|
|
|
6. Litigation
In June 2006, Akamai Technologies, Inc., or Akamai, and the Massachusetts Institute of
Technology, or MIT, filed a lawsuit against the Company in the U.S. District Court for the District
of Massachusetts alleging that the Company was infringing two patents assigned to MIT and
exclusively licensed by MIT to Akamai, U.S. Patent No. 6,553,413 (the 413 patent) and U.S. Patent
No. 6,108,703 (the 703 patent). In September 2006, Akamai and MIT expanded their claims to assert
infringement of a third, recently issued patent, U.S. Patent No. 7,103,645 (the 645 patent). In
February 2008, a jury returned a verdict in this lawsuit, finding that the Company infringed four
claims of the ‘703 patent at issue and rejecting the Company’s invalidity defenses for the period
April 2005 through December 31, 2007. The jury awarded an aggregate of approximately $45.5 million
which includes lost profits, reasonable royalties and price erosion damages. In addition, the jury
awarded pre-judgment interest which the Company estimates to be $2.6 million at December 31, 2007.
The Company has recorded the aggregate $48.1 million as a provision for litigation as of December
31, 2007. A key determinant in our ability to estimate possible future charges is the extent to
which we are able to determine a correlation between the jury awarded amount to the various
elements of the allegations. For the three and nine month periods ended September 30, 2008, the
Company estimated its revenue from alleged infringing methods totaled approximately 11% and 34% of
its total revenue. The Company recorded a potential additional damage liability totaling $1.6
million and $14.8 million, respectively, plus additional interest of $0.7 million and $1.4 million,
respectively, for the three and nine month periods ended September 30, 2008. The total provision
for litigation at September 30, 2008 was $64.4 million.
While the Company will continue to pursue multiple legal recourses available to it which could
reduce or even possibly eliminate the related financial exposure in the jury verdict, if the
Company is not able to prevail in its efforts, there could be additional charges recorded by the
Company in future periods. Akamai is also seeking a permanent injunction to enjoin the Company from
further infringement of the ‘703 patent. Such charges would be dependent in part upon judicial
determinations made on the various elements of the matter and the activities of the Company in
future periods. The Company, during its financial statement close process, will evaluate if
additional accrual amounts are required at each reporting period. The Company would record
additional accrual amounts to the extent the Company determines amounts are probable of being paid
and are also reasonably estimable. Such amounts could be, but are not limited to, damages
associated with post-judgment lost profits, price erosion, and royalties as well as interest
related to pre-and-post-judgment amounts.
In December 2007, Level 3 Communications, LLC, or Level 3, filed a lawsuit against the Company
in the U.S. District Court for the Eastern District of Virginia alleging that the Company is
infringing three patents Level 3 allegedly acquired from Savvis Communications Corp. In addition to
monetary relief, including treble damages, interest, fees and costs, the complaint seeks an order
permanently enjoining the Company from conducting its business in a manner that infringes the
relevant patents. The parties recently
11
participated in a claim construction hearing before the Court. The Court has not yet ruled on the
claim construction issues. Discovery is ongoing and the Court has set a trial date for January
2009. While the Company believes that the claims of infringement asserted against it by Level 3 in
the present litigation are without merit and intends to vigorously defend the action, there can be
no assurance that this lawsuit ultimately will be resolved in the Company’s favor. An adverse
ruling could seriously impact the Company’s ability to conduct its business and to offer its
products and services to its customers. This, in turn, would harm the Company’s revenue, market
share, reputation, liquidity and overall financial position. The Company is not able at this time
to estimate the range of potential loss nor does it believe that a loss is probable. Therefore,
there is no provision for this lawsuit in the Company’s financial statements.
In August 2007, the Company, certain of its officers and current and former directors, and the
firms that served as the lead underwriters in the Company’s initial public offering were named as
defendants in several purported class action lawsuits filed in the U. S. District Courts for the
District of Arizona and the Southern District of New York. All of the New York cases were
transferred to Arizona and consolidated into a single action. The plaintiffs’ consolidated
complaint asserted causes of action under Sections 11, 12, and 15 of the Securities Act of 1933, as
amended, on behalf of a purported class of individuals who purchased the Company’s common stock in
its initial public offering and/or pursuant to its Prospectus. The complaint alleges, among other
things, that the Company omitted and/or misstated certain facts concerning the seasonality of its
business and the loss of revenue related to certain customers. On March 17, 2008, the Company and
the individual defendants moved to dismiss all of the plaintiffs’ claims and a hearing was held on
June 16, 2008. On August 8, 2008, the court granted the motion to dismiss, dismissing plaintiffs’
claims under Section 12 with prejudice and granting leave to amend the claims under Sections 11 and
15. Plaintiffs chose not to amend the claims under Sections 11 and 15, and on August 29, 2008 the
court entered judgment in favor of the Company. On September 5, 2008, Plaintiffs filed a notice of
appeal. Although the Company believes that it and the individual defendants have meritorious
defenses to the plaintiffs’ claims and intends to contest the lawsuits vigorously, an adverse
resolution of the lawsuits may have a material adverse effect on the Company’s financial position
and results of operations in the period in which the lawsuits are resolved. The Company is not able
at this time to estimate the range of potential loss nor does it believe that a loss is probable.
Therefore, there is no provision for these lawsuits in the Company’s financial statements.
In April 2008, Two-Way Media LLC (TWM) filed a lawsuit against the Company and other
defendants, including Akamai, AT&T Corp., SBC Internet Services and Southwestern Bell Telephone
Company, in the U.S. District Court for the Southern District of Texas, Corpus Christi Division.
TWM alleged the Company infringed four patents owned by TWM. TWM sought both monetary and
injunctive relief against the Company. In September 2008, the Company entered into a settlement
agreement with TWM. As part of the settlement agreement, TWM agreed to dismiss the lawsuit, and the
Company acquired a non-exclusive license under the TWM patents.
7. Net Income (Loss) Per Share
The Company follows EITF Issue No. 03-6, Participating Securities and the Two-Class Method
under FASB Statement 128, which established standards regarding the computation of earnings per
share (EPS) by companies that have issued securities other than common stock that contractually
entitle the holder to participate in dividends and earnings of the company. EITF Issue No. 03-6
requires earnings available to common stockholders for the period, after deduction of preferred
stock dividends, to be allocated between the common and preferred shareholders based on their
respective rights to receive dividends. Basic net loss per share is then calculated by dividing
income allocable to common stockholders (including the reduction for any undeclared, preferred
stock dividends assuming current income for the period had been distributed) by the
weighted-average number of common shares outstanding, net of shares subject to repurchase by the
Company, during the period. EITF Issue No. 03-6 does not require the presentation of basic and
diluted net loss per share for securities other than common stock; therefore, the following net
loss per share amounts only pertain to the Company’s common stock. The Company calculates diluted
net loss per share under the if-converted method unless the conversion of the preferred stock is
anti-dilutive to basic net loss per share. To the extent preferred stock is anti-dilutive, the
Company calculates diluted net loss per share under the two-class method. Potential common shares
include restricted common stock and incremental shares of common stock issuable upon the exercise
of stock options and warrants using the treasury stock method.
12
The following table sets forth the components used in the computation of basic and diluted net
loss per share for the periods indicated (in thousands, except per share data):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
|
For the |
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(15,352 |
) |
|
$ |
(3,125 |
) |
|
$ |
(49,126 |
) |
|
$ |
(17,675 |
) |
Preferred dividend rights |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss allocable to common stockholders |
|
$ |
(15,352 |
) |
|
$ |
(3,125 |
) |
|
$ |
(49,126 |
) |
|
$ |
(17,675 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares |
|
|
83,022 |
|
|
|
82,045 |
|
|
|
82,845 |
|
|
|
49,929 |
|
Less: Weighted-average unvested common
shares subject to repurchase |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic net loss per share |
|
|
83,022 |
|
|
|
82,045 |
|
|
|
82,845 |
|
|
|
49,929 |
|
Dilutive effect of stock options and shares
subject to repurchase |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Dilutive effect of outstanding stock warrants |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted net loss per share |
|
|
83,022 |
|
|
|
82,045 |
|
|
|
82,845 |
|
|
|
49,929 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net loss per share |
|
$ |
(0.18 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.59 |
) |
|
$ |
(0.35 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net loss per share |
|
$ |
(0.18 |
) |
|
$ |
(0.04 |
) |
|
$ |
(0.59 |
) |
|
$ |
(0.35 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The following outstanding options, common stock subject to repurchase and common stock
warrants were excluded from the computation of diluted net loss per common share for the periods
presented because including them would have had an antidilutive effect:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
For the |
| |
|
Three Months Ended |
|
Nine Months Ended |
| |
|
September 30, |
|
September 30, |
| |
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Options to purchase
common stock and
stock subject to
repurchase |
|
|
2,105 |
|
|
|
8,700 |
|
|
|
2,198 |
|
|
|
8,700 |
|
8. Comprehensive Income (Loss)
The following table presents the calculation of comprehensive income (loss) and its components (in
thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
|
For the |
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Net loss |
|
$ |
(15,352 |
) |
|
$ |
(3,125 |
) |
|
$ |
(49,126 |
) |
|
$ |
(17,675 |
) |
Other comprehensive (loss) income, net of tax: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
(loss) gain on investments |
|
|
(127 |
) |
|
|
8 |
|
|
|
(271 |
) |
|
|
(109 |
) |
Foreign exchange translation |
|
|
(253 |
) |
|
|
— |
|
|
|
(138 |
) |
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive (loss) income |
|
|
(380 |
) |
|
|
8 |
|
|
|
(409 |
) |
|
|
(109 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(15,732 |
) |
|
$ |
(3,117 |
) |
|
$ |
(49,535 |
) |
|
$ |
(17,784 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
For the periods presented, accumulated other comprehensive income consisted of (in thousands):
| |
|
|
|
|
|
|
|
|
| |
|
As of |
|
|
As of |
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2008 |
|
|
2007 |
|
Net unrealized gain (loss) on investments |
|
$ |
(162 |
) |
|
$ |
110 |
|
Foreign currency translation |
|
|
(142 |
) |
|
|
(4 |
) |
|
|
|
|
|
|
|
Total accumulated other comprehensive (loss) income |
|
$ |
(304 |
) |
|
$ |
106 |
|
|
|
|
|
|
|
|
13
9. Stockholders’ Equity
Initial Public Offering (IPO)
On June 8, 2007, the Company completed an initial public offering of its common stock in which
the Company sold and issued 14,900,000 shares of its common stock and selling stockholders sold
3,500,000 shares of the Company’s common stock, in each case at a price to the public of $15.00 per
share. The common shares began trading on the NASDAQ Global Market on June 8, 2007. The Company
raised a total of $223.5 million in gross proceeds from the IPO, or approximately $203.9 million in
net proceeds after deducting underwriting discounts and commissions of approximately $15.6 million
and other offering costs of approximately $4.0 million.
Stock Split
On May 14, 2007, the Company effected a 3-for-2 forward stock split of its outstanding capital
stock. All share and per-share data have been restated to reflect this stock split.
Conversion of Preferred Stock
On June 14, 2007, upon the closing of the Company’s IPO, all outstanding shares of the
Company’s Series A and Series B Convertible Preferred Stock automatically converted into 44,940,261
shares of common stock on a 1-for-1 share basis.
10. Share-Based Compensation
The following table summarizes the components of share-based compensation expense included in
the Company’s condensed consolidated statement of operations for the three and nine month periods
ended September 30, 2008 and 2007 in accordance with SFAS No. 123R (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
|
For the |
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Share-based compensation expense by type of award: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options |
|
$ |
2,027 |
|
|
$ |
3,181 |
|
|
$ |
8,290 |
|
|
$ |
12,844 |
|
Restricted stock |
|
|
2,278 |
|
|
|
774 |
|
|
|
4,259 |
|
|
|
2,441 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total share-based compensation expense |
|
$ |
4,305 |
|
|
$ |
3,955 |
|
|
$ |
12,549 |
|
|
$ |
15,285 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of share-based compensation expense on
operations by line: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services |
|
$ |
594 |
|
|
$ |
422 |
|
|
$ |
1,658 |
|
|
$ |
1,010 |
|
General and administrative expense |
|
|
1,669 |
|
|
|
1,702 |
|
|
|
5,031 |
|
|
|
9,199 |
|
Sales and marketing expense |
|
|
1,400 |
|
|
|
1,289 |
|
|
|
4,137 |
|
|
|
2,676 |
|
Research and development expense |
|
|
642 |
|
|
|
542 |
|
|
|
1,723 |
|
|
|
2,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost related to share-based compensation expense |
|
$ |
4,305 |
|
|
$ |
3,955 |
|
|
$ |
12,549 |
|
|
$ |
15,285 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective May 15, 2008 the Company initiated a Stock Option/Restricted Stock Unit Exchange
Offer (the Offer). Pursuant to the Offer, employees (other than executive officers) had the
opportunity to exchange certain stock options issued by the Company after April 1, 2007 for
restricted stock units (RSUs). The exchange ratio was one RSU in exchange for two stock options.
The RSUs vest one-sixth on December 1, 2008 and one-sixth each six months thereafter such that all
RSUs issued pursuant to the Offer will be vested no later than June 1, 2011. The Offer was carried
out in accordance with tender offer documents filed with the SEC on May 15, 2008. The Offer expired
June 16, 2008. 2,002,100 eligible stock options were tendered by eligible employees and 1,001,051
RSUs were issued in exchange pursuant to the Offer. The Company determined this was a Type I
(probable-to-probable) modification under SFAS No. 123(R) for substantially all of the tendered
options. Accordingly, the Company measured the incremental fair value of the RSUs issued over that
of the options tendered and recorded $29,000 of additional unrecognized share-based compensation
related to the Offer. This additional unrecognized share-based compensation, as well as
unrecognized share-based compensation related to the options tendered in the Offer, will be
recognized over the vesting period of the RSUs using the straight-line method over the vesting
period. The Offer also included the exchange of performance-base stock options for one employee.
At the time of the Offer, the Company determined the original award was not probable of being
earned, and had not recorded any share-based compensation expense. As such, the exchange of this
performance-based option for RSUs is considered to be a Type III (improbable to probable)
modification under SFAS No. 123(R). The Company measured the fair value of the RSUs issued in the
Offer, and will recognize the expense using the straight-line method over the vesting period.
11. Related Party Transactions
The Company leases office space from a company owned by one of the Company’s executives. Rent
expense for the lease, including reimbursement for telecommunication lines, was approximately
$3,000 and $9,000, respectively, for each of the three and nine month periods ended September 30,
2008 and 2007.
The Company sells services to several entities owned, in whole or in part, by several Company
executives. Revenue derived from related parties was less than 1% for each of the three and nine
month periods ended September 30, 2008 and 2007, respectively. Management believes that all of the
Company’s related party transactions reflected arm’s length terms.
14
12. Concentrations
For
the three and nine month periods ended September 30, 2008 and
2007, the Company had one major
customer for which revenue exceeded 10% of total revenue.
Revenue from non-U.S. sources aggregated approximately $5.5 million and $3.4 million
respectively, for the three month period
ended September 30, 2008 and 2007, respectively. Revenue from non-U.S. sources aggregated
approximately $14.6 million and $9.6 million, respectively, for the nine month period ended
September 30, 2008 and 2007, respectively.
13. Income taxes
We utilize the asset and liability method of accounting for income taxes as set forth in SFAS
No. 109, Accounting for Income taxes, or SFAS 109. Under the asset and liability method, deferred
taxes are determined based on the temporary differences between the financial statement and tax
basis of assets and liabilities using tax rates expected to be in effect during the years in which
the basis differences reverse. A valuation allowance is recorded when it is more likely than not
that some of the deferred tax assets will not be realized.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with
FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a two-step process to
determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to
determine the likelihood that it will be sustained upon external examination. If the tax position
is deemed more-likely-than-not to be sustained, the tax position is then assessed to determine the
amount of benefit to recognize in the financial statements. The amount of the benefit that may be
recognized is the largest amount that has a greater than fifty percent likelihood of being realized
upon ultimate settlement.
As of September 30, 2008, the Company has a total of approximately $604,000 for unrecognized
tax benefits which did not materially change during the first, second and third quarters of 2008.
This total of unrecognized tax benefits, if recognized, would favorably affect the effective income
tax rate. The Company anticipates its unrecognized tax benefits will decrease within twelve months
of the reporting date, as a result of settling potential tax liabilities in certain foreign and
state jurisdictions.
The Company recognizes interest and penalties related to unrecognized tax benefits in its tax
provision. As of September 30, 2008, the Company has recorded a liability of $194,000 for the
payment of interest and penalties, of which $12,000 was recorded in the third quarter.
During the nine months ended September 30, 2008, the Company performed its assessment of the
recoverability of deferred tax assets and determined there was sufficient negative evidence as a
result of the Company’s cumulative losses to conclude that is was more likely than not that the
Company’s deferred tax assets would not be realized and accordingly maintained a full valuation
allowance. The Company recorded an income tax expense related to reconciling its income tax
receivable associated with filing 2007 income tax returns during the period ended September 30,
2008. In calculating its effective income tax rate for 2008, no benefit is provided for temporary
differences that increase deferred tax assets relating to stock-based compensation.
The Company conducts business in various jurisdictions in the United States and in foreign
countries and is subject to examination by tax authorities. As of September 30, 2008, the Company
received notification of IRS exam for the 2006 tax year. The tax years 2003 through 2006 remain
open to examination by U.S. and certain state and foreign taxing jurisdictions.
14. Segment Reporting
The Company operates in one industry segment—content delivery network services. The Company
operates in three geographic areas— the United States, Europe and Asia Pacific.
SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes
standards for reporting information about operating segments. Operating segments are defined as
components of an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker, or decision making group, in deciding
how to allocate resources and in assessing performance. The Company’s chief operating decision
maker is its Chief Executive Officer. The Company’s Chief Executive Officer reviews financial
information presented on a consolidated basis for purposes of allocating resources and evaluating
financial performance. The Company has one business activity and there are no segment managers who
are held accountable for operations, operating results and plans for products or components below
the consolidated unit level. Accordingly, the Company reports as a single operating segment.
15
Revenue by geography is based on the location of the customer from which the revenue is
earned. The following table sets forth revenue and long-lived assets by geographic area (in
thousands).
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
|
For the |
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Domestic Revenue |
|
$ |
27,661 |
|
|
$ |
25,813 |
|
|
$ |
79,041 |
|
|
$ |
64,391 |
|
International Revenue |
|
|
5,455 |
|
|
|
3,377 |
|
|
|
14,591 |
|
|
|
9,588 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue |
|
$ |
33,116 |
|
|
$ |
29,190 |
|
|
$ |
93,632 |
|
|
$ |
73,979 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table sets forth long-lived assets by geographic area (in thousands).
| |
|
|
|
|
|
|
|
|
| |
|
As of |
|
|
As of |
|
| |
|
September 30, |
|
|
December 31, |
|
| |
|
2008 |
|
|
2007 |
|
Domestic long-lived assets |
|
$ |
30,435 |
|
|
$ |
33,490 |
|
International long-lived assets |
|
|
11,920 |
|
|
|
13,478 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total long-lived assets |
|
$ |
42,355 |
|
|
$ |
46,968 |
|
|
|
|
|
|
|
|
15. Fair Value Measurements
In September 2006, the FASB issued statement No. 157, Fair Value Measurements (SFAS No. 157).
SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance
with accounting principles generally accepted in the United States, and expands disclosures about
fair value measurements. The Company has adopted the provisions of SFAS No. 157 as of January 1,
2008, for financial instruments. Although the adoption of SFAS No. 157 did not materially impact
its financial condition, results of operations, or cash flow, the Company is now required to
provide additional disclosures as part of its financial statements.
SFAS No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used
in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted
prices in active markets; Level 2, defined as inputs other than quoted prices in active markets
that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in
which little or no market data exists, therefore requiring an entity to develop its own
assumptions.
As of September 30, 2008, the Company held certain assets that are required to be measured at
fair value on a recurring basis. These include commercial paper, corporate notes and bonds, and US
Government Agency Bonds which are classified as marketable securities on the Company’s condensed
consolidated balance sheet. All of these investments are publicly traded and for which market
prices are readily available.
The Company’s assets measured at fair value on a recurring basis subject to the disclosure
requirements of SFAS 157 at September 30, 2008, were as follows (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Fair Value Measurements at Reporting Date Using |
|
| |
|
|
|
|
|
Quoted |
|
|
|
|
|
|
|
| |
|
|
|
|
|
Prices |
|
|
|
|
|
|
|
| |
|
|
|
|
|
In Active |
|
|
Significant |
|
|
|
|
| |
|
|
|
|
|
Markets for |
|
|
Other |
|
|
Significant |
|
| |
|
|
|
|
|
Identical |
|
|
Observable |
|
|
Unobservable |
|
| |
|
|
|
|
|
Assets |
|
|
Inputs |
|
|
Inputs |
|
| Description |
|
Total |
|
|
(Level 1) |
|
|
(Level 2) |
|
|
(Level 3) |
|
Government agency bonds |
|
$ |
32,114 |
|
|
$ |
32,114 |
|
|
$ |
— |
|
|
$ |
— |
|
Commercial paper |
|
|
4,250 |
|
|
|
— |
|
|
|
4,250 |
|
|
|
— |
|
Corporate notes and bonds |
|
|
17,145 |
|
|
|
17,145 |
|
|
|
— |
|
|
|
— |
|
Publicly traded common stock |
|
|
16 |
|
|
|
16 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets measured at fair value |
|
$ |
53,525 |
|
|
$ |
49,275 |
|
|
$ |
4,250 |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
For the period ended September 30, 2008, realized gains and losses for marketable securities
are reported in interest income, unrealized gains and losses for marketable securities are included
in other comprehensive income and expense.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations
should be read in conjunction with the condensed consolidated financial statements and the related
notes thereto included elsewhere in this quarterly report on Form 10-Q and the audited consolidated
financial statements and notes thereto and management’s discussion and analysis of financial
condition and results of operations for the year ended December 31, 2007 included in our annual
report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 25, 2008.
This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include
statements as to industry trends and future expectations of ours and other matters that do not
relate strictly to historical facts. These statements are often identified by the use of words such
as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” or “continue,”
and similar expressions or variations. These statements are based on the beliefs and assumptions of
our management based on information currently available to management. Such forward-looking
statements are subject to risks, uncertainties and other factors that could cause actual results
and the timing of certain events to differ materially from future results expressed or implied by
such forward-looking statements. Factors that could cause or contribute to such differences
include, but are not limited to, those identified below, and those discussed in the section titled
“Risk Factors” set forth in Part II, Item 1A of this quarterly report on Form 10-Q and in our other
SEC filings. We undertake no obligation to update any forward-looking statements to reflect events
or circumstances after the date of such statements.
Overview
We were founded in 2001 as a provider of content delivery network, or CDN, services to deliver
digital content over the Internet. We began development of our infrastructure in 2001 and began
generating meaningful revenue in 2002. As of September 30, 2008, we had over 1,300 active customers
worldwide. 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. Recently 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 revenue is important to our financial success. Accordingly, to be successful, we must
maintain our base of recurring revenue contracts by eliminating or reducing any customer
cancellations or terminations and build on that base by adding new customers and increasing the
number of services, features and functionalities our existing customers purchase.
We primarily derive revenue from the sale of CDN and related services to our customers. These
services include delivery of digital media, including video, music, games, software and social
media as well as associated services such as storage, data center, transit and consulting services.
We primarily generate revenue by charging customers on a per-gigabyte basis or on a variable basis
based on peak delivery rate for a fixed period of time, as our
services are used. During 2007, we
entered into a multi-element arrangement which generates revenue by providing consulting services
related to the development of a Custom CDN solution, through the cross-license of certain
technologies, including certain components of our CDN software and technology, and post-contract
customer support (PCS) for both the custom CDN-solution and the software component. We also derive
some business from the sale of custom CDN services. These are generally limited to
modifying our network to accommodate non-standard content player software or to establish dedicated
customer network components that reside both within our network or that operate within our
customers’ network.
In February 2008, a jury returned a verdict in a patent infringement lawsuit filed by Akamai
Technologies, Inc., or Akamai, and the Massachusetts Institute of Technology, or MIT, against us,
finding that we infringed four claims of the “703” patent and rejecting our invalidity defenses.
The jury awarded Akamai an aggregate of approximately $45.5 million in lost profits, reasonable
royalties and price erosion damages, plus pre-judgment interest estimated to be $2.6 million that
we recorded in 2007. An additional provision of approximately $2.3 million and $16.2 million for
potential additional infringement damages and interest was recorded during the three and nine month
periods ended September 30, 2008. On July 1, 2008, the Court denied our Motions for Judgment as a
Matter of Law, Obviousness, and a New Trial. The Court also denied Akamai’s Motion for Permanent
Injunction as premature and its Motions for Summary Judgment regarding our equitable defenses. The
court has scheduled a hearing for November 12, 2008 to hear arguments regarding our equitable
defenses and our motion for reconsideration of our motion for judgment as a matter of law. A final
judgment has not yet been entered. We continue to believe that the claims of infringement
asserted against us by Akamai and MIT in the present litigation are without merit and that the
jury’s verdict is incorrect, and we will continue to defend the case vigorously; however, we cannot
assure you that this lawsuit ultimately will be resolved in our favor. An adverse judgment or
injunction 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 CDN to
deliver certain types of traffic, which could impact the viability of our business. These adverse
outcomes, in turn, would harm our revenue, market share, reputation, liquidity and overall
financial position. Whether or not we prevail in this case, we expect that the litigation will
continue to be expensive, time consuming and a distraction to our management in operating our
business. This lawsuit and other ongoing legal proceedings are described under “Legal Proceedings”
in Part II, Item 1 of this quarterly report on Form 10-Q.
17
Overview of Operations
Traffic on our network has grown in each of the last three years. This traffic growth is the
result of growth in the number of new customers, as well as growth in the traffic delivered to
existing customers. Our revenue is generated primarily by charging for traffic delivered. During
the three and nine month periods ended September 30, 2008, we continued to add new customers. We
have seen an increase in the length of our sales cycle, but we continue to see that new customers
want the benefits of the unique services that we bring to the market. However, it is not possible
to accurately determine the longer term impact associated with the overhang of litigation will have
on our ability to effectively compete.
Historically, we have derived a portion of our revenue from outside of the United States. Our
international revenue has grown recently, and we expect this trend to continue as we focus on our
strategy of expanding our network and customer base internationally. For the year ended December
31, 2007 revenue derived from customers outside the United States accounted for approximately 13%
of our total revenue, of which nearly all was derived from operations in Europe. For the three
month periods ended September 30, 2008 and 2007, revenue derived from customers outside the United
States accounted for approximately 16% and 12%, respectively, of our total revenue. For the nine
month periods ended September 30, 2008 and 2007, revenue derived from customers outside the United
States accounted for approximately 16% and 13%, respectively, of our total revenue. For the three
and nine month periods ended September 30, 2008, we derived approximately 76% of our international
revenue from Europe and approximately 24% of our international revenue from Asia Pacific,
respectively. We expect foreign revenue as a percentage of our total revenues to increase as a
percentage of revenue in 2008. Our international business is managed as a single geographic
segment, and we report our financial results on this basis.
During any given fiscal period, a relatively small number of customers typically account for a
significant percentage of our revenue. For example, in 2007, sales to our top 20 customers, in
terms of revenue, accounted for approximately 57% of our total revenue. During 2007, one of these
top 20 customers, Microsoft, represented approximately 12% of our total revenue for that period.
For the three and nine month periods ended September 30, 2008, sales to our top 20 customers, in
terms of revenue, accounted for approximately 52% and 53% of our total revenue. During the three
and nine month periods ended September 30, 2008, we had one
customer, Microsoft, that accounted for
approximately 21% and 18% of our revenue during those periods. During 2007, we entered into a
multi-element arrangement with Microsoft which generates revenue by providing CDN traffic delivery
services, consulting services related to the development of a Custom CDN solution, amortization of
prepaid license and amortization of prepaid post-contract customer support (PCS) for both the
custom CDN-solution and the software component. CDN traffic delivery revenue is recognized as
traffic is delivered, all other revenue from this multi-element arrangement is being recognized
over the term of the software agreement which at September 30, 2008, had 29-months remaining. Our
relationship with Microsoft includes a minimum annual traffic commitment which runs through March
2012. We anticipate customer concentration levels will decline compared to prior years as our
customer base continues to grow and diversify. In addition to selling to our direct customers, we
maintain relationships with a number of resellers that purchase our services and charge a mark-up
to their end customers. Revenue generated from sales to reseller customers accounted for
approximately 1% for the year ended December 31, 2007. For the three and nine month periods ended
September 30, 2008, revenue generated from sales to reseller customers accounted for approximately
1% of our total revenue.
In addition to these revenue-related business trends, our cost of revenue as a percentage of
revenue increased during the three and nine month periods ending September 30, 2008 compared to the
three and nine month periods ended September 30, 2007. The increase is primarily the result of
increased cost of depreciation, network operations personnel costs and co-location costs related to
the increased investments to build out the capacity and geographic reach of our network as well as
declines in sales value of each unit sold due to competitive pressures. Operating expense has
increased in absolute dollars each period as revenue has increased. In 2007, these increases
accelerated due primarily to increased stock-based compensation, cost of litigation with Akamai and
MIT, professional services and other fees associated with becoming a public company, payroll and
payroll-related costs associated with additional general administrative and sales and marketing
resources to support our current and future growth. For the three and nine month periods ended
September 30, 2008, operating expenses continued to increase primarily due to increased litigation
costs and legal fees associated with ongoing intellectual property litigation.
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 2005, 2006 and 2007,
we made capital purchases of $10.9 million, $40.4 million and $26.5 million, respectively. For the
three and nine month periods ended September 30, 2008, we made capital investments of $6.8 million
and $14.9 million, respectively. This was considerably lower than historical levels primarily
related to two things. First, continued improvements in the efficiency of our network allowing us
to meet traffic growth with less investment and second, during the first quarter of 2008 one large
traffic customer shut down its site and we discontinued service to two large customers for non-payment of services which allowed us to recoup a significant amount of network capacity to meet
future growth needs. We expect to have ongoing capital expenditure requirements, as we continue to
invest in and expand our CDN. We currently anticipate making aggregate capital expenditures of
approximately $4.0 million to $5.0 million during the remainder of 2008.
18
We have also generated revenue from certain customers that are entities related to certain of
our founders. The aggregate amounts of revenue derived from these related party transactions was
less than 1% for the year ended December 31, 2007. For the three and nine month periods ended
September 30, 2008, revenue from related parties was less than 1% of our total revenue. We believe
that all of our related party transactions reflected arm’s length terms.
We are currently engaged in litigation with one of our principal competitors, Akamai
Technologies, Inc., or Akamai, and its licensor, the Massachusetts Institute of Technology, or MIT,
in which these parties have alleged that we are infringing three of their patents. In February
2008, a jury returned a verdict in this lawsuit, finding that we infringed four claims of the
patent at issue (U.S. Patent No. 6,108,703 (the 703 patent) and rejecting our invalidity defenses.
The jury awarded Akamai an aggregate of approximately $45.5 million in lost profits, reasonable
royalties and price erosion damages, plus pre-judgment interest estimated to be $2.6 million that
we recorded in 2007. On July 1, 2008, the Court denied our Motions for Judgment as a Matter of Law,
Obviousness, and a New Trial. The Court also denied Akamai’s Motion for Permanent Injunction as
premature and its Motions for Summary Judgment regarding our equitable defenses and has scheduled a
hearing for November 12, 2008. A final judgment has not yet been entered. While we will
continue to pursue multiple legal recourses available to us which could reduce or possibly
eliminate the related financial exposure, if we are not able to prevail in our efforts, there could
be additional charges recorded by us in future periods. Such charges would be dependent in part
upon judicial determinations made on the various elements of the matter and our activities in
future periods. During our financial statement close process, we evaluate if additional accrual
amounts are required at each reporting period. We record additional accrual amounts to the extent
we determine amounts are probable of being paid and are also reasonably estimable. Such amounts
could be, but are not limited to, damages associated with post-judgment lost profits, and royalties
as well as interest related to pre-and-post-judgment amounts. A key determinant in our ability to
estimate possible future charges is the extent to which we are able to determine a correlation
between the jury awarded amount to the various elements of the allegations. During the three and
nine month periods ended September 30, 2008, we estimated our revenue from alleged infringing
methods totaled approximately 11% and 34%, respectively, of our total revenue. We recorded a
potential additional provision for litigation totaling $1.6 million and $14.8 million,
respectively, plus additional interest of $0.7 million and $1.4 million, respectively, for the
three and nine month periods ended September 30, 2008. Our legal and other expenses associated with
this case have been significant. We include these litigation expenses in general and administrative
expenses, as reported in our unaudited consolidated statement of operations. We expect that these
expenses will continue to remain significant. Initially, a portion of the cash impact of these
litigation expenses was offset through the availability of an escrow fund established in connection
with our Series B preferred stock financing. This escrow account was established with an initial
balance of approximately $10.1 million, however, after the closing our initial public offering,
$3.7 million of the escrow was paid back to the tendering Shareholders. The remaining escrow
balance of $6.4 million was drawn fully drawn as of January 2008. During the nine month period
ended September 30, 2008, we received reimbursement of approximately $1.0 million from the escrow
account. At September 30, 2008, the balance in the escrow was fully depleted.
In December 2007, Level 3 Communications, LLC, or Level 3, filed a lawsuit against us in the
U.S. District Court for the Eastern District of Virginia alleging that we are infringing three
patents Level 3 allegedly acquired from Savvis Communications Corp. In addition to monetary relief,
including treble damages, interest, fees and costs, the complaint seeks an order permanently
enjoining us from conducting our business in a manner that infringes the relevant patents. The
parties recently participated in a claim construction hearing before the Court. The Court has not
yet ruled on the claim construction issues. The Court has set a trial date for January 2009. While
we believe that the claims of infringement asserted against us by Level 3 in the present litigation
are without merit and intend to vigorously defend the action, there can be no assurance that this
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. This, in
turn, would harm our revenue, market share, reputation, liquidity and overall financial position.
In August 2007, we, certain of our officers and current and former directors, and the firms
that served as the lead underwriters in our initial public offering were named as defendants in
several purported class action lawsuits filed in the U. S. District Courts for the District of
Arizona and the Southern District of New York. All of the New York cases were transferred to
Arizona and consolidated into a single action. The plaintiffs’ consolidated complaint asserted
causes of action under Sections 11, 12, and 15 of the Securities Act of 1933, as amended, on behalf
of a purported class of individuals who purchased our common stock in our initial public offering
and/or pursuant to our Prospectus. The complaint alleged, among other things, that we omitted
and/or misstated certain facts concerning the seasonality of our business and the loss of revenue
related to certain customers. On March 17, 2008, we and the individual defendants moved to dismiss
all of the plaintiffs’ claims, a hearing was held on this motion on June 16, 2008. On August 8,
2008, the court granted the motion to dismiss, dismissing plaintiffs’ claims under Section 12 with
prejudice and granting leave to amend the claims under Sections 11 and 15. Plaintiffs chose not to
amend the claims under Sections 11 and 15, and on August 29, 2008, the court entered judgment in
favor of us. On September 5, 2008 Plaintiffs filed a notice of appeal. Although we believe that we
and the individual defendants have meritorious defenses to the plaintiffs’ claims and intend to
contest the lawsuits vigorously, an adverse resolution of the lawsuits may have a material adverse
effect on our financial position and results of operations in the period in which the lawsuits are
resolved. We are not able at this time to estimate the range of potential loss nor do we believe
that a loss is probable. Therefore, there is no provision for these lawsuits in our financial
statements.
19
In April 2008, Two-Way Media LLC (TWM) filed a lawsuit against us and other defendants,
including Akamai, AT&T Corp., SBC Internet Services and Southwestern Bell Telephone Company, in the
U.S. District Court for the Southern District of Texas, Corpus Christi Division. TWM alleges we
infringe four patents owned by TWM. TWM sought both monetary and injunctive relief against us. In
September 2008, we entered into a settlement agreement with TWM. As part of the settlement
agreement, TWM agreed to dismiss the lawsuit, and we acquired a non-exclusive license under the TWM
patents.
We were unprofitable for the nine month period ended September 30, 2008; the largest negative
impact to our profitability was the accrual of $14.8 million, for the potential continuing damages,
plus additional interest of $1.4 million, respectively from the jury verdict returned against us
regarding the patent infringement lawsuit filed by Akamai Technologies, Inc., litigation costs of
$16.2 million, and $12.5 million in share-based compensation. The significant increase in
litigation cost primarily results from our on-going litigation with Akamai and Level 3. Going
forward, litigation costs will continue to be significant as we will continue to have costs
associated with completion of the initial trial with Akamai and the subsequent appeal as well as
the costs associated with the Level 3 case.
Our future results will be affected by many factors identified in the section captioned “Risk
Factors,” in this quarterly report on
Form 10-Q, including our ability to:
| |
• |
|
successfully implement technical changes in our methods to deliver customer traffic to
avoid alleged further infringing on Akamai patents; |
| |
| |
• |
|
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 and Level 3 to a positive conclusion; |
| |
| |
• |
|
prevent disruptions to our services and network due to accidents or intentional attacks; and |
| |
| |
• |
|
continued ability to deliver a significant portion of our traffic through settlement free
peering relationships which significantly reduce our cost of delivery. |
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 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 for interim periods. These principles require us
to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue
and expenses, cash flow and related disclosure of contingent assets and liabilities. Our estimates
include those related to revenue recognition, accounts receivable reserves, income and other taxes,
stock-based compensation and equipment and contingent obligations. We base our estimates on
historical experience and on various other assumptions that we believe to be reasonable under the
circumstances. Actual results may differ from these estimates. To the extent that there are
material differences between these estimates and our actual results, our future financial
statements will be affected.
As of September 30, 2008, there have been no material changes to any of the critical
accounting policies as described in our annual report on Form 10-K dated March 25, 2008. During the
quarter ended March 31, 2008, we began to estimate the potential continuing damages from the jury
verdict against us regarding the patent infringement lawsuit filed by Akamai Technologies, Inc.
Results of Operations
Revenue
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
(in thousands) |
|
(in thousands) |
Revenue |
|
$ |
33,116 |
|
|
$ |
29,190 |
|
|
$ |
3,926 |
|
|
|
14 |
% |
|
$ |
93,632 |
|
|
$ |
73,979 |
|
|
$ |
19,653 |
|
|
|
27 |
% |
20
Revenue increased 14%, or $3.9 million, to $33.1 million for the three months ended September
30, 2008 as compared to $29.2 million for the three months ended September 30, 2007. For the nine
months ended September 30, 2008, total revenues increased 27%, or $19.7 million, to $93.6 million
as compared to $74.0 million for the nine months ended September 30, 2007. The increase in revenue
for the three months ended September 30, 2008 as compared to the same period in the prior year was
primarily attributable to an increase in our CDN service revenue of $3.9 million. It should be
noted that revenue for the three month period ended September 30, 2007 included $2.6 million of
revenue associated with the multi-element arrangement that was signed during the second quarter of
2007. The increase in CDN service revenue was primarily attributable to an increase in the number
of customers under recurring revenue contracts, as well as an increase in traffic, partially offset
by a decline in unit sales price, and additional services sold to new and existing customers. The
increase in revenue for the nine months ended September 30, 2008 as compared to the same period in
the prior year was primarily attributable to an increase in our CDN service revenue of $19.1
million. As of September 30, 2008, we had over 1,300 customers under recurring CDN service revenue
contracts as compared to 988 as of September 30, 2007. During the year ended December 31, 2007, we
deferred $3.4 million of custom CDN services revenue from one customer as the amounts were part of
a multi-element arrangement. Entering into the multi-element arrangement with this customer changed
the way we accounted for revenue earned from this customer during 2007. The revenue from the custom
CDN services is being recognized ratably over a 44 month period which began in July 2007. As new
service and or license fees are billed they are added to the deferred revenue and amortized over
the then remaining contract term. As of September 30, 2008, we had $3.7 million of deferred custom
CDN services revenue remaining of which approximately $0.4 million will be recognized during the
remainder of 2008, $1.6 million in 2009 and the remainder thereafter.
For the three months ended September 30, 2008 and 2007, approximately 16% and 12%,
respectively, of our total revenues were derived from our operations located outside of the United
States. For the three months ended September 30, 2008, we derived approximately 76% our
international revenue from Europe and approximately 24% of our international revenue from Asia
Pacific. For the nine months ended September 30, 2008 and 2007, approximately 16% and 13%,
respectively, of our total revenues were derived from our operations located outside of the United
States. For the nine months ended September 30, 2008, we derived approximately 76% of our
international revenue from Europe and approximately 24% of our international revenue from Asia
Pacific. For the three and nine month periods ended September 30, 2007, our international revenue
was derived primarily from Europe. No single country outside of the United States accounted for 10%
or more of revenues during these periods.
Cost of Revenue
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Cost of revenue |
|
$ |
21,557 |
|
|
$ |
17,773 |
|
|
$ |
3,784 |
|
|
|
21 |
% |
|
$ |
61,980 |
|
|
$ |
47,106 |
|
|
$ |
14,874 |
|
|
|
32 |
% |
Cost of revenue includes fees paid to network providers for bandwidth and fees paid to data
center operators for co-location of our network equipment. Cost of revenue also includes payroll
and related costs, depreciation of network equipment used to deliver our CDN services and
equity-related compensation for network operations personnel.
Cost of revenue increased 21%, or $3.8 million, to $21.6 million for the three months ended
September 30, 2008 as compared to $17.8 million for the three months ended September 30, 2007. For
the nine months ended September 30, 2008, cost of revenues increased 32%, or $14.9 million, to
$62.0 million as compared to $47.1 million for the nine months ended September 30, 2007. These
increases were primarily due to an increase in aggregate bandwidth and co-location fees of $1.5
million and $7.2 million, respectively, due to higher traffic levels and increased amounts of
deployed network assets, an increase in depreciation expense of network equipment of $1.0 million
and $3.5 million, respectively, due to increased investment in our network, and an increase in
payroll and related employee costs of $1.0 million and $2.9 million, respectively, associated with
increased staff and an increase in other costs of $0.2 million and $0.7 million, respectively.
Other costs include costs associated with the build-out of custom CDN solution for a specific
customer. During the three and nine month periods ended September 30, 2008, we recognized $21,000
and $63,000, respectively, of deferred costs associated with revenue related to the Multi-Element
Arrangement entered into during the second quarter of 2007. As of September 30, 2008, there was
$0.2 million of deferred costs remaining to be amortized ratably into cost of services over a 44
month period that commenced in July 2007.
Additionally, during the three and nine months ended September 30, 2008 and 2007, cost of
revenue includes share-based compensation expense of approximately $0.6 million and $1.7 million,
and $0.4 million and $1.0 million, respectively, resulting from our application of SFAS No. 123R.
21
Cost of revenue was composed of the following (in millions):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
|
For the |
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Bandwidth and co-location fees |
|
$ |
11.5 |
|
|
$ |
10.0 |
|
|
$ |
33.9 |
|
|
$ |
26.7 |
|
Depreciation — network |
|
|
6.6 |
|
|
|
5.6 |
|
|
|
18.8 |
|
|
|
15.3 |
|
Payroll and related employee costs |
|
|
2.2 |
|
|
|
1.2 |
|
|
|
5.6 |
|
|
|
2.7 |
|
Share-based compensation |
|
|
0.6 |
|
|
|
0.4 |
|
|
|
1.7 |
|
|
|
1.0 |
|
Royalty expenses |
|
|
0.1 |
|
|
|
0.2 |
|
|
|
0.7 |
|
|
|
0.8 |
|
Other costs |
|
|
0.6 |
|
|
|
0.4 |
|
|
|
1.3 |
|
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues |
|
$ |
21.6 |
|
|
$ |
17.8 |
|
|
$ |
62.0 |
|
|
$ |
47.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We have long-term purchase commitments for bandwidth usage and co-location with various Tier 1
network providers and data center operators. The minimum commitments related to bandwidth usage and
co-location services under agreements currently in effect are approximately: $8.0 million for the
remainder of 2008, $24.5 million for 2009, $9.5 million for 2010, $1.7 million for 2011 and $1.4
million for 2012 and beyond.
We expect that cost of revenues will increase during the remainder of 2008. We expect to
deliver more traffic on our network, which would result in higher expenses associated with the
increased traffic; additionally, we anticipate deploying additional network equipment into our
network which will increase depreciation expense related to our network equipment and increase the
fixed cost associated with co-location space where equipment is deployed, along with payroll and
related costs, as we expect to continue to make investments in our network to service our expanding
customer base. The increase in network personnel and the granting of stock options to those new
employees will result in additional expense associated with the amortization of share-based
compensation.
General and Administrative
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
General and
administrative |
|
$ |
15,112 |
|
|
$ |
7,849 |
|
|
$ |
7,263 |
|
|
|
93 |
% |
|
$ |
37,346 |
|
|
$ |
24,144 |
|
|
$ |
13,202 |
|
|
|
55 |
% |
General and administrative expenses consist primarily of the following components:
| |
• |
|
payroll, share-based compensation and other related costs, including
related expenses for executive, finance, 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; |
| |
| |
• |
|
depreciation of property and equipment we use internally; |
| |
| |
• |
|
the provision for doubtful accounts; and |
| |
| |
• |
|
non-income related taxes. |
General and administrative expenses increased 93%, or $7.3 million, to $15.1 million for the
three months ended September 30, 2008 as compared to $7.8 million for the three months ended
September 30, 2007. For the nine months ended September 30, 2008, general and administrative
expenses increased 55%, or $13.2 million, to $37.3 million as compared to $24.1 million for the
nine months ended September 30, 2007. The increase in general and administrative expenses for the
three and nine months ended September 30, 2008 as compared to the three and nine months ended
September 30, 2007 was primarily due to an increase of $6.1 million and $11.7 million,
respectively, in litigation expenses. The increase is also attributable to an increase of $0.1
million and $3.1 million, respectively, in professional fees. Our increase in professional fees is
primarily due to $0.2 million and $1.3 million, respectively, in increased accounting fees and
costs associated with being a publicly traded company offset by a decrease of $0.1 million and an
increase of $1.8 million, respectively, in general legal and other professional fees. Included in
the increase of general legal fees and other professional fees of $0.1 million and $3.1 million,
respectively, for the three and nine month periods ended September 30, 2008, is $0.1 million and
$0.9 million, respectively, for legal fees and other costs associated with patents.
In addition, we had an increase of $0.3 million and $2.0 million, respectively, in bad debt
expense and an increase of $0.8 million and $0.6 million, respectively, in payroll and related
employee costs.
These increases were offset by a decrease in our share-based compensation expense of $ 0 and
$4.2 million. There was no variance for other expenses. The decrease in share-based compensation
expense is the result of having fully expensed equity grants made to our founders in connection
with our Series B preferred stock financing in July 2006. Other expenses include such items as
rent, utilities, telephone, insurance, travel and travel-related expenses, fees and licenses and
property taxes.
22
General and administrative expense was composed of the following (in millions):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
|
For the |
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Litigation expenses |
|
$ |
8.1 |
|
|
$ |
2.0 |
|
|
$ |
16.2 |
|
|
$ |
4.5 |
|
Share-based compensation |
|
|
1.7 |
|
|
|
1.7 |
|
|
|
5.0 |
|
|
|
9.2 |
|
Bad debt expense |
|
|
0.9 |
|
|
|
0.6 |
|
|
|
3.4 |
|
|
|
1.4 |
|
Payroll and related employee costs |
|
|
1.6 |
|
|
|
0.8 |
|
|
|
3.6 |
|
|
|
3.0 |
|
Professional fees |
|
|
1.2 |
|
|
|
1.1 |
|
|
|
4.6 |
|
|
|
1.5 |
|
Other expenses |
|
|
1.6 |
|
|
|
1.6 |
|
|
|
4.5 |
|
|
|
4.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total general and administrative |
|
$ |
15.1 |
|
|
$ |
7.8 |
|
|
$ |
37.3 |
|
|
$ |
24.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We expect general and administrative expenses to increase in 2008 in absolute dollars and to
increase as a percentage of revenue. The increase is due to litigation costs, bad debt,
professional fees and payroll related costs. We expect that these increases will be partially
offset by expected lower share-based compensation expense.
Sales and Marketing
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Sales and marketing |
|
$ |
8,577 |
|
|
$ |
7,421 |
|
|
$ |
1,156 |
|
|
|
16 |
% |
|
$ |
25,684 |
|
|
$ |
16,843 |
|
|
$ |
8,841 |
|
|
|
53 |
% |
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 16%, or $1.2 million, to $8.6 million for the three
months ended September 30, 2008, as compared to $7.4 million for the three months ended September
30, 2007. For the nine months ended September 30, 2008, sales and marketing expenses increased 53%,
or $8.8 million, to $25.7 million, as compared to $16.8 million for the nine months ended September
30, 2007. The increase in sales and marketing expenses in the three and nine month periods ended
September 30, 2008 as compared to the three and nine month periods ended September 30, 2007 was
primarily due to an increase of $0.9 million and $5.2 million, respectively, in payroll and related
employee costs including $0.9 million and $5.3 million respectively, in additional salaries.
Additional increases were due to an increase of $0.1 million and $1.4 million, respectively, in
share-based compensation expense, an increase of $-0- million and $0.5 million in travel and
travel-related expenses, an increase of $0.2 million and $0.7 million in professional fees, and an
increase of $0.5 million and $2.0 million, respectively, in other expenses. Other expenses included
such items as rent and property taxes for our Europe and Asia Pacific sales offices, telephone and
office supplies. These increases were offset by a decrease in our reseller commissions of $0.1
million and $0.3 million, respectively, for the three and nine month periods ended September 30,
2008 compared to the three and nine month periods ended September 30, 2007 and a decrease of $0.4
million and $0.6 million, respectively, in marketing programs for the three and nine month periods
ended September 30, 2008 compared to the three and nine month periods ended September 30, 2007.
23
Sales and marketing expense was composed of the following (in millions):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
|
For the |
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Payroll and related employee costs |
|
$ |
5.0 |
|
|
$ |
4.1 |
|
|
$ |
14.7 |
|
|
$ |
9.5 |
|
Share-based compensation |
|
|
1.4 |
|
|
|
1.3 |
|
|
|
4.1 |
|
|
|
2.7 |
|
Marketing programs |
|
|
0.4 |
|
|
|
0.8 |
|
|
|
1.5 |
|
|
|
2.1 |
|
Travel and travel-related expenses |
|
|
0.6 |
|
|
|
0.6 |
|
|
|
1.7 |
|
|
|
1.2 |
|
Professional fees |
|
|
0.5 |
|
|
|
0.3 |
|
|
|
1.3 |
|
|
|
0.6 |
|
Reseller commissions |
|
|
— |
|
|
|
0.1 |
|
|
|
0.1 |
|
|
|
0.4 |
|
Other expenses |
|
|
0.7 |
|
|
|
0.2 |
|
|
|
2.3 |
|
|
|
0.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total sales and marketing |
|
$ |
8.6 |
|
|
$ |
7.4 |
|
|
$ |
25.7 |
|
|
$ |
16.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We anticipate our sales and marketing expense will continue to increase in 2008 in absolute
dollars and as a percentage of revenue. The increase is due to an expected increase in commissions
on higher forecasted sales, the increase in payroll and related costs of sales and marketing
personnel, increases in share-based compensation expense under SFAS No. 123R and additional
expected increases in marketing costs such as advertising and other lead generating activities.
Research and Development
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Research and
development |
|
$ |
2,008 |
|
|
$ |
1,294 |
|
|
$ |
714 |
|
|
|
55 |
% |
|
$ |
5,293 |
|
|
$ |
4,119 |
|
|
$ |
1,174 |
|
|
|
29 |
% |
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 55%, or $0.7 million, to $2.0 million for the
three months ended September 30, 2008, as compared to $1.3 million for the three months ended
September 30, 2007. For the nine months ended September 30, 2008, research and development expenses
increased 29%, or $1.2 million, to $5.3 million, as compared to $4.1 million for the nine months
ended September 30, 2007. The increase in research and development expenses in the three and nine
month periods ended September 30, 2008 as compared to the three and nine month periods ended
September 30, 2007 was primarily due to an increase of $0.1 million and $0.8 million respectively,
in payroll and related employee costs associated with our hiring of additional network and software
engineering personnel, an increase in other expenses of $0.5 million and $1.1 million,
respectively, which is primarily due to increased consulting costs of $0.4 million and $0.8
million, respectively, an increase in share-based compensation of $0.1 million for the three months
ended September 30, 2008 compared to the same period for the previous year, and a decrease for the
nine months ended September 30, 2007 of $0.7 million compared to the same period for the previous
year. Other expenses include such items as travel and travel related expenses, consulting,
telephone, and office supplies.
Research and development expense was composed of the following (in millions):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
For the |
|
|
For the |
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Payroll and related employee costs |
|
$ |
0.8 |
|
|
$ |
0.7 |
|
|
$ |
2.4 |
|
|
$ |
1.6 |
|
Share-based compensation |
|
|
0.6 |
|
|
|
0.5 |
|
|
|
1.7 |
|
|
|
2.4 |
|
Other expenses |
|
|
0.6 |
|
|
|
0.1 |
|
|
|
1.2 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total research and development |
|
$ |
2.0 |
|
|
$ |
1.3 |
|
|
$ |
5.3 |
|
|
$ |
4.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We anticipate our research and development expense will continue to increase in 2008 in
absolute dollars and remain constant as a percentage of revenue due to increased payroll and
related costs associated with continued hiring of research development personnel and contractors,
and investments in our core technology and refinements to our other service offerings. We expect
that these increases will be offset partially by projected lower share-based compensation expenses.
24
Provision for Litigation
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Provision for
litigation |
|
$ |
2,343 |
|
|
$ |
— |
|
|
$ |
2,343 |
|
|
NA% |
|
$ |
16,220 |
|
|
$ |
— |
|
|
$ |
16,220 |
|
|
NA% |
Provision for litigation relates to our accrual for potential additional damages associated with
revenue generated during the three and nine month periods ended September 30, 2008 from infringing
methods associated with the Akamai litigation. On February 29, 2008, a jury returned a verdict in
favor of Akamai. For the year ended December 31, 2007, we recognized a provision for litigation in
the amount of $45.5 million plus pre-judgment interest estimated to be $2.6 million. During the
quarter ended March 31, 2008, we began to estimate the potential continuing damages from the jury
verdict. For the three and nine month periods ended September 30, 2008, we accrued an additional
$1.6 million and $14.8 million, respectively, for potential on-going damages, plus additional
interest of $0.7 million and $1.4 million, respectively.
Interest Expense
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Interest expense |
|
$ |
11 |
|
|
$ |
18 |
|
|
$ |
(7 |
) |
|
|
(38 |
)% |
|
$ |
43 |
|
|
$ |
1,412 |
|
|
$ |
(1,369 |
) |
|
|
(97 |
)% |
Interest expense includes interest paid on our debt obligations as well as amortization of
deferred financing costs.
Interest expense decreased 38%, or $7,000 to $11,000 for the three months ended September 30,
2008, as compared to $18,000 for the three months ended September 30, 2007. For the nine months
ended September 30, 2008, interest expense decreased 97%, or $1.4 million, to $44,000, as compared
to $1.4 million for the nine months ended September 30, 2007. The $11,000 and $44,000 for the three
and nine month periods ended September 30, 2008 represents the amortization of loan fees associated
with our unused line of credit. The decrease in interest expense for the three and nine month
periods ended September 30, 2008, was the result of our repayment of our outstanding credit
facilities on June 14, 2007 from the proceeds from our initial public offering. As of September 30,
2008, we had no outstanding balances due on any of our credit facilities. We do not expect to incur
any interest expense on debt during the remainder of 2008.
Interest Income
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Interest income |
|
$ |
1,203 |
|
|
$ |
2,456 |
|
|
$ |
(1,253 |
) |
|
|
(51 |
)% |
|
$ |
4,428 |
|
|
$ |
3,118 |
|
|
$ |
1,310 |
|
|
|
42 |
% |
Interest income includes interest earned on invested cash balances and marketable securities.
Interest income decreased 51%, to $1.2 million for the three months ended September 30, 2008,
as compared to $2.5 million for the three months ended September 30, 2007. For the nine months
ended September 30, 2008, interest income increased 42%, to $4.4 million, as compared to $3.1
million for the nine months ended September 30, 2007. The decrease in interest income in the three
month period ended September 30, 2008 as compared to the three month period ended September 30,
2007 was primarily due to lower market interest rates on decreased cash balances. The increase in
interest income in the nine month period ended September 30, 2008 as compared to the nine month
period ended September 30, 2007 was primarily due to an increase in our average cash balance and
the investment of the net proceeds from our initial public offering after the repayment of our
outstanding credit facilities.
Other Income/Expense
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, |
|
Nine Months Ended September 30, |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Other
income/(expense) |
|
$ |
410 |
|
|
$ |
33 |
|
|
$ |
377 |
|
|
|
1,132 |
% |
|
$ |
203 |
|
|
$ |
33 |
|
|
$ |
170 |
|
|
|
515 |
% |
Other income for the three and nine months ended September 30, 2008 consists primarily of foreign
exchange gains resulting from the re-measurement of accounts payable for invoices denominated in a
foreign currency, and the effect of exchange rates on monetary balance sheet and income statement
items resulting from foreign operations in Japan, Germany and the United Kingdom. Other income
for the three and nine months ended September 30, 2007 consists primarily of net gains from the
disposal of assets.
25
Income Tax Expense (Benefit)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended September 30, 2008 |
|
Nine Months Ended September 30, 2008 |
| |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
|
|
|
|
|
|
|
|
|
Increase |
|
Percent |
| |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
|
2008 |
|
2007 |
|
(Decrease) |
|
Change |
| |
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Income tax expense
(benefit) |
|
$ |
130 |
|
|
$ |
181 |
|
|
$ |
(51 |
) |
|
|
(28 |
%) |
|
$ |
(78 |
) |
|
$ |
602 |
|
|
$ |
(680 |
) |
|
|
(113 |
%) |
Based upon our estimated annual effective tax rate and after consideration of discrete tax
items in the quarter, our estimated tax benefit for the nine months ended September 30, 2008
consisted of federal, foreign and state provisions/(benefits) for income tax. Our effective tax
rate was (.86%) and .16% on our loss before taxes of $15.2 million and $49.2 million for the three
and nine month periods ended September 30, 2008, respectively. Our income tax benefit on our loss
before taxes of $15.2 million in the third quarter was different than our statutory income tax rate
due primarily to an increase in our valuation allowance, netted with the tax benefit of an
anticipated federal loss carry-back. The effective income tax rate is based primarily upon
forecasted income or loss for the year, the composition of the income or loss in different
countries, and adjustments, if any, for the potential tax consequences, benefits or resolutions for
tax audits.
In the first nine months of 2007, approximately $7.7 million of share-based compensation
expense was not deductible for tax purposes by us, as certain executives and other employees made
tax elections which established tax bases in these awards granted at lower than the fair value
recognized within the financial statements. This permanent difference was not material to our
pre-tax net loss of $49.2 million for the first nine months of 2008. The current unvested awards
are expected to generate permanent differences of $1.3 million for the remaining three months of
2008 and $2.6 million, and $0.6 million for 2009 and 2010, respectively, based upon the unvested
portion of the equity awards outstanding at September 30, 2008 and the anticipated vesting at the
time.
During the nine months ended September 30, 2008, we performed our assessment of the
recoverability of deferred tax assets and determined there was sufficient negative evidence as a
result of our cumulative losses to conclude that it was more likely than not that our deferred tax
assets would not be realized and accordingly maintained a full valuation allowance. In calculating
our effective income tax rate for 2008, no benefit is provided for temporary differences that
increase deferred tax assets relating to stock-based compensation.
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; |
| |
| |
• |
|
borrowing on credit facilities; and |
| |
| |
• |
|
cash generated by operations. |
As of September 30, 2008, our cash, cash equivalents and marketable securities classified as
current totaled $176.7 million.
Operating Activities
Net cash provided by operating activities decreased $30.7 million to $7.2 million net cash
used in operating activities for the nine months ended September 30, 2008, compared to $23.5
million net cash provided by operating activities for the nine months ended September 30, 2007. The
decrease in cash provided by operating activities for the nine month period ended September 30,
2008 was primarily due to the net loss incurred during the nine months ended September 30, 2008 and
changes in working capital resulting from decreases in deferred revenue, increases in accounts
receivable, prepaid and other current assets, and decreases in non-cash charges in stock-based
compensation, partially offset by increases in non-cash charges of depreciation and amortization,
litigation provision and accounts receivable charges, and changes in working capital as a result of
a decrease in income taxes receivable and other assets, and increase in accounts payable and other
current liabilities.
We expect that cash provided by operating activities will not be sufficient to cover new
purchases of property and equipment during the remainder of 2008 and fund potential damages
associated with patent litigation. The timing and amount of future working capital changes,
requirement to secure potential infringement damages and our ability to manage our days sales
outstanding will also affect the future amount of cash used in or provided by operating activities.
26
Investing Activities
Cash provided by investing activities increased $101.1 million to $15.4 million for the nine
months ended September 30, 2008, compared to $85.7 million used in investing activities for the
nine months ended September 30, 2007. Cash provided by investing activities represented cash
received from the sale of short-tem marketable securities and lower capital expenditures primarily
for network equipment associated with adding additional capacity and geographic expansion of our
content delivery network.
While we expect to have ongoing capital expenditure requirements as we continue to invest in
and expand our CDN, we anticipate lower outflows than we had in 2007. We currently anticipate
making aggregate capital expenditures of approximately $4.0 million to $5.0 million during the
remainder of 2008.
Financing Activities
Cash provided by financing activities decreased $182.0 million to $1.3 million for the nine
months ended September 30, 2008, as compared to $183.3 million for the nine months ended September
30, 2007. The decrease is primarily due to the receipt of net proceeds of approximately $203.9
million from our IPO on June 8, 2007, $2.3 million decrease in reimbursement of litigation expenses
from our escrow account as compared with the nine month period ended September 30, 2007, offset by
a net decrease in payments of $23.8 million on our bank line, $0.3 million decrease in capital
lease obligations, and $0.1 million proceeds from stock option exercise.
At September 30, 2008 we had no outstanding balance on any of our credit facilities and we had
an unused line of credit of up to $5.0 million dollars. Under the terms of the line of credit, we
can borrow up to 50% of the cash balances we hold at the bank, up to a maximum of $5.0 million
dollars. We do not anticipate having to utilize the line of credit for the remainder of 2008.
In connection with our Series B preferred stock financing in July 2006, an escrow account was
established with an initial balance of approximately $10.1 million to serve as security for the
indemnification obligations of our stockholders tendering shares in that financing and to fund 50%
of the ongoing monthly expenses associated with the Akamai litigation. In May 2007, we, the
tendering stockholders and the Series B preferred stock investors agreed to distribute $3.7 million
of the escrow account to the tendering stockholders upon the closing of our initial public
offering. During the nine month period ended September 30, 2008, we received reimbursements from
this escrow of approximately $1.1 million. At September 30, 2008, the balance in the escrow was
fully depleted.
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 debt repurchases and issuances, stock option exercises, sales of equity investments and
similar events.
At September 30, 2008, we had accrued $64.4 million associated with potential damages and
interest owed to Akamai associated with the ongoing patent infringement litigation. During 2008, we
may be required to issue an appeal bond to the court to securitize the potential damage award. Such
a bond will require that we pledge a certain amount of our cash reserves as collateral. At this
time we are unable to determine if an appeal bond would be required or the amount of such an appeal
bond.
The trial date for the Level 3 Communications patent infringement law suit is set for January
2009. In the event of a negative outcome at trial there could be additional demands put on our cash
reserves to satisfy any potential award associated with that case. It is impossible to determine
the amount, if any, of any award and the associated appeal bond requirement.
We believe that our existing cash and cash equivalents 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 and cost of ongoing litigation change, or if unexpected
opportunities or needs arise, we may seek to raise additional cash by selling equity or debt
securities. If additional funds are raised through the issuance of equity or debt securities, these
securities could have rights, preferences and privileges senior to those accruing to holders of
common stock, and the terms of such debt could impose restrictions on our operations. The sale of
additional equity or convertible debt securities would also result in additional dilution to our
stockholders. In the event that additional financing is required from outside sources, we may not
be able to raise it on terms acceptable to us or at all. If we are unable to raise additional
capital when desired, our business, operating results and financial condition could be harmed.
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 2008 to 2013. We expect that the growth of our business will require us to
continue to add to and increase our long-term commitments in 2008 and beyond. As a result of our
growth strategies, we believe that our liquidity and capital resources requirements will grow in
absolute dollars but will be generally consistent with that of historical periods on an annual
basis as a percentage of net revenue.
27
The following table presents our contractual obligations and commercial commitments, as
of September 30, 2008 over the next five years and thereafter (in thousands):
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Payments Due by Period |
|
| |
|
|
|
|
|
Less than |
|
|
|
|
|
|
|
|
|
|
More than |
|
| Contractual Obligations as of September 30, 2008 |
|
Total |
|
|
1 year |
|
|
1-3 years |
|
|
3-5 years |
|
|
5 years |
|
Operating Leases |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bandwidth leases |
|
$ |
17,813 |
|
|
$ |
11,808 |
|
|
$ |
4,302 |
|
|
$ |
1,518 |
|
|
$ |
185 |
|
Rack space leases |
|
|
27,264 |
|
|
|
15,811 |
|
|
|
11,453 |
|
|
|
— |
|
|
|
— |
|
Real estate leases |
|
|
2,421 |
|
|
|
1,204 |
|
|
|
1,217 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating leases |
|
|
47,498 |
|
|
|
28,823 |
|
|
|
16,972 |
|
|
|
1,518 |
|
|
|
185 |
|
Capital leases |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Bank debt |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Interest on bank debt |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total commitments |
|
$ |
47,498 |
|
|
$ |
28,823 |
|
|
$ |
16,972 |
|
|
$ |
1,518 |
|
|
$ |
185 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Off Balance Sheet Arrangements
We do not have, and have never had, any relationships with unconsolidated entities or
financial partnerships, such as entities often referred to as structured finance or special purpose
entities, which would have been established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes.
Use of Non-GAAP Financial Measures
To evaluate our business, we consider and use Non-GAAP revenue, Non-GAAP net income
(loss) and Adjusted EBITDA as a supplemental measure of operating performance. We consider Non-GAAP
revenue and net income (loss) to be an important indicator of overall business performance because
it allows us to illustrate the impact of the effects from our multi-element contract as well as
eliminate the effects of share-based compensation, litigation expenses and provision for
litigation. We define EBITDA as GAAP net income (loss) before interest income, interest expense,
other income and expense, provision for income taxes, depreciation and amortization. We define
Adjusted EBITDA as EBITDA plus income from our multi-element contract and 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.
The terms Non-GAAP revenue, net income (loss), EBITDA and Adjusted EBITDA are not defined
under U.S. generally accepted accounting principles, or U.S. GAAP, and are not measures of
operating income, operating performance or liquidity presented in accordance with U.S. GAAP. Our
Non-GAAP revenue, net income (loss), EBITDA and Adjusted EBITDA have limitations as analytical
tools, and when assessing our operating performance, Non-GAAP revenue, net income, 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 U.S. 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 and damages accruals; |
| |
| |
• |
|
they do not reflect the interest expense, or the cash requirements necessary to service
interest or principal payments, on our debt; |
| |
| |
• |
|
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 Revenue, Net Income (Loss) and Adjusted EBITDA only as supplemental support for
management’s analysis of business performance. Non-GAAP Revenue, Net Income (Loss), EBITDA and
Adjusted EBITDA are calculated as follows for the periods presented in thousands:
28
Reconciliation of Non-GAAP Financial Measures
In accordance with the requirements of Regulation G issued by the Securities and Exchange
Commission, the Company is presenting the most directly comparable GAAP financial measures and
reconciling the non-GAAP financial metrics to the comparable GAAP measures.
Reconciliation of GAAP Revenue to Non-GAAP Revenue
(In thousands)
(Unaudited)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
June 30, |
|
|
September 30, |
|
|
June 30, |
|
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2008 |
|
|
2007 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
GAAP Revenue |
|
|
NA |
|
|
|
NA |
|
|
$ |
29,190 |
|
|
$ |
21,436 |
|
|
|
NA |
|
|
$ |
73,979 |
|
Deferred Traffic Revenue |
|
|
— |
|
|
|
— |
|
|
|
(2,645 |
) |
|
|
2,645 |
|
|
|
— |
|
|
|
— |
|
Deferred Custom CDN Services Revenue |
|
|
— |
|
|
|
— |
|
|
|
1,504 |
|
|
|
820 |
|
|
|
— |
|
|
|
2,324 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-GAAP Revenue |
|
|
NA |
|
|
|
NA |
|
|
$ |
28,049 |
|
|
$ |
24,901 |
|
|
|
NA |
|
|
$ |
76,303 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company did not report any non GAAP revenue for any periods during 2008.
Reconciliation of GAAP Net Income (Loss) to Non-GAAP Net Income (Loss)
(In thousands)
(Unaudited)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
June 30, |
|
|
September 30, |
|
|
June 30, |
|
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2008 |
|
|
2007 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
GAAP net loss |
|
$ |
(15,352 |
) |
|
$ |
(15,331 |
) |
|
$ |
(3,125 |
) |
|
$ |
(10,644 |
) |
|
$ |
(49,126 |
) |
|
$ |
(17,675 |
) |
Deferred revenue |
|
|
— |
|
|
|
— |
|
|
|
(1,141 |
) |
|
|
3,465 |
|
|
|
— |
|
|
|
2,324 |
|
Deferred cost of traffic and services |
|
|
— |
|
|
|
— |
|
|
|
649 |
|
|
|
(935 |
) |
|
|
— |
|
|
|
(286 |
) |
Provision for litigation |
|
|
2,343 |
|
|
|
6,743 |
|
|
|
— |
|
|
|
— |
|
|
|
16,220 |
|
|
|
— |
|
Share-based compensation |
|
|
4,305 |
|
|
|
4,285 |
|
|
|
3,955 |
|
|
|
6,259 |
|
|
|
12,549 |
|
|
|
15,285 |
|
Litigation defense expenses |
|
|
8,189 |
|
|
|
2,667 |
|
|
|
2,002 |
|
|
|
1,636 |
|
|
|
16,222 |
|
|
|
4,523 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-GAAP net (loss) income |
|
$ |
(515 |
) |
|
$ |
(1,636 |
) |
|
$ |
2,340 |
|
|
$ |
(219 |
) |
|
$ |
(4,135 |
) |
|
$ |
4,171 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
29
Reconciliation of GAAP Net Income (Loss) to EBITDA to EBITDA
Adjusted for Share-Based Compensation and Litigation and Damage Costs
(In thousands)
(Unaudited)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Three Months Ended |
|
|
Nine Months Ended |
|
| |
|
September 30, |
|
|
June 30, |
|
|
September 30, |
|
|
June 30, |
|
|
September 30, |
|
|
September 30, |
|
| |
|
2008 |
|
|
2008 |
|
|
2007 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
GAAP net loss |
|
$ |
(15,352 |
) |
|
$ |
(15,331 |
) |
|
$ |
(3,125 |
) |
|
$ |
(10,644 |
) |
|
$ |
(49,126 |
) |
|
$ |
(17,675 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Add: depreciation and amortization |
|
|
6,950 |
|
|
|
6,503 |
|
|
|
5,870 |
|
|
|
5,194 |
|
|
|
19,713 |
|
|
|
15,889 |
|
Add: interest expense |
|
|
11 |
|
|
|
11 |
|
|
|
18 |
|
|
|
821 |
|
|
|
43 |
|
|
|
1,412 |
|
Less: interest and other income |
|
|
(1,613 |
) |
|
|
(957 |
) |
|
|
(2,490 |
) |
|
|
(573 |
) |
|
|
(4,631 |
) |
|
|
(3,151 |
) |
Plus income tax (benefit) expense |
|
|
130 |
|
|
|
(25 |
) |
|
|
181 |
|
|
|
221 |
|
|
|
(78 |
) |
|
|
602 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA |
|
$ |
(9,874 |
) |
|
$ |
(9,799 |
) |
|
$ |
454 |
|
|
$ |
(4,981 |
) |
|
$ |
(34,079 |
) |
|
$ |
(2,923 |
) |
Add: deferred revenue |
|
|
— |
|
|
|
— |
|
|
|
(1,141 |
) |
|
|
3,465 |
|
|
|
— |
|
|
|
2,324 |
|
Add: provision for litigation |
|
|
2,343 |
|
|
|
6,743 |
|
|
|
— |
|
|
|
— |
|
|
|
16,220 |
|
|
|
— |
|
Add: share-based compensation |
|
|
4,305 |
|
|
|
4,285 |
|
|
|
3,955 |
|
|
|
6,259 |
|
|
|
12,549 |
|
|
|
15,285 |
|
Add: litigation defense expenses |
|
|
8,189 |
|
|
|
2,667 |
|
|
|
2,002 |
|
|
|
1,636 |
|
|
|
16,222 |
|
|
|
4,523 |
|
Less: deferred traffic and service |
|
|
|
|
|
|
|
|
|
|
649 |
|
|
|
(935 |
) |
|
|
|
|
|
|
(286 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA |
|
$ |
4,963 |
|
|
$ |
3,896 |
|
|
$ |
5,919 |
|
|
$ |
5,444 |
|
|
$ |
10,912 |
|
|
$ |
18,923 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our debt
and investment portfolio. In our investment portfolio, we do not use derivative financial
instruments. Our investments are primarily with our commercial and investment banks and, by policy,
we limit the amount of risk by investing primarily in money market funds, United States Treasury
obligations, high-quality corporate and municipal obligations and certificates of deposit. We do
not believe that a 10% change in interest rates would have a significant impact on our interest
income, operating results or liquidity.
Foreign Currency Risk
Substantially all of our customer agreements are denominated in U.S. dollars, and
therefore our revenue is not subject to foreign currency risk. Because we have operations in Europe
and Asia, however, we may be exposed to fluctuations in foreign exchange rates with respect to
certain operating expenses and cash flows. Additionally, we may continue to expand our operations
globally and sell to customers in foreign locations, potentially with customer agreements
denominated in foreign currencies, which may increase our exposure to foreign exchange
fluctuations. At this time, we do not have any foreign hedge contracts.
Inflation Risk
We do not believe that inflation has had a material effect on our business, financial
condition or results of operations. If our costs were to become subject to significant inflationary
pressures, we may not be able to fully offset such higher costs through price increases. Our
inability or failure to do so could harm our business, financial condition and results of
operations.
Item 4. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
We are responsible for establishing and maintaining adequate internal control over financial
reporting, as such term is defined in SEC Rule 13a-15(e). We maintain disclosure controls and
procedures, as such term is defined in SEC Rule 13a-15(e), that are designed to ensure that
information required to be disclosed in our reports under the Securities Exchange Act of 1934, as
amended, is recorded, processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission’s rules and forms and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow for timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision
and with the participation of our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our disclosure controls and
procedures as of the end of September 30, 2008. Based on the foregoing, our Chief Executive Officer
and Chief Financial Officer concluded that our disclosure controls and procedures were effective at
the reasonable assurance level.
Changes in Internal Control over Financial Reporting
There has been no change in our internal controls over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period covered by
this Form 10-Q that have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting. Commencing with our year ending December 31, 2008, we
must perform system and process evaluations and testing of our internal controls over financial
reporting to allow management and our independent registered public accounting firm to report on
the effectiveness of our internal controls over financial reporting, as
required under Section 404 of the Sarbanes-Oxley Act. See the Risk Factor entitled “ If we fail to
maintain proper and effective internal controls, our ability to produce accurate financial
statements could be impaired, which could adversely affect our operating results, our ability to
operate our business and investors view of us ” in this quarterly report on Form 10-Q.
30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in litigation with Akamai Technologies, Inc. and the Massachusetts Institute
of Technology relating to a claim of patent infringement. The action was filed in June 2006 in the
U.S. District Court for the District of Massachusetts. The trial date was set for February 2008
with respect to four claims in U.S. Patent No. 6,108,703 (the 703 patent). In February 2008, a jury
returned a verdict in this lawsuit, finding that we infringed four claims of the 703 patent at
issue and rejecting our invalidity defenses for the period April 2005 through December 31, 2007.
The jury awarded an aggregate of approximately $45.5 million which includes lost profits,
reasonable royalties and price erosion damages. In addition the jury awarded pre-judgment interest
which we estimated to be $2.6 million at December 31, 2007. We have recorded the aggregate
$48.1 million as a provision for litigation as of December 31, 2007. An additional provision of
approximately $16.2 million for potential additional infringement damages and interest was recorded
during the nine month period ended September 30, 2008 for an aggregate provision for litigation of
$64.4 million. On July 1, 2008, the Court denied our Motions for Judgment as a Matter of Law,
Obviousness, and a New Trial. The Court also denied Akamai’s Motion for Permanent Injunction as
premature and its Motions for Summary Judgment regarding our equitable defenses and has scheduled a
hearing for November 12, 2008. A final judgment has not yet been entered. We continue to believe
that the claims of infringement asserted against us by Akamai and MIT in the present litigation are
without merit and that the jury’s verdict is incorrect, and we will continue to defend the case
vigorously. Regardless of the outcome on the pending issues, it is likely that appeals by Akamai,
us or both will follow. We cannot assure you, however, that this lawsuit ultimately will be
resolved in our favor. An adverse judgment or injunction 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 CDN to deliver certain types of traffic, which could
impact the viability of our business. These adverse outcomes, in turn, would harm our revenue,
market share, reputation, liquidity and overall financial position. Whether or not we prevail in
this case, we expect that the litigation will continue to be expensive, time consuming and a
distraction to our management in operating our business.
Beginning in August 2007, we, certain of our officers and directors, and the firms that
served as the lead underwriters in our initial public offering were named as defendants in several
purported class action lawsuits. These lawsuits have been consolidated into a single lawsuit in
U.S. District Court for the District of Arizona. The consolidated complaint assert causes of action
under Sections 11, 12 and 15 of the Securities Act of 1933, as amended, on behalf of a professed
class consisting of all those who were allegedly damaged as a result of acquiring our common stock
in our initial public offering (IPO) between June 8, 2007 and August 8, 2007. The complaint
alleges, among other things, that we omitted and/or misstated certain facts concerning the
seasonality of our business and that the loss of revenue with respect to certain customers. On
March 17, 2008, we and the individual defendants moved to dismiss all of the plaintiffs’ claims,
and a hearing was held on this motion on June 16, 2008. On August 8, 2008, the court granted the
motion to dismiss, dismissing plaintiffs’ claims under Section 12 with prejudice and granting leave
to amend the claims under Sections 11 and 15. Plaintiffs chose not to amend the claims under
Sections 11 and 15, and on August 29, 2008 the court entered judgment in favor of us. On September
5, 2008 Plaintiffs filed a notice of appeal. Although we believe that we and the individual
defendants have meritorious defenses to the claims made in the complaint and we intend to contest
the lawsuits vigorously, an adverse resolution of the lawsuits may have a material adverse effect
on our financial position and results of operations in the period in which the lawsuits are
resolved. We are not able at this time to estimate the range of potential loss nor do we believe
that a loss is probable. Therefore, we have made no provision for this lawsuit in our financial
statements.
In December 2007, Level 3 Communications, LLC, or Level 3, filed a lawsuit against us in the
U.S. District Court for the Eastern District of Virginia alleging that we are infringing three
patents Level 3 allegedly acquired from Savvis Communications Corp. In addition to monetary relief,
including treble damages, interest, fees and costs, the complaint seeks an order permanently
enjoining us from conducting our business in a manner that infringes the relevant patents. The
parties recently participated in a claim construction hearing before the Court. The Court has not
yet ruled on the claim construction issues. The Court has set a trial date for January 2009. While
we believe that the claims of infringement asserted against us by Level 3 in the present litigation
are without merit and intend to vigorously defend the action, there can be no assurance that this
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. This, 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 do we believe that a loss
is probable. Therefore, we have made no provision for this lawsuit in our financial statements.
In April 2008, Two-Way Media LLC (TWM) filed a lawsuit against us and other defendants,
including Akamai, AT&T Corp., SBC Internet Services and Southwestern Bell Telephone Company, in the
U.S. District Court for the Southern District of Texas, Corpus Christi Division. TWM alleged we
infringed four patents owned by TWM. TWM sought both monetary and injunctive relief against us. In
September 2008 we entered into a settlement agreement with TWM. As part of the settlement
agreement, TWM agreed to
dismiss the lawsuit, and we acquired a non-exclusive license under the TWM patents.
From time to time, we also may become involved in legal proceedings arising in the
ordinary course of our business.
31
Item 1A. Risk Factors
Investments in the equity securities of publicly traded companies involve significant
risks. Our business, prospects, financial condition or operating results could be materially
adversely affected by any of these risks, as well as other risks not currently known to us or that
we currently consider immaterial. The trading price of our common stock could decline due to any of
these risks, and you may lose all or part of your investment. In assessing the risks described
below, you should also refer to the information contained in this report on Form 10-Q, including
our unaudited condensed consolidated financial statements and the related notes, before deciding to
purchase any shares of our common stock.
Risks Related to Our Business
We have updated the risk factors previously disclosed in Part I Item 1A of our Annual Report on
Form 10-K for the year ended December 31, 2007, which was filed with the Securities and Exchange
Commission on March 25, 2008, as set forth below.
A jury has determined that we are infringing a competitor’s patent, and an injunction may be
entered against us that could force us to cease providing our CDN services.
In February 2008, a jury returned a verdict in a patent infringement lawsuit filed by
Akamai Technologies, Inc., or Akamai, and the Massachusetts Institute of Technology, or MIT,
against us, finding that we infringed four claims of the patent at issue and rejecting our
invalidity defenses. The jury awarded Akamai an aggregate of approximately $45.5 million in lost
profits, reasonable royalties and price erosion damages, plus pre-judgment interest estimated to be
$2.6 million that we have recorded in 2007. An additional provision of approximately $2.3 million
and $16.2 million, respectively, for potential additional infringement damages and interest was
recorded during the three and nine month periods ended September 30, 2008. Additional accruals for
future periods are expected. On July 1, 2008, the Court denied our Motions for Judgment as a Matter
of Law, Obviousness, and a New Trial. The Court also denied Akamai’s Motion for Permanent
Injunction as premature and its Motions for Summary Judgment regarding our equitable defenses and
has scheduled a hearing for November 12, 2008. A final judgment has not yet been entered. We
continue to believe that the claims of infringement asserted against us by Akamai and MIT in the
present litigation are without merit and that the jury’s verdict is incorrect, and we will continue
to defend the case vigorously; however, we cannot assure you that this lawsuit ultimately will be
resolved in our favor. An adverse judgment or injunction 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 CDN to deliver certain types of traffic, which could
impact the viability of our business. These adverse outcomes, in turn, would harm our revenue,
market share, reputation, liquidity and overall financial position. Whether or not we prevail in
this case, we expect that the litigation will continue to be expensive, time consuming and a
distraction to our management in operating our business. This lawsuit and other ongoing legal
proceedings are described under “Legal Proceedings” in Part II, Item 1 of this quarterly report on
Form 10-Q.
We may need to defend our intellectual property and processes against patent or copyright
infringement claims, which would cause us to incur substantial costs and threaten our ability to do
business.
Companies, organizations or individuals, including our competitors, may hold or obtain
patents or other proprietary rights that would prevent, limit or interfere with our ability to
make, use or sell our services or develop new services, which could make it more difficult for us
to operate our business. From time to time, we may receive inquiries from holders of patents
inquiring whether we infringe their proprietary rights. Companies holding Internet-related patents
or other intellectual property rights are increasingly bringing suits alleging infringement of such
rights or otherwise asserting their rights and seeking licenses. For example, in June 2006, we were
sued by Akamai and MIT alleging we infringed patents licensed to Akamai, and in February 2008 a
jury returned a verdict in this case, finding that we infringed four claims of the patent at issue
and rejecting our invalidity defenses. The jury awarded Akamai an aggregate of approximately $45.5
million in lost profits, reasonable royalties and price erosion damages, plus pre-judgment interest
estimated to be $2.6 million that we have recorded in 2007. An additional provision of
approximately $2.3 million and $16.2 million, respectively, for potential additional infringement
damages and interest was recorded during the three and nine month periods ended September 30, 2008
and additional accruals for future periods are expected. Although a final judgment has not yet been
entered, an adverse judgment or injunction 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 CDN to deliver certain types of traffic, which could impact the
viability of our business. In addition, in December 2007, Level 3 Communications, or Level 3, filed
a lawsuit against us alleging that we are infringing three patents Level 3 allegedly acquired from
Savvis Communications Corp. In addition to monetary relief, including treble damages, interest,
fees and costs, the complaint seeks an order permanently enjoining us from conducting our business
in a manner that infringes the relevant patents. Any litigation or claims, whether or not valid,
could result in substantial costs and diversion of resources. See “Legal Proceeding” in Part II,
Item 1 of this quarterly report on Form 10-Q. In addition, if we are determined to have infringed
upon a third party’s intellectual property rights, we may be required to do one or more of the
following:
32
| |
• |
|
cease selling, incorporating or using products or services that incorporate the challenged intellectual property; |
| |
| |
• |
|
pay substantial damages; |
| |
| |
• |
|
obtain a license from the holder of the infringed intellectual property right, which license may or may not be
available on reasonable terms or at all; or |
| |
| |
• |
|
redesign products or services. |
If we are forced to take any of these actions, our business may be seriously harmed. In the
event of a successful claim of infringement against us and our failure or inability to obtain a
license to the infringed technology, our business and operating results could be harmed.
The expense of defending these lawsuits and other lawsuits to which we may be a party
(see discussion in “Legal Proceedings” in Part II, Item 1 of the quarterly report on Form 10Q),
particularly fees paid to our lawyers and expert consultants, has been and will continue to be
significant and will continue to adversely affect our operating results during the pendency of the
lawsuits.
Our limited operating history makes evaluating our business and future prospects difficult, and may
increase the risk of your investment.
Our company has only been in existence since 2001. A significant amount of our growth, in
terms of employees, operations and revenue, has occurred since 2004. For example, our revenue has
grown from $5.0 million in 2003 to $65.2 million in 2006 and to $103.1 million in 2007. For the
nine-month period ended September 30, 2008 our revenue was $93.6 million. As a consequence, we have
a limited operating history which makes it difficult to evaluate our business and our future
prospects. We have encountered and will continue to encounter risks and difficulties frequently
experienced by growing companies in rapidly changing industries, such as the risks described in
this quarterly report on Form 10-Q. If we do not address these risks successfully, our business
will be harmed.
If we fail to manage future growth effectively, we may not be able to market and sell our services
successfully.
We have recently expanded our operations significantly, increasing our total number of
employees from 29 at December 31, 2004 to 286 at September 30, 2008, and we anticipate that further
significant expansion will be required. Our future operating results depend to a large extent on
our ability to manage this expansion and growth successfully. Risks that we face in undertaking
this expansion include: training new sales personnel to become productive and generate revenue;
forecasting revenue; controlling expenses and investments in anticipation of expanded operations;
implementing and enhancing our content delivery network, or CDN, and administrative infrastructure,
systems and processes; addressing new markets; and expanding international operations. A failure to
manage our growth effectively could materially and adversely affect our ability to market and sell
our products and services.
If we fail to maintain proper and effective internal controls, our ability to produce accurate
financial statements could be impaired, which could adversely affect our operating results, our
ability to operate our business and investors’ views of us.
We must ensure that we have adequate internal financial and accounting controls and procedures
in place so that we can produce accurate financial statements on a timely basis. We are required to
spend considerable effort on establishing and maintaining our internal controls, which is costly
and time-consuming and needs to be re-evaluated frequently. We have very limited experience in
designing and testing our internal controls. For example, during the third quarter of 2007, we
discovered material weaknesses in our system of internal controls over our revenue recognition and
stock-based compensation processes that required us to restate our previously reported consolidated
financial statements for the three-and nine-months ended September 30, 2006, the three-months and
year ended December 31, 2006, the three-months ended March 31, 2007, and the three-and-six months
ended June 30, 2007. We are in the process of documenting, reviewing and, where appropriate,
improving our internal controls and procedures.
As a newly public company we will be required to comply with the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002, which will require annual management assessments of
the effectiveness of our internal control over financial reporting. In addition, we will be
required to file a report by our independent registered public accounting firm addressing these
assessments beginning with our Annual Report on Form 10-K for the year ended December 31, 2008.
Both we and our independent auditors will be testing our internal controls in anticipation of being
subject to Section 404 requirements and, as part of that documentation and testing, may identify
areas for further attention and improvement. We have encountered challenges in the implementation
of Section 404. While management believes these challenges will be timely overcome, these
challenges could impair the timely completion of the implementation and testing of internal
controls by the Company and our auditors, and in turn impair the timely completion of management’s
assessment of the effectiveness of our internal controls and the report by our independent
registered public accounting firm addressing the assessment. Implementing any appropriate changes
to our internal controls may entail substantial costs to modify our existing financial and
accounting systems, take a significant period of time to complete, and distract our officers,
directors and employees from the operation of our business. These changes may not, however, be
effective in maintaining the adequacy of our internal controls, and any failure to maintain that
adequacy, or a consequent inability to produce accurate financial statements on a timely basis,
could increase our operating costs and could materially impair our ability to operate our business.
In addition, investors’
perceptions that our internal controls are inadequate or that we are unable to produce accurate
financial statements may adversely affect our stock price.
33
We currently face competition from established competitors and may face competition from others in
the future.
We compete in markets that are intensely competitive, rapidly changing and characterized
by constantly declining prices and vendors offering a wide range of content delivery solutions. We
have experienced and expect to continue to experience increased competition, and particularly
aggressive price competition. Many of our current competitors, as well as a number of our potential
competitors, have longer operating histories, greater name recognition, broader customer
relationships and industry alliances and substantially greater financial, technical and marketing
resources than we do. As a consequence of the competitive dynamics in our market we have
experienced reductions in our prices, which in turn adversely affect our revenue, gross margin and
operating results.
Our primary competitors include content delivery service providers such as Akamai, Level
3 Communications, AT&T, CDNetworks and Internap Network Services Corporation, which acquired
VitalStream. Also, as a result of the growth of the content delivery market, a number of companies
are currently attempting to enter our market, either directly or indirectly, some of which may
become significant competitors in the future. Our competitors may be able to respond more quickly
than we can to new or emerging technologies and changes in customer requirements. Given the
relative ease by which customers typically can switch among CDN providers, differentiated offerings
or pricing by competitors could lead to a rapid loss of customers. Some of our current or potential
competitors may bundle their offerings with other services, software or hardware in a manner that
may discourage content providers from purchasing the services that we offer. In addition, as we
expand internationally, we face different market characteristics and competition with local content
delivery service providers, many of which are very well positioned within their local markets.
Increased competition could result in price reductions and revenue shortfalls, loss of customers
and loss of market share, which could harm our business, financial condition and results of
operations.
We may lose customers if they elect to develop content delivery solutions internally.
Our customers and potential customers may decide to develop their own content delivery
solutions rather than outsource these solutions to CDN services providers like us. This is
particularly true as our customers increase their operations and begin expending greater resources
on delivering their content using third-party solutions. For example, in 2006, one customer within
our top 10 customers, MySpace.com, which was contracted through a reseller of our services, CDN
Consulting, accounted for approximately 21% of our total revenue for that period. At the end of
2006, MySpace became a direct customer of ours. During 2007, sales to the MySpace.com were
approximately 3% of our total revenue. For the year ended December 31, 2007, sales to the reseller
CDN Consulting were less than 1% of revenue after this change. For the nine-month period ended
September 30, 2008, revenue from MySpace.com and CDN Consulting was less than 2% of our total
revenue, respectively. If we fail to offer CDN services that are competitive to in-sourced
solutions, we may lose additional customers or fail to attract customers that may consider pursuing
this in-sourced approach, and our business and financial results would suffer.
We may lose customers if they are unable to build business models that effectively monetize
delivery of their content.
Our customers may not be successful in selling advertising or otherwise monetizing the
content we delivery on their behalf and consequently may not be successful in creating a profitable
business model. This may result in some of our customers discontinuing their internet or web-based
business operations and discontinuing use of our services and products. For example, during the
three-month period ended March 31, 2008, a significant customer discontinued it website business
and ceased using our CDN services. We expect further customers may similarly discontinue
operations. Further loss of customers may adversely affect our financial results.
Rapidly evolving technologies or new business models could cause demand for our CDN services to
decline or could cause these services to become obsolete.
Customers or third parties may develop technological or business model innovations that
address content delivery requirements in a manner that is, or is perceived to be, equivalent or
superior to our CDN services. If competitors introduce new products or services that compete with
or surpass the quality or the price/performance of our services, we may be unable to renew our
agreements with existing customers or attract new customers at the prices and levels that allow us
to generate attractive rates of return on our investment. For example, one or more third parties
might develop improvements to current peer-to-peer technology, which is a technology that relies
upon the computing power and bandwidth of its participants, such that this technological approach
is better able to deliver content in a way that is competitive to our CDN services, or even that
makes CDN services obsolete. We may not anticipate such developments and may be unable to
adequately compete with these potential solutions. In addition, our customers’ business models may
change in ways that we do not anticipate and these changes could reduce or eliminate our customers’
needs for CDN services. If this occurred, we could lose customers or potential customers, and our
business and financial results would suffer. As a result of these or similar potential
developments, in the future it is possible that competitive dynamics in our market may require us
to reduce our prices, which could harm our revenue, gross margin and operating results.
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If we are unable to sell our services at acceptable prices relative to our costs, our revenue and
gross margins will decrease, and our
business and financial results will suffer.
Prices for content delivery services have fallen in recent years and are likely to fall
further in the future. We have invested significant amounts in purchasing capital equipment to
increase the capacity of our content delivery services. For example, in 2006 we invested
$40.6 million in capital expenditures and $22.7 million in capital expenditures during 2007,
primarily for computer equipment associated with the build-out and expansion of our CDN. For the
nine-month period ended September 30, 2008, we invested $14.9 million. Our investments in our
infrastructure are based upon our assumptions regarding future demand and also prices that we will
be able to charge for our services. These assumptions may prove to be wrong. If the price that we
are able to charge customers to deliver their content falls to a greater extent than we anticipate,
if we over-estimate future demand for our services or if our costs to deliver our services do not
fall commensurate with any future price declines, we may not be able to achieve acceptable rates of
return on our infrastructure investments and our gross profit and results of operations may suffer
dramatically.
In addition, during 2008 and beyond, we expect to increase our expenses, in absolute
dollars, in substantially all areas of our business, including sales and marketing, general and
administrative, and research and development. During 2008 and 2009, as we further expand our CDN,
and we begin to refresh our network equipment, we also expect our capital expenditures to be
generally consistent with the high level of expenditures we made in this area in 2006 and 2007. As
a consequence, we are dependent on significant future growth in demand for our services to provide
the necessary gross profit to pay these additional expenses. If we fail to generate significant
additional demand for our services, our results of operations will suffer and we may fail to
achieve planned or expected financial results. There are numerous factors that could, alone or in
combination with other factors, impede our ability to increase revenue, moderate expenses or
maintain gross margins, including:
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failure to increase sales of our core services; |
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significant increases in bandwidth and rack space costs or other operating expenses; |
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inability to maintain our prices relative to our costs; |
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failure of our current and planned services and software to operate as expected; |
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loss of any significant customers or loss of existing customers at a rate greater than our
increase in new customers or our sales to existing customers; |
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failure to increase sales of our services to current customers as a result of their ability to reduce
their monthly usage of our services to their minimum monthly contractual commitment; |
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failure of a significant number of customers to pay our fees on a timely basis or at all or failure to
continue to purchase our services in accordance with their contractual commitments; and |
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inability to attract high-quality customers to purchase and implement our current and planned services. |
If we are unable to develop new services and enhancements to existing services or fail to predict
and respond to emerging technological trends and customers’ changing needs, our operating results
may suffer.
The market for our CDN services is characterized by rapidly changing technology, evolving
industry standards and new product and service introductions. Our operating results depend on our
ability to develop and introduce new services into existing and emerging markets. The process of
developing new technologies is complex and uncertain. We must commit significant resources to
developing new services or enhancements to our existing services before knowing whether our
investments will result in services the market will accept. For example, during 2007 we introduced
our Geo-Compliance paid service option, and we do not yet know whether our customers will adopt
this offering in sufficient numbers to justify our development costs. Furthermore, we may not
execute successfully our technology initiatives because of errors in planning or timing, technical
hurdles that we fail to overcome in a timely fashion, misunderstandings about market demand or a
lack of appropriate resources. Failures in execution or market acceptance of new services we
introduce could result in competitors providing those solutions before we do, which could lead to
loss of market share, revenue and earnings.
We depend on a limited number of customers for a substantial portion of our revenue in any fiscal
period, and the loss of, or a significant shortfall in demand from, these customers could
significantly harm our results of operations.
During any given fiscal period, a relatively small number of customers typically account
for a significant percentage of our revenue. For example, in 2007, sales to our top 10 customers,
in terms of revenue, accounted for approximately 45% of our total revenue. For the nine month
period ended September 30, 2008, sales to our top 10 customers, in terms of revenue, accounted for
approximately 42% of our total revenue. During 2007 one of these top 10 customers, Microsoft,
represented approximately 12% of our total revenue for that period. For the nine-month period ended
September 30, 2008, one of these top 10 customers, Microsoft, represented approximately 18% of our
total revenue for that period. In the past, the customers that comprised our top 10 customers
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have continually changed, and we also have experienced significant fluctuations in our individual
customers’ usage of our services. As a consequence, we may not be able to adjust our expenses in
the short term to address the unanticipated loss of a large customer during any particular period.
As such, we may experience significant, unanticipated fluctuations in our operating results which
may cause us to not meet our expectations or those of stock market analysts, which could cause our
stock price to decline.
If we are unable to attract new customers or to retain our existing customers, our revenue could be
lower than expected and our operating results may suffer.
In addition to adding new customers, to increase our revenue, we must sell additional
services to existing customers and encourage existing customers to increase their usage levels. If
our existing and prospective customers do not perceive our services to be of sufficiently high
value and quality, we may not be able to retain our current customers or attract new customers. We
sell our services pursuant to service agreements that generally include some form of financial
minimum commitment. Our customers have no obligation to renew their contracts for our services
after the expiration of their initial commitment, and these service agreements may not be renewed
at the same or higher level of service, if at all. Moreover, under some circumstances, some of our
customers have the right to cancel their service agreements prior to the expiration of the terms of
their agreements. Because of our limited operating history, we have limited historical data with
respect to rates of customer service agreement renewals. This fact, in addition to the changing
competitive landscape in our market, means that we cannot accurately predict future customer
renewal rates. Our customers’ renewal rates may decline or fluctuate as a result of a number of
factors, including:
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their satisfaction or dissatisfaction with our services; |
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the prices of our services; |
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the prices of services offered by our competitors; |
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Discontinuation by our customers of their internet or web-based content distribution business; |
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mergers and acquisitions affecting our customer base; and |
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reductions in our customers’ spending levels. |
If our customers do not renew their service agreements with us or if they renew on less
favorable terms, our revenue may decline and our business will suffer. Similarly, our customer
agreements often provide for minimum commitments that are often significantly below our customers’
historical usage levels. Consequently, even if we have agreements with our customers to use our
services, these customers could significantly curtail their usage without incurring any penalties
under our agreements. In this event, our revenue would be lower than expected and our operating
results could suffer.
It also is an important component of our growth strategy to market our CDN services to
industries, such as enterprise and the government. As an organization, we do not have significant
experience in selling our services into these markets. We have only recently begun a number of
these initiatives, and our ability to successfully sell our services into these markets to a
meaningful extent remains unproven. If we are unsuccessful in such efforts, our business, financial
condition and results of operations could suffer.
Our results of operations may fluctuate in the future. As a result, we may fail to meet or exceed
the expectations of securities analysts or investors, which could cause our stock price to decline.
Our results of operations may fluctuate as a result of a variety of factors, many of
which are outside of our control. If our results of operations fall below the expectations of
securities analysts or investors, the price of our common stock could decline substantially. In
addition to the effects of other risks discussed in this section, fluctuations in our results of
operations may be due to a number of factors, including:
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our ability to increase sales to existing customers and attract new customers to our CDN services; |
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the addition or loss of large customers, or significant variation in their use of our CDN services; |
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costs associated with current or future intellectual property lawsuits and other lawsuits; |
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service outages or security breaches; |
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the amount and timing of operating costs and capital expenditures related to the maintenance and
expansion of our business, operations and infrastructure; |
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the timing and success of new product and service introductions by us or our competitors; |
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the occurrence of significant events in a particular period that result in an increase in the use of
our CDN services, such as a major media event or a customer’s online release of a new or updated
video game; |
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changes in our pricing policies or those of our competitors; |
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the timing of recognizing revenue; |
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share-based compensation expenses associated with attracting and retaining key personnel; |
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limitations of the capacity of our content delivery network and related systems; |
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the timing of costs related to the development or acquisition of technologies, services or businesses; |
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general economic, industry and market conditions (such as the fluctuations experienced in the stock
and credit markets during the third quarter and of 2008) and those conditions specific to Internet
usage and online businesses; |
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limitations on usage imposed by our customers in order to limit their online expenses; and |
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geopolitical events such as war, threat of war or terrorist actions. |
We believe that our revenue and results of operations may vary significantly in the future and
that period-to-period comparisons of our operating results may not be meaningful. You should not
rely on the results of one period as an indication of future performance.
After being profitable in 2004 and 2005, we were unprofitable in 2006, 2007 and year to date 2008
primarily due in part to increased stock-based compensation expense and litigation costs, which
could affect our ability to achieve and maintain profitability in the future.
Our adoption of SFAS 123R in 2006 substantially increased the amount of share-based
compensation expense we record and has had a significant impact on our results of operations. After
being profitable in 2004 and 2005, we were unprofitable in 2006 and 2007 and for the nine-month
period ended September 30, 2008 partially due to an increase in our share-based compensation
expense which increased from $0.1 million in 2005 to $9.2 million in 2006 and further increased to
$18.9 million in 2007. For the nine month period ended September 30, 2008 our share-based
compensation expense was $12.5 million. This significant increase in share-based compensation
expense reflects an increase in the level of option and restricted stock grants coupled with a
significant increase in the fair market value per share at the date of grant. Our unrecognized
share-based compensation expense totaled $42.8 million at September 30, 2008, of which we expect to
amortize $5.6 million during the remainder of 2008, $16.8 million in 2009 and the remainder
thereafter based upon the scheduled vesting of the options outstanding at that time. We further
expect our share-based compensation expense to increase in 2008 and potentially to increase
thereafter as we grant additional options or restricted stock awards. The increased share-based
compensation expense could adversely affect our ability to achieve and maintain profitability in
the future. In 2006, we were sued by Akamai and MIT alleging infringement of certain patents. In
December 2007 we were sued by Level 3 Communications alleging infringement of certain patents; and
in April 2008 we were sued by Two Way Media also alleging infringement of certain patents. We have
incurred, and will continue to incur, significant costs associated with litigation. These costs
were $6.8 million and $3.2 million in 2007 and 2006, respectively. For the nine month period ended
September 30, 2008 we incurred $16.2 million in litigation costs. We expect these costs will
continue to increase during the remainder of 2008.
We generate our revenue almost entirely from the sale of CDN services, and the failure of the
market for these services to expand as we expect or the reduction in spending on those services by
our current or potential customers would seriously harm our business.
While we offer our customers a number of services associated with our CDN, we generated
nearly 100% of our revenue in 2007 and for the nine months ended September 30, 2008, from charging
our customers for the content delivered on their behalf through our CDN. As we do not currently
have other meaningful sources of revenue, we are subject to an elevated risk of reduced demand for
these services. Furthermore, if the market for delivery of rich media content in particular does
not continue to grow as we expect or grows more slowly, then we may fail to achieve a return on the
significant investment we are making to prepare for this growth. Our success, therefore, depends on
the continued and increasing reliance on the Internet for delivery of media content and our ability
to cost-effectively deliver these services. Factors that may have a general tendency to limit or
reduce the number of users relying on the Internet for media content or the number of providers
making this content available online include a general decline in Internet usage, litigation
involving our customers and third-party restrictions on online content, including copyright
restrictions, digital rights management and restrictions in certain geographic regions, as well as
a significant increase in the quality or fidelity of offline media content beyond that available
online to the point where users prefer the offline experience. The influence of any of these
factors may cause our current or potential customers to reduce their spending on CDN services,
which would seriously harm our operating results and financial condition.
Many of our significant current and potential customers are pursuing emerging or unproven business
models which, if unsuccessful, could lead to a substantial decline in demand for our CDN services.
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Because the proliferation of broadband Internet connections and the subsequent
monetization of content libraries for distribution to Internet users are relatively recent
phenomena, many of our customers’ business models that center on the delivery of rich media and
other content to users remain unproven. For example, social media companies have been among our top
recent customers and are pursuing emerging strategies for monetizing the user content and traffic
on their web sites. Our customers will not continue to purchase our CDN services if their
investment in providing access to the media stored on or deliverable through our CDN does not
generate a sufficient return on their investment. A reduction in spending on CDN services by our
current or potential customers would seriously harm our operating results and financial condition.
Our business will be adversely affected if we are unable to protect our intellectual property
rights from unauthorized use or infringement by third parties.
We rely on a combination of patent, copyright, trademark and trade secret laws and
restrictions on disclosure to protect our intellectual property rights. These legal protections
afford only limited protection, and we have only one currently issued patent. Monitoring
infringement of our intellectual property rights is difficult, and we cannot be certain that the
steps we have taken will prevent unauthorized use of our intellectual property rights. We have
applied for patent protection in a number of foreign countries, but the laws in these jurisdictions
may not protect our proprietary rights as fully as in the United States. Furthermore, we cannot be
certain that any pending or future patent applications will be granted, that any future patent will
not be challenged, invalidated or circumvented, or that rights granted under any patent that may be
issued will provide competitive advantages to us.
Any unplanned interruption in the functioning of our network or services could lead to significant
costs and disruptions that could reduce our revenue and harm our business, financial results and
reputation.
Our business is dependent on providing our customers with fast, efficient and reliable
distribution of application and content delivery services over the Internet. Many of our customers
depend primarily or exclusively on our services to operate their businesses. Consequently, any
disruption of our services could have a material impact on our customers’ businesses. Our network
or services could be disrupted by numerous events, including natural disasters, failure or refusal
of our third-party network providers to provide the necessary capacity, failure of our software or
CDN delivery infrastructure and power losses. In addition, we deploy our servers in approximately
68 third-party co-location facilities, and these third-party co-location providers could experience
system outages or other disruptions that could constrain our ability to deliver our services. We
may also experience disruptions caused by software viruses or other attacks by unauthorized users.
While we have not experienced any significant, unplanned disruption of our services to
date, our CDN may fail in the future. Despite our significant infrastructure investments, we may
have insufficient communications and server capacity to address these or other disruptions, which
could result in interruptions in our services. Any widespread interruption of the functioning of
our CDN and related services for any reason would reduce our revenue and could harm our business
and financial results. If such a widespread interruption occurred or if we failed to deliver
content to users as expected during a high-profile media event, game release or other
well-publicized circumstance, our reputation could be damaged severely. Moreover, any disruptions
could undermine confidence in our services and cause us to lose customers or make it more difficult
to attract new ones, either of which could harm our business and results of operations.
We may have difficulty scaling and adapting our existing architecture to accommodate increased
traffic and technology advances or changing business requirements, which could lead to the loss of
customers and cause us to incur unexpected expenses to make network improvements.
Our CDN services are highly complex and are designed to be deployed in and across
numerous large and complex networks. Our network infrastructure has to perform well and be reliable
for us to be successful. The greater the user traffic and the greater the complexity of our
products and services, the more resources we will need to invest in additional infrastructure and
support. Further, we have made significant investment in designing and implementing changes to our
CDN architecture in order to implement our CDN services in a manner we believe do not infringe the
claims of Akamai’s ‘703 patent as alleged in the February 2008 trial. We have spent and expect to
continue to spend substantial amounts on the purchase and lease of equipment and data centers and
the upgrade of our technology and network infrastructure to handle increased traffic over our
network, implement changes to our CDN architecture and to roll out new products and services. This
expansion is expensive and complex and could result in inefficiencies, operational failures or
defects in our network and related software. If we do not implement such changes or expand
successfully, or if we experience inefficiencies and operational failures, the quality of our
products and services and user experience could decline. From time to time, we have needed to
correct errors and defects in our software or in other aspects of our CDN. In the future, there may
be additional errors and defects that may harm our ability to deliver our services, including
errors and defects originating with third party networks or software on which we rely. These
occurrences could damage our reputation and lead us to lose current and potential customers. We
must continuously upgrade our infrastructure in order to keep pace with our customers’ evolving
demands. Cost increases or the failure to accommodate increased traffic or these evolving business
demands without disruption could harm our operating results and financial condition.
Our operations are dependent in part upon communications capacity provided by third-party
telecommunications providers. A material disruption of the communications capacity we have leased
could harm our results of operations, reputation and customer relations.
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We lease private line capacity for our backbone from a third party provider, Global
Crossing Ltd. Our contracts for private line capacity with Global Crossing generally have terms of
three years. The communications capacity we have leased may become unavailable for a variety of
reasons, such as physical interruption, technical difficulties, contractual disputes, or the
financial health of our third party provider. As it would be time consuming and expensive to
identify and obtain alternative third-party connectivity, we are dependent on Global Crossing in
the near term. Additionally, as we grow, we anticipate requiring greater private line capacity than
we currently have in place. If we are unable to obtain such capacity on terms commercially
acceptable to us or at all, our business and financial results would suffer. We may not be able to
deploy on a timely basis enough network capacity to meet the needs of our customer base or
effectively manage demand for our services.
Our business depends on continued and unimpeded access to third-party controlled end-user access
networks.
Our content delivery services depend on our ability to access certain end-user access
networks in order to complete the delivery of rich media and other online content to end-users.
Some operators of these networks may take measures, such as the deployment of a variety of filters,
that could degrade, disrupt or increase the cost of our or our customers’ access to certain of
these end-user access networks by restricting or prohibiting the use of their networks to support
or facilitate our services, or by charging increased fees to us, our customers or end-users in
connection with our services. This or other types of interference could result in a loss of
existing customers, increased costs and impairment of our ability to attract new customers, thereby
harming our revenue and growth.
In addition, the performance of our infrastructure depends in part on the direct
connection of our CDN to a large number of end-user access networks, known as peering, which we
achieve through mutually beneficial cooperation with these networks. If in the future a significant
percentage of these network operators elected to no longer peer with our CDN, the performance of
our infrastructure could be diminished and our business could suffer.
If our ability to deliver media files in popular proprietary content formats was restricted or
became cost-prohibitive, demand for our content delivery services could decline, we could lose
customers and our financial results could suffer.
Our business depends on our ability to deliver media content in all major formats. If our
legal right or technical ability to store and deliver content in one or more popular proprietary
content formats, such as Adobe Flash or Windows Media, was limited, our ability to serve our
customers in these formats would be impaired and the demand for our content delivery services would
decline by customers using these formats. Owners of propriety content formats may be able to block,
restrict or impose fees or other costs on our use of such formats, which could lead to additional
expenses for us and for our customers, or which could prevent our delivery of this type of content
altogether. Such interference could result in a loss of existing customers, increased costs and
impairment of our ability to attract new customers, which would harm our revenue, operating results
and growth.
If we are unable to retain our key employees and hire qualified sales and technical personnel, our
ability to compete could be harmed.
Our future success depends upon the continued services of our executive officers and
other key technology, sales, marketing and support personnel who have critical industry experience
and relationships that they rely on in implementing our business plan. In particular, we are
dependent on the services of our Chief Executive Officer, Jeffrey W. Lunsford and also our Chief
Technical Officer, Nathan F. Raciborski. Neither of these officers nor any of our other key
employees is bound by an employment agreement for any specific term. In addition, we do not have
“key person” life insurance policies covering any of our officers or other key employees, and we
therefore have no way of mitigating our financial loss were we to lose their services. There is
increasing competition for talented individuals with the specialized knowledge to deliver content
delivery services and this competition affects both our ability to retain key employees and hire
new ones. The loss of the services of any of our key employees could disrupt our operations, delay
the development and introduction of our services, and negatively impact our ability to sell our
services.
Our senior management team has limited experience working together as a group, and may not be able
to manage our business effectively.
Four members of our senior management team, our President and Chief Executive Officer,
Jeffrey W. Lunsford, our Chief Financial Officer, Doug Lindroth, our Senior Vice President of
Worldwide Sales, Marketing and Services, David M. Hatfield, and our Senior Vice President and Chief
Legal Officer, Philip C. Maynard, have been hired since November 2006. As a result, our senior
management team has limited experience working together as a group. This lack of shared experience
could harm our senior management team’s ability to quickly and efficiently respond to problems and
effectively manage our business. In July 2008, we announced that
Matthew Hale our former Chief Financial Officer will be leaving the
Company by December 31, 2008; and in October 2008 Mr. Lindroth, a member of our board of directors
since February 2008, resigned from our board and succeeded Mr.
Hale as our Chief Financial Officer.
We face risks associated with international operations that could harm our business.
We have operations, equipment and personnel in the United States, Japan and the United
Kingdom, and we currently maintain network equipment in Australia, Canada, France, Germany, Hong
Kong, Singapore, Ireland, Japan, Sweden, the Netherlands, Italy and
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Spain. As part of our growth strategy, we intend to expand our sales and support organizations
internationally, as well as to further expand our international network infrastructure. We have
limited experience in providing our services internationally and such expansion could require us to
make significant expenditures, including the hiring of local employees, in advance of generating
any revenue. As a consequence, we may fail to achieve profitable operations that will compensate
our investment in international locations. We are subject to a number of risks associated with
international business activities that may increase our costs, lengthen our sales cycle and require
significant management attention.
These risks include:
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increased expenses associated with sales and marketing, deploying services and maintaining
our infrastructure in foreign countries; |
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competition from local content delivery service providers, many of which are very well
positioned within their local markets; |
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unexpected changes in regulatory requirements resulting in unanticipated costs and delays; |
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interpretations of laws or regulations that would subject us to regulatory supervision or,
in the alternative, require us to exit a country, which could have a negative impact on the
quality of our services or our results of operations; |
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longer accounts receivable payment cycles and difficulties in collecting accounts receivable; |
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corporate and personal liability for violations of local laws and regulations; |
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currency exchange rate fluctuations; and |
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potentially adverse tax consequences. |
Internet-related and other laws relating to taxation issues, privacy and consumer protection and
liability for content distributed over our network, could harm our business.
Laws and regulations that apply to communications and commerce conducted over the
Internet are becoming more prevalent, both in the United States and internationally, and may impose
additional burdens on companies conducting business online or providing Internet-related services
such as ours. Increased regulation could negatively affect our business directly, as well as the
businesses of our customers, which could reduce their demand for our services. For example, tax
authorities abroad may impose taxes on the Internet-related revenue we generate based on where our
internationally deployed servers are located. In addition, domestic and international taxation laws
are subject to change. Our services, or the businesses of our customers, may become subject to
increased taxation, which could harm our financial results either directly or by forcing our
customers to scale back their operations and use of our services in order to maintain their
operations. In addition, the laws relating to the liability of private network operators for
information carried on or disseminated through their networks are unsettled, both in the United
States and abroad. Network operators have been sued in the past, sometimes successfully, based on
the content of material disseminated through their networks. We may become subject to legal claims
such as defamation, invasion of privacy and copyright infringement in connection with content
stored on or distributed through our network. In addition, our reputation could suffer as a result
of our perceived association with the type of content that some of our customers deliver. If we
need to take costly measures to reduce our exposure to these risks, or are required to defend
ourselves against such claims, our financial results could be negatively affected.
If we are required to seek additional funding, such funding may not be available on acceptable
terms or at all.
We may need to obtain additional funding due to a number of factors beyond our control,
including a shortfall in revenue, increased expenses, final adverse judgments in litigation
matters, increase investment in capital equipment or the acquisition of significant businesses or
technologies. We believe that our cash, plus cash from operations will be sufficient to fund our
operations
and proposed capital expenditures for at least the next 12 months. However, we may need funding
before such time. If we do need to obtain funding, it may not be available on commercially
reasonable terms or at all. If we are unable to obtain sufficient funding, our business would be
harmed. Even if we were able to find outside funding sources, we might be required to issue
securities in a transaction that could be highly dilutive to our investors or we may be required to
issue securities with greater rights than the securities we have outstanding today. We might also
be required to take other actions that could lessen the value of our common stock, including
borrowing money on terms that are not favorable to us. If we are unable to generate or raise
capital that is sufficient to fund our operations, we may be required to curtail operations, reduce
our capabilities or cease operations in certain jurisdictions or completely. Further, the
availability of our current cash will be adversely affected if we are required to provide security
for the recent jury verdict in the Akamai trial in connection with an appeal or a stay of
injunction, should an appeal of a final judgment in favor of Akamai be required or an injunction
and stay thereof be issued.
Our business requires the continued development of effective business support systems to support
our customer growth and related services.
40
The growth of our business depends on our ability to continue to develop effective
business support systems. This is a complicated undertaking requiring significant resources and
expertise. Business support systems are needed for:
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implementing customer orders for services; |
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delivering these services; and |
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timely billing for these services. |
Because our business plan provides for continued growth in the number of customers that we
serve and services offered, there is a need to continue to develop our business support systems on
a schedule sufficient to meet proposed service rollout dates. The failure to continue to develop
effective business support systems could harm our ability to implement our business plans and meet
our financial goals and objectives.
Changes in financial accounting standards or practices may cause adverse, unexpected financial
reporting fluctuations and affect our reported results of operations.
A change in accounting standards or practices can have a significant effect on our
operating results and may affect our reporting of transactions completed before the change is
effective. New accounting pronouncements and varying interpretations of existing accounting
pronouncements have occurred and may occur in the future. Changes to existing rules or the
questioning of current practices may adversely affect our reported financial results or the way we
conduct our business. For example, our recent adoption of SFAS 123R in 2006 has increased the
amount of stock-based compensation expense we record. This, in turn, has impacted our results of
operations for the periods since this adoption and has made it more difficult to evaluate our
recent financial results relative to prior periods.
We have incurred, and will continue to incur significantly increased costs as a result of operating
as a public company, and our management is required to devote substantial time to compliance
initiatives.
As a public company, we have incurred, and will continue to incur, significant accounting
and other expenses that we did
not incur as a private company. These expenses include increased accounting, legal and other
professional fees, insurance premiums, investor relations costs, and costs associated with
compensating our independent directors. In addition, the Sarbanes-Oxley Act of 2002, as well as
rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq Global
Market, impose additional requirements on public companies, including requiring changes in
corporate governance practices. For example, the listing requirements of the Nasdaq Global Market
require that we satisfy certain corporate governance requirements relating to independent
directors, audit committees, distribution of annual and interim reports, stockholder meetings,
stockholder approvals, solicitation of proxies, conflicts of interest, stockholder voting rights
and codes of conduct. Our management and other personnel need to devote a substantial amount of
time to these compliance initiatives. Moreover, these rules and regulations have increased our
legal and financial compliance costs and make some activities more time-consuming and costly. For
example, these rules and regulations make it more difficult and more expensive for us to obtain
director and officer liability insurance. These rules and regulations could also make it more
difficult for us to identify and retain qualified persons to serve on our board of directors, our
board committees or as executive officers.
Failure to effectively expand our sales and marketing capabilities could harm our ability to
increase our customer base and achieve broader market acceptance of our services.
Increasing our customer base and achieving broader market acceptance of our services will
depend to a significant extent on our ability to expand our sales and marketing operations.
Historically, we have concentrated our sales force at our headquarters in Tempe, Arizona. However,
we have recently begun building a field sales force to augment our sales efforts and to bring our
sales personnel closer to our current and potential customers. Developing such a field sales force
will be expensive and we have limited knowledge in developing and operating a widely dispersed
sales force. As a result, we may not be successful in developing an effective sales force, which
could cause our results of operations to suffer.
We believe that there is significant competition for both inside and direct sales
personnel with the sales skills and technical knowledge that we require. Our ability to achieve
significant growth in revenue in the future will depend, in large part, on our success in
recruiting, training and retaining sufficient numbers of inside and direct sales personnel. We have
expanded our sales and marketing personnel from a total of 13 at December 31, 2004 to 121 at
December 31, 2007. As of September 30, 2008, we had 136 sales and marketing personnel. New hires
require significant training and, in most cases, take a significant period of time before they
achieve full productivity. Our recent hires and planned hires may not become as productive as we
would like, and we may be unable to hire or retain sufficient numbers of qualified individuals in
the future in the markets where we do business. Our business will be seriously harmed if these
expansion efforts do not generate a corresponding significant increase in revenue.
41
If the estimates we make, and the assumptions on which we rely, in preparing our financial
statements prove inaccurate, our
actual results may be adversely affected.
Our financial statements have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial statements requires us
to make estimates and judgments about, among other things, taxes, revenue recognition, share-based
compensation costs, contingent obligations and doubtful accounts. These estimates and judgments
affect the reported amounts of our assets, liabilities, revenue and expenses, the amounts of
charges accrued by us, and related disclosure of contingent assets and liabilities. We base our
estimates on historical experience and on various other assumptions that we believe to be
reasonable under the circumstances and at the time they are made. If our estimates or the
assumptions underlying them are not correct, we may need to accrue additional charges that could
adversely affect our results of operations, investors may lose confidence in our ability to manage
our business and our stock price could decline.
As part of our business strategy, we may acquire businesses or technologies and may have difficulty
integrating these operations.
We may seek to acquire businesses or technologies that are complementary to our business.
Acquisitions involve a number of risks to our business, including the difficulty of integrating the
operations and personnel of the acquired companies, the potential disruption of our ongoing
business, the potential distraction of management, expenses related to the acquisition and
potential unknown liabilities associated with acquired businesses. Any inability to integrate
operations or personnel in an efficient and timely manner could harm our results of operations. We
do not have prior experience as a company in this complex process of acquiring and integrating
businesses. If we are not successful in completing acquisitions that we may pursue in the future,
we may be required to reevaluate our business strategy, and we may incur substantial expenses and
devote significant management time and resources without a productive result. In addition, future
acquisitions will require the use of our available cash or dilutive issuances of securities. Future
acquisitions or attempted acquisitions could also harm our ability to achieve profitability. We may
also experience significant turnover from the acquired operations or from our current operations as
we integrate businesses.
Risks Related to Ownership of Our Common Stock
The trading price of our common stock has been, and is likely to continue to be, volatile.
The trading prices of our common stock and the securities of technology companies
generally have been highly volatile. Factors affecting the trading price of our common stock will
include:
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variations in our operating results; |
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announcements of technological innovations, new services or service enhancements, strategic
alliances or significant agreements by us or by our competitors; |
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commencement or resolution of, or our involvement in, litigation, particularly our current
litigation with Akamai and MIT, Level 3 Communications, and our Securities Litigation matter; |
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• |
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recruitment or departure of key personnel; |
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• |
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changes in the estimates of our operating results or changes in recommendations by any securities
analysts that elect to follow our common stock; |
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developments or disputes concerning our intellectual property or other proprietary rights; |
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• |
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the gain or loss of significant customers; |
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market conditions in our industry, the industries of our customers and the economy as a whole; and |
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adoption or modification of regulations, policies, procedures or programs applicable to our business. |
In addition, if the market for technology stocks or the stock market in general experiences
loss of investor confidence, the trading price of our common stock could decline for reasons
unrelated to our business, operating results or financial condition. The trading price of our
common stock might also decline in reaction to events that affect other companies in our industry
even if these events do not directly affect us.
42
We are currently subject to a securities class action lawsuit, the unfavorable outcome of which
might have a material adverse effect on our financial condition, results of operations and cash
flows.
A putative class action lawsuit has been filed against us, certain of our officers and
directors, and the lead underwriters of our recent initial public offering, alleging, among other
things, securities laws violations. On March 17, 2008, we and the individual
defendants moved to dismiss all of the plaintiffs’ claims. On August 8, 2008, the court granted the
motion to dismiss, dismissing certain of plaintiffs’ claims with prejudice and granting leave
to amend other claims. Plaintiffs chose not to amend its claims, and on August 29, 2008 the court
entered judgment in favor of us. On September 5, 2008 Plaintiffs filed a notice of appeal. While
we intend to vigorously contest this lawsuit and any similar lawsuits filed against us in the
future, we cannot determine the final outcome or resolution of these claims or when they might be
resolved. In addition to the expense and burden incurred in defending this litigation and any
damages that we may suffer, our management’s efforts and attention may be diverted from the
ordinary business operations in order to address these claims. If the final resolution of this
litigation is unfavorable to us, our financial condition, results of operations and cash flows may
be materially adversely affected if our existing insurance coverage is unavailable or inadequate to
resolve the matter.
If securities or industry analysts do not publish research or reports about our business or if they
issue an adverse or misleading opinion regarding our stock, our stock price and trading volume
could decline.
The trading market for our common stock will be influenced by the research and reports
that industry or securities analysts publish about us or our business. If any of the analysts who
cover us issue an adverse or misleading opinion regarding our stock, our stock price would likely
decline. If one or more of these analysts cease coverage of our company or fail to publish reports
on us regularly, we could lose visibility in the financial markets, which in turn could cause our
stock price or trading volume to decline.
Insiders have substantial control over us and will be able to influence corporate matters.
As of September 30, 2008, our directors and executive officers and their affiliates
beneficially owned, in the aggregate, approximately 53% of our outstanding common stock, including
approximately 36% beneficially owned by investment entities affiliated with Goldman, Sachs & Co. As
a result, these stockholders will be able to exercise significant influence over all matters
requiring stockholder approval, including the election of directors and approval of significant
corporate transactions, such as a merger or other sale of our company or its assets. This
concentration of ownership could limit other stockholders’ ability to influence corporate matters
and may have the effect of delaying or preventing a third party from acquiring control over us.
Anti-takeover provisions in our charter documents and Delaware law could discourage, delay or
prevent a change in control of our company and may affect the trading price of our common stock.
We are a Delaware corporation and the anti-takeover provisions of the Delaware General
Corporation Law may discourage, delay or prevent a change in control by prohibiting us from
engaging in a business combination with an interested stockholder for a period of three years after
the person becomes an interested stockholder, even if a change in control would be beneficial to
our existing stockholders. In addition, our certificate of incorporation and bylaws may discourage,
delay or prevent a change in our management or control over us that stockholders may consider
favorable. Our certificate of incorporation and bylaws:
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authorize the issuance of “blank check” preferred stock that could be
issued by our board of directors to thwart a takeover attempt; |
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provide for a classified board of directors, as a result of which the
successors to the directors whose terms have expired will be elected
to serve from the time of election and qualification until the third
annual meeting following their election; |
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require that directors only be removed from office for cause and only upon a majority stockholder vote; |
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provide that vacancies on the board of directors, including newly created directorships, may be filled only by a
majority vote of directors then in office; |
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limit who may call special meetings of stockholders; |
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prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders; and |
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require supermajority stockholder voting to effect certain amendments to our certificate of incorporation and bylaws. |
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On June 7, 2007, our registration statement on Form S-1 (No. 333-141516) was declared
effective in connection with our initial public offering. The offering closed on June 13, 2007,
and, as a result, we received net proceeds of approximately $203.9 million after underwriters’
discounts and commissions of approximately $15.6 million and additional offering-related costs of
approximately $4.0 million.
43
In June 2007, we used $23.8 million of the net proceeds to repay the outstanding balance
of our credit facility with Silicon Valley
Bank. We expect to use the remaining net proceeds for capital expenditures, working capital and
other general corporate purposes. For the nine month period ended September 30, 2008, we made
capital expenditures of $14.9 million and expect total expenditures for the full year 2008 to be
between $19.0 million and $20.0 million. We may also use a portion of our net proceeds to fund
acquisitions of complementary businesses, products or technologies. However, we do not have
agreements or commitments for any specific acquisitions at this time. Pending the uses described
above, we intend to invest the net proceeds in a variety of short-term, interest-bearing,
investment grade securities. Depending upon the final outcome of pending litigation, including the
Akamai patent litigation, a portion of the net proceeds may be used to satisfy a final damages
judgment, if any.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
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Incorporated by Reference |
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| Exhibit |
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Filing |
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Provided |
| Number |
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Exhibit Description |
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Form |
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File No. |
|
Exhibit |
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Date |
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Herewith |
3.02
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Amended and Restated Certificate of Incorporation of
Limelight Networks, Inc.
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S-1
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333-141516
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3.2 |
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5/21/07 |
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3.04
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Amended and Restated Bylaws of Limelight
Networks, Inc.
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S-1
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333-141516
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3.4 |
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3/22/07 |
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10.5.01
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Amended and Restated Employment Agreement between
the Registrant and Matthew Hale dated
July 9, 2008.
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8-K
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001-33508
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99.1 |
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7/10/08 |
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10.15.01
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Amendment to Edge Computing Network Service and
License Agreement between Limelight Networks,
Inc.
and Microsoft Corporation dated October 1, 2008. †
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X |
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10.17
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Employment Agreement between the Registrant and
Nathan F. Raciborski dated September 22, 2008.
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8-K
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001-33508
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99.1 |
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9/23/08 |
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10.18
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Employment Agreement between the Registrant and
Michael M. Gordon dated September 22, 2008.
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8-K
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001-33508
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99.2 |
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9/23/08 |
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10.19
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Employment Agreement between the Registrant and
Douglas Lindroth dated October 14, 2008.
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8-K
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001-33508
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99.1 |
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10/15/08 |
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31.01
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Certification of Principal Executive Officer
Pursuant to Securities Exchange Act
Rule 13a-14(a).
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X |
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31.02
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Certification of Principal Financial Officer
Pursuant to Securities Exchange Act
Rule 13a-14(a).
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X |
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32.01
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Certification of Principal Executive Officer
Pursuant to 18 U.S.C. Section 1350 and Securities
Exchange Act Rule 13a-14(b).*
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X |
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32.02
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Certification of Principal Financial Officer
Pursuant to 18 U.S.C. Section 1350 and Securities
Exchange Act Rule 13a-14(b).*
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X |
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| * |
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This certification is not deemed “filed” for purposes of Section 18 of
the Securities Exchange Act, or otherwise subject to the liability of
that section. Such certification will not be deemed to be incorporated
by reference into any filing under the Securities Act of 1933 or the
Securities Exchange Act of 1934, except to the extent that Limelight
Networks, Inc. specifically incorporates it by reference. |
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| † |
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Confidential treatment has been requested for portions of this
exhibit. These portions have been omitted from this Form 10-Q and have
been filed separately with the Securities and Exchange Commission. |
44
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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LIMELIGHT NETWORKS, INC.
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| Date: November 13, 2008 |
By: |
/s/ Doug Lindroth
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Doug Lindroth |
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Chief Financial Officer and Secretary
(Principal Financial Officer) |
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45
EXHIBIT INDEX
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Incorporated by Reference |
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| Exhibit |
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Filing |
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Provided |
| Number |
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Exhibit Description |
|
Form |
|
File No. |
|
Exhibit |
|
Date |
|
Herewith |
3.02
|
|
Amended and Restated Certificate of Incorporation of
Limelight Networks, Inc.
|
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S-1
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333-141516
|
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|
3.2 |
|
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5/21/07 |
|
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|
|
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3.04
|
|
Amended and Restated Bylaws of Limelight
Networks, Inc.
|
|
S-1
|
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333-141516
|
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3.4 |
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3/22/07 |
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10.5.01
|
|
Amended and Restated Employment Agreement between
the Registrant and Matthew Hale dated
July 9, 2008.
|
|
8-K
|
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001-33508
|
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99.1 |
|
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7/10/08 |
|
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|
|
|
|
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10.15.01
|
|
Amendment to Edge Computing Network Service and
License Agreement between Limelight Networks,
Inc.
and Microsoft Corporation dated October 1, 2008. †
|
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X |
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10.17
|
|
Employment Agreement between the Registrant and
Nathan F. Raciborski dated September 22, 2008.
|
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8-K
|
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001-33508
|
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99.1 |
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9/23/08 |
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10.18
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Employment Agreement between the Registrant and
Michael M. Gordon dated September 22, 2008.
|
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8-K
|
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001-33508
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99.2 |
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9/23/08 |
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10.19
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Employment Agreement between the Registrant and
Douglas Lindroth dated October 14, 2008.
|
|
8-K
|
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001-33508
|
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|
99.1 |
|
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10/15/08 |
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31.01
|
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Certification of Principal Executive Officer
Pursuant to Securities Exchange Act
Rule 13a-14(a).
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X |
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31.02
|
|
Certification of Principal Financial Officer
Pursuant to Securities Exchange Act
Rule 13a-14(a).
|
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|
X |
|
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|
|
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32.01
|
|
Certification of Principal Executive Officer
Pursuant to 18 U.S.C. Section 1350 and Securities
Exchange Act Rule 13a-14(b).*
|
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X |
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|
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32.02
|
|
Certification of Principal Financial Officer
Pursuant to 18 U.S.C. Section 1350 and Securities
Exchange Act Rule 13a-14(b).*
|
|
|
|
|
|
|
|
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|
X |
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| * |
|
This certification is not deemed “filed” for purposes of Section 18 of
the Securities Exchange Act, or otherwise subject to the liability of
that section. Such certification will not be deemed to be incorporated
by reference into any filing under the Securities Act of 1933 or the
Securities Exchange Act of 1934, except to the extent that Limelight
Networks, Inc. specifically incorporates it by reference. |
| |
| † |
|
Confidential treatment has been requested for portions of this
exhibit. These portions have been omitted from this Form 10-Q and have
been filed separately with the Securities and Exchange Commission. |
46