AKAMAI TECHNOLOGIES, INC. This quarterly report on Form 10-Q, particularly Management's Discussion and Analysis of Financial Condition and Results of Operations set forth below, and notes to our unaudited consolidated financial statements included herein contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management as of the date hereof based on information currently available to our management. Use of words such as "believes," "expects," "anticipates," "intends," "plans," "estimates," "should," "forecasts," "if," "continues," "goal," "likely" or similar expressions indicates a forward-looking statement. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions. Actual results may differ materially from the forward-looking statements we make. See "Risk Factors" elsewhere in this quarterly report on Form 10-Q for a discussion of certain risks associated with our business. We disclaim any obligation to update forward-looking statements as a result of new information, future events or otherwise. Our management's discussion and analysis of our financial condition and results of operations is based upon our unaudited consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, which we have prepared in accordance with accounting principles generally accepted inthe United States of America , or GAAP, for interim periods and with Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended, or the Exchange Act. The preparation of these unaudited consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related items, including, but not limited to, revenue recognition, accounts receivable and related reserves, valuation and impairment of marketable securities, goodwill and acquired intangible assets, capitalized internal-use software development costs, impairment and useful lives of long-lived assets, income taxes and stock-based compensation. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances at the time they are made. Actual results may differ from our estimates. See the section entitled "Application of Critical Accounting Policies and Estimates" in our annual report on Form 10-K for the year-endedDecember 31, 2019 for further discussion of our critical accounting policies and estimates.
Overview
We provide solutions for securing, delivering and optimizing content and business applications over the Internet. The key factors that influence our financial success are our ability to build on recurring revenue commitments for our security and performance offerings, increase media traffic on our network, effectively manage the prices we charge for our solutions, develop new products and carefully manage our capital spending and other expenses.
Revenue
For most of our solutions, our customers commit to contracts having terms of a year or longer, which allows us to have a consistent and predictable base level of revenue. In addition to a base level of revenue, we are also dependent on media customers where usage of our solutions is more variable. As a result, our revenue is impacted by the amount of media and software download traffic we serve on our network, the rate of adoption of gaming, social media and video platform offerings and the timing and variability of customer-specific one-time events. Seasonal variations that impact traffic on our network, such as holiday shopping, can cause unpredictable revenue swings from quarter to quarter. Over the longer term, our ability to expand our product portfolio and to effectively manage the prices we charge for our solutions are key factors impacting our revenue growth.
We have observed the following trends related to our revenue in recent years:
•Increased sales of our security solutions have made a significant contribution
to revenue growth. We plan to continue to invest in this area with a focus on
further enhancing our product portfolio and extending our go-to-market
capabilities.
•We have experienced increases in the amount of traffic delivered for customers
that use our solutions for video, gaming downloads and social media,
contributing to an increase in our revenue in the first quarter of 2020 as
compared to the same period in 2019. In addition, as a result of the novel
coronavirus, or COVID-19, outbreak, and resultant shelter-in-place requirements
in various locations around the world, the rate of increase in traffic in the
first quarter of 2020, as compared to prior quarters, accelerated significantly.
This increased growth could continue in 2020 if the various shelter-in-place
restrictions are extended or moderate if they are broadly lifted.
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•We have increased committed recurring revenue from our solutions by increasing sales of incremental solutions to our existing customers and adding new customers; however, we have also experienced slower revenue growth in recent quarters particularly in our web performance solutions. We expect the trend of slower revenue growth in our web division to continue in 2020 as our customers, particularly in the commerce and travel and hospitality industries, continue to experience financial pressure, especially in light of the negative impacts of the COVID-19 pandemic on these customers' operations. •The prices paid by some of our customers have declined, particularly in the context of contract renewals and large media consolidations, reflecting the impact of competition and volume discounts. Our revenue would have been higher absent these price declines. •In recent years, revenue from our international operations has been growing at a faster pace than from ourU.S. operations, particularly in terms of new customer acquisition and cross-selling of incremental solutions. Because we publicly report inU.S. dollars, the strong dollar has negatively impacted our results in recent quarters. If the dollar continues to strengthen, our reported revenue results will be negatively impacted. •We have experienced variations in certain types of revenue from quarter to quarter. In particular, we typically experience higher revenue in the fourth quarter of each year for some of our solutions as a result of holiday season activity. In addition, we experience quarterly variations in revenue attributable to, among other things, the nature and timing of software and gaming releases by our customers; whether there are large live sporting or other events or situations (like the COVID-19 pandemic) that impact the amount of media traffic on our network; and the frequency and timing of purchases of custom solutions.
Expenses
Our level of profitability is also impacted by our expenses, including direct
costs to support our revenue such as bandwidth and co-location costs. We have
observed the following trends related to our profitability in recent years:
•Our profitability improved in the first quarter of 2020 as compared to the same
period in 2019 due to higher revenue as well as the effects of cost savings and
efficiency initiatives we have undertaken. We expect to continue to undertake
efforts intended to improve the efficiency of operations. If we are able to
continue our efficiency efforts such that our rate of revenue growth exceeds our
expense growth rate and our business is not impacted more severely than
currently anticipated by repercussions of the COVID-19 pandemic, we anticipate
overall profitability improvement in 2020 as compared to 2019.
•Network bandwidth costs represent a significant portion of our cost of revenue.
Historically, we have been able to mitigate increases in these costs by reducing
our network bandwidth costs per unit and investing in internal-use software
development to improve the performance and efficiency of our network. Our total
bandwidth costs may increase in the future as a result of expected higher
traffic levels and serving more traffic from higher cost regions. We will need
to continue to effectively manage our bandwidth costs to maintain current levels
of profitability.
•Co-location costs are also a significant portion of our cost of revenue. By
improving our internal-use software and managing our hardware deployments to
enable us to use servers more efficiently, we have been able to manage the
growth of co-location costs. We expect to continue to scale our network in the
future and will need to continue to effectively manage our co-location costs to
maintain current levels of profitability.
•We expect to continue to manage our headcount and payroll costs in the future
to focus investments on certain areas of the business while maintaining
efficient operations in others. We expect to continue to hire employees in
support of our strategic initiatives, but do not expect overall headcount to
increase significantly in 2020. We also anticipate our ability to hire employees
to be negatively impacted by the COVID-19 outbreak.
•Depreciation expense related to our network equipment also contributes to our
overall expense levels, and we expect to continue to invest in our network in
2020, which will increase our capital expenditures and resulting depreciation
expense. We have, however, experienced negative effects on our supply chain and
some of our network deployment operations due to the COVID-19 pandemic; if these
persist, there may be limitations on our ability to scale our network in the
shorter term and network equipment costs can rise due to limited supply from
manufacturing delays.
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We report our revenue by division, which is a customer-focused reporting view that reflects revenue from customers that are managed by the division. We report our revenue in two divisions: the Web Division and the Media and Carrier Division. As the purchasing patterns and required account expertise of customers change over time, we may reassign a customer from one division to another. In early 2020, we reassigned some of our customers between the Media and Carrier Division and the Web Division and revised historical results in order to reflect the most recent categorization and to provide a comparable view for all periods presented. Results of Operations
The following table sets forth, as a percentage of revenue, consolidated statements of income data for the periods indicated:
For the Three Months
Ended March 31,
2020 2019
Revenue 100.0 % 100.0 %
Costs and operating expenses:
Cost of revenue (exclusive of amortization of acquired intangible assets
shown below) 35.1 34.1
Research and development 9.3 9.4
Sales and marketing 16.2 17.9
General and administrative 16.7 17.4
Amortization of acquired intangible assets 1.4 1.4
Restructuring charge 1.4 0.9
Total costs and operating expenses 80.1 81.1
Income from operations 19.9 18.9
Interest income 0.9 1.2
Interest expense (2.3) (1.7)
Other (expense) income, net (0.5) 0.1
Income before provision for income taxes 18.0 18.5
Provision for income taxes (1.9) (3.5)
Loss from equity method investment (0.1) -
Net income 16.0 % 15.0 %
Revenue
Revenue by division during the periods presented was as follows (in thousands):
For the Three Months
Ended March 31,
% Change at
Constant
2020 2019 % Change Currency
Web Division $ 405,995 $ 374,202 8.5 % 9.6 %
Media and Carrier Division 358,307 332,306 7.8 8.7
Total revenue $ 764,302 $ 706,508 8.2 % 9.2 %
During the three-month period ended March 31, 2020 , the increase in our revenue
as compared to the same period in 2019 was primarily the result of higher media
traffic volumes, due in part to the impact of the outbreak of COVID-19, and
continued strong growth in sales of our Cloud Security Solutions. During the
three-month period ended March 31, 2020 , our Cloud Security Solutions revenue
was $240.3 million as compared to $190.1 million during the three-month period
ended March 31, 2019 , which represents a 26.4% increase. Cloud Security
Solutions revenue increased due to higher sales of solutions across our security
portfolio.
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The increase in Web Division revenue during the three-month period endedMarch 31, 2020 , as compared to the same period in 2019, was primarily the result of increased sales of both new and existing Cloud Security Solutions to this customer base, as described above. Customers who are experiencing financial difficulties as a result of the COVID-19 pandemic, specifically those in the commerce and travel and hospitality verticals, are primarily customers of our Web Division. Web Division revenue was negatively impacted, albeit modestly, during the three-months endedMarch 31, 2020 as a result of the pandemic, and we anticipate this trend to continue. However, it is difficult to predict length of time and amount by which the Web Division will be impacted due to the uncertain nature of the pandemic. The increase in Media and Carrier Division revenue during the three-month period endedMarch 31, 2020 , as compared to the same period in 2019, was primarily the result of increased customer traffic volumes from video delivery, gaming and social media customers, due in part to the impact of the outbreak of COVID-19, and sales of Cloud Security Solutions to this customer base. Revenue derived in theU.S. and internationally during the periods presented was as follows (in thousands): For the Three Months Ended March 31, 2020 2019 % Change % Change at Constant Currency U.S.$ 428,930 $ 418,200 2.6 % 2.6 % International 335,372 288,308 16.3 18.7 Total revenue$ 764,302 $ 706,508 8.2 % 9.2 % For the three-month period endedMarch 31, 2020 , approximately 43.9% of our revenue was derived from our operations located outside theU.S. , compared to 40.8% for the three-month period endedMarch 31, 2019 . No single country outside theU.S. accounted for 10.0% or more of revenue during either of these periods. During the three-month period endedMarch 31, 2020 , we continued to see strong revenue growth from our operations in theAsia-Pacific region and steady revenue growth in our EMEA region. Changes in foreign currency exchange rates impacted our revenue by an unfavorable$6.7 million during the three-month period endedMarch 31, 2020 , as compared to the same period in 2019.
Cost of Revenue
Cost of revenue consisted of the following for the periods presented (in
thousands):
For the Three Months
Ended March 31,
2020 2019 % Change
Bandwidth fees $ 45,780 $ 42,473 7.8 %
Co-location fees 35,389 29,492 20.0
Network build-out and supporting services 30,561 22,711 34.6
Payroll and related costs 65,807 60,263 9.2
Stock-based compensation, including amortization of prior capitalized amounts
12,994 13,309 (2.4)
Depreciation of network equipment 36,397 30,168 20.6
Amortization of internal-use software 41,654 42,327 (1.6)
Total cost of revenue $ 268,582 $ 240,743 11.6 %
As a percentage of revenue 35.1 % 34.1 %
The increase in total cost of revenue for the three-month period endedMarch 31, 2020 , as compared to the same period in 2019, was primarily due to amounts paid for network build-out and supporting services related to installation fees and investments to our network. These investments resulted in higher depreciation costs as well as growth in payroll and related costs due to increased hiring in our services team in 2019 to support revenue growth. 27
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During 2020, we plan to continue to focus our efforts on managing our operating margins, including continuing to manage our bandwidth and co-location costs. We anticipate depreciation of network equipment to increase in 2020 due to increased investments in our network with the expectation that our customer base will continue to expand and that we will continue to deliver more traffic to existing customers.
Research and Development Expenses
Research and development expenses consisted of the following for the periods
presented (in thousands):
For the Three Months
Ended March 31,
2020 2019 % Change
Payroll and related costs $ 102,821 $ 94,944 8.3 %
Stock-based compensation 12,065 12,057 0.1Capitalized salaries and related costs (46,300) (43,359) 6.8 Other expenses
2,638 2,499 5.6
Total research and development$ 71,224 $ 66,141 7.7 % As a percentage of revenue 9.3 % 9.4 % The increase in research and development expenses during the three-month period endedMarch 31, 2020 , as compared to the same period in 2019, was primarily due to growth in payroll and related costs as a result of headcount growth to support investments in new product development and network scaling. Research and development costs are expensed as incurred, other than certain internal-use software development costs eligible for capitalization. Capitalized development costs consist of payroll and related costs for personnel and external consulting expenses involved in the development of internal-use software used to deliver our services and operate our network. We capitalized$8.1 million of stock-based compensation during each of the three-month periods endedMarch 31, 2020 andMarch 31, 2019 . These capitalized internal-use software development costs are amortized to cost of revenue over their estimated useful lives, which is generally two years, but can be up to seven years based on the software developed and its expected useful life.
We expect research and development costs to increase in 2020 as we maintain our focus on innovation; however, we do not expect these costs to increase as a percentage of revenue.
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Sales and Marketing Expenses
Sales and marketing expenses consisted of the following for the periods
presented (in thousands):
For the Three Months
Ended March 31,
2020 2019 % Change
Payroll and related costs $ 93,594 $ 92,651 1.0 %
Stock-based compensation 15,735 15,050 4.6
Marketing programs and related costs 9,137 14,533 (37.1)
Other expenses 5,320 4,042 31.6
Total sales and marketing $ 123,786 $ 126,276 (2.0) %
As a percentage of revenue 16.2 % 17.9 %
The decrease in sales and marketing expenses during the three-month period ended
March 31, 2020 , as compared to the same period in 2019, was primarily due to the
cancellation or postponement of certain marketing events as a result of
COVID-19.
During 2020, we do not expect significant increases in sales and marketing expenses as we plan to continue to carefully manage costs in our efforts to refine and optimize our go-to-market efforts and improve operating margins.
General and Administrative Expenses
General and administrative expenses consisted of the following for the periods
presented (in thousands):
For the Three Months
Ended March 31,
2020 2019 % Change
Payroll and related costs $ 48,599 $ 49,651 (2.1) %
Stock-based compensation 13,957 12,628 10.5
Depreciation and amortization 20,465 18,373 11.4
Facilities-related costs 24,672 21,023 17.4
Allowance for doubtful accounts 2,199 800 174.9
Acquisition-related costs 76 451 (83.1)
License of patent - (4,403) (100.0)
Professional fees and other expenses 17,393 24,312 (28.5)
Total general and administrative $ 127,361 $ 122,835 3.7 %
As a percentage of revenue 16.7 % 17.4 %
The increase in general and administrative expenses for the three-month period
ended March 31, 2020 , as compared to the same period in 2019, was primarily due
to expansion of company infrastructure throughout 2019, including moving into
our new corporate headquarters in Cambridge, Massachusetts , which increased
facilities-related costs and depreciation and amortization. Additionally, the
three-month period ended March 31, 2019 included license patent fees received as
a result of our litigation with Limelight Networks, Inc. that did not recur in
2020. The allowance for doubtful accounts has also increased as a result of the
estimated impact of COVID-19 on our customers' ability to pay. These increases
in general and administrative expenses were partially offset by a decrease in
amounts paid to professional service providers for advisory services provided in
connection internal transformation programs designed to improve operating
margins.
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Our general and administrative expenses can be categorized across three areas.
Global functions expense includes payroll, stock-based compensation and other
employee-related costs for administrative functions, including finance,
purchasing, order entry, human resources, legal, information technology and
executive personnel, as well as third-party professional service fees.
Infrastructure expense includes payroll, stock-based compensation and other
employee-related costs for our network infrastructure functions, as well as
facility rent expense, depreciation and amortization of facility and IT-related
assets, software and software-related costs, business insurance and taxes. Our
network infrastructure function is responsible for network planning, sourcing,
architecture evaluation and platform security. Other expense includes
acquisition-related costs, provision for doubtful accounts, legal settlements,
transformation costs and the license of a patent.
General and administrative expenses for the three-month periods ended
For the Three Months
Ended March 31,
2020 2019 % Change
Global functions $ 47,866 $ 49,468 (3.2) %
As a percentage of revenue 6.3 % 7.0 %
Infrastructure 77,220 72,327 6.8
As a percentage of revenue 10.1 % 10.2 %
Other 2,275 1,040 118.8
Total general and administrative expenses
3.7 % As a percentage of revenue 16.7 % 17.4 %
During 2020, we plan to continue to focus our efforts on managing our operating margins and, in particular, assessing opportunities to reduce third-party spending and increase automation of manual tasks.
Amortization of Acquired Intangible Assets
For the Three Months
Ended March 31,
(in thousands) 2020 2019 % Change
Amortization of acquired intangible assets $ 10,434 $ 9,599 8.7 %
As a percentage of revenue 1.4 % 1.4 %
The increase in amortization of acquired intangible assets for the three-month
period ended March 31, 2020 , as compared to the same period in 2019, was the
result of amortization of assets related to our recent acquisitions. Based on
our intangible assets at March 31, 2020 , we expect amortization of acquired
intangible assets to be approximately $31.4 million for the remainder of 2020,
and $43.0 million , $37.3 million , $28.9 million and $20.5 million for 2021,
2022, 2023 and 2024, respectively.
Restructuring Charge
For the Three Months
Ended March 31,
(in thousands) 2020 2019 % Change
Restructuring charge $ 10,585 $ 6,389 65.7 %
As a percentage of revenue 1.4 % 0.9 %
The restructuring charges for the three-month period ended March 31, 2020 were
primarily the result of management actions to focus on investments with the
potential to accelerate revenue growth. The restructuring charge relates to
certain headcount reductions and a $6.2 million impairment of a right-of-use
asset related to the exit of a leased facility. We do not expect material
additional restructuring charges related to these actions.
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The restructuring charges for the three-month period ended March 31, 2019 were
primarily the result of certain restructuring actions initiated in the fourth
quarter of 2018. Management's intention in implementing the restructuring was to
re-balance investments with the goal of improving long-term revenue growth and
scale. The restructuring charges primarily consist of costs associated with
headcount reductions. We do not expect significant additional restructuring
charges related to this action.
Non-Operating Income (Expense)
For the Three Months
Ended March 31,
(in thousands) 2020 2019 % Change
Interest income $ 7,043 $ 8,635 (18.4) %
As a percentage of revenue 0.9 % 1.2 %
Interest expense $ (17,205) $ (12,116) 42.0 %
As a percentage of revenue (2.3) % (1.7) %
Other (expense) income, net $ (4,108) $ 511 (903.9) %
As a percentage of revenue (0.5) % 0.1 %
For the periods presented, interest income primarily consisted of interest
earned on invested cash balances and marketable securities. The decrease in
interest income for the three-month period ended March 31, 2020 , as compared to
the same period in 2019, was primarily the result of lower interest rates during
the three-month period ended March 31, 2020 , as compared to the same period in
2019.
Interest expense is related to our debt transactions, which are described in
Note 7 to the consolidated financial statements. The increase in interest
expense for the three-month period ended March 31, 2020 , as compared to the same
period in 2019, was due to the August 2019 issuance of $1,150.0 million in par
value of convertible senior notes due 2027.
Other (expense) income, net primarily represents net foreign exchange gains and
losses and other non-operating expense and income items. The fluctuation in
other (expense) income, net for the three-month period ended March 31, 2020 , as
compared to the same period in 2019, is primarily due to the unfavorable impact
of changes in foreign exchange rates.
Provision for Income Taxes
For the Three Months
Ended March 31,
(in thousands) 2020 2019 % Change
Provision for income taxes $ (14,292) $ (24,425) (41.5) %
As a percentage of revenue (1.9) % (3.5) %
Effective income tax rate (10.4) % (18.6) %
For the three-month period ended March 31, 2020 , as compared to the same period
in 2019, our provision for income taxes decreased due to an increase in foreign
income taxed at lower rates, an increase in the excess tax benefit related to
stock-based compensation, a decrease in intercompany sales of intellectual
property and a decrease in the valuation allowance recorded against deferred tax
assets related to state tax credits. These amounts were partially offset by an
increase in profitability and a decrease in the benefit of U.S. federal, state
and foreign research and development credits.
For the three-month period ended March 31, 2020 , our effective income tax rate
was lower than the federal statutory tax rate due to foreign income taxed at
lower rates, the impact of the excess tax benefit related to stock-based
compensation and the benefit of U.S. federal, state and foreign research and
development credits. These amounts were partially offset by the impact of the
valuation allowance recorded against deferred tax assets related to state tax
credits, non-deductible stock-based compensation and state taxes.
For the three-month period ended March 31, 2019 , our effective income tax rate
was lower than the federal statutory tax rate due to foreign income taxed at
lower rates, the impact of the excess tax benefit related to stock-based
compensation and the
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benefit of U.S. federal, state and foreign research and development credits.
These amounts were partially offset by the valuation allowance recorded against
deferred tax assets related to state tax credits, non-deductible executive
compensation, state taxes and an intercompany sale of intellectual property.
In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic
Security Act ("CARES Act") was enacted on March 27, 2020 . The CARES Act did not
have a material impact on the effective tax rate for the period ending March 31,
2020 . We will continue to monitor further changes to the global legislative and
regulatory developments enacted as a result of COVID-19.
In determining our net deferred tax assets and valuation allowances, annualized
effective income tax rates and cash paid for income taxes, management is
required to make judgments and estimates about domestic and foreign
profitability, the timing and extent of the utilization of net operating loss
carryforwards, applicable tax rates, transfer pricing methodologies and tax
planning strategies. Judgments and estimates related to our projections and
assumptions are inherently uncertain; therefore, actual results could differ
materially from our projections.
Loss from
For the Three Months
Ended March 31,
(in thousands) 2020 2019 % Change
Loss from equity method investment $ (622) $ - (100.0) %
As a percentage of revenue (0.1) % - %
During 2019, we started recognizing our share of earnings from our
previously-announced investment with Mitsubishi UFJ Financial Group in a joint
venture, Global Open Network, Inc. , or GO-NET. GO-NET intends to operate a new
blockchain-based online payment network. For the three-month period ended
March 31, 2020 , we recorded a loss of $0.6 million dollars which reflects our
share of the losses incurred by GO-NET. We expect to record additional losses in
2020 and beyond as GO-NET continues executing on the early stages of its
business plan.
Non-GAAP Financial Measures
In addition to providing financial measurements based on generally accepted accounting principles inthe United States of America , or GAAP, we provide additional financial metrics that are not prepared in accordance with GAAP, or non-GAAP financial measures. Management uses non-GAAP financial measures, in addition to GAAP financial measures, to understand and compare operating results across accounting periods, for financial and operational decision making, for planning and forecasting purposes, to measure executive compensation and to evaluate our financial performance. These non-GAAP financial measures are non-GAAP income from operations, non-GAAP operating margin, non-GAAP net income, non-GAAP net income per share, Adjusted EBITDA, Adjusted EBITDA margin, capital expenditures and impact of foreign currency exchange rates, as discussed below. Management believes that these non-GAAP financial measures reflect our ongoing business in a manner that allows for meaningful comparisons and analysis of trends in the business, as they facilitate comparison of financial results across accounting periods and to those of our peer companies. Management also believes that these non-GAAP financial measures enable investors to evaluate our operating results and future prospects in the same manner as management. These non-GAAP financial measures may exclude expenses and gains that may be unusual in nature, infrequent or not reflective of our ongoing operating results.
The non-GAAP financial measures do not replace the presentation of our GAAP financial measures and should only be used as a supplement to, not as a substitute for, our financial results presented in accordance with GAAP.
The non-GAAP adjustments, and our basis for excluding them from non-GAAP financial measures, are outlined below:
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•Amortization of acquired intangible assets - We have incurred amortization of intangible assets, included in our GAAP financial statements, related to various acquisitions we have made. The amount of an acquisition's purchase price allocated to intangible assets and term of its related amortization can vary significantly and are unique to each acquisition; therefore, we exclude amortization of acquired intangible assets from our non-GAAP financial measures to provide investors with a consistent basis for comparing pre- and post-acquisition operating results. •Stock-based compensation and amortization of capitalized stock-based compensation - Although stock-based compensation is an important aspect of the compensation paid to our employees, the grant date fair value varies based on the stock price at the time of grant, varying valuation methodologies, subjective assumptions and the variety of award types. This makes the comparison of our current financial results to previous and future periods difficult to interpret; therefore, we believe it is useful to exclude stock-based compensation and amortization of capitalized stock-based compensation from our non-GAAP financial measures in order to highlight the performance of our core business and to be consistent with the way many investors evaluate our performance and compare our operating results to peer companies. •Acquisition-related costs - Acquisition-related costs include transaction fees, advisory fees, due diligence costs and other direct costs associated with strategic activities. In addition, subsequent adjustments to our initial estimated amounts of contingent consideration and indemnification associated with specific acquisitions are included within acquisition-related costs. These amounts are impacted by the timing and size of the acquisitions. We exclude acquisition-related costs from our non-GAAP financial measures to provide a useful comparison of our operating results to prior periods and to our peer companies because such amounts vary significantly based on the magnitude of our acquisition transactions and do not reflect our core operations. •Restructuring charges - We have incurred restructuring charges that are included in our GAAP financial statements, primarily related to workforce reductions and charges associated with exiting facility lease commitments. We exclude these items from our non-GAAP financial measures when evaluating our continuing business performance as such items vary significantly based on the magnitude of the restructuring action and do not reflect expected future operating expenses. In addition, these charges do not necessarily provide meaningful insight into the fundamentals of current or past operations of our business. •Amortization of debt discount and issuance costs and amortization of capitalized interest expense - InAugust 2019 , we issued$1,150 million of convertible senior notes due 2027 with a coupon interest rate of 0.375%. InMay 2018 , we issued$1,150 million of convertible senior notes due 2025 with a coupon interest rate of 0.125%. InFebruary 2014 , we issued$690 million of convertible senior notes due 2019 with a coupon interest rate of 0%. The imputed interest rates of these convertible senior notes were 3.10%, 4.26% and 3.20%, respectively. This is a result of the debt discounts recorded for the conversion features that are required to be separately accounted for as equity under GAAP, thereby reducing the carrying values of the convertible debt instruments. The debt discounts are amortized as interest expense together with the issuance costs of the debt. The interest expense excluded from our non-GAAP results is comprised of these non-cash components and is excluded from management's assessment of our operating performance because management believes the non-cash expense is not representative of ongoing operating performance. •Gains and losses on investments - We have recorded gains and losses from the disposition, changes to fair value and impairment of certain investments. We believe excluding these amounts from our non-GAAP financial measures is useful to investors as the types of events giving rise to them are not representative of our core business operations and ongoing operating performance. •Transformation costs - We have incurred professional services fees associated with internal transformation programs designed to improve operating margins and that are part of a planned program intended to significantly change the manner in which business is conducted. We believe excluding these amounts from our non-GAAP financial measures is useful to investors as the types of events and activities giving rise to them occur infrequently and are not representative of our core business operations and ongoing operating performance. •Income and losses from equity method investment - We record income or losses on our share of earnings and losses of our equity method investment. We exclude such income and losses because we lack control over the operations of the investment and the related income and losses are not representative of our core business 33 -------------------------------------------------------------------------------- Table of Contents operations. •Income tax effect of non-GAAP adjustments and certain discrete tax items - The non-GAAP adjustments described above are reported on a pre-tax basis. The income tax effect of non-GAAP adjustments is the difference between GAAP and non-GAAP income tax expense. Non-GAAP income tax expense is computed on non-GAAP pre-tax income (GAAP pre-tax income adjusted for non-GAAP adjustments) and excludes certain discrete tax items (such as recording or releasing of valuation allowances), if any. We believe that applying the non-GAAP adjustments and their related income tax effect allows us to highlight income attributable to our core operations.
The following table reconciles GAAP income from operations to non-GAAP income from operations and non-GAAP operating margin for the periods presented (in thousands):
For the Three Months
Ended March 31,
2020 2019
Income from operations $ 152,330 $ 134,525
Amortization of acquired intangible assets 10,434 9,599
Stock-based compensation 47,493 45,305
Amortization of capitalized stock-based compensation and capitalized interest
expense 8,589 9,233
Restructuring charge 10,585 6,389
Acquisition-related costs 76 451
Transformation costs - 4,191
Non-GAAP income from operations GAAP operating margin 20 % 19 % Non-GAAP operating margin 30 % 30 %
The following table reconciles GAAP net income to non-GAAP net income for the periods presented (in thousands):
For the Three Months
Ended March 31,
2020 2019
Net income $ 123,146 $ 107,130
Amortization of acquired intangible assets 10,434 9,599
Stock-based compensation 47,493 45,305
Amortization of capitalized stock-based compensation and capitalized interest
expense 8,589 9,233
Restructuring charge 10,585 6,389
Acquisition-related costs 76 451
Transformation costs - 4,191
Amortization of debt discount and issuance costs 15,633 11,618
Gain on investments - (690)
Loss from equity method investment 622 -
Income tax effect of above non-GAAP adjustments and certain discrete tax items (20,445)
(12,304)
Non-GAAP net income $ 196,133 $ 180,922
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The following table reconciles GAAP net income per diluted share to non-GAAP net
income per diluted share for the periods presented (in thousands, except per
share data):
For the Three Months
Ended March 31,
2020 2019
GAAP net income per diluted share $ 0.75 $ 0.65
Amortization of acquired intangible assets 0.06 0.06
Stock-based compensation 0.29 0.27
Amortization of capitalized stock-based compensation and capitalized interest
expense 0.05 0.06
Restructuring charge 0.06 0.04
Acquisition-related costs - -
Transformation costs - 0.03
Amortization of debt discount and issuance costs 0.10 0.07
Gain on investments - -
Loss from equity method investment - -
Income tax effect of above non-GAAP adjustments and certain discrete tax items (0.12)
(0.07)
Non-GAAP net income per diluted share (1) $ 1.20 $ 1.10
Shares used in diluted per share calculations 163,684 164,787
(1) May not foot due to rounding
Non-GAAP net income per diluted share is calculated as non-GAAP net income divided by diluted weighted average common shares outstanding. GAAP diluted weighted average common shares outstanding are adjusted in non-GAAP per share calculations for the shares that would be delivered to us pursuant to the note hedge transactions entered into in connection with the issuance of our convertible senior notes. Under GAAP, shares delivered under hedge transactions are not considered offsetting shares in the fully-diluted share calculation until they are delivered. However, we would receive a benefit from the note hedge transactions and would not allow the dilution to occur, so management believes that adjusting for this benefit provides a meaningful view of net income per share. Unless and until our weighted average stock price is greater than$95.10 , the initial conversion price of the convertible senior notes due 2025, or$116.18 , the initial conversion price of the convertible senior notes due 2027, there will be no difference between our GAAP and non-GAAP diluted weighted average common shares outstanding. We consider Adjusted EBITDA to be another important indicator of the operational strength and performance of our business and a good measure of our historical operating trends. Adjusted EBITDA eliminates items that we do not consider to be part of our core operations. We define Adjusted EBITDA as GAAP net income excluding the following items: interest income; income taxes; depreciation and amortization of tangible and intangible assets; stock-based compensation; amortization of capitalized stock-based compensation; acquisition-related costs; restructuring charges; transformation costs; foreign exchange gains and losses; interest expense; amortization of capitalized interest expense; certain gains and losses on investments; gains and losses from equity method investments; and other non-recurring or unusual items that may arise from time to time. Adjusted EBITDA margin represents Adjusted EBITDA stated as a percentage of revenue. 35 -------------------------------------------------------------------------------- Table of Contents The following table reconciles GAAP net income to Adjusted EBITDA and Adjusted EBITDA margin for the periods presented (in thousands): For the Three Months Ended March 31, 2020 2019 Net income$ 123,146 $ 107,130 Interest income (7,043) (8,635) Provision for income taxes 14,292 24,425 Depreciation and amortization 97,185 89,373
Amortization of capitalized stock-based compensation and capitalized interest expense
8,589 9,233
Amortization of acquired intangible assets 10,434 9,599
Stock-based compensation 47,493 45,305
Restructuring charge 10,585 6,389
Acquisition-related costs 76 451
Transformation costs - 4,191
Interest expense 17,205 12,116
Gain on investments - (690)
Loss from equity method investment 622 -
Other expense, net 4,108 179
Adjusted EBITDA $ 326,692 $ 299,066 Adjusted EBITDA margin 43 % 42 %
Impact of Foreign Currency Exchange Rates
Revenue and earnings from our international operations have historically been an important contributor to our financial results. Consequently, our financial results have been impacted, and management expects they will continue to be impacted, by fluctuations in foreign currency exchange rates. For example, when the local currencies of our foreign subsidiaries weaken, generally our consolidated results stated inU.S. dollars are negatively impacted. Because exchange rates are a meaningful factor in understanding period-to-period comparisons, management believes the presentation of the impact of foreign currency exchange rates on revenue and earnings enhances the understanding of our financial results and evaluation of performance in comparison to prior periods. The dollar impact of changes in foreign currency exchange rates presented is calculated by translating current period results using monthly average foreign currency exchange rates from the comparative period and comparing them to the reported amount. The percentage change at constant currency presented is calculated by comparing the prior period amounts as reported and the current period amounts translated using the same monthly average foreign currency exchange rates from the comparative period.
Liquidity and Capital Resources
To date, we have financed our operations primarily through public and private sales of debt and equity securities and cash generated by operations. As ofMarch 31, 2020 , our cash, cash equivalents and marketable securities, which primarily consisted of corporate bonds, totaled$2.2 billion . Factoring in the$2.3 billion in principal amount of convertible senior notes we have outstanding, our net cash atMarch 31, 2020 was in a negative position of$89.6 million . We place our cash investments in instruments that meet high-quality credit standards, as specified in our investment policy. Our investment policy is also designed to limit the amount of our credit exposure to any one issue or issuer and seeks to manage these assets to achieve our goals of preserving principal and maintaining adequate liquidity at all times. Changes in cash, cash equivalents and marketable securities are dependent upon changes in, among other things, working capital items such as accounts receivable, deferred revenues, accounts payable and various accrued expenses, as well as changes in our capital and financial structure due to common stock repurchases, debt repayments and issuances, purchases and sales of marketable securities and similar events. We do not expect events related to the outbreak of COVID-19 to have a material 36 -------------------------------------------------------------------------------- Table of Contents impact to our liquidity in the near term; however, some of our customers may be unable to pay us for our services or may be unable to remit payments in a timely manner due to financial stresses the outbreak may have caused them. We believe that, particularly in situations like these, our strong balance sheet and cash position are important competitive differentiators that provide the financial stability and flexibility to enable us to continue to make investments at opportune times. As ofMarch 31, 2020 , we had cash and cash equivalents of$324.0 million held in accounts outside theU.S. TheU.S. Tax Cuts and Jobs Act establishes a territorial tax system in theU.S. , which provides companies with the potential ability to repatriate earnings with minimalU.S. federal income tax impact. As a result, our liquidity is not materially impacted by the amount of cash and cash equivalents held in accounts outside theU.S.
Cash Provided by Operating Activities
For the Three Months
Ended March 31,
(in thousands) 2020 2019
Net income $ 123,146 $ 107,130 Non-cash reconciling items included in net income 188,498 173,989 Changes in operating assets and liabilities
(88,401) (120,269)
Net cash provided by operating activities$ 223,243 $
160,850
The increase in cash provided by operating activities for the three-month period endedMarch 31, 2020 , as compared to the same period in 2019, was primarily due to increased profitability, the timing of vendor payments and lower cash paid for taxes in 2020.
Cash (Used in) Provided by Investing Activities
For the Three Months
Ended March 31,
(in thousands) 2020 2019Cash received (paid) for business acquisitions, net of cash acquired $
106$ (121,464) Cash paid for asset acquisition (36,376) -
Purchases of property and equipment and capitalization of internal-use software development costs
(215,429) (142,429)
Net marketable securities activity 141,037 537,412
Other investing activity (76) (37,278)
Net cash (used in) provided by investing activities $
(110,738)
The change in cash flows from investing activities during the three-month period endedMarch 31, 2020 , as compared to the same period in 2019, was driven by our marketable securities activity. During the three-month period endedMarch 31, 2019 we did not reinvest the majority of our proceeds from maturities of our marketable securities in order to repay our$690 million convertible senior note. During the three-month period endedMarch 31, 2020 , our net marketable securities activity was less because we reinvested the majority of investments that matured. Partially offsetting this change in investing cash activities, was lower cash paid for acquisitions, as we acquiredJanrain, Inc. during the three-month period endedMarch 31, 2019 and the assets ofInstart Logic, Inc. during the same period in 2020. 37 -------------------------------------------------------------------------------- Table of Contents Cash Used in Financing Activities For the Three Months Ended March 31, (in thousands) 2020 2019 Activity related to convertible senior notes $ -$ (690,000) Activity related to stock-based compensation (31,289) (18,865) Repurchases of common stock (80,550) (34,872) Other financing activities - (1,558) Net cash used in financing activities$ (111,839) $
(745,295)
Cash used in financing activities decreased during the three-month period endedMarch 31, 2020 , as compared to the same period in 2019, due to the repayment of$690 million in convertible senior notes that were due inFebruary 2019 , partially offset by an increase in repurchases of common stock in 2020. EffectiveNovember 2018 , the Board authorized a$1.1 billion share repurchase program throughDecember 2021 . Our goals for the share repurchase program are to offset the dilution created by our employee equity compensation programs and provide the flexibility to return capital to shareholders as business and market conditions warrant. During the three-month period endedMarch 31, 2020 , we repurchased 0.9 million shares of common stock at a weighted average price of$92.45 per share for an aggregate of$80.6 million . As ofMarch 31, 2020 ,$684.9 million remains available for future share repurchases. The timing and amount of any future share repurchases will be determined by our management based on its evaluation of market conditions and other factors.
Convertible Senior Notes
InAugust 2019 , we issued$1,150.0 million in par value of convertible senior notes due 2027 and entered into related convertible note hedge and warrant transactions. We intend to use the net proceeds of the offering for share repurchases, working capital and general corporate purposes, including potential acquisitions and other strategic transactions. InMay 2018 , we issued$1,150.0 million in par value of convertible senior notes due 2025 and entered into related convertible note hedge and warrant transactions. We used a portion of the net proceeds to repay at maturity all of our$690.0 million outstanding aggregate principle amount of convertible senior notes due in 2019. InFebruary 2014 , we issued$690.0 million in par value of convertible senior notes due 2019 and entered into related convertible note hedge and warrant transactions. We repaid the full principal amount due in cash inFebruary 2019 , as the notes matured and no conversions occurred. The terms of the notes and hedge transactions are discussed more fully in Note 7 to the consolidated financial statements included elsewhere in this quarterly report on Form 10-Q. Revolving Credit Facility InMay 2018 , we entered into a$500.0 million , five-year revolving credit agreement, or the Credit Agreement. Borrowings under the facility may be used to finance working capital needs and for general corporate purposes. The facility provides for an initial$500.0 million in revolving loans. Under specified circumstances, the facility can be increased to up to$1.0 billion in aggregate principal amount. Borrowings under the Credit Agreement bear interest, at our option, at a base rate plus a spread of 0.00% to 0.25% or an adjusted LIBOR rate plus a spread of 0.875% to 1.25%, in each case with such spread being determined based on our consolidated leverage ratio specified in the Credit Agreement. Regardless of what amounts, if any, are outstanding under the Credit Agreement, we are also obligated to pay an ongoing commitment fee on undrawn amounts at a rate of 0.075% to 0.15%, with such rate being based on our consolidated leverage ratio specified in the Credit Agreement. The Credit Agreement contains customary representations and warranties, affirmative and negative covenants, and events of default. Principal covenants include a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio. There were no outstanding borrowings under the Credit Agreement as ofMarch 31, 2020 . 38
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Liquidity Outlook
Based on our present business plan, we expect our current cash, cash equivalents and marketable securities balances and our forecasted cash flows from operations to be sufficient to meet our foreseeable cash needs for at least the next 12 months. Our foreseeable cash needs, in addition to our recurring operating costs, include our expected capital expenditures, investments in information technology, opportunistic business acquisitions, anticipated share repurchases, lease and purchase commitments and settlements of other long-term liabilities.
Contractual Obligations
Our principal commitments consist of service agreements with various vendors for bandwidth usage, obligations under leases with co-location facilities for data center capacity, obligations under leases for office space and open vendor purchase orders. Our minimum commitments related to bandwidth usage and co-location leases may vary from period to period depending on the timing and length of contract renewals with our vendors. As ofMarch 31, 2020 , there have been no significant changes in our future non-cancelable minimum payments under these commitments from those reported in our annual report on Form 10-K for the year endedDecember 31, 2019 , other than normal period-to-period variations.
Off-Balance Sheet Arrangements
We have entered into indemnification agreements with third parties, including vendors, customers, landlords, our officers and directors, shareholders of acquired companies, joint venture partners and third parties to which we license technology. Generally, these indemnification agreements require us to reimburse losses suffered by a third party due to various events, such as lawsuits arising from patent or copyright infringement or our negligence. These indemnification obligations are considered off-balance sheet arrangements in accordance with the authoritative guidance for guarantor's accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. See also Note 13 to our consolidated financial statements included in our annual report on Form 10-K for the year endedDecember 31, 2019 for further discussion of these indemnification agreements. The fair value of guarantees issued or modified during the three months endedMarch 31, 2020 was determined to be immaterial.
As of
Significant Accounting Policies and Estimates
See Note 1 to the consolidated financial statements included elsewhere in this quarterly report on Form 10-Q for information regarding recent and newly adopted accounting pronouncements. See also Note 2 to our consolidated financial statements included in our annual report on Form 10-K for the year endedDecember 31, 2019 . There have been no material changes to our significant accounting policies and estimates from those reported in our annual report on Form 10-K for the year endedDecember 31, 2019 .
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