Business Context and Reporting Period
Akamai Technologies, Inc. provides cloud services for delivering, optimizing, and securing content and business applications over the Internet through a globally distributed platform of more than 200,000 servers across 130 countries. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017, with comparisons to the same periods in 2016.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | Change |
|---|
| Revenue | $621.4 million | $584.1 million | 6.4% increase |
| Income from operations | $85.9 million | $111.8 million | 23.2% decrease |
| GAAP operating margin | 13.9% | 19.2% | Down 5.3 percentage points |
| Net income | $60.5 million | $76.0 million | 20.4% decrease |
| Diluted EPS | $0.35 | $0.43 | Decrease |
| Adjusted EBITDA | $225.8 million | $238.1 million | 5.2% decrease |
| Adjusted EBITDA margin | 36% | 41% | Down 5 percentage points |
| Metric | Nine months 2017 | Nine months 2016 | Change |
|---|
| Revenue | $1.840 billion | $1.724 billion | 6.7% increase |
| Income from operations | $288.3 million | $336.1 million | 14.2% decrease |
| GAAP operating margin | 15.7% | 19.5% | Down 3.8 percentage points |
| Net income | $199.2 million | $224.5 million | 11.3% decrease |
| Diluted EPS | $1.15 | $1.27 | Decrease |
| Operating cash flow | $603.5 million | $687.6 million | 12.2% decrease |
| Adjusted EBITDA | $690.0 million | $703.3 million | 1.9% decrease |
Revenue and Profitability
- Cloud Security Solutions revenue grew 27% in the quarter and 32% for the nine-month period.
- Performance and Security Solutions revenue increased 10.5% in the quarter and 14.1% year to date.
- Media Delivery Solutions revenue declined 2.8% in the quarter and 7.1% year to date, primarily because major Internet Platform Customers increasingly used internal infrastructure.
- Cost of revenue increased 10.3% in the quarter, causing gross cost pressure. Research and development, sales and marketing, and general and administrative expenses increased 35.2%, 17.1%, and 9.9%, respectively, in the quarter.
- The effective tax rate was 29.7% in the quarter and 30.9% for the nine months, compared with 32.0% and 32.7%, respectively, in the prior-year periods.
Cash Flow, Liquidity, and Debt
- At September 30, 2017, cash and cash equivalents were $368.2 million and marketable securities totaled approximately $1.046 billion, for combined liquidity of approximately $1.4 billion.
- Convertible senior notes had $690.0 million of principal outstanding, with a $657.1 million carrying value and a February 2019 maturity. Management reported net cash of approximately $723.9 million using cash, securities, and note principal.
- Nine-month operating cash flow was $603.5 million. Investing cash use was $257.7 million, including $197.2 million for the Soasta acquisition, $185.5 million for property and equipment, and $122.5 million for capitalized internal-use software.
- Financing cash use was $314.1 million, including $306.6 million for repurchases of 5.8 million shares. Approximately $387.9 million remained available under the repurchase authorization at September 30, 2017.
- Management stated that existing liquidity and forecast operating cash flow should meet foreseeable cash needs for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Revenue growth continued, but profitability and cash generation declined as operating expenses, network investment, headcount, and acquisition-related costs increased.
- Web Division revenue rose 13.8% in the quarter and 14.4% year to date, while Media Division revenue declined 1.0% and 1.1%, respectively.
- Revenue from the six major Internet Platform Customers declined to $50.6 million in the quarter and $153.1 million year to date, from $58.0 million and $192.0 million in the comparable periods.
- International revenue grew 18.3% in the quarter and 17.8% year to date, representing approximately 34% of total revenue versus 31% in the prior-year periods.
- The April 2017 acquisition of Soasta cost $199.3 million in cash, increased goodwill by $121.7 million, and was dilutive to earnings per share in the second and third quarters.
- Restructuring charges declined to $0.3 million in the quarter and $3.3 million year to date, compared with $2.9 million and $10.2 million in the prior-year periods.
- The company adopted new share-based payment accounting guidance in 2017. The filing states that the new revenue recognition standard, to be adopted retrospectively on January 1, 2018, was not expected to materially affect reported income, although capitalization of contract acquisition costs could materially affect the balance sheet.
Guidance, Outlook, Commentary, and Risks
- Management expected fourth-quarter revenue to increase from the third quarter, although fourth-quarter results were described as difficult to predict because of holiday seasonality.
- Management expected fourth-quarter cost of revenue, research and development, sales and marketing, and general and administrative expenses to increase due to traffic, network capacity investments, hiring, commissions, customer conference costs, and facility expansion.
- Management expected the full-year effective tax rate to decline from the nine-month rate because of known fourth-quarter discrete tax items.
- A planned acquisition of Nominum, announced in October 2017, was expected to close in the fourth quarter and to be dilutive to earnings during the fourth quarter and 2018 due to purchase accounting and integration costs.
- Key risks include slower network traffic growth, customer migration to internally built infrastructure, pricing pressure and lower renewal rates, competition, cybersecurity incidents, service disruptions, high fixed network costs, acquisition integration, foreign currency exposure, tax uncertainty, and the ability to refinance or satisfy the 2019 convertible notes.
- A pending Limelight Networks patent litigation matter remains unresolved. The company has indemnified XO Communications for potential damages, has made counterclaims, and stated that no loss provision was recorded because a possible loss range could not be estimated.
- The company received $13.5 million from Limelight during the first nine months, including $12.3 million recorded as a gain contingency that reduced general and administrative expense and $1.2 million recorded as interest income.
Important Facts for Investors to Verify
- Whether Cloud Security growth can offset continued declines or pricing pressure in Media Delivery Solutions.
- The sustainability of operating margins as network investments, headcount, stock-based compensation, and acquisition expenses increase.
- The effect of the Nominum acquisition and Soasta integration on revenue, earnings, cash flow, and goodwill.
- The timing and cash or equity settlement implications of the $690.0 million convertible notes due in February 2019.
- The impact of the January 2018 revenue recognition adoption, especially balance-sheet capitalization of commissions and incentive payments.
- Future share repurchases and their effect on liquidity, share count, and per-share results.
- Developments in the Limelight patent litigation and any related financial exposure.
- Actual fourth-quarter seasonality, traffic levels, customer usage, foreign exchange effects, and tax-rate changes relative to management’s expectations.
