Akamai Technologies, Inc. — Form 10-Q Summary
Business context and reporting period
Akamai provides cloud services for delivering, optimizing, and securing Internet content and business applications through a globally distributed platform of more than 222,000 servers in approximately 125 countries. This unaudited Form 10-Q covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Revenue | $584.1 million | $551.0 million | $1.724 billion | $1.618 billion |
| Income from operations | $111.8 million | $115.7 million | $336.1 million | $343.5 million |
| GAAP operating margin | 19.2% | 21.0% | 19.5% | 21.2% |
| Net income | $76.0 million | $88.0 million | $224.5 million | $233.0 million |
| Diluted EPS | $0.43 | $0.49 | $1.27 | $1.29 |
| Operating cash flow | Not separately provided | Not separately provided | $684.5 million | $546.4 million |
| Adjusted EBITDA | $238.1 million | $222.2 million | $703.3 million | $659.5 million |
Revenue increased 6.0% in the quarter and 6.5% year to date. Cloud Security Solutions grew 46% in the quarter and 45% year to date. Performance and Security Solutions revenue increased 19.4% in the quarter and 17.1% year to date, while Media Delivery Solutions declined 13.9% and 9.1%, respectively. Services and Support Solutions increased 17.1% and 16.8%.
Profitability weakened because cost of revenue increased to 35.0% of revenue in the quarter and 35.1% year to date, compared with 33.2% and 32.9% in the prior-year periods. Cost increases reflected bandwidth, payroll, network equipment depreciation, and internal-use software amortization. Restructuring charges were $2.9 million in the quarter and $10.2 million year to date.
Cash, cash equivalents, and marketable securities totaled approximately $1.7 billion at September 30, 2016. The balance sheet reported $381.8 million of cash and cash equivalents, $1.297 billion of marketable securities, and $634.5 million of convertible senior notes, net of discount and issuance costs. Management stated that net cash was $988.9 million using its debt measure.
Capital expenditures and capitalized internal-use software development totaled $240.4 million during the first nine months. Financing cash use included $294.9 million of share repurchases. The company repurchased 5.7 million shares year to date and had approximately $773.4 million remaining under its repurchase authorization at September 30.
Material changes versus the prior comparable period
- Revenue growth remained positive but moderated, primarily because six large Internet Platform Customers—Amazon, Apple, Facebook, Google, Microsoft, and Netflix—continued do-it-yourself delivery efforts. Revenue from these customers fell to $58.0 million in Q3 from $95.2 million and to $192.0 million year to date from $287.6 million.
- GAAP operating margin declined by 1.8 percentage points in the quarter and 1.7 percentage points year to date.
- Net income declined 13.7% in the quarter and 3.6% year to date, while diluted EPS declined to $0.43 from $0.49 in the quarter and to $1.27 from $1.29 year to date.
- Adjusted EBITDA increased to $238.1 million in the quarter and $703.3 million year to date; Adjusted EBITDA margin was 41% in both periods, compared with 40% in Q3 2015 and 41% year to date.
- Operating cash flow increased $138.2 million year to date, supported by customer collections, timing of working-capital payments, and lower commissions and bonuses.
- The company increased headcount by 250 employees during the first nine months and continued investing in network capacity, product development, and international operations.
Guidance, outlook, commentary, and unusual items
- Management expected fourth-quarter cost of revenue, research and development, sales and marketing, and general and administrative expenses to increase relative to earlier quarters because of network deployment, hiring, commissions, marketing activity, facilities, information technology, and litigation costs.
- Management expected the year-to-date effective tax rate to decrease slightly in the fourth quarter, excluding potential discrete tax items.
- The company expected modest decreases in traffic from the six large Internet Platform Customers during the remainder of 2016 and noted continued competitive pricing pressure.
- In October 2016, Akamai acquired Soha Systems for $55.0 million in cash plus up to $5.0 million in milestone payments. In September, it acquired Concord Systems for $3.0 million in cash.
- In July 2016, Akamai licensed certain technology to Limelight Networks as part of a patent dispute resolution. Limelight is required to pay $54.0 million in 12 installments; Akamai recorded the first $4.5 million payment in Q3 as a reduction of general and administrative expense.
- A June 2016 non-prosecution agreement with the Commission resolved an FCPA-related matter for $0.7 million, including interest. The company disclosed potential additional regulatory risk if the agreement is violated.
- In November 2016, after the reporting date, Akamai signed a 15-year Cambridge headquarters lease and related arrangements with total minimum obligations of $698.4 million.
- The company had $690.0 million principal amount of zero-coupon convertible notes due February 2019. The notes had a $634.5 million carrying amount and an estimated fair value of $676.6 million at September 30, 2016.
- A Limelight patent-infringement trial was scheduled for January 2017. No loss provision was recorded, and the company stated that a possible loss range could not be estimated.
Key risks and contingencies
- Slower network traffic growth, customer insourcing, customer cancellations, renewal price reductions, and competition could reduce revenue growth and profitability.
- The company has significant relatively fixed bandwidth, co-location, infrastructure, and personnel costs that may not be reduced quickly if revenue growth slows.
- Cybersecurity incidents, service interruptions, network capacity constraints, software defects, and failures by third-party network providers could result in customer losses, credits, liability, and reputational damage.
- International operations expose the company to foreign-exchange, regulatory, tax, privacy, anti-corruption, and geopolitical risks.
- Patent litigation, including the Limelight matter, could result in substantial damages or costs, although the filing states that the outcome is not currently expected to materially affect the company.
- Convertible-note obligations could require cash payments, refinancing, or issuance of potentially dilutive shares. The notes may convert into approximately 7.7 million shares, subject to the applicable terms.
- Management concluded that disclosure controls and procedures were effective as of September 30, 2016, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Cloud Security and other Performance and Security growth can offset continued declines from large Internet Platform Customers and in Media Delivery Solutions.
- Whether bandwidth, co-location, hiring, infrastructure, facilities, and litigation costs continue to pressure GAAP operating margins.
- The remaining authorization and future pace of share repurchases, including their effect on share count and capital allocation.
- Cash generation, capital expenditures, the Soha acquisition consideration, and the company’s ability to fund the 2019 convertible notes and substantial lease commitments.
- Developments in the Limelight patent litigation and compliance with the FCPA-related non-prosecution agreement.
- The effect of future accounting standards, including revenue recognition, leases, share-based payments, and credit-loss guidance, which the company was still evaluating.