Akamai Technologies, Inc. — 2014 Q3 Form 10-Q Summary
Business Context and Reporting Period
Akamai provides cloud services for delivering, optimizing and securing online content and business applications through a globally distributed platform. The filing covers the unaudited quarter and nine months ended September 30, 2014, compared with the corresponding 2013 periods.
In February 2014, Akamai acquired Prolexic Technologies for approximately $392.1 million in cash, expanding its security offerings. Prolexic’s results were included from February 18, 2014.
Financial Performance and Key Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Revenue | $498.0 million, up 25.8% | $1.428 billion, up 25.0% |
| Income from operations | $120.2 million | $353.4 million |
| Operating margin | 24.1% | 24.8% |
| Net income | $91.2 million | $236.8 million |
| Net margin | 18.3% | 16.6% |
| Diluted EPS | $0.50 | $1.31 |
| Adjusted EBITDA | $213.1 million; 43% margin | $620.9 million; 43% margin |
Revenue growth was broad-based. Third-quarter revenue was $230.6 million from Media Delivery Solutions, $224.2 million from Performance and Security Solutions, and $43.3 million from Service and Support Solutions. Resellers represented 25% of revenue, compared with 21% in the prior-year periods.
Gross margin improved as cost of revenue declined to 31.9% of revenue from 33.4% in the third quarter of 2013 and to 31.4% from 33.0% for the nine-month period. However, sales and marketing, research and development, and amortization expenses increased as Akamai expanded its workforce, infrastructure and go-to-market activities.
Cash provided by operating activities was $462.5 million for the nine months, compared with $392.2 million in 2013. Capital expenditures and capitalized internal-use software costs totaled $226.3 million. Net cash used in investing activities was $1.042 billion, primarily reflecting the Prolexic acquisition and purchases of marketable securities.
At September 30, 2014, cash and cash equivalents were $214.3 million and marketable securities totaled $1.347 billion. Total cash, cash equivalents and marketable securities were approximately $1.6 billion. The company reported $690.0 million of convertible senior notes due 2019, carried at $600.1 million after debt discount. Stockholders’ equity was $2.848 billion.
Material Changes Versus the Prior Comparable Period
- Revenue increased 25.8% in the quarter and 25.0% year to date, driven by demand across solutions and geographies.
- Performance and Security Solutions revenue increased 28.9% in the quarter and 28.3% year to date, partly reflecting Prolexic.
- Operating income increased to $120.2 million from $99.5 million in the quarter and to $353.4 million from $298.2 million year to date.
- GAAP operating margin declined to 24.1% from 25.1% in the quarter and to 24.8% from 26.1% year to date, primarily because operating expenses grew faster than revenue.
- Net income increased to $91.2 million from $79.8 million in the quarter and to $236.8 million from $213.1 million year to date.
- Interest expense increased by $4.5 million in the quarter and $10.9 million year to date because of the convertible notes issued in February 2014.
- Cash flow benefited from higher profitability, while investing cash outflows increased substantially because of the Prolexic acquisition and higher securities purchases.
- Akamai repurchased 3.9 million shares for $226.5 million during the first nine months, including 648,968 shares for $39.0 million in the third quarter. Approximately $475.8 million remained authorized under the repurchase program at September 30.
Guidance, Outlook, Commentary, Risks and Unusual Items
The filing does not provide a clear numerical revenue or earnings forecast. Management expects fourth-quarter expenses to increase relative to each of the first three quarters due to higher server deployments, traffic, co-location, hiring, sales and marketing, facilities, information technology and network investment. Capital expenditures are also expected to increase in the fourth quarter.
Management stated that existing cash, marketable securities and forecast operating cash flow should be sufficient to meet foreseeable cash needs for at least the next 24 months, including capital expenditures, expansion, lease commitments, share repurchases and potential strategic transactions.
- The third-quarter effective tax rate was 22.5%; the nine-month rate was 31.5%. A $13.3 million state tax benefit related to software development activities covered the period from January 1, 2010 through September 30, 2014. Management expected the effective tax rate to increase slightly in the fourth quarter because of the third-quarter discrete benefit.
- The Prolexic acquisition generated $4.1 million of acquisition-related costs for the nine months and is expected to be slightly dilutive to earnings per share in its first full year.
- Amortization of acquired intangible assets was $8.4 million in the quarter and $23.7 million year to date; management expected approximately $8.4 million in the fourth quarter of 2014.
- The convertible notes have no regular coupon, but produce non-cash interest expense through amortization of debt discount and issuance costs. The notes may convert into approximately 7.7 million shares at an initial conversion price of approximately $89.56 per share; related hedge and warrant transactions generally increase the effective conversion price to approximately $104.49.
- Key risks include intense competition and pricing pressure, customer cancellations or lower-priced renewals, execution and integration risks from acquisitions, cybersecurity and service interruptions, reliance on third-party bandwidth and co-location providers, foreign currency exposure, tax uncertainty, intellectual-property claims and potential dilution or liquidity needs related to the convertible notes.
- Management reported no material changes to previously disclosed risk factors, no material adverse expectation from routine litigation, effective disclosure controls, and no material change in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether revenue growth, particularly in Performance and Security Solutions and reseller channels, continues after the Prolexic acquisition contribution.
- Whether planned hiring, network expansion, co-location and infrastructure spending pressure operating margins and free cash flow.
- The integration progress and earnings impact of Prolexic, including final purchase-price allocation and intangible-asset amortization.
- The remaining authorization and future pace of share repurchases, as well as the potential dilution and cash obligations associated with the 2019 convertible notes and warrants.
- The sustainability of the reported tax rate after the nonrecurring $13.3 million state tax benefit.
- Exposure to competitive pricing, customer renewal rates, cybersecurity incidents, network outages, foreign currency movements and unresolved tax or intellectual-property matters.