Akamai Technologies, Inc. — Q1 2014 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 of more than 145,000 servers in approximately 1,200 networks across over 90 countries. The filing covers the unaudited three months ended March 31, 2014, compared with the three months ended March 31, 2013.
Revenue growth reflected strong demand across solutions and geographies, the February 2014 acquisition of Prolexic Technologies, and continued growth in reseller activity. Approximately 28% of revenue came from operations outside the United States in both periods.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $453.5 million | $368.0 million | 23.2% increase |
| Income from operations | $120.8 million | $101.2 million | 19.4% increase |
| Operating margin | 26.6% | 27.6% | Down 1.0 point |
| Net income | $72.8 million | $71.5 million | 1.8% increase |
| Net margin | 16.1% | 19.4% | Down 3.3 points |
| Diluted earnings per share | $0.40 | $0.39 | Increase |
| Adjusted EBITDA | $203.6 million | $166.1 million | 22.6% increase |
| Adjusted EBITDA margin | 45% | 45% | Stable |
| Cash flow from operations | $89.0 million | $93.2 million | Decrease |
Revenue by solution category was $214.8 million for Media Delivery, $198.0 million for Performance and Security, and $40.7 million for Service and Support. Prolexic contributed $7.0 million of revenue in the quarter.
Cost of revenue increased 16.0% to $139.6 million, but declined to 30.8% of revenue from 32.7%, reflecting lower bandwidth costs per unit and network efficiencies. Research and development, sales and marketing, and general and administrative expenses increased 28.9%, 29.3%, and 37.5%, respectively, driven largely by hiring, infrastructure investments, geographic expansion, and acquisition-related activity.
Cash, cash equivalents, and marketable securities totaled approximately $1.4 billion at March 31, 2014, including $248.7 million of cash and cash equivalents and $1.17 billion of marketable securities. Cash and cash equivalents held outside the United States totaled $124.7 million.
Total assets were $3.65 billion, compared with $2.96 billion at December 31, 2013. Convertible senior notes had a March 31 carrying value of $590.7 million and $690.0 million of principal outstanding. The notes mature in February 2019, bear no regular interest, and have an effective interest rate of approximately 3.2%.
Material Changes Versus the Prior Comparable Period
- Revenue increased 23.2%, supported by broad-based demand, higher Service and Support revenue, stronger international and reseller activity, and $7.0 million from Prolexic.
- Performance and Security Solutions revenue increased 26.4%; Service and Support Solutions increased 48.2%; Media Delivery Solutions increased 18.6%.
- Net income grew only modestly because of higher operating expenses, a higher effective tax rate, and new non-cash interest expense associated with the convertible notes.
- The effective tax rate increased to 39.2% from 30.4%, primarily due to first-quarter discrete items, stock-based compensation accounting, state taxes, expiration of the federal research and development credit, and changes in the geographic mix of earnings.
- Operating cash flow declined despite higher net income, primarily because of the timing of collections, payments, and estimated tax payments.
- Investing cash outflows increased to $730.5 million from $84.2 million, including $386.6 million paid for acquisitions, $84.0 million for property, equipment, and internal-use software, and net marketable securities purchases.
- Financing activities provided $555.5 million, primarily from the convertible-note issuance, related warrant proceeds, and stock-plan activity, partially offset by $116.1 million of share repurchases.
Acquisitions, Capital Allocation, and Unusual Items
On February 18, 2014, Akamai acquired Prolexic for approximately $392.2 million in cash and assumed equity awards. The acquisition added security capabilities addressing application-layer, network-layer, and data-center attacks. The purchase-price allocation remained preliminary and included $293.4 million of goodwill and $87.0 million of identifiable intangible assets. Acquisition-related costs were $3.9 million, including $3.4 million in general and administrative expense, and the acquisition was expected to be slightly dilutive to earnings per share.
Akamai issued $690.0 million of convertible senior notes, received $78.0 million from related warrants, and paid $101.3 million for a note hedge intended to reduce potential dilution. The notes are initially convertible at approximately $89.56 per share, while the warrant transactions generally increase the effective conversion price to approximately $104.49 per share.
The company repurchased approximately 2.0 million shares for $116.1 million at an average price of $58.77 per share. Approximately $62.0 million of the note proceeds funded concurrent repurchases. The remaining authorization under the share repurchase program was approximately $586.1 million at March 31, 2014.
Restructuring charges were $0.7 million, primarily related to Prolexic employee severance and transition costs. Acquired-intangible amortization was $6.8 million in the quarter; the company expected approximately $25.2 million of additional amortization for the remainder of 2014.
Guidance, Outlook, and Management Commentary
- Management expected revenue growth to continue based on recurring contracts, customer additions, increased service adoption, traffic growth, and geographic expansion.
- Cost of revenue, research and development, sales and marketing, and general and administrative expenses were expected to increase in absolute dollars during the remainder of 2014 as the company expanded its network, facilities, technology investments, and workforce.
- Management expected lower bandwidth costs per unit and network efficiencies to partially offset higher traffic, co-location, depreciation, software-amortization, and payroll costs.
- The company expected its effective tax rate to decrease from the first-quarter level, although quarterly tax rates could fluctuate because of discrete items, equity compensation, audits, acquisitions, and changes in geographic earnings.
- Management believed existing cash, marketable securities, and forecast operating cash flow would meet foreseeable cash needs for at least the next 24 months, including capital expenditures, hiring, facilities, share repurchases, lease commitments, and potential strategic transactions.
Risks and Contingencies
- Intense competition may lead to customer losses, lower renewal prices, reduced traffic commitments, and pricing pressure, particularly in media delivery.
- Service interruptions, network or data-center capacity constraints, software defects, cyberattacks, and security breaches could cause customer credits, liability, reputational damage, and lost revenue.
- Prolexic and other acquisitions create integration, execution, impairment, employee-retention, and potential-liability risks.
- The convertible notes create refinancing, conversion, repurchase, liquidity, and potential dilution risks; the notes do not restrict future borrowing.
- International operations expose Akamai to foreign-exchange, regulatory, tax, privacy, anti-corruption, and data-protection risks. Currency movements reduced first-quarter 2014 revenue by $1.7 million versus the prior-year period.
- The company has long-term bandwidth, co-location, lease, and vendor commitments, which may limit its ability to reduce expenses quickly if revenue growth slows.
- Routine litigation was disclosed, but management did not expect current matters to have a material adverse effect. The filing states that there were no material changes to previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether Prolexic integration produces the expected security revenue growth, operating synergies, and limited dilution.
- Revenue retention, renewal pricing, traffic growth, reseller contribution, and customer concentration trends.
- Progress in controlling hiring, co-location, bandwidth, infrastructure, and software-development costs as investments increase.
- Potential dilution from the convertible notes and warrants, including the effects of the note hedge and stock-price thresholds.
- Cash conversion and working-capital trends, particularly collections, tax payments, capital expenditures, and marketable-security purchases.
- Changes in the effective tax rate and the resolution of tax reserves or other uncertain tax positions.
- Cybersecurity, network reliability, intellectual-property, privacy, regulatory, and international-currency exposures.