Akamai Technologies, Inc. — Q3 2018 Form 10-Q Summary
Business context and reporting period
Akamai provides cloud-based security, web and mobile performance, enterprise access, and video delivery solutions through a globally distributed platform of more than 200,000 servers in over 130 countries. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods.
The company adopted the new revenue recognition standard retrospectively on January 1, 2018. Management stated that the adoption primarily affected the timing of revenue for a small number of licensed software customers and had little impact on core services revenue.
Financial performance and key metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $669.6 million | $624.4 million | $2.001 billion | $1.831 billion |
| Income from operations | $116.5 million | $91.3 million | $242.2 million | $282.2 million |
| GAAP operating margin | 17.5% | 14.6% | 12.1% | 15.4% |
| Net income | $107.6 million | $63.9 million | $204.4 million | $195.2 million |
| GAAP diluted EPS | $0.64 | $0.37 | $1.20 | $1.13 |
| Operating cash flow | Not separately provided | Not separately provided | $722.2 million | $603.5 million |
| Adjusted EBITDA | $273.2 million | $231.1 million | $791.3 million | $683.9 million |
| Adjusted EBITDA margin | 41% | 37% | 40% | 37% |
Q3 revenue increased 7.2% year over year, or 8.1% at constant currency. Nine-month revenue increased 9.3%, or 8.3% at constant currency. Cloud Security Solutions revenue rose 37.2% in Q3 to $168.6 million and 35.3% for the nine months to $473.1 million.
International revenue increased 21.2% in Q3 and 21.5% for the nine months, while U.S. revenue increased 0.1% and 3.1%, respectively. Web Division revenue increased 8.2% in Q3 and 11.6% year to date; Media and Carrier Division revenue increased 6.1% and 6.9%.
Q3 profitability improved despite higher interest expense. Nine-month GAAP operating income declined because of restructuring charges, a $14.9 million Limelight litigation settlement charge, a $50.0 million Akamai Foundation endowment, and other costs. Non-GAAP operating margin improved to 27% in Q3 and 26% for the nine months, compared with 24% in each 2017 period.
Cash, liquidity, debt, and capital allocation
- Cash and cash equivalents were $705.4 million at September 30, 2018, compared with $313.4 million at December 31, 2017.
- Marketable securities totaled approximately $1.353 billion, producing cash, cash equivalents, and marketable securities of approximately $2.1 billion.
- Total convertible-notes carrying value was approximately $1.545 billion; principal outstanding was $1.150 billion due 2025 and $690.0 million due February 2019.
- The company issued $1.150 billion of 2025 convertible notes in May 2018, with a 0.125% coupon and an effective interest rate of 4.26%. Proceeds were partly invested in marketable securities and are intended to support repayment of the 2019 notes, repurchases, working capital, acquisitions, and other corporate purposes.
- A new five-year revolving credit facility provides $500.0 million of capacity, potentially expandable to $1.0 billion. There were no borrowings at September 30, 2018.
- Operating cash flow was $722.2 million for the first nine months. Investing cash use was $678.2 million, including $288.4 million for property, equipment, and internal-use software and increased purchases of marketable securities. Financing cash flow was positive $359.7 million, including debt issuance proceeds offset by $625.9 million of share repurchases.
- The company repurchased 8.3 million shares for $625.9 million during the first nine months, leaving $124.1 million available under the then-current authorization at September 30, 2018. A subsequent November 2018 authorization added $1.1 billion through December 2021.
- Management expects existing cash, marketable securities, and operating cash flows to meet foreseeable needs for at least the next 12 months, including capital spending, acquisitions, repurchases, commitments, and repayment of the 2019 notes.
Material changes versus the prior comparable period
- Revenue growth accelerated in security and international operations, but U.S. growth remained limited by declining revenue from large Internet Platform Customers and certain commerce customers.
- Interest expense more than doubled to $28.6 million for the nine months, primarily because of the 2025 convertible notes and associated debt-discount amortization.
- Operating margin declined year to date to 12.1% from 15.4%, despite Q3 expansion, due largely to unusual expenses and restructuring activity.
- General and administrative expense increased 22.4% year to date, including the Limelight settlement, the Foundation endowment, stockholder-matter costs, and higher infrastructure-related costs.
- Bandwidth expense declined, but network build-out, payroll, stock-based compensation, and internal-use software amortization increased.
- Share count declined because of repurchases; basic weighted-average shares fell to 168.8 million for the nine months from 172.3 million in the prior-year period.
- Remaining customer performance obligations were $2.3 billion at September 30, 2018, with more than 70% expected to be recognized within the following 12 months.
Guidance, outlook, risks, contingencies, and unusual items
The filing does not provide a clear numerical revenue or earnings guidance target. Management expects continued investment in security offerings, network capacity, internal software, and international growth. It expects 2018 cost of revenue, research and development, and sales and marketing expenses to increase in absolute dollars, while generally maintaining similar expense ratios; it also expects internal transformation initiatives to generate additional professional-services fees.
- Key demand risks include competition, pricing pressure, customer cancellations or renewals at lower rates, slower media traffic, and customers developing internal delivery infrastructure.
- Large Internet Platform Customers contributed $43.1 million in Q3 revenue and $131.5 million year to date, down from $50.7 million and $153.3 million in the comparable 2017 periods.
- Cybersecurity incidents, service disruptions, insufficient bandwidth or co-location capacity, privacy and data-transfer regulation, and intellectual-property claims could materially affect results.
- The company is subject to tax audits and litigation, including an appeal of adverse Massachusetts audit findings. Gross unrecognized tax benefits could decrease by approximately $30.8 million within 12 months if local statutes expire.
- The company recorded $14.4 million of restructuring charges during the first nine months and $14.9 million for the Limelight settlement. It also recorded the $50.0 million Foundation endowment and $23.1 million of legal and stockholder-matter costs in general and administrative expense.
- The company expects to adopt the new lease standard in the first quarter of 2019 and anticipates significant right-of-use assets and lease liabilities, but no material impact on operating results or cash flows.
- Management concluded that disclosure controls and procedures and internal control over financial reporting were effective as of September 30, 2018.
Most important facts for investors to verify
- Whether security growth and international expansion can offset declining usage and pricing pressure among large platform, media, and commerce customers.
- The company’s ability to repay or refinance the $690.0 million principal amount of convertible notes due in February 2019.
- The effect of convertible-note accounting, potential conversion, warrants, and note hedges on future dilution and interest expense.
- Whether Q3 operating-margin improvement is sustainable after excluding restructuring, legal, endowment, transformation, and other unusual items.
- Future cash deployment among debt repayment, share repurchases, capital expenditures, acquisitions, and strategic investments.
- Resolution of tax audits, the Massachusetts appeal, remaining Tax Cuts and Jobs Act accounting matters, and other legal contingencies.
- The impact of competition, cybersecurity threats, customer insourcing, foreign-exchange movements, and evolving privacy and data-regulation requirements.