AKAMAI TECHNOLOGIES INC annual report, FY2012

Akamai Technologies, Inc. — Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2012. The filing also provides unaudited fourth-quarter 2012 results. Akamai provides content delivery, cloud infrastructure, application performance, streaming media, software distribution, optimization, and security services through a globally distributed network of more than 125,000 servers in over 1,100 networks.

Financial performance and position

Metric	2012	2011	Change
Revenue	$1,373.9 million	$1,158.5 million	19%
Operating income	$314.5 million	$290.6 million	8%
Operating margin	22.9%	25.1%	Down 2.2 percentage points
Net income	$204.0 million	$200.9 million	2%
Net margin	14.8%	17.3%	Down 2.5 percentage points
Diluted EPS	$1.12	$1.07	5%
Adjusted EBITDA	$615.4 million	$525.3 million	17%
Operating cash flow	$530.4 million	$452.6 million	17%

Fourth-quarter 2012 revenue was $377.9 million, compared with $323.7 million in the fourth quarter of 2011. Fourth-quarter net income was $68.3 million, or $0.38 diluted EPS, compared with $60.1 million, or $0.33 diluted EPS, in the prior-year quarter.

Cost of revenues increased 15% to $431.9 million, while sales and marketing expense increased 34% to $304.4 million and research and development expense increased 43% to $74.7 million. The company reported $90.6 million of stock-based compensation expense, compared with $61.3 million in 2011.

At December 31, 2012, cash, cash equivalents and unrestricted marketable securities totaled approximately $1.095 billion, down from $1.230 billion at year-end 2011. Working capital was $525.4 million. The company had no outstanding interest-bearing debt and reported total liabilities of $254.9 million against stockholders’ equity of $2.346 billion.

Cash flow, capital allocation and liquidity

• Operating cash flow was $530.4 million.
• Investing activities used $779.0 million, including $336.7 million for four acquisitions, $219.8 million for property and equipment and capitalized internal-use software, and net purchases of marketable securities.
• Financing activities used $108.5 million, principally reflecting $141.5 million of share repurchases and $34.7 million of employee tax payments related to equity awards.
• Akamai repurchased approximately 4.4 million shares during 2012. Approximately $38.5 million remained available under the then-current repurchase authorization at year-end.
• Management stated that cash, marketable securities and expected operating cash flow should be sufficient to fund working capital and capital expenditures for at least the next 24 months.
• Contractual obligations totaled $319.8 million, including $155.1 million of real estate leases, $110.4 million of bandwidth and co-location commitments, and $54.3 million of open vendor purchase orders.

Material changes versus prior comparable period

• Revenue growth accelerated to 19% from 13% in 2011, driven primarily by Media & Entertainment, Commerce, Enterprise, High Tech and Public Sector customers.
• Media and Entertainment contributed $90.7 million of the $215.4 million year-over-year revenue increase; Commerce contributed $50.4 million and Enterprise $32.9 million.
• Traffic growth increased in video and software download solutions, but competitive pricing pressure, particularly in media, continued to reduce unit prices.
• Operating and net margins declined as the company increased investment in sales, marketing, research and development, personnel and infrastructure.
• Headcount increased from 2,380 to 3,074 employees, supporting product development and global go-to-market initiatives.
• Akamai completed acquisitions of Blaze, Cotendo, FastSoft and Verivue for aggregate cash consideration of approximately $336.7 million. Goodwill increased from $452.9 million to $731.3 million, and other intangible assets increased from $45.4 million to $84.6 million.
• Depreciation and amortization increased substantially due to network equipment and internal-use software investment. Management expects network asset useful lives to increase by approximately one year, reducing network equipment depreciation in 2013, while internal-use software amortization is expected to increase.
• The company’s former 1% convertible senior notes were fully converted in 2010; Akamai reported no interest expense in 2012 or 2011.

Outlook, commentary and unusual items

• Management expected continued revenue growth and net income in 2013, but cautioned that growth could be slower because of competition, economic conditions and the sale of the Advertising Decision Solutions business.
• Management expected international revenue to remain approximately 28% of total revenue in 2013.
• Revenue is seasonally stronger in the fourth quarter and weaker during summer months, primarily due to retail e-commerce usage patterns.
• Management expected 2013 cost of revenues, research and development, sales and marketing, and general and administrative expenses to increase as the company continued investing in network capacity, products and personnel.
• Management expected the 2013 effective tax rate to decline slightly, partly because the federal research and development credit was retroactively reinstated. A tax benefit of approximately $4.8 million related to 2012 qualifying expenditures was expected to be recognized in the first quarter of 2013.
• 2012 included $5.8 million of acquisition-related costs, a $0.4 million restructuring charge and $21.0 million of amortization of acquired intangible assets.
• During the fourth quarter, Akamai corrected prior-period income tax expense errors, reducing fourth-quarter tax expense by $5.3 million.
• Effective January 1, 2013, F. Thomson Leighton became chief executive officer. MediaMath acquired substantially all assets of Akamai’s Advertising Decision Solutions business and received exclusive rights to use related pixel-free technology under a multi-year relationship.
• In February 2013, the board authorized a new $150 million, 12-month extension of the share repurchase program.

Key risks and contingencies

• Intense competition and continuing price pressure could reduce revenue, market share and profitability. Customer contracts typically run 12 to 24 months, and renewals may occur at lower prices or committed traffic levels.
• The company has significant fixed and semi-fixed costs, including bandwidth, co-location, depreciation, personnel and infrastructure expenses. Lower-than-expected traffic growth could disproportionately reduce margins.
• Service interruptions, network failures, cybersecurity attacks, DDoS attacks, software defects or inadequate third-party bandwidth and co-location capacity could result in credits, liability, customer losses and reputational damage.
• Acquisitions may create integration challenges, management distraction, goodwill and intangible-asset impairment risk, and additional amortization.
• International operations expose the company to foreign-exchange, tax, regulatory, privacy, data protection and compliance risks. Foreign operations represented 28% of 2012 revenue.
• Akamai had $26.9 million of unrecognized tax benefits, including accrued interest and penalties, and believed approximately $3.7 million could be recognized by the end of 2013.
• Outstanding letters of credit totaled $6.2 million, primarily related to facility leases. Indemnification obligations generally had unlimited stated maximum exposure, although management considered expected liabilities immaterial based on historical experience.
• Routine litigation was disclosed, but management did not expect current matters to have a material adverse effect.
• Goodwill impairment testing at December 31, 2012 did not indicate impairment, but the company carried $731.3 million of goodwill and $84.6 million of other intangible assets.

Investor verification checklist

• Verify whether revenue growth continues to offset unit-price declines, customer cancellations and lower renewal pricing.
• Track operating margin and expense growth, especially sales and marketing, research and development, bandwidth, co-location and stock-based compensation.
• Assess the revenue contribution, integration progress and impairment risk associated with the 2012 acquisitions, particularly Cotendo.
• Reconcile operating cash flow with capital expenditures, acquisition spending and share repurchases.
• Monitor the effect of the Advertising Decision Solutions sale and the new CEO’s strategic changes on 2013 revenue and profitability.
• Review tax audit developments, the reinstated research and development credit and the $26.9 million unrecognized tax benefit balance.
• Evaluate cybersecurity, service availability, third-party network capacity and customer indemnification exposure.
• Confirm the effect of outstanding equity awards and $134.7 million of unrecognized stock-based compensation on future expenses and share dilution.