Mixed 4Q for Akamai, Shares Fall

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Shares of Akamai Technologies, Inc. (AKAM) skid 15.7% ($6.53) in after hours trading on the heels of fourth quarter results, in which the content delivery network solutions provider failed to beat the Zacks Consensus Estimate of revenues.

However, earnings of 43 cents per share comfortably exceeded the Zacks Consensus Estimate by 6 cents. Earnings per share (“EPS”) include stock-based compensation expense and amortization of capitalized stock-based compensation, but exclude amortization of other intangibles, restructuring charges, acquisition related costs and legal settlement charges

Earnings excluding all aforementioned charges and benefits came at 54 cents per share, up 20.0% from 45 cents earned in the year-ago quarter. Earnings also surged 25.6% sequentially and were well above management’s guided range of 48 cents to 52 cents per share. The significant improvement in EPS was primarily driven by strong revenues and operating margin growth.

Revenues

Total revenues jumped 16.7% year over year and 9.4% quarter over quarter to $377.9 million, which fell slightly short of the Zacks Consensus Estimate. Total revenues also failed to beat the mid-point of management’s guided range of $373.0 million to $385.0 million. The miss was primarily due to lower-than-expected e-Commerce traffic level during the holiday season compared with the year-ago quarter.

Revenues from content delivery solutions grew 11.0% year over year and 5.0% sequentially. Cloud infrastructure solutions increased 20.0% from the year-ago quarter and 12.0% sequentially. Higher adoption of cloud infrastructure services (60% of the total revenue) and increased demand for security solutions (5 times year-over-year growth) were the main revenue drivers in the quarter.

Industry wise, Enterprise was the fastest-growing vertical in the quarter. Revenues jumped 27.7% year over year and 11.0% sequentially to $52.7 million, driven by continuing shift to the cloud-based applications and increasing demand for Akamai’s security solutions.

Commerce was the second fastest growing vertical, with revenues increasing 16.8% from the year-ago quarter and 21.4% from the previous quarter to $89.8 million. The strong growth was driven by increasing demand for security as well as website acceleration solutions.

Revenues from Media & Entertainment increased 15.1% year over year and 6.3% quarter over quarter to $158.1 million.

High Tech climbed 12.9% from the year-ago quarter and 5.9% sequentially to $59.9 million, driven by higher software download volumes and increasing sales of cloud infrastructure solutions.

Public Sector increased 14.4% year over year but declined 6.5% sequentially to $17.4 million in the reported quarter. The sequential decline resulted from the timing factor as several government projects were completed in the last quarter.

Region wise, revenues (excluding impact of currency) from North America (71% of total revenue) jumped 15.0% year over year and 9.0% sequentially. International revenues (29% of total revenue) jumped 22.0% on a year-over-year basis and 10% sequentially in the quarter. Resellers represented 23% of total revenues in the quarter.

Margins

Gross margin expanded 210 basis points (bps) year over year and 230 bps sequentially to 68.1%. The strong growth was primarily attributable to improving server network efficiency that continues to pull down costs.

Total operating expenses as percentage of revenues surged 130 bps on a year over year basis and 20 bps sequentially to 45.1%. The year-over-year growth in expenses was primarily due to higher sales & marketing (S&M) expense, up 200 bps in the quarter. Research & development (R&D) expense increased 70 bps in the quarter. However, general & administrative expense (G&A) declined 20 bps in the reported quarter.

Sequentially, the modest growth in operating expenses was driven by higher S&M, which increased 60 bps and fully offset a 20 bps decline in both R&D and G&A, respectively. The higher S&M expense reflects continued headcount investments focused on sales capacity.

Adjusted earnings before interest, taxes, depreciation, and amortization (:EBITDA) margin increased 20 bps year over year and 50 bps sequentially to 45.8%. Operating margin expanded 80 bps from the year-ago quarter and surged 210 bps sequentially to 25.3%. The strong growth was driven by higher gross margin base and lower-than-expected increase in operating expenses.

Net income margin increased 50 bps on a year over year basis and jumped significantly from 15.6% posted in the previous quarter to 19.8%.

Balance Sheet & Cash Flows

Akamai exited the quarter with cash and cash equivalents (including short-term marketable securities) of $437.6 million compared with $465.2 million in the prior quarter. Akamai generated cash flow from operations of $146.9 million in the reported quarter versus $141.5 million in the previous quarter. Akamai repurchased 800K shares for $30.0 million in the quarter.

Guidance

Akamai expects revenues in the range of $352.0 million to $362.0 million for the first quarter of 2013. This represents 13.0% to 16.0% year-over-year growth. Akamai expects GAAP gross margin of approximately 73.0%. Operating expenses are projected to be up about $4.0 million sequentially. Akamai expects adjusted EBITDA margin to be in the range of 42.0% to 43.0% for the first quarter.

Earnings are expected to be between 50 cents and 52 cents per share, including tax charge of $26 million to $29 million. Akamai forecasts capital expenditure (excluding equity-based compensation) of approximately $65.0 million to $70.0 million for the forthcoming quarter.

Our Take

We believe that strong demand for cloud infrastructure solutions, security, mobile products and online video will drive top-line growth going forward. Akamai’s superior content delivery platform has been chosen by the likes of Apple (AAPL) and News Corp. (NWS) due to its ability to provide high-quality service at a much lower rate compared to its peers. Akamai’s dominance in the web application business, where it serves companies such as eBay (EBAY), is a significant growth catalyst going forward.

Akamai continues to manage its server networks in an efficient way, which is expected to reduce depreciation expense going forward. This will further boost gross margins. Moreover, aggressive share repurchase (its board of directors recently authorized a $150.0 million extension of the program) will boost its profitability in 2013.

However, intense competition has kept pricing under tremendous pressure, which is a significant headwind going forward. In order to differentiate its products, Akamai is significantly investing in R&D and is also expanding its sales force through new appointments. This may hurt margins going forward.

Moreover, Akamai’s first quarter top-line growth is expected to be negatively impacted by foreign exchange headwind, difficult comps and winding down of some unprofitable contracts. Thus, we prefer to remain on the sidelines for the time being.

Currently, Akamai has a Zacks Rank #3 (Hold).

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