(AKAM) Akamai Technologies Misses Earnings Expectations – Margins Lag

Akamai Technologies, Inc. (AKAM) reported earnings of 25 cents per share in the third quarter of 2011, which missed the Zacks Consensus Estimate by a penny. However, earnings per share (EPS) increased 8.7% from the 23 cents per share reported in the year-ago quarter.

Reported EPS includes stock-based compensation expense and amortization of capitalized stock-based compensation but excludes amortization of other intangible charges and restructuring charges.

The year-over-year growth was primarily driven by strong revenues; partially offset by higher expenses, which dragged margins in the reported quarter.

Operating Performance

Gross profit (including stock-based compensation) increased 7.3% year over year to $188.6 million in the reported quarter. However, gross margin contracted 230 basis points (bps) year over year to 67.0% in the same period.

Adjusted EBITDA (including stock-based compensation) increased 7.3% year over year to $122.4 million in the quarter. Adjusted EBITDA margin was 43.4% compared with 45.0% in the year-ago quarter.

Total operating expenses increased 5.6% year over year to $118.9 million. The year-over-year growth in expenses was primarily attributed to higher general & administrative expense (up 19.0% year over year), which fully offset declines in research & development expense (down 4.9% year over year) and sales & marketing expense (down 2.0% year over year) in the quarter.

Operating income on a non-GAAP basis was $69.7 million versus $63.2 million in the year-ago quarter. Operating margin in the quarter was 24.7% compared with 24.9% in the year-ago quarter.

Net income was $46.6 million in the reported quarter, up 6.4% year over year. Net income margin declined 80 bps on a year-over-year basis to 16.5% in the quarter.

Revenue

Total revenue in the quarter was $281.9 million, up 11.2% year over year and surpassed the Zacks Consensus Estimate of $279.0 million. Total revenue also managed to achieve the higher end of management’s guided range of $273.0 million to $283.0 million.

The better-than-expected result was primarily driven by continued solid growth for value added solutions. Revenue from Akamai’s fastest-growing Enterprise vertical grew 30.0% year over year to $39.0 million, as more customers adopted cloud services for their businesses.

Commerce increased 23.0% year over year to $61.4 million, driven by strong demand for Dynamic Site Acceleration solutions (DSA) and security solutions. The company signed approximately 100 DSA deals and more than 30 customers purchased Akamai’s security solutions during the quarter.

Public sector climbed 5.0% year over year to $15.5 million and Media & Entertainment jumped 5.0% to $117.7 million. Revenue from the High Tech vertical grew 3.0% year over year to $48.2 million in the reported quarter.

Region wise, revenue from North America climbed 10.0% year over year. International revenues jumped 6.0% year over year. Sales through resellers were 19.0% of the total revenue in the third quarter.

Balance Sheet

As of September 30, 2011, cash and cash equivalents (includes marketable securities and restricted marketable securities) were $687.6 million compared with $497.3 million, as of June 30, 2011.

Akamai generated cash flow from operations of $116.3 million in the reported quarter versus $111.8 million in the previous quarter. During the third quarter, Akamai repurchased approximately 7.0 million shares for $155.0 million, at an average price of $22.75 per share.

Guidance

Akamai expects revenue in the range of $303.0 million to $315.0 million (6% to 11% year-over-year growth) for the fourth quarter of 2011. Favorable foreign exchange rate is expected to have an impact of approximately $2.0 million on a year-over-year basis.

Akamai expects gross margins to remain flat on a sequential basis. For the fourth quarter, Akamai expects operating expenses to increase approximately $10.0 million year over year. Akamai expects adjusted EBITDA margin in the range of 43% to 44%.

EPS is expected to be between 37 cents and 41 cents, including tax charge of $25 million to $30 million, based on a full-year GAAP tax rate of about 36%. Currently, the Zacks Consensus Estimate (including stock-based compensation) for the fourth quarter is pegged at 31 cents per share.

Akamai forecasts capital expenditure (excluding equity-based compensation) of approximately $50 million for the forthcoming quarter. For fiscal 2011, capital expenditure is expected to be 16% of revenues.

Our Take

We believe that increased usage of cloud computing technology ensures higher adoption of value-added solutions, which will drive strong top-line growth going forward. Moreover, strong demand for security products, aggressive share repurchase and strategic partnerships are positives for the stock over the long term.

However, weak traffic growth remains a concern, as Akamai continues to face intense pricing pressure from competitors like Level 3 Communications Inc. (LVLT), Limelight Networks, Inc. (LLNW) and carriers such as AT&T Inc. (T) and Verizon Communications (VZ), who are developing their own content delivery network. We believe this will hurt revenue growth going forward.

We maintain our Neutral recommendation on a long-term basis (6-12 months). Currently, Akamai has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.

AKAMAI TECH (AKAM): Free Stock Analysis Report

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