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Akamai Technologies, Inc. (AKAM - Analyst Report) reported third quarter 2013 earnings of 50 cents per share, which jumped 31.6% from the year-ago quarter and 8.7% from the previous quarter. Excluding 3 cents related to a tax benefit, earnings were 47 cents per share, in line with the high-end of management’s guided range of 44 cents to 47 cents per share.

Revenues

Revenues jumped 14.6% year over year and 4.7% quarter over quarter to $395.8 million, well ahead of the Zacks Consensus Estimate of $388.0 million. Revenues were higher than management’s guided range of $380.0 million to $392.0 million.

Excluding Akamai’s Advertising Decision Solutions (ADS) business, divested in late January, revenues increased 18.0% on a year-over-year basis. The strong growth in revenues was primarily driven by robust performance of most of the solutions.

Media delivery solutions revenue grew 14.6% year over year and 5.4% sequentially to $189.1 million. The growth was driven by the large software release and robust traffic growth.

Performance & security solutions revenues jumped 18.9% year over year and 3.6% on a sequential basis to $173.9 million. The strong year-over-year performance was driven by the completion of a couple of deals and higher contribution from the IT accelerator products launched in the previous quarter.

Service & support systems achieved the strongest year-over-year revenue growth in the quarter, up 34.0% to $32.9 million. On a sequential basis, revenues increased 4.7% in the quarter.

Region wise, revenues from North America (71% of total revenue) jumped 11.0% year over year and 4.0% sequentially. International revenues (28% of revenues) jumped 17.0% on a year-over-year basis and a modest 1.0% on a sequential basis in the quarter. Resellers represented 21.0% of the total revenue in the quarter.

Margins

Gross margin (including stock based compensation but excluding depreciation and amortization expense) expanded 210 basis points (bps) year over year and 20 bps sequentially to 75.7%. The strong growth was primarily attributable to improving server network efficiency that continues to pull down costs.

Total operating expenses as a percentage of revenues surged 330 bps on a year-over-year basis but declined 10 bps sequentially to 38.1%. Total operating expenses include stock based compensation expense but exclude amortization of intangible assets, depreciation & amortization, restructuring charges, acquisition related costs and gain and other activity related to divestiture.

The year-over-year rise in expenses was primarily due to higher research & development (R&D) expense, general & administrative expense (G&A) and sales & marketing (S&M) expense, which increased 70 bps, 110 bps and 200 bps, respectively.

Sequentially, the modest decrease in operating expenses was due to lower S&M expense, which declined 80 bps in the quarter. G&A and R&D expense increased 70 bps and 60 bps, respectively.

Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) margin decreased 150 bps on a year-over-year basis but remained flat sequentially at 43.8%.

Operating margin contracted 120 bps from the year-ago quarter but increased 30 bps sequentially to 37.6%. The year-over-year decline was due to higher operating expenses. The sequential improvement was due to a slight decline in operating expenses.

Net income margin expanded 190 bps from the year-ago quarter and 60 bps from the previous quarter to 22.8%. Net income excludes stock based compensation, amortization of capitalized stock-based compensation, amortization of acquired intangible assets, restructuring charges, acquisition related costs, gain and other activity related to divestiture and related tax effect.

Including stock based compensation and amortization of capitalized stock-based compensation but excluding all other non-recurring items, net income margin was 20.7% compared with 15.1% in the year-ago quarter and 17.2% in the previous quarter.

Earnings on a GAAP basis were 44 cents per share compared with 27 cents reported in the year-ago quarter and 34 cents in the previous quarter. Adjusting for retroactive tax-benefit of 9 cents, earnings were 35 cents in the quarter, which missed the Zacks Consensus Estimate of 38 cents.

Earnings, including stock based compensation and amortization of capitalized stock-based compensation but excluding all other non-recurring items were 45 cents per share compared with 29 cents reported in the year-ago quarter and 36 cents in the previous quarter. Adjusting for retroactive tax-benefit of 3 cents, earnings were 42 cents in the quarter.

Balance Sheet & Cash Flow

Akamai exited the quarter with cash and cash equivalents (including short-term marketable securities) of $584.3 million compared with $530.9 million in the prior quarter. The company generated cash flow from operations of $158.1 million in the reported quarter versus $140.9 million in the previous quarter.

Akamai repurchased 0.7 million shares for approximately $30.0 million in the quarter. The company’s board of directors authorized a new share buyback program worth $750.0 million effective from Oct 16, 2013 through Dec 31, 2016.

Guidance

Akamai expects revenues in the range of $412.0 million to $430.0 million for the fourth quarter of 2013. This represents 14.0% to 19.0% year-over-year growth. The guidance is primarily based on two factors -- the impact of the upcoming holiday season and the timing of a contract renewal with a large customer that will impact revenues.

Management expects that a strong holiday season and the contract renewal in the first quarter of 2014 will help the company to reach the high-end of the revenue guidance in the upcoming quarter.

However, a weak holiday season and the client renewal in the fourth quarter instead of the first quarter of 2014 will negatively impact top-line growth.

Akamai expects gross margin (excluding stock based compensation and depreciation and amortization) to be in the range of 77.0% to 78.0%. Operating expenses are projected to be up about $13.0 million to $17.0 million sequentially. Management expects adjusted EBITDA margin to be in the range of 43.0% to 44.0% for the fourth quarter.

Earnings are expected to be between 49 cents and 53 cents per share, including tax charge of $46.0 million to $50.0 million. Akamai forecasts capital expenditure (excluding equity-based compensation) of approximately $60.0 million for the fourth 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 product Kona Site Defender has been chosen by IBM (IBM - Analyst Report).

The company also recently entered into a partnership with Cisco (CSCO - Analyst Report) to work on hybrid cloud optimization, an upcoming segment within the performance and security solutions.

Moreover, Akamai’s superior content delivery platform has been selected by the likes of Apple (AAPL - Analyst Report) due to its ability to provide high-quality service at a much lower rate compared to its peers. Additionally, the company’s dominance in the web application business is expected to be a significant growth catalyst going forward.  

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.

Currently, Akamai has a Zacks Rank #2 (Buy).

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