Akamai Misses, Shares Plunge

Akamai Technologies (AKAM) reported second quarter 2010 earnings of 23 cents, missing the Zacks Consensus Estimate of 24 cents. Shares plunged more than 11% in morning trade on the Nasdaq.

Earnings including stock based compensation but excluding onetime items increased 6.1% year-over-year, but decreased 5.3% sequentially.

Revenue

Revenues jumped 19.9% year-over-year and 2.2% on a sequential basis to $245.3 million, marginally above the Zacks Consensus Estimate of $243.0 million. Resellers contributed 19.0% of revenues and sales outside the U.S. accounted for 28.0% of revenues in the quarter. International revenues increased 20.0% year-over-year and 2.0% sequentially. Revenues from North America were up 20% year-over-year, and 2% sequentially.

The strong year-over-year growth was primarily driven by increased use of cloud computing technology, growth in online high definition (HD) video and improving online advertising in the quarter.

Akamai achieved solid growth from the Media and Entertainment market (43.1% of second quarter revenue), with revenues increasing 21.9% year-over-year based on strong traffic growth.

On a year-over-year basis, revenues from Commerce (31.9% of second quarter revenue) increased 21.3%, High Tech (19.4% of second quarter revenue) rose 7.6% and Public Sector (5.6% of second quarter revenue) surged 50.5% in the quarter.

New signings for value-added solutions increased 36.0% from first quarter of 2010.

Margins

Adjusted EBITDA increased 9.0% year-over-year, but decreased 7.3% sequentially to $90.0 million. EBITDA margin plunged significantly to 36.7% in the second quarter, as compared with 40.4% in the year-ago quarter and 40.5% in the previous quarter.

Operating income on a GAAP basis increased 4.5% year-over-year, but decreased 14.0% on a sequential basis to $56.8 million. Operating margin fell to 23.2% in the second quarter as compared with 26.6% in the year-ago quarter and 27.5% in the first quarter of 2010.

We believe, a significant increase in costs negatively affected margins in the quarter. Total costs and operating expenses spiked 25.5% year-over-year and 8.3% sequentially to $188.5 million. As a percentage of revenues, total costs and operating expenses upped 340 basis points year-over-year and 430 basis points sequentially.

Balance Sheet

As of Jun 30, 2010, cash and cash equivalents were $120.5 million, compared to $173.2 million at the end of Mar 31, 2010. Cash from operations declined to $86.4 million as compared with $103.8 million in the year-ago quarter. During the second quarter, Akamai repurchased approximately 537,000 shares worth $20.4 million, at an average price of $38.02 per share.

During the quarter, Akamai completed the acquisition of Velocitude, a mobile services platform that uses cloud computing. Management expects the acquisition to be approximately neutral to earnings over the next twelve to eighteen months.

We believe the merger will strengthen Akamai’s strategic position in the mobile market. By using Velocitude’s mobile services platform, Akamai aims to improve the quality of mobile content and applications, and provide superior HD video and secure e-commerce to mobile devices.

Outlook

For the third quarter of 2010, Akamai forecasts revenues in the range of $242.0 million to $252.0 million, representing approximately 20.0% year-over- year growth. Akamai expects an unfavorable foreign exchange impact of $2.0 million in the third quarter.

Akamai expects gross margin in the range of 81.0% to 82.0% in the third quarter. Management expects operating expenses to increase in the third quarter. Adjusted EBITDA margin is projected to be in the range of 44.0% to 45.0% for the quarter.

Akamai expects capital expenditure to decline approximately $40.0 million in the third quarter. For full year 2010, management estimates capital expenditure to be about 17.0% of total revenue, driven by volume growth and aggressive investment in capitalized software development.

Akamai expects earnings to be in the range of 32 cents to 34 cents per share, including the impact of the Velocitude acquisition and reflecting a 188.0% year-over-year growth.

Although Akamai remains concerned about the overall macroeconomic condition, management believes the company is well positioned to grow in the long term, driven by strong growth across all verticals. The company expects to generate revenues of $1.0 billion in 2010.

Recommendation

We maintain a Neutral recommendation on a long-term basis (6+ months), due to increasing operating expenses, higher capital expenditure and a sluggish macro-economic environment.

Akamai continues to face stiff competition from large companies, such as Level 3 Communications Inc. (LVLT) and Limelight Networks, Inc. (LLNW).

However, we believe increasing usage of cloud computing technology and partnerships with companies such as International Business Machines Corp. (IBM) will boost its profitability going forward. Moreover, Akamai’s recent acquisition of Velocitude, a mobile services platform that uses cloud computing, adds a new dimension to its plethora of online solutions.

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