Alphabet Earnings And Revenues Beat On Solid Execution

Alphabet’s (NASDAQ:GOOGL) second-quarter earnings smashed the Zacks Consensus Estimate on revenue that also beat. Earnings were up 42.0% from a year ago. As a result, shares gained 4.1% in extended trading.

On the Other Bets side, revenues remains lumpy because of the early stages of most businesses included in it. Management said that Nest, Fiber and Verily were revenue contributors in the last quarter. Investments remain focused mainly on Fiber efforts.

The main drivers of the Google business haven’t changed. Pricing remains under pressure, both on account of the ongoing FX concerns as well as continued strength in mobile and TrueView. Volumes are very encouraging however: total paid click growth of 29% remains an encouraging number.

Google continues to report strength on the mobile platform. One of the drivers is Accelerated Mobile Pages (AMP) with the company having indexed 150 million AMPs so far, adding 4 million a week from across 200 countries. Management is focused on driving mobile experiences and the company is well positioned to pick up strong intent-to-buy signals as a result of studying mobile searches from its huge data base. As a result, direct response marketers remain interested in it.

Google also mentioned messaging as an important addition to its product line in the form of Allo (mobile messaging) and Duo (video messaging) to further drive user experience.

The company has greater control on the browser through Android as well as through distribution agreements with Apple (NASDAQ:AAPL) . But upcoming threats shouldn’t be ignored either: Apple may not renew its agreement, Microsoft (NASDAQ:MSFT) Windows 10 could steal overall search market share, Facebook (NASDAQ:FB) graph search and the social network itself could take away advertising dollars, and Amazon (NASDAQ:AMZN) already takes care of most product searches.

Management said that YouTube remains a very strong contributor benefiting from the increase in online video consumption. More than a thousand creators are currently engaged with the platform bringing in a thousand subscribers everyday. Also significant is the $2 billion it has paid out to partners to date.

And finally, Google platforms like Android, Chrome and Daydream continue to help the company draw more users and sell more ads.

Cash and Investments continue to pile up with 61% ($48 million) residing overseas. Management clearly wants to keep investing because there is so much room for growth in Other Bets.

The numbers in detail-

Revenue

Gross total revenue of $21.50 billion grew 6.1% sequentially and grew 21.3% year over year (up 25% in constant currency or CC).

Alphabet’s hedging programs were partially successful in offsetting the negative impact of $113 million ($35 million negative impact after adjusting hedging gains) on account of the stronger dollar in the year-over-year comparison. FX was positive in the sequential comparison.

The geographic distribution was as follows: the U.S. generated around 47% of revenues, up 7.0% sequentially and up 25.8% from a year ago. The U.K., with a 9% revenue share was flat sequentially and up 8.0% (20% ex-FX) from last year. Other international markets accounted for the balance, representing sequential and year-over-year increases of 6.7% and 19.7% (26% ex-FX), respectively.

Google Segment

The segment includes search, advertising, Play, hardware and Cloud & Apps. So first, the search business-

Revenue from Google-owned sites grew 7.5% sequentially, while that from partner sites grew 1.4% resulting in a total advertising revenue increase of 6.2%. Both segments grew (24.2% and 3.4%, respectively) from the year-ago quarter. Overall, Google-owned and partner sites brought in 72% and 17% of quarterly revenue, respectively.

Management said that mobile search continued to benefit from improvements in ad formats and delivery initiated in the third quarter of 2015 and remained optimistic about search revenue growth on both tablets and desktops. TrueView and Google Preferred were the primary drivers of YouTube revenue although app promotions are growing into a bigger contributor.

The traditional AdSense benefited from strength in programmatic as offset by a decline in the traditional network business.

Other revenue was up 4.9% sequentially and 27.5% year over year to just over 10% of revenue. The strength was on account of Play Store sales (apps, content) and cloud revenues. Hardware also contributed.

Other Bets Segment

Alphabet broke out the segment for the first time in the March quarter, which includes its Fiber, Verily, Calico, Nest, self-driving cars and incubation activities in X Labs. Revenues were up 11.4% sequentially.

Since this segment is a combination of several businesses that are in the pre-revenue stage, operating different models and serving diverse end markets, the results are likely to be lumpy in any given quarter. The main drivers of revenues in the last quarter were Nest Fiber and Verily.

Total traffic acquisition cost, or TAC (the portion of revenue shared with Google’s partners and amounts paid to distribution partners and others who direct traffic to the Google website) was up 4.9% sequentially and up 17.7% year over year to nearly 21% of total advertising revenues. The percentage was down from both the previous and the year-ago quarters indicating more efficient revenue generation.

TAC paid out to network partners was up 2.0% sequentially and 7.9% year over year, representing 70% of network revenue. Mobile search carries higher TAC so the increase in mobile search revenue is increasing related TAC according to management.

TAC for distribution arrangements was up 11.1% sequentially and 43.1% year over year, representing nearly 9% of Google website revenue.

Net advertising revenue, excluding TAC was up 6.6% sequentially and 19.9% year over year.

Revenue net of TAC came in at $17.53 billion, up 6.4% sequentially and 22.1% year over year, beating the Zacks Consensus Estimate by 3.8%.

Margins

The gross margin of 62.2% shrank 6 bps sequentially and 68 bps from last year.

Price declines remained negative in both the sequential and year-over-year comparison as the mix continued to move toward lower-margin business.

The cost per click (CPC) was down a respective 1% and 7% from the previous and year-ago quarters. On a sequential basis, they were down 2% on both Google sites and network sites. CPCs on Google sites were down 9% from last year, while network CPC declined 8%.

Paid clicks grew7% sequentially and 29% year over year, helped in part by growing volumes of mobile and TrueView ads on YouTube. Google sites did better than Network sites with paid clicks growing 9% and 37%, respectively from the previous and year-ago quarters. Network paid clicks declined 3% sequentially and were consistent with the year-ago quarter.

Operating expenses of $7.40 billion increased 1.9% sequentially and 17.1% from the June quarter of 2015. The operating margin was 27.8%, up 139 bps sequentially and 54 bps from last year. As a percentage of sales, R&D dropped 98 bps sequentially and 9 bps year over year. S&M was down 55 bps and 50 bps respectively. G&A increased 8 bps sequentially and dropped 63 bps from last past year.

Non-operating gains were $151 million compared to losses of $213 million in the previous quarter and gains of $131 million in the June 2015 quarter.

Alphabet reported net income of $4.88 billion, or 22.7% of sales, compared to $4.21 billion, or 20.8% of sales in the March 2016 quarter and $3.93 billion, or 22.2% of sales in the year-ago quarter. GAAP earnings of $7.00 a share were up from $6.02 in the previous quarter and $4.93 in the year-ago quarter.

Balance Sheet

Alphabet has a solid balance sheet, with cash and short term investments of around $78.46 billion, up $3.20 billion during the quarter. Management said that $48 billion of this is held overseas. The company generated around $9.12 billion of cash from operations in the last quarter and spent $2.12 billion on capex, netting a free cash flow of $6.98 billion. Alphabet also spent $2.10 billion to repurchase shares, $38 million on acquisitions, $1.60 billion on share repurchases and refinanced some debt. Net cash at quarter end was around $70.06 billion.

Zacks Rank

Alphabet shares have a Zacks Rank #3 (Hold).