) reported earnings of $8.53, missing our estimates by 22 cents, or
2.5% (in line with the Zacks earnings expected surprise prediction
of -2.5%). Revenue beat by a wide margin.
Historically, Google has done much better than
), which has been struggling to hold its own, and
), which has yet to gain critical mass. Google's superior
algorithms have consistently attracted more users and generated
better conversions. However, the last quarter had a few
moving parts, given the Nexus 7 launch and the inclusion of
Google's gross revenue touched a record $12.21 billion,
representing sequential and year-over-year increases of 14.7% and
35.3%, respectively. Excluding the $1.25 billion contribution from
Motorola, revenue was up 3.0% sequentially and 21.5% from the
Google is very strongly positioned in the mobile segment, where
both smartphones and tablets have been making strong headway. The
dominant position has enabled Google to generate very strong mobile
revenue growth. In fact, the company's position in mobile looks
better than it was in traditional computing, which says something
about its strategic planning and execution.
Additionally, Google continues to benefit from the secular shift
in advertising spending from offline to online properties,
increasing contribution from medium and small-sized advertisers,
success of the DoubleClick ad exchange, improving search algorithms
and better ad quality.
Revenues from both Google-owned and partner sites continued to
grow double-digits on a year-over-year basis (they have grown
double-digits each quarter over the last few years). Google
websites accounted for around 62% of quarterly revenue, while
partner sites accounted for another 24%. Total advertising revenue
was up 3.0% sequentially and 20.8% year over year. Google-owned
sites were stronger than partner sites in the last quarter.
Total traffic acquisition costs, 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
down 16.0% sequentially, although it continued to increase (up
24.5% from last year). However, we do not consider this a reason
for concern since the traffic acquisition cost as a percentage of
total advertising revenue went up 13 basis points (bps)
sequentially and 52 bps from the year-ago quarter.
While both items in TAC went up in the last quarter,
distribution payouts were up more significantly. Net advertising
revenue, excluding TAC was up 2.8% sequentially and 19.9% year over
Licensing and other fees brought in the remaining 4% of revenue
in the last quarter, up 3.3% sequentially and 41.6% from the June
The Hardware and Other segment (mainly Motorola, but also Nexus
7) accounted for 10% of revenue in the last quarter, with 67%
coming from mobile products and the balance from home products.
Total revenue excluding total traffic acquisition costs came in
at $9.62 billion, 14.4% higher than the Consensus Estimate of $8.41
The U.S. generated around 51% of revenue, up 28.3% sequentially
and 50.5% from a year ago. The U.K., with a 10% revenue share was
up 3.1% sequentially and 21.5% from last year. Other markets
accounted for the remaining 39% of revenue, representing sequential
and year-over-year increases of 14.7% and 35.3%, respectively.
Google stated that the U.S., Canada, Asia/Pacific and Northern
Europe did well in the last quarter, with Southern Europe slowing
slightly due to macro concerns and a weak ad market in Spain.
Motorola derives more than half its revenue from the U.S. and has a
limited presence in the U.K. Therefore, both the U.S. and other
international markets gained from the addition of Motorola's
results in the last quarter.
The gross margin of 59.0% declined significantly from both the
previous and year-ago quarters, due to the much lower margins of
Motorola's hardware business. The standalone Google gross margin
was 63.7% (down 71 bps and 116 bps, respectively from the previous
and year-ago quarters) compared to standalone Motorola's 17.7%.
The advertising gross margin was the combined effect of revenue
growth, a 1% sequential (42% year-over-year) increase in the number
of paid clicks, and a 1% sequential increase (16% year-over-year
decline) in the cost per click.
The number of paid clicks and cost per click appears
significant, as they are indicative of higher volumes coming at
lower prices. The mobile and emerging markets businesses are
growing strongly and distribution costs are increasing, which could
be the reasons.
Other costs, associated with data center operation, amortization
of intangible assets, content acquisition, credit card processing
and manufacturing and inventory-related costs increased
significantly as a percentage of sales, which also negatively
impacted the gross margin in the last quarter.
Operating expenses of $3.91 billion were higher than the
previous quarter's $3.47 billion. The operating margin was 27.0%,
again impacted by the higher hardware-related costs. R&D and
S&M were down as a percentage of sales from both the previous
and year-ago quarters, with G&A increasing slightly from both
Non-operating gains were $254 million, up from $156 million in
the previous quarter and $204 million in the June 2011 quarter.
Google had some investment gains in the last quarter, which more
than offset the impact of lower interest income and FAS 133-related
Google reported net income of $2.82 billion, or 23.1% of sales,
compared to $2.89 billion, or 27.1% of sales in the March 2012
quarter and $2.51 billion, or 27.8% of sales in the year-ago
quarter. GAAP earnings of $8.42 a share were down from $8.75 in the
previous quarter and $7.68 in the June quarter of 2011. Excluding
$89 million (11 cents a share on a tax-adjusted basis) for
severance and benefit arrangements related to the Motorola
acquisition, the pro forma EPS was $8.53 a share. There were no
special items in the previous and year-ago quarters.
Google has a solid balance sheet, with cash and short term
investments of nearly $43.12 billion, down $6.19 billion during the
quarter. The company generated around $4.25 billion from operations
in the last quarter and spent $774 million on capex, netting a free
cash flow of $3.48 billion.
Google generates revenue primarily from the sale of advertising
space on its online properties. It has therefore focused on
protecting and growing its position in the search market through
continued innovation and quality improvements. This focus has
ensured that it remains the dominant player in search, not just in
the traditional computing segment, but even more so in the emerging
Google's Android OS has gone a long way to cementing its
position in mobile. Google has also made acquisitions over time
that have augmented its in-house capabilities.
With the growing importance of social networking, Google
introduced Google Plus. While some have commented that Google will
not be as popular as
), this is really not that much of a concern and remains to be
proved. In the meantime, it is obvious that social data will be an
additional tool for Google, which has been making a number of
acquisitions and innovations in the space. Management has stated
that social relevance in search is resulting in better conversions
and the company's success in the display format is well borne out
by the latest eMarketer estimates.
Toward the end of last year, Google stepped up efforts targeting
the small and medium business (SMB) segment. The SMB segment has
played a key role in elevating Google's position in display and we
expect the company to continue chipping away at Yahoo's market
Google's success in display is very encouraging, since display
advertising is expected to grow very strongly over the next few
years, surpassing search advertising by 2015. While Facebook is
expected to maintain a slight edge this year, Google is expected to
become the display market leader next year.
Despite the initiatives to drive growth and superb execution to
date that have enabled the company to maintain share in a
fast-growing market, Google's share prices have dropped 10.9% since
the beginning of the year. This could be because of its many legal
entanglements related to competitive matters.
While prices responded positively to its second quarter results
and some momentum may be in the shares, we expect them to remain
range-bound over the next 1-3 months given margin concerns related
to the hardware segment.
Google shares therefore carry a Zacks Rank of #3, implying a
short-term Hold recommendation.
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