Google’s (GOOGL) fourth-quarter earnings of $5.50 missed the Zacks Consensus Estimate by 36 cents, on revenue that missed by 2.5%. Earnings also dropped 3.3% from a year ago while increasing 12.0% sequentially.
Google shares rode higher during the day and climbed 1.5% in extended trading. While the miss troubled investors and sent shares sliding right after the earnings report, investor confidence improved after the call.
The main story didn’t change much: prices are still soft, volume growth is still decelerating, Google sites still doing better than partner sites and other revenue still growing.
Moreover market trends favoring mobile over desktop and therefore a lower dependence on browser-based search and increased use of social networks like Facebook (FB) that are stealing eyeballs also remained much the same.
But currency had a negative impact of half a billion dollars on revenue and Google also saw an inventory shortfall that impacted Nexus 7 shipments. And operating expenses increased and will likely continue to increase as Google doubles down on investments in the future (wearables, auto, robotics, fiber, satellites, et al).
Minus these negatives, the business remains strong, with mobile and programmatic being the major drivers. Network CPCs also grew strongly as promised.
What also helped was the fantastic balance sheet on which Google holds around $64 billion in cash (60% of which is held overseas). There are talks of a new law that could facilitate repatriation without much of a tax burden, which just might get Google to distribute some.
The numbers in detail-
Revenue
Gross total revenue was $18.10 billion, which was a 9.6% sequential and 15.3% year-over-year increase, as advertising revenue on Google websites and Other revenue continued to outdo revenue growth on network sites. The stronger dollar had a negative impact of more than half a billion dollars that was slightly mitigated by Google’s hedging program.
Revenue from Google-owned sites was up 10.5% sequentially, while that from partner sites was up 8.5% resulting in a total advertising revenue increase of 10.0%. Both segments continued to grow (17.9% and 5.6%, respectively) from the year-ago quarter. Overall, Google-owned and partner sites brought in 69% and 20% of quarterly revenue, respectively.
The year-over-year increase in Google site revenue was attributed to strength on the mobile platform. The traditional AdSense business is struggling because of policy changes to increase CPC, with newer programmatic and display businesses including AdMob, Ad Exchange and DoubleClick Bid Manager driving the revenue increase at partner sites.
Other revenue was up 6.1% sequentially and 18.6% year over year to around 11% of revenue. This was despite the fact that Play Store sales (apps, content and chromecast) were negatively impacted by currency particularly in Japan and insufficient inventory of Nexus 7 to meet forecasted demand.
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 8.4% sequentially and 9.5% from the year-ago quarter.
TAC related to AdSense arrangements spiked in the last quarter in line with the increased revenue from partner websites. Distribution-related TAC on the other hand, continues to increase at a mid-single-digit rate.
But TAC as a percentage of advertising revenue was down 33 bps and 110 bps, respectively, indicating that Google is paying out more to partners but at a lower rate.
Net advertising revenue, excluding TAC was up 10.5% sequentially and 16.5% year over year.
Total revenue excluding total TAC came in at $14.48 billion, up 9.9% sequentially and 16.8% year over year, 2.5% short of our estimated $14.84 billion.
The U.S. generated around 44% of Google revenue, up 12.9% sequentially and -10.2% from a year ago. The U.K., with a 9% revenue share was up 2.0% sequentially and 10.7% from last year. Other international markets accounted for the balance, representing sequential and year-over-year increases of 8.2% and 57.6%, respectively.
Margins
The gross margin of 61.8% expanded 229 bps sequentially and 158 bps from last year. Pricing remained a slight negative. The increasing contribution from the mobile and emerging markets, as well as programmatic strength is affecting the gross margin.
Moreover, other costs, associated with data center operation, amortization of intangible assets, content acquisition and manufacturing and inventory-related costs increased by a point as a percentage of sales, which also negatively impacted the gross margin in the last quarter.
The cost per click (CPC) was down 3% from both the previous and year-ago quarters. The 8% year-over-year decline in CPC for Google sites pulled down the numbers, as network CPC increased 6%. The trend is clearer in the sequential comparison which shows an 8% decline in Google-owned sites that was partially offset by a 10% increase at network sites.
But the CPC decline was compensated by the solid paid click growth of 11% and 14% from the previous and year-ago quarters, respectively. Compare this with Yahoo (YHOO), which saw a 7% decline in CPC but could only grow paid clicks 10% and Google’s numbers don’t look too bad.
Click volume growth at Google sites accelerated (up 18% sequentially and 25% year over year). Network click volume declines of 7% and 11%, respectively was disappointing however. Google appears to be raising prices for network partners, which is impacting volumes even as it does the opposite for its owned and operated sites.
Operating expenses of $6.78 billion were up 18.5% sequentially and 35.0% from the Dec quarter of 2013. The operating margin was 24.3%, down 53 bps sequentially and 390 bps from last year. All expenses increased both sequentially and year on year as a percentage of sales, but R&D increased the most, followed by G&A and then S&M. A reclassification of compensation expenses, real estate write-down charges and headcount increases contributed to the higher opex.
Non-operating gains were down again to $128 million compared to $133 million in the previous quarter but were higher than the $112 million in the Dec 2013 quarter.
Google reported net income of $3.79 billion, or 20.9% of sales, compared to $3.38 billion, or 20.4% of sales in the Sep 2014 quarter and $3.88 billion, or 24.7% of sales in the year-ago quarter. GAAP earnings of $6.91 a share were up from $4.09 in the previous quarter and from $4.95 in the Dec quarter of 2013.
The Motorola sale closed in October 2014, fetching a net gain of $740 million (1.07 a share).
Balance Sheet
Google has a solid balance sheet, with cash and short term investments of around $64.40 billion, up $2.24 billion during the quarter. The company generated around $6.36 billion from operations in the last quarter and spent $3.55 billion on capex, netting a free cash flow of $2.81 billion. Google also spent $256 million on acquisitions and refinanced $2.4 billion of debt.
Recommendation
Google shares have a Zacks Rank #3 (Hold), similar to peer Baidu (BIDU), but better than both Yahoo and Yandex (YNDX), which are ranked #4 (Sell).
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