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April 16, 2010
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Although shares advanced 1.07% during the day in anticipation of a stronger quarter and further light on the situation in China, investors were obviously disappointed at management’s reiteration of previous announcements on the matter. As a result, the shares slid 4.89% after hours.
Revenue
Gross revenue of $6.78 billion was up 1.5% sequentially and 23.0% year over year. Management stated that growth was broad-based across search, display, mobile and enterprise segments, with particular strength in the retail, travel, technology and finance verticals. The continued recovery fueled higher advertisement spending, with many large customers coming back.
Revenues from both Google-owned and partner sites were flat sequentially and up double-digits from the year-ago quarter. Google websites accounted for around 65% of quarterly revenue, while partner sites accounted for another 35%. Total advertising revenue was flat sequentially and up 21.5% year over year.
Traffic continues to improve, with total traffic acquisition cost (TAC, the portion of revenue shared with Google’s partners) dropping 1.4% sequentially, but jumping up 18.0% from year-ago levels. However, TAC as a percentage of total advertising revenue was down 12 basis points (bps) sequentially and 45 bps from the year-ago quarter. Net advertising revenue, excluding TAC was down 0.4% sequentially.
Licensing and other fees brought in the remaining 5% of revenue in the last quarter.
By geography, the U.S. generated 35% of revenue (down 38.8% sequentially), the U.K. generated 15% (up 9.1%), while other countries accounted for the balance (down 0.4%).
Margins
The gross margin of 63.8% was down 10 bps sequentially and up 195 bps from the year-ago quarter. The sequential decline was the result of a 5% increase in number of paid clicks and 4% decrease in the cost per click, offset by higher costs associated with the Nexus One mobile phone.
The increase from the year-ago period was due to a 15% increase in the number of paid clicks, offset by a 7% increase in the cost per click as well as other costs associated with the Nexus One.
Operating expenses of $1.84 billion were higher than the previous quarter’s $1.78 billion. The operating margin was 36.7%, down 45 bps from the 37.2% recorded in the previous quarter. The increase was mainly on account of higher R&D expenses, which were up 104 bps (as a percentage of sales). G&A also increased slightly.
The company reported net income of $1.96 billion, or 28.9% of sales, compared to $1.97 billion, or 29.6% of sales in the Dec 2009 quarter and $1.42 billion, or 25.8% of sales in the year-ago quarter. GAAP earnings of $6.06 a share fell from $6.13 in the preceding quarter and $4.49 in the Mar quarter of 2009. There were no special items in the last quarter.
Balance Sheet
Google has a solid balance sheet, with cash and short term investments of $26.51 billion, up $2.03 billion during the quarter. The company generated $2.6 billion from operations in the last quarter and spent $239 million on capex, netting a free cash flow of $2.3 billion. Google has no debt.
In Conclusion
Google, Inc. generates revenue primarily from the sale of advertising space on its online properties. The company is therefore, focused on user experience and convenience, which could bring back customers and generate new ones.
It is already proved that the Google search engine generates more useful results than do those from competitors, since it is currently the most popular search engine in the world. Google has also made acquisitions over time that have augmented its in-house capabilities.
The problem with Google is the lack of diversification in its revenue source. The company is totally dependent on online advertisement revenue, which is no longer limited to the PC platform.
With smart phones and MIDs growing in popularity over the past few years, Google faces the threat of losing market share to software companies, such as Microsoft Corp (MSFT). Since Microsoft and Apple Inc. (AAPL) have a position in mobile platforms, they have the clout to promote their own/any other search engine, by bundling another search engine with the mobile operating system they are selling.
Google has responded to this threat by launching Android, its own mobile operating system, followed by Nexus One, its own smartphone. However, this places it in direct competition with not just Microsoft and Apple, but also Research In Motion (RIMM), Nokia (NOK) and Palm (PALM) in what is already a very crowded market. To make matters worse, it has sent its Chinese opportunity down the drain, which will limit growth going forward.
We have a Neutral recommendation on Google shares.
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