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What's Dragging Down Google's Results?

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Google missed the Zacks Consensus Estimate by 5 cents, or less than 1% on revenue that also missed by less than 1%. Earnings did, however, exceed year-ago levels by 6.0% on revenue that increased 10.4%. Despite the growth, investors punished the shares, sending Google Class A shares down 3.3% and Google Class C shares down 3.2%.

Loss of revenue from Motorola, which was around 7% of revenue in both the previous and year-ago quarters impacted results in the last quarter. Google standalone revenue was down 1.8% sequentially but jumped 19.1% year over year.

The other sore point was the cost per click (CPC), which was flat sequentially but down 9% year on year. This did, however, generate paid click growth of -1% and 26% from the two periods, respectively.

Compare this with Yahoo search, where an 8% year-on-year increase in prices allowed for a mere 6% increase in paid clicks. So Google appears to be picking up a lot of lower-priced clicks that Yahoo is leaving on the table (note that Google saw very strong double-digit growth in non-U.S, non-U.K. revenue).

The numbers in detail-

Revenue

Revenue from Google-owned sites was flat sequentially, while that from partner sites was down 3.5% resulting in net advertising revenue decline of 1.4%. Both segments continued to grow (21.2% and 4.1%, respectively) from the year-ago quarter. Overall, Google-owned and partner sites brought in 68% and 22% of quarterly revenue, respectively.

Other revenue was down 5.8% sequentially and up 48.1% year over year to around 10% of revenue. Management attributed the increase to higher Play Store sales (apps, content and chromecast).

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 down 2.4% sequentially and up 9.3% from the year-ago quarter (down 22 bps and 154 bps, respectively as a percentage of advertising revenue).

TAC related to AdSense arrangements has been declining in recent quarters, although distribution-related TAC has been increasing steadily. The steady increase in distribution-related TAC is significant, as it is indicative of growing competition for the Google platform.

Net advertising revenue, excluding TAC was down 1.2% sequentially and up 18.9% year over year.

Total revenue excluding total TAC came in at $12.2 billion, down 10.0% sequentially and up 10.7% year over year, slightly lower than our estimated $12.3 billion.

The U.S. generated around 43% of Google revenue, down 24.1% sequentially and up 14.1% from a year ago. The U.K., with a 10% revenue share was up 5.3% sequentially and 13.9% from last year. Other international markets accounted for the balance, representing sequential and year-over-year increases of 32.1% and 25.3%, respectively.

Margins

The gross margin of 61.3% expanded 537 bps sequentially and 342 bps from last year, positively impacted by the exclusion of Motorola. Pricing remained a negative as explained above. The increasing contribution from the mobile and emerging markets, as well as growing distribution costs were other factors.

Other costs, associated with data center operation, amortization of intangible assets, content acquisition, credit card processing and manufacturing and inventory-related costs increased slightly as a percentage of sales, which also negatively impacted the gross margin in the last quarter.

Operating expenses of $5.34 billion were down 2.8% sequentially and 17.5% from the Mar quarter of 2013. The operating margin was 26.7%, up 333 bps sequentially and 132 bps from last year. R&D and G&A increased sequentially as a percentage of sales while S&M fell.

Non-operating gains were $357 million, up from $125 million in the previous quarter and $134 million in the Mar 2013 quarter.

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