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Internet powerhouse Alphabet’s (GOOGL - Free Report) second-quarter diluted non-GAAP earnings of $8.90 exceeded the Zacks Consensus Estimate of $8.17. Also, earnings were up 15.1% sequentially and 27.1% year over year.

Following the strong second-quarter earnings, share price jumped 0.45% to $998.31.

However, Alphabet’s shares have returned 22.12% year to date, slightly underperforming the industry’s gain of 22.43%.

The company has been facing significant litigation globally due to its dominant position in search. This has lately been impacting Google’s share price and is being a drain on resources. Apart from these, litigation issues have also given the company a bad name.

Also, during the quarter, the company’s GAAP profits were impacted because of a recent EU regulatory ruling, which stated that certain actions taken by Google related to its display and ranking of shopping search results and ads infringed European competition law. The company was slapped with a fine of $2.74 billion. The amount is 3% of Alphabet’s worldwide revenues in 2016 ($90 billion).

However, the company reported decent top-line numbers. Net Revenue, excluding total traffic acquisition cost or TAC (TAC is the portion of revenue shared with Google’s partners and amounts paid to distribution partners and others who direct traffic to the Google website), came in at $20.92 billion, up 4% sequentially and 19.4% year over year. The top line beat the Zacks Consensus Estimate of $20.83 billion.

On the Other Bets front, most of the businesses included there are in early stages. However, it is gradually picking up.

The primary drivers of the Google business haven’t changed. Pricing remains under pressure both on account of nagging FX concerns as well as continued strength in mobile and TrueView. However, volumes are encouraging as total paid click growth of 52% remains a reassuring number.

Google continues to enjoy strength on the mobile platform. One of the drivers is Accelerated Mobile Pages (AMP), which is being accepted by a number of publishers and sites across the world covering more than 700,000 domains. Management is focused on driving mobile experiences and the company is well positioned to pick up strong intent-to-buy signals by studying mobile searches from its huge data base. As a result, direct response marketers continue to show interest in it.

The company also said that Google Cloud is generating substantial revenue growth, reflecting the ongoing momentum in the business. 

The company has greater control on the browser through Android as well as distribution agreements with Apple (AAPL - Free Report) . However, upcoming threats should not be ignored. Apple may not renew its agreement; Microsoft (MSFT - Free Report) Windows 10 could steal overall search market share; Facebook graph search and the social network could take away advertising dollars; and Amazon (AMZN - Free Report) already takes care of most product searches.

Management said that YouTube remains a strong contributor benefiting from growth in online video consumption. More than a thousand creators are currently engaged with the platform, bringing in a thousand subscribers every day.

Finally, Google platforms like Android, Chrome and Daydream continue to help it in drawing more users and selling more ads.

The Numbers in Detail

Revenues

Gross total revenue of $26 billion was up 5.1% sequentially and 21% year over year (up 23% in constant currency or CC). The increase was primarily driven by strength in core advertising business.

Google Segment

The segment includes search, advertising, Play, hardware and Cloud & Apps.

Coming to the search business, revenues from Google-owned sites increased 5.9% on a sequential basis, while that from partner sites increased 6%, resulting in a total advertising revenue increase of 5.9%. However, Google-owned sites and partner sites grew 19.6% and 13.5%, respectively, year over year, and brought in 71% and 16% of quarterly revenues.

Management said that mobile search continued to benefit from improvements in ad formats and delivery initiated in the third quarter of 2015 as well as remained optimistic about search revenue growth on both tablets and desktops.

Other revenue decreased 0.2% sequentially but increased 42.3% year over year, accounting for 11.9% of second-quarter revenue.

Other Bets Segment

Alphabet broke up the segment in the March quarter of 2016. The segment includes Fiber, Verily, Calico, Nest and incubation activities in X Labs. Revenues were up 1.6% and 34.1% year over year.

Since this segment is a combination of a number of businesses that are in the pre-revenue stage, operating different models and serving diverse end markets, the results are likely to be soft in any given quarter.  However, this segment is gaining momentum and has performed well in the second quarter.

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 10% sequentially and 28.1% year over year.

TAC paid out to network partners were up 7.7% sequentially and 16% year over year. Given that mobile search carries higher TAC, the increase in mobile search revenue is driving related TAC according to management.

TAC for distribution arrangements was up 13.5% sequentially and 51.6% year over year.

Net advertising revenue, excluding TAC was up 4.8% sequentially and 15.9% year over year.

Margins

Gross margin of 60.1% decreased 31 bps sequentially and 207 bps from the year-ago quarter.

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

Cost per click (CPC) was down 6% and 23%, respectively, from the previous and year-ago quarters. On a sequential basis, CPC was down 8% on Google sites but increased 5% on network sites. On Google sites, CPCs were down 26% from the year-ago quarter, while network CPC declined 11%.

Paid clicks grew 12% sequentially and 52% year over year, driven partly by growing volumes of mobile and TrueView ads on YouTube. Google sites paid clicks grew 15% and 61%, respectively, from the previous and year-ago quarters. Network paid clicks decreased 5% sequentially but increased 9% from the year-ago quarter.

Operating expenses of $8.77 billion decreased 4.6% sequentially but increased 18.5% year over year. The operating margin was 26.4%, down 13 bps sequentially and 135 bps from the year-ago quarter.

Alphabet reported net income of $3.52 billion compared with $5.43 billion in the previous quarter and $4.88 billion in the year-ago quarter. GAAP earnings of $5.01 per share were down from $7.73 in the previous quarter and $7.00 in the year-ago quarter.

This figure included a fine of $2.7 billion (2.42 billion euro) imposed by the European Commission.

Balance Sheet

Alphabet has a solid balance sheet, with cash and short-term investments of around $94.71 billion, up $2.27 billion from the first quarter. The company generated around $7.40 billion of cash from operations in the second quarter and spent $2.83 billion on capex, netting a free cash flow of $4.57 billion.

Alphabet also spent $42 million on acquisitions and $38 million to repay some debt.

Alphabet Inc. Price, Consensus and EPS Surprise

 

Alphabet Inc. Price, Consensus and EPS Surprise | Alphabet Inc. Quote

ZacksRank

Alphabet carries a Zacks Rank #3 (Hold).You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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