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Rising costs shrink Alphabet’s Q1 operating margin

Sheetal Sukhija - Wednesday 25th April, 2018

CALIFORNIA, U.S. - Google parent Alphabet released its earnings, which showed that while the company recorded strong growth in ad sales on Google search and YouTube, the growth figures were not enough to offset a surge in costs at parent Alphabet.

The company’s results showed that its dramatic rise in costs shrank the first-quarter operating margin, leaving shares flat after hours on Monday.

According to the company, Alphabet received a boost from how it values investments in Uber Technologies and other startups. 

It is this accounting change and a one-time benefit which cut its effective tax rate nearly in half.

The company’s results left investors uncertain about future profit at Alphabet as the company navigates the move to a phone-based computing world.

The company is also investing in small, fast-growing initiatives from self-driving cars to selling hardware and cloud computing services.

However, it noted that the quarterly results did not clarify the outlook.

The results showed Alphabet's operating margin of 22 percent, down from 27 percent a year ago, and missed expectations because of the growth in expenses.

James Cordwell, analyst at Atlantic Equities pointed out that Alphabet is investing to keep pace with Amazon.com Inc and having to share more of its revenue with phone and browser makers.

He added, "The jump in profits is purely due to one-time items.”

Alphabet noted that its longer-term capital expenditures nearly tripled to $7.3 billion in the first quarter from $2.5 billion a year ago.

According to Thomson Reuters I/B/E/S, still its worldwide sales increased to $31.1 billion, above the average analysts' estimate of $30.3 billion.

Further, it showed that Alphabet's quarterly profit of $9.4 billion, or $13.33 per share, exceeded estimates of $6.56 billion, or $9.28 per share.

According to the report, about $2.4 billion in earnings were attributable to a new accounting method for unrealized gains in Alphabet's investments in startups such as Uber and Airbnb. 

Further, Alphabet now records estimates of the current value of its startup investments rather than waiting to report income once it has opportunity to sell those shares.

Excluding the investment-related gains and other items, adjusted earnings stood at $9.93 per share.

According to analysts, the ad sales showed investors that there were no immediate signs that rising global privacy concerns had affected profits, even as concerns over Facebook's use of privacy cast some suspicion on Google.

Analyst Ivan Feinseth from Tigress Financial Partners noted, “The strong economy has companies spending more on advertising.”

Adding, “Google continues to dominate both mobile and desktop search" and there will be "very little effect" from Facebook privacy data fallout.”

Announcing parent company Alphabet’s earnings call, Google Chief Executive Sundar Pichai told analysts, "It's important to understand that most of our ad business is search, where we rely on very limited information, essentially what is in the keywords to show a relevant ad."

According to the earnings, Google recorded several one-time costs including acquiring 2,000 employees in Taiwan for $1.1 billion from HTC Corp and moving up when it awards equity to employees.

Its continuing cost increases came from acquiring streaming rights for YouTube's new TV service and marketing new products.

According to Google executives, the spending to install powerful computers and internet cables is necessary to keep up with demand for YouTube, its Google Assistant virtual helper service and data analytics tools within its Google Cloud services.

Meanwhile, revenue from Google's non-advertising units stood at $4.4 billion in the first quarter.

The earnings report also showed that when it comes to "other bets," a set of ancillary projects in areas such as medical technology and drones, Alphabet is paring back. 

Its operating loss from "other bets" fell to $571 million, from $703 million a year ago.

Meanwhile, investors are counting on the Waymo self-driving vehicles effort by the company, in a bid to generate noteworthy revenue this year as it begins offering ride-hailing services.

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