Google Finally Reveals Cloud Contribution in Mixed Results

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Alphabet Inc. (NASDAQ: GOOGL) (NASDAQ: GOOG) reported its fourth-quarter and full-year 2017 financial results after the market closed on Thursday, and based on the reaction, you might think it was a terrible quarter.

That was far from the truth, as things continued much the way the company has said they would. Revenue was higher than many expected, but an increase in cost of revenue had some investors spooked. That appears to be something of an overreaction and may provide an opportunity for investors with a long time horizon. Let's dig into the details.

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The raw numbers

For the just-completed quarter, Alphabet reported revenue of $32.32 billion, up 24% year over year and beating analysts' consensus estimates of $31.9 billion. Operating income of $7.66 billion grew by 15% year over year, producing a net loss of $3.02 billion and resulting in a diluted loss per share of $4.35. But that leaves out an important consideration.

Alphabet took a $9.86 billion tax provision charge associated with recently enacted U.S. tax legislation. Excluding the effect of that one-time charge would have resulted in net income of $6.83 billion and diluted earnings per share of $9.70, which increased 28% over the prior-year quarter. This missed analysts' expectations for net income of $7 billion and earnings of $10 per share.

Both cost of revenue and operating expenses grew faster than revenue growth, putting pressure on the company's margin. A portion of that was related to higher costs and increased marketing to manufacture and promote Google Hardware products over the just-completed holiday season.

One area of concern for investors, however, is the escalating traffic acquisition costs (TAC) for its flagship search, which grew 33% year over year, to a total of 24% of advertising revenue, up from 22% in the prior-year quarter. Mobile search tends to carry higher TAC, but during the conference call to discuss the results, Alphabet CFO Ruth Porat assured investors that the rate should begin to slow after the first quarter of 2018.

Google Other

The Google Other reporting segment, which includes cloud computing, hardware sales, and Google Play, turned in a solid quarter, with revenue of $4.69 billion, up 38% year over year, and higher than the $4.58 analysts expected.

Alphabet finally provided insight into its cloud computing segment, which is widely regarded as one of the three biggest players in the space. During the company's earnings conference call, Alphabet CEO Sundar Pichai revealed that Google Cloud was "already a $1 billion-per-quarter business." He also stated that based on publicly reported data, he believed it "is the fastest growing major public cloud provider in the world." G Suite, its set of cloud software productivity and collaboration tools, surpassed 4 million paying customers.

While a $4 billion run rate is impressive, it still has a long way to go to compete with cloud leader Amazon.com, which recently revealed cloud computing revenue that exceeded $17 billion for 2017.

Google hardware products, which include the Google Home, Mini, Max, and Chromecast, saw device shipments that more than doubled over the prior-year quarter. The company sold "tens of millions" of the devices, though it didn't disclose the exact amount.

The company still has a significant focus in the area of artificial intelligence, specifically in the realm of machine learning. Google Cloud recently released AutoML, which makes it far easier for its cloud customers to build complex deep learning neural networks. Google also uses the technology to provide more relevant search results, to improve the image stabilization for photos and videos in its Pixel phones, and to detect inappropriate content on YouTube.

Alphabet announced that its AI-powered Google Assistant is now available on more than 400 million devices, in a dozen countries, and in eight different languages. It also controls more than 1,500 smart home devices across 225 brands.

Other Bets

Other Bets, which includes Nest, Google Fiber, and self-driving-car unit Waymo, increased revenue 56% to $409 million but reported an operating loss of nearly $1 billion.

Waymo surpassed 4 million miles driving on public roads, with the most recent million miles occurring in the past six months. In addition, Waymo is the only company with a fleet of completely autonomous cars on the roads, having removed the drivers late last year. Waymo recently announced a deal to add "thousands" of additional minivans to its fleet in advance of an expansion of its driverless ride-hailing service later this year.

Looking ahead

Alphabet continued with its custom of not providing a forecast for the coming quarter and year.

Alphabet is investing heavily in its future, expanding in the realms of cloud computing, hardware, and YouTube, and said the majority of its capital expenditures would be to support expansion in those key growth areas.

Mobile and programmatic advertising, as well as product marketing for its hardware over the just-completed holiday season, weighed heavily on results.

While the higher cost of revenue and increased expenses bear watching, the company has long noted that a lot of variability exists from quarter to quarter. Alphabet isn't sweating the small stuff, and I don't think investors should, either.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Alphabet (A shares) and Amazon. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool has a disclosure policy.

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