Alphabet Inc. 10-Q Summary: Q3 2018
Business Context and Reporting Period
This filing is a Quarterly Report on Form 10-Q for Alphabet Inc. covering the period ended September 30, 2018. Alphabet operates primarily through its Google segment, which generates revenue from online advertising, cloud services, hardware, and digital content. The "Other Bets" segment includes emerging businesses such as Waymo, Verily, and Calico. As of the filing date, the company had approximately 94,372 employees.
Key Financial Metrics
| Metric | Q3 2018 (3 Months) | Q3 2017 (3 Months) | YTD 2018 (9 Months) | YTD 2017 (9 Months) |
|---|---|---|---|---|
| Total Revenues | $33.74 billion | $27.77 billion | $97.54 billion | $78.53 billion |
| Net Income | $9.19 billion | $6.73 billion | $21.79 billion | $15.68 billion |
| Diluted EPS | $13.06 | $9.57 | $30.95 | $22.30 |
| Operating Cash Flow | $13.2 billion (Q3 est.) | N/A | $34.98 billion | $26.82 billion |
| Capital Expenditures | $5.28 billion (Q3 est.) | N/A | $18.06 billion | $8.88 billion |
| Cash & Marketable Securities | $106.42 billion (as of Sept 30, 2018) | |||
| Long-Term Debt | $3.99 billion (as of Sept 30, 2018) |
Margins (Q3 2018): Operating margin was approximately 24.6%. The effective tax rate for the quarter was 8.8%.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 21% year-over-year (YoY) in Q3 2018. Constant currency revenue growth was 22%.
- Segment Performance: Google segment revenue grew 21% to $33.6 billion. "Other Bets" revenue grew 25% to $146 million.
- Advertising Metrics: Google properties revenue grew driven by mobile search and YouTube. Paid clicks increased 62% YoY, while cost-per-click decreased 28% YoY. Google Network Members' impressions were relatively flat (1% growth), but cost-per-impression increased 11%.
- Other Income: Other income (expense), net surged to $1.77 billion in Q3 2018 from $197 million in Q3 2017, primarily due to $1.38 billion in gains on equity securities (both marketable and non-marketable) recognized under new accounting standards (ASU 2016-01).
- European Commission Fines: A $5.07 billion fine related to Android distribution practices was accrued in Q2 2018. This is reflected in the "European Commission fines" line item in the income statement for the nine-month period ($5.07 billion total for YTD 2018 vs. $2.74 billion for YTD 2017).
- Capital Expenditures: CapEx for the nine months ended Sept 30, 2018, more than doubled to $18.06 billion from $8.88 billion in the prior year period, reflecting significant investment in data centers and infrastructure.
Guidance, Outlook, and Risks
- Outlook: Management expects revenue growth rates to fluctuate due to seasonality, macroeconomic conditions, and the increasing base of revenue. They anticipate cost of revenues, R&D, and sales/marketing expenses to increase in dollars and potentially as a percentage of revenue.
- Foreign Exchange: The company expects its foreign exchange risk management program will not fully offset net exposure to currency fluctuations. Q3 2018 results were favorably affected by the weakening U.S. dollar in certain regions (e.g., APAC) but unfavorably in others (e.g., EMEA).
- Legal & Regulatory Risks:
- EC Android Fine: The $5.07 billion fine is due in October 2018; the company intends to provide bank guarantees rather than cash payment.
- Antitrust Investigations: Ongoing investigations by the EC regarding AdSense for Search and other jurisdictions (India, Brazil, Korea, Argentina) remain unresolved with uncertain potential losses.
- Oracle Litigation: The Federal Circuit denied Alphabet's petition for an en banc rehearing regarding the Java API copyright case; the case has been remanded for a trial on damages.
- Accounting Changes: The adoption of ASU 2016-01 increased the volatility of "Other income (expense), net" as unrealized gains and losses on equity securities are now recognized in net income.
Key Facts for Investor Verification
- Equity Gains Volatility: Verify the sustainability of the $1.38 billion gain on equity securities in Q3 2018, as this is a non-operating item driven by market dynamics and accounting changes.
- EC Fine Payment: Confirm the status of the $5.07 billion Android fine payment and the issuance of bank guarantees in October 2018.
- CapEx Trajectory: Monitor the continued acceleration of capital expenditures ($18 billion YTD) and its impact on future free cash flow.
- Tax Rate Stability: Assess the impact of the U.S. Tax Cuts and Jobs Act on the effective tax rate, which dropped to 8.8% in Q3 2018, and the finalization of transition tax calculations.
- Share Repurchases: Note that $6.4 billion was spent on share repurchases in the first nine months of 2018, with approximately $4.3 billion remaining under the current authorization as of September 30, 2018.