Source: Seeking Alpha
Facebook Inc. (NASDAQ:FB)
Q2 2014 Earnings Conference Call
July 23, 2014 05:00 PM ET
Deborah Crawford – Director, IR
Mark Zuckerberg – CEO
Sheryl Sandberg – COO
Dave Wehner – CFO
Eric Sheridan – UBS
Heather Bellini – Goldman Sachs
Douglas Anmuth – JPMorgan
Ross Sandler – Deutsche Bank
Justin Post – Merrill Lynch
Mark Mahaney – RBC Capital Markets
Arvind Bhatia – Sterne Agee
Neil Doshi – CRT Capital
Ken Sena – Evercore
Brian Nowak – SIG
Brian Pitz – Jefferies
Colin Sebastian – Robert Baird
Ben Schachter – Macquarie
Good afternoon. My name is Jay and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). Thank you very much.
Ms. Deborah Crawford, Facebook’s Director of Investor Relations, you may begin.
Thank you. Good afternoon and welcome to Facebook’s second quarter earnings conference call. Joining me today to talk about our results are Mark Zuckerberg, CEO, Sheryl Sandberg, COO and Dave Wehner, CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements, and actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in today’s press release and our Quarterly Report on Form 10-K filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation to update these statements as a result of new information or future events.
During this call we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today’s earnings press release. The press release and an accompanying investor presentation are available on our Web site at investor.fb.com.
And now, I’d like to turn the call over to Mark.
Thanks Deborah, and thanks everyone for joining today. This was a good quarter for us and a good end to the first half of the year. We’ve continued to grow our community in size and engagement with 1.32 billion people now connecting on Facebook each month, and 63% of them visiting daily. Our momentum remains especially strong on mobile to now 829 million people using Facebook everyday with more than 650 million people using our services on mobile every day.
One thing that’s exciting is that there is still so much room to grow. On average, people on the Facebook in the U.S. spend around 40 minutes each day using our service, including about one in five minutes on mobile. This is more than any other app by are, but overall people in the U.S. spend about nine hours per day engaging with digital media on TVs, phones and computers. So there is a big opportunity to improve the way that people connect and share across — how we all engage with the rest of media as well.
Now when it comes to our business, we continue to be pleased with our growth. This quarter, our total revenue grew to over 2.9 billion and advertising revenue grew by 67% from a year ago. Mobile now accounts for 62% of our advertising revenue, which is a good sign of how the growth of our community mobile is also producing better business results for our partners. The results this quarter show our continued focus on improving our core products and business. We’re going to continue investing aggressively in areas that are important for our mission and long term strategy, but we’re also going to stay focused on our core products and business. This is the best way for us to continue creating value for our community.
Now let’s talk about how we’re making progress and our three big company goals; connecting everyone; understanding the world; and building the knowledge economy. Our strategy for connecting everyone has two basic approaches. Our first approach is Internet.org; our effort to bring affordable Internet access to every person in the world. Our second approach is by giving everyone more tools for connecting, so they can share all the different kinds of content they want with the right people. Instagram, Messenger and creative laptops are a part of the second approach.
So with Internet.org this quarter we’ve continued to deepen our partnerships with global operators and laid a foundation for running tests in more countries. Already, our initial partnerships in the Philippine, Paraguay and Tanzania have helped around 3 million people connect to the Internet who had no access before. We’re really proud of these early results. In June we acquired Pryte, which has a lot of expertise bringing affordable Internet access to communities by partnering with mobile operators, app developers and content providers. Later this year, we expect to launch a broader set of free basic Internet services in a number of other countries as well.
In our app efforts, we’re continuing to build momentum with messaging. People now send than 12 billion messages a day on Facebook, and in April we reached 200 million monthly actives on messenger. Last month we announced that David Marcus will be joining us from PayPal to lead our messaging efforts. We expect David to continue growing Messenger, building out new experiences to serve our community and ultimately to build Messenger into an important business.
Instagram continues to make great progress in giving people new ways to share their stories through photos and videos. Last month we made one of the biggest updates ever to Instagram by adding new creative tools that allow people to refine exactly how their photos look and feel. This is an important part of building out Instagram’s capability as a platform and serving the creativity of the Instagram community.
Next, let’s talk about understanding the world. As of last month, on average, more than 1 billion search queries are made every day on Facebook. This is a great milestone and it shows we’re in a unique position to answer a lot of questions for people. But this is just a start. And over the next few years as we make progress on building out search and our broader efforts in artificial intelligence, I expect us to deliver even greater utility for people.
Our progress on public content is also very promising. As part of helping people to better understand the world, we want to help you connect around important public moments and personalities. And now nearly 800 million people on Facebook are connected to public figures. These connections are driving conversations at a huge scale. During the World Cup over 350 million people made over 3 billion interactions on Facebook. To enable even more of these conversations, we’ve improved the ranking of videos and newsfeed and launched new APIs to help TV and media organizations use Facebook content in their productions. Public content will continue to be a growing focus for us over the coming months and we plan to invest in building more great products and partnerships in this area.
Now building great social experiences to serve our community isn’t something we do alone. Supporting developers is a key part of our strategy, and in our F8 conference in April we announced new ways to help mobile developers build, grow and monetize their apps. Over 1 billion people use Facebook on their phones every month and more than 80% of the top apps on iOS and Android now use Facebook logins. So we think we’re in a great position to be the cross platform-platform that lets developers build great apps across every platform.
So far we’re very encouraged by the reaction from developers. App Links, our new method of deep linking to specific content in any app is now being used by 100s of apps across iOS, Android and Windows phone, with links to more than 1 billion individual destinations in these apps. We also launched our Audience Network, our first big effort to help developers monetize on mobile and we’ve received a lot of interest from developers. We’re rolling out the Audience Network gradually. We’re going to continue to ramp this app over the coming months and are excited by the opportunities ahead.
Finally, let’s talk about our efforts to build the knowledge economy. This has been a strong period for us, and we’ve reached some new milestones in the business. Now more than 30 million small businesses use Facebook pages to connect with their customers and more than 1.5 million of them are active marketers on Facebook. To continue delivering the best returns for marketers, we’ve been very focused on improving the quality of the ad experiences for our community. Our goal here is to make ads as interesting and useful as your friend’s content on Facebook. We’re investing heavily in this area. In this quarter we launched a number of efforts to improve the quality and relevance of our ads, including our new ads preferences tool, interest based advertising and improvements to News Feed design to reduce low quality content.
In some countries our surveys indicate that our ads are getting close to the quality level of organic content. But in most developed countries we still have lot to do. We expect to continue to focusing on this for a long time.
So that’s my update on how we’ve been executing over the last quarter. It’s been a quarter with good performance and continued momentum. So I want to thank everyone who works with Facebook and is part of our community, including our shareholders and partners. Because of your efforts, we’re continuing to make progress towards our mission to help connect the world, and we’re improving 100s of millions of peoples’ lives every day. I am grateful for your support and to have the chance to work with all of you.
Thanks and now here’s Sheryl.
Thanks Mark and hi everyone. As Mark said, we had a strong second quarter. Ad revenue grew 67% year-over-year to more than 2.6 billion. Mobile ad revenue grew 151% year-over-year and that makes up 62% of our ad revenue. We continue to focus on three key areas in investment; capitalizing on the shift to mobile; growing the number of marketers using Facebook; and building our ad products. These investments continue to generate broad based growth.
All geographies and all marketer segments performed well this quarter. Our team has a really strong belief in what we’re building; the world’s first ad platform that delivers personalized marketing at scale. While we believe it’s still early days, we’re pleased with the progress we’re making and I want to join Mark in congratulating our global teams on their continued execution.
Today I’m going to focus on two of our key marketer segments; small business and brand marketers, as well as cover some of the investments we’re making on the products in ad-tech front. We believe that personalized marketing of scale can drivers else for all types of marketers. Just a few weeks ago, I was in India and I hosted our first India SMB roundtable. One of the entrepreneurs I met, Vivek Prabhakar built his house just a few years ago to raise the money to start his and his wife’s dream business Chumbak, a company that makes India Inspired products. Facebook is Chumbak’s leading marketing channel and is responsible for 35% of online revenue and 38% of their Web site traffic. Their Facebook ads deliver a 5x return on advertising spend and has helped company grow to more than 150 employees in three offices.
We have more than 30 million active small business pages, and over 19 million of these are active on mobile. We think we have a big opportunity to help SMBs like Chumbak grow their businesses, and I’m pleased to announce today that we have over 1.5 million active advertisers. We’re also ramping up our engagement with this community. In the U.S., we’re hosting Facebook Fit workshops in cities like New York, Chicago and Miami to help small businesses. And we’re doing this globally, including forming our first European SMB cap.
We’re also making great strides in our work with our larger brands to increasingly recognize how our scale, targeting and measurement capabilities can drive great results. For example, P&G and Gillette worked with us and agencies IVS and Mediacom to launch its Vector III razor to men in India. 80% of the 100 million Facebook users in India are on mobile and a majority of these are using feature phones. This was our first feature phone only Facebook campaign. It reached 60% of Gillette’s target audience and generated significant lift in both message and ad recall.
As we work with brand marketers around the world, we focus on how they can leverage our technology platform to build their brands to create a story telling. We saw many great examples of this, at the recent online festival. We were excited that campaigns that make Facebook a key part of their effort took home prestigious awards.
The World Cup also provided a great opportunity for brand building on Facebook. Facebook was an important part of this global event with 350 million people joining a conversation, generating 3 billion interactions. The final was the single most talked about sporting event in Facebook history, generating 280 million interactions from 88 million people.
Brands such as Diesel, Nike, Ford and McDonalds capitalize on this global conversation. McDonalds worked with agencies, OMD, Framestore, and ARC sponsorship, as well as Facebook’s Creative Shop to produce 30 videos that used french fries as players. FryFutbol recreated the most spectacular World Cup moments and ran them as videos the very next day with the french fries acting as the players. This campaign reached 125 million people in 158 countries.
We also remain committed to investing in product development to drive higher returns for all of our marketers. Our custom audience’s capabilities, which enable better targeting are been adopted quickly and are now been used by 91 Ad Age 100. Earlier this year, we launched website Custom Audiences, which enabled marketers to target recent visitors to their websites. This is likely targeting but it’s even more effective because it works across both web and mobile. We’re pleased with the early reaction from marketers.
We also introduced premium autoplay video ads this year. Video on Facebook helps brands extend their TV investments by combining traditional reach focus campaigns with our unparalleled targeting abilities. Today, we run about a dozen campaigns and the early data show promising results. We’ll continue to roll this product out slowly and carefully. Similarly we’re seeing positive early demand for marketers for ads on Instagram and we’re rolling these ads outs carefully as well.
In all of this we remained focused on the transition to mobile. Our recently launched audience network lets advertisers use Facebook targeting while extending their campaign beyond Facebook. This can improve the relevance of ad peoples see both on and off Facebook and we’re encouraged by the early response.
Finally, earlier this summer we announced the acquisition of LiveRail, a leading online video advertising platform that enables customers like MLB.com and A&E Networks to monetize their video inventory efficiently. We have a lot to do here, but with LiveRail we’re investing in tools that can improve the relevance of video ads across the web.
In summary, we’re pleased with our performance and the progress we’re making. We’re the first platform that can deliver personalized marketing at scale and marketers are increasingly recognizing to great result so we can drive for them. Staying focused and executing will remain a major thing for us moving forward. Our teams know that our future success depends upon our continued acquisition and our plan is to stay focused.
Thanks. And now here is Dave.
Thanks, Sheryl. And good afternoon everyone. Q2 was a good quarter for us across our key operating and financial metrics. We generated strong revenue growth in operating margins and delivered $872 million of free cash flow and we continue to make investments to drive our core business, as well as to support our long term strategic priorities.
Let’s start with a review of our network. We are executing well on our ongoing mission to connect everyone. 829 million people use Facebook on an average day in June, up 130 million from a year ago. This represents 63% of the 1.32 billion people who used Facebook during June.
Mobile continues to be a strong driver of our growth with over 1 billion people using Facebook monthly on mobile. At the same time we’re enabling more ways for people to connect and share beyond the core Facebook app. For instance, both Instagram and Messenger have each passed over 200 million MAU and continue to grow nicely.
Turning now to the financials, total revenue in the second quarter was 2.9 billion up 61% or 59% on a constant currency basis. Total ad revenue was $2.7 billion, up 67% or 65% on a constant currency basis. Ad revenue growth was strong around the world with each of our four geographic regions growing by over 60%. Mobile ad revenue was approximately 1.66 billion or 62% of ad revenue, compared to approximately $660 million or 41% of ad revenue last year.
Desktop ad revenue was up 8% year-over-year. In Q2, the average affective price per ad increased 123% compared to last year, while total ad impressions declined 25%. The decrease in ad impressions continues to be driven by the shift towards mobile usage where people are shown fewer ads compared to desktop.
The increase in the average price per ad was primarily driven by an increase in the percentage of our ads being served in News Feed. The price volume trends were generally consistent across all four reported geographic regions.
Total payments and other fees revenue was $234 million up 9% versus last year. As we have noted in the past we believe the more meaningful comparison that better reflects the organic growth rate of the payments business, comes from looking at payments volume from games specifically, which was up 1% in Q2 versus last year.
Our current games payment revenue comes entirely from desktop usage and we are seeing declines in the number of people using Facebook on desktop, a trend that will make growing this business challenging going forward.
Turning to expenses, our Q2 GAAP expenses were $1.5 billion, up 22%, and our non-GAAP expenses were $1.2 billion, up 18%. Note that cost of revenue grew 2% on a GAAP basis and 1% on a non-GAAP basis, mainly driven by unusually high expenses in 2013 related to the transition out of certain leased data centers. This flatness in cost of revenue was the primary reason overall expenses grew relatively slowly.
Operating expenses excluding cost of revenue grew 33% on a GAAP basis and 31% on a non-GAAP basis. We ended Q2 with 7185 employees, up 36% from last year. Our Q2 GAAP operating income was $1.4 billion, representing a 48% operating margin, up from 31% last year and our non-GAAP operating income was $1.7 billion, representing a 59% non-GAAP operating margin, up from 44% last year. Our GAAP and non-GAAP tax rates were 43% and 36%, respectively. GAAP net income was $791 million or $0.30 per share, and non-GAAP net income was $1.1 billion or $0.42 per share.
In Q2, we spent $469 million on CapEx and generated $872 million of free cash flow. We ended Q2 with approximately $14 billion in cash and investments. This excludes the impact of the Oculus acquisition which was closed earlier this week and included am approximately $400 million cash payment.
Now looking forward, let me start by noting that the forward-looking comments I’ll share today for 2014 include the impact from the recently closed acquisition of Oculus, but exclude except where otherwise noted the impact from WhatsApp which we continue to expect will close later this year.
In terms of expenses, we expect that our total 2014 GAAP expenses, including cost of revenue and stock compensation, will likely grow in the neighborhood of 30% to 35%, and that our non-GAAP expenses, including cost of revenue but excluding stock compensation, will grow at a similar rate. These rates are slightly lower than our prior expectations due to the efficiencies in areas like cost of revenue and G&A.
However, we believe that we are still in the early days of building out all of the services to maximize Facebook’s impact on the world and we intend to continue to invest aggressively in people, products and infrastructure in the second half of 2014 and beyond. Though it is premature to give a specific outlook for 2015 expenses, I wanted to note that we expect significant stock-based compensation and amortization expenses, as well as substantial incremental operating costs related to the acquisitions of Oculus and WhatsApp. This will add to our overall expenses in 2015 and subsequent periods. These costs will be incremental to core Facebook expenses, which will continue to grow significantly in 2015 as we ramp investments in people, products and infrastructure.
For taxes, we expect GAAP and non-GAAP rates for the rest of 2014 to be similar to our Q2 rates, although these could vary widely depending on our international revenue and expense mix, and other factors, most notably the impact from acquisitions, including the expected closing of WhatsApp later this year. We continue to anticipate that 2014 CapEx will be approximately $2 billion to $2.5 billion. We expect shares outstanding to grow from around 2.6 billion at the end of 2013 to approximately 2.9 billion at the end of 2014, again assuming WhatsApp closes by the end of the year.
Turning last to revenue. As we saw in Q2, our year-over-year growth rate declined from 72% in Q1 to 61% in Q2 or 59% on a constant currency basis. This is consistent with our comments on the Q1 call when we indicated that over the course of 2014, the year-over-year growth rates in revenue would decline meaningfully as the comps became more difficult. We expect this trend to continue over the course of the second half of the year.
While we are excited about the long-term potential of our app initiatives like Instagram, autoplay video, and the Audience Network, we are still in the early days of building these businesses and expect their revenue contribution to remain small in the near term. We remain optimistic as ever about the long-term opportunity to grow revenue by improving the quality and relevance of our ads and increasing the value we bring to marketers through our products, tools and technologies.
In summary, we’re very pleased with our overall performance in Q2 and in particular the continued growth of our mobile audience, the strength of our ads business and the investments we’re making to build long-term shareholder value.
With that, Jay, let’s open up the call for questions
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