Google (GOOG) Q2 2014 Results – Earnings Call Transcript

These statements involve a number of risks and uncertainties that could cause actual results to differ materially.

Please note these forward-looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation to revise or publicly release the results of any revisions to these forward look statements in light of new information or future events. Please refer to our SEC filings for more detailed description of the risk factors that may affect our results.

Please note that certain financial measures that we use on this call such as operating income and operating margin are expressed on a non-GAAP basis and have been adjusted to exclude charges related to stock-based compensation and restructuring. We’ve also adjusted our net cash provided by operating activities to remove capital expenditures which we refer to as free cash flow. Our GAAP results and reconciliations of non-GAAP to GAAP measures can be found in our earnings press release.

With that, I will now turn the call over to Patrick.

Patrick Pichette – SVP and CFO

Thank you, Jane. Good afternoon and thank you for joining us for our second quarter 2014 earnings call. So I will dive right into the numbers. Nikesh is going to give you a business update and then we will open-up for Q&A. So let’s dive into the details of our financial performance for Q2.

Our gross total consolidated revenue grew a healthy 22% year-over-year to $16 billion and was up 3% quarter-over-quarter. Without currency fluctuations, our gross total consolidated revenue growth would in fact have been 21% year-over-year, still very healthy.

Our Google site revenue was up 23% year-over-year to $10.9 billion and was up 4% quarter-over-quarter driven by strength in our core search advertising business.

Our Network revenue was up 7% year-over-year at $3.4 billion and was up 1% quarter-over-quarter driven by year-over-year growth in our AdMob and Ad Exchange businesses.

Finally, Google other revenue grew 53% year-over-year to $1.6 billion and was up 3% quarter-over-quarter. Digital sales of apps and content in our Play Store drove the year-over-year growth.

Our global aggregate paid click was strong this quarter, up 25% year-over-year and 2% quarter-over-quarter. Aggregate CPC were down 6% year-over-year, but flat quarter-over-quarter.

And without currency fluctuation, aggregate cost per click would have been down 7% year-over-year. So currency had a very minimal — and currency had no impact on quarter-over-quarter CPC growth.

As we indicated in our last earnings call, we’re now disclosing paid clicks and cost per click changes by property type in addition to aggregate numbers. So to that end, Google sites paid clicks were up 33% year-over-year and up 6% quarter-over-quarter. Our Google site CPC were down 7% year-over-year and down 2% quarter-over-quarter.

On the Network side, network paid clicks were up 9% year-over-year and down 5% quarter-over-quarter. And our network CPCs were down 13% year-over-year and up 3% quarter-over-quarter.

Our monetization metrics continue to be impacted by a number of factors at an aggregate level, including geographic mix, device mix, property mix, as well as our ongoing product and policy changes. And since we’re now disclosing additional property metrics related to our monetization, it maybe helpful to remind you all of what we include in each property. So let’s start with sites.

Sites monetization metrics includes ads that were served on Google owned and operated properties across different geographies and form factors. So these properties include YouTube search obviously — YouTube engagement ads like TrueView, and then other owned and operated properties such like Maps or Finance and otherwise.

Our Network monetization metrics include ads served on non-Google properties participating in our AdSense for Search, AdSense for Content, and AdMob businesses. We also provide corresponding historical data since Q1 of 2013 for reference, which can be found on — in our earnings slides.

Nikesh and I’ll obviously be happy to respond as usual to your question about our Q2 monetization in the Q&A today. But I’m sure that some of you may have detailed questions about monetization trends from prior quarters. And to help you with that, the IR team will be ready to answer your questions after the call.

Turning to geographic performance, we saw solid performance in the U.S. and U.K and continued strong performance in rest of the world. In our earnings slides, which you can find in our Investor Relations’ website, you’ll see that we’ve broken down our revenue by U.S., U.K., and rest of world, to show the impact of FX and the benefits of our hedging program. So please do refer to these slides for the exact calculations.

The U.S. revenue was up 12% year-over-year to $6.6 billion. The U.K. was up 22% to $1.6 billion and in fixed FX terms, the U.K. grew 15% year-over-year, a clear improvement from last quarter’s performance.

As we’ve mentioned in previous quarters, our AdSense for search business skews toward the U.S and the U.K. And our ongoing user focused product and policy changes have continued to have a clear impact on our revenue growth in these two geographies.

Our non-U.S. revenue excluding the U.K. was up 31% year-over-year to $7.7 billion, and this accounted for 48% of our total revenue, which includes a $6 million benefit from our hedging program. So in FX term, the rest of the world grew also 31% year-over-year.

Let me now turn to expenses. Traffic acquisition costs were $3.3 billion or 23% of total advertising revenue this quarter. Our non-GAAP other cost of revenue was $2.7 billion in Q2. This is excluding stock-based compensation.

Our non-GAAP operating expenses totaled $4.8 billion, again excluding SBC and as a result, our non-GAAP operating profit was $5.1 billion and our non-GAAP operating margin stood at 32% in Q2.

Headcount was up, roughly 2,200 people in Q2 in the last 90 days. And in total, we ended the quarter with approximately 52,000 full-time employees, but please note that the headcount does include approximately 3,500 full-time employees from the Motorola business.

Our effective tax rate was 21% in Q2. Our tax rate this quarter was impacted by the continued mix shift of earnings between our domestic and international subsidiaries.

Let me now turn to cash management. Our OI&E, our other income and expense was $145 million for the quarter. Interest income and realized gains on investments offset the continued impact of expenses from our FX hedging program. And for more detail on OI&E, please refer to the slides that accompany this call on our IR Web site.

We continue to be happy with our strong operating cash flow at $5.6 billion. And CapEx for the quarter was $2.6 billion. This quarter, the majority of the CapEx spend was related to data center construction, real estate purchases and finally production equipment in that order. Investor should see our investment in CapEx as a positive signal, since it reflects our sustained optimism about Google’s business.

As I’ve mentioned before, we will continue to invest for the long-term and our infrastructure and real estate assets remain a key strategic area of investment for us. Our free cash flow for the quarter was $3 billion.

And before I close, I want to give a brief update on Motorola. The team continues to be hard at work and we look forward to seeing them join with the Lenovo team soon. Motorola had a great Q2 with the Moto E and Moto G, both showing strong sales momentum especially in emerging markets.

So there you have it, strong results and an optimism that provides us the confidence to continue to fund strategic growth opportunities in many areas including our CapEx area that we talked about earlier.

And now I’ll let Nikesh cover some more details on our business performance in the quarter and after his remarks, I will take it back to open-up the phone lines for questions. Here you go Nikesh.

Nikesh Arora – SVP and Chief Business Officer

Thank you, Patrick. You’ve had an amazing last few months at Google and our focus in creating great multi skin experience is paying off. I hope you saw our annual IO Developer Conference a few weeks ago. We were joined by over 6,000 developers in San Francisco along with approximately 1.9 million people globally tuning in online.

We unveiled the upcoming Android L release. We also showed how we’re expanding android platform to cars, watches, TVs, as well as making it easy to search Google from anywhere by simply saying okay Google. Making magical products that people love using everyday is what drives our ambition, fuels our business.

Last quarter we saw strong growth with $16 billion in gross revenue. We saw particular strength in the travel and retail verticals as well as in several countries like Japan and India.

By now you know the four areas driving our business. One, performance or direct response marketing; two helping clients build their brands; third our ad tech platforms for agencies and publishers; and four, our emerging businesses like digital content, enterprise, and hardware.

I’ll quickly go through each of them and this quarter I want to highlight the investments we’re making to serve the small businesses. Firstly, in performance advertising, in the long-term we’re battling towards a world where people jump seamlessly across screens of all sizes on all types of surfaces.

In today’s world, unlocking the mobile phone opportunity is absolutely key for every marketeer and we’re seeing tremendous amounts of momentum here. We’ve been building popular mobile app formats for years like showcasing a businesses location or click to call, etcetera.

The teams are laser focused on making ad campaigns easier across screens and helping businesses measure their effectiveness across devices as well as offline. We already offer great solutions for marketeers wanting to promote app installs, in April at our AdWords performance forum, we supercharged our offerings for app developers across search, display and as well as YouTube.

We launched improvements like app deep linking and search to help developers re-engage users, who have already downloaded their app, better targeting options in AdMob to help them recent most likely customers, even a new app install format on YouTube and more powerful measurement tools, so they know exactly how their app is performing at every stage.

Mobile hotel booking app Hotel Tonight uses mobile search ads as a the key part of their global marketing efforts because it drives consistently high value users or more likely to purchase quickly in the apps. In fact, international mobile search campaigns drive three times higher conversion rates compared to other direct response channels.

We’re also seeing tremendous amounts of momentum in the retailer segments, product listing ads across screen. In fact this past quarter, we sent over three times as much traffic to merchants on smartphones and tablet devices compared to Q2 of last year.

Let me go to the second area of brand building. I recently spend some times at Cannes Lions Festival. I know it was working Canne, where Google had a big presence, hosting over 300 meetings with creative agencies and brands. What was actually interesting this year was how much the conversation with brands has changed from years past. Whereas digital used to be just one channel, today’s brand are putting digital at the center of the brand building campaign.

We see this from our clients as well and video seems to be the linchpin of the strategy. YouTube continues to be driven by the insanely popular channels from some of our top content creators like Breakout Hip — Hit Epic Rap Battles of History and new sensation Vice News.

We launched our Google Preferred Video offering at BrandCast in April, giving marketeers access to top content at YouTube and we’ve gotten phenomenal amount of support from agencies and brands so far.

Digitas was our first agency to sign on and since then Omnicom Media Group has also pledged their support. Brands including General Motors, Coca Cola, and Universal Pictures are also having tremendous amounts of success as Google preferred. Adidas was one of the major brands to leverage our global platform to reach fans during the World Cup. They engaged soccer fans by live streaming events with athletes, promoted them on YouTube through TrueView ads, as well as using beautiful light box ads across our display network.

Now a few words about our ad technologies for agencies and publishers. Again, video is at the forefront of our efforts here. Last month we introduced a premium programmatic video marketplace called Google Partner Select to help publishers monetize their video content and to help agencies reach top quality video content across the Web.

The feedback that we’ve gotten from agencies and publishers has been great. We continue to see strong growth across premium inventory, particularly with the growth of private exchanges across AdMob and AdSense publishers are increasing their investments in mobile sites and apps and growing their businesses using our platforms.

Before I move on to our emerging businesses, I want to talk about an area we continue to invest in, online tools for small businesses. Small businesses are the cornerstone of the world’s economy and a major priority for us at Google. But there is still a huge opportunity as over 50% of SMBs still don’t have a Web site. To help set them up for online success; last month we introduced Google My Business, which helps small businesses manage their online presence across search, maps and Google+.

We also have a vibrant ecosystem of partners who have local businesses optimize their AdWords campaigns and we’ve been improving our customer support for small businesses. In fact, over the last few years, we’ve doubled our advertiser customer satisfaction scores which bodes really well.

Now, let me talk about emerging new businesses, digital content, enterprise and hardware. Google Play continues to grow at breakneck speed across all types of digital content, helping developers and content partners reach users around the world. For instance, Play Movies is now available in over 90 countries, with its recent additions in Argentina, Poland and the Czech Republic.

We also recently signed deals with CBS TV and Viacom to bring their TV content to Google Play. With over a 1 billion active android users to going success of Google Play, means that more developers are building successful global businesses in our platform. As we mentioned at IO, since last June, we paid out more than $5 billion to developers through Play which clearly means it’s a growing business for us as well.

Shifting gears to our enterprise business, I can report that over 60% of the Fortune 500 use our paid products. This quarter we added even more like Rockwell Collins. They signed up 20, 00 employees to use Google apps.

We also launched Google Drive for work, a premium service of businesses that includes unlimited storage. The reception so far has been great and we even closed our first sale within minutes of the announcement. Our cloud platform business also has momentum with new features announced at IO.

On the hardware side, over 1 million Chromebooks were sold into schools. Clearly a record quarter and the popularity of Chromecast continues to grow. Now available in Australia, Korea, Portugal and many more. I got to watch some World Cup games from the ESPN app using my Chromecast.

Before I close, I want to mention our marketing team, in addition to a great IO this year, we also launched the Made with Code initiatives with partners like Girl Scouts with the USA and Girls to Code, to inspire the next generation of women coders. We are really excited about the enthusiasm around this initiative and who knows hopefully some of this chorus will join us at Google.

With that, I’d like to thank today all the Googlers around the world who helped make this a fantastic quarter. On a personal note, as you might have seen, I’m moving on to a new adventure. I’d like to thank Larry and Sergey and the founders of Google, my colleagues and Larry’s staff as well as everyone at Google for the amazing experiences and the phenomenal 10 years I’ve had. I look forward to working with them in the future and cheering them from the sidelines.

I’ll hand back to Patrick.

Patrick Pichette – SVP and CFO

Thank you, Nikesh. And as you’ve just heard, this will be Nikesh’s last call. So I want to take a minute on behalf of Nikesh, your friends here at Google, your colleagues and also all of Google — all of our Googlers, to thank you for all of your contributions to Google over like what has been really a decade of work. So thank — huge thanks. Well many of you on the call may have questions about transition, if you don’t mind, we’d like to the keep the discussion focused on our performance in the last quarter, if you don’t mind. So that’s really where we will focus our questions.

And with that, why don’t I turn it over to Jamie who will line us up for our Q&A. Jamie?

Question-and-Answer Session

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