Google Inc (GOOG) CEO Discusses Q2 2013 Results - Earnings Call Transcript

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Google Inc (GOOG) Q2 2013 Earnings Conference Call July 18, 2013 4:30 PM ET

Executives

Larry Page - CEO

Patrick Pichette - SVP and CFO

Nikesh Arora - SVP and Chief Business Officer

Willa Chalmers - Investor Relations

Analysts

Ross Sandler - Deutsche Bank

Ben Schachter - Macquarie Capital Inc.

Mark Mahaney - RBC Capital Markets LLC

Carlos Kirjner - Sanford C. Bernstein & Co. LLC

Douglas Anmuth - JPMorgan Securities LLC

Scott Devitt - Morgan Stanley

Anthony DiClemente - Barclays

Mark May - Citigroup

Heather Bellini - Goldman Sachs & Co.

Justin Post - Bank of America Merrill Lynch

Brian Pitz - Jefferies & Co.

Gene Munster - Piper Jaffray

Operator

Good day everyone and welcome to the Google Inc. Second Quarter 2013 Earnings Conference Call. Today’s call is being recorded. At this time, I’d like to turn the call over to Willa Chalmers, Investor Relations Manager. Please go ahead ma'am.

Willa Chalmers

Thank you, Jamie. Good afternoon, everyone, and welcome to today's second quarter 2013 earnings conference call. With us are Larry Page, Chief Executive Officer; Patrick Pichette, Senior Vice President and Chief Financial Officer; and Nikesh Arora, Senior Vice President and Chief Business Officer.

Also, as you know, we distribute our earnings release through our Investor Relations website located at investor.google.com. So please refer to our IR website for our earnings releases, as well as supplementary slides that accompany the6 call. You can also visit our Google+ Investor Relations page for the latest Company news and update, please check it out. This call is also being webcast from investor.google.com. A replay of the call will be available on our website later today.

Now, let me quickly go over the Safe Harbor. Some of the statements that we make today may be considered forward-looking, including statements regarding Google's future investments, our long-term growth and innovation, the expected performance of our businesses, and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please note that 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-looking statements in light of new information or future events.

Please refer to our SEC filings for a 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.

We have 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’ll now turn the call over to Larry.

Larry Page

Hello, everyone and thanks for joining our call this afternoon. Google had a great quarter. Over $14 billion of revenue, up 19% year-on-year, amazing performance for a Company that is yet to celebrate its 15th birthday. We live in a world of abundant computing, with multiple operating systems and increasing number of the devices. And it’s a very different environment from when Google started. There was essentially one OS, and one device category, the PC. These kind of changes don’t happen that often. Once a decade, maybe even less are coming. The shift from laptop to mobiles, from on screen to multiple screens, create a tremendous opportunity for Google. With more devices, more information and more activity online than ever, the potential to improve people’s lives is immense.

Getting you the right information, just when you need it, creating the tools to make everyone more effective at home and at work, and helping you share and remember the moments that matter in life.

That’s why I’m so excited about the velocity and execution of our platforms, apps, and devices. First, platforms. With hindsight, Android and Chrome were no brainers. At the time, they were big bets. The movements across these platforms is tremendous. As you saw in our Annual Average Developer Conference in May, I was astounded, we had over 1 million people tuning in life just to watch our developer keynote.

We’ve now activated more than 900 million Android devices worldwide and we’re lining up our over 1.5 million devices every day. That’s pretty amazing as in the first android phone launched less than five years ago and apps usage is increasing fast. Over 50 million apps have been now downloaded from the Google Playstore. In fact, we already paid out more money to Android developers this year than in the whole of 2012.

I love the ability to access your stuff on play anywhere. Take our new music subscription service, launched in May, it has a new fun way to discover new music, with all the songs there ready to go. I’ve to think about the delay seriously. Chrome, even though only four year old, has over 750 million users worldwide and growing.

The next apps, our goal is to design everything so it’s beautifully simple and hassle free. Users shouldn’t have to need to think about our technology, it should just work. This quarter we completely revamped our maps. The map is a screen, no clutter quarter around the edges, because more information about your surroundings, so it’s easier to explore. And we launched a new improved navigation feature. And not execution about incidents, before you leave and updates to save time if traffic condition change.

First of all, this new maps experience is now available on almost all devices, you would be likely to use. The same with Google plus. We’ve done a complete redesign to make using the entire screen and that really looks consistent to whatever the delays or the platform. In addition, the team massively upgraded the photos experience. Making software design for professionals automatically available to everyone for fee. There is no need for wrinkles anymore.

Take a look on Plus, many of your photos will now be marked enhanced and improved automatically.

Finally we launched a new communication app called Hangouts. You can talk to the people you care about across all the major platforms. Video calls from your phone are very cool, give them a try.

And I'm excited about the progress we've continued to make with Search. Our Knowledge Graph is now available in 29 languages and we've expanded the range of information available. For example, we just added nutrition data. Ask Google how many calories there are in a glass of white wine and you'll find out its 123, or an avocado, 235 calories. It's good to have the facts if you want to keep healthy. And we launched Google Now on iOS in April.

In the same way, we want to make advertising super simple for customers. Online advertising have developed in very specific ways with separate campaigns for desktop and mobile. This made arduous work for advertisers and agencies and meant mobile opportunities often got missed.

It's why we launched Enhanced Campaigns. Advertisers have upgraded 6 million campaigns. That's almost 75% of all their active campaigns. And Nikesh will talk in a little more detail about the positive reaction from clients. This is the biggest ever change to AdWords and the velocity and execution has been great thanks to the hard work of all the teams.

Finally, devices; there is so much excitement around new devices today and the potential for innovation is tremendous. You can now buy the HTC One and the Samsung Galaxy S4 Google Play editions and enjoy the best of Google. There's a ton of momentum around Chromebooks, which are growing fast and defying the more general decline in PC sales.

Finally, I know you're all eagerly anticipating what Motorola is launching soon. Having been a tester for a while, I'm really excited. We're very optimistic about the opportunities in front of Google today. The potential for technology to make people's lives better is tremendous. But to achieve that potential we need to stay focused. It's why we continue to invest the vast majority of our resources and time in our core products. But my job as CEO is also to think about the future and ensure we continue to bet on new technology that can solve big problems in the world.

Project Loon, which we launched in June, is a great example. Bringing affordable, balloon-powered Internet access to remote areas is an idea that Sergey and I had been thinking about for over a decade. It was great to see that project literally get off the ground, and give people a bit more hope for an improving world.

None of this would happen without great people and we are so lucky that we have them. I'd like to thank all the Googlers and Motorolans who make everything possible. Keep up that velocity and execution.

Now, I'll hand the call over to Patrick.

Patrick Pichette

Thank you, Larry, and good afternoon everyone. Thank you for joining us. So why don't we go dive in by reviewing the details of our overall business financial performance, so here we go. Our gross total consolidated revenue grew 19% year-over-year to $14.1 billion. The overall business was up 1% quarter-over-quarter.

Google standalone gross revenue grew 20% year-over-year to 13.1 billion and was up 1% quarter-over-quarter. Our Google website revenues was up 18% year-over-year to 8.9 billion and was in fact up 3% quarter-over-quarter. Our Google network revenue grew 7% year-over-year to 3.2 billion and was down 2% quarter-over-quarter.

You'll remember the advertising policy decisions we implemented during Q4 and Q1 to ensure the useful and safe user experience continued to have its negative impact on network revenue. Other revenue grew 138% year-over-year to $1 billion and roughly flat quarter-over-quarter.

Play store digital sales of apps and content drove the year-on-year and quarter-over-quarter growth and it's worth noting that in Q1, we included some seasonal hardware sales due to overflow from Q4 which skewed the Q2 comps somewhat. Finally, please note that without currency fluctuations Google standalone revenue growth would in fact have been 22% year-over-year and 3% quarter-over-quarter.

Turning to Motorola Mobility, gross revenue there was $998 million, just shy of a $1 billion and it's clear that we've made a lot of progress at Motorola in the past year and that we are especially excited about the future of our upcoming product lineup, so stay tuned.

At Google, our global aggregate paid click growth was strong at 22% year-over-year, in fact up 4% quarter-over-quarter. Our aggregate cost-per-paid was down 6% year-over-year and down 2% quarter-over-quarter and currency fluctuations in this case had a minimal effect in Q2 CPC growth, and yet our monetization metrics continued to be impacted by the usual factors that we've discussed many times including geographic mix, channel mix, property mix, our product and policy changes as well as FX.

Turning to the geographic performance of Google standalone business, we continued to see a steady performance in the U.S. and rest of world, while the UK was negatively impacted by a warm spring, some FX in their case and a tough year-over-year comp. In our earnings slides which you can find on our Investor Relations website, you'll see that we've broken down our revenue by U.S., UK and rest of world to show the impact of FX and the benefits of our hedging program. So please refer to those slides for the exact calculations.

U.S. revenue was up 18% year-over-year to $5.9 billion. The UK was up 12% year-over-year to 1.3 billion which included 24 million of benefits from our hedging program. It is in fact worth noting that in fixed FX terms, the UK grew 15% year-over-year. Non-U.S. revenue, excluding UK, accounted for 45% of the total revenue or 5.9 billion and it was up 23% year-over-year which includes 11 million benefits from our hedging program. In fixed FX terms, rest of world grew a solid 28%.

Coming back to an aggregate level for the total consolidated business, our other cost of revenue was 2.9 billion in Q2 excluding stock-based compensation and Motorola restructuring. Our non-GAAP operating expenses totaled 4.2 billion also excluding stock-based compensation and Motorola restructuring and our non-GAAP operating profit was $4 billion in Q2 resulting in a non-GAAP operating margin for the consolidated business of 28%.

For standalone Google, our traffic acquisition costs were $3 billion or 25% of total advertising revenue. Other cost of revenue was 2.1 billion, again excluding 110 of stock-based compensation. Non-GAAP operating expenses were 3.8 billion, excluding stock-based compensation of 633 million. And non-GAAP operating profit was $4.2 billion in Q2 resulting in non-GAAP operating margin of 32% for the standalone Google segment.

Please note that a reevaluation of our depreciation policy as it relates to our real estate portfolio resulted in an additional 121 million in Google segment depreciation expenses, about half of which were presented a one-time charge for assets that are now fully depreciated. With this change in place, depreciation and amortization expense on property, plant and equipment for standalone Google was 667 million for this quarter.

At Motorola Mobility, total non-GAAP operating expenses including cost of revenue were $1.2 billion. Keep in mind intangible amortization expenses attributed to the standalone Google and Motorola Mobility are in fact, included in these non-GAAP measures. Of the 283 million in intangible amortization expense in the quarter, $153 million was the result of the acquisition of Motorola of which 116 million was allocated to Google and 37 million was allocated to Motorola Mobility.

And as a result, the non-GAAP operating loss for Motorola Mobility was 218 million in Q2 and an non-GAAP operating margin for that segment of minus 22%. Headcount for the consolidated business was down roughly 9,000 people in Q2. Please keep in mind that consolidated headcount now excludes Motorola Home business. It also reflects the impact of the ongoing mobility restructuring. Standalone Google added about a 1,400 people during the quarter and in total the consolidated Company ended the quarter with around 44,800 full-time employees. While effective tax rate was 24% in Q2, like in Q1 several one-time items as well as the continued shift of earnings between domestic and international subsidiaries impacted our tax rate this quarter and also please remember that in Q1 we also had a significant lower rate in that case due to the 2012 R&D credit which was obviously not applied to our Q2 rate.

Let me now turn to cash management. Other income and expense was $247 million for the quarter which reflects realized gains on investments and interest income offset by the continued impact of our FAS 133 expense on our hedging program. For more detail on OI&E again please refer to the slides that accompany this call on our IR website.

We continue to be very pleased with our operating cash flow which is strong this quarter at $4.7 billion. CapEx for the quarter was $1.6 billion, and this is versus last quarter at $1.2 billion. I want to remind everybody the majority of our CapEx spend is related to data center construction, facilities related purchases and production equipment. CapEx is just inherently lumpy. And as I mentioned last quarter during my remarks our infrastructure will continue to be a strategic area of investment. It's one of the foundations of our future growth. Our free cash flow again very strong $3.1 billion for the quarter.

Larry’s comments make it clearer that there are just enormous growth opportunities ahead of us as a Company. It's in this spirit of optimism that we continue to fully fund strategic growth opportunities with the same confidence and discipline we demonstrated while growing our Mobile Business, Android, YouTube, Chrome, just to name a few.

And with this, I’ll hand it off to Nikesh who will cover more details of our business performance in the quarter and after his remarks we’ll open up the lines for questions.

Nikesh Arora

Thank you, Patrick. As Patrick mentioned our businesses had a strong quarter. We had over $13.1 billion in Google standalone gross revenue. Overall the performance was particularly strong in the auto sector in Brazil. And as Patrick mentioned growth in the U.K. was hampered because of a particularly warm spring. Before I talk about trends, we’re seeing in investments we’re making in our business let me call out the effort of our marketing team that continues to create great Google moments. In May, they put on our second annual YouTube brand cast event in New York for 1,800 advertisers. The event was a great way to show YouTube’s unique ability to help marketers connect with highly coveted consumers and ultimately build their brands.

At Brandcast, Jeffrey Katzenberg of DreamWorks said YouTube is a whole new entertainment paradigm, and we think he’s right. Also Larry mentioned the team put on another successful Google I/O Development Conference showcasing our incredible momentum across our platforms to over 6000 developers in San Francisco with over a million people tuning in from around the world. We continue to be pleased with how our business is evolving, growing and diversifying.

There are three key areas where we continue to make investments. First, our transformation into a marketing platform that works across the connected world Larry described. Second, our systematic move up the marketing funnel helped clients more and more with brand building campaigns. Third, our investments in our non-ads business such as enterprise services, hardware and digital contents for Google Play.

First, our message for our constantly connected users. The rapid adoption of new devices means that more people are spending more time online and connected. In fact new devices and new connectivity means we’re moving to a world where people are constantly connected with devices with them all the time. As an example you marketers say for the time spent online our mobile devices by U.S. adults grew 273% from 2009 to 2012. From 2011 to 2012 alone the time spent connected to mobile devices increased by nearly half an hour a day. This means not only a lot of new services and apps available for users and also a huge opportunity exists for businesses looking to reach mobile users at the right time and location.

That brings in enhanced campaigns. As Larry talked about this, enhanced campaigns was a big long-term bet that is designed to help advertisers more easily reach customers across devices with the right message, all within one campaign. We already migrated six million of active campaigns to enhanced campaigns over the last many months. Our goal is to migrate all of our advertisers and campaigns by the end of this month. This effort has been executed at breakneck-speed and client reaction has been generally positive.

We’re getting back evidence from clients seeing improved performance unit using enhanced campaigns. For example Pizza Hut. Social mobile ROI increased by 20%. They found that mobile click through rate has increased by more than 60% while that cost per order on smartphones is dropped by 17%. We believe enhanced campaigns does set up our clients and our business really well for the long-term and the move towards a constantly connected world goes far beyond just direct response and transaction of marketing.

People are spending time watching videos, playing games, consumer news. All this creates great new opportunities from brand marketers to engage users. In fact powered by a TrueView Format, Youtube’s mobile revenue in June of this year was three times what it was at the beginning of the year. And to help advertisers reach viewers across more screens we opened up our TrueView Formats with all of our ad mob network across 1000s of apps.

Turning our attention to brand marketers this is a very, very important area for us where we continue to invest broadly. It's important because the largest global marketers from CPG companies to film studios all conduct large major brand advertising campaigns, of course that referenced in the significant budgets that have historically been spent on TV.

A good example of this was seen in the Cannes Lions Festival; the Dove real beauty sketches campaign that appeared on YouTube won the Titanium Grand Prix award which is considered the best to the highest honor. We worked with Burberry to launch Burberry Kisses which allows users to send message to loved ones sealed with the digital imprint of their real kiss. This campaign runs on YouTube and our network across desktop, tablets and mobiles. In the last month we began to integrate our recent acquisition Wildfire into the double click platforms so that brands can now manage the broader customer journey across search, display, mobile, social, rich media and video again all within one platform.

Finally, I want to talk a little bit about our investment in emerging non-ad businesses. We’ve made a bunch of bets that are now beginning to show profit. We’re seeing acceleration in new business such as hardware, digital content and enterprise. First hardware, we continue to see great momentum across Chromebook’s and mobile devices such as our Nexus program. Around the world Chromebook’s are now in more than 6,600 brick and mortar stores including Walmart and Staples, that’s about a three time increase this quarter. As Larry said, we’ve also added two new devices to the Google Play Store from Samsung and HTC.

On the digital ads and content front, through Google Play we continue to see tremendous amount of growth in this area. People from over 190 countries now download apps from Google Play everyday. More than 50 billion apps have been downloaded so far. In the last year Google Play digital content like music and movies has launched in 21 new countries including India, Mexico, Russia, with eight more European countries launching Google Play books this week. Publishers like Penguin, Random House, Time Inc. movie studies like Disney and NBC Universal, and app developers like King and Square Enix are creating terrific experiences for our users. We’ve also collaborated with all the major record labels to launch a new music subscription service that users seem to be enjoying really -- enjoying a lot.

Lastly on the enterprise front, that’s another great revenue stream for Google. It comprises productivity apps like Docs and Gmail as well as our Cloud infrastructure. Now more than half of the Fortune 500 companies use the paid enterprise product from Google, and over 5 million businesses use our productivity apps. This means we have close long-term relationships with our enterprise customers. New customers this quarter includes some of our worlds leading businesses, like Federal Express, which has built their store locator in Google Maps, Snapchat which runs an application with Google’s Cloud infrastructure and LinkedIn is using Google Search Appliance. New Google apps customers include Pearson, Keller Williams Realty and the city of Boston. And HP is now Google apps reseller combining Google’s software with HP’s hardware for an initiative to help small businesses called SMB IT in a Box.

To conclude, across our entire business we’re investing with enthusiasm and have tremendous opportunities. We strongly believe that we’re making the right moves to our users and clients and we’re extremely optimistic about the future.

With that let me hand back to Patrick.

Patrick Pichette

Thank you, Nikesh. So Jamie, if you want to give us the instructions please to get going on the Q&A please. I’d appreciate it.

Earnings Call Part 2:

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