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Google's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Google Inc. (GOOG) Q3 2013 Earnings Conference Call October 17, 2013 4:30 PM ET

Executives

Larry Page - CEO

Patrick Pichette - SVP and CFO

Nikesh Arora - SVP and Chief Business Officer

Jane Penner - Director, Investor Relations

Analysts

Mark Mahaney - RBC Capital Markets LLC

Ben Schachter - Macquarie Capital Inc.

Carlos Kirjner - Sanford C. Bernstein & Co. LLC

Ross Sandler - Deutsche Bank

Dan Salmon - BMO Capital Markets

Gene Munster - Piper Jaffray

Timothy O'Shea - Jefferies & Co.

Ken Sena - Evercore Partners

Colin Sebastian - Robert W. Baird & Co.

Stephen Ju - Credit Suisse

John Blackledge - Cowen and Company

Scott Devitt - Morgan Stanley

Heather Bellini - Goldman Sachs & Co.

Justin Post - Bank of America Merrill Lynch

Douglas Anmuth - JPMorgan Securities LLC

Operator

Good day everyone and welcome to the Google Inc. Third Quarter 2013 Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the call over to Ms. Jane Penner, Director, Investor Relations. Please go ahead ma'am.

Jane Penner

Good afternoon, everyone, and welcome to today’s third 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 the supplementary slides that accompany the 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 cover 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 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 the 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’ll turn the call over to Larry.

Larry Page

Thank you. Hi, everyone. Thanks for joining us today. Google had another strong quarter with $14.9 billion in revenue and great product progress. We are closing in our goal of a beautiful, simple, and intuitive experience regardless of your device.

Research has shown that people tend to overestimate the impact of technology in the short-term, yet underestimate the scale of change longer term. For years everyone talked about the multi screen world. Now it’s arrived, but on a scale few imagined, people increasingly have more than one device and screens are proliferating in the home as well as wearable screens like watches and Google Glass.

When android was still a (indiscernible) project I used to feel kind of guilty visiting the team. We are a search company and building a new operating system wasn’t an obvious move to most people. It turns out that was a lot of (indiscernible) over 1 billion android devices have now been activated worldwide and 1.5 million devices are led off everyday.

I’m also tremendously excited about Chromebooks, which are growing fast and defining the more general decline in laptops. It’s like the chrome browser; updates are seamless and frequent improving security and usability. It was a great example of technology doing the hard work, so you can get all the stuff that matters.

Two weeks ago we launched the new HP Chromebook 11. Its beautifully designed and light weight and just over 2 pounds and at $279, highly affordable. Best of all, it has a high power micro USB charger that can also charge your android phone. Recharging isn’t too much of a sweat and there is tremendous potential to innovate. So it’s great to see progress here.

This quarter we also launched the Moto X. The first one that Motorola has developed and produced since Google acquired the company. Super fast and clean and the voice features are great. While it’s still early days, Dennis and the team have already transformed Motorola’s product quality. Now they’re working to build out marketing and distribution.

As screens multiply people navigate across them seamlessly becomes more and more important. That’s why I love Chromecast which we launched in July and immediately became a best seller. On your phone, tablet or laptop and start playing some music from Youtube or a show from Google play or Netflix. One click the content is there on the bigger screen in your home, your TV, all for just $35.

And unlike some other streaming devices, you can continue to email search and share as the Chromecast handles the hard work without draining your device battery, genuine multi-tasking in a multi screen world. We’ve also making great progress across devices with Youtube. Almost 40% of Youtube’s traffic now comes from mobile, up from 6% two years ago. And in August we updated our Youtube apps for android and iOS. You can now leave a video playing at the bottom of your screen while you explore other content.

Our execution in velocity and search from maps is getting better and better and from a very high base. A new map app for iOS and android shipped in July, but is specifically for downloads to make the most of this larger screens. And in September we’ve rebuilt our entire mobile search experience of a simple card interface that is easy to read and have designed, that is optimized for touch.

Our momentum on voice search is tremendous. We added four new languages this quarter making available on over 78 languages and accents. We’ve also expanded the quick answers, we can provide just for you. Fast Google for your flight details and up here instantly in your search results, no digging around in your email required. And the search across Google+ photos is extraordinary. Search for sunsets and all the pictures you've ever taken of sunsets to appear instantly. If you haven't tried it, prepare to be amazed.

About two years ago, when I became CEO again, my goal was to ensure that Google maintains the passion and soul of a start-up as we grow. It's why I've worked so hard to increase the velocity and execution. So we create great products people love to use and iterate fast to ensure they get better and better. Because great is just never good enough.

When you look across the company, it's amazing how well the teams are executing. For example, we rolled out Enhanced Campaigns in AdWords across all devices for all our advertisers in less than a year. Of course 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.

Before I hand over to Patrick, I want to let you know that going forward, I won't be joining every earnings call. Patrick and Nikesh do a great job covering our business each quarter and they'll continue to do that great work. I know you all would love to have me on, but you are also depending on me to ruthlessly prioritize my time for the benefit of the business. I'm very confident you are in good hands with Patrick and Nikesh.

So now, over to Patrick.

Patrick Pichette

Thank you, Larry. Good afternoon, everyone, and thank you for joining us again. Without further ado why don't we just dive into the details of Google's financial performance in Q3? So here we go. Our gross consolidated revenue was just shy of $15 billion at $14.9 billion. The overall business was up 6% quarter-over-quarter and 12% year-over-year.

Our Google segment, gross revenue grew a healthy 19% year-over-year to $13.8 billion and was up 5% quarter-over-quarter without currency fluctuations, Google segment revenue would have actually grown 21% year-over-year and the currency impact on sequential growth was actually immaterial in our case this quarter.

Google sites revenue was up 22% year-over-year to $9.4 billion and was up 6% quarter-over-quarter, driven by the strength in our core search advertising business. The advertising policy decisions that we implemented earlier this year to ensure good user experience continued to negatively impact Google's network revenue in the short term, and therefore our network revenue was in fact flat year-over-year to $3.1 billion and was down 1% quarter-over-quarter.

Despite the short-term pressures we continue to believe that this is clearly the right answer for our users and shareholders in the long term. And finally to finish Google's segment on a positive note, Google's other revenue grew 85% year-over-year to $1.2 billion and was up 18% quarter-over-quarter. Digital sales of apps and content in our Play store drove year-over-year and quarter-over-quarter growth in this line.

Turning to Motorola segment, our gross revenue there was $1.2 billion. As Larry mentioned, while it's still the early days, Dennis and the team have already transformed Motorola's product quality and they're working now at building marketing and distribution.

By the way, some of you may have noticed that our total consolidated revenue does not exactly equal to some of our segment revenue this quarter. This is driven by new transactions in our Motorola segment resulting in intersegment and certain deferred revenues that are eliminated in our consolidated results.

Coming back to our Google segment, our global aggregate paid click growth was strong this quarter, up 26% year-over-year, 8% quarter-over-quarter. Our aggregate cost-per-click was down 8% year-over-year and down 12% quarter-over-quarter. And we should note that the currency fluctuations had a real minimal impact on Q3 cost-per-click.

Once again, I wish to remind everyone that our monetization metrics continue to be impacted by a whole set of factors discussed on previous calls. They include geographic mix, channel mix, property mix as well as product and policy changes.

Turning to geographic performance of our Google segment, we continue to see steady performance in the U.S. and the U.K. and strong performance in the rest of the world. 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., U.K. and rest of world to show the impact of FX and the benefits from our hedging program. So please refer to those slides for the exact calculation.

The U.S. revenue was up 13% year-over-year to $6.1 billion and it's worth noting that network revenue that I mentioned a bit earlier which continues to be impacted by ongoing policy decisions skew toward the U.S. The U.K. was up 14% year-over-year to $1.4 billion which includes a small $17 million benefit from our hedging program. In fixed FX the U.K. grew 15% year-over-year.

In our non-U.S. revenue excluding the U.K. accounted for 46% of total revenue or $6.3 billion. This was up 28% year-over-year which includes a $5 million benefit from our hedging program and in fixed FX terms, our rest of world actually grew 32% year-over-year.

Coming back to an aggregate level for the total consolidated business, our non-GAAP other cost of revenue was $3.3 billion in Q3 excluding SBC and Motorola restructuring. Our non-GAAP operating expenses totaled 4.3 billion again excluding SBC and Motorola restructuring. For a non-GAAP operating profit was $4.3 billion in Q3 resulting in non-GAAP operating margin for the consolidated business of 29%.

For Google segment our traffic acquisition costs were $3 billion or 24% of total advertising revenue. Our other cost of revenue was $2.3 billion excluding $133 million of SBC. Google segment operating expenses were $3.9 billion also excluding SBC of $723 million.

Depreciation and amortization expense on our property, plant and equipment for the Google segment was $630 million this quarter. And our Google segment operating profit as a result was a strong $4.6 billion in Q3 resulting in Google segment operating margin of 34%.

At Motorola our total segment operating expenses including cost of revenue were $1.4 billion. That excludes $30 million of stock-based compensation and $12 million of Motorola restructuring charges. Please keep in mind that intangible amortization expense attributed to the Google segment and Motorola are in fact included in these segment measures.

Of the $281 million in consolidated intangible amortization expense in the quarter, $153 million was the result of the acquisition of Motorola of which $116 million was allocated to Google segment and $37 million allocated to the Motorola segment. And as a result, the operating loss at Motorola segment was $248 million in Q3 and operating margins for that segment were negative 21%.

Headcount for the consolidated business was roughly 1,500 people, up in Q3. The Google segment added just about 2,000 people during the quarter and in total the consolidated company ended the quarter with approximately 46,000 full-time employees. Our effective tax rate was 15% in Q3. 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 other income and expense was 24 million for this quarter. The impact of FAS 133 expense from our hedging program and realized losses mostly offset interest income in this quarter. And as you know we often get questions on quarter-to-quarter volatility of our hedging costs.

So to help everyone understand this better, we put together a video tutorial on the topic. You can find the new video on our Investor Relations website. I hope you find it helpful and let us know what you think. For more detail on OI&E, please again refer to the slides that accompany this call on our IR website.

We continue to be happy with our strong operating cash flow at $5.1 billion. CapEx for the quarter was $2.3 billion. This quarter the majority of our CapEx was spent on production equipment, data center construction and real estate purchases. As I mentioned last quarter during my remarks, we continue to invest for the long term and our infrastructure continues to be a key strategic area of investment for us.

Consequently, our free cash flow was $2.8 billion, very strong again. So there you have it. Strong results and an optimism that provides us the confidence to fund strategic growth fully in the opportunities, areas including Mobile Business, Android, Chrome, YouTube, Enterprise just to name a few. With that I’ll hand it off to Nikesh, who’ll cover more details of our business performance in the quarter and after these remarks we’ll open up the phone lines for questions. Here you go, Nikesh.

Nikesh Arora

Thank you, Patrick. As Patrick mentioned our business had a strong quarter with $13.8 billion in Google segment gross revenue. Overall performance was strong in the retail sector. We had good growth in Japan, South Korea and Australia. There are three key areas I want to talk about today, that are big growth drivers for us and our partners. First; our continued efforts to make advertising seamless, effective and measurable across multiple screens. Second; our progress in bringing bad advertisers online with a special emphasis on our efforts that are on Youtube; and third our early investments in commerce and shopping to help users, retailers and merchants. And last say a few words about newly areas like digital content, hardware and enterprise.

On seamless advertising; it's been a few months since our advertisers moved over to enhanced campaigns and AdWords. Clients are telling us they like the new system. Many are still adjusting their campaigns and keywords and developing their multi-screen bidding strategies. For example; we’re seeing advertisers bidding more frequently in mobile keywords because enhanced campaigns makes it so much easier to do so. They’re discovering how they can use the needed capabilities in mobile and their ads, like location Click2Call. Example is discover who has just increased their mobile spend and used it to promote their [it card].

Talking about mobile, we’ve also launched cross device measurement tools and analytics. There are three observations here. First; mobile is driving higher online conversion. American Apparels found that mobile ads were actually driving 16% more conversions than they initially thought and as a result they’re now investing more to drive more sales. Second, mobile drives more phone calls. On average there are more than 40 million calls driven by Google ads every month, this is twice as much as it was a year ago. Third, mobile drives in-store traffic.

Moving over to brand in YouTube. You’ve seen that our CPG and entertainment clients have moved online at greater speed with our efforts that are on brand. Spend by our CPG clients on displaying YouTube has grown over 75% over the past two years. For example, the Google YouTube campaign for Dove’s Camera Shy brand in more than 20 countries and delivered over 62 million views for Unilever. We’re also partnering very closely with agencies, we really like integrating our technology, insights and media with their creativity and client relationships.

For agencies, marketers and Googlers it's a huge win, win, win. All of the top 10 global agencies now use our DoubleClick products. On the other side YouTube continues to do well. Video ads which include CUview now form a significant part of our YouTube in brand advertising and they’re growing north of 75% year-over-year. We found that YouTube is our brand torch bearer. It offers brands valuable engaged audiences, terrific reach and compelling context. Smart brands are really loving their engagement with YouTube.

Moving on to commerce and shopping. As Google search moves to provide people with answers and entities not just links, we’re making good progress helping people take commercial access too like buying products. We’re seeing great traction on product listing ads both in desktop and mobile. As part of this moved to a seamless purchasing experience we’re also helping retailers offer better payment solutions to their customers particularly on mobile where it's traditionally been difficult. Google Wallet InstaBuy helps merchants here up implementing instant buy Google (indiscernible) saw that from May to August users of Google Wallet on their Android app had a purchase conversion rate that was four times higher than other shoppers.

Finally I want to talk about an area which we’re being putting more emphasis on which is our investment in emerging non-ads businesses. As we mentioned last quarter, we continue to see acceleration in the new businesses such as hardware, digital content and enterprise. As Larry mentioned Chromecast and Chromebooks are enjoying great success. Chromebooks are now available in over 8000 locations around the world and are being used in more than 20% of school districts in United States. We’re also rolling out unified Google experience in more than 750 Best Buy stores to showcase Chromebooks, Chromecast and the newest Nexus devices under our one Google branded design.

On digital apps and content we continue to work hard to roll out Google Play in more markets around the world and add content to it. For instance this quarter to help students go back to school we added a comprehensive catalogue of textbooks to Google Play Books for rental purchase. We brought on content partners like HBO and DC Entertainment. This quarter we brought Play Music to eight more countries and Play Books to 18 new countries. So for example now users in Russia can enjoy music and users in Indonesia can enjoy books. There’s tremendous momentum here and we look forward to making progress in this area.

Another strong area of recovering and growing revenue is our enterprise software business, making available the best of Google for work. Some great new clients this quarter include whirlpool which is now using Google Apps to help 30,000 employees collaborate and innovate more quickly. In education, apps for education is being used by 30 million students, faculty and staff worldwide. Beyond apps, Amtrak uses Google Maps to let people see all the trains in the U.S. in real time, and we’re continuing to invest in the Google Cloud Platform which has over 300,000 customers including Sanmina, a Fortune 500 Company using cloud platforms to build internal applications that improve their efficiency across their offices globally.

Lastly let me call out the efforts of our marketing team that continues to roll out the Google Welcome Mat to the world. To put on our third annual Google Science Fair honoring 15 global finalists from the ages of 13 to 18 from around the world where we hosted 400 partners and customers who are at our Annual Site Cast Event, more interestingly to introduce the newest version of Android called KitKat, we’ve built a partnership with Nestle to get more than 50 million special Android KitKat chocolate bars on store shelves around the world. And I have to give a shout out to the wonderful ad for our Nexus devices featuring the great sport of cricket that our marketing team is running in Australia, that’s a bit of a personal favorite sport. With that, let me hand it over to Patrick. Thank you again to all the Googlers for all their hard work in getting us here.

Patrick Pichette

So there you have it folks. Why don’t we have Jamie turn on the lines and then we’ll take your questions. So Jamie, over to you.

Earnings Call Part 2: