Google – 2Q09 In-line but not good enough

Google reported a net revenue increase of 3% year-over-year and -.2% quarter-over-quarter to $4.065bn, Adjusted EBITDA of 62.6%, and Non-GAAP EPS of $5.36. Consensus Wall Street estimates expected Google to deliver $4.031 billion in revenues, EBITDA margin of 61.7%, and $5.09 in Adjusted EPS. Google beat those estimates but the results were not good enough. Whisper had expected a quarter-over-quarter increase of 1% or more and the huge EPS beat was due to a lower than expected tax rate of 20%, down from 25% in 1Q09. A normalized tax rate would have resulted in an EPS rate of close to the consensus number. See my previews here.

Highlights from the quarter:
Capex was 3% of sales, the lowest in any quarter since becoming a public company

Headcount declined by 378, the first time headcount has decline sequentially. That was due to the cuts in the marketing department

Paid clicks up 15% y/y, down from 17% in 1Q09 but healthy nonetheless

Cost per click pricing down 13% y/y but up 5% y/y. FX was the main reasons for both movements

Ended the quarter with $19nm in cash. What does management plan to do with the cash?

Free cash flow was $1.47bn; The model could produce $7bn in free cash flow in 2009

Revenue growth ex-FX was 12% YoY and ex-FX and hegding was 10% YoY, down from 14% YoY and 12% YoY in 1Q09, respectively

U.K. revenues declined 7.6% YoY


Google’s CEO on the business stabilizing:
“On the stabilizing question, we a quarter ago, we had no idea where the bottom was. We started off the year and all of a sudden our metrics were off and it became clear that starting roughly Christmas, people were spending more time searching and when they purchased products, they were purchasing products of less value. Furthermore, when they did so, they -- the whole process just took more time. It appears as though, although the RPM's have not fully recovered, the other aspects of behavior have in fact come back. And with the notable exception of the financial vertical, the other verticals in particular, shopping and travel, which had been significantly effected, appear to be recovering. So the sum of those tells us to say the word 'stabilizing. ' We're not at the moment looking at that downward spiral that we thought we might see six months ago.”

Comments on mobile:
“Mobile monetization picked up a good bit of momentum as search traffic grew, again, driven mostly by the smart phones. And we're seeing that users on these high end phones are very active and engaged beyond search, so display advertising on those phones is actually emerging as an interesting mechanism.

On the mobile search side, one of the key things we've done in the last few months, is we've started to show the desktop ads. Turns out that the separate mobile ads have their own formats. Typically it wasn't enough demand, there weren't enough kind of creatives and so forth. So we started showing the desktop ads on the mobile browsers of high quality and these, of course, include the iPhone and the Android phone and anything that's a web kit inspired browser. All of a sudden we started seeing a tremendous number of searches and also very good click-through rates. So they monetize it at a similar level if they are desk-top-based -- it makes sense over time that those ads should perform better than on PCs because on a mobile device we know more about the person and we can have an even more targeted ad, but we don't do that today.”

Comments on display:
“think the way to think about display for us is actually in multi tall strands. One is clearly on the YouTube side, which you just talked about in -- beginning to see some good trajectory in. I think to couple that, the secondary of focus for us is the Google content network, where we Genessee that the revenues are going well and that's performing well. There has been sort of an aversion to more performance-based display advertising in the last quarter because most of the advertisers have started going back to focusing on CPC and clicks. Where we're bringing sort of the metrics to search to display effectively and we're seeing a shift away back to -- on the content network because display inventory continues to rise and people are beginning to want metrics to measure that. On the third, as you have the double click invasion, we've made tremendous progress on the -- double click changed with ad words and AdSense, and we're seeing traction where -- all want to work with an exchange that allows us to expose inventory across the board to various -- both parties in the transaction. So I think Eric's right that that is the next area where the online advertising is going to shift and we're going to see tremendous growth in the display space and we're exited about all three areas individually.”

Comments on CPCs:
“Thank you. My question's on paid clicks and CPCs. First, on CPCs, it looks like if we back out currency at 44 million, they were up 4% quarter over quarter. Is there any kind of sign of stabilization in that number, or is that due to mix and seasonality? And the second thing is paid clicks, 15% growth. Could you talk a little bit about the mix? Are the higher value clicks in, say, the US and UK growing slower than maybe some of the lower value clicks internationally? Could that be a long-term CPC pressure, or are paid clicks growing pretty even across your entire system? Thank you.
This is Jonathan. Just back to the clicks across the system, I think the growth is more seasonality in mix. One of the things that we see is that Brazil and China, for example, are pretty significant and probably have disproportionately more clicks. So I think we're seeing a mix of clicks from the high CPC Western European countries and US, seeing less relative to some of the growing markets. So that overall is having downward pressure on CPC. I think the bids tended to decline more earlier this year and are declining -- are no longer declining now as a general rule across the board.

Thank you. So you have mentioned that -- have been impacted because of the increase in query volumes in Brazil and China. If you were to think about it macro conditions were to improve and higher CPC geographies, do you think the momentum could be big enough for all the declining CPCs of Brazil and China or declining CPCs we should start to expect as a secular trend going on -- market higher and more developed countries? I think it is the puzzle the right way which is international mix has a real effect on our CPC and it has it in two days, which country it comes from whether it be Germany versus India, the growth rates between these different countries, and then obviously there's all the currency issue, FX issues that play into it as well. So I mean the, what we talked about, you know, it was down year-over-year, and up quarter-over-quarter as a good illustration of what the combination of all of these things do and you have seasonality on top of it. So this, these are the pieces at work. Jonathan if you have color. Well, I mean international growth will be a significant component in terms of what the blended average CPC will move toward. You know, we certainly expect growth in those developed markets as the economy rebounds, but the relative difference between the Montyization and the US, Canada, Australia, western European countries is quite significant relative to some of the more markets. So as you add incremental clicks from those developing markets that's going to continue, that brings the blended average, everything else being constant down.

The one thing I think we can say for sure, queries are less sensitive to the economy. There's more comparison shopping when the economy not strong, and potentially a little bit less buying. So you could still have high paid, clicks can be high even when the economy is bad and I think the CPCs would adjust if the users aren't converting if that's consistent with the hypothesis that you are trying to articulate.”

Comments on taxes:
“And one final question, in terms of tax, tax issue reveals in 2009,. I can tell you that at the end of the second quarter, 20% was good because that's where, I can't give you any forward, and again I think that the comment I made on the call was an important one; right. There are really two sets of kind of big dynamics in our tax rates. Obviously it is remember, you know, all of the mix between our international versus US mix of revenues as a big component that will actually swing the tax rate and second there's how the hedging programs rolls out and depending on the types of gains that we may have on hedging and the way that this flows through also has a significant impact on our tax rate. So for if you remember in Q4 for example where we had very large gains on FX, it drew a lot of tax implications. So it is just these are the two big ticket items that you have to consider through modeling.

Finally on the tax rate, my understanding and previously has always been the tax rate in the quarter what you exapproximate peck was your best guess for the year and we should all think about that as your best guess for the year; is that correct?

Thanks for taking the questions. Two questions I think pretty straightforward. First one on cash flow, your net income was higher Q to Q but your free cash flow was lower so can you clarify what's going on working capital and also income taxes, and then secondly, on, came? Somewhat higher than we expected. So I am curious how much you are benefiting at this point from the dell deal coming off? Are you still paying residuals there? And are we likely to see sort of greater benefits from that going forward? Thanks.


So on the cash flow, I will give you the most simple answer which is in Q2 you have two tax payments and they occur for the federal and the California state and they occur April 15th and I think June 15th. So just those, those, you know are not in Q1 and then you get a big hit in Q2. It is a big amount of money like hundreds and hundreds of million. Like 800 million or 900 million in that range. So it is like a ton of money. That will impact free cash, obviously impact by far out weight everything else on the free cash flow calculations. Everything else actually is in pretty good shape. On the tax side, I think, you know, there's again if you look at our tack and how it has been progressing as I said on the call prior on, on the previous call, you just got moving pieces but you wouldn't have kind of, there's no significant event that would have actually moved it in one way or another. You just have they if he can between the Google and the nongoogle and then you have the at the effects between the smaller and larger guys. And then that moves all of the time and that's what you see in the reflection. Obviously, you know, so what we have seen is higher percentage of the smaller partners, and slightly higher on the Google and that's what you end up with.”

Comments on Hedging:
“No. So, it -- again FX is a complicated matter; right for two reasons. One is we started building our FX program last year roughly at this time, and at that time, we had nothing for the GDP for example; right. We actually only started setting up GDP hedges at the end of the second quarter, actually at the end of the third quarter so kind of September-October time frame. So if you think of the ladder of hedges we have started building last year, right, they come at different times and then therefore they impact through this year in different magnitudes. So be careful of using like this quarter and the numbers you see as what should be the steady state for a certain set of exposures. Second is where the currency was last year depending on where we were, you know, Q1, Q2, Q3 on a delta year-over-year basis gets very different sets of numbers. You have so think of the puzzle in terms of those two factors and fortunately right, you don't have all of this information to build. But that's how the mechanics really work from our FX desk. So that's why you end up with this quarter, the delta between -- today for Q2 versus the Q2 of last year give you this kind of sense of magnitudes. So that's the simplest way I can explain it.”