Google Inc. (NASDAQ:GOOG)
Q1 2009 Earnings Call
April 16, 2009 4:30 pm ET
Krista Bessinger – Director, Investor Relations
Eric Schmidt – Chief Executive Officer
Patrick Pichette – Chief Financial Officer
Jonathan Rosenberg – Senior Vice President, Product Management
Omid Kordestani – Senior Vice President, Global Sales & Business Development
James Mitchell - Goldman Sachs
Justin Post - Merrill Lynch
Imran Khan – J.P. Morgan
Christa Quarles - Thomas Weisel Partners
Mark Mahaney - Citigroup
Youssef Squali - Jefferies & Company
Jeffrey Lindsay - Sanford Bernstein
Doug Anmuth - Barclays Capital
Spencer Wang - Credit Suisse
Ross Sandler - RBC Capital Markets
Sandeep Aggarwal - Collins Stewart
Mark May - Needham & Company
Jeetil Patel - Deutsche Bank
Good day and welcome everyone to the Google Inc. conference call. This call is being recorded. At this time, I would like to turn the call over to Ms. Krista Bessinger, Director of Investor Relations.
Good afternoon, everyone, and welcome to today's first quarter 2009 earnings conference call. With us are Eric Schmidt, Chief Executive Officer; Patrick Pichette, Chief Financial Officer; Jonathan Rosenberg, Senior Vice President of Products Management; and Omid Kordestani, Senior Advisor to the Office of the CEO and Founders. Eric, Patrick and Jonathan will provide us with the results on the quarter, and then Omid will join us for Q&A.
Please note that this call is being webcast from our Investor Relations website located at investor.google.com. Please refer to our website for important information, including our earnings press release issued a few minutes ago, along with slides that accompany today's prepared remarks.
A replay of this call will also be available on our website in a few hours. Please note that we routinely post important information on our Investor Relations website, located at investor.google.com, and we encourage you to make use of that resource.
As a reminder, we are continuing with the two-call structure this quarter. First, we will host our traditional strategic overview and Q&A with the usual format, followed by a second call, which is effectively an extended Q&A session giving the opportunity for participants to ask more detailed financial and products questions in an efficient and regulatory compliant manner. The second call will begin at 3:00 p.m. and will also be webcast from our Investor Relations website.
Now, let me quickly cover the Safe Harbor. Some of the statements we make today may be considered forward-looking, including statements regarding investments in our core business and growth agenda, expected performance of aspects of our business, operational efficiency in costs, 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 of these forward-looking statements in light of new information or future events. Please refer to our SEC filings, including our annual report on Form 10-K, for the year ended December 31, 2008, as well as our earning press release for a more detailed description of the risk factors that may affect our results. Copies can be obtained from the SEC or by visiting the Investor Relations section of our website.
Also, please note that certain financial measures we use on this call, such as EPS, net income, operating margins, operating income are expressed on a non-GAAP basis and have been adjusted to exclude charges relating to stock-based compensation. We have also adjusted our net cash providing by operating activities to remove capital expenditures, which we refer to as free cash flow. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release.
With that, it's my pleasure to turn the call over to Eric.
Good afternoon to everybody. Welcome to our first quarter earnings call. I am going to talk obviously about the big picture, Patrick will then run through all the financials, Jonathan will put together not just products but also a whole bunch of insights about advertising.
Despite the tough economic climate, we think Google had a good quarter visited in the context of GDP falling over 6% in Q4, U.S. consumer confidence falling one-third in February, retail sales falling 9.5% a year, year-over-year in March, Google revenues were up 6% year-over-year on the back of continued strong traffic growth, down only 3% quarter-for-quarter on a revenue basis.
If you look at the economic situation, we are still basically in an unchartered territory and I think that’s just sort of the frank statement everybody wants to talk about in the business world today. The current economic environment, which everybody on the call is very, very familiar with, remains tough.
No company is recession-proof. Google is absolutely feeling the impact. Users are still searching but they’re buying less. Ultimately, what that really means is that the ads are converting less. More window and comparison shopping, purchasing lower priced goods. In other words, users are doing the right thing. They’re doing what you would expect them to do given, the enormous economic changes around us.
So advertisers are still spending but they’re lowering their bids to manage their ROI, behaving correctly in our view. So one way to say that is our advertising model is working. The user and advertising behavior that we’re seeing is entirely rational. And the auction, we base our whole business, is working to deliver great value for both.
So we think Google is now well placed for the recovery as it occurs, or when it occurs. Obviously we don’t know exactly when, and the shift continues, this is the shift to online, continues to give us a real advantage. Users migrating to the web and advertisers investing online were ROI’s highest.
It appears that the shift to online ROI as movement into our category, is outpacing any, on a relative basis, any loss in economic activity we benefit from that.
From a prioritization perspective at Google, our priorities remain unchanged: basically long-term growth. Internet growth continues, our goal is to build business and be an innovator.
In our core business, search, making it easier and faster to find things globally, we’re doing well there.
Search advertising ads on new properties, for example [inaudible] search, we’ll finance all of those Jonathan will talk about.
We also believe that there is growth in new businesses based on superior technical insights. In display, for example, you have a highly fragmented market with multiple buyers, sellers, and data sources. By using our technology we can create an integrated product that will really improve the display as modeled.
Look at the success of Android and the mobile space in general. By improving the mobile web experience people search many, many times more than they did in previous mobile devices. We benefit both in terms of end-user happiness as well as ultimately in strong revenue growth from that area.
And in enterprise the same thing. People are no longer thinking of IT as these expensive boxes but rather trying to apply the consumer market principles to IT, giving increased efficiency as well as higher productivity. So in that sense our mission is unchanged.
One thing that has changed is we have just announced that after ten years of managing our global sales operations, Omid Kordestani has decided to hand things over to Nikesh, but he’s going to stay with us, he’s going to become senior advisor to the office of the CEO and founders and he’s going to be working on some new business opportunities and Nikesh will be responsible for all revenue consumer operations, marketing, and partnerships.
When I travel, when I spend time within the Google context, I see the hand-impacted brilliance of Omid and how he built the business of Google, and he will certainly—it’s impossible in an hour let alone a minute to talk about the level of contribution that he’s had. As a business founder at Google no one is better placed to advise us on issues, like future revenue growth for Google.
Nikesh, of course, also with us for many years, running our European operations, is the right person to take on everything to the next level.
So putting it into context, good quarter for Google despite tough sort of overall economic conditions, we’re still in unchartered territory, and I want to remind everybody that we are heading into the Q2, Q3 seasonally weaker quarters. We see this every year. It’s no change. We expect that will happen as well. The first quarter has demonstrated the resilience of our business model in a very severe global recession and we are going to continue to invest for the long term, as we should and as we will.
Now Patrick, would you like to proceed and take us through the financials.
As Eric has already covered, we are continuing to manage the business well in what is a difficult economic environment.
Gross revenue was up 6% year-over-year to $5.5 billion, mostly due to the good performance of Google.com, and this despite two strong headwinds, in fact: the economy but also the strengthening of the U.S. dollar in the last twelve months.
Google.com was up 9% year-over-year to $3.7 billion driven primarily by traffic growth. AdSense business, on the other hand, was down 3% year-over-year to $1.6 billion, driven by several factors. Year-over-year growth on the AdSense for search was impacting by a continuing clean up of low-quality network partners that began late in Q1 of last year, FX and general economic weaknesses, along with other quality and ROI initiatives implemented in Q1 of this year.
On the AdSense for content side, branding oriented display campaigns remain challenging in Q1 as our advertisers slowed their spend relative to the performance-based advertising. Global aggregate paid-click growth remained relatively strong, however, up 17% year-over-year and 3% quarter-over-quarter.
The U.S. growth was also fairly healthy year-over-year given the challenging economic environment, with revenues up 4% to $2.6 billion, even if down 7% quarter-over-quarter, reflecting the normal seasonal trend that we see in Q1, again, exacerbated by the weak economy.
Our international revenue accounted for 52% of our total revenues, or $2.9 billion. The U.K. was down 9% year-over-year to $733.0 million but up 7% quarter-over-quarter. We did see a seasonal uptick in Q1, which is normal pattern for the U.K. but not as much in prior years due to weakness in for example, travel and finance, two very economically sensitive verticals.
Note that our U.K. results in Q1 also benefitted from a significant gain from the expiration of a set of pound hedges that were put in place in Q3 of 2008.
The rest of EMEA is beginning to experience the slowdown seen in other countries. Ireland and Spain were clearly weaker while Germany was a relative bright spot, as well as Benowitz. Outside the U.S. and Europe, China and Brazil performed reasonably well with relatively strong growth year-over-year.
Let me now turn to expenses. Google may be an unconventional company but our Q1 margin demonstrates Google’s responsible management in light of the economic situation we all face. Q4 versus Q1 could be summarized as continued tight cost management but also lower labor costs, primarily as we reset our company bonus plan for 2009 in the first quarter.
Moving down the P&L, profit acquisition costs were $1.4 billion, or 27% of federal advertising revenue and roughly flat with Q4. Other cost of revenues decreased $41.0 million from Q4 to $666.0 million, which included $13.0 million in stock-based compensation. This decrease was driven by non-data center-related expenses, primarily payroll again.
And finally, all other operating expenses totaled $1.52 billion, including approximately $265.0 million in stock-based compensation. Please not that in Q1 our expenses include $26.0 million related to the exit of our audio and print out business as well as severance costs related to the layoffs announced, all of which impacted G&A.
Also in G&A is $20.0 million related to a proposed legal settlement in the Hasmin case. That said, expenses improved significantly from Q4 reflecting lower labor costs, as I already mentioned, primarily due to the reset of the company bonus plan at the beginning of the year.
This favorability in labor expense more than offset the various costs described above in G&A. And as a result non-GAAP operating profit, which excludes the stock-based compensation increased to $2.2 million in Q1 resulting in a healthy non-GAAP operating profit margin of 39.2%.
Note also however, that while we maintain focus on our prudent approach to managing expenses, and as Eric noted, we continue to fully fund our strategic growth areas, including for example, investments in display ads, and mobile.
And we’re still hiring, but only in the critical areas. We had approximately 20,000 full-time employees at the end of Q1, roughly flat from Q4. We also announced in late March that we will eliminate approximately 200 positions in sales and marketing. Please note however, that these reductions are not reflected in our ending headcount numbers for Q1.
Finally, and also important to note, with slower growth rates in this challenging environment, seasonality in our results, obviously more apparent, such as what Eric mentioned, a typical summer slowdown of Q2 and Q3.
Let me quickly turn to cash management. Other income and expenses was $6.0 million for Q1, down from $70.0 million last quarter. We continue to manage our portfolio responsibly and adopt a conservative approach to investing. This means that we are recognizing somewhat lower yields on our investments in Q1 relative to Q4.
Also, we realized gains on investments. Our realized gains on investments were $32.0 million. More important to note is the high volatility relative to the auction strike prices which required this quarter the acceleration of our hedging expenses as per the details of FAS 133 rule. In consequence, these accounting rules required us to recognize close to double the expense, or $91.0 million, related to our hedging programs versus Q4, of $49.0 million.
Our hedging program continues to work well. We’re pleased that our cash flow hedging program allowed us to recognize a benefit of approximately $154.0 million toward revenue this quarter. Before hedging, the recent strength of the U.S. dollar, relative to other currencies, had a negative impact of $120.0 million on revenue in Q1 compared to the prior quarter and $429.0 million compared to the prior year.
Also, as I mentioned before, our U.K. results for Q1 benefitted from a significant gain from the expiration of some pound hedges.
We are still generating very strong operating cash flow at $2.2 billion for Q1. Capex for the quarter was $263.0 million and related primarily to our data center operation. This is down significantly from prior period. Google will continue to make significant investments to support our core business and please keep in mind that capex can be lumpy from quarter to quarter. Free cash flow also remains strong, just shy of $2.0 billion.
So in summary, we are pleased with our Q1 results, which illustrate the resiliency of our business model as well the prudent management of our expenses in these difficult time. Although we remain focused on operational efficiencies, we are not cutting any corners on our growth agenda and continue to fully fund both our core business and our growth businesses.
Finally I wish to reiterate our revenues typically exhibit seasonality for Q2 and while our revenues may be seasonal obviously our expenses are not as seasonal.
With that I would like to thank you for your time and I will turn it over to Jonathan for his thoughts on the quarter.
In the current economy Google is more focused than ever on prioritizing resources to our next multi-billion dollar business. That, of course, is search-based advertising and to find more revenue we need to make sure that we monetize our searches judiciously and to only do that in ways that benefit both advertisers and users.
You have to understand that most advertisers, even today, do not max out their daily budget. So that tells us they are willing to take all the clicks that we can give them at current CPCs. It turns out advertisers see Google as a sales channel for customer acquisition and not as a marketing expense.
The problem that they have is that if you are an advertiser and you have tens of thousands of products, if you want to run an effective campaign you need lists of key words, a creative, and a bid for each product. This takes a lot of effort to manage. So to increase our revenue, as well as theirs, we are investing in tools that make the process easier.
We see that when we build the right advertiser tools it can have an even bigger impact than the ads quality enhancements that we typically talk about on this call. One example is the conversion optimizer and that automates the bid part of the process. For advertisers who have adopted this tool, their cost per action in down 14% while conversions are up 21%.
More recently, we launched the search-based key word tool and that one automates the key word part of the process. It takes a look at an advertiser’s landing pages and then it matches those up with actual user queries. Since that launch what we’re seeing is cases where key words suggested by the tool have higher conversion rates and lower CPCs.
We are also investing in a new AdWords front end and that’s now available to over $100,000 advertisers in twelve languages. This is actually the biggest overhaul to AdWords in the past five years and it greatly simplifies the whole campaign management and reporting process.
Over on the search side, we know a lot about how people interact with search and we can make everyone’s experience much better as a result. We launched a feature internationally this quarter that automatically gives you the best results, even if you misspell the query.
It turns out there are over 800 ways our users misspelled Britney Spears, but with this feature we will show you right results for most of them, without the user even having to click and rerun the query with the suggested spell correction. You can go ahead and try spelling Britney poorly or if you’re a bad speller just type it wrong naturally and you’ll see. People click on these results a lot so we know that we’ve made good progress here.
Patrick highlighted in his remarks that Google has rigorous management of expenses, but we also have a history of making big investments based on technical insights and we are going to continue to do that today, especially in areas like display, mobile, and Android.
On the display side the problem that we have is a fragmented market and that makes it difficult for advertisers to run campaigns across the thousand of sites that they want to reach. So there is an opportunity to turn a complex process into something much simpler and open up the market to new advertisers.
We just launched a feature called Display Ads builder which helps do this and we want to make display ads as relevant and useful to users as search ads and that’s the intent of interest based advertising, which we also announced this quarter for beta launch in Q2.
On the mobile side, more people are accessing the web from their phones. The number of mobile searches has gone up five times in just the last couple of years and this new generation of phones has eyes, a camera; ears, a microphone; skin; a touch screen; and they know their location. This makes them a great platform for very compelling applications.
We launched Google Latitude which you can use to share your location with friends with a fun Google news cluster just this morning on Latitude helping catch a thief in San Francisco. If you go to Google news and type in Latitude thief.
We are also investing in Android to make a great mobile web experience available to everyone and over 8% of mobile browsing is now conducted through Android, which is second only to the iPhone.
Eric noted earlier the unchartered economic conditions that we face. What’s interesting from my perspective is to see how graphically search engines shed light on the state of the economy. Searches on foreclosures are up 42% year-over-year. Bankruptcy is up 53% year-over-year. Unemployment is more than doubled. We also increases in education, self-help, spirituality, and on the other side of the stress-release spectrum, alcohol and gambling.
Some of this data about traffic on specific queries is probably not surprising but our economic analysts look at things in terms of buckets and that can be more interesting. So we are seeing some surprises when you look at the categories of search queries.
Health, for example, has seen strong growth in the U.S. and it’s now one of our largest verticals. Automotive, which is an industry that is actually in dire shape, is investing more in search advertising. It could be there that they’re shifting budgets online.
We also see increases in auto maintenance and auto parts, which may be a do-it-yourself phenomena. On the online shopping side, users are looking for bargains in the mature markets and they are shifting purchasing to the web in the emerging markets.
So amidst all the economic uncertainty, we are focusing on delivering the best search experience, driving more revenue, and on investing in the key areas where our technical insights will help us make a big difference.
With that, back to Patrick.
So we will turn it back to the operator to set up the call for us.
(Operator Instructions) Your first question comes from James Mitchell - Goldman Sachs.
James Mitchell - Goldman Sachs
You mentioned the impact of the phone trend on costs. Would that be the same for each quarter of 2009 or was it front-end loaded? And then second, you mentioned some U.K. pound sterling hedges expired, but would that imply that your are less hedged going into the second quarter than you were in the first quarter or that you’re hedged at less advantageous FX rates?
In answer to your first question, we had a ramp up in Q3 and Q4 of 2008 in our bonus accruals, if you wish, because we had a very strong end of 2008. And now we are just resetting the plan for the year at the regular bonus accrual. So that’s why you see the big change. So we had a very strong end of last year and so that’s why the big discrepancy.
On the issue of the hedges, the original tranche of pound hedges were put in, you will remember, in Q3 of last year. And we are building the ladder of these hedges right over time. And it just happens now that the first tranche came to expire at the end of Q1 so we had to actually exercise them, if you wish, and we have continued through Q4 and in Q1 to continue to build our ladder.
So there is continued kind of benefit or impact of this insurance kind of policy, the way we think about it, over the coming quarters just as much, but it all depends on the spread price that we set at those times.
Your next question comes from Justin Post - Merrill Lynch.
Justin Post - Merrill Lynch
I want to get back to the seasonality comment. I know you brought it up and we’ve been seeing it every year. Do you think you’re going to see any abnormal seasonality, given the recession.
And then a quick financial question. You’ve got, it looks like a 36% hedging ratio, as far as the benefit to the impact from the currency, $429.0 million over 154. Is that your target ratio or is it going to move around a lot over time?
Can you just repeat the second question?
Justin Post - Merrill Lynch
It looks like your foreign exposure was about $429.0 million hit and you’ve got $154.0 million benefit, so it looks like it was like a 36% ratio, as far as offsetting the hit. Do you think that’s what we should look for going forward or can that number move around a lot?
So on the latter question, you can’t use it that way. The issue you have is the more volatility you have in all of these exchange rates, the more volatility you will have in all these ratios. So you can’t use a ratio and plug it forward.
Remember, I just want to remind everybody, we are not hedging revenue. We are hedging margin. And so it happens that FAS 133 forces us to actually file as a revenue for a portion of it, but it really is the margin that we are. And it’s the international portion of our revenues only. So it doesn’t affect the U.S.
On seasonality, I will let Jonathan answer it.
We don’t give forward guidance so let’s just be clear on that. But seasonality can become more visible in an environment where you have relatively slower core growth. So that is certainly a dynamic to understand. The second thing to understand is that if you look at the history of our seasonality, over many, many years, there were early years there where in many markets now where we enjoy significant market share, we were gaining market share and that can mask some of the seasonality and is less to be the case now.
I can add more color from an advertising perspective in the different regions. In the U.S. we also saw the typical seasonal down tick in Q1 but it was exacerbated by a weak consumer although we had some interesting vertical bright spots in health, auto, and shopping. In shopping, for example, people were looking for bargains and doing maybe some of their offline purchases online, making some of those shifts. Or in a recession environment, certain auto cores like maintenance and repairs being popular.
In U.K. we saw the seasonal uptick in Q1, which is usually the reverse of the U.S. but not as much this time versus prior years due to the weakness in travel and finance. Those are economically very sensitive verticals.
And then the rest of world, emerging markets, we saw continued growth and optimistic to continue that.
The other easy thing to do is just check the calendar and look at the timing of Easter, which is different this year than it was last year, which is actually in the fourth factor.
So for Q2 and Q3 the issues that Eric mentioned right at the front end of the call in these illustrations is simply to say that it is traditional that Q2 and Q3 are slower and so typically you should kind of think about it as that.
Your next question comes from Imran Khan – J.P. Morgan.
Imran Khan – J.P. Morgan
I think you talked about trends in different countries in Europe. This question is more about month-over-month. Did you see the business condition getting better on a year-over-year basis in March or are you seeing the same kind of trend you see in January and February. Can you give us some sense, in that you have a pretty good pulse on the economy, what kind of pulse trend you are seeing.
And secondly, my understanding is that you have a pretty large small business customers and with the credit crisis and credit crunch, what impact are you seeing on the small businesses. Are they growing slower than the overall business growth rate?
I will let Omid actually talk about the small-medium business and I will come back to the first topic afterwards.
It is interesting to highlight, I think we did see that effect that we actually have a difference in behavior between the smaller and larger customers and I think the way we can explain this in the case of large advertisers you typically have the CMO making decisions and looking at the spending as a marketing expense, and in this kind of downturn and the severity of the crisis that we all face, a lot of those budgets were put on hold or certain decisions were delayed and you know, our sales force and online teams are busy servicing and accessing those customers to show them performance information and OI information and all the tools that we have in our hands to help with that spending.
We did see that in the actually small to medium segment that customers continued spending and we kind of attribute that to the fact they really see this form of search advertising as a sales channel, as a way to generate leads and as long as they are gaining those leads and customers, they continue to spend.
So it was an interesting pattern that we notices.
On the issue of month-over-month I think that the simplest answer is that a) we don’t comment on this monthly activity. I think that Eric summarized the point very well that the economic situation, it just remains difficult. And it’s a tough economy out there, whether you’re in Europe, whether you’re in North America, and that continues to be unchartered territory in so many dimensions. So that’s really how we can best portray the situation.
Your next question comes from Christa Quarles - Thomas Weisel Partners.
Christa Quarles - Thomas Weisel Partners
I know some of the hedging benefit goes into the TAC rates but they continue to come down but they continue to come down and I was just wondering if you could give us your philosophy on your position on TAC.
And the second question I have is actually on the licensing side. There was a fairly steep sequential slowdown and I was wondering if you could give any color there as to whether or not it was on the double-click side.
On the TAC side, our TAC was actually kind of pretty stable between Q4 and Q1, even with the hedging benefits included. So we are not seeing continued decline. They’re actually pretty stabilizing. There is a mix shift change so that obviously between Google and the network, on one piece and the fact that we see lower TAC, in general, right now also is driven by, we see stronger growth in our smaller partners, which just have relatively lower TAC than our larger partners, so it’s no more complicated than that.
On the licensing, yes, it is the impact of double-click.
Your next question comes from Mark Mahaney – Citigroup.
Mark Mahaney - Citigroup
One on display advertising, one on cost. Both Eric and Jonathan, you talked about the display advertising. Jonathan, anything more you can tell us about the interest-based display advertising? Overall on the Internet and I guess across all advertising there is a move towards performance-based advertising, which obviously search is part of it, but in display there is probably a very significant opportunity broadly what’s missing in display advertising now and specifically what does interest-based display advertising do to solve that?
And then Patrick, any qualitative comments you care to give about how much more cost opportunity do you see, we’ve only been in there for two to three quarters but we’ve already seen a pretty material move in the margin structure so far. Do you feel like you’re early innings and the opportunities you have to right size the cost structure the way you think most appropriate.
It’s a little early to really give you deep insights on interest-based advertising. We announced that we would launch interest-based advertising on the content network and YouTube and start those deployment in data in Q2. We are very optimistic because today when you think about the way these ads are run, we are showing ads based on the context of the page the user is viewing at the moment. So for example, if you are on a sports page we might show you ads for running shoes.
But interest-based advertising, basically you use information about the sites the people visit to show them ads about the things that interest them. And we’ve certainly seen, you know, if you like cars we might show you ads for cars even if you’re not on a car site. And we think that that is very robust in terms of its ability to generate much more targeted interest. But we don’t actually yet have deep insights from customers on how that’s working in the field.
Omid may have a sense of what feedback we’re getting from customers in terms of their level of interest in display advertising but I can’t otherwise report to you data on how interest-based advertising is improving the targeting.
I will take the second part of the question which is about costs. As we had said in Q4 and we’re saying again this quarter, given all the uncertainty in this environment I think that the Googlers, in general the entire community of our employees have been quite prudent on cost management.
On the flip side of that, we continue to fully fund all our strategic growth. Fully fund. So we are, as Eric said at the front end of the call, we are really focused on our growth agenda and we’re not stopping that. So from that perspective, I think it’s simply a balance we’re trying to strike between those two components.
I will let Eric further comment.
My personal view on this is that it’s all about making us a better efficiency engine. That the changes and the sort of tightness with which we’re running now will put us in a stronger position as the recovery comes out. We have been able to do the things that we care a lot about and I think the company benefits from the sort of discipline that Patrick has helped lead here.
Your next question comes from Youssef Squali - Jefferies & Company.
Youssef Squali - Jefferies & Company
Jonathan, going back to double-click, can you tell us about the integration and when that be done? When will you be able to finally offer the fully integrated platform for both the search and display?
And then, if I may, on YouTube, Eric, you seem to be getting some traction with the studios getting short and long form content. Is the model, as you see it, ad-based only or do you see a potential for some fee-based, potentially even some subscription model as the platform evolves.
We basically just hit the anniversary of the double-click integration and it has been a pretty smooth integration. The good news there is we’ve gained customers on both the publisher and the advertiser side. We are pretty well on our way to being fully integrated with AdSense and AdWords.
For example, we saw the integration of DART for publishers and AdSense completed in Q4 and that basically combines double-clicks management and control tools for publishers with the advertiser demand for the Google content network.
I’m not sure exactly how we define full integration and the details of everything that’s left, but those efforts, as well as the efforts on the ad exchange are coming along pretty nicely, only one year since the acquisition so I think we’re doing pretty well.
And on the YouTube side, we are making very good progress now with small-, medium-, and even large-scale studios. The most interesting deal that we just announced involved Universal Music, which we announced last week which we are beyond excited about because it really redefines the business model between content owners and companies like Google.
With respect to how it will get monetized, our first priority, as you pointed out, is on the advertising side. We do expect over time to see micro payments and other forms of subscription models coming as well. But our initial focus is on advertising. We will be announcing additional things in that area literally very, very soon.
Your next question comes from Jeffrey Lindsay - Sanford Bernstein .
Jeffrey Lindsay - Sanford Bernstein
Can I ask two things? First of all, can you give us an indication of the percentage of YouTube that is actually carrying out at the minute and what are the sorts of rates of advertising are relative to what you had hoped they would be. And what I’m trying to understand is there significant upside potential here or do we think that YouTube is kind of reached its maximum potential on the advertising side.
And secondly, was really low. Do we think this is sustainable or are you deferring projects and what aspects of infrastructure are likely to come up in the next twelve months.
I’ll let Omid answer the first one and then I’ll take the capex question.
It’s early for us still to settle down on any specific trends here. We are just finding that we continue to have tremendous usage of the service. We continue to have a lot of great content and there is great advertiser interest and as you know, there is an overall downturn in the display market so what we’re doing is just working with the advertisers to figure out at what price they can work with us, how creatively they can work with us.
Today for example, on the home page, you can see a large ad format for Crank II movie opening tomorrow. So there is great interest and we just look forward to working with the advertisers both in terms of the traditional ad formats, the new ones we’re with, the transaction model that we have developed, and then basically to be able to share more with you in the future as we have better trends.
And let me just add if I may that there is a real synergy between YouTube and the display products. It’s their first and most interesting scale partner and YouTube and its adoption, which obviously is very strong, will benefit from very, very highly targeted display ad models, which is what we’re in the process of building.
On capex, there is no doubt that this quarter again is a perfect illustration of the lumpiness of our capex and that you have to beware of models and trend lines because if you trend the last three quarters then in a couple of quarters we have no more capex. So beware of the modeling at its simplistic level.
There is no doubt though that because of the economies of scale that we have now with the size of the company and our better efficiencies, working at Mores law, doing more with less, we obviously see a positive trend that are actually demonstrated in the last few quarters but I just want to reiterate that this thing is lumpy.
For example, just as an illustration, it is public now that we have acquired a site in Scandinavia and anybody who lives around there knows that working in the winter and trying to do anything on the site, you know, there has got to be delays. So it’s just an illustration of the lumpiness of how much we can put our capex on the line.
Your next question comes from Doug Anmuth - Barclays Capital.
Doug Anmuth - Barclays Capital
Is there any structural reason to think that pricing would not come back to previous levels as macro improves at some point?
And just following up on the hedging related to the U.K. can you comment on the amount of benefit that was received specifically in the U.K. due to the hedge.
I will answer the latter first and then I will let Omid and Jonathan talk about the pricing section question.
On hedging, we don’t give any of the details of the gains. Unfortunately, we just don’t do that.
I think advertisers are just being very rational here. They really are looking at their costs per acquisition or action and adjusting their pricing based on that. We’re not seeing any significant trends in terms of people dropping out of the auction. So our expectation is, again, as the competition increases and the dynamics return we will get back to the previous status. I just think it’s purely a results-driven rational behavior for advertisers.
Your next question comes from Spencer Wang - Credit Suisse.
Spencer Wang - Credit Suisse
On mobile, can you give us a sense of what the click view rates look like on mobile relative to traditional search?
And on the cash balance on the balance sheet, any new thoughts on how you may deploy that in terms of a sizeable acquisition or perhaps returning that to shareholders.
I don’t have specific data on click through rate. We are certainly seeing more advertisers are choosing to run their ads on mobile devices. You can see examples if you query auto insurance on the iPhone or an Android device. And the RPMs on the iPhone and Android are high, even though we’re in very early days of the mobile ecosystem, but I don’t have any specific data on how click through rates differ.
On the cash balance, obviously we do have a significant cash balance and I would love to get Eric’s thoughts on it.
I think the most important to say is that it is not burning a hole in our pockets. $2.2 billion of incremental cash will sit in nice, safe, low-interest bearing accounts while the economic system works its way through the banking system and all of that. We continue to evaluate what we might do with the cash but our view at the moment is to remain very, very conservative and I don’t think that will change any time soon.
We are fortunate that our very high profitability really does generate a lot of cash and that’s a nice position for us to be in.
Your next question comes from Ross Sandler - RBC Capital Markets.
Ross Sandler - RBC Capital Markets
If we look at the international growth, like ex-foreign currency and ex-hedging, it looks like it’s gone from 30% year-over-year to around 22% in the first quarter, a little more of a deceleration than the 32% to 30% from Q3 to Q4. So just wanted to get a little more color on regions that you’re seeing potentially more weakness outside the U.K., on the international front.
And the second question, back to the [inaudible] accrual issue, if we look at your cash operating expense, so cost of goods ex-TAC, R&D, sales and marketing, and G&A, it went down by about $168.0 million from Q4 to Q1. How much of that decline was related to the change in bonus accrual policy versus just straight cost cutting.
On the international front and Omid can give more color commentary on that, but essentially what I mentioned at the front end of the call is for Europe specifically there are a few countries that—the economic downturn has made its way to Europe so now obviously the effects are there and I’ve mentioned a few countries and then internationally the big cannons like China and Brazil and a few others continue to perform relatively well.
Omid, would you have any additional comments on these markets?
Except, I think it’s consistent with the comments you opened with Patrick. In general we are seeing the lens of Google gives a lot of insights by industry and the economic conditions that we all know about. For example, finance or real estate, in specific countries are hit. And China and Brazil for example we have performed reasonably well and very strong growth year-to-year. And in markets where finance is hardly hit or real estate is hardly hit we see the same patterns.
In autos, for example, as I mentioned in my comments, there is actually robust activity in people doing repairs or maintenance of cars rather than purchasing new cars. So it’s really industry by industry and country by country kind of mirroring the activity we see in the economy overall.
On the accrual, we don’t give all the details of the economic facts but what I can tell you it is true that it finds itself in numerous line items. So it is not only in the G&A portion but would find itself into the R&D as it is part of a labor cost. And so from that perspective, don’t be surprised to find it in a few line items. But we don’t divulge the details of it.
Your next question comes from Sandeep Aggarwal - Collins Stewart.
Sandeep Aggarwal - Collins Stewart
Eric, you mentioned towards the beginning of the call some plans in the CPC so one question is the CPC trends you are seeing, are they largely cyclical or there any secular shift in terms of not necessarily search getting matured but as search gets 13 or 14 year [inaudible].
And secondly, what kind of traction you are seeing for Android on mobile and what do you think about the potential of Android on the netbook?
I will start with your question on the CPC. I think the main thing that you are seeing is really a function of some of the remarks we made earlier. We see users are still searching but they are searching for lower value stuff, you know, used cars versus new cars, as Omid said. When they do search, they do seem to be a little bit less interest in buying and that is shown by somewhat fewer clicks and conversions.
So I think part of the dynamic, as we said, is just the auction acting rationally and the advertisers not pulling out but just cutting their bid to manage their ROI.
I think the other thing that you see across the board is there is a bit of a geographical mix dynamic when you look at overall CPC. We have high growth in some of the emerging markets like China and Brazil and there is also an FX component to the whole thing. So I think that is the set of things that we see.
As the economy comes back I have every expectation that we will see the kind of dynamics that we have seen in the past and as we get better at targeting our ad system and building tools, like some of the ones I mentioned in my prepared remarks, like the version optimizer, I think there is certainly headroom for us to target much, much better ads which could and should have higher CPCs if they are yielding better conversion.
Overall it looks like Android is going to have a very, very strong year. We are already aware of many, many uses of Android, which as you know is open source, where literally the devices we hear about near the announcements, so the open source part of the strategy is working. We have also recently just announced an upgrade in new software for Android which is out now among the technical community and again, the stability, the proof points are really there now.
There are announcements happening between now and the end of the year that are quite significant from operators and new hardware partners in the Android space, which I won’t preannounce except to say that they really do fulfill much of the vision that we laid out more than a year ago.
On the netbook side, there are a number of people who have actually taken Android and ported it over to netbook or netbook-similar devices. So we think that’s another one of the great benefits of the open source model that we’ve used. We’re excited that that investment is occurring. And again, largely outside of Google, which we think is great.
Your next question comes from Mark May - Needham & Company.
Mark May - Needham & Company
I’m hoping that someone will talk about the downsizing in your sales team recently and what your aims are in terms of how you are trying to optimize the group, just explain the rationale behind those changes.
And then second I think you highlighted health as being one of the stronger ad categories in the quarter. There were obviously some letters from the FDA with some search advertisers in that category. Are you concerned about how that might impact the health advertising search category for you going forward.
In terms of the positions that were eliminated, it is obviously always painful for us to do that and thankful for the employees and their contributions to Google. We just have been very disciplined in how we measure the performance of each region and looking at whether we have expectations that have not materialized and do we have some investments in areas that we need to shift for example from one region to another.
So when we look at the kind of light countries in terms of their status of growth and potential and look at some of the emerging markets, we just very systematically looked at the performance and the resources that are against them and decided in certain areas, for example, that we were over-invested.
In other cases, you know, we had to align our organizations better so we had taken marketing positions, for example, and combined them with our sales force and field marketing organizations and in some cases there were overlaps in those groups and we have just been very disciplined at looking at those areas and eliminating those.
As a complement to that point, I think it is just fair to say that when you grow so quickly in the way we did, it’s almost impossible to get everything right every step of the way. So in that sense these rationalizations are not because the business is not performing it’s just when you take a pause and it’s time to optimize a little bit more, you get these kind of opportunities that show up.
A to your question on the health ad categories, I don’t know all the details about the FDA’s issues but I know that their suggestions, I’m not sure they’re regulations, that we want to make the ads to be compliant with particular rules. They generally relate to pharmaceutical advertising and the dynamics around drugs needing to have side effects along with the benefits.
So we are working with the advertisers to try to figure out how to get their ads in compliance and that’s certainly going to take some work. I would say that pharma is the largest component of total revenue in that category. So I think we will figure that out with the advertisers and move forward.
Your next question comes from Jeetil Patel - Deutsche Bank.
Jeetil Patel - Deutsche Bank
You mentioned a couple of times throughout this call that your customers view you as more of a sales and distribution channel over a marketing channel. I guess, broadly, have you approached a lot of the larger companies and said lets go into the VP of sales, the CFO, the CEO, to have a conversation about how Google can help move the sales needle. And almost similar to an outsource sales force or distribution channel as opposed to going in at the marketing level, which seems to be a kind of a tough area these days.
And second, just curious, I know Twitter has been talked about in the marketplace and the media a lot of late. It seems like more of a passive communication model that is very effective. When you look at that type of business model or that concept, can you talk about how you monetize something like that in general using the existing paid search or display type ad models. I know that it’s an independent company but curious of your thoughts of a model like that.
On the sales channels, absolutely, that’s exactly what we do and we really try to service all the senior level executives in our target customer base and named accounts. You know, make all the tools that we have from analytical tools to presentations, case studies, vertical analysis, to really demonstrate that we are a very, very strong customer [inaudible] channel.
Obviously as we are also entering into the display business more and more on YouTube there is all the branding benefits and traditional ways of reaching an audience and kind of creating the classic impressions that display advertising is wonderful for. So we are really trying to fire on all cylinders and approach it from all angles.
On the Twitter side I think Twitter proves that innovation is alive and well in Silicon Valley and it’s really come on board very strong in the last year. It’s been around for a couple of years. And it is an incredibly useful thing, what am I doing right now.
So the question here is how could you make some money at that and without conversating specifically about twitter, because there are a number of real-time update companies like Twitter, you can imagine that to the degree that they become successful, and obviously Twitter is already doing so, it could be a channel for product information, marketing information, real-time information, for which you can hang advertising products whether it’s a text ad or video ad or so forth off to it.
And I don’t know personally their strategy but it strikes me that’s a logical strategy for them to pursue and something that we would be very happy to pursue with them and all the other players in that space.
The real great thing about Twitter is that it proves that people really want to communicate and the communication can occur in many, many different forms.
Let me close with the last comments before we close the call formally. Just to summarize, obviously a good quarter despite tough economic conditions out there. I think the key message is around we’re still in unchartered territory. This is a tough environment for everyone. And then finally, the resilience of the model is actually pretty interesting given everything that’s been thrown at us both from the economy and the FX. Finally, I think it is really important to recognize all of the Googlers and all our partners for an unbelievable set of efforts in Q1 and I think it really is important to thank them for all their efforts.
And let’s make sure we also thank Omid for his extraordinary service to the company, which will continue in a new form. Omid thank you very much.
This concludes today’s conference call.
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