Google's Q3 Results in its Own Words

Oct.20.06 | About: Alphabet Inc. (GOOG)

Excerpt from Google Inc.'s (NASDAQ:GOOG) earnings conference call; CFO George Reyes is speaking:

Gross revenue the quarter was $2.7 billion, reflecting growth of 70% over Q3 of last year. revenue was $1.6 billion, representing an increasing percentage of our total revenue at 60% and growth of 84% year-over-year.

As we have previously discussed, Q2 and Q3 are typically seasonal quarters for us, with somewhat weaker traffic growth offset by higher monetization. This year, the seasonal trend was slightly dampened in Q3 with stronger than anticipated traffic on As with previous years, however, monetization gains were the primary driver of sequential revenue growth.

In our AdSense businesses, where we experienced a more typical seasonal growth trend, revenue growth was driven primarily by monetization gains and search and traffic gains and content, and by the addition of new partners across the board, particularly internationally.

Revenue from the U.S. was $1.5 billion, driven by higher than expected traffic growth and continued monetization gains. International growth was very strong in Q3 as well. Our largest European markets, the UK and Germany, performed very well, as did many other countries throughout the world, including the Netherlands, Spain, France, Italy, Canada, and Australia. While still a small percentage of our overall revenues, many of our emerging markets, most notably India and Brazil, are growing at very high rates as well.

We do expect historic seasonal trends in Q4 to continue, where the growth in the U.S. has typically been greater than internationally. This is largely attributable to more pronounced effects of the holiday season in the U.S.

Turning to traffic acquisition costs, or TAC, they were $825 million. The majority of TAC expenses is related to the amounts ultimately paid to our AdSense partners, which totaled $780 million in the quarter. TAC also consists of amounts ultimately paid to certain distribution partners, which totaled $45 million in the third quarter. We expect that in the future, substantially all fees related to distribution partnerships will be recognized as TAC, as we are better able to estimate the useful life of access points and better able to match costs to revenues earned.

Turning to operating expenses, operating expenses included $98 million in stock-based compensation and totaled $710 million. These expenses included $382 million in payroll-related and facilities expense and $50 million in advertising and promotional expenses, which includes $14 million related to certain distribution deals. We expect operating expenses to increase in the future as we continue to hire aggressively and invest in marketing programs.

Non-GAAP operating profit, which excludes stock-based compensation, grew to over $1 billion with non-GAAP operating margins of 38%, up slightly from Q2. However, as we have previously discussed, margins may decline as we continue to hire aggressively and make significant investments in the business.

In Q3, CapEx totaled $492 million, the majority of which was related to IT infrastructure investments, including data centers, servers, and networking equipment. As usual, we carefully and prudently evaluate capital expenditures and believe that the long-term benefits justify these upfront investments. As we have noted previously, CapEx growth would be substantially greater than the annual rate of revenue growth in 2006, and we continue to anticipate this going into Q4.

Now turning to cash, we continue to generate strong cash flow from operations at $1 billion. Free cash flow, a non-GAAP measure, which we define as cash flow from operations, less CapEx, increased to $512 million. Our effective tax rate was 29% for the third quarter. We currently anticipate that our effective tax rate for the full year will be at or below 30%.

Our headcount at September 30 was 9,378 employees, an increase of 1,436 employees over Q2 levels. We expect to continue to hire aggressively around the world in Q4 across all functions.

In closing, we are delighted to report a very strong quarter with very healthy growth across the board.

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