Google's Growth Grinds To A Halt

Google’s growth in Q2 slowed to a paltry 3%, which was in line with expectations.  Operating income was also in line.  By next quarter, revenue may well be shrinking.

One of the most important points on the call was that YouTube’s growth trajectory has improved and the division will be profitable within a reasonably timeframe (undefined).  It will likely be at least several quarters (and probably years) before YouTube is material enough to help drive the growth of Google as a whole, but it still has the potential to be a massive business someday.

Here’s the press release >.

First take: Revenue in line with printed estimates, which is a bit disappointing.  EPS better than expected, but operating income was in line, and the EPS upside appears to have come from a lower-than-expected tax rate).  Overall, probably not enough to drive stock higher. 

Free Cash Flow was weak, but this was because of a massive income tax payment.  The tax payment is not an operating item, and CAPEX was a startlingly low $139 million.  The drop in CAPEX is very encouraging for future free cash generation. 

Key Stats (Consensus):

  • Net Revenue: $4.07 billion vs. $4.05 billion consensus
  • Adj. Operating Income: $2.2 billion vs. $2.1 billion consensus
  • Adj. EPS: $5.35 vs. $5.05 consensus
  • Paid clicks up 15% (in line)
  • Free Cash Flow: $1.5 billion, down sequentially and below expectations

Earnings slides here.  Conference call starts at 4:30PM ET / 1:30 PM ET.  Listen here:


4:36, Sorry technical difficulties. We’re now on the call.

4:37, CEO Erich Schmidt is talking about Chrome OS. He calls it core to Google’s strategy.

4:38,  Now he’s talking about Google’s ad innovations.

4:38, On the sales side we’ve been much more rigorous. Nikesh has been driving that.

4:38, “Display and particularly YouTube have performed very well this quarter. YouTube is now on a trajectory we’re very pleased with.”

4:39, “We saw relative stability in the second quarter.”

4:40, Patrick Pitchette takes the line. He says we’re pleased.

4:41, was up 2.5% y/y. Shopping and computer electronics verticals were strong. Finance was weak. Ad quality improved.

4:42, The US had revenues up 2% y/y. International accounted for 53% of total revenue. The UK was down, impacted by the FX.

4:42, TAC were $1.5 billion. OpEx was lower $120 million y/y and flat on the quarter.

4:43, Free cash flow was strong at $1.5 billion.

4:47, Jonathan Rosenberg takes the line. Recently we’ve become a lot more focused on the active power users. They’re typing in longer queries. Today they get upset when they don’t find what they want. To better serve power users we’ve launched search options.

4:48, Basic user principle: Fast is better than slow.

4:49, Gmail is getting one new feature a week. Automatic message translation is the coolest.

4:50, Google is bullish on HMTL 5.0. It’s especially important in mobile.

4:50, Driving monitzation with Mobile. Search traffic grew. Users on these high-end phoens are very active and engaged. Display advertising is interesting.

4:51, On YouTube, monetized views have more than tripled in the last year.

4:52, If email were invented today, what would it be? Google Wave.

4:53, We’re in the Q&A portion now.

4:55, Mark Mahaney wants to know, what are the two most important things to determine if business is stabilizing. Also, what does cost structure look like coming out of the recession.

4:56, Eric Schmidt says a quarter ago we had no idea where the bottom was. We started the year and all of the sudden our metrics were off. In December people were doing more searching and buying less expensive items. RPMs have not recovered, but the other metrics have come back. We’re not looking at a downward spiral.

4:57, Nikesh says that advertisers are not as uncertain as they once were. The small advertisers have stayed consistent because they understand the ROI of search. The big advertisers stayed away for a bit but are back now.

4:58, Patrick takes the second question. Says that we’ve managed to keep the culture of being frugal but generous. Most of all we are managing the company to best position itself for long-term growth.

5:00, Is there a future in vertical search?

5:01, Eric Schmidt says Google doesn’t look at search queries in verticals and treats all queries equally. Of course, in some verticals the ads are more valuable than the search results. Google hasn’t taken advantage of this yet.

5:03, Will we see new ad formats inside of basic search?

5:03, Nikesh says there is CPA, CPM elswhere, like in Google AdSense and YouTube. That doesn’t really answer the question.

5:06, How will Chrome OS be distributed?

5:06, Schmidt: We’re talking to the OEMs now. The empasis will be speed.

5:08, Now they’re talking about YouTube again.

5:09, Nikesh: We are beginning to see lots of interest in Pre-roll advertising from clients. The next phase of YouTube will be pre-roll advertising. Homepage ads are big too.

5:10, Analysts asks why Google is so bullish about display all of the sudden.

5:10, Nikesh talks about display. Multiple strands: YouTube and the Google Content Network, where CPC ads are hot in a downturn.

5:13, YouTube trajectory has been effectively about our ability to scale. We’ve gotten into the selling cycle. The reason we’re excited is we finally have all the pieces in places, getting in with the agencies. We’re also excited about pre-rolls on premium content.

5:13, Nikesh on user-experience: Users are accepting that when they’re going to watch premium content its going to have to be supported either by advertising or paying for it.

5:14, Jonathan Rosenberg says “there’s very little drop-off.”

5:14, Is YouTube profitable or a net negative? And do you plan to make money off Google OS?

5:14, We’re really pleased with YouTube’s trajectory, and not long in future we see a very profitable future for us.

5:19, Now they’re talking about the future of content on the Web. Schmidt says it’ll either be paid or free. Brilliant.

5:24, TAC isn’t swinging wildly anymore.


The stock has had a nice run on chatter about the global recovery.  We’ve also heard anecdotal talk of strength in performance-based online ads.  Given this, Google likely has to beat the Street on the revenue to drive the stock higher.  An “in-line” quarter will likely be perceived as a disappointment, as will an earnings “beat” driven by cost savings.

Key Stats (Consensus):

  • Net Revenue: $4.05 billion
  • Non-GAAP Operating Income: $2.1 billion
  • EPS: $5.05
  • Paid Click Growth: +13%
  • CAPEX: $430 million

Here’s Citi analyst Mark Mahaney’s excellent preview and “cheat sheet.”

We are looking for $3,968MM in net revenue (+2% Y/Y and down 3% Q/Q) and $4.85
in non-GAAP EPS (excluding stock-based compensation).  This compares with
consensus expectations of $4,047MM and $5.05.  Based on extensive intra-
quarter channel checks, our model sensitivity work, our FX analysis, and our
Macro read, we believe Street Q2 estimates are reasonable.

In Addition To P&L Results, Key Areas To Focus On — GOOG will clearly provide a fundamentals read for Internet advertising stocks and a sentiment read for all Internet stocks. 

Specific non-P&L issues of interest include:

1) Insight into how various verticals and geographies have been trending;

2) Paid click and CPC growth;

3) Discussion on whether marketers are increasing budgets for Q3 and Q4;

4) International traction and the impact from FX and Hedging activities;

5) Cost cutting measures within the company and its ability
to maintain/grow margins;

6) Thoughts on MSFT’s new search engine, Bing, and Google’s new Chrome O.S.,

7) An update on Display (YouTube and DoubleClick) and Mobile advertising.

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