Google Earnings Released: Revenue And Paid Clicks Up, CPCs And Stock Down

“Google had a great quarter with over $14 billion in revenue – up 19% year-on-year,” said Larry Page, CEO of Google. “The shift from one screen to multiple screens and mobility creates tremendous opportunity for Google. With more devices, more information, and more activity online than ever, the potential to improve people’s lives even more is immense.”

Q2 Financial Summary

Google Inc. reported consolidated revenues of $14.11 billion for the quarter ended June 30, 2013, an increase of 19% compared to the second quarter of 2012. Google Inc. reports advertising revenues, consistent with GAAP, on a gross basis without deducting traffic acquisition costs (TAC). In the second quarter of 2013, TAC totaled $3.01 billion, or 25% of advertising revenues.

Operating income, operating margin, net income, and earnings per share (EPS) are reported on a GAAP and non-GAAP basis. The non-GAAP measures, as well as free cash flow, an alternative non-GAAP measure of liquidity, are described below and are reconciled to the corresponding GAAP measures at the end of this release.

• GAAP operating income in the second quarter of 2013 was $3.12 billion, or 22% of revenues. This compares to GAAP operating income of $3.24 billion, or 27% of revenues, in the second quarter of 2012. Non-GAAP operating income in the second quarter of 2013 was $3.99 billion, or 28% of revenues. This compares to non-GAAP operating income of $3.94 billion, or 33% of revenues, in the second quarter of 2012.
• GAAP net income including net income from discontinued operations in the second quarter of 2013 was $3.23 billion, compared to $2.79 billion in the second quarter of 2012. Non-GAAP net income in the second quarter of 2013 was $3.23 billion, compared to $3.36 billion in the second quarter of 2012.
• GAAP EPS including impact from net income from discontinued operations in the second quarter of 2013 was$9.54 on 338 million diluted shares outstanding, compared to $8.42 in the second quarter of 2012 on 331 million diluted shares outstanding. Non-GAAP EPS in the second quarter of 2013 was $9.56, compared to $10.16 in the second quarter of 2012.
• Non-GAAP operating income and non-GAAP operating margin exclude stock-based compensation (SBC) expense, as well as restructuring and related charges recorded in our Motorola Mobile business.  Non-GAAP net income and non-GAAP EPS exclude the expenses noted above, net of the related tax benefits, as well as net income or loss from discontinued operations. In the second quarter of 2013, the expense related to SBC and the related tax benefits were $778 million and $167 million compared to $561 million and $134 million in the second quarter of 2012. In the second quarter of 2013, restructuring and related charges recorded in our Motorola Mobile business and the related tax benefits were $89 million and $21 million, compared to $141 million and $39 million in the second quarter of 2012. In addition, net income from discontinued operations in the second quarter of 2013 was $674 million, compared to net loss from discontinued operations of $48 million in the second quarter of 2012.

Q2 Financial Highlights

Revenues and other information – On a consolidated basis, Google Inc. revenues for the quarter ended June 30, 2013 were $14.11 billion, an increase of 19% compared to the second quarter of 2012.

Other Cost of Revenues – Other cost of revenues, which is comprised primarily of manufacturing and inventory-related costs, data center operational expenses, amortization of intangible assets, and content acquisition costs, increased to $3.05 billion, or 22% of revenues, in the second quarter of 2013, compared to $2.08 billion, or 18% of revenues, in the second quarter of 2012.

Operating Expenses – Operating expenses, other than cost of revenues, were $4.92 billion in the second quarter of 2013, or 35% of revenues, compared to $3.89 billion in the second quarter of 2012, or 33% of revenues.

Amortization Expenses – Amortization expenses of acquisition-related intangible assets were $283 million for the second quarter of 2013, compared to $184 million in the second quarter of 2012.  Of the $283 million, $153 million was as a result of the acquisition of Motorola, of which $116 million was allocated to Google and $37 million was allocated to Motorola Mobile.

Stock-Based Compensation (SBC) – In the second quarter of 2013, the total charge related to SBC was $783 million, compared to $635 million in the second quarter of 2012. We currently estimate SBC charges for grants to employees prior to June 30, 2013 to be approximately $3.2 billion for 2013. This estimate does not include expenses to be recognized related to employee stock awards that are granted after June 30, 2013 or non-employee stock awards that have been or may be granted.

Operating Income – On a consolidated basis, GAAP operating income in the second quarter of 2013 was $3.12 billion, or 22% of revenues. This compares to GAAP operating income of $3.24 billion, or 27% of revenues, in the second quarter of 2012. Non-GAAP operating income in the second quarter of 2013 was $3.99 billion, or 28% of revenues. This compares to non-GAAP operating income of $3.94 billion, or 33% of revenues, in the second quarter of 2012.

• Google Operating Income – GAAP operating income for Google was $3.47 billion, or 26% of Google revenues, in the second quarter of 2013. This compares to GAAP operating income of  $3.44 billion, or 31% of Google revenues, in the second quarter of 2012. Non-GAAP operating income in the second quarter of 2013 was $4.21 billion, or 32% of Google revenues. This compares to non-GAAP operating income of $3.99 billion in the second quarter of 2012, or 36% of Google revenues.
• Motorola Mobile Operating Loss – GAAP operating loss for Motorola Mobile was $342 million, or -34% of Motorola Mobile revenues in the second quarter of 2013. This compares to GAAP operating loss of $199 million, or -24% of Motorola Mobile revenues in the second quarter of 2012. Non-GAAP operating loss for Motorola Mobile in the second quarter of 2013 was $218 million, or -22% of Motorola Mobile revenues. This compares to non-GAAP operating loss of $49 million, or -6% of Motorola Mobile revenues in the second quarter of 2012.

Interest and Other Income, Net – Interest and other income, net, was $247 million in the second quarter of 2013, compared to $253 million in the second quarter of 2012.

Income Taxes – Our effective tax rate was 24% for the second quarter of 2013.

Net Income (Loss) from Discontinued Operations – Net income from discontinued operations in the second quarter of 2013 was $674 million which included a gain on disposal of Motorola Home of $747 million, compared to a loss of $48 million in the second quarter of 2012.

Net Income – GAAP net income in the second quarter of 2013 was $3.23 billion, compared to $2.79 billion in the second quarter of 2012. Non-GAAP net income was $3.23 billion in the second quarter of 2013, compared to $3.36 billion in the second quarter of 2012. GAAP EPS in the second quarter of 2013 was $9.54 on 338 million diluted shares outstanding, compared to $8.42 in the second quarter of 2012 on 331 million diluted shares outstanding. Non-GAAP EPS in the second quarter of 2013 was $9.56, compared to $10.16 in the second quarter of 2012.

Cash Flow and Capital Expenditures – Net cash provided by operating activities in the second quarter of 2013 totaled $4.71 billion, compared to $4.25 billion in the second quarter of 2012. In the second quarter of 2013, capital expenditures were $1.6 billion, the majority of which was for production equipment, data center construction and facilities-related purchases. Free cash flow, an alternative non-GAAP measure of liquidity, is defined as net cash provided by operating activities less capital expenditures. In the second quarter of 2013, free cash flow was $3.09 billion.

We expect to continue to make significant capital expenditures.

A reconciliation of free cash flow to net cash provided by operating activities, the GAAP measure of liquidity, is included at the end of this release.

Cash – As of June 30, 2013, cash, cash equivalents, and marketable securities were $54.4 billion.

Headcount – On a worldwide basis, we employed 44,777 full-time employees (40,178 in Google and 4,599 in Motorola Mobile) as of June 30, 2013, compared to 53,891 full-time employees (38,739 in Google, 9,982 Motorola Mobile, and 5,170 Motorola Home) as of March 31, 2013.

WEBCAST AND CONFERENCE CALL INFORMATION

A live audio webcast of Google’s second quarter 2013 earnings release call will be available at http://investor.google.com/webcast.html. The call begins today at 1:30 PM (PT) / 4:30 PM (ET). This press release, the financial tables, as well as other supplemental information including the reconciliations of certain non-GAAP measures to their nearest comparable GAAP measures, are also available on that site.

We also announce investor information, including news and commentary about our business and financial performance, SEC filings, notices of investor events and our press and earnings releases, on our investor relations website (http://investor.google.com) and our investor relations Google+ page (https://plus.google.com/+GoogleInvestorRelations/posts).

FORWARD-LOOKING STATEMENTS

This press release contains forward-looking statements that involve risks and uncertainties. These statements include statements regarding our investments in areas of strategic focus, our expected SBC charges, and our plans to make significant capital expenditures. Actual results may differ materially from the results predicted, and reported results should not be considered as an indication of future performance. The potential risks and uncertainties that could cause actual results to differ from the results predicted include, among others, unforeseen changes in our hiring patterns and our need to expend capital to accommodate the growth of the business, as well as those risks and uncertainties included under the captions “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2012  and our most recent Quarterly Report on Form 10-Q for the quarter ended March 31, 2013 which are on file with the SEC and are available on our investor relations website at investor.google.com and on the SEC website at www.sec.gov. Additional information will also be set forth in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013.  All information provided in this release and in the attachments is as of July 18, 2013, and we undertake no duty to update this information unless required by law.

ABOUT NON-GAAP FINANCIAL MEASURES

To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we use the following non-GAAP financial measures: non-GAAP operating income, non-GAAP operating margin, non-GAAP net income, non-GAAP EPS, free cash flow, and non-GAAP international revenues. The presentation of this financial information is not intended to be considered in isolation or as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. For more information on these non-GAAP financial measures, please see the tables captioned “Reconciliations of selected non-GAAP financial measures to the nearest comparable GAAP financial measures,”

“Reconciliations of non-GAAP results of operations to the nearest comparable GAAP measures,” “Reconciliation from net cash provided by operating activities to free cash flow,” and “Reconciliation from GAAP international revenues to non-GAAP international revenues” included at the end of this release.

We use these non-GAAP financial measures for financial and operational decision-making and as a means to evaluate period-to-period comparisons. Our management believes that these non-GAAP financial measures provide meaningful supplemental information regarding our performance and liquidity by excluding certain expenses and expenditures that may not be indicative of our recurring core business operating results, meaning our operating performance excluding not only non-cash charges, such as SBC, but also discrete cash charges that are infrequent in nature. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance and when planning, forecasting, and analyzing future periods. These non-GAAP financial measures also facilitate management’s internal comparisons to our historical performance and liquidity as well as comparisons to our competitors’ operating results. We believe these non-GAAP financial measures are useful to investors both because (1) they allow for greater transparency with respect to key metrics used by management in its financial and operational decision-making and (2) they are used by our institutional investors and the analyst community to help them analyze the health of our business.

Non-GAAP operating income and operating margin. We define non-GAAP operating income as operating income plus expenses related to SBC, and, as applicable, other special items. Non-GAAP operating margin is defined as non-GAAP operating income divided by revenues. Google considers these non-GAAP financial measures to be useful metrics for management and investors because they exclude the effect of SBC, and as applicable, other special items so that Google’s management and investors can compare Google’s recurring core business operating results over multiple periods. Because of varying available valuation methodologies, subjective assumptions and the variety of award types that companies can use under FASB ASC Topic 718, Google’s management believes that providing a non-GAAP financial measure that excludes SBC allows investors to make meaningful comparisons between Google’s recurring core business operating results and those of other companies, as well as providing Google’s management with an important tool for financial and operational decision making and for evaluating Google’s own recurring core business operating results over different periods of time. There are a number of limitations related to the use of non-GAAP operating income versus operating income calculated in accordance with GAAP. First, non-GAAP operating income excludes some costs, namely, SBC, that are recurring. SBC has been and will continue to be for the foreseeable future a significant recurring expense in Google’s business. Second, SBC is an important part of our employees’ compensation and impacts their performance. Third, the components of the costs that we exclude in our calculation of non-GAAP operating income may differ from the components that our peer companies exclude when they report their results of operations. Management compensates for these limitations by providing specific information regarding the GAAP amounts excluded from non-GAAP operating income and evaluating non-GAAP operating income together with operating income calculated in accordance with GAAP.

Non-GAAP net income and EPS. We define non-GAAP net income as net income plus expenses related to SBC and, as applicable, other special items less the related tax effects, as well as net income (loss) from discontinued operations. The tax effects of SBC and, as applicable, other special items are calculated using the tax-deductible portion of SBC, and, as applicable, other special items, and applying the entity-specific, U.S. federal and blended state tax rates.  We define non-GAAP EPS as non-GAAP net income divided by the weighted average outstanding shares, on a fully-diluted basis. We consider these non-GAAP financial measures to be useful metrics for management and investors for the same reasons that Google uses non-GAAP operating income and non-GAAP operating margin. However, in order to provide a complete picture of our recurring core business operating results, we exclude from non-GAAP net income and non-GAAP EPS the tax effects associated with SBC and, as applicable, other special items. Without excluding these tax effects, investors would only see the gross effect that excluding these expenses had on our operating results. The same limitations described above regarding Google’s use of non-GAAP operating income and non-GAAP operating margin apply to our use of non-GAAP net income and non-GAAP EPS. Management compensates for these limitations by providing specific information regarding the GAAP amounts excluded from non-GAAP net income and non-GAAP EPS and evaluating non-GAAP net income and non-GAAP EPS together with net income and EPS calculated in accordance with GAAP.

Free cash flow. We define free cash flow as net cash provided by operating activities less capital expenditures. We consider free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that, after the acquisition of property and equipment, including information technology infrastructure and land and buildings, can be used for strategic opportunities, including investing in our business, making strategic acquisitions, and strengthening the balance sheet. Analysis of free cash flow also facilitates management’s comparisons of our operating results to competitors’ operating results. A limitation of using free cash flow versus the GAAP measure of net cash provided by operating activities as a means for evaluating Google is that free cash flow does not represent the total increase or decrease in the cash balance from operations for the period because it excludes cash used for capital expenditures during the period. Our management compensates for this limitation by providing information about our capital expenditures on the face of the statement of cash flows and under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Quarterly Report on Form 10-Q and Annual Report on Form 10-K. Google has computed free cash flow using the same consistent method from quarter to quarter and year to year.

Non-GAAP international revenues. We define non-GAAP international revenues as international revenues excluding the impact of foreign exchange and hedging. Non-GAAP international revenues are calculated by translating current quarter revenues using prior quarter and prior year exchange rates, as well as excluding any hedging gains realized in the current quarter. We consider non-GAAP international revenues as a useful metric as it facilitates management’s internal comparison to our historical performance.