Google Q4 Earnings Call Transcript

123jump.com Staff
29 Jan, 2009
New York City

The Internet search and advertising company revenue rose to 18% to $5.7 billion. Net earnings dropped 68% to $382.4 million on AOL impairment charges. Earnings per share declined to $1.21 compared to $3.79 a year ago.

Google Inc. ((GOOG))
Q4 2008 Earnings Call Transcript
January 22, 2009 4:30 p.m. ET

Executives

Krista Bessinger - Director of Investor Relations
Eric Schmidt - Chairman and Chief Executive Officer
Patrick Pichette – Senior Vice President and Chief Financial Officer
Jonathan Rosenberg – Senior Vice President, Product Management
Omid Kordestani – Senior Vice President of Global Sales & Business Development

Analysts

Ben Schachter - UBS
Imran Khan - JPMorgan
Justin Post - Merrill Lynch
Spencer Wang - Credit Suisse
Mark Mahaney - Citigroup
James Mitchell - Goldman Sachs
Doug Anmuth - Barclays Capital
Christa Quarles - Thomas Weisel Partners
Heath Terry - FBR Capital Markets

Presentation

Operator

Please stand by, we are about to begin. 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. Please go ahead, ma''am.

Krista Bessinger

Good afternoon, everyone, and welcome to today''s fourth quarter 2008 earnings conference call.

With us are Eric Schmidt, Chief Executive Officer joining from New York; Patrick Pichette, Chief Financial Officer; and Jonathan Rosenberg, Senior Vice President of Products Management, both joining from Mountain View; and Omid Kordestani, Senior Vice President of Global Sales and Operations is joining from London. 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.

In addition, please note that we''re moving to a 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 P.M. Pacific 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, expected performance of aspects of our business, profit acquisition costs, operational efficiency in costs, our expected level of capital expenditures, and our proposed option exchange program, including the expected resulting modification charge. 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 provide 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 quarterly report on Form 10-Q, for the quarter ended September 30, 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 and our effective tax rate, are expressed on a non-GAAP basis and have been adjusted to exclude charges related to stock-based compensation. We''ve 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.

Eric Schmidt

Thank you very much, Krista, and good afternoon to everybody on the call. As she mentioned, we''re making a couple of changes here. In particular, Patrick and I are going to be taking the lead on these calls, and Larry and Sergey will occasionally attend. They continue to focus on technology and product innovation which, of course, they do so very, very well.

Looking at the quarter, we had a strong quarter, and I want to thank everybody for their hard work, both customers, employees, and all the people who made this possible. We had strong search query growth year-on-year, with revenue up in most verticals and we had tight control over costs, something which had eluded us perhaps in the past, but we got the formula down now.

The results, we think, show that advertisers'' value targeted measurable ads. In the fourth quarter advertisers invested where ROI was the highest, and it was online. That''s one of the few really good stories in the past quarter. Our sales force went out to tell people it''s really important to understand that revenue is what you need, and the quickest way to get revenue is to use targeted Google advertising and its strategy had worked very well for us.

Consumers, of course, are also using search for comparison shopping and that helped as well. As you''ll see in our results, we took significant write-downs with AOL and Clearwire, as write-downs are mandated by the way the accounting works. Both deals made sense to us then and make sense to us now, and continue to be a strategic part of our overall business philosophy.

Now, looking at the economic situation which is on everyone''s minds, in some ways Q4 was the easy part. After all, we had holidays, had excess inventory and so forth. Now we''re in a situation, where last quarter we said it was going to be uncharted territory, it''s now clear we''re in a worldwide recession as everybody knows, rising unemployment, foreclosures, that sort of thing but we don''t know how long this period will last. We, obviously, hope it will be short, but we''re certainly prepared to get through this, no problem.

From Google''s perspective, in the short-term we''re doing ongoing prudent management of our business, and that means the kind of actions that we''ve taken in the last quarter and we''re prepared to continue that focus.

In the long-term, we''re obviously very optimistic about Google and its future. It is absolutely true that users shift to the web and advertising is moving online. Both those trends are fundamental and they benefit Google, and obviously, our company, our employees and our shareholders.

Now, we''re in this for the long haul. Another issue that we faced in the last couple of quarters is that about 85% of our employees have at least some stock options that are underwater, which, for most of you, I think, know the exercise price is significantly higher than the current market price of a common stock. So we''re going to offer people an opportunity to do a Stock Exchange. Our theory here is that part of the compensation in stock is how it happens in high-tech and it needs ultimately to have some value over the long-term. This, obviously, is a voluntary program and the number of shares subject to outstanding options will not change as a result of this exchange offer, although there may be more ultimately exercised, which may ultimately result in a change in that number. Total options are expected to represent 3% of total shares currently outstanding. As part of the bargain that we''re working with employees, they have to give up 12 months of vesting, literally have 12 months of vesting added, and they have to wait 6 months to exercise. We think that''s a good deal for shareholders and for our employees as well.

We''re also, of course, focusing on new opportunities, which means we''ve been looking at things which have not been performing as well as we wanted. We''ve discontinued some products with low impact and that has been widely covered. We will continue to review that.

So, our core focus is on the huge untapped potential of search and ads. Search: more dynamic; less static; empower people to use. SearchWiki is a current example where people can add a search quality, and tell us how to make the search better and so forth and so on. Overall, just better search quality. Wouldn''t it be nice if Google understood the meaning of your phrase rather than just the words that are in that phrase? We have a lot of discoveries in that area that are going to roll out in the next little while.

On ads we''re producing more relevant as against more commercial queries every time. Relevancy against commercial queries equals ROI, which equals revenue for Google. We also have very significant advanced bidding measurement and optimization tools underway because we know that larger advertisers are willing to take more clicks if we can give them the tools to generate those clicks. Of course, obviously, the local market remains very large.

We''re also focusing on products with the greatest potential for transformation. Google is at its best when we transform markets or ideas or how information works and displays, for example, Booklet creation is almost complete, a business plan is in place. We''re really trying to bring the science of search to the art of display, somewhat, to think about it, increasing relevance, greater ability to measure results, and an integrated one-stop-shop for advertisers and publishers and increase choice. For example, for YouTube, part of Google, we are very optimistic that we''ll see breakthroughs in 2009.

In the area of Android and mobile, we''re going to open up mobile devices for developers to stimulate innovation. As an example, 800 free apps are already onto the Android marketplace and making the mobile web much more user friendly, with billions of page impressions already available through the G1 phone.

The enterprise - same argument applies. The Cloud is now mainstream, and it''s having a big impact on lots of companies, and by focusing on, for example, the one million Google Apps business customers we can get enterprise quality applications hosted by Google at a dramatically lower price, really makes a big difference, especially with people who are looking for areas to control costs.

Big businesses are using applications already, Genentech, Apago, the Washington DC Government, for example, and we also have a big reseller program there that has just been launched, where we had more than 1000 resellers apply to the program.

So looking back, we had a strong quarter, ending what turned out to be a strong year and business is quite healthy, especially, given the tough economic climate. We''re very much focused on the long-term. We have confidence in our technology and our people, and our enduring power of the web, and how users will use the web in the future.

So with that, Patrick, maybe you''d like to take us through the financials? Thank you.

Patrick Pichette

Thank you, Eric. Good afternoon, everyone. Well, we had another solid quarter and this despite a challenging economic environment, to say the least. Gross revenue was up 18% year-over-year to $5.7 billion, reflecting a healthy growth across both google.com and the AdSense for content network. Google.com was up 22% year-over-year to $3.8 billion, driven by a steady traffic growth and a significant number of ads quality launches this quarter. AdSense was up 4% year-over-year to $1.7 billion, driven by decent performance in our AdSense for content network. This was partially offset by the impact of the clean-up efforts on our AdSense for search network, as we continue to focus on delivering high quality traffic to our advertisers.

Our global aggregate paid-click growth was also reasonably good. It was up 18% year-over-year and 10% quarter-over-quarter, reflecting healthy growth across all major geographies.

We saw good growth in the US with revenues up 13% year-over-year to $2.8 billion and up 5% quarter-over-quarter. International revenue also held up reasonably well accounting for 50% of total revenue or $2.9 billion.

The UK did show some softness largely due to the currency, though. It was down 1% year-over-year to $685 million and down 12% quarter-over-quarter. The rest of EMEA - Europe performed much better, driven by strong performance in Germany, France and the Netherlands. Asia and Latin America were solid as well, driven by the relatively good performance of Brazil and China.

Let me turn now to expenses. As a reminder, we have three broad categories. First, traffic acquisition costs were $1.5 billion for this quarter. This is 27% of total advertising revenue and we''re down from 28% in Q3; second, are the costs of revenue, those increased by $29 million over Q3 to $707 million. The largest driver of the increase - datacenter related costs, including depreciation, equipment and operations. Finally, all other operating expenses totaled $1.65 billion, including approximately $286 million in stock-based compensation.

As we stated before, it makes sense in a difficult economic environment to maintain a clear focus on operational efficiency and cost containment. To this end the Googlers have clearly responded to the call in Q4. As a result, our non-GAAP operating profit, which excludes stock-based compensation, reached $2.1 billion for Q4, resulting in a non-GAAP operating margin of 37.6%.

Our prudent approach to expense management is also reflected in our headcount numbers. We had approximately 20,000 full-time employees at the end of Q4. As mentioned previously, we do continue to hire, with approximately 100 net new employees added this quarter.

A few other topics are clearly worthy of mention this quarter. First, note that we recognize approximately $1.1 billion in strategic investment asset impairment charges related primarily to our investment in AOL and Clearwire in Q4. These charges have been excluded from our non-GAAP results, but are detailed in our earnings press release.

Also, our non-GAAP effective tax rate before these impairment charges, stock-based compensation and related income tax effect was 27%. The increase from 24% in Q3 was primarily due to the increase in earnings in countries with higher statutory tax rates as well as the effect on earnings of various hedging activities. This was partially offset by certain benefits, primarily in R&D tax credits, which was enacted several months ago, before which we took the entire 2008 benefits in Q4.

On FX now, it''s clear that currency was working against us again this quarter, but our hedging programs continue to work well. Before hedging, the recent strength of the US dollar relative to other currencies had a negative impact of $334 million on revenue in Q4 compared to prior quarter. We''re pleased that our cash flow hedging program allowed us to recognize a benefit of approximately $129 million to revenue this quarter.

I''m also pleased to report that operating cash flow remained strong at $2.1 billion. Our CapEx for the quarter was $368 million. As in previous quarters, the majority of this CapEx is related to our IT infrastructure investments, including datacenters, production of servers, and networking equipment. I wish to note here that Google will continue to make significant investments in CapEx in future period. Our free cash flow remained also strong at $1.8 billion, up 73% year-over-year.

But before closing, let me quickly touch base on the exchange offer program we announced today and that Eric talked about a few minutes ago, which would, when launched, offer employees the opportunity to participate in a voluntary one-for-one exchange of their underwater stock options. As Eric mentioned, the program is intended to help us motivate, but also retain our employees. A number of Google shares subject to the outstanding options will not change as a result of the exchange offer, although a lower stock price attached to the new options will increase the likelihood that they''ll ultimately be exercised. The options expected to be exchanged represent, as Eric said, 3% of total shares outstanding. To increase retention, the new options will have 12 months added to their original vesting schedules, and in addition, new options will vest no sooner than 6 months after the close of the offer period.

We do expect to take a modification charge estimated to be about $460 million over the vesting period of the options to be exchanged. These vesting periods range from six months to approximately five years. If the offer launches as expected, this modification charge will be recorded as additional stock-based compensation beginning in the first quarter of 2009.

Please note that the terms and timelines of the exchange offer may change, and we encourage you to read the documents we will file with the SEC when the exchange offer commences.

So, in summary, from a financial perspective, our core business continues to demonstrate strength despite a challenging economic environment and while we''re focused on operational efficiency, we have and we will continue to make crucial investments that drive value for our users, our advertisers, our partners and for Google in the long-term.

With that, thank you for your time, and I''ll turn it over to Jonathan for his thoughts on the quarter. Jonathan?

Jonathan Rosenberg

Okay. Thanks, Patrick. I think I''d like to just take a few minutes to cover some of the top product accomplishments from both the quarter and the year. I''ll start, of course, with search.

So we launched over 350 search quality improvements in 2008. The biggest addition was the size of our index, and that grew substantially over the year. I think people often forget that it''s the behind the scenes work that keeps our results fresh and comprehensive. So, I wanted to remind folks that the index matters. We also worked very hard on latency across the board that was not just on search, but, in fact, on all of our products.

We''ve also mentioned universal search on many calls this year, and for perspective over 2008, we tripled the number of queries that trigger different types of results across images, videos, news, blogs, websites, and of course, books.

Blending books is particularly promising because we''ve now reached a settlement to our lawsuits in the US with book search and if that''s approved by the court, millions more in copyright books will be accessible to the searcher. Many of them will be available for purchase even if they''re out of print. So, in that area, in effect, we feel like we''ll be creating a whole new market for out-of-print books.

Our founders have said something to the effect that even a great search engine won''t help much if the content you''re looking for isn''t online. So, adding more books and expanding our index are very, very important efforts.

It''s also clear more people are searching from mobile phones and they''re doing that more often. Our general objective there, with mobile, is simply to make search from a mobile phone as easy and as fast that as it is from a computer. In some cases, like with the voice search feature that we launched this quarter for iPhones, we''re making it even easier. You basically just pick up your phone and talk. I mean it couldn''t be much easier than that.

With all of our improvements, mobile search traffic went up substantially this year and not surprisingly it peaked at the end of December.

We''re also excited to work with T-Mobile to bring the first Android phone to market, which we did in US in October. It''s done very well today, and I''m pleased to personally report I have two happy and dedicated teenage G1 users in my own house. There are more phones in the works, so we think Android will spread innovation and competition in the mobile world.

On the ad side, I think you all have probably already surmised that this was, in fact, one of our strongest quarters for ad quality improvement. We''re going to keep working to get smarter about which ads we show users so that the queries that should have ads do have ads.

I think you also know that our ads coverage dipped some earlier in the year and Sergey alluded to that on some of the previous earning calls and some of our launches this quarter helped us increase coverage, but keep in mind, we''re now only back to about where we were at the beginning of 2008 from a coverage perspective.

We''re also working to make it easier for our advertisers to create and run great campaigns. This quarter we beta launched the search-based keyword tool. That, of course, helped advertisers identify relevant queries on which they''re currently not running any ads.

Also, remember, most of our advertisers don''t max out their daily budget. So there''s really a lot of opportunity there if we can just figure out how to deliver more clicks to them. It''s also a lot of work to create a display campaign. So many AdWords customers don''t bother and we''re working to fix that too. There we launched the display ad builder to let advertisers create nice looking display ads and they do that directly from the AdWords interface. A good example there is triprez.com. They had not, in fact, done display advertising before, but they''re now running a campaign for Las Vegas travel packages on lots of Las Vegas related sites.

YouTube, of course, is emerging as a key component of our display strategy and this quarter we, of course, launched the Sponsored Videos. People are browsing for videos hundreds of millions of times a day and Sponsored Videos is a great way to show them relevant and useful ads. You can try querying a movie on YouTube as a good way to see some of them.

We also launched over 100 feature releases to our application suite in 2008, and of course, the big advantage there of those web-based apps is how quickly and easily you can push new features out to customers and that you can build apps that otherwise wouldn''t be available to businesses, like chat in Gmail, which we launched in Q4 and I hope you guys have tried.

Momentum is particularly strong in the apps area. We now have more than a million businesses on apps with over 10 million users and over 3 million active users from schools.

Perhaps the thing I''m most proud of this year is how we worked with Patrick''s team to establish much more mature business practices, while maintaining our culture of innovation. In the fall, we conducted a whole series of thorough resource and technology reviews and all of that led to more focused resource allocations going into 2009.

The review process that we created is now basically a part of how we do business, but at the same time, we''ve added this good business process in rigor. The pace of innovation at Google is still very strong. Chrome is a great example of that innovation. It''s fast. It''s stable. It''s gotten great user momentum since we launched officially in Q4. So, we hope, Chrome will spur even greater innovation both within Google, and of course, externally, and we hope Chrome will make the web better for our users, our customers, our partners, and of course, for all the Wall Street analysts that we have here on the phone as well.

So, Happy New Year and thank you, and back to Patrick.

Patrick Pichette

Thanks, Jonathan. We will today be conducting the Q&A with the operator, simply because Eric is in New York and I''m in Mountain View. So I''ll turn it back to you, operator, and then give us the rule for the Q&A, please.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically today. If you would like to ask a question, you may do so by pressing the “*” key followed by the digit “1” on your touchtone telephone. If you are using a speakerphone, please make sure your mute button is turned off to allow your signal to reach our equipment. And once again that is “*1” for questions and we will pause for just a moment to assemble the roster. And we will take our first question from Ben Schachter from UBS.

Ben Schachter – UBS

Hey, guys why don’t you talk about video a bit in terms of what have been the biggest barriers to making that more meaningful and why haven''t we seen more experimentation around the types of ad units that are available on video? And then, related to that, is there anything Google is doing to help get video directly to the television sets across America, across the world? Thank you.

Patrick Pichette

I''ll let Eric introduce the subject and then Jonathan may have additional comments.

Eric Schmidt

Ben, we have introduced three new video formats in the last four to five months. This is for advertising now and each of them is having some traction. I think it''s fair to say that we''ve not found a single solution that really drives revenue, for example, widely, and we''re certainly working on that.

From the standpoint of getting video to the devices, there are quite a few deals in the way now or on the way now, which are basically anything that you can do on television you can also do from YouTube, and virtually all of the new device manufacturers, and there are some that have been announced already, have the ability not only to display Internet content with video, but also YouTube content. We would expect eventually your vision to be realized. It''s just a matter of the product cycle of the partners.
Patrick Pichette

Jonathan?

Jonathan Rosenberg

Sure. Hi, Ben. We actually have done quite a few experiments. I mean, you know, there are multiple ad solutions that we have been working with on YouTube. It''s hard to match the right format with the right content, but as Eric mentioned, we''ve got a few attempts there. We''ve obviously got the in-video ads and the click-through rates there are very good. They''re many times that of standard click to play video ads. There''s also these contest videos, which I mentioned once this quarter. The contest platform, the homepage sponsorship, the click-to-buy work that we''ve done as well, but I think the hard part there is we''ve got to find a way to come up with a standardized format that works and makes the creative development of the ad much, much easier. So, I think, that''s a significant constrain.

On TV, we have extended the reach of Google TV ads with a bunch of cable networks. We signed NBC, Universal and got six new networks, including CNBC and MSNBC this quarter. So I think there is pretty good progress there.

Patrick Pichette

Thanks. We''ll go to the next question, please. Operator?

Operator

And we''ll go next to Imran Khan from JPMorgan.

Imran Khan – JPMorgan

Yes, hi. Thank you for taking my questions. Two questions. If I look at your paid clicks growth rate, it was 10% sequentially versus fourth quarter revenue growth rate of 3% year-over-year. So I am trying to understand the dynamics of the price bucket. It seems like probably the revenue per click went down, but I understand the verticals.

And, the second question is, if you look at your partner revenue growth rate significantly underperforming, the google.com revenue growth rate, trying to better understand, what percentage of that growth, revenue growth, faster growth rate is attributable because the partner''s volume is not growing versus advertisers that are allocating more dollars on the google.com site because they''re seeing better conversion? Thank you.

Patrick Pichette

I''ll just give a quick summary of some of the mix issues and then I''ll turn it to Omid and Jonathan. Just very quickly on the mix issue, it is true, that in a relative sense, the AdSense revenue was weaker. We should say, though, that the AdSense for content actually had a relatively strong quarter, and we''re pleased with that. In the case of AdSense for search, we work closely with all of these partners to improve the quality, but we do quite a bit of arbitrary clean-up in Q3 and Q4 to make sure that we do provide the best information, but I''ll turn it over to Omid for more details as well as Jonathan, afterwards.

Omid Kordestani

Thanks, Patrick. Yes, again on the network I''d just like to emphasize with you that number of quality measures to remove some of the arbitrage that was happening under various parts of that network and that clean up led to some of that downturn that you saw in the numbers. In terms of CPC, we don''t break out the CPC number specifically, but a big impact on it had to do with unfavorable changes in the euro and the pound exchange rates.

Then, aside from FX, we just have various drivers that have to do with the mix in our business. Growth rate in emerging markets, for example, versus developed markets, where newer markets tend to have lower prices and therefore, put a downward pressure on CPCs. Different property mixes, google.com versus the network has different characteristics and different pricing dynamics in the auction.

And the other interesting factor is that as advertisers find new less-monetized keywords and we have a number of launches that we have done where we actually improved the coverage of that by helping the advertisers automatically take advantage of more keywords. Some of the new keywords have lower CPCs; again, they put downward pressure on the pricing. Again, all of this, in long-term, in our view, is going to improve the quality and improve the auction dynamics over time. Thank you.

Patrick Pichette

Are you okay Jonathan?

Jonathan Rosenberg

I think that really did pretty much cover it all, yes, FX, its mixed issues. I think the only thing we didn''t mention is that advertisers are looking very carefully at conversions in ROI, and so, one of the dynamics that I think we did see is the consumers are doing more comparison shopping. So, they''re clicking more, but in some verticals they are not necessarily converting as much, or maybe what they''re engaged in is smaller purchase sizes. They''re buying things that are a little less expensive. So the auction is working. The advertisers are basically adjusting their bids to maintain their ROI or even enjoy the slightly increased ROI, which we''ve typically seen in December and we saw again this year. Brazil and China are probably the examples when we talk about mix of countries of markets where we saw growth, but it''s presumably growth that’s modestly lower CPC.

Imran Khan – JPMorgan

Great. Thank you.

Patrick Pichette

Thank you. We''ll go to the next question, please.

Operator

And we''ll go next to Justin Post from Merrill Lynch.

Justin Post - Merrill Lynch

Thank you. First on the call today Microsoft indicated a slowdown in activity in the last six months and I''m just wondering if you see anything abnormal that you want to highlight since the holiday season. And then, the second thing is, just on the ratio of the foreign exchange hedging, it looks like there was a $266 million year-over-year impact, and it looks like in your release you had a $129 million benefit. Is that the kind of ratio we could kind of think about going forward? Thanks.

Patrick Pichette

So, on the issue of what''s going on in the market, I mean, I think, everybody knows we don''t comment on what''s going on in the market and we don''t speculate and we don''t give guidance on it. On the issue of the FX, there are two things we should remember. One is Q4 was an extraordinary quarter from a volatility point of view. So that''s the first message. Everybody that''s running models right now is probably scratching their heads, given that the pound went from $1.80 something to $1.50 something in a matter of weeks. It just threw the entire market kind of for a spin and in that context that''s why we''ve had the results that we''ve had.

In some cases we''ve had a lot more benefit because of these hedges. In the case of the UK, I can mention that we have put most of these in Q3 and they really are taking hold in Q1 of this year. So, we had a partial benefit. So, it wasn''t perfect for Q4. All this said, though, one last point is, you got to remember that we do hedge bottom-line not top line. So, we''re not trying to match revenue for revenue, because of FASB 133. We are really looking for bottom-line hedging, and that''s why you see a proportion. So the models are really porky this quarter, because of all these factors at play, and second is, always remember, we''re not hedging for revenue, we''re hedging for bottom-line.

Justin Post - Merrill Lynch

Thank you.

Patrick Pichette

You''re welcome. We''ll go for the next question.

Operator

And we''ll take our next question from James Mitchell from Goldman Sachs. Mr. Mitchell, your line is open.

Patrick Pichette

James? If you''re on mute; we''ll go to the next question and then we''ll come back to James.

Operator

And we''ll take our next question from Spencer Wang from Credit Suisse.

Spencer Wang - Credit Suisse

Two quick questions. First, CapEx was down in the quarter pretty significantly and down on a full-year basis and, I know, Patrick, I think you said that you would continue to make significant investments, but is this kind of a normalized level? That''s question one. And then, the second question was, looking at the cost structure of Google now, I was wondering if you could give us a sense of how flexible the cost structure is, maybe excluding the percentage of the costs or fixed versus variable versus semi? Thank you.

Patrick Pichette

Okay. So on CapEx, first and foremost is, we are really glad of the performance of CapEx this quarter. Again, it''s a combination of two things that are at work. I just want to reiterate we are investing, and we are investing and never jeopardizing the quality of the experience and the robustness of our infrastructure. It just happens that we are benefited by two factors, one is we are benefiting from economies of scale, as well as the greater efficiencies of our infrastructure. So, if you think of the Moore''s Law at work; get a cheaper cost for equipment as well as better utilization. So, all of these factors we really push hard on, and therefore are gaining benefits.

The second factor, which is also quite important in the modeling, is it''s lumpy. Big data centers are lumpy in the way that they are invested. So, in that sense, I''d be careful about looking at one quarter to make a forward-looking modeling assumption. So we''re pleased about our performance. Obviously, we don''t give guidance, but we are committed to making sure that we invest to make sure our infrastructure is robust.

On the cost structure point of view, I think that if you look very simply at Google, I mean you really have a cost structure that is, if Hal was here, he would say all costs are variable in the long run. So that makes the answer easy. But the real issue is we''re a labor-intensive business. We have a lot of labor. And so, depending on your views on labor, right, I mean we take care of our employees. We have a lot of flexibility within our model and we''re going to continue to manage the business responsibly in that sense.

Having said that, there is no doubt that in the mindset of the company, we really are and having finished my first six months around here, I think that it is true. We are managing this business for the long-term. There is no doubt about it. The decisions are built on that basis. So, I hope that answers your questions.

Spencer Wang - Credit Suisse

It does. Thank you very much.

Patrick Pichette

We''ll turn to the next question, please.

Operator

And we''ll go next to Mark Mahaney from Citigroup.

Mark Mahaney – Citigroup

Thank you. Patrick, one question for you; Eric mentioned he got the formula down now for cost controls. How much more opportunity do you think there is? You''ve only been there for a quarter-and-a-half; do you feel like you''re just starting to find ways to cut costs or do you think we saw that major impact of what you can achieve already in the quarter?

And then a quick question on CPC. If you could help us think through how deflationary CPC trends could be in an environment where, the millions of advertisers who are on Google, some of them must be going out of business, people have got stretched advertising budgets or reduced advertising budgets. Of all the different mix factors, how much of CPC pressure could we see on the downside, just from core recessionary factors? Thank you.

Patrick Pichette

I''ll answer the first question, and I''ll let the combination of Jonathan and Omid maybe comment on the second. On the first one, I think that you have to keep in mind that the mindset of the company is to be a growth company. I think that Eric, Larry, Sergey always pounded into every management meeting that, we''re a growth company and we''re focused on growth. So, in a certain way, we are really focused on growing this company. In that sense, I''d love to have more cost because I have more revenue and we''re going to continue to focus on that. On the issue of, is there more available cost cutting or efficiencies available, all I''d say is we''re just managing responsibly given the environment.

Let me turn around the CPC question to Jonathan.

Jonathan Rosenberg

Sure, Mark. I think it''s pretty easy. A recession actually causes less commerce to take place. If there were fewer transactions, then that would adversely impact us and you''d see revenue going down. I don''t think you''d sort of see a CPC-based deflationary spiral because some modest number of businesses went out of business. I think that the auction is pretty robust. There are many, many other businesses behind that subset of businesses that would come into the auction if there was a transaction that was going to be consummated.

So I think it''s really a function of whether or not overall commerce is reduced. In the end, the CPC question, the way we see it, is really driven by users and it''s not quite as much the number of advertisers coming in and out at any given time.

Mark Mahaney – Citigroup

Thank you, Jonathan. Thank you, Patrick.

Patrick Pichette

Thank you. We''ll go to the next question, please.

Operator

And we''ll take our next question from James Mitchell from Goldman Sachs.

James Mitchell - Goldman Sachs

Great. Thank you for taking my question this time. Could you discuss why traffic acquisition costs were down quarter-on-quarter and could you talk about the taxation of the FX hedging benefits?

Patrick Pichette

Yes. The reason for TAC down quarter-over-quarter is due for mixed reasons for the most part, because as you can think about it, our mix between Google.com versus all other partners is the primary force for that.

On the tax of the hedging, could you just give me more precision on your question, please?

James Mitchell - Goldman Sachs

I think in the introductory remarks, you mentioned that the effective tax rate increased from 24% to 27%, and you cited one of the reasons for that as being the FX hedging benefits. I assume that there''s some sort of capital gains related tax or something?

Patrick Pichette

Yes. Thank you for your clarification. So here''s the issue. I mean, in a very simple world the following happens. Our hedging program is not made for the wide ranges of benefit or loss that we would have seen with the huge fluctuations of this quarter if you think of it in these extraordinary times. So, if you do have a huge disparity in a currency and you end up with a large benefit that is US-based, it will be taxed in the US. The reverse of that, the loss is on the euro side, you get all the benefit in the US. You have the loss on the other side. The net is - you end up paying taxes more than you would have thought. So, if it''s a small number, it doesn''t matter. If it''s a bigger number, then it becomes more material.

James Mitchell - Goldman Sachs

It''s purely because the general tax rate is higher in the US than in Europe?

Patrick Pichette

That''s correct. That''s exactly right.

James Mitchell - Goldman Sachs

Thank you.

Patrick Pichette

You''re welcome. We''ll go for the next question, please.

Operator

Thank you. We''ll take our next question from Doug Anmuth from Barclays Capital.

Doug Anmuth - Barclays Capital

Thanks for taking my question. First one is on the distribution deals, and in particular, can you talk about how your philosophy has changed on distribution deals like Dell and Verizon recently, and what were the primary reasons you did not win those deals and would you expect to maintain most of the query volume from the Dell deal? Then, just the second one for Jonathan, in terms of coverage, you mentioned that you''re just back to early ''08 levels. What kind of levels would you like to be at and how do you think about that going forward? Thanks.

Patrick Pichette

Great. I''ll let Omid answer the first one and then we''ll pass it on to Jonathan.

Omid Kordestani

Hi. On the distribution deals we''re engaged in, all of these partnerships and renewals discussions are new ones. First, we have a number of opportunities from different segments, PC manufacturers to software companies that bundle our various toolbars or Chrome. We do very sophisticated business modeling and are looking at the value of this traffic to us, and then ultimately we''re just willing to pay a certain amount of that distribution.

So, there are other factors that enter these negotiations, competitive dynamics, other benefits that a partner may get from a different provider, a very competitive environment and we believe there''s a lot of choice there. We have alternative opportunities for distribution. So we have a very active program. We are happy with the forecast that we have and the alternatives that we have to distribute the products.

Patrick Pichette

Thanks Omid. Jonathan?

Jonathan Rosenberg

Yeah. On coverage, I think the answer is we don''t know what the optimal coverage level is. You know, it certainly depends on the dynamics of the mix of commercial versus noncommercial queries and how that changes over time. So, we''d really like to show fewer ads on the searches and the queries that don''t really want them, and we''d probably like to show fewer better ads on the queries that do. So, I don''t think we actually – we don’t have a clearer answer than that.

Doug Anmuth - Barclays Capital

Okay, great. Thank you.

Patrick Pichette

Thanks. We''ll take another question.

Operator

And we''ll take our next question from Christa Quarles from Thomas Weisel Partners.

Christa Quarles - Thomas Weisel Partners

Hi. First question was, I think, Hal said last quarter that, advertisers would take as many clicks as they could get at current prices. I was wondering if you still stand by that, I guess, relative to the comments that were just made as it relates to potentially ROI discipline waning in Q4, and then maybe back and forth in Q1? And then, the second question, I was just wondering if you could add any color or commentary on how SMBs with us and Fortune 500 marketers acted in Q4? Thanks.

Patrick Pichette

Great. I''ll let Omid talk to both of these points; he has great insights on it.

Omid Kordestani

Hi. On the first question, very much Jonathan talked about earlier. Advertisers acted very rationally in the quarter. They lowered their bids in certain cases, certain verticals, and looked basically for proper returns on their campaigns rather than just dropping out. And a majority of our revenue comes from advertisers that do not max out on their campaign budgets. So basically what Hal said is that they''ll max out, they''ll take more clicks if we can deliver them and that''s a very good trend for us.

The other factor, to your second question, that we saw is that quite a bit of diversity, actually in the way the customers are behaving, some of the larger customers are definitely in a mode where they''re evaluating their marketing budgets and any kind of savings that they can undertake, they do and they put some of these marketing spending and budgets on freeze. And what we''re finding, though, is that among those big customers, the ones who have been online and are familiar with the benefits and the metrics and are doing the measurements and using analytical tools to do the kind of marketing that we provide, they continue to take advantage of this.

They just perhaps lowered their CPCs or changed their campaign sizes, but, in general, we''re seeing, again, the ones that are sophisticated understand how to market with us, they stay with us. We''re seeing robustness actually in the smaller segments of our customers. Again that just speaks to the fact that they understand the metrics and they''re willing to pay for those clicks based on the measurements that they have.

So it''s hard to again predict with the visibility still not clear for us and we''re hard at work in the field calling on all the segments and servicing all the segments for the customers.

Christa Quarles - Thomas Weisel Partners

Okay. Thanks.

Patrick Pichette

Jonathan, a few comments?

Jonathan Rosenberg

The small and medium advertisers, they actually have some data on and I think Omid''s statements are all absolutely, directionally correct. What we see is that small and medium advertisers tend to cut their ad budgets back less than the larger direct advertisers and we think what happens there is that the larger advertisers are much more prone to doing more across the board media spend cut; but most of our advertisers basically don''t max out their daily budget, and because every single conversion is ROI positive for them, they''re basically willing to take as many positive ROI conversions as we can give them.

Patrick Pichette

Great, thank you. I just want to say that because of the distributed aspects of our call today, with Eric in New York and Omid in London, we''ll take one last question now and then, obviously, invite everybody who wants to participate for the follow-up call. So we''ll go for the last question, please.

Operator

Thank you. And we''ll take our last question from Heath Terry from FBR Capital Markets.

Heath Terry - FBR Capital Markets

Great, thank you. I was wondering if you could kind of give us an idea of the strategy for the display advertising side of the business, particularly, first as it relates to the DoubleClick Ad Exchange and its development? And then, second, to the display advertising inventory that you have on YouTube and your other non-search sites?

Patrick Pichette

Yes. I''ll let Omid cover this, please.

Omid Kordestani

Hello. First of all, we are doing very well with the DoubleClick integration. As Eric mentioned, the business plan is set and the product roadmap is really set and delivering every month, every quarter and we''re starting to see that we''re getting more inventory actually because we''re doing a great job of monetizing it.

DoubleClick is getting integrated with the Google systems for the publishers. This means, that with AdSense Systems, we have DSP and have beta launched a number of features. Publishers basically can make more inventory available to us and we monetize it with AdSense only if the publisher can''t sell that higher price, which is again, a great way for the publishers to optimize the sales of their inventory.

For advertisers who are working on integrating AdSense for content tools with DFA products, YouTube is fully integrated into the Google display platform, and in effect, YouTube is a client of these systems and the DoubleClick video product is the way that YouTube sells the video inventory on a reservation basis, and we use AFC AdSense for content on YouTube for sales of auction-based inventory.

Again, we still believe that this is a great market for us. They''re very fragmented. It''s really ready for better measurements and better optimizations for both publishers and advertisers and we''re having great success with the DoubleClick team and Jonathan''s team is doing a great job by integrating the products as we''re gaining more traction here.

Heath Terry - FBR Capital Markets

Great, thank you.

Patrick Pichette

Just as we close the call, in conclusion, I think, just to reiterate the points Eric made at the very beginning of the call; very strong quarter, ending a strong year, I think pleased with the results, especially given the tough economic climate and all of these uncharted waters and territory we''ve gone through. We''re delighted to have a healthy business through this.

Clearly, we are and remain focused on the long-term. We have confidence in our technology, our people and the enduring power of the web that really pushes us.

So, with that, I''ll turn it over to the operator to close the call.

Operator

Thank you and this concludes today''s conference. We thank you for your participation. You may now disconnect. If you are joining us for the second portion of today''s call, please disconnect at this time and dial back in on the numbers that were provided for the second conference call.

And again, if you''re joining us for the second conference call today, you must disconnect at this time and dial back in for the second conference call, which begins at 1700 Central Standard Time. Thank you and have a good day.