San Francisco — In a rare financial setback, Google Inc.’s earnings growth bogged down more than investors had projected, said that second-quarter profits climbed 35 percent, falling short of loftier Wall Street expectations and sending its shares down 8 percent, raising fears that the ailing U.S. economy is starting to sap the Internet search leader.
The owner of the most admired Web-search engine dropped to $470.55, the lowest level in three months. Excluding costs such as stock-based compensation, profit amounted to $4.63 a share, trailing the $4.73 average of estimates compiled by Bloomberg.
The tech giant failed Wall Street’s estimates for the second quarter, sending the stock price back near levels where it had hovered in April, when investors had estimated a weak first quarter.
However, Google then turned the table and proved investors wrong by topping first-quarter estimates, but did not perform on similar strings when reporting second-quarter numbers. Thus, the shares took a beating, falling 8% to $490.23 in after-hours trading.
Blaming the souring economy, the report raised concerns that advertisers are trimming back their spending with the Mountain View Internet titan. But, in fact, the shortfall was largely a consequence of lower interest income from investments.
The company earned $1.25 billion, or $3.92 a share, in the second quarter compared to $925.1 million or $2.93 a share a year ago. Excluding certain expenses, the company earned $1.47 billion or $4.63 a share, falling well short of analysts’ estimates of $4.74 a share.
Nonetheless, Google’s second-quarter revenue increased 39 percent to $5.37 billion, up from $3.87 billion for the equivalent period in 2007. Without the commissions paid to advertising partners, Google would have had revenue of $3.9 billion, matching analyst forecasts.
“Strong international development as well as continuous traffic increases on Google’s web properties propelled us to another strong quarter, despite a more challenging economic environment,” said Eric Schmidt, Google’s chief executive.
“As we carry on our center of attention on innovating in our core business of search, ads and apps, we also look forward to improving the experience of our users and expanding the reach of our advertisers and partners with new technologies and formats, particularly as our integration of DoubleClick gains momentum and create new opportunities in display advertising and elsewhere.”
In truth, the times of plenty are practically all that Google has known during much of its gilded 10-year history. Whether the company will continue its torrid growth in lean times is a major question in the technology industry.
Google’s management agreed Thursday that advertisers in some sectors, such as auto finance and real estate mortgages, have cut back on spending. But the company claimed the loss has been mostly offset by growth in other areas, even consumer durables and furnishings, which are some of the most sensitive to consumer penny-pinching.
“Traffic and revenue have held up well despite uncertain economic conditions,” said Schmidt.
Although Google’s management asserts that the company will thrive even if the economy weakens further, investors were mainly reacting to indications that Google is fretting about the economic climate for the first time since it went public nearly four years ago.
Stanford Group analyst Clayton Moran interpreted the performance as “confirmation that there is a slowdown in Internet advertising that is affecting Google.”
The trouble may stem further from reluctant consumers than advertisers. Google generally only gets paid for ads that are clicked on and that was not happening as frequently in the second quarter.
The number of paid clicks on the Web sites operated by Google and its partners during the second quarter fell 1 percent from the first quarter, the first sequential downturn that the company has ever reported in the category. The 19 percent year-over-year increase in Google’s paid clicks also was the company’s lowest ever.
Hal Varian, Google’s chief economist, explained in his first appearance during earnings call that search advertising will probably be one of the last areas on which advertisers will reduce spending, because it is highly targeted and its success can be easily measured. He raised the possibility of a “Wal-Mart effect,” in which price-sensitive shoppers use Google more frequently to search for bargains.
“Consumers are being cautious in their online spending patterns, just as they are in their off-line spending patterns,” Varian told analysts during Thursday’s conference call.
“That was a tipoff,” said Cantor Fitzgerald analyst Derek Brown. “Economic sluggishness has entered the discussion at Google, more so than we have ever heard.”
Despite Google’s lack of ability to sustain its rate of revenue growth — the closer Google gets to 100% search market share, the less growth is possible — it is still doing pretty well. “Google took more than its fair share of the overall increase in search spending: For every new dollar spent on search in Q2 2008 versus Q2 2007, $1.10 went to Google,” said Lee-Ann Prescott, director of research and communication for research firm Efficient Frontier, in a blog post.
Besides, a greater part of Google’s profit shortfall was a drop in income from cash investments to $58 million in the second quarter, versus $137 million in the same quarter a year earlier. The down-trend was attributed to Google’s $3.2 billion acquisition of online advertising firm DoubleClick, which left less cash on hand to invest at a time of lower interest rates.
Still, Google seems to be more careful with its hiring process, an issue that its executives have admitted has gotten out of hand in the past. The company added 448 workers during the second quarter, down from more than 1,000 per quarter in recent years when its recruiters had more latitude in adding new staff.
Google currently employs 19,604 globally.
Contributions from online video site YouTube also remained vague as Schmidt and others admitted that they still haven’t found the best way to monetize on advertising.
Google co-founder Sergey Brin guaranteed investors with talk of Google’s ongoing search improvements and the promise of the mobile advertising market. “We have substantially increased the size of our index … now our users get much fresher and faster results across a greater range of sources,” he said.
Brin said Google had launched over 100 search quality improvements during the quarter. And he said that over half a million businesses are using Google Apps, the company’s online productivity programs.
Google’s planned tie-up with Yahoo for online advertising has drawn scrutiny from Washington and complaints from rivals that it would dominate the Internet advertising business.
Widely famous for its free spending ways, Google appears to be watching its budget more carefully too. The company said it expects “to continue to make significant capital expenditures” but offered no details in its earnings report.