Google's 35% Profit Growth Misses Expectations

Google posts a $1.25 billion profit that would thrill most companies, but Wall Street is cringing because it falls short of expectations. Google Chief Economist Hal Varian joins the call to soothe the analysts' fears about online ad weakness.

In a hint that the online advertising market may be in a downslide, Google missed second-quarter earnings estimates with a profit of $1.25 billion and earnings per share of $3.92.
Google, which watched shares plummet 10 percent to $479.70 in after-hours trading on the shortfall, reported a profit of $4.63 per share, excluding stock-based compensation costs, compared with $4.84 in the first quarter of 2008.

Analysts surveyed by Reuters were expecting a net profit of $4.00 per share for Q2 and an average $4.72 per share, excluding stock option expenses.
On the bright side, Google posted gross sales of $5.37 billion, which was 3 percent greater than the first quarter and 39 percent greater than the year-ago period. This hit the sweet spot of the analyst estimates' average ranging from $5.16 billion to $5.62 billion.
TAC, or traffic acquisition costs, the money Google pays partner sites to run its ads, totaled $1.47 billion, or 28 percent of the search company's advertising sales for the second quarter. This puts Google's actual earnings at $3.9 billion.
Paid clicks, which include clicks related to ads served on Google sites and the sites of Google's AdSense partners, decreased 1 percent over the first quarter of 2008, which is not enough for anyone to panic about but could relate to the flagging economy.
Google Chief Economist Hal Varian, who was subbing for absent Google Co-founder Larry Page, did his best to allay fears of a downturn for Google and the online ad space, noting that query growth has been positive in even "economically sensitive" areas such as automotive, real estate and travel. Varian concluded:

"Consumers are being cautious in their online spending patterns just as they are in their offline spending. Despite the weakness in the economy, advertising seems to be holding up remarkably well in most sectors. This illustrates the point that we've made several times that during periods of slow economic growth, the last thing an advertiser wants to cut is its spending on search-based advertising."

What sparked the profit?
Google CEO Eric Schmidt on the earnings call pointed to strong growth of Google sites internationally, a category Citi Investment Research analyst Mark Mahaney said he would be watching this quarter.
Revenues from outside the United States totaled $2.80 billion, representing 52 percent of total revenues for the quarter, compared with 48 percent in Q2 2007 and 51 percent in Q1 2008.
Schmidt also took the time at the beginning of the call to quote from Google General Counsel David Drummond's testimony in front of the Senate and House judiciary committees July 15, in which he argued that the Google-Yahoo deal embraces fair competition.
Google missing estimates by a bit is not a big deal considering the company's strong profit and $12.7 billion in cash. Most companies would kill for a 35 percent profit, so what is there to panic about?

Financial analysts peppered Schmidt, Varian and Google Co-founder Sergey Brin with fiscal, product and strategy questions in the Q&A, which I'll cover in more detail tomorrow, July 18.