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Google Q3 Surprises

goog earnsIn July, the results failed to meet high expectations.  Now, its October, expectations were low and the results exceeded them.  Such is the sometimes awkward reality of predicting the performance of a company that refuses to give much in the way of forward guidance.

Thursday, Google reported third quarter results. They return showed sequential growth is decelerating, but overall the performance was more than enough to best expectations. Net income of $1.35b or $4.24 a share, good enough to best last year’s result of $1.07b (3.38/share) for the same period by 26%. Revenues were also up handsomely to $5.54b from $4.23b last year.   

With many companies cutting back on their ad spending to conserve capital, there had been some expectation the results would be impaired. Turns out, so far, search advertising has remained resilient.  One explanatory theory, particularly emphasized moving forward, is that cost conscious customers are increasingly using the Internet to seek bargains.  Search being a key part of that process, the ad dollars are flowing to it, in part, in the equivalent of a “flight to quality.”

That was the sentiment expressed by both Google’s CEO Eric Schmidt and Chief Economist Hal Varian. Schmidt, characterized the current economic climate as "unchartered territory" and Varian said, "our experience is advertisers are willing to take all the clicks they can get.. Even in tough times that continue to be true. No one wants to turn away a customer."

Google held 63 percent of the U.S. search traffic in August. Their share of the market revenue is close to seventy percent.

Moving ahead, the challenges for Google will involve managing costs, and, addressing the deceleration of growth in certain areas.  Paid clicks on Google owned and partner sites, for example, were up 18% year over year but rose just four percent sequentially from last quarter.  Similarly, Network Revenues from partner sites were up 15% year over year but just 1% from last quarter. Eventually, though perhaps not anytime soon and maybe not for another few years, Google will need to start drawing more substantial revenue from alternate business lines beyond search or at least, come up with new growth channels.

The rest of the results by the numbers:

Revenues :
Google reported revenues of $5.54 billion for the quarter ended September 30, 2008, representing a 31% increase over third quarter 2007 revenues of $4.23b and a 3% increase sequentially from the second quarter.  (The sequential growth in revenue from Q1 to Q2 was also just 3%).   Google reports its revenues, consistent with GAAP, on a gross basis without deducting Traffic Acquisition Costs (TAC). TAC, which is detailed further below, was 28% of advertising revenues.

Owned vs. Network Sites:
Google-owned sites generated revenues of $3.67 billion, or 67% of total revenues, this quarter. That represents a 34% increase over Q3 2007 revenues of $2.73 billion and a 4% increase over Q2 2008 revenues of $3.53 billion.    (Q1 to Q2 growth was also 4%)

Google’s partner sites generated revenues through AdSense programs of $1.68 billion, or 30% of total revenues, this quarter.  That was a 15% increase over network revenues of $1.45 billion generated in Q3 2007 and a 1% increase over Q2  2008 revenues of $1.66 billion.  

Geographic Distributions:
domestic split
•International revenue (revenue from outside of the United States) was $2.85 billion, or 51% of total revenues on the quarter. That was up slightly compared to 48% in the third quarter of 2007 and, down barely, from 52% during the second quarter of 2008.  (If calculated at constant exchange rates from the second quarter through the third quarter, revenues would have been $59 million higher. At constant exchange rates from Q3 2007 through the third quarter of 2008, current revenues would have been $168 million lower.) 

•Singling out the United Kingdom, revenue there totaled $776 million, representing 14% of revenue this quarter, the same share as last.  That compares to 16% in the Q3 2007.

Paid Clicks :
Aggregate paid clicks, the number of times ads are actually clicked on (which include clicks related to ads served on Google sites and the sites of AdSense partners), increased approximately 18% over Q3  2007 and were up approximately 4% over Q2 2008.    

TAC – Traffic Acquisition Costs:
tac chart
•Revenues shared with Google’s partners, or TAC, increased slightly to $1.50 billion in the this quarter versus TAC of $1.47 billion in Q2 of 2008.  TAC as a percentage of advertising revenues was 28% in the third quarter, the same as Q2.
•TAC expense paid to AdSense partners totaled $1.33 billion. 

Other Cost of Revenues :
Other cost of revenues, which is primarily costs related to data center operational expenses, amortization of intangible assets, credit card processing charges and content acquisition costs, increased to $678 million, or 12% of revenues versus $674 million, or 13% of revenues, in Q2 2008.

Operating Expenses :
Operating expenses, other than cost of revenues, were $1.63 billion, or 29% of revenues, compared to $1.64 billion in Q2 2008, or 31% of revenues. 

Operating Income:
GAAP operating income was $1.74 billion, or 31% of revenues.  This compares to GAAP operating income of $1.58 billion, or 29% of revenues, in Q2 of 2008.  Non-GAAP operating income was $2.02 billion, or 37% of revenues versus non-GAAP operating income of $1.85 billion, or 34% of revenues, in the first quarter of 2008.

Net Income:
 GAAP net income for the second quarter of 2008 was $1.35 billion as compared to $1.25 billion in the second quarter of 2008.  Non-GAAP net income was $1.56 billion in the 3rd quarter of 2008, compared to $1.47 billion in the second quarter of 2008.  GAAP EPS for the 3rd quarter of 2008 was $4.24 on 318 million diluted shares outstanding, compared to $3.92 for the second quarter of 2008, on 318 million diluted shares outstanding.  Non-GAAP EPS for the third quarter of 2008 was $4.92, compared to $4.63 in the second quarter of 2008. 

Cash Flow and Capital Expenditures :
•Net cash provided by operating activities totaled $2.18 billion as compared to $1.77 billion for Q2 2008.  Capital expenditures were $452 million, the majority of which was related to IT infrastructure investments, including data centers, servers, and networking equipment. 
•Free cash flow, which is an alternative measure of liquidity defined as net cash provided by operating activities less capital expenditures,  was $1.73 billion. 

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More detailed press coverage on Google’s finances can be found at:
Yahoo Finance
Google Finance

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