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Google hurdles over profit estimate

Search ad giant reports net income is well above analyst estimates for the third quarter; revenue almost matches expectations.

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Stephen Shankland
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Google's revenue continued to rise in the third quarter of 2008.
Google's revenue continued to rise in the third quarter of 2008. Google

Updated at 3:22 p.m. PDT with further details.

Google easily cleared analysts' profit expectations for the third quarter of the year, patting itself on the back for the results but offering a cautious qualifier about current economic conditions.

The company reported net income of $4.92 per share, excluding various items such as stock-based compensation, compared to expectations of $4.75 from analysts surveyed by Thomson Reuters. Revenue was $4.04 billion, excluding commissions called traffic acquisition costs that are paid to advertising partners, compared to an expected $4.053 billion.

"We had a good third quarter with strong traffic and revenue growth across all of our major geographies thanks to the underlying strength of our core search and ads business. The measurability and return on investment of search-based advertising remain key assets for Google," said Chief Executive Eric Schmidt in a statement. "While we are realistic about the poor state of the global economy, we will continue to manage Google for the long term, driving improvements to search and ads, while also investing in future growth areas such as enterprise, mobile, and display."

Using generally accepted accounting principles, net income increased from $1.07 billion in the year-earlier quarter and $1.25 billion in the second quarter to $1.35 billion in the third, the company said.

In Google's second quarter, the company missed expectations for profit and issued a more cautious assessment of the online advertising market, sending the stock down to $478 or so. With the current economic pessimism, that price looks downright giddy: Google's stock closed at $353.02 a share on Thursday, and Collins Stewart analyst Sandeep Aggarwal pointed out that a full third of Google's employees have nothing but valueless "underwater" stock options that have greatly diminished incentive value.

After-hours trading sent the stock up 10 percent to $389.

Search ad strength
Google makes most of its money through ads delivered alongside search results. Advertisers bid to have their ads placed next to results based on search keywords that people type into the search box, and they pay Google only once people click on those ads. One significant measurement from the company: the number of search ads on which people clicked increased 18 percent from the year-earlier quarter.

The company also is eyeing new ad revenue from increasing use of the Internet by people with mobile devices.

"We're seeing an explosion in mobile search volume," Schmidt said on a conference call to discuss earnings results. "The compound growth rate is one of the fastest growing things in the company."

Because of the paid-click mechanism, advertisers' spending on search ads can be tightly linked to the success of specific ads, a factor Google executives eagerly point out when confronted by worries about advertisers' cold feet. "Advertisers are willing to take all the clicks we can give them at the current cost per click. Even in tough times, that will continue to be true because nobody wants to turn away a customer," said Omid Kordestani, Google's senior vice president of global sales and business development.

The company, through its acquisition of DoubleClick earlier this year, is trying to bring the same measurability to the more loosey-goosey world of graphical "display" ads, where costs are paid when ads are displayed and many ads are intended to promote brands rather than more specific actions such as buying a particular gadget.

Is a recession good for Google? 'The Wal-Mart effect'
Taking the big-picture view, Google has been cheery about Silicon Valley's prospects overall, but analysts skeptical of online advertising growth have reduced forecasts. The credit crunch and expected recession have sent tech companies' stock plunging downward in October.

Schmidt was careful to include plenty of cautionary statements in his conference call remarks. "It's clear the economic situation is so fluid that we're all in uncharted territory...It's clear the global economic situation is worse than predictions just a month ago," he said.

However, he and chief economist Hal Varian were willing to raise expectations that Google could fare well in the current climate. Not only do advertisers prefer ads they can prove are profitable to run, but even consumers might put the company ahead.

"As consumer budgets are squeezed, people use the Web for comparison shopping," Schmidt said.

"When there is a recessionary event, and people are counting pennies and researching purchases, this potentially has an upside for Google," added Varian, who called the phenomenon "the Wal-Mart effect." "We think this kind of effect could work to Google's benefit potentially."

Keeping expenses down
Not that Google is immune to ordinary business pressures. The company also is trying to keep expenses in check, though it continues to hire at a slower rate. "We kept tight control over costs," Schmidt said.

The company hired at a relatively slow rate, with employee head count increasing by 521 to 20,123, the company said.

Schmidt offered no new guidance on the search-ad deal with Yahoo, a partnership the companies had expected to have begun by now but that they delayed for further antitrust review at the Justice Department.

"When we did the deal, we understood it would be controversial, that competitors would oppose it, and there's a proper role for legal review," Schmidt said. "We anticipated what turned out to be about a four-month (antitrust review). We're hopefully nearing the end of that period. We're in communication with the Justice Department and others."