By Rolfe Winkler and Alistair Barr
Fast-rising expenses eroded Google Inc.'s first-quarter profits,
disappointing investors and sending Google shares lower in
after-hours trading.
The Internet-search giant said revenue for the quarter rose 19%
to $15.4 billion from $13 billion a year earlier, excluding the
Motorola Mobility business Google plans to sell to China's Lenovo
Group Ltd. Analysts had projected revenue of $15.5 billion on that
basis, according to S&P Capital IQ.
But expenses grew faster--at 23%. As a result, Google's net
income increased 3% to $3.65 billion, or $5.33 a share, from $3.53
billion, or $5.24 a share. The figures were adjusted for the
pending Motorola sale and a 2-for-1 stock split.
Excluding stock-based compensation and other items, Google said
earnings were $6.27 a share; on that basis, analysts had predicted
$6.41 a share.
"The top line was pretty good, but the margin compression
probably disappointed the market," said Brian Wieser, an analyst at
Pivotal Research Group. "The margin erosion trend seems to be well
in place."
Shares fell nearly 3% in after-hours trading Wednesday, after
rising by a similar amount to $563.90 during the regular trading
day. Since hitting a peak in late February, Google shares have
followed the broader stock market downward. Still, shares have
risen about 60% since the beginning of 2013.
Mr. Weiser said Google's profit margins have declined as the
company expands into more businesses. Newer businesses like
online-video service YouTube, as well as display advertising, are
less profitable than the company's original search-advertising
business, Mr. Wieser said.
Chief Financial Officer Patrick Pichette told investors on a
conference call that operating expenses rose in part because of
one-time research-and-development costs related to Google's $3.2
billion purchase of home-automation company Nest Labs.
Research-and-development expense increased 31% from a year earlier
to $2.1 billion.
"There will always be one-time items for a company like Google
that does so many acquisitions," said RBC Capital Markets analyst
Mark Mahaney, who added that Google is smart to continue making
acquisitions to find new growth opportunities.
Wall Street estimates suggest that Google's profit margins will
remain roughly flat in the future as revenue continues to grow
strongly, but Mr. Wieser said that isn't realistic. He pointed to
some of Google's more-ambitious new projects, such as self-driving
cars and a high-altitude Internet service, which may also be less
profitable than the search business.
Google also is increasing investments in data centers and other
infrastructure to beef up its computing capacity, something
Google's Mr. Pichette called strategically important. Capital
spending nearly doubled from a year earlier, to $2.3 billion from
$1.2 billion.
As a result, Google generated less cash--after subtracting
capital expenses--than in any quarter in at least two years.
"[Capital expenditure] was quite a bit higher than Street
estimates, but keep in mind they are building out a lot of
infrastructure, which in our view is certainly justified by the
massive revenue opportunities still ahead for Google," said Colin
Sebastian, an analyst at RW Baird.
Google said revenue in its core advertising business rose 17%.
Clicks on advertiser links next to Google's search results
increased 26% from a year earlier.
But the amount Google got paid per click fell 9% from a year
earlier, continuing a trend, as a higher percentage of searches
occur on smartphones, where Google's clicks are less valuable. The
smaller screens and limited bandwidth of smartphones make them a
less-appealing tool than desktop computers for consumers looking to
buy products or services online.
Marketers that work with digital-ad firm Rimm Kaufman Group paid
about 60% less for smartphone clicks than desktop clicks in the
first quarter to generate an equivalent payback.
Google's earnings report came a day after Yahoo Inc. said its
revenue, after commissions paid to partners, grew for the first
time in more than a year. Yahoo reported that its revenue, minus
commissions paid to partners for Web traffic, rose 1% in the latest
quarter.
While Yahoo struggles to regain its footing in online
advertising, Facebook Inc. has emerged as Google's chief rival.
Research firm eMarketer predicts that Facebook's net advertising
revenue will grow 54% to $10.8 billion this year while Google's
will grow 14% to $43.5 billion.
To build upon its dominant position, Google is trying to prove
that its ads work. The company now provides advertisers with data
showing the sales the advertiser is generating via desktop
computers but which Google says can be traced back to clicks on
smartphone ads.
The idea is to persuade advertisers to bid more for smartphone
clicks says Mark Ballard, research director at Rimm Kaufman
Group.
Meanwhile, it also has a pilot program under way to match the
anonymous tracking "cookies" on users' computers to in-store sales
information collected by data providers like Acxiom Corp. and
DataLogix Holdings Inc. The idea is to connect online ads to
offline purchases, and therefore to convince advertisers to spend
more with Google.
Write to Rolfe Winkler at rolfe.winkler@wsj.com and John Kell at
john.kell@wsj.com
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