Digital Media

It took awhile, but the recession has definitely sunk its teeth into Google's financial performance.

"No company is recession-proof. Google is absolutely feeling the impact," Google CEO Eric Schmidt said in a conference call Thursday after reporting first-quarter financial results.

Google's revenue growth rate has been slowing, but for the first time since it went public, the company's quarter-to-quarter revenue declined. (Click to enlarge.)

(Credit: Google)

The company, as is customary, reported results that most business only dream of, recession or not. Its net income grew 8 percent to $1.42 billion and its revenue, excluding commissions paid to advertising partners, grew 10 percent to $4.07 billion. It generated free cash flow of $2 billion for the quarter, the vast majority of it derived from money advertisers pay Google when people click on ads next to search results.

But everything is most definitely not coming up roses. Google's revenue, after ascending steadily quarter after quarter, peaked in the fourth quarter and declined 3 percent in the first quarter. Google's business is still relatively strong, and it's been hit by the recession less than many in the tech world, but it's been hit nonetheless.

Curtailed clicks
Why? In short, because people are buying less and advertisers consequently are advertising less. As an Efficient Frontier study released earlier this week showed, advertisers are getting more conservative by bidding for search terms where there is a proven return on investment (ROI).

Here's Schmidt's explanation, including his assertion that the company's overall business of showing ads next to search results is still intact:

Users are still searching, but buying less. What that means is the ads are converting less. There's more window- and comparison-shopping, purchasing lower-priced goods. In other words, users are doing the right thing. They're doing what you'd expect them to do given the enormous economic changes around us.

Advertisers are still spending, but they're lowing their bids to manage their ROI. They're behaving correctly in our view. One way to say that is our advertising model is working. The user and advertising behavior we're seeing is entirely rational, and the auction model is working for both.

In short, Google Chief Economist Hal Varian's "Wal-Mart effect," in which people under financial pressure would steer more of their purchasing behavior through search engines in an attempt to get the best deals, has its limits.

Creeping pessimism
To put this in context, let's retrace some history over the previous four earnings conference calls. The company's statements have grown gradually more pessimistic:

First quarter 2008: "We've looked at this really carefully, and we do not see an impact as of this time," Schmidt said. "We're well positioned should economics change. We continue to do well because our model is so targeted, and targeted (advertising) does well in most scenarios."

Google CEO Eric Schmidt

(Credit: Stephen Shankland/CNET)

Second quarter 2008: "Despite the weakness in the economy, advertising revenue seems to be holding up remarkably well in most sectors. I think this illustrates the point that we have made several times: during periods of slow economic growth, the last thing an advertiser wants to cut is its spending on search-based advertising," said Google chief economist Hal Varian.

Third quarter 2008: "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," Schmidt said, and Varian added, "When there is a recessionary event, and people are counting pennies and researching purchases, this potentially has an upside for Google...We think this kind of effect could work to Google's benefit potentially."

Fourth quarter 2008: "In some ways, the fourth quarter was the easy part," Schmidt said, when the economy was in "uncharted territory. Now it's clear we're in recession. We don't know how long this period will last. We're certainly prepared to get through this (with) no problem."

So yes, Google has been getting more cautious about the economy and its effects, but Thursday's assessment was the most sober by far. In contrast, other companies including Yahoo saw these effects sooner and issued cautionary statements earlier.

Through a Google lens darkly
One curiosity about the timing disparity is that Google, through analysis of search activity through what the company calls the "Google lens," has a view on the economy most other companies lack. Where a business such as Proctor & Gamble has to look at sales data and surveys to project consumer sentiment, Google can look directly at what people are searching for.

Searches on "bankruptcy" increased 53 percent in the last year, and those for "unemployment" more than doubled, said Jonathan Rosenberg, senior vice president of product management.

So what comes next? Google clearly isn't done with search advertising, and there are plenty of opportunities for more money: Google can improve search results overall, drawing ever more search traffic. It can show ads more often, as long as it maintains the quality standards to avoid showing irrelevant or inappropriate ads. It can draw more advertisers to search advertising, increasing the bidding for search terms.

And of course, the company is working on any number of other projects, from closely aligned ones such as ads on image search results, to more distant ones such as graphical "display" ads on YouTube that are targeted at users based on their Web-surfing behavior, to remote ones such as charging subscriptions for online office productivity tools. Such areas are subsidized by search results today, but there could come a day when they stand on their own.

Even though the recession's teeth took a bite out of Google's results, even though Google has trimmed a number of projects that didn't pass muster, and even though the company's employee count actually dropped for the first time, the company still has plenty of money to invest in its other areas.

"We think Google is now well placed for the recovery as it occurs It appears (advertisers') shift to online ROI...is outpacing, on a relative basis, any on loss of economic activity. We benefit from that," Schmidt said. "Our priorities remain unchanged. Basically, long-term growth."

Google's revenue growth rate has been slowing, but for the first time since it went public, the company's quarter-to-quarter revenue declined.

(Credit: Google)

Buoyed by continued growth in search and by cost cuts, Google reported better-than-expected profitability for the first quarter of 2009.

Google's net income increased 8 percent annually to $1.42 billion for the quarter ended March 31, the company reported Thursday. Revenue increased 6 percent to $5.51 billion, but excluding commissions paid to advertisers (called traffic acquisition costs), revenue increased 10 percent to $4.07 billion.

On average, analysts surveyed by Thomson Reuters had expected revenue excluding commissions of $4.085 billion, a bit more than what Google reported. However, the company cleared the earnings forecast as it did in the fourth quarter with earnings per share of $5.16 compared to the $4.93 expected once various charges were factored out.

"Google had a good quarter given the depth of the recession--while revenues were down quarter over quarter, they grew 6% year over year thanks to continued strong query growth. These results underline both the resilience of our business model and the ongoing potential of the web as users and advertisers shift online," Chief Executive Eric Schmidt said in a statement. "Going forward, our priority remains investing for the long term to drive future growth in our core and emerging businesses."

Google makes money when people click on ads next to search results, so search volume growth is central to the company's business. So is the number of times people click, and that figure increased 17 percent from the year-earlier period, Google said.

"Aggregate paid clicks, which include clicks related to ads served on Google sites and the sites of our AdSense partners, increased approximately 17 percent over the first quarter of 2008 and increased approximately 3 percent over the fourth quarter of 2008," the company said.

Google been restraining its exuberant experimentalism, cutting several projects that weren't performing up to snuff. That included not just online services such as Dodgeball but also potential revenue-generation engines such as print and radio ads.

And it's cut hundreds of employees through the process--nearly 200 in sales and marketing, 100 recruiters, 40 in a radio ad project, and an undisclosed number of contractors.

Google's revenue increased yearly but decreased compared to the most recent quarter for the first time. It's not the only ascending curve to start dipping though: Google also for the first time had fewer employees, trimming head count from 20,222 in the fourth quarter of 2008 to 20,164 in the first quarter of 2009.

Google CEO Eric Schmidt

(Credit: Stephen Shankland/CNET)

Update 2:25 p.m. PDT: On a conference call to discuss the earnings results, Schmidt spoke in sober tones while touting his company's overall performance.

"No company is recession-proof. Google is absolutely feeling the impact," Schmidt said.

For one thing, people are still searching, but they're doing more window-shopping and comparison while buying less, Schmidt said. And advertisers are pulling back to bid more on search keywords that produce a stronger return on investment, which means bids in the keyword auctions are generally lower.

Overall, though, the company's business model is healthy, according to Schmidt. "We think Google is now well-placed for the recovery," he said. "The shift to online gives us a real advantage."

He made no economic forecasts about the future beyond cautioning that Google's second and third quarters are typically seasonally slower. Regarding the economy, he said, "we're still basically in uncharted territory."

Google also said that longtime executive Omid Kordestani, senior vice president of global sales and business development, is stepping down to become a senior adviser. He's being replaced by Nikesh Arora, currently president of international operations.

Google has withstood the current economic troubles better than other advertising-dependent companies, but on Thursday, investors will get to see how well the company's belt-tightening is offsetting the recession's deepening effects.

The search giant, which makes the vast majority of its revenue when people click on ads next to search results, reports first-quarter financial results Thursday after the market closes. So far, though, financial analysts are mixed on whether Google's glass is half full or half empty.

On average, analysts surveyed by Thomson Reuters expect revenue excluding commissions to increase 11 percent to $4.085 billion and earnings to increase 2 percent to $4.93 per share compared with a year ago. Because Google reported $4.22 billion in fourth-quarter revenue excluding commissions, this could be the first revenue drop from one quarter to the next.

Google's Mountain View, Calif., headquarters

(Credit: Stephen Shankland/CNET)

But analysts differ in their assessments.

Broadpoint AmTech analyst Rob Sanderson is on the half-empty side. He downgraded Google's stock from "buy" to "neutral," with this to say: "We believe consensus estimates are too high and need to come down for the first quarter and second quarter...We see the stock as more risky in the near-term and believe there may be a better entry point."

But Oppenheimer & Co.'s Jason Helfstein and Anil Gupta differ, expecting Google to meet or beat analyst expectations based on favorable developments with search ad payments. Despite lowering overall 2009 financial projections because of the recession and currency conversion rate issues, Google's "valuation remains compelling" and the analysts raised their stock price target from $390 to $410.

Ripple effects
Though Google's atypical business means it's hard to apply its fortunes to the overall market, its results have ripple effects.

For example, in the long run, the degree of Google's profitability could have repercussions for the company's high innovation rate. Google has shown the patience to invest in services that at least in the short run are money sinkholes. YouTube is the most prominent example, but newer arrivals include a revamped Google Voice, the Android mobile phone operating system, App Engine cloud-computing infrastructure, and Chrome browser.

A more restrained Google has cut several projects that weren't performing up to snuff, not just online services such as Dodgeball but also potential revenue-generation engines such as print and radio ads. And it's cut hundreds of employees through the process--nearly 200 in sales and marketing, 100 recruiters, 40 in a radio ad project, and an undisclosed number of contractors.

So far, the cuts haven't come close to the bone, but Google is being more careful choosing which projects to explore. Google now has "more focused resource allocations going into 2009...The review process is now a part of how we do business," said Jonathan Rosenberg, senior vice president of product management, as Google reported results from the fourth quarter of 2008.

For regular folks on the Web, that could mean fewer Google services or slower improvements to existing services. For competitors such as Facebook, Yahoo, or Microsoft, that could mean a little more breathing room, though of course no competitor is going to be complacent about the Google juggernaut.

Search ad questions
Google's reticence about financial performance and projections keeps people guessing about exactly how it's faring, and the present economic uncertainty compounds the situation. However, there are some data points worth noting.

First is, of course, how much people are searching. Each new search is an opportunity for Google--or search rivals Yahoo and Microsoft--to show an advertisement.

Next is ad coverage. Search engines must carefully balance showing ads more frequently, which can lead to more clicks on those ads and therefore more revenue, against showing them only when they're relevant to the searcher's query, which increases the likelihood that people will find the ads useful. Irrelevant or spammy ads instill the dreaded "ad blindness," in which people grow to ignore ads altogether.

Nielsen said searches grew 16.7 percent annually to 9.5 billion searches in March 2009, with Google outpacing the market with 27.6 percent growth to 6.1 billion searches. But upon seeing the more closely watched numbers from ComScore, JP Morgan analyst Imran Khan lowered his projections of Google's revenue and profit, and lowered his price target as well from $430 to $409.

"We think U.S. search performance will be weaker than previously expected," Khan said in a research note.

Cost-per-click declines
Bad news for search ad fortunes in general were results from Efficient Frontier, a search engine marketing company, which found that companies spent less per search ad in the first quarter of 2009. However, that effect was offset by greater search engine traffic and higher ad coverage, so it's not clear what the overall effect will be to Google and to search companies in general. The uncertainty is made worse by the fact that many statistics are only for the United States, but search and search advertising is a global business.

Finally, there's uncertainty about just how much effect Google's cost cuts are having. Khan estimates Google's expenses will be cut by about $450 million throughout all 2009.

Overall, though, there's no question that Google dominates a large and growing business. The troubles could be big or small, short or long, but Google's online cash engine remains stronger than those at Microsoft or Yahoo.

Investment bank UBS has cut its estimates on digital-ad growth, in conjunction with gloominess about the overall advertising industry. The sector will continue to grow, a report said, but it will slow down significantly.

"UBS estimates that Internet will remain the only segment with positive growth until 2010," a release from the company read, "though the growth rate could drop as low as 10.4 percent in 2009." That's still optimistic compared with some folks in the industry, like Gawker Media founder Nick Denton, who released his own predictions this week that Internet advertising will see a 40 percent drop before the worst of the recession is over.

The bank's estimate for 2008 digital-ad growth has been lowered from 22.1 percent to 21.7 percent.

Some other tidbits from the UBS report: It's optimistic about the fate of Yahoo, despite its stock's sink into the $9 range, because of the likelihood of a merger with AOL or another chance at an acquisition by Microsoft. The bank also gave a thumbs-up to Google, which "has significantly decreased hiring and delayed the implementation of its 'server farm' in Oklahoma until 2010."

UBS is more bearish on eBay, which it says "remains a company in an identity crisis" as it vacillates between a focus on auctions and fixed-price commerce.

Apparently there's nothing like a crisis to get people to check financial Web sites.

(Credit: ComScore)

Yahoo is falling victim to the current economic woes, with analysts lowering forecasts for the company's financial future and layoffs in the works. But one part of the company is all but chortling with glee: Yahoo Finance.

According to ComScore's latest statistics, Yahoo is king of the heap, with 19.9 million unique users in the month of September, an all-time high for the site, according to Yahoo. I'm guessing that's going to look small once we see the October statistics, too.

Nowhere in the top 10 is Google Finance. Disclosure: No. 8, though, is BNET, part of CBS Interactive, which operates CNET News.

NEW YORK--He made it past the Federal Communications Commission. But Sirius XM Radio CEO Mel Karmazin now has to deal with Wall Street.

In his keynote interview Tuesday at the Media & Money Conference, a joint production of Dow Jones and Nielsen, Karmazin wasn't in humility mode. "We're probably one of the top 25 media companies today," he said of the newly merged Sirius XM, which brought together the world's only two satellite radio companies. "I think it's very clear that we will be the most successful company in the audio entertainment industry. I know certainly, as ranked by revenue, we'll be there soon. Now we just need to grow our free cash flow and demonstrate that."

As so many have argued in recent weeks, Karmazin's mantra was that Wall Street is misguided, myopic even. "You need to make money, and in this particular environment, with Wall Street being what it is today, I think the companies that get rewarded today are companies that have an awful lot of cash flow, that make a great balance sheet. And that's not us today."

Sirius XM is in a tight spot. The merger was long and costly, both companies have shelled out extraordinary amounts of money to secure personalities like Howard Stern (who cost $500 million alone), and the credit crunch has dealt a blow to the most lucrative base of new satellite radio subscribers--car buyers. Sirius XM also has to refinance about $1 billion in debt, something else that won't be easy considering the volatile market.

Karmazin, a veteran of Viacom and CBS (which publishes CNET News), joined Sirius pre-merger in 2004, and acknowledged that he was brought onboard to accomplish a very difficult task of making the company profitable. "Before Sirius got its first dollar of revenue, which was in 2002, we had billions of dollars invested in the company," he said, explaining that the company had to launch three satellites before a single subscriber could sign up. That was a billion-dollar project.

"The day I joined the company, we had revenues of $67 million, and with revenues of $67 million the company had announced five months before that it had signed Howard Stern for $500 million," he said.

Today, Sirius XM has 19.5 million subscribers, which Karmazin said makes it the second-biggest subscriber base in the cable-satellite space behind Comcast, and is slated to keep growing. Sirius cut back its net losses last quarter, its final quarter before the merger. But the downturn in car sales is making Wall Street and the rest of the world less confident about Sirius' growth projections.

Karmazin said that if the auto market does poorly, there will still be millions of new satellite radio subscribers. "(Let's say) in 2009 there were only 12 million cars sold. That could happen, but no one has forecast that number as low," he speculated. "Of the 12 million, 6 million will leave the assembly line with satellite radio installed. So that would get us 6 million gross adds, and then there's a conversion rate. About 50 percent of those people choose to keep satellite radio...That would mean we're going to add about 3 million new subscribers just from that OEM (original equipment manufacturer) platform.

It was an optimistic pitch to the suit-clad audience, especially considering the widespread belief that satellite radio has been an overpriced, failed experiment.

But the good-ish news? The coming advertising downturn won't shoot down satellite radio. Karmazin said that between 94 percent and 96 percent of Sirius XM's revenue comes from monthly subscription fees, not advertising.

A typo was corrected: Sirius first pulled in revenue in 2002, not 2022.

What was the unlikely culprit behind a 75 percent drop in United Airlines' stock on Monday? An erroneous Google News search, that's what.

The problem was that an investor news service, the South Florida-based Income Securities Advisors, found a Chicago Tribune article from 2002 via Google News and consequently included it in that day's news digest--which wound up on Bloomberg's news wire. The content of the story wasn't the sort you want to be publishing if it isn't true: that United Airlines had filed for bankruptcy. Considering the state of the airline industry today, it was by no means unbelievable, especially considering that United only emerged from bankruptcy in 2006.

By the time United put out a release denying the news, its stock had plummeted 75 percent from $12.30 on Friday to less than $3. It eventually climbed back up to $10.49; Chicago Tribune parent company Tribune Co. pulled the 6-year-old story from its online archives to avoid further confusion. But Nasdaq, which lists United Airline's stock (UAL), decided against rescinding trades that had happened as a result of the mishap.

Income Securities Advisors later said the story had turned up in a bankruptcy-related Google News search, with no time stamp attached. But different accounts of how it exactly happened upon the story don't fully add up.

The Tribune Co. effectively blamed Google's automated news search process, where headlines are filtered by bots and algorithms rather than by humans. The Chicago Tribune reported Tuesday that the six-year-old story "prominently popped up" in a news search, a position usually reserved for very recent news. The reason for its prominence, Google later explained, was that it had wound up on a list of most-read stories on the Web site of the Orlando Sun-Sentinel, another Tribune Co. newspaper. Increased traffic to the story, Google said, set off the bot--as did the fact that the day of the week that the original story was published was a Monday and hence lined up.

Bloomberg has admitted that it doesn't verify the accuracy of the news that comes over its financial data service through third-party partners. But, the Chicago Tribune reported after the fact, there's no evidence of malicious stock manipulation in this case.

Considering the lightning-speed nature of news on the Web, investors have had the occasional sobering reminder that online media isn't always accurate. Last year, a hoax memo published to a blog convinced many a securities professional that there would be delays in the release of the original iPhone, sending Apple's stock tumbling and leading to occasional whispers that someone may have been trying to manipulate the stock price. But the United Airlines situation is unique in that there was no hoax involved--the Tribune story was a real one, albeit old, and nobody appears to have been pulling a prank.

Late last month, Bloomberg accidentally sent the draft of a Steve Jobs obituary over the wire momentarily; luckily, it was pulled before incorrect reports of the Apple CEO's demise could have any effect on company stock.

This post was updated to clarify Income Security Advisors' relationship to Bloomberg, and expanded at 7:41 a.m. PT.