Google: The Recession Takes Its Toll

The company's first quarter-on-quarter sales decline shows even the mighty search giant isn't immune to the pullback in ad spending

It's official now: Even Google can't escape the recession. With its first-quarter results on Apr. 16, the leader in Web search revealed its first quarter-on-quarter decline in sales, reflecting cutbacks in online ad spending. Thanks to cost cutting, Google (GOOG) handily beat profit expectations, but it offered no assurance that overall business conditions would turn around anytime soon.

Google's revenue, almost all of which comes from advertisements placed next to related search results, rose 6% from a year earlier but slipped 3% from the fourth quarter. Sales, after subtracting commissions to Web site partners, were $4.07 billion. That's about what analysts, who have been reducing their estimates in recent weeks, had expected.

Investors initially liked what they saw, boosting the stock almost 6% in extended trading after the figures were released. After all, Google's slowdown looks good compared with the larger advertising market, which is expected to fall at least 5% this year. But as it became apparent that Google's underlying business was feeling the effects of the recession, shares reversed course and gained only a fraction of 1%. "The quarter confirms that Google is suffering from the economic slowdown," says Sandeep Aggarwal, analyst at financial-services firm Collins Stewart.

No Rebound Yet

In comments during a conference call with analysts, Google executives, who don't provide formal earnings guidance, were muted in their outlook. They noted that the second and third quarters are usually "seasonally weak," implying they see little scope for a rebound, at least for now. "We're still basically in uncharted territory" in the overall economy, Google Chief Executive Eric Schmidt said, repeating a phrase he used in the previous quarter. "The economic environment…remains tough. Google absolutely feels the impact."

Google's reluctance to discuss the outlook for Web advertising echoes the unwillingness of chipmaker Intel (INTC) to issue a forecast when announcing its first-quarter results. But unlike Google, Intel was able to call a bottom in demand for the computers that use its semiconductors. Even mobile-phone maker Nokia (NOK) said it expects sales of wireless handsets to be flat or rise in the current quarter.

As uncertain as the market remains, Google's stock has been on a tear lately. Before rising 2.4% on Apr. 16 ahead of the earnings report, to 388.74 a share, the stock had risen 18% since the start of the year and more than 40% since hitting bottom last November. That run came during a period when the Nasdaq gained about 25%. In January, Google reported better-than-expected fourth-quarter results.

Slashing Expenditures

Because Google dominates just one business, search advertising, it's difficult to extrapolate its results to other Internet companies, such as Yahoo! (YHOO), which reports earnings on Apr. 21. But comments by Google's executives on the state of online advertising and the outlook for the economy provide the earliest indication of the difficulties that online advertising firms, and perhaps media overall, will face in coming months.

Thanks to belt-tightening, Google's profit picture was much brighter. After years of high spending on hiring and capital improvements, which started easing last year, Google cut expenses sharply. It has shaved its employee count by 58 since December, to 20,164. Capital spending, $263 million, was down 40% from the fourth quarter, though the company said it could rise again.

Under the direction of Chief Financial Officer Patrick Pichette, who joined the company last August, Google has announced two rounds of job cuts since January, eliminating up to 300 positions in sales, marketing, and employee recruiting. That's in addition to cutting thousands of contractors late last year. At the same time, it has shuttered several small operations, including a radio advertising project. All that helped Google earn $5.16 a share, notably more than analysts' forecasts of $4.93 a share and up from $4.84 a year ago.

Notable Departures

Google also announced that Omid Kordestani, Google's top sales executive and senior vice-president for global sales and business development, is stepping into a new role of advising the company's executive trio, Schmidt and co-founders Sergey Brin and Larry Page. Kordestani's departure from the sales job (he has been replaced by Nikesh Arora, current head of European and Middle Eastern operations) caps a tumultuous period in Google's sales organization. In recent weeks, top sales executive Tim Armstrong left to be CEO of Time Warner's AOL unit, and Sukhinder Singh Cassidy, former president for Asian and Latin American sales, left for venture capital firm Accel Partners.

Later in the day, Google's video-sharing site, YouTube, announced plans to offer free TV shows and full-length movies from several studios. The studios involved are Sony Pictures (SNE), CBS (CBS), MGM Mirage (MGM), Lions Gate Entertainment (LGF), and Liberty Media's Starz—though it's uncertain how much content each will make available. YouTube also redesigned its site to put greater emphasis on professionally produced material.

As for Google's core business, analysts aren't anticipating a return to higher growth for online advertising anytime soon. Recent reports from search marketing firms indicated first-quarter drops in search ad spending comparable to the one suffered by Google, though they also saw an uptick in March. Search marketers continue to be careful about how they spend. "People are coming to us with more stringent metrics for returns," says David Karnstedt, CEO of search marketing firm Efficient Frontier.

More Clicks Per Sale

What's more, consumers are shopping around more before buying, making ads placed on sites such as Google's less valuable to marketers on a click-by-click basis. Google said the number of paid clicks in the quarter rose a healthy 17% from a year ago. "People are searching and clicking on ads as much as ever," says Jeffrey Lindsay, senior analyst with Sanford Bernstein. "But it's now taking 15 to 20 clicks vs. 10 to 15 clicks to sell something." As a result, prices per click on search ads fell 13% in the first quarter from the fourth, Efficient Frontier says.

Another search marketing company, SearchIgnite, said in a recent report that the average time between when a consumer clicked on an ad and subsequently bought something increased 32% from a year ago. "Consumers are being more cautious," says SearchIgnite President Roger Barnette. "But they're eventually making the purchase."

Analysts said Google may have an advantage over other companies in advertising and technology once the economy improves. "Paid search will respond almost immediately to an upturn," says Lindsay, because marketers can instantly start spending, unlike in traditional media, where more planning is required. But as Google made clear, that upturn is still nowhere in sight.

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