Google Q2 profit surges but below expectations

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SAN FRANCISCO -- Google Inc.'s earnings growth decelerated dramatically in the second quarter as the Internet search leader spent more money hiring new employees and acquiring online content, jolting investors who had been betting on higher profits.

For most companies, the 28% earnings increase Google reported Thursday would be a cause for celebration. But the Mountain View-based company's quarterly profits had never before improved by less than 60%, so Wall Street viewed Google's latest results as a major letdown.

The distress caused Google shares to plunge more than 7%.

"It seems like a pretty significant overreaction in the market," said Cantor Fitzgerald analyst Derek Brown. "The quarter wasn't perfect, but it was really good."

Capitalizing on the Internet's largest ad network, Google earned $925.1 million, or $2.93 per share, during the three months ended in June. That compared with net income of $721.1 million, or $2.33 per share, at the same time last year.

If not for costs associated with employee stock compensation, Google said it would have earned $3.56 per share. That figure missed the average analyst estimate of $3.59 per share among analysts polled by Thomson Financial. It marked just the second time that Google hasn't exceeded analyst expectations in its 12 quarters as a public company.

Revenue for the period totaled $3.87 billion, a 58% increase from $2.46 billion at the same time last year.

After subtracting commissions paid to its advertising partners, Google's revenue was $2.72 billion -- about $40 million above analyst projections.

Google also fared far better than one of its biggest rivals, Yahoo Inc., whose profit dipped 2% in the second quarter while revenue increased by 8%.

But investors nevertheless focused on Google's slowing earnings growth. Google shares plummeted $39.06, or 7.1%, in extended trading after ending Thursday's regular session at $548.59.

At the time of Google's August 2004 initial public offering, co-founders Sergey Brin and Larry Page stressed that they wouldn't manage the company just so it could hit Wall Street's short-term earnings target.

True to form, Brin shrugged off the sharp drop in Google's stock price. "I guess there are some people out there who think we have already picked all the low-hanging, juicy fruit, but I think the jury is still out on how far we can take this business," Brin said.

Google already has come a long way in a short time by turning its search engine into a moneymaking machine as more advertisers shift their spending to the Internet. The search engine, which processes about half of all search queries in the United States, has become the centerpiece of an ad network that spans thousands of Web sites.

Although Google isn't even a decade old yet, the company's revenue is expected to surpass $15 billion this year.

But the second quarter left analysts guessing about how much of that revenue will trickle down to Google's bottom line.

Already well-known for pampering its employees, Google poured even more money into expanding its work force during the spring. Google hired 1,548 additional employees during the quarter, compared with the 1,152 workers it added at the same time last year.

Google Chairman Eric Schmidt told analysts in a conference call that the company would be more "careful" about adding employees in future quarters. Brin reiterated that sentiment in an interview, saying the company would be more disciplined in its future hiring now that it has attracted enough employees to pursue its ambitions.

"We have always been perpetually understaffed until now," Brin said.

Google ended June with 13,786 employees, a 74% increase during the past year.

The company also listed "content acquisition costs" in its quarterly breakdown for the first time.

American Technology Research analyst Rob Sanderson interpreted that development as a sign that Google is anteing up to avoid copyright complaints, particularly at YouTube.com, the popular online video site acquired late last year for $1.76 billion.

Viacom Inc. is suing YouTube and Google for $1 billion in damages, alleging rampant infringement.

Google included its content acquisition costs with expenses for operating data centers and processing credit card charges. Combined, those costs totaled $412 million, or 11% of revenue in the second quarter. Last year, Google spent $204 million, or 8% of revenue, in the same category last year when content acquisition costs weren't included.
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