Google's (NASDAQ:GOOG) (NASDAQ:GOOGL) third-quarter earnings are in, and the market doesn't seem impressed, as both classes of its public shares have fallen by about 3% in after-hours trading. The search-engine giant and all-around technology titan reported consolidated revenue of $16.52 billion, and $6.35 in adjusted earnings per share, good for year-over-year revenue growth of 20% and EPS growth of 13%. On a GAAP basis, Google's EPS were $4.09, down from the $4.38 in GAAP EPS reported a year ago.
Despite solid growth on top and bottom lines, Google fell quite a bit short of Wall Street's expectations, which had called for $16.57 billion in consolidated revenue and $6.53 in adjusted EPS. A big reason why Google fell short this quarter was because its paid clicks -- a metric that tracks the number of ads served up to everyone using Google sites or Google's many partner sites -- grew at the slowest rate since the third quarter of 2010.
It's all about clicks
At growth of 17% year-over-year, paid clicks failed to grow by at least 20% for the first time since the second quarter of 2011. A small silver lining exists in the fact that costs-per-click, a measure of how much Google actually makes per ad, declined at the slowest rate since such declines began in late 2011:
When I previewed Google's earnings earlier this week, I warned that a slowdown in paid clicks would prove damaging if the company's costs-per-click fell at faster-than-usual rates. The minuscule drop in costs-per-click certainly prevented a worse showing today, and a 20% year-over-year growth in revenue is nothing to sneeze at.
However, 20% growth might seem confusing to anyone who's been calculating Google's growth rates based on Motorola's contributions during the time it was part of the company. Google apparently excludes Motorola revenue entirely from its unaudited financial history -- with Motorola sources included, Google's revenue is only up by roughly 11% over the third quarter of 2011:
Cash flow stability
Google's EPS growth also looks a bit wobbly, as it keeps bouncing from highs of 20%-plus growth year-over-year to barely any growth at all over the past three years. However, an extended stretch of negative free cash flow growth ended in a big way this quarter -- with a year-over-year growth rate of 28%, Google's third quarter free cash flow improved at a faster rate than it has since mid-2012:
After years of surging capital expenditures, Google barely spent more on capex this quarter than it did a year ago -- capex spending is up only 5.6% from the year-ago quarter. At $2.42 billion for the quarter, Google's still pouring a lot of money into capex, but it seems to have finally found a level at which it can comfortably remain while still addressing its insatiable hardware and real estate demands. This could easily change going forward, but it's nice to see Google finding a level at which it can grow this important metric without sacrificing its future.
Ad revenue share
Google remains very much an advertising company, as ad revenues accounted for 88.9% of all revenue during the third quarter. However, advertising is now at its lowest share of consolidated revenue this decade, and this is also the first time that Google's ad revenue has been less than 89% of all revenues, down from a consistent 95% share just a few years ago.
To reduce its reliance on ad spending, Google keeps investing heavily into R&D, which accounted for 15.5% of revenue during the third quarter -- by far its highest level in this decade. This diversification effort has had the effect of hurting Google's net margin, which (barring one Motorola-damaged quarter in 2012) is at its lowest level this decade:
All in all, today's earnings report paints a picture of a maturing Google in mid-pivot toward a more diverse range of revenue sources. It's still an incredibly strong company, but the data now indicate that Google may no longer be able to sustain its supercharged margins as it seeks out new ways to leverage its dominance over the world's Internet data.
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