Why Google Inc. Earnings Missed the Mark

By Markets Fool.com

Google just announced fourth-quarter 2014 results, and the search giant's stock initially fell around 3% in after-hours trading.

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On the surface Google's performance seems strong: Quarterly consolidated revenue climbed 15%, to $18.1 billion, which translated to adjusted net income of $4.74 billion, or $6.88 per share. But analysts, on average, were looking for higher earnings of $7.12 per share on revenue of $18.47 billion.

So what happened?

The challenge of a global business
Google CFO Patrick Pichette noted its revenue growth came "despite strong currency headwinds." International revenue totaled $10.23 billion during the quarter, representing 56% of Google's overall sales. That includes $1.66 billion, or 9% of the total, from the United Kingdom alone.

Had foreign exchange rates remained constant on a sequential basis from Q3 to Q4, Google says its revenue in the fourth quarter would have been $541 million higher. But that's also not mentioning that Google eased its currency pain through its foreign exchange risk management program. Excluding gains from that program, revenue would have been $616 million higher. Either way, it's apparent Google's revenue "weakness" isn't a symptom of a deeper problem with its business.

On the "Other" category
Google's "Other Revenues" category -- which most notably includes young non-search products like mobile hardware and Google Play -- rose 19% over the same year-ago period, to $1.95 billion. Curiously, though, that represents a significant deceleration from the growth Google's "Other" segment enjoyed last quarter, when sales jumped 50% year over year, to $1.84 billion.

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Pichette noted during the subsequent conference call that "Other" revenue growth was driven once again by app sales from the Google Play store, but offset by a combination of the same foreign exchange headwinds and challenges in its hardware business. Specifically on the latter, Pichette stated that, while Google's Nexus 6 smartphone was very well received by consumers, the company had trouble securing sufficient inventory to meet the demand it had forecasted.

Google's core ad business is still strong
The share of Google's core advertising business rose to 89.2% of total revenue, up from 88.9% last quarter.Google's Sites revenue performed admirably, rising 18% year over year, to $12.43 billion, while Google's Network revenue from partner sites rose just 6%, to $3.72 billion.

Aggregate paid clicks increased roughly 14% over the same period last year. That was driven by a solid 18% year-over-year increase in clicks from Google-owned sites like YouTube, Maps, and Finance, and held back by an 11% decrease in paid clicks from Network partners.

Average cost-per-click -- which measures how much Google actually makes per advertisement -- decreased a modest 3% over the same period, driven by an 8% decline in cost-per-click at Google sites, and propped up by a 6% increase in Network cost-per-click. This is a reasonably strong result, and marks the second-slowest fall in cost-per-click since declines began in late 2011.

On cash flow, CapEx and operating expenses
Google's net cash from operations rose 21.4% year over year, to $6.36 billion. After it spent $3.55 billion on capital expenditures, free cash flow was $2.81 billion during the quarter. Most of those capital expenditures were allocated for purchases of real estate, production equipment, and data center construction to support growth from Google's already-massive scale, so it should come as no surprise Google insists it plans to continue making these significant investments going forward.

Finally, Google's operating expenses were $6.78 billion during the quarter, or roughly 37% of revenue, compared to $5.03 billion, or 32% of revenue at this time last year. This shouldn't be of much concern to long-term investors, as this cash is largely used to fund Google's ambitious R&D efforts, foster innovation, and invest in promising future revenue sources. To the contrary, investors should be elated Google isn't resting on its laurels.

Google's foreign exchange headwinds were a primary antagonist; that's why I'm convinced this quarter just isn't as bad as the headline numbers seem to imply.

The article Why Google Inc. Earnings Missed the Mark originally appeared on Fool.com.

Steve Symington has no position in any stocks mentioned. The Motley Fool recommends Google (A shares) and Google (C shares). The Motley Fool owns shares of Google (A shares) and Google (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.