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GOOG > SEC Filings for GOOG > Form 10-Q on 30-Oct-2012All Recent SEC Filings

Show all filings for GOOGLE INC.

Form 10-Q for GOOGLE INC.


30-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Overview

Google is a global technology leader focused on improving the ways people connect with information. Our innovations in web search and advertising have made our website a top internet property and our brand one of the most recognized in the world. Our mission is to organize the world's information and make it universally accessible and useful. We serve three primary constituencies:

Users. We provide users with products and services that enable people to more quickly and easily find, create, and organize information that is useful to them.

Advertisers. We provide advertisers with cost-effective ways to deliver online and offline ads to customers across Google-owned websites and through the Google Network, which is the network of third parties that use our advertising programs to deliver relevant ads with their search results and content.

Google Network Members and Other Content Providers. We provide members of our Google Network with our Google AdSense programs. These include programs through which we distribute our advertisers' AdWords ads for display on the websites of our Google Network Members. We share most of the fees these ads generate with our Google Network Members, thereby creating an important revenue stream for them. In addition, we have entered into arrangements with other content providers under which we distribute or license their video and other content, and we may display ads next to or as part of this content on the pages of our websites. We share most of the fees these ads generate with these content providers, thereby creating an important revenue stream for these partners.

As a result of our acquisition of Motorola, we also provide innovative technologies, products and services that enable a range of mobile and wireline digital communication, information and entertainment experiences. Motorola's integrated products and platforms deliver rich multimedia content, such as voice, video, messaging and internet-based applications and services to multiple screens, such as mobile devices, including smartphones and media tablets, televisions, and personal computers.


Table of Contents

Our Motorola business is comprised of two segments. The Mobile segment is focused on mobile wireless devices and related products and services. The Home segment is focused on technologies and devices that provide video entertainment services to consumers by enabling subscribers to access a variety of interactive digital television services.

How We Generate Revenue

We generate revenues from our Google business primarily by delivering online advertising, and from our Motorola business primarily by selling hardware products.

Google (Advertising and Other)

Advertising revenues made up 96% of our Google revenues for the three and nine months ended September 30, 2011, and 94% and 95% of our Google revenues for the three and nine months ended September 30, 2012, respectively. We derive most of our other revenues from our enterprise products, as well as our display advertising management services to advertisers, ad agencies, and publishers.

Google AdWords is our auction-based advertising program that enables advertisers to place text-based and display ads on our websites and our Google Network Members' websites. Display advertising comprises the videos, text, images, and other interactive ads that run across the web on computers and mobile devices, including smart phones and handheld computers such as netbooks and tablets. Most of our AdWords advertisers pay us on a cost-per-click basis, which means that an advertiser pays us only when a user clicks on one of its ads. We also offer AdWords on a cost-per-impression basis that enables advertisers to pay us based on the number of times their ads appear on our websites and our Google Network Members' websites as specified by the advertisers. For advertisers using our AdWords cost-per-click pricing, we recognize as revenue the fees charged to advertisers each time a user clicks on one of the ads that appears next to the search results or content on our websites or our Google Network Members' websites. For advertisers using our AdWords cost-per-impression pricing, we recognize as revenue the fees charged to advertisers each time their ads are displayed on our websites or our Google Network Members' websites. Our AdWords agreements are generally terminable at any time by our advertisers.

Google AdSense refers to the online programs through which we distribute our advertisers' AdWords ads for display on our Google Network Members' websites, as well as programs to deliver ads on television broadcasts. Our AdSense programs include AdSense for search and AdSense for content.

AdSense for search is our online service for distributing relevant ads from our advertisers for display with search results on our Google Network Members' websites. To use AdSense for search, most of our AdSense for search partners add Google search functionality to their web pages in the form of customizable Google search boxes. When visitors to these websites search either the website or the internet using these customizable search boxes, we display relevant ads on the search results pages, targeted to match user search queries. Ads shown through AdSense for search are text ads.

AdSense for content is our online service for distributing ads from our advertisers that are relevant to content on our Google Network Members' websites. Under this program, we use automated technology to analyze the meaning of the content on the web page and serve relevant ads based on the meaning of such content. For example, a web page on an automotive blog that contains an entry about vintage cars might display ads for vintage car parts or vintage car shows. These ads are displayed in spaces that our AdSense for content partners have set aside on their websites. AdSense for content allows a variety of ad types to be shown, including text ads, image ads, Google Video Ads, link units (which are sets of clickable links to topic pages related to page content), themed units (which are regular text ads with graphic treatments that change seasonally and by geography), and gadget ads (which are customized "mini-sites" that run as ads on AdSense publisher websites).

For our online AdSense program, our advertisers pay us a fee each time a user clicks on one of our advertisers' ads displayed on our Google Network Members' websites or, for those advertisers who choose our cost-per-impression pricing, as their ads are displayed. To date, we have paid most of these advertiser fees to our Google Network Members, and we expect to continue doing so for the foreseeable future. We recognize these advertiser fees as revenue and the portion of the advertiser fee we pay to our Google Network Members as traffic acquisition costs under cost of revenues. Google Network Members do not pay any fees associated with the use of our AdSense program on their websites.

Our agreements with Google Network Members consist largely of uniform online "click-wrap" agreements that members enter into by interacting with our registration websites. The standard agreements have no stated term and are terminable at will. Agreements with our larger members are individually negotiated. Both the standard agreements and the negotiated agreements require us to share with the Google Network Member most of the advertiser fees generated by users clicking on ads on the Google Network Member's website or, for advertisers who choose our cost-per-impression pricing, as the ads are displayed on the Google Network Member's website. For example, under our standard agreements, we pay 51% and 68% of the fees collected from advertisers to our Google Network Members in AdSense for search and AdSense for content, respectively.


Table of Contents

We have entered into arrangements with certain content providers under which we distribute or license their video and other content. Our agreements with content providers are typically standard agreements with no stated term and are terminable at will. Agreements with our larger members are individually negotiated. Both the standard agreements and the negotiated agreements require us to pay the content providers for the content we license. In a number of these arrangements, we display ads on the pages of our websites from which the content is viewed and share most of the fees these ads generate with the content providers. We recognize these advertiser fees as revenue and the fees we pay to our content providers as content acquisition costs under cost of revenues.

We believe the factors that influence the success of our advertising programs include the following:

The relevance, objectivity, quality, and precision of our search results and the relevance and quality of ads displayed with each search results page.

The number of searches initiated at our websites and our Google Network Members' websites and the underlying purpose of these searches (for instance, whether they are for academic research, to find a news article, or to find a product or service) and the platform used to initiate the searches (for instance, whether they are initiated via desktop or mobile devices).

Our ability to increase traffic on our websites and our Google Network Members' websites via new and improved ad formats, through devices other than personal computers, such as mobile phones and tablets.

The number and prominence of ads displayed on our websites and our Google Network Members' websites.

The number of visits to, and the content of, our Google Network Members' websites and certain of our websites and the relevance and quality of the ads we display next to this content.

The advertisers' return on investment from advertising campaigns on our websites or our Google Network Members' websites compared to other forms of advertising and other available online environments for advertising, including those of our competitors.

The total advertising spending budgets of each advertiser.

The number of advertisers and the breadth of items advertised.

The amount we ultimately pay our Google Network Members, distribution partners, and our content providers for traffic, access points, and content, compared to the amount of revenues we generate.

We also generate revenues from the sale of hardware products. We recognize fees derived from the sale of these products as other revenues in the period in which they are delivered.

Motorola (Hardware and Other)

We generate revenues from our Motorola business through two segments. The Mobile segment designs, manufactures, sells and services wireless mobile devices, with integrated software and accessory products. The Home segment designs, manufactures, sells, installs and services set-top boxes for digital and Internet protocol (IP) video, satellite and terrestrial broadcast networks, and Internet protocol television (IPTV) distribution systems, broadband access network infrastructure platforms, and associated software solutions to cable TV and telecommunication service providers.

Trends in Our Businesses

Advertising transactions continue to shift from offline to online as the digital economy evolves. This has contributed to the rapid growth of our business since inception, resulting in substantially increased revenues, and we expect that our business will continue to grow. However, our revenue growth rate has generally declined over time, and it could do so in the future as a result of a number of factors, including increasing competition, our investments in new business strategies, products, services, and technologies, changes in our product mix, query growth rates and how users make queries, challenges in maintaining our growth rate as our revenues increase to higher levels, and the evolution of the online advertising market, including the increasing variety of online platforms for advertising, and other markets in which we participate. Mobile search queries and mobile commerce are growing dramatically around the world, and consumers are using multiple devices to access information. Over time these trends have resulted in changes in our product mix, including a significant increase in mobile search queries and a deceleration in the growth of desktop queries. We expect that our revenue growth rate will continue to be affected by evolving consumer preferences, as well as by advertising trends, the acceptance by mobile users of our products and services, and our ability to create a seamless experience for both users and advertisers in a multi-screen environment. In addition, if there is a further general economic downturn, this may result in fewer commercial queries by our users and may cause advertisers to reduce the amount they spend on online advertising, including the amount they are willing to pay for each click or impression, which could negatively affect the growth rate of our revenues. We plan to continue to invest aggressively in our core areas of strategic focus.


Table of Contents

The main focus of our advertising programs is to provide relevant and useful advertising to our users, reflecting our commitment to constantly improve their overall web experience. As a result, we expect to continue to take steps to improve the relevance of the ads displayed on our websites and our Google Network Members' websites. These steps include not displaying ads that generate low click-through rates or that send users to irrelevant or otherwise low quality websites and terminating our relationships with those Google Network Members whose websites do not meet our quality requirements. We may also continue to take steps to reduce the number of accidental clicks by our users. These steps could negatively affect the growth rate of our revenues.

Both seasonal fluctuations in internet usage and traditional retail seasonality have affected, and are likely to continue to affect, our business. Internet usage generally slows during the summer months, and commercial queries typically increase significantly in the fourth quarter of each year. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenues, as well as aggregate paid click and average cost-per-click growth rates.

The operating margin we realize on revenues generated from ads placed on our Google Network Members' websites through our AdSense program is significantly lower than the operating margin we realize from revenues generated from ads placed on our websites because most of the advertiser fees from ads served on Google Network Members' websites are shared with our Google Network Members. For the past five years, growth in advertising revenues from our websites has generally exceeded that from our Google Network Members' websites. This trend has had a positive impact on our operating margins, and we expect that this will continue for the foreseeable future, although the relative rate of growth in revenues from our websites compared to the rate of growth in revenues from our Google Network Members' websites may vary over time. Also, the margins on advertising revenues from mobile devices and other newer advertising formats are generally lower than those from desktop computers and tablets. We expect this trend to continue in the near future and that it will continue to pressure our margins, particularly if we fail to realize the opportunities we anticipate with the transition to a dynamic multi-screen environment.

We conduct our Motorola business in highly competitive markets, facing both new and established competitors. The markets for many of our products are characterized by rapidly changing technologies, frequent new product introductions, changing consumer trends, short product life cycles, consumer loyalty and evolving industry standards. Market disruptions caused by new technologies, the entry of new competitors, consolidations among our customers and competitors, changes in regulatory requirements, changes in economic conditions, supply chain interruptions or other factors, can introduce volatility into our businesses. Meeting all of these challenges requires consistent operational planning and execution and investment in technology, resulting in innovative products that meet the needs of our customers around the world.

From an overall business perspective, we continue to invest aggressively in our systems, data centers, corporate facilities, information technology infrastructure, and employees. We expect to continue our hiring in the remainder of 2012 and provide competitive compensation programs for our employees. Our full-time employee headcount was 31,353 at September 30, 2011 and 53,546 at September 30, 2012, which includes 17,428 headcount related to Motorola. Acquisitions will also remain an important component of our strategy and use of capital, and we expect our current pace of acquisitions to continue. We expect our cost of revenues will increase in dollars and may increase as a percentage of revenues in future periods, primarily as a result of forecasted increases in traffic acquisition costs, data center costs, content acquisition costs, credit card and other transaction fees, manufacturing and inventory-related costs, and other costs. In particular, traffic acquisition costs as a percentage of advertising revenues may increase in the future if we are unable to continue to improve the monetization or generation of revenues from traffic on our websites and our Google Network Members' websites.

As we expand our advertising programs and other products to international markets, we continue to increase our exposure to fluctuations in foreign currency to U.S. dollar exchange rates. We have a foreign exchange risk management program that is designed to reduce our exposure to fluctuations in foreign currency exchange rates. However, this program will not fully offset the effect of fluctuations on our revenues and earnings.

Results of Operations

We completed our acquisition of Motorola on May 22, 2012 (the acquisition date). The operating results of Motorola were included in our Consolidated Statement of Income from the acquisition date through September 30, 2012. In addition, we initiated a restructuring plan in our Motorola business. See Note 10 of Notes to Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion of this restructuring plan and the associated restructuring charges. We continue to evaluate our plans and further restructuring actions may occur, which may cause us to incur additional restructuring charges, some of which may be significant.


Table of Contents

The following table presents our historical operating results as a percentage of our revenues for the periods indicated:

                                                  Three Months Ended             Nine Months Ended
                                                    September 30,                  September 30,
                                                 2011            2012           2011           2012
                                                                    (unaudited)
Consolidated Statements of Income Data:
Revenues:
Google (advertising and other)                     100.0 %         81.7 %         100.0 %        89.7 %
Motorola (hardware and other)                          0           18.3               0          10.3

Total revenues                                     100.0 %        100.0 %         100.0 %       100.0 %

Costs and expenses:
Cost of revenues - Google (advertising and
other)                                              34.8           31.5            34.7          33.0
Cost of revenues - Motorola (hardware and
other)                                                 0           15.0               0           8.5
Research and development                            14.4           14.2            14.1          13.6
Sales and marketing                                 12.4           12.5            12.2          12.1
General and administrative                           6.9            7.4             7.1           7.6
Charge related to resolution of Department
of Justice investigation                               0              0             1.8             0

Total costs and expenses                            68.5           80.6            69.9          74.8

Income from operations                              31.5           19.4            30.1          25.2
Interest and other income, net                       3.1            0.4             2.2           1.3

Income before income taxes                          34.6           19.8            32.3          26.5
Provision for income taxes                           6.5            4.4             6.6           5.3

Net income                                          28.1 %         15.4 %          25.7 %        21.2 %

Revenues

The following table presents our revenues, by revenue source, for the periods
presented (in millions):



                                                    Three Months Ended            Nine Months Ended
                                                       September 30                 September 30,
                                                   2011            2012          2011           2012
                                                                      (unaudited)
Google:
Advertising revenues:
Google websites                                  $   6,740       $  7,727      $  18,851      $ 22,581
Google Network Members' websites                     2,595          3,133          7,506         9,029

Total advertising revenues                           9,335         10,860         26,357        31,610
Other revenues                                         385            666            965         1,525

Total Google revenues (advertising and other)        9,720         11,526         27,322        33,135
Motorola:
Total Motorola revenues (hardware and other)             0          2,575              0         3,825

Total revenues                                   $   9,720       $ 14,101      $  27,322      $ 36,960


Table of Contents

The following table presents our revenues, by business, as a percentage of total revenues for the periods presented:

                                       Three Months Ended           Nine Months Ended
                                          September 30,               September 30,
                                       2011            2012         2011           2012
                                                         (unaudited)
    Google (advertising and other)        100 %           82 %         100 %          90 %
    Motorola (hardware and other)           0             18             0            10

    Total revenues                        100 %          100 %         100 %         100 %

The following table presents our Google revenues, by revenue source, as a percentage of total Google revenues for the periods presented:

                                                  Three Months Ended              Nine Months Ended
                                                    September 30,                   September 30,
                                                2011             2012           2011             2012
                                                                     (unaudited)
Advertising revenues:
Google websites                                     69 %             67 %           69 %             68 %
Google Network Members' websites                    27               27             27               27

Total advertising revenues                          96               94             96               95
Google websites as % of advertising
revenues                                            72               71             72               71
Google Network Members' websites as % of
advertising revenues                                28               29             28               29
Other revenues                                       4 %              6 %            4 %              5 %

Our revenues increased $4,381 million and $9,638 million from the three and nine months ended September 30, 2011 to the three and nine months ended September 30, 2012. These increases resulted primarily from an increase in advertising revenues generated by Google websites and Google Network Members' websites and, to a lesser extent, an increase in other revenues driven by hardware product sales. The increase in advertising revenues for Google websites and Google Network Members' websites resulted primarily from an increase in the number of paid clicks through our advertising programs, partially offset by a decrease in the average cost-per-click paid by our advertisers. The increase in the number of paid clicks generated through our advertising programs was due to an increase in aggregate traffic including mobile queries, certain monetization improvements including new ad formats, the continued global expansion of our products, advertisers, and user base, as well as an increase in the number of Google Network Members. The decrease in the average cost-per-click paid by our advertisers was driven by various factors, such as the general strengthening of the U.S dollar compared to certain foreign currencies (primarily the Euro), the revenue shift mix between Google websites and Google Network Members' websites, the changes in platform mix due to traffic growth in mobile devices, where the average cost-per-click is typically lower compared to desktop computers and tablets, and the changes in geographical mix due to traffic growth in emerging markets, where the average cost-per-click is typically lower compared to more mature markets.

In addition, the increase in our revenues from the three and nine months ended September 30, 2011 to the three and nine months ended September 30, 2012 resulted from the inclusion of revenues from our Motorola business of $2,575 million (of which $1,778 million was from the Mobile segment and $797 million from the Home segment) and $3,825 million (of which $2,621 million was from the Mobile segment and $1,204 million from the Home segment), respectively.

Improvements in our ability to ultimately monetize increased traffic primarily relate to enhancing the end user experience, including providing end users with ads that are more relevant to their search queries or to the content on the Google Network Members' websites they visit. For instance, these improvements include increasing site links to be full size links with the URL (uniform resource locator), moving a portion of the first line of the ad to the heading to better promote the content of the ad, providing an option to preview the ad, and moving the ad's URL to a separate line below the heading for greater page format consistency.

Aggregate paid clicks on Google websites and Google Network Members' websites increased approximately 33% from the three months ended September 30, 2011 to the three months ended September 30, 2012 and 38% from the nine months ended September 30, 2011 to the nine months ended September 30, 2012. Average cost-per-click on Google websites and Google Network Members' websites decreased approximately 15% from the three months ended

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