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GOOG > SEC Filings for GOOG > Form 10-Q on 24-Oct-2013All Recent SEC Filings

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Form 10-Q for GOOGLE INC.


24-Oct-2013

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. We aspire to build products and provide services that improve the lives of billions of people globally. Our mission is to organize the world's information and make it universally accessible and useful. 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 Google segment generates revenues primarily by delivering relevant, cost-effective online advertising. Businesses use our AdWords program to promote their products and services with targeted advertising. In addition, the third parties that comprise the Google Network use our AdSense program to deliver relevant ads that generate revenues and enhance the user experience.
Our Motorola Mobile business is focused on mobile wireless devices and related products and services and generates revenues primarily by selling hardware products.
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.


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Our users are increasingly connected to the internet and using multiple devices to access our products and services, a trend that has increased our global search queries and changed our platform mix. 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 users of our products and services as they are delivered on diverse devices, and our ability to create a seamless experience for both users and advertisers in this multi-screen environment. The main focus of our advertising programs is to help businesses reach people in the moments that matter across all devices with smarter ads that are relevant to their intent and context, 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, updating our advertising policies and ensuring their compliance, 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 clicks 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 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 Mobile 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 areas of strategic focus, our systems, data centers, corporate facilities, information technology infrastructure, and employees. We expect to increase our hiring for the remainder of 2013 and provide competitive compensation programs to our employees. Our full-time employee headcount was 53,546 (including 12,433 headcount from Motorola Mobile and 4,995 from Motorola Home) at September 30, 2012, and 46,421 (which includes 4,259 headcount from Motorola Mobile) at September 30, 2013. Acquisitions will also remain an important component of our strategy and use of capital, and we expect our current pace of acquisitions to continue to increase. 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, manufacturing and inventory-related costs, data center costs, content acquisition costs, credit card and other transaction fees, 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


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We completed our acquisition of Motorola on May 22, 2012 (the acquisition date). In December 2012, we entered into an agreement for the disposition of the Motorola Home segment, and, consequently, the related financial results are presented as net income (loss) from discontinued operations in the Consolidated Statements of Income in all periods presented. In April 2013, we completed the sale of the Motorola Home segment.
Subsequent to the acquisition in May 2012, we initiated a restructuring plan in our Motorola business. See Note 9 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.
The following table presents our historical operating results as a percentage of revenues for the periods indicated:

                                              Three Months Ended          Nine Months Ended
                                                 September 30,              September 30,
                                              2012           2013         2012          2013
                                                               (unaudited)
Consolidated Statements of Income Data:
Revenues:
Google (advertising and other)                 86.6 %         92.4 %      92.7  %        92.7 %
Motorola Mobile (hardware and other)           13.4            7.6         7.3            7.3
Total revenues                                100.0          100.0       100.0          100.0
Costs and expenses:
Cost of revenues-Google (advertising and
other)                                         33.4           36.3        34.2           36.6
Cost of revenues-Motorola Mobile (hardware
and other)                                     11.4            6.7         6.2            6.2
Research and development                       14.1           13.5        13.6           13.6
Sales and marketing                            12.9           12.1        12.3           11.9
General and administrative                      7.6            8.3         7.5            8.3
Total costs and expenses                       79.4           76.9        73.8           76.6
Income from operations                         20.6           23.1        26.2           23.4
Interest and other income, net                  0.5            0.2         1.3            0.9
Income from continuing operations before
income taxes                                   21.1           23.3        27.5           24.3
Provision for income taxes                      4.9            3.4         5.5            3.8
Net income from continuing operations          16.2           19.9        22.0           20.5
Net income (loss) from discontinued
operations                                      0.1            0.1        (0.1 )          1.7
Net income                                     16.3 %         20.0 %      21.9  %        22.2 %

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

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                                    Three Months Ended         Nine Months Ended
                                      September 30,              September 30,
                                    2012          2013         2012         2013
                                                    (unaudited)
Google segment
Advertising revenues:
Google websites                  $    7,727    $  9,394     $  22,581    $ 26,902
Google Network Members' websites      3,133       3,148         9,029       9,603
Total advertising revenues           10,860      12,542        31,610      36,505
Other revenues                          666       1,230         1,525       3,325
Google segment revenues              11,526      13,772        33,135      39,830
Motorola Mobile segment
Total Motorola Mobile revenues        1,778       1,184         2,621       3,200

Elimination and other (1)                 -         (63 )           -         (63 )

   Total consolidated revenues   $   13,304    $ 14,893     $  35,756    $ 42,967

(1) Beginning in the quarter ended September 30, 2013, Google and Motorola Mobile segment revenues are impacted by intersegment transactions that are eliminated in consolidation. Additionally, segment revenues associated with certain products were recognized in the quarter ended September 30, 2013 in our segment results, but deferred to future periods in our consolidated financial statements. This presentation is consistent with what is provided to the chief operating decision maker for purposes of making decisions about allocating resources to each segment and assessing its performance. The following table presents our Google segment revenues, by revenue source, as a percentage of total Google segment revenues for the periods presented:

                                           Three Months Ended           Nine Months Ended
                                              September 30,               September 30,
                                           2012           2013         2012           2013
                                                             (unaudited)
Advertising revenues:
Google websites                             67.0 %         68.2 %       68.1 %         67.5 %
Google Network Members' websites            27.2 %         22.9 %       27.3 %         24.1 %
Total advertising revenues                  94.2 %         91.1 %       95.4 %         91.6 %
Google websites as % of advertising
revenues                                    71.2           74.9         71.4           73.7
Google Network Members' websites as %
of advertising revenues                     28.8           25.1         28.6           26.3
Other revenues                               5.8 %          8.9 %        4.6 %          8.4 %

Our Google segment revenues increased $2,246 million and $6,695 million from the three and nine months ended September 30, 2012 to the three and nine months ended September 30, 2013. The increase from the three months ended September 30, 2012 to the three months ended September 30, 2013 resulted primarily from an increase in advertising revenues generated by Google websites and an increase in other revenues driven by higher sales related to digital content and hardware products. The increase from the nine months ended September 30, 2012 to the nine months ended September 30, 2013 resulted primarily from an increase in advertising revenues generated by Google websites and Google Network Members' websites and an increase in other revenues driven by higher sales related to digital content and hardware products. 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 and richer ad formats, the continued global expansion of our products,


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advertisers, and user base, as well as an increase in the number of Google Network Members, partially offset by certain advertising policy changes. The decrease in the average cost-per-click paid by our advertisers was driven by various factors, such as 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, 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, and to a lesser extent, the general strengthening of the U.S. dollar compared to certain foreign currencies. These decreases were partially offset by the revenue shift mix between Google websites and Google Network Members' websites and certain advertising policy changes. Aggregate paid clicks on Google websites and Google Network Members' websites increased approximately 26% from the three months ended September 30, 2012 to the three months ended September 30, 2013 and 23% from the nine months ended September 30, 2012 to the nine months ended September 30, 2013. Average cost-per-click on Google websites and Google Network Members' websites decreased approximately 8% from the three months ended September 30, 2012 to the three months ended September 30, 2013 and 6% from the nine months ended September 30, 2012 to the nine months ended September 30, 2013. The rate of change in aggregate paid clicks and average cost-per-click, and their correlation with the rate of change in revenues, has fluctuated and may fluctuate in the future because of various factors, including the revenue growth rates on our websites compared to those of our Google Network Members, advertiser competition for keywords, changes in foreign currency exchange rates, seasonality, the fees advertisers are willing to pay based on how they manage their advertising costs, changes in advertising quality or formats, and general economic conditions. In addition, traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels, also contributes to these fluctuations. Changes in aggregate paid clicks and average cost-per-click may not be indicative of our performance or advertiser experiences in any specific geographic market, vertical, or industry.
Improvements in our ability to 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 displaying advertiser-nominated images that are relevant to the user query and creating a more engaging user shopping experience by enhancing search ads to include richer product information, such as product image, price, and merchant name.
We believe that the increase in the number of paid clicks on Google websites and Google Network Members' websites is substantially the result of our commitment to improving the relevance and quality of both our search results and the advertisements displayed, which we believe results in a better user experience, which in turn results in more searches, advertisers, and Google Network Members and other partners.
Our Motorola Mobile segment revenues decreased $594 million from the three months ended September 30, 2012 to the three months ended September 30, 2013. The decrease is due to a more streamlined product portfolio as a result of the various restructuring activities that have occurred in our Motorola Mobile segment.
Our Motorola Mobile segment revenues increased $579 million from the nine months ended September 30, 2012 to the nine months ended September 30, 2013. The increase was primarily because approximately four months of results were included in the nine months ended September 30, 2012 while full period results were included in the nine months ended September 30, 2013. This increase was partially offset by the impact of our restructuring activities aimed at simplifying our Motorola Mobile product portfolio. Revenues by Geography
The following table presents our Google segment domestic and international revenues as a percentage of Google segment revenues, determined based on the billing addresses of our customers for our Google segment:

                    Three Months Ended        Nine Months Ended
                       September 30,            September 30,
                     2012          2013       2012         2013
                                    (unaudited)
United States         47 %           44 %      46 %          45 %
United Kingdom        11 %           10 %      11 %          10 %
Rest of the world     42 %           46 %      43 %          45 %


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The following table presents our consolidated domestic and international revenues as a percentage of consolidated revenues, determined based on the billing addresses of our customers for our Google segment, and ship-to addresses of our customers for our Motorola Mobile segment:

                    Three Months Ended        Nine Months Ended
                       September 30,            September 30,
                     2012          2013       2012         2013
                                    (unaudited)
United States         49 %           45 %      47 %          45 %
United Kingdom         9 %            9 %      10 %          10 %
Rest of the world     42 %           46 %      43 %          45 %

The growth in revenues from the rest of the world (other than the United Kingdom) as a percentage of the Google segment and consolidated revenues from the three and nine months ended September 30, 2012 to the three and nine months ended September 30, 2013 resulted largely from increased acceptance of our advertising programs, and our continued progress in developing localized versions of our products for the international markets.
In addition, the general strengthening of the U.S. dollar relative to certain foreign currencies (primarily the Japanese yen and the Brazilian real) had an unfavorable impact on our consolidated international revenues, which was partially offset by the general weakening of the U.S. dollar relative to other foreign currencies (primarily the Euro), from the three months ended September 30, 2012 to the three months ended September 30, 2013. Had foreign exchange rates remained constant in these periods, our revenues from the rest of the world would have been approximately $136 million, or 2.0%, higher in the three months ended September 30, 2013 and our consolidated revenues from the United Kingdom would have been $19 million, or 1.4%, higher. This is before consideration of hedging gains of $5 million and $17 million recognized to revenues from the rest of the world and the United Kingdom in the three months ended September 30, 2013.
The general strengthening of the U.S. dollar relative to certain foreign currencies (primarily the Japanese yen and the Brazilian real) had an unfavorable impact on our consolidated international revenues, which was partially offset by the general weakening of the U.S. dollar relative to other foreign currencies (primarily the Euro), from the nine months ended September 30, 2012 to the nine months ended September 30, 2013. Had foreign exchange rates remained constant in these periods, our revenues from the rest of the world would have been approximately $441 million, or 2.3%, higher in the nine months ended September 30, 2013 and our consolidated revenues from the United Kingdom would have been $72 million, or 1.8%, higher. This is before consideration of hedging gains of $31 million and $61 million recognized to revenues from the rest of the world and the United Kingdom in the nine months ended September 30, 2013.

Although we expect to continue to make investments in international markets, these investments may not result in an increase in our international revenues as a percentage of total revenues in the remainder of 2013 or thereafter. See Note 14 of Notes to Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information about geographic areas.
Costs and Expenses
Cost of Revenues
Cost of revenues consists primarily of traffic acquisition costs. Traffic acquisition costs consist of amounts ultimately paid to our Google Network Members under AdSense arrangements and to certain other partners (our distribution partners) who distribute our toolbar and other products (collectively referred to as access points) or otherwise direct search queries to our website (collectively referred to as distribution arrangements). These amounts are primarily based on the revenue share and fixed fee arrangements with our Google Network Members and distribution partners.
Certain distribution arrangements require us to pay our partners based on a fee per access point delivered and not exclusively - or at all - based on revenue share. These fees are non-refundable. Further, these arrangements are terminable at will, although under the terms of certain contracts we or our distribution partners may be subject to penalties in the event of early termination. We recognize fees under these arrangements over the estimated useful lives of the access points (approximately two years) to the extent we can reasonably estimate those lives and they are longer than one year, or based on any contractual revenue share, if greater. Otherwise, the fees are charged to expense as incurred. The estimated useful life of the access points is based on the historical average period of time they generate traffic and revenues.


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Cost of revenues also includes the expenses associated with the operation of our data centers, including depreciation, labor, energy, and bandwidth costs, hardware inventory costs, credit card and other transaction fees related to processing customer transactions, amortization of acquisition-related intangible assets, as well as content acquisition costs. We have entered into arrangements with certain content providers under which we distribute or license their video and other content. 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 also license content on the pages of our web sites from which the content is sold and share most of the fees these sales generate with content providers. To the extent we are obligated to make guaranteed minimum revenue share payments to our content providers, we recognize as content acquisition costs the contractual revenue share amount or the amount determined on a straight-line basis, whichever is greater, over the terms of the agreements.
In addition, cost of revenues includes manufacturing and inventory-related costs primarily from our Motorola Mobile segment.
The following tables present our consolidated cost of revenues, our traffic acquisition costs, and traffic acquisition costs as a percentage of advertising revenues in the Google segment, for the periods presented (dollars in millions):

                                               Three Months Ended               Nine Months Ended
                                                  September 30,                   September 30,
                                               2012             2013           2012            2013
                                                                  (unaudited)
Cost of revenues - Google (advertising
and other)                               $     4,440         $   5,409     $    12,213     $   15,740
Cost of revenues - Motorola Mobile
(hardware and other)                           1,515             1,004           2,208          2,680
Total cost of revenues (1)               $     5,955         $   6,413     $    14,421     $   18,420

(1) Total cost of revenues includes stock-based compensation expense, as well as restructuring and other charges.

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