UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 000-50726
Google Inc.
(Exact name of registrant as specified in its charter)
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Delaware |
77-0493581 |
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(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification Number) |
1600 Amphitheatre Parkway
Mountain View, CA 94043
(Address of principal executive offices)
(Zip Code)
(650) 253-0000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨
Non-accelerated filer (Do not check if a smaller reporting company) ¨ Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
At October 31, 2008, there were 239,534,290 shares of Google’s Class A common stock and 75,219,823 shares of Google’s Class B common stock outstanding.
GOOGLE INC.
INDEX
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Page No.
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PART I. FINANCIAL INFORMATION |
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Item 1 |
Financial Statements |
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Consolidated Balance Sheets—December 31, 2007 and September 30, 2008 (unaudited) |
3 |
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Consolidated Statements of Income—Three and Nine Months Ended September 30, 2007 and 2008 (unaudited) |
4 |
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Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2007 and 2008 (unaudited) |
5 |
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Notes to Consolidated Financial Statements (unaudited) |
6 |
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Item 2 |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
21 |
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Item 3 |
Quantitative and Qualitative Disclosures About Market Risk |
37 |
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Item 4 |
Controls and Procedures |
38 |
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PART II. OTHER INFORMATION |
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Item 1 |
Legal Proceedings |
39 |
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Item 1A |
Risk Factors |
39 |
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Item 2 |
Unregistered Sales of Equity Securities and Use of Proceeds |
51 |
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Item 6 |
Exhibits |
51 |
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Signatures |
52 |
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Exhibit Index |
53 |
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Certifications |
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PART I—FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GOOGLE INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value per share)
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As of
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As of
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(unaudited) |
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Assets |
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Current assets: |
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Cash and cash equivalents............................................................................................................................... |
$ 6,081,593 |
$ 8,370,469 |
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Marketable securities......................................................................................................................................... |
8,137,020 |
6,042,140 |
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Accounts receivable, net of allowance of $32,887 and $75,259................................................................... |
2,162,521 |
2,541,492 |
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Deferred income taxes, net................................................................................................................................ |
68,538 |
111,401 |
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Income taxes receivable, net............................................................................................................................. |
145,253 |
— |
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Prepaid revenue share, expenses and other assets....................................................................................... |
694,213 |
897,349 |
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Total current assets........................................................................................................................................... |
17,289,138 |
17,962,851 |
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Prepaid revenue share, expenses and other assets, non-current.......................................................................... |
168,530 |
456,378 |
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Deferred income taxes, net, non-current.................................................................................................................... |
33,219 |
204,319 |
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Non-marketable equity securities............................................................................................................................... |
1,059,694 |
1,100,896 |
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Property and equipment, net....................................................................................................................................... |
4,039,261 |
5,213,167 |
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Intangible assets, net................................................................................................................................................... |
446,596 |
1,047,717 |
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Goodwill.......................................................................................................................................................................... |
2,299,368 |
4,821,646 |
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Total assets.................................................................................................................................................................... |
$ 25,335,806 |
$ 30,806,974 |
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Liabilities and Stockholders’ Equity |
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Current liabilities: |
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Accounts payable.............................................................................................................................................. |
$ 282,106 |
$ 240,706 |
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Accrued compensation and benefits.............................................................................................................. |
588,390 |
622,658 |
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Accrued expenses and other current liabilities.............................................................................................. |
465,032 |
544,627 |
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Accrued revenue share..................................................................................................................................... |
522,001 |
515,949 |
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Deferred revenue................................................................................................................................................ |
178,073 |
200,378 |
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Income taxes payable......................................................................................................................................... |
— |
99,959 |
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Total current liabilities....................................................................................................................................... |
2,035,602 |
2,224,277 |
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Deferred revenue, non-current.................................................................................................................................... |
30,249 |
29,992 |
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Deferred income taxes, net, non-current.................................................................................................................... |
— |
20,420 |
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Income taxes payable, non-current............................................................................................................................ |
478,372 |
783,348 |
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Other long-term liabilities............................................................................................................................................. |
101,904 |
274,075 |
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Commitments and contingencies |
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Stockholders’ equity: |
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Convertible preferred stock, $0.001 par value, 100,000 shares authorized; no shares issued and outstanding.................................................................................................................................................... |
— |
— |
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Class A and Class B common stock, $0.001 par value: 9,000,000 shares authorized; 312,917 (Class A 236,097, Class B 76,820) and par value of $313 (Class A $236, Class B $77) and 314,587 (Class A 239,364, Class B 75,223) and par value of $315 (Class A $240, Class B $75) shares issued and outstanding, excluding 361 (Class A 336, Class B 25) and 46 (Class A 46) shares subject to repurchase at December 31, 2007 and September 30, 2008..................................................................... |
313 |
315 |
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Additional paid-in capital.................................................................................................................................. |
13,241,221 |
14,194,197 |
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Accumulated other comprehensive income................................................................................................... |
113,373 |
101,162 |
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Retained earnings............................................................................................................................................... |
9,334,772 |
13,179,188 |
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Total stockholders’ equity.......................................................................................................................................... |
22,689,679 |
27,474,862 |
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Total liabilities and stockholders’ equity.................................................................................................................. |
$ 25,335,806 |
$ 30,806,974 |
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See accompanying notes.
GOOGLE INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
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Three Months Ended
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Nine Months Ended
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2007
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2008
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2007
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2008
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(unaudited) |
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Revenues................................................................................................................ |
$ 4,231,351 |
$ 5,541,391 |
$ 11,767,307 |
$ 16,094,646 |
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Costs and expenses: |
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Cost of revenues (including stock-based compensation expense of $4,031, $10,729, $16,080 and $29,240)................................................. |
1,662,579 |
2,173,390 |
4,693,261 |
6,431,501 |
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Research and development (including stock-based compensation expense of $130,655, $169,263, $408,425 and $550,343)................... |
548,712 |
704,571 |
1,489,202 |
2,059,851 |
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Sales and marketing (including stock-based compensation expense of $29,918, $64,497, $93,553 and $149,666)......................................... |
380,820 |
508,801 |
1,038,976 |
1,440,252 |
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General and administrative (including stock-based compensation expense of $33,352, $35,550, $105,288 and $104,345)....................... |
321,398 |
507,064 |
902,202 |
1,391,278 |
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Total costs and expenses.................................................................................... |
2,913,509 |
3,893,826 |
8,123,641 |
11,322,882 |
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Income from operations....................................................................................... |
1,317,842 |
1,647,565 |
3,643,666 |
4,771,764 |
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Interest income and other, net............................................................................ |
154,428 |
21,217 |
422,287 |
246,485 |
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Income before income taxes................................................................................ |
1,472,270 |
1,668,782 |
4,065,953 |
5,018,249 |
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Provision for income taxes................................................................................... |
402,281 |
378,844 |
1,068,682 |
1,173,833 |
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Net income............................................................................................................. |
$ 1,069,989 |
$ 1,289,938 |
$ 2,997,271 |
$ 3,844,416 |
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Net income per share of Class A and Class B common stock: |
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Basic............................................................................................................. |
$ 3.44 |
$ 4.10 |
$ 9.66 |
$ 12.25 |
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Diluted.......................................................................................................... |
$ 3.38 |
$ 4.06 |
$ 9.50 |
$ 12.10 |
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See accompanying notes.
GOOGLE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
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Nine Months Ended
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2007
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2008
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(unaudited) |
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Operating activities |
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Net income..................................................................................................................................................................... |
$ 2,997,271 |
$ 3,844,416 |
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Adjustments: |
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Depreciation and amortization of property and equipment......................................................................... |
565,841 |
898,762 |
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Amortization of intangibles and other............................................................................................................ |
111,881 |
215,615 |
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Stock-based compensation.............................................................................................................................. |
623,346 |
833,594 |
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Excess tax benefits from stock-based award activity................................................................................... |
(238,577 ) |
(114,770 ) |
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Deferred income taxes....................................................................................................................................... |
(184,520 ) |
(124,597 ) |
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Other, net............................................................................................................................................................ |
(7,215 ) |
(14,488 ) |
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Changes in assets and liabilities, net of effects of acquisitions: |
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Accounts receivable............................................................................................................................... |
(559,425 ) |
(218,326 ) |
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Income taxes, net..................................................................................................................................... |
615,568 |
552,673 |
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Prepaid revenue share, expenses and other assets........................................................................... |
(237,262 ) |
(169,959 ) |
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Accounts payable................................................................................................................................... |
20,155 |
(152,165 ) |
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Accrued expenses and other liabilities................................................................................................ |
206,522 |
162,882 |
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Accrued revenue share.......................................................................................................................... |
136,446 |
(4,433 ) |
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Deferred revenue..................................................................................................................................... |
32,131 |
21,354 |
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Net cash provided by operating activities............................................................................................................... |
4,082,162 |
5,730,558 |
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Investing activities |
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Purchases of property and equipment...................................................................................................................... |
(1,724,631 ) |
(1,990,617 ) |
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Purchases of marketable securities............................................................................................................................ |
(11,756,147 ) |
(7,814,293 ) |
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Maturities and sales of marketable securities.......................................................................................................... |
11,519,001 |
9,634,903 |
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Investments in non-marketable equity securities.................................................................................................... |
(21,288 ) |
(44,869 ) |
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Acquisitions, net of cash acquired and proceeds received from divestiture, and purchases of intangible and other assets...................................................................................................................................................... |
(823,092 ) |
(3,287,708 ) |
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Net cash used in investing activities........................................................................................................................ |
(2,806,157 ) |
(3,502,584 ) |
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Financing activities |
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Net proceeds (payments) related to stock-based award activity.......................................................................... |
19,073 |
(38,252 ) |
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Excess tax benefits from stock-based award activity.............................................................................................. |
238,577 |
114,770 |
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Net cash provided by financing activities................................................................................................................ |
257,650 |
76,518 |
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Effect of exchange rate changes on cash and cash equivalents........................................................................... |
28,078 |
(15,616 ) |
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Net increase in cash and cash equivalents.............................................................................................................. |
1,561,733 |
2,288,876 |
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Cash and cash equivalents at beginning of year.................................................................................................... |
3,544,671 |
6,081,593 |
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Cash and cash equivalents at end of period............................................................................................................ |
$ 5,106,404 |
$ 8,370,469 |
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Supplemental disclosures of cash flow information |
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Cash paid for interest................................................................................................................................................... |
$ 1,032 |
$ 1,291 |
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Cash paid for income taxes......................................................................................................................................... |
$ 638,050 |
$ 743,440 |
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See accompanying notes.
GOOGLE INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Google Inc. and Summary of Significant Accounting Policies
Nature of Operations
We were incorporated in California in September 1998. We were re-incorporated in the State of Delaware in August 2003. We provide highly targeted advertising and global internet search solutions as well as intranet solutions via an enterprise search appliance.
Basis of Consolidation
The Consolidated Financial Statements include the accounts of Google and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.
Unaudited Interim Financial Information
The accompanying Consolidated Balance Sheet as of September 30, 2008, the Consolidated Statements of Income for the three and nine months ended September 30, 2007 and 2008, and the Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2008 are unaudited. These unaudited interim Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles. In our opinion, the unaudited interim Consolidated Financial Statements include all adjustments of a normal recurring nature necessary for the fair presentation of our financial position as of September 30, 2008, our results of operations for the three and nine months ended September 30, 2007 and 2008, and our cash flows for the nine months ended September 30, 2007 and 2008. The results of operations for the three and nine months ended September 30, 2008 are not necessarily indicative of the results to be expected for the year ending December 31, 2008.
These unaudited interim Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and related notes included in our 2007 Annual Report on Form 10-K filed on February 15, 2008.
Use of Estimates
The preparation of interim Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to accounts receivable, bad debt and sales allowances, fair values of marketable and non-marketable securities, fair values of prepaid revenue share, intangible assets and goodwill, useful lives of intangible assets and property and equipment, fair values of options to purchase our common stock, income taxes, and legal contingencies, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
Effect of Recent Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. SFAS 141R also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This statement is effective for us beginning January 1, 2009. We are currently evaluating the potential impact of the adoption of SFAS 141R on our consolidated financial position, results of operations and cash flows.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51 (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This statement is effective for us beginning January 1, 2009. We are currently evaluating the potential impact of the adoption of SFAS 160 on our consolidated financial position, results of operations and cash flows.
In February 2008, the FASB issued Financial Staff Positions (“FSP”) SFAS 157-2, Effective Date of FASB Statement No. 157 (“FSP 157-2”), which delays the effective date of SFAS No. 157, Fair Value Measurement (“SFAS 157”), for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. FSP 157-2 partially defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. FSP 157-2 is effective for us beginning January 1, 2009. We are currently evaluating the potential impact of the adoption of those provisions of SFAS 157, for which effectiveness was delayed by FSP 157-2, on our consolidated financial position and results of operations.
In April 2008, the FASB issued FSP SFAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP 142-3”). This guidance is intended to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), and the period of expected cash flows used to measure the fair value of the asset under SFAS 141R when the underlying arrangement includes renewal or extension of terms that would require substantial costs or result in a material modification to the asset upon renewal or extension. Companies estimating the useful life of a recognized intangible asset must now consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, must consider assumptions that market participants would use about renewal or extension as adjusted for SFAS 142’s entity-specific factors. FSP 142-3 is effective for us beginning January 1, 2009. We are currently evaluating the potential impact of the adoption of FSP 142-3 on our consolidated financial position, results of operations and cash flows.
In October 2008, the FASB issued FSP SFAS 157-3, Determining the Fair Value of a Financial Asset When The Market for That Asset Is Not Active (“FSP 157-3”), to clarify how an entity would determine fair value in an inactive market. FSP 157-3 is effective immediately and applies to our September 30, 2008 financial statements. The application of the provisions of FSP 157-3 did not materially impact our consolidated financial position, results of operations and cash flows as of and for the period ended September 30, 2008.
Note 2. Net Income per Share of Class A and Class B common stock
The following table sets forth the computation of basic and diluted net income per share of Class A and Class B common stock (in thousands, except per share amounts, unaudited):
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For the Three Months Ended
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For the Nine Months Ended
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2007
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2008
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2007
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2008
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(unaudited) |
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Class A
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Class B
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Class A
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Class B
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Class A
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Class B
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Class A
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Class B
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Basic net income per share: |
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Numerator: |
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Allocation of undistributed earnings. |
$ 798,259 |
$ 271,730 |
$ 980,865 |
$ 309,073 |
$ 2,225,486 |
$ 771,785 |
$ 2,916,217 |
$ 928,199 |
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Denominator: |
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Weighted average common shares outstanding................... |
232,703 |
79,136 |
239,002 |
75,295 |
231,111 |
80,065 |
238,130 |
75,757 |
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Less: Weighted average unvested common shares subject to repurchase or cancellation.................... |
(519 ) |
(99 ) |
(54 ) |
(2 ) |
(694 ) |
(158 ) |
(148 ) |
(10 ) |
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Number of shares used in per share computations........... |
232,184 |
79,037 |
238,948 |
75,293 |
230,417 |
79,907 |
237,982 |
75,747 |
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Basic net income per share.......... |
$ 3.44 |
$ 3.44 |
$ 4.10 |
$ 4.10 |
$ 9.66 |
$ 9.66 |
$ 12.25 |
$ 12.25 |
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Diluted net income per share: |
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Numerator: |
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Allocation of undistributed earnings for basic computation.. |
$ 798,259 |
$ 271,730 |
$ 980,865 |
$ 309,073 |
$ 2,225,486 |
$ 771,785 |
$ 2,916,217 |
$ 928,199 |
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Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares.......... |
271,730 |
— |
309,073 |
— |
771,785 |
— |
928,199 |
— |
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|||
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For the Three Months Ended
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For the Nine Months Ended
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|||||||||
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2007
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2008
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2007
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2008
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(unaudited) |
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Class A
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Class B
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Class A
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Class B
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Class A
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Class B
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Class A
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Class B
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Reallocation of undistributed earnings to Class B shares.......... |
— |
(2,076 ) |
— |
(2,622 ) |
— |
(4,765 ) |
— |
(8,386 ) |
|||
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Allocation of undistributed earnings......................... |
$ 1,069,989 |
$ 269,654 |
$ 1,289,938 |
$ 306,451 |
$ 2,997,271 |
$ 767,020 |
$ 3,844,416 |
$ 919,813 |
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Denominator: |
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|||
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Number of shares used in basic computation........ |
232,184 |
79,037 |
238,948 |
75,293 |
230,417 |
79,907 |
237,982 |
75,747 |
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Weighted average effect of dilutive securities......... |
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Add: |
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Conversion of Class B to Class A common shares outstanding........ |
79,037 |
— |
75,293 |
— |
79,907 |
— |
75,747 |
— |
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Unvested common shares subject to repurchase or cancellation......... |
618 |
99 |
56 |
2 |
852 |
158 |
158 |
10 |
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Employee stock options including warrants issued under TSO program (see Note 12)............... |
3,719 |
646 |
2,871 |
200 |
3,537 |
709 |
3,128 |
263 |
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Restricted shares and restricted stock units..................... |
1,018 |
— |
608 |
— |
925 |
— |
715 |
— |
|||
|
|
|
|
|
|
|
|
|
|
|||
|
Number of shares used in per share computations |
316,576 |
79,782 |
317,776 |
75,495 |
315,638 |
80,774 |
317,730 |
76,020 |
|||
|
|
|
|
|
|
|
|
|
|
|||
|
Diluted net income per share...... |
$ 3.38 |
$ 3.38 |
$ 4.06 |
$ 4.06 |
$ 9.50 |
$ 9.50 |
$ 12.10 |
$ 12.10 |
|||
|
|
|
|
|
|
|
|
|
|
|||
The net income per share amounts are the same for Class A and Class B because the holders of each class are legally entitled to equal per share distributions whether through dividends or in liquidation. Certain securities have been excluded from our net income per share computation because their effect was anti-dilutive. The number of shares excluded was not material in any of the periods presented.
Note 3. Cash and Investments
We have classified our investments in auction rate securities as non-current assets on the accompanying Consolidated Balance Sheet at September 30, 2008. As of December 31, 2007, these securities were classified as marketable securities. As a result, these amounts have been excluded from the September 30, 2008 balances in the tables below.
Cash, cash equivalents and marketable securities consists of the following (in thousands):
|
|
|
|
|
|
As of
|
As of
|
|
|
|
(unaudited) |
|
Cash and cash equivalents: |
|
|
|
Cash...................................................................................................................................................................... |
$ 2,869,528 |
$ 3,559,448 |
|
Cash equivalents: |
|
|
|
U.S. government notes........................................................................................................................... |
— |
8,995 |
|
U.S. government agencies...................................................................................................................... |
110,272 |
234,488 |
|
Municipal securities................................................................................................................................ |
232,278 |
81,527 |
|
Time deposits........................................................................................................................................... |
500,000 |
2,004,511 |
|
Money market mutual funds.................................................................................................................. |
2,369,515 |
2,481,500 |
|
|
|
|
|
Total cash and cash equivalents................................................................................................ |
6,081,593 |
8,370,469 |
|
|
|
|
|
Marketable securities: |
|
|
|
U.S. government notes...................................................................................................................................... |
475,781 |
247,021 |
|
U.S. government agencies................................................................................................................................ |
2,120,972 |
707,430 |
|
Municipal securities........................................................................................................................................... |
4,991,564 |
5,087,689 |
|
Time deposits...................................................................................................................................................... |
500,000 |
— |
|
Auction rate preferred securities..................................................................................................................... |
48,703 |
— |
|
|
|
|
|
Total marketable securities..................................................................................................................... |
8,137,020 |
6,042,140 |
|
|
|
|
|
Total cash, cash equivalents and marketable securities.................................................................... |
$ 14,218,613 |
$ 14,412,609 |
|
|
|
|
The following table summarizes unrealized gains and losses related to our investments in marketable securities designated as available-for-sale (in thousands):
|
|
|
|
|
|
|
|
As of December 31, 2007
|
|||
|
|
Adjusted
|
Gross
|
Gross
|
Fair Value
|
|
U.S. government notes.................................................................................................. |
$ 472,040 |
$ 3,745 |
$ (4 ) |
$ 475,781 |
|
U.S. government agencies............................................................................................. |
2,102,710 |
18,306 |
(44 ) |
2,120,972 |
|
Municipal securities....................................................................................................... |
4,975,587 |
16,308 |
(331 ) |
4,991,564 |
|
Time deposits.................................................................................................................. |
500,000 |
— |
— |
500,000 |
|
Auction rate preferred securities.................................................................................. |
48,703 |
— |
— |
48,703 |
|
|
|
|
|
|
|
Total marketable securities................................................................................. |
$ 8,099,040 |
$ 38,359 |
$ (379 ) |
$ 8,137,020 |
|
|
|
|
|
|
|
|
|
|||
|
|
As of September 30, 2008
|
|||
|
|
Adjusted
|
Gross
|
Gross
|
Fair Value
|
|
|
(unaudited) |
|||
|
U.S. government notes.................................................................................................. |
$ 246,327 |
$ 916 |
$ (222 ) |
$ 247,021 |
|
U.S. government agencies............................................................................................. |
708,972 |
114 |
(1,656 ) |
707,430 |
|
Municipal securities....................................................................................................... |
5,096,755 |
10,360 |
(19,426 ) |
5,087,689 |
|
|
|
|
|
|
|
Total marketable securities................................................................................. |
$ 6,052,054 |
$ 11,390 |
$ (21,304 ) |
$ 6,042,140 |
|
|
|
|
|
|
Time deposits were held by institutions outside the U.S. at December 31, 2007 and at September 30, 2008. Gross unrealized gains and losses on cash equivalents were not material at December 31, 2007 and September 30, 2008.
We recognized gross realized gains of $12.9 million and $45.2 million on the sale of our marketable securities during the three and nine months ended September 30, 2007. We recognized gross realized losses of $2.9 million and $28.2 million during the three and nine months ended September 30, 2007. We recognized gross realized gains of $12.6 million and $71.5 million on the sale of our marketable securities during three and nine months ended September 30, 2008. Gross realized losses were not material in the three and nine months ended September 30, 2008. There were no other-than-temporary impairments to our marketable securities in the three and nine months ended September 30, 2007 and 2008. Realized gains and losses are included in interest income and other, net, in our accompanying Consolidated Statements of Income.
The following table summarizes the estimated fair value of our investments in marketable debt securities designated as available-for-sale classified by the contractual maturity date of the security (in thousands):
|
|
|
|
|
|
As of
|
As of
|
|
|
|
(unaudited) |
|
Due within 1 year.................................................................................................................................... |
$ 1,964,325 |
$ 1,077,839 |
|
Due in 1 to 5 years.................................................................................................................................. |
3,359,472 |
3,149,165 |
|
Due in 5 to 10 years................................................................................................................................ |
310,332 |
276,549 |
|
Due after 10 years................................................................................................................................... |
2,454,188 |
1,538,587 |
|
|
|
|
|
Total marketable debt securities................................................................................................ |
$ 8,088,317 |
$ 6,042,140 |
|
|
|
|
In accordance with EITF 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, the following table shows gross unrealized losses and fair value for those investments that were in an unrealized loss position as of December 31, 2007 and September 30, 2008, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in thousands):
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007
|
|||||
|
|
Less than 12 Months
|
12 Months or Greater
|
Total
|
|||
|
Security Description
|
Fair Value
|
Unrealized
|
Fair Value
|
Unrealized
|
Fair Value
|
Unrealized
|
|
U.S. government notes........................................................ |
$ 30,525 |
$ (4 ) |
$ — |
$ — |
$ 30,525 |
$ (4 ) |
|
U.S. government agencies................................................... |
98,682 |
(41 ) |
19,993 |
(3 ) |
118,675 |
(44 ) |
|
Municipal securities............................................................. |
270,708 |
(227 ) |
54,832 |
(104 ) |
325,540 |
(331 ) |
|
|
|
|
|
|
|
|
|
Total............................................................................. |
$ 399,915 |
$ (272 ) |
$ 74,825 |
$ (107 ) |
$ 474,740 |
$ (379 ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2008
|
|||
|
|
Less than 12 Months
|
Total
|
||
|
Security Description
|
Fair Value
|
Unrealized
|
Fair Value
|
Unrealized
|
|
U.S. government notes................................................................................................... |
$ 35,343 |
$ (222 ) |
$ 35,343 |
$ (222 ) |
|
U.S. government agencies.............................................................................................. |
514,899 |
(1,656 ) |
514,899 |
(1,656 ) |
|
Municipal securities........................................................................................................ |
2,631,304 |
(19,426 ) |
2,631,304 |
(19,426 ) |
|
|
|
|
|
|
|
Total........................................................................................................................ |
$ 3,181,546 |
$ (21,304 ) |
$ 3,181,546 |
$ (21,304 ) |
|
|
|
|
|
|
As of September 30, 2008, we did not have any investments in marketable securities that were in an unrealized loss position for 12 months or greater.
Auction Rate Securities
At September 30, 2008, we held $233.9 million of auction rate securities (“ARS”). The assets underlying these 37 individual investments are primarily student loans which are mostly AAA rated and substantially guaranteed by the U.S. government under the Federal Family Education Loan Program. Historically, these securities have provided liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined intervals every 7 to 49 days. However, these auctions began to fail in the first quarter of 2008. Since these auctions have failed, we have realized higher interest rates for many of these ARS than we would have otherwise. Although we have been receiving interest payments at these rates, the related principal amounts will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, the issuer calls the security, or the security matures according to contractual terms. Maturity dates for these ARS investments range from 2015 to 2047. Since these auctions have failed, $25.7 million of the related securities were called at par by their issuers.
As a result of the auction failures, these ARS do not have a readily determinable market value. To estimate their fair values at September 30, 2008, we used a discounted cash flow model based on estimated interest rates, timing and amount of cash flows, the credit quality of the underlying securities and illiquidity considerations. Specifically, we estimated the future cash flows of our ARS over the expected workout periods using a projected weighted average interest rate of 5.7% per annum, which is based on the forward swap curve at the end of September 2008 plus any additional basis points currently paid by the issuers assuming these auctions continue to fail. A discount factor was applied over these estimated cash flows of our ARS, which is calculated based on the interpolated forward swap curve adjusted by up to 525 basis points to reflect the current market conditions for instruments with similar credit quality at the date of the valuation and additionally adjusted for a liquidity discount of up to 400 basis points to reflect the risk in the marketplace for these investments that has arisen due to the lack of an active market.
At September 30, 2008, the estimated fair values of these ARS were $10.8 million ($6.4 million, net of tax effect) less than their costs. Based primarily on the period of time and the extent of the impairment, as well as our ability to hold these securities for an extended period of time without materially affecting our liquidity needs, we concluded it was temporary and recorded it to accumulated other comprehensive income on the accompanying Consolidated Balance Sheet at September 30, 2008.
To the extent we determine that any impairment is other-than-temporary, we would record a charge to earnings. In addition, we have concluded that the auctions for these securities may continue to fail for at least the next 12 months and as a result, they have been classified as non-current assets on our Consolidated Balance Sheet at September 30, 2008.
Investment in America Online (“AOL”)
We review our investment in AOL for impairment in accordance with FSP SFAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP 115-1”). Based on our review, we believe our investment in AOL is impaired. After consideration of the duration of the impairment, as well as the reasons for any decline in value and the potential recovery period, we do not believe that such impairment is “other-than-temporary” at September 30, 2008 as defined under FSP 115-1. As a result, our investment in this non-marketable equity security is carried at cost on our Consolidated Balance Sheets. We will continue to review this investment for impairment on a quarterly basis. There can be no assurance that impairment charges will not be required in the future, and any such amounts could be material to our Consolidated Statements of Income.
Note 4. Derivative Financial Instruments
We enter into foreign currency contracts with financial institutions to reduce the risk that our cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations. Our program is not designated for trading or speculative purposes.
In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), we recognize derivative instruments as either assets or liabilities on the balance sheet at fair value. Changes in the fair value (i.e., gains or losses) of the derivatives are recorded in the accompanying Consolidated Statements of Income as interest income and other, net, or as part of revenues, or on the accompanying Consolidated Balance Sheets as accumulated other comprehensive income.
Cash Flow Hedges
We use options designated as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. Any gain on the effective portion of a cash flow hedge is initially reported as a component of accumulated other comprehensive income and subsequently reclassified to revenues when the hedged exposure affects revenues or as interest income and other, net, if the hedged transaction becomes probable of not occurring. The effective portion of our cash flow hedges, which we reclassified to revenues from accumulated other comprehensive income, was $34.2 million and $38.9 million for the three and nine months ended September 30, 2008.
At September 30, 2008, the effective portion of our cash flow hedges before tax effect was $83.7 million, substantially all of which is expected to be reclassified from accumulated other comprehensive income to revenues within 12 months.
Any gain after a hedge is de-designated because the hedged transaction is no longer probable of occurring or related to an ineffective portion of a hedge is recognized as interest income and other, net, immediately. The ineffective portion of our cash flow hedges was $1.0 million and $1.1 million for the three and nine months ended September 30, 2008. Further, the change in the time value of the options is excluded from our assessment of hedge effectiveness. The premium paid or time value of an option whose strike price is equal to or greater than the market price on the date of purchase is recorded as an asset. Thereafter, any change to this time value is included in interest income and other, net. Amounts recorded in interest income and other, net were $65.6 million and $94.6 million for the three and nine months ended September 30, 2008.
At September 30, 2008, the notional principal and fair value of foreign exchange contracts to purchase U.S. dollars with Euros were €1.6 billion (or approximately $2.4 billion) and $118.5 million; the notional principal and fair value of foreign exchange contracts to purchase U.S. dollars and Euros with British pounds were £1.1 billion (or approximately $1.9 billion) and $34.7 million; and the notional principal and fair value of foreign exchange contracts to purchase U.S. dollars with Canadian dollars were C$162.9 million (or approximately $154.7 million) and $3.6 million. These foreign exchange options have maturities of 18 months or less. There were no other foreign exchange contracts designated as cash flow hedges.
Other Derivatives
Other derivatives not designated as hedging instruments under SFAS 133 consist of forward contracts that we use to hedge intercompany balances and other monetary assets or liabilities denominated in currencies other than the functional currency of the subsidiary. Gains and losses on these contracts as well as the related costs are included in interest income and other, net, along with the gains and losses of the related hedged items. During the three and nine months ended September 30, 2008, we recognized $10.8 million and $24.7 million of costs related to these contracts. Costs incurred during the three and nine months ended September 30, 2007 were not material. The fair value of these foreign exchange contracts was not material at December 31, 2007 and September 30, 2008. The notional principal of foreign exchange contracts to purchase U.S. dollars with foreign currencies was $1.5 billion and $2.6 billion at December 31, 2007 and September 30, 2008. The notional principal of foreign exchange contracts to sell U.S. dollars for foreign currencies was $23.2 million at September 30, 2008. The notional principal of foreign exchange contracts to purchase Euros with other currencies was €296.5 million (or approximately $433.4 million) and €534.6 million (or approximately $780.8 million) at December 31, 2007 and September 30, 2008.
Note 5. Fair Value Measurements
Effective January 1, 2008, we adopted SFAS 157, except as it applies to the nonfinancial assets and nonfinancial liabilities subject to FSP 157-2. SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, SFAS 157 establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2—Include other inputs that are directly or indirectly observable in the marketplace.
Level 3—Unobservable inputs which are supported by little or no market activity.
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
In accordance with SFAS 157, we measure our cash equivalents, marketable securities, auction rate securities and foreign currency derivative contracts at fair value. Our cash equivalents and marketable securities are classified within Level 1 or Level 2. This is because our cash equivalents and marketable securities are valued using quoted market prices or alternative pricing sources and models utilizing market observable inputs. Our investments in auction rate securities are classified within Level 3 because they are valued using a discounted cash flow model (see Note 3). Some of the inputs to this model are unobservable in the market and are significant. Our foreign currency derivative contracts are classified within Level 2 as the valuation inputs are based on quoted prices and market observable data of similar instruments.
Assets and liabilities measured at fair value are summarized below (unaudited, in thousands):
|
|
|
|
|
|
|
|
|
Fair value measurement at reporting date using
|
||
|
Description
|
September 30,
|
Quoted Prices in Active
|
Significant Other
|
Significant
|
|
Assets |
|
|
|
|
|
Cash equivalents: |
|
|
|
|
|
U.S. government notes................................... |
$ 8,995 |
$ — |
$ 8,995 |
$ — |
|
U.S. government agencies.............................. |
234,488 |
— |
234,488 |
— |
|
Municipal securities........................................ |
81,527 |
— |
81,527 |
— |
|
Time deposits................................................... |
2,004,511 |
— |
2,004,511 |
— |
|
Money market mutual funds.......................... |
2,481,500 |
2,481,500 |
— |
— |
|
Marketable securities: |
|
|
|
|
|
U.S. government notes................................... |
247,021 |
— |
247,021 |
— |
|
U.S. government agencies.............................. |
707,430 |
— |
707,430 |
— |
|
Municipal securities........................................ |
5,087,689 |
— |
5,087,689 |
— |
|
Foreign currency derivative contracts.................... |
157,307 |
— |
157,307 |
— |
|
Auction rate securities.............................................. |
233,854 |
— |
— |
233,854 |
|
|
|
|
|
|
|
Total assets................................................................. |
$ 11,244,322 |
$ 2,481,500 |
$ 8,528,968 |
$ 233,854 |
|
Liabilities |
|
|
|
|
|
Foreign currency derivative contracts......... |
$ 786 |
$ — |
$ 786 |
$ — |
|
|
|
|
|
|
|
Total liabilities........................................................... |
$ 786 |
$ — |
$ 786 |
$ — |
|
|
|
|
|
|
The following table presents our assets measured at fair value using significant unobservable inputs (Level 3) as defined in SFAS 157 at September 30, 2008 (unaudited, in thousands):
|
|
|
|
|
Level 3
|
|
Balance at December 31, 2007................................................................................................................................ |
$ — |
|
Transfers to Level 3................................................................................................................................................. |
311,225 |
|
Unrealized loss included in other comprehensive income................................................................................ |
(10,842 ) |
|
Net settlements........................................................................................................................................................ |
(66,529 ) |
|
|
|
|
Balance at September 30, 2008............................................................................................................................... |
$ 233,854 |
|
|
|
Effective January 1, 2008, we also adopted SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities – including an Amendment of FASB Statement No. 115, which allows an entity to choose to measure certain financial instruments and liabilities at fair value on a contract-by-contract basis. Subsequent fair value measurement for the financial instruments and liabilities an entity chooses to measure will be recognized in earnings. As of September 30, 2008, we did not elect such option for our financial instruments and liabilities.
Note 6. Property and Equipment
Property and equipment consist of the following (in thousands):
|
|
|
|
|
|
As of
|
As of
|
|
|
|
(unaudited) |
|
Information technology assets......................................................................................... |
$ 2,734,916 |
$ 3,393,749 |
|
Construction in process.................................................................................................... |
1,364,651 |
1,979,963 |
|
Land and buildings............................................................................................................. |
951,334 |
1,336,745 |
|
Leasehold improvements................................................................................................... |
416,884 |
553,508 |
|
Furniture and fixtures......................................................................................................... |
52,127 |
61,827 |
|
|
|
|
|
Total........................................................................................................................... |
5,519,912 |
7,325,792 |
|
Less accumulated depreciation and amortization.......................................................... |
1,480,651 |
2,112,625 |
|
|
|
|
|
Property and equipment, net............................................................................................. |
$ 4,039,261 |
$ 5,213,167 |
|
|
|
|
Note 7. Acquisitions
In March 2008, we acquired Click Holding Corp. (“DoubleClick”), a company that offers online ad serving and management services to advertisers, ad agencies and web site publishers. We acquired DoubleClick primarily for their customer relationships, as well as patents and developed technology. This transaction was accounted for as a business combination. In August 2008, we sold the search marketing business of Performics, a division of DoubleClick for approximately $53 million paid in cash. As the sale of Performics was planned at the time of the acquisition of DoubleClick, the proceeds from the sale are netted against the purchase price of DoubleClick. The total net purchase price of DoubleClick was $3.2 billion paid in cash, including transaction costs of $70.4 million.
The following table summarizes the allocation of the purchase price of DoubleClick as of September 30, 2008 (unaudited, in thousands):
|
|
|
|
Goodwill................................................................................................................................................................. |
$ 2,337,814 |
|
Customer relationships........................................................................................................................................ |
629,600 |
|
Patents and developed technology................................................................................................................... |
143,400 |
|
Tradenames and other......................................................................................................................................... |
27,800 |
|
Net assets acquired.............................................................................................................................................. |
85,683 |
|
Deferred tax assets............................................................................................................................................... |
270,262 |
|
Deferred tax liabilities........................................................................................................................................... |
(301,179 ) |
|
|
|
|
Total............................................................................................................................................................. |
$ 3,193,380 |
|
|
|
Goodwill is not deductible for tax purposes.
Customer relationships have a weighted-average useful life of 6.7 years. Patents and developed technology have a weighted-average useful life of 5.0 years. Tradenames and other have a weighted-average useful life of 5.5 years. The majority of these assets are not deductible for tax purposes.
Supplemental information on an unaudited pro forma basis, as if the DoubleClick acquisition had been consummated at the beginning of each of the periods presented, is as follows (in millions, except per share amounts):
|
|
|
|
|
|
Nine Months Ended
|
|
|
|
2007
|
2008
|
|
|
(unaudited) |
|
|
Revenues............................................................................................................................................. |
$ 11,995 |
$ 16,164 |
|
Net income.......................................................................................................................................... |
2,811 |
3,815 |
|
Net income per share of Class A and Class B common stock - diluted..................................... |
8.91 |
12.01 |
The unaudited pro forma supplemental information is based on estimates and assumptions, which we believe are reasonable. It is not necessarily indicative of our consolidated financial position or results of income in future periods or the results that actually would have been realized had we been a combined company as of the beginning of the periods presented. The unaudited pro forma supplemental information includes incremental intangible asset amortization and other charges as a result of the acquisition, net of the related tax effects.
In connection with certain acquisitions in prior periods, we are obligated to make additional cash payments if certain criteria are met. As of September 30, 2008, our remaining contingent obligations related to these acquisitions was approximately $582.2 million, which if the criteria are met, would be recorded as part of the purchase price. Since these contingent payments are based on the achievement of performance targets, actual payments may be substantially lower.
Note 8. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the nine months ended September 30, 2008 are as follows (in thousands):
|
|
|
|
Balance as of December 31, 2007....................................................................................................................... |
$ 2,299,368 |
|
Goodwill acquired, net of divestiture................................................................................................................ |
2,348,146 |
|
Goodwill adjustment............................................................................................................................................ |
174,131 |
|
|
|
|
Balance as of September 30, 2008...................................................................................................................... |
$ 4,821,645 |
|
|
|
The goodwill adjustment of $174.1 million was primarily a result of contingent payments earned upon the achievement of certain performance targets.
Information regarding our acquisition-related intangible assets that are being amortized is as follows (in thousands):
|
|
|
|
|
|
|
As of December 31, 2007
|
||
|
|
Gross
|
Accumulated
|
Net
|
|
Patents and developed technology..................................................... |
$ 364,937 |
$ 179,102 |
$ 185,835 |
|
Customer relationships.......................................................................... |
171,876 |
37,738 |
134,138 |
|
Tradenames and other........................................................................... |
196,392 |
69,769 |
126,623 |
|
|
|
|
|
|
Total............................................................................................... |
$ 733,205 |
$ 286,609 |
$ 446,596 |
|
|
|
|
|
|
|
|
||
|
|
As of September 30, 2008
|
||
|
|
Gross
|
Accumulated
|
Net
|
|
|
|
(unaudited) |
|
|
Patents and developed technology..................................................... |
$ 527,573 |
$ 268,883 |
$ 258,690 |
|
Customer relationships.......................................................................... |
801,476 |
122,758 |
678,718 |
|
Tradenames and other........................................................................... |
215,217 |
104,908 |
110,309 |
|
|
|
|
|
|
Total............................................................................................... |
$ 1,544,266 |
$ 496,549 |
$ 1,047,717 |
Amortization expense of acquisition-related intangible assets for the three and nine months ended September 30, 2007 was $40.9 million and $111.5 million and for the three and nine months ended September 30, 2008 was $76.0 million and $210.7 million. Expected amortization expense for acquisition-related intangible assets on our September 30, 2008 Consolidated Balance Sheet for the remainder of 2008 and each of the next five years and thereafter is as follows (unaudited, in thousands):
|
|
|
|
Remainder of 2008................................................................................................................................................ |
$ 72,167 |
|
2009......................................................................................................................................................................... |
251,873 |
|
2010......................................................................................................................................................................... |
220,990 |
|
2011......................................................................................................................................................................... |
168,185 |
|
2012......................................................................................................................................................................... |
129,790 |
|
2013......................................................................................................................................................................... |
103,686 |
|
Thereafter.............................................................................................................................................................. |
101,026 |
|
|
|
|
|
$ 1,047,717 |
|
|
|
Note 9. Interest Income and Other, Net
The components of interest income and other, net were as follows (in thousands):
|
|
|
|
|
|
|
|
Three Months Ended
|
Nine Months Ended
|
||
|
|
2007
|
2008
|
2007
|
2008
|
|
|
(unaudited) |
|||
|
Interest income........................................................................ |
$ 146,114 |
$ 90,996 |
$ 414,574 |
$ 301,086 |
|
Realized gains on marketable securities, net...................... |
9,977 |
10,939 |
17,005 |
64,762 |
|
Foreign exchange gains (losses), net.................................. |
2,760 |
(81,470 ) |
(2,315 ) |
(122,477 ) |
|
Other......................................................................................... |
(4,423 ) |
752 |
(6,977 ) |
3,114 |
|
|
|
|
|
|
|
Interest income and other, net................................... |
$ 154,428 |
$ 21,217 |
$ 422,287 |
$ 246,485 |
|
|
|
|
|
|
Note 10. Comprehensive Income
The changes in the components of other comprehensive income were as follows (in thousands):
|
|
|
|
|
|
|
|
Three Months Ended
|
Nine Months Ended
|
||
|
|
2007
|
2008
|
2007
|
2008
|
|
|
(unaudited) |
|||
|
Net income................................................................ |
$ 1,069,989 |
$ 1,289,938 |
$ 2,997,271 |
$ 3,844,416 |
|
Change in unrealized gains (losses) on marketable securities, net of taxes................... |
29,974 |
(1,546 ) |
16,323 |
(34,637 ) |
|
Change in cumulative translation adjustment..... |
22,322 |
(65,588 ) |
41,910 |
(27,167 ) |
|
Change in unrealized gains on cash flow hedges, net of taxes........................................... |
— |
49,128 |
— |
49,593 |
|
|
|
|
|
|
|
Comprehensive income................................ |
$ 1,122,285 |
$ 1,271,932 |
$ 3,055,504 |
$ 3,832,205 |
|
|
|
|
|
|
The components of accumulated other comprehensive income were as follows (in thousands):
|
|
|
|
|
|
As of
|
As of
|
|
|
|
(unaudited) |
|
Unrealized gains (losses) on marketable securities, net of taxes................................ |
$ 22,501 |
$ (12,136 ) |
|
Cumulative translation adjustment.................................................................................. |
90,872 |
63,705 |
|
Unrealized gains on cash flow hedges, net of taxes..................................................... |
— |
49,593 |
|
|
|
|
|
Accumulated other comprehensive income................................................................... |
$ 113,373 |
$ 101,162 |
|
|
|
|
Note 11. Contingencies
Legal Matters
Companies have filed trademark infringement and related claims against us over the display of ads in response to user queries that include trademark terms. The outcomes of these lawsuits have differed from jurisdiction to jurisdiction. We currently have three cases pending at the European Court of Justice, which will address questions regarding whether advertisers and search engines can be held liable for use of trademarked terms in keyword advertising. We are litigating, or have recently litigated similar issues in other cases, in the U.S., Australia, Austria, Brazil, China, France, Germany, Israel, and Italy.
We have also had copyright claims filed against us by companies alleging that features of certain of our products and services, including Google Web Search, Google News, Google Video, Google Image Search, Google Book Search and YouTube, infringe their rights. In the U.S. we recently announced a settlement with the Authors Guild and the Association of American Publishers (“AAP”) (see Note 15), however this class action is subject to approval by the U.S. District Court for the Southern District of New York and we are subject to additional claims with respect to Google Book Search in other parts of the world. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements or orders preventing us from offering certain functionalities, and may also result in a change in our business practices, which could result in a loss of revenue for us or otherwise harm our business. In addition, any time one of our products or services links to or hosts material in which others allegedly own copyrights, we face the risk of being sued for copyright infringement or related claims. Because these products and services comprise the majority of our products and services, our business could be harmed in the event of an adverse result in any of these claims.
We have also had patent lawsuits filed against us alleging that certain of our products and services, including Google Web Search, Google AdWords, and Google AdSense, infringe patents held by others. In addition, the number of demands for license fees and the dollar amounts associated with each request continue to increase. Adverse results in these lawsuits, or our decision to license patents based upon these demands, may result in substantial costs and, in the case of adverse litigation rulings, could prevent us from offering certain features, functionalities, products or services, which could result in a loss of revenue for us or otherwise harm our business.
We are also a party to other litigation and subject to claims incident to the ordinary course of business, including intellectual property claims (in addition to the trademark and copyright matters noted above), labor and employment claims, breach of contract claims, tax and other matters.
Although the results of litigation and claims cannot be predicted with certainty, we believe that the final outcome of the matters discussed above will not have a material adverse effect on our business, consolidated financial position, results of operations and cash flows.
Income Taxes
We are currently under audit by the Internal Revenue Service and various other tax authorities. We have reserved for potential adjustments to our provision for income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities, and we believe that the final outcome of these examinations or agreements will not have a material effect on our results of operations. If events occur which indicate payment of these amounts is unnecessary, the reversal of the liabilities would result in the recognition of tax benefits in the period we determine the liabilities are no longer necessary. If our estimates of the federal, state, and foreign income tax liabilities are less than the ultimate assessment, a further charge to expense would result.
Note 12. Stockholders’ Equity
The following table presents the weighted-average assumptions used to estimate the fair values of the stock options granted in the periods presented:
|
|
|
|
|
|
|
|
Three Months Ended
|
Nine Months Ended
|
||
|
|
2007
|
2008
|
2007
|
2008
|
|
|
(unaudited) |
|||
|
Risk-free interest rate............................................................................... |
4.5 % |
3.3 % |
4.6 % |
3.2 % |
|
Expected volatility.................................................................................... |
29 % |
35 % |
29 % |
35 % |
|
Expected life (in years)............................................................................. |
5.6 |
5.3 |
4.7 |
5.3 |
|
Dividend yield........................................................................................... |
— |
— |
— |
— |
|
Weighted-average estimated fair value of options granted during the period............................................................................................. |
$ 193.29 |
$ 196.86 |
$ 163.14 |
$ 205.27 |
The following table summarizes the activity for our options for the nine months ended September 30, 2008:
|
|
|
|
|
|
|
|
Options Outstanding
|
|||
|
|
Number of
|
Weighted-
|
Weighted-
|
Aggregate
|
|
|
(unaudited) |
|||
|
Balance at December 31, 2007............................................................................ |
12,892,886 |
$ 333.62 |
|
|
|
Options granted.............................................................................. |
3,081,322 |
$ 505.42 |
|
|
|
Exercised (2)..................................................................................... |
(1,241,200 ) |
$ 66.33 |
|
|
|
Canceled/forfeited.......................................................................... |
(442,391 ) |
$ 438.40 |
|
|
|
|
|
|
|
|
|
Balance at September 30, 2008........................................................................... |
14,290,617 |
$ 385.63 |
7.2 |
$ 898.7 |
|
|
|
|
|
|
|
Vested and exercisable as of September 30, 2008................................. |
6,121,888 |
$ 253.40 |
6.6 |
$ 731.0 |
|
Vested and exercisable as of September 30, 2008 and expected to vest thereafter (3)................................................................................. |
13,641,957 |
$ 381.24 |
7.2 |
$ 886.2 |
(1) The aggregate intrinsic value is calculated as the excess, if any, of the closing price of $400.52 of our Class A common stock on September 30, 2008 over the exercise price of the underlying awards.
(2) Includes options vested during the period that were early exercised.
(3) Options expected to vest reflect an estimated forfeiture rate.
The following table summarizes additional information regarding outstanding, exercisable and exercisable and vested stock options at September 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
Options Exercisable
|
Options Exercisable
|
||||||
|
Range of Exercise Prices
|
Total
|
Unvested
|
Number of
|
Weighted-
|
Weighted
|
Number of
|
Weighted
|
Number of
|
Weighted
|
|
$ 0.30–94.80.................. |
1,620,800 |
46,039 |
1,574,761 |
5.0 |
$ 19.52 |
1,491,296 |
$ 18.23 |
1,255,330 |
$ 19.48 |
|
$117.84–$198.41........... |
1,593,173 |
— |
1,593,173 |
4.6 |
$ 176.68 |
1,397,266 |
$ 175.40 |
1,391,785 |
$ 175.53 |
|
$205.96–$298.91........... |
1,356,081 |
— |
1,356,081 |
5.4 |
$ 274.52 |
1,017,204 |
$ 273.84 |
1,016,771 |
$ 273.83 |
|
$300.97–$399.00........... |
1,704,949 |
— |
1,704,949 |
5.9 |
$ 329.82 |
1,146,126 |
$ 327.29 |
1,141,241 |
$ 327.32 |
|
$401.78–$499.07........... |
1,665,874 |
— |
1,665,874 |
7.8 |
$ 450.99 |
655,148 |
$ 444.96 |
653,699 |
$ 444.96 |
|
$500.00–594.05............. |
6,094,660 |
— |
6,094,660 |
9.0 |
$ 545.50 |
664,055 |
$ 512.21 |
662,572 |
$ 512.22 |
|
$615.95–$699.35........... |
203,937 |
— |
203,937 |
9.2 |
$ 655.40 |
370 |
$ 639.92 |
370 |
$ 639.92 |
|
$707.00–$732.94........... |
51,143 |
— |
51,143 |
9.1 |
$ 718.15 |
120 |
$ 707.00 |
120 |
$ 707.00 |
|
|
|
|
|
|
|
|
|
|
|
|
$ 0.30–$732.94.............. |
14,290,617 |
46,039 |
14,244,578 |
7.2 |
$ 385.63 |
6,371,585 |
$ 244.51 |
6,121,888 |
$ 253.40 |
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at September 30, 2008 in the above tables include 46,039 options granted and exercised subsequent to March 21, 2002 that are unvested at September 30, 2008, in accordance with EITF Issue No. 00-23, Issues Related to Accounting for Stock Compensation Under APB Opinion No. 25 and FASB Interpretation No. 44. However, the computations of the weighted-average exercise prices, weighted-average remaining contractual term and aggregate intrinsic value do not consider these unvested shares. Further, the above tables include 1,417,501 warrants held by financial institutions that were options purchased from employees under our Transferable Stock Option (“TSO”) program.
The total grant date fair value of stock options vested during the three and nine months ended September 30, 2008 was $141.2 million and $461.2 million. The total grant date fair value of stock options vested during the three and nine months ended September 30, 2007 was $152.4 million and $441.0 million. The aggregate intrinsic value of all options exercised for the three and nine months ended September 30, 2008 was $64.4 million and $424.2 million. The aggregate intrinsic value of all options exercised for the three and nine months ended September 30, 2007 was $179.1 million and $823.7 million. These amounts do not include the aggregate sales price of options sold under our TSO program.
During the nine months ended September 30, 2008, the number of shares underlying TSOs sold to selected financial institutions under the TSO program was 493,102 at a total value of $136.3 million, or an average of $276.46 per share, and an average premium of $38.28 per share. The premium is calculated as the difference between (a) the sale price of the TSO and (b) the intrinsic value of the TSO, which we define as the excess, if any, of the price of our Class A common stock at the time of the sale over the exercise price of the TSO. At September 30, 2008, the number of options eligible for participation under the TSO program was 10.6 million.
As of September 30, 2008, there was $1,242.4 million of unrecognized compensation cost related to outstanding employee stock options, net of forecasted forfeitures. This amount is expected to be recognized over a weighted average period of 3.0 years. To the extent the forfeiture rate is different from what we have anticipated, stock-based compensation related to these awards will be different from our expectations.
The following table summarizes the activity for our unvested restricted stock units and restricted shares for the nine months ended September 30, 2008:
|
|
|
|
|
|
Unvested Restricted Stock Units
|
|
|
|
Number of
|
Weighted-
|
|
|
(unaudited) |
|
|
Unvested at December 31, 2007.......................................................................................... |
2,990,222 |
$ 526.92 |
|
Granted......................................................................................................................... |
1,427,527 |
$ 483.21 |
|
Vested........................................................................................................................... |
(566,413 ) |
$ 397.12 |
|
Forfeited....................................................................................................................... |
(227,093 ) |
$ 521.30 |
|
|
|
|
|
Unvested at September 30, 2008......................................................................................... |
3,624,243 |
$ 529.41 |
|
|
|
|
|
Expected to vest after September 30, 2008 (1)................................................................... |
3,353,512 |
$ 529.41 |
(1) Restricted stock units and restricted shares expected to vest reflect an estimated forfeiture rate.
As of September 30, 2008, there was $1,485.7 million of unrecognized compensation cost related to employee unvested restricted stock units and restricted shares, net of forecasted forfeitures. This amount is expected to be recognized over a weighted average period of 3.0 years. To the extent the actual forfeiture rate is different from what we have anticipated, stock-based compensation related to these awards will be different from our expectations.
Note 13. Income Taxes
We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Financial Standards Accounting Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (“SFAS 109”), and prescribes a recognition threshold of more-likely-than-not to be sustained upon examination. Our total unrecognized tax benefits as of December 31, 2007 and September 30, 2008 were $387.2 million and $627.5 million. Also, our total unrecognized tax benefits that, if recognized, would affect our effective tax rate were $283.5 million and $478.6 million as of December 31, 2007 and September 30, 2008. The increase in our unrecognized tax benefits during the nine months ended September 30, 2008 was primarily related to uncertain tax positions on our international structure.
On October 1, 2008, the state of California enacted a law to establish a 20% penalty applicable to corporations that underpay their taxes by an amount that is greater than one million dollars. On October 3, 2008, the United States enacted a law, the “Emergency Economic Stabilization Act of 2008,” which contains the “Tax Extenders and Alternative Minimum Tax Relief Act of 2008”. Under this act, the federal research and development credit was retroactively extended for amounts paid or incurred after December 31, 2007 and before January 1, 2010. The effects of these changes in the tax law will be determined and recognized in the fourth quarter, which is the quarter in which the laws were enacted.
Note 14. Information about Geographic Areas
Our chief operating decision-makers (i.e., our chief executive officer, his direct reports and our presidents) review financial information presented on a consolidated basis, accompanied by disaggregated information about revenues by geographic region for purposes of allocating resources and evaluating financial performance. There are no segment managers who are held accountable by our chief operating decision-makers, or anyone else, for operations, operating results and planning for levels or components below the consolidated unit level. Accordingly, we consider ourselves to be in a single reporting segment and operating unit structure.
Revenues by geography are based on the billing addresses of the advertisers. The following table sets forth revenues and long-lived assets by geographic area (in thousands):
|
|
|
|
|
|
|
|
|
Three Months Ended
|
Nine Months Ended
|
|||
|
|
September 30,
|
June 30,
|
September 30,
|
September 30,
|
September 30,
|
|
|
(unaudited) |
||||
|
Revenues: |
|
|
|
|
|
|
United States.................................................................... |
$ 2,205,809 |
$ 2,567,024 |
$ 2,695,012 |
$ 6,192,133 |
$ 7,797,510 |
|
United Kingdom............................................................... |
661,016 |
773,958 |
776,160 |
1,838,889 |
|