Form 10-Q

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 March 31, 2009

¨	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)

Delaware

77-0493581

(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ 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 April 30, 2009, there were 241,087,476 shares of Google’s Class A common stock outstanding and 74,851,783 shares of Google’s Class B common stock outstanding.

GOOGLE INC.

INDEX


		Page No.

	PART I. FINANCIAL INFORMATION

Item 1	Financial Statements

	Consolidated Balance Sheets—December 31, 2008 and March 31, 2009 (unaudited)	3

	Consolidated Statements of Income—Three Months Ended March 31, 2008 and 2009 (unaudited)	4

	Consolidated Statements of Cash Flows—Three Months Ended March 31, 2008 and 2009 (unaudited)	5

	Notes to Consolidated Financial Statements (unaudited)	6

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3	Quantitative and Qualitative Disclosures About Market Risk	37

Item 4	Controls and Procedures	39

	PART II. OTHER INFORMATION

Item 1	Legal Proceedings	40

Item 1A	Risk Factors	40

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	52

Item 6	Exhibits	53

	Signatures	54

	Exhibit Index	55

	Certifications

PART I—FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

GOOGLE INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par value per share)


	As of December 31, 2008		As of March 31, 2009
			(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	8,656,672	$	10,426,291
Marketable securities		7,189,099		7,358,642
Accounts receivable, net of allowance of $80,086 and $112,511		2,642,192		2,543,105
Deferred income taxes, net		286,105		434,903
Prepaid revenue share, expenses and other assets		1,404,114		1,317,861

Total current assets		20,178,182		22,080,802
Prepaid revenue share, expenses and other assets, non-current		433,846		416,168
Deferred income taxes, net, non-current		—		52,296
Non-marketable equity securities		85,160		100,999
Property and equipment, net		5,233,843		5,122,105
Intangible assets, net		996,690		910,344
Goodwill		4,839,854		4,830,315

Total assets	$	31,767,575	$	33,513,029

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	178,004	$	196,220
Accrued compensation and benefits		811,643		464,899
Accrued expenses and other current liabilities		480,263		465,164
Accrued revenue share		532,547		522,835
Deferred revenue		218,084		216,937
Income taxes payable, net		81,549		317,799

Total current liabilities		2,302,090		2,183,854
Deferred revenue, non-current		29,818		30,146
Income taxes payable, net, non-current		890,115		1,160,158
Deferred income taxes, net, non-current		12,515		—
Other long-term liabilities		294,175		290,776
Stockholders’ equity:
Convertible preferred stock, $0.001 par value, 100,000 shares authorized; no shares issued and outstanding		—		—
Class A and Class B common stock, $0.001 par value: 9,000,000 shares authorized; 315,114 (Class A 240,073, Class B 75,041) and par value of $315 (Class A $240, Class B $75) and 315,761 (Class A 240,872, Class B 74,889) and par value of $316 (Class A $241, Class B $75) shares issued and outstanding, excluding 26 and 10 Class A shares subject to repurchase at December 31, 2008 and March 31, 2009		315		316
Additional paid-in capital		14,450,338		14,694,501
Accumulated other comprehensive income		226,579		168,820
Retained earnings		13,561,630		14,984,458

Total stockholders’ equity		28,238,862		29,848,095

Total liabilities and stockholders’ equity	$	31,767,575	$	33,513,029

See accompanying notes.

GOOGLE INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)


	Three Months Ended March 31,
	2008		2009
	(unaudited)
Revenues	$	5,186,043	$	5,508,990
Costs and expenses:
Cost of revenues (including stock-based compensation expense of $9,148 and $12,537)		2,110,536		2,101,504
Research and development (including stock-based compensation expense of $193,800 and $168,561)		673,069		641,643
Sales and marketing (including stock-based compensation expense of $42,576 and $59,026)		446,898		433,941
General and administrative (including stock-based compensation expense of $35,255 and $37,359)		409,305		448,311

Total costs and expenses		3,639,808		3,625,399

Income from operations		1,546,235		1,883,591
Interest income and other, net		167,343		6,210

Income before income taxes		1,713,578		1,889,801
Provision for income taxes		406,492		466,973

Net income	$	1,307,086	$	1,422,828

Net income per share of Class A and Class B common stock:
Basic	$	4.17	$	4.51

Diluted	$	4.12	$	4.49

See accompanying notes.

GOOGLE INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)


	Three Months Ended March 31,
	2008			2009
	(unaudited)
Operating activities
Net income	$	1,307,086		$	1,422,828
Adjustments:
Depreciation and amortization of property and equipment		280,564			321,129
Amortization of intangibles and other		55,960			82,093
Stock-based compensation expense		280,779			277,483
Excess tax benefits from stock-based award activities		(51,101	)		(31,844	)
Deferred income taxes		(38,214	)		(12,847	)
Other, net		(44,903	)		(21,409	)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable		(223,493	)		97,390
Income taxes, net		438,175			324,753
Prepaid revenue share, expenses and other assets		(41,584	)		77,457
Accounts payable		53,784			21,879
Accrued expenses and other liabilities		(234,277	)		(322,339	)
Accrued revenue share		(10,124	)		4,264
Deferred revenue		6,794			8,675

Net cash provided by operating activities		1,779,446			2,249,512

Investing activities
Purchases of property and equipment		(841,597	)		(262,755	)
Purchases of marketable securities		(2,819,512	)		(5,244,845	)
Maturities and sales of marketable securities		5,379,228			5,109,590
Investments in non-marketable equity securities		—			(18,750	)
Acquisitions, net of cash acquired, and purchases of intangible and other assets		(3,125,113	)		(2,072	)

Net cash used in investing activities		(1,406,994	)		(418,832	)

Financing activities
Net payments related to stock-based award activities		(22,445	)		(36,736	)
Excess tax benefits from stock-based award activities		51,101			31,844

Net cash provided by (used in) financing activities		28,656			(4,892	)

Effect of exchange rate changes on cash and cash equivalents		37,048			(56,169	)

Net increase in cash and cash equivalents		438,156			1,769,619
Cash and cash equivalents at beginning of year		6,081,593			8,656,672

Cash and cash equivalents at end of period	$	6,519,749		$	10,426,291

Supplemental disclosures of cash flow information
Cash paid for interest	$	387		$	162

Cash paid for income taxes	$	12,091		$	158,439

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 March 31, 2009, the Consolidated Statements of Income for the three months ended March 31, 2008 and 2009, and the Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2009 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 March 31, 2009, our results of operations for the three months ended March 31, 2008 and 2009, and our cash flows for the three months ended March 31, 2008 and 2009. The results of operations for the three months ended March 31, 2009 are not necessarily indicative of the results to be expected for the year ending December 31, 2009.

These unaudited interim Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and related notes included in our 2008 Annual Report on Form 10-K filed on February 13, 2009.

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 and sales allowances, fair values of financial instruments, 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, and income taxes, 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 April 2009, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, which amends and clarifies the initial recognition and measurement, subsequent measurement and accounting, and related disclosures of assets and liabilities arising from contingencies in a business combination under Statement of Financial Accounting Standards (SFAS) No. 141 (revised 2007), Business Combinations (SFAS 141R). This FSP is effective for assets and liabilities arising from contingencies in business combinations for which the acquisition date is on or after December 15, 2008. We adopted this FSP in the first quarter of 2009 and the impact of the adoption on our consolidated financial statements largely depends on the size and nature of the business combinations.

In April 2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, which provides additional guidance for estimating fair value in accordance with SFAS No. 157, Fair Value Measurements (SFAS 157). This FSP states that a significant decrease in the volume and level of activity for the asset or liability when compared with normal market activity is an indication that transactions or quoted prices may not be determinative of fair value because there may be increased instances of transactions that are not orderly in

such market conditions. Accordingly, further analysis of transactions or quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value. This FSP is effective for us beginning April 1, 2009. We do not expect the impact of the adoption of this FSP to be material on our consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, which requires disclosures about the fair value of our financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the balance sheets, in the interim reporting periods as well as in the annual reporting periods. In addition, the FSP requires disclosures of the methods and significant assumptions used to estimate the fair value of those financial instruments. This FSP is effective for us beginning April 1, 2009. We do not expect the impact of the adoption of this FSP to be material on our consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, which establishes a new method of recognizing and reporting other-than-temporary impairments of debt securities and requires additional disclosures related to debt and equity securities. This FSP does not change existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. This FSP is effective for us beginning April 1, 2009. We do not expect the impact of the adoption of this FSP to be material on our consolidated financial statements.

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):


	For the Three Months Ended March 31,
	2008						2009
	(unaudited)
	Class A			Class B			Class A			Class B
Basic net income per share:
Numerator:
Allocation of undistributed earnings	$	989,006		$	318,080		$	1,084,488		$	338,340
Denominator:
Weighted average common shares outstanding		237,185			76,219			240,303			74,965
Less: Weighted average unvested common shares subject to repurchase or cancellation		(256	)		(19	)		(16	)		—

Number of shares used in per share computation		236,929			76,200			240,287			74,965

Basic net income per share	$	4.17		$	4.17		$	4.51		$	4.51

Diluted net income per share:
Numerator:
Allocation of undistributed earnings for basic computation	$	989,006		$	318,080		$	1,084,488		$	338,340
Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares		318,080			—			338,340			—
Reallocation of undistributed earnings to Class B shares		—			(2,868	)		—			(1,715	)

Allocation of undistributed earnings	$	1,307,086		$	315,212		$	1,422,828		$	336,625
Denominator:
Number of shares used in basic computation		236,929			76,200			240,287			74,965
Weighted average effect of dilutive securities
Add:
Conversion of Class B to Class A common shares outstanding		76,200			—			74,965			—
Unvested common shares subject to repurchase or cancellation		275			19			16			—
Employee stock options and warrants under Transferable Stock Option program		3,244			322			1,767			86
Restricted shares and restricted stock units		744			—			186			—

Number of shares used in per share computation		317,392			76,541			317,221			75,051

Diluted net income per share	$	4.12		$	4.12		$	4.49		$	4.49

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.

Note 3. Cash and Investments

Cash, cash equivalents and marketable securities consist of the following (in thousands):


	As of December 31, 2008		As of March 31, 2009
			(unaudited)
Cash and cash equivalents:
Cash	$	3,330,658	$	4,070,597
Cash equivalents:
U.S. government agencies		—		214,998
Municipal securities		14,250		—
Time deposits		3,015,557		3,027,156
Money market mutual funds		2,296,207		3,113,540

Total cash and cash equivalents		8,656,672		10,426,291

Marketable securities:
U.S. government notes		—		410,233
U.S. government agencies		3,342,406		3,943,242
Municipal securities		2,721,603		2,000,677
Money market mutual funds		73,034		50,132
Corporate debt securities		907,056		694,692
Agency residential mortgage-backed securities		—		60,312
Commercial mortgage-backed securities		—		47,883
Marketable equity security		145,000		151,471

Total marketable securities		7,189,099		7,358,642

Total cash, cash equivalents and marketable securities	$	15,845,771	$	17,784,933

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, 2008
	Adjusted Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
U.S. government agencies	$	3,324,750	$	17,747	$	(91	)	$	3,342,406
Municipal securities		2,690,270		34,685		(3,352	)		2,721,603
Money market mutual funds		73,034		—		—			73,034
Corporate debt securities		903,963		3,265		(172	)		907,056
Marketable equity security		145,000		—		—			145,000

Total	$	7,137,017	$	55,697	$	(3,615	)	$	7,189,099


	As of March 31, 2009
	Adjusted Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(unaudited)
U.S. government notes	$	410,153	$	80	$	—		$	410,233
U.S. government agencies		3,932,108		11,253		(119	)		3,943,242
Municipal securities		1,964,823		36,151		(297	)		2,000,677
Money market mutual funds		50,132		—		—			50,132
Corporate debt securities		695,000		499		(807	)		694,692
Agency residential mortgage-backed securities		59,939		373		—			60,312
Commercial mortgage-backed securities		47,906		69		(92	)		47,883
Marketable equity security		145,000		6,471		—			151,471

Total	$	7,305,061	$	54,896	$	(1,315	)	$	7,358,642

Time deposits were held by institutions outside the U.S. at December 31, 2008 and March 31, 2009. Gross unrealized gains and losses on cash equivalents were not material at December 31, 2008 and March 31, 2009.

Our corporate debt securities are guaranteed by the full faith and credit of the United States government under the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program (TLGP) or the sovereign guarantee of foreign governments under similar programs to the TLGP.

Our agency residential mortgage-backed securities are specified pools of mortgage pass-through securities that are guaranteed by government-sponsored enterprises. Our commercial mortgage-backed securities are fully defeased securities with underlying collateral loans replaced by U.S. Treasury notes.

We recognized gross realized gains of $50.8 million and $34.3 million on the sale of our marketable securities for the three months ended March 31, 2008 and 2009. Gross realized losses were not material in either period. 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 securities, excluding the marketable equity security, designated as available-for-sale classified by the contractual maturity date of the security (in thousands):


	As of March 31, 2009
	(unaudited)
Due within 1 year	$	3,108,150
Due within 1 year through 5 years		2,158,027
Due within 5 years through 10 years		674,778
Due after 10 years		1,266,216

Total	$	7,207,171

In accordance with Emerging Issues Task Force (EITF) Issue No. 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, 2008 and March 31, 2009, 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, 2008
	Less than 12 Months					Total
Security Description	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. government agencies	$	183,054	$	(91	)	$	183,054	$	(91	)
Municipal securities		274,042		(3,352	)		274,042		(3,352	)
Corporate debt securities		199,828		(172	)		199,828		(172	)

Total	$	656,924	$	(3,615	)	$	656,924	$	(3,615	)


	As of March 31, 2009
	Less than 12 Months					Total
Security Description	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
	(unaudited)
U.S. government agencies	$	158,374	$	(119	)	$	158,374	$	(119	)
Municipal securities		112,408		(297	)		112,408		(297	)
Corporate debt securities		444,193		(807	)		444,193		(807	)
Commercial mortgage-backed securities		27,288		(92	)		27,288		(92	)

Total	$	742,263	$	(1,315	)	$	742,263	$	(1,315	)

As of December 31, 2008 and March 31, 2009, 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 March 31, 2009, we held $189.8 million of auction rate securities (ARS). The assets underlying these 35 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 generally higher 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 2025 to 2047. Since these auctions have failed, $47.8 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 March 31, 2009, 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 4.0% per annum, which is based on the forward swap curve at the end of March 2009 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 2,000 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 March 31, 2009, the estimated fair values of these ARS were $32.8 million ($19.5 million, net of tax effect) less than their costs. Based primarily on our ability and intent to hold these securities until recovery and the extent of impairment, we concluded the decline in fair values was temporary and recorded the unrealized loss to accumulated other comprehensive income on the accompanying Consolidated Balance Sheet at March 31, 2009.

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 the accompanying Consolidated Balance Sheet at March 31, 2009.

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, as part of revenues, or to accumulated other comprehensive income (AOCI) on the accompanying Consolidated Balance Sheets.

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 AOCI and subsequently reclassified to revenues when the hedged revenues are recorded or as interest income and other, net, if the hedged transaction becomes probable of not occurring.

At March 31, 2009, the effective portion of our cash flow hedges before tax effect was $338.1 million, of which $316.7 million is expected to be reclassified from AOCI to revenues within the next 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. 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.

The notional principal of foreign exchange contracts to purchase U.S. dollars with Euros was €1.9 billion (or approximately $2.6 billion) and €2.1 billion (or approximately $2.8 billion) at December 31, 2008 and March 31, 2009; the notional principal of foreign exchange contracts to purchase U.S. dollars with British pounds was £1.1 billion (or approximately $1.8 billion) and £1.1 billion (or approximately $1.7 billion) at December 31, 2008 and March 31, 2009 ; and the notional principal of foreign exchange contracts to purchase U.S. dollars with Canadian dollars was C$229.7 million (or approximately $202.2 million) and C$261.8 million (or approximately $216.7 million) at December 31, 2008 and March 31, 2009 . 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 local currency of a 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. Costs incurred related to these contracts during the three months ended March 31, 2008 and 2009 were not material. The notional principal of foreign exchange contracts to purchase U.S. dollars with foreign currencies was $2.6 billion and $2.1 billion at December 31, 2008 and March 31, 2009. The notional principal of foreign exchange contracts to sell U.S. dollars for foreign currencies was $54.2 million and $97.4 million at December 31, 2008 and March 31, 2009. The notional principal of foreign exchange contracts to purchase Euros with other currencies was €630.5 million (or approximately $897.6 million) and €476.7 million (or approximately $634.3 million) at December 31, 2008 and March 31, 2009. The notional principal of foreign exchange contracts to sell Euros for other currencies was €4.0 million (or approximately $5.3 million) at March 31, 2009.

Effective January 1, 2009, we adopted the disclosure requirements of SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities—an Amendment of FASB Statement No. 133 (SFAS 161). At December 31, 2008 and March 31, 2009, the fair values of our outstanding derivative instruments are summarized below (in thousands):


		Fair Value of Derivative Instruments
	Balance Sheet Location	As of December 31, 2008		As of March 31, 2009
				(unaudited)
Derivative Assets
Derivatives designated as hedging instruments under SFAS 133:
Foreign exchange option contracts	Prepaid revenue share, expenses and other assets, current and non-current	$	451,722	$	391,700
Derivatives not designated as hedging instruments under SFAS 133:
Foreign exchange forward contracts	Prepaid revenue share, expenses and other assets, current		13,270		151

Total		$	464,992	$	391,851

Derivative Liabilities
Derivatives not designated as hedging instruments under SFAS 133:
Foreign exchange forward contracts	Accrued expenses and other current liabilities		877		1,005

Total		$	877	$	1,005

The effect of derivative instruments in cash flow hedging relationship on income and other comprehensive income for the three months ended March 31, 2008 and 2009 is summarized below (in thousands):


Derivatives in SFAS 133 Cash Flow Hedging Relationships	Gains Recognized in AOCI on Derivative Before Tax Effect (Effective Portion)				Gains Reclassified from AOCI into Income (Effective Portion)					Gains or (Losses) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)¹
	2008		2009		Location	2008		2009		Location	2008			2009
	(unaudited)
Foreign exchange option contracts	$	152	$	137,950	Revenue	$	95	$	154,085	Interest income and other, net	$	(1,628	)	$	(99,979	)

Total	$	152	$	137,950		$	95	$	154,085		$	(1,628	)	$	(99,979	)

Amount of gains (losses) recognized in income on derivatives includes losses of $1.6 million and $100.6 million related to the amount excluded from the assessment of hedge effectiveness in the three months ended March 31, 2008 and 2009. Gains (losses) related to the ineffectiveness portion of the hedges were not material in the three months ended March 31, 2008 and 2009.

The effect of derivative instruments not designated as hedging instruments on the Consolidated Statements of Income for the three months ended March 31, 2008 and 2009 is summarized below (in thousands):


Derivatives Not Designated as Hedging Instruments under SFAS 133	Gains or (Losses) Recognized in Income on Derivative
	Location	2008			2009
		(unaudited)
Foreign exchange forward contracts	Interest income and other, net	$	(99,600	)	$	112,617

Total		$	(99,600	)	$	112,617

Note 5. Fair Value Measurements

In accordance with SFAS 157, we measure our cash equivalents, marketable securities, auction rate securities and foreign currency derivative contracts at fair value. 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.

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 ARS is classified within Level 3 because they are valued using valuation techniques (see Note 3). Some of the inputs to these models 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 on a recurring basis are summarized below (in thousands):


			Fair value measurement at reporting date using
Description	December 31, 2008		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash equivalents:
Municipal securities	$	14,250	$	—	$	14,250	$	—
Time deposits		3,015,557		—		3,015,557		—
Money market mutual funds		2,296,207		2,296,207		—		—
Marketable securities:
U.S. government agencies		3,342,406		—		3,342,406		—
Municipal securities		2,721,603		—		2,721,603		—
Money market mutual funds		73,034		—		73,034		—
Corporate debt securities		907,056		—		907,056		—
Marketable equity securities		145,000		145,000		—		—
Foreign currency derivative contracts		464,993		—		464,993		—
Auction rate securities		197,361		—		—		197,361

Total	$	13,177,467	$	2,441,207	$	10,538,899	$	197,361

Liabilities
Foreign currency derivative contracts	$	877	$	—	$	877	$	—

Total	$	877	$	—	$	877	$	—


			Fair value measurement at reporting date using
Description	March 31, 2009		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(unaudited)
Assets
Cash equivalents:
U.S. government agencies	$	214,998	$	—	$	214,998	$	—
Time deposits		3,027,156		—		3,027,156		—
Money market mutual funds		3,113,540		3,113,540		—		—
Marketable securities:
U.S. government notes		410,233		410,233		—		—
U.S. government agencies		3,943,242		—		3,943,242		—
Municipal securities		2,000,677		—		2,000,677		—
Money market mutual funds		50,132		—		50,132		—
Corporate debt securities		694,692		—		694,692		—
Agency residential mortgage-backed securities		60,312		—		60,312		—
Commercial mortgage-backed securities		47,883		—		47,883		—
Marketable equity security		151,471		151,471		—		—
Foreign currency derivative contracts		391,851		—		391,851		—
Auction rate securities		189,793		—		—		189,793

Total	$	14,295,980	$	3,675,244	$	10,430,943	$	189,793

Liabilities
Foreign currency derivative contracts	$	1,005	$	—	$	1,005	$	—

Total	$	1,005	$	—	$	1,005	$	—

The following table presents a reconciliation for our assets measured and recorded at fair value on a recurring basis, using significant unobservable inputs (Level 3) as defined in SFAS 157 for the three months ended March 31, 2008 (in thousands):


	Level 3
	(unaudited)
Balance at December 31, 2007	$	—
Transfers to Level 3		311,225
Unrealized loss included in other comprehensive income		(10,815	)
Net settlements		(40,850	)

Balance at March 31, 2008	$	259,560


	Level 3
	(unaudited)
Balance at December 31, 2008	$	197,361
Change in unrealized loss included in other comprehensive income		2,656
Net settlements		(10,224	)

Balance at March 31, 2009	$	189,793

Note 6. Property and Equipment

Property and equipment consist of the following (in thousands):


	As of December 31, 2008		As of March 31, 2009
			(unaudited)
Information technology assets	$	3,573,499	$	3,662,099
Construction in progress		1,643,136		1,558,473
Land and buildings		1,725,336		1,835,106
Leasehold improvements		572,908		580,739
Furniture and fixtures		61,462		61,070

Total		7,576,341		7,697,487
Less accumulated depreciation and amortization		2,342,498		2,575,382

Property and equipment, net	$	5,233,843	$	5,122,105

Note 7. Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill for the three months ended March 31, 2009 are as follows (in thousands, unaudited):


Balance as of December 31, 2008	$	4,839,854
Goodwill adjustment		(9,539	)

Balance as of March 31, 2009	$	4,830,315

Information regarding our acquisition-related intangible assets that are being amortized is as follows (in thousands):


	As of December 31, 2008
	Gross Carrying Amount		Accumulated Amortization		Net Carrying Value
Patents and developed technology	$	551,332	$	297,428	$	253,904
Customer relationships		800,113		153,516		646,597
Tradenames and other		209,492		113,303		96,189

Total	$	1,560,937	$	564,247	$	996,690


	As of March 31, 2009
	Gross Carrying Amount		Accumulated Amortization		Net Carrying Value
	(unaudited)
Patents and developed technology	$	538,732	$	312,959	$	225,773
Customer relationships		774,713		168,348		606,365
Tradenames and other		196,618		118,412		78,206

Total	$	1,510,063	$	599,719	$	910,344

Amortization expense of acquisition-related intangible assets for the three months ended March 31, 2008 and 2009 was $55.0 million and $78.2 million. As of March 31, 2009, expected amortization expense for acquisition-related intangible assets on our March 31, 2009 Consolidated Balance Sheet for each of the next five years and thereafter is as follows (in thousands, unaudited):


Remainder of 2009	$	184,379
2010		218,900
2011		170,615
2012		131,955
2013		105,817
2014		72,095
Thereafter		26,583

	$	910,344

Note 8. Interest Income and Other, Net

The components of interest income and other, net were as follows (in thousands):


	Three Months Ended March 31,
	2008			2009
	(unaudited)
Interest income	$	122,003		$	66,092
Realized gains on marketable securities, net		46,571			31,764
Foreign exchange gains (losses), net		1,726			(90,920	)
Other, net		(2,957	)		(726	)

Interest income and other, net	$	167,343		$	6,210

Note 9. Comprehensive Income

The changes in the components of other comprehensive income, net of taxes, were as follows (in thousands):


	Three Months Ended March 31,
	2008			2009
	(unaudited)
Net income	$	1,307,086		$	1,422,828
Change in unrealized gains (losses) on marketable securities, net of taxes		(9,809	)		9,664
Change in cumulative translation adjustment		29,793			(57,839	)
Change in unrealized gains (losses) on cash flow hedges, net of taxes		58			(9,584	)

Comprehensive income	$	1,327,128		$	1,365,069

The components of accumulated other comprehensive income, net of taxes, were as follows (in thousands):


	As of December 31, 2008		As of March 31, 2009
			(unaudited)
Unrealized net gains on marketable securities, net of taxes	$	9,995	$	19,659
Cumulative translation adjustment		6,677		(51,162	)
Unrealized gains on cash flow hedges, net of taxes		209,907		200,323

Accumulated other comprehensive income	$	226,579	$	168,820

Note 10. 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 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 the rights of others. 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, Google AdSense and Google Chrome, 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 results, 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 and threatened 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 or cash flows.

EPA Investigation

In February 2009, we learned of a U.S. Environmental Protection Agency (EPA) investigation into an alleged release of refrigerant at one of our smaller data facilities, which we acquired from DoubleClick, and the accuracy of related statements and records. We are cooperating with the EPA and have provided documents and other materials. The EPA investigation could result in fines, civil or criminal penalties, or other administrative action.

While we currently believe this matter will not have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows, we have noted it in accord with Securities and Exchange Commission regulations that call for disclosure of certain environmental proceedings that may result in monetary sanctions of $100,000 or more.

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 11. Stockholders’ Equity

The following table presents the weighted-average assumptions used to estimate the fair values of the stock options granted (excluding options granted in connection with the Exchange, see below) in the periods presented:


	Three Months Ended March 31,
	2008			2009
	(unaudited)
Risk-free interest rate		2.7	%		2.1	%
Expected volatility		35	%		40	%
Expected life (in years)		5.3			5.7
Dividend yield		—			—
Weighted-average estimated fair value of options granted during the period	$	269.79		$	129.49

The following table summarizes the activities for our options for the three months ended March 31, 2009:


	Options Outstanding
	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in millions) (1)
	(unaudited)
Balance at December 31, 2008	13,971,438		$	391.40
Options granted (2)	8,153,945		$	308.67
Exercised (3)	(362,235	)	$	30.93
Canceled/forfeited (2)	(7,782,427	)	$	522.04

Balance at March 31, 2009	13,980,721		$	280.52	6.8	$	1,048.8

Vested and exercisable as of March 31, 2009	4,754,867		$	215.56	5.9	$	658.2
Vested and exercisable as of March 31, 2009 and expected to vest thereafter (4)	13,228,704		$	278.19	6.8	$	1,017.4

(1)	The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the closing stock price of $348.06 of our Class A common stock on March 31, 2009.

(2)	The number of options granted and canceled/forfeited includes options granted and canceled in connection with the Exchange (see below).

(3)	Includes options vested during the period that were early exercised.

(4)	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 March 31, 2009:


	Options Outstanding						Options Exercisable			Options Exercisable and Vested
Range of Exercise Prices	Total Number of Shares	Unvested Options Granted and Exercised Subsequent to March 21, 2002	Number of Shares	Weighted- Average Remaining Life (Years)	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price		Number of Shares	Weighted Average Exercise Price
	(unaudited)
$ 0.30–$94.80	966,958	10,153	956,805	4.6	$	20.97	900,426	$	19.35	799,770	$	20.64
$117.84–$198.41	1,565,998	—	1,565,998	3.8	$	176.70	1,556,876	$	176.60	1,554,768	$	176.02
$205.96–$298.91	1,362,492	—	1,362,492	4.8	$	274.70	1,223,547	$	273.70	1,222,646	$	273.12
$300.97–$399.00	9,442,850	—	9,442,850	8.0	$	310.31	1,074,927	$	316.54	989,289	$	312.16
$401.78–$499.07	276,631	—	276,631	3.9	$	441.36	196,034	$	438.29	88,587	$	435.72
$500.00–$594.05	357,943	—	357,943	5.3	$	533.76	193,689	$	526.44	96,923	$	531.99
$615.95–$699.35	7,126	—	7,126	6.9	$	638.24	3,228	$	643.62	2,563	$	644.09
$707.00–$732.94	723	—	723	7.2	$	727.49	321	$	724.45	321	$	723.65

$ 0.30–$732.94	13,980,721	10,153	13,970,568	6.8	$	280.52	5,149,048	$	224.84	4,754,867	$	215.56

Options outstanding at March 31, 2009 in the above tables include 10,153 options granted and exercised subsequent to March 21, 2002 that are unvested at March 31, 2009, 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 1.7 million 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 months ended March 31, 2008 and 2009 was $161.0 million and $112.3 million. The aggregate intrinsic value of all options exercised during the three months ended March 31, 2008 and 2009 was $228.3 million and $106.9 million. These amounts do not include the aggregate sales price of options sold under our TSO program.

During the three months ended March 31, 2009, the number of shares underlying TSOs sold to selected financial institutions under the TSO program was 149,239 at a total value of $18.0 million, or an average of $120.51 per share, and an average premium of $44.69 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 March 31, 2009, the number of options eligible for participation under the TSO program was 10.3 million.

In March 2009, we completed an offer to exchange certain employee stock options issued under Google’s 2004 Stock Plan (the Exchange). Certain previously granted options were exchanged for new options with a lower exercise price granted on a one-for-one basis. Options for an aggregate of approximately 7.6 million shares of Google’s Class A common stock were exchanged. Options granted pursuant to the Exchange have an exercise price of $308.57 per share, the closing price of Google’s Class A common stock as reported by The Nasdaq Global Select Market on March 6, 2009. Options granted pursuant to the Exchange have a new vesting schedule determined by adding 12 months to each vesting date under the exchanged options’ original vesting schedule. In addition, new options will vest no sooner than six months after the date of the Exchange. The Exchange resulted in a modification charge of approximately $360 million which will be recognized over the vesting periods of the new options. These vesting periods range from six months to five years. We recorded approximately $11 million of this $360 million modification charge in the three months ended March 31, 2009.

As of March 31, 2009, there was $1,375.6 million of unrecognized compensation cost related to outstanding employee stock options. This amount is expected to be recognized over a weighted average period of 3.6 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 activities for our unvested restricted stock units and restricted shares for the three months ended March 31, 2009:


	Unvested Restricted Stock Units and Restricted Shares
	Number of Shares		Weighted- Average Grant-Date Fair Value
	(unaudited)
Unvested at December 31, 2008	3,268,089		$	514.56
Granted	288,969		$	320.53
Vested	(420,662	)	$	488.38
Forfeited	(47,335	)	$	536.39

Unvested at March 31, 2009	3,089,061		$	500.07

Expected to vest after March 31, 2009 (1)	2,840,392		$	500.07

(1)	Restricted stock units and restricted shares expected to vest reflect an estimated forfeiture rate.

As of March 31, 2009, there was $1,265.1 million of unrecognized compensation cost related to employee unvested restricted stock units and restricted shares. This amount is expected to be recognized over a weighted average period of 2.7 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 12. 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. FASB 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 SFAS 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, 2008 and March 31, 2009 were $721.0 million and $995.7 million. Also, our total unrecognized tax benefits that, if recognized, would affect our effective tax rate were $561.3 million and $673.5 million as of December 31, 2008 and March 31, 2009. The increase in our unrecognized tax benefits during the three months ended March 31, 2009 was primarily related to uncertain tax positions relating to our international structure.

Note 13. 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
	March 31, 2008		December 31, 2008		March 31, 2009
	(unaudited)
Revenues:
United States	$	2,535,474	$	2,838,043	$	2,627,060
United Kingdom		802,973		685,397		733,408
Rest of the world		1,847,596		2,177,464		2,148,522

Total revenues	$	5,186,043	$	5,700,904	$	5,508,990


	As of December 31, 2008		As of March 31, 2009
			(unaudited)
Long-lived assets:
United States	$	9,782,825	$	9,647,365
International		1,806,568		1,784,862

Total long-lived assets	$	11,589,393	$	11,432,227

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, among other things, statements concerning our expectations:

•

regarding the growth and growth rate of our operations, business, revenues, or operating margins;

•

that seasonal fluctuations in internet usage and traditional retail seasonality are likely to affect our business;

•

that growth in advertising revenues from our web sites will continue to exceed that from our Google Network members’ web sites;

•

regarding our future stock-based compensation charges;

•

that we will continue to pay most of the Google AdSense fees we receive from advertisers to our Google Network members;

•

that we will continue to take steps to improve the relevance of the ads we deliver;

•

that we may continue to take steps to reduce the number of accidental clicks;

•

that we will continue to make investments and acquisitions;

•

that our cost of revenues and traffic acquisition costs may increase in dollars and as a percentage of revenues;

•

that our research and development and sales and marketing expenses may increase in the future;

•

regarding the increase of costs related to hedging activity under our foreign exchange risk management program;

•

regarding fluctuations in paid clicks and cost-per-click;

•

regarding the sufficiency of our existing cash, cash equivalents, marketable securities and cash generated from operations;

•

regarding fluctuations in our effective tax rate;

•

regarding continued investments in international markets;

•

regarding the impact on our business, consolidated financial position, results of operations, or cash flows of the EPA’s investigation;

as well as other statements regarding our future operations, financial condition and prospects and business strategies. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this report, and in particular, the risks discussed under the heading “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

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 elsewhere in this report.

Overview

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

•

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

•

Advertisers. We provide advertisers with cost-effective ways to deliver online ads, as well as ads on traditional media such as TV (offline ads), to customers across Google sites and through the Google Network, which is the network of online and offline third parties that use our advertising programs to deliver relevant ads with their search results and content.

•

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

How We Generate Revenue

Advertising revenues made up 98% of our revenues for the three months ended March 31, 2008 and 97% for the three months ended March 31, 2009. We derive most of our additional revenues from offering internet ad serving and management services to advertisers and ad agencies, the license of our enterprise products, search solutions and web search technology.

Google AdWords is our automated online program that enables advertisers to place targeted text-based and display ads on our web sites and our Google Network members’ web sites. Most of our AdWords customers pay us on a cost-per-click basis, which means that an advertiser pays us only when a user clicks on one of its ads. We also offer AdWords on a cost-per-impression basis that enables advertisers to pay us based on the number of times their ads appear on our web sites and our Google Network members’ web sites as specified by the advertiser. For advertisers using our AdWords cost-per-click pricing, we recognize as revenue the fees charged advertisers each time a user clicks on one of the ads that appears next to the search results on our web sites or next to the search results or content on our Google Network members’ web sites. For advertisers using our AdWords cost-per-impression pricing, we recognize as revenue the fees charged advertisers each time their ads are displayed on the Google Network members’ web sites. Our AdWords agreements are generally terminable at any time by our advertisers.

Google AdSense refers to the online programs through which we distribute our advertisers’ AdWords ads for display on the web sites of our Google Network members as well as programs to deliver ads on television. Our AdSense programs include AdSense for search and AdSense for content.

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

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

For our online AdSense program, our advertisers pay us a fee each time a user clicks on one of our advertisers’ ads displayed on our Google Network members’ web sites or, for those advertisers who choose our cost-per-impression pricing, as their ads are displayed. To date, we have paid most of these advertiser fees to our Google Network members, and we expect to continue doing so for the foreseeable future. We recognize these advertiser fees as revenue and the portion of the advertiser fee we pay to our Google Network members as traffic acquisition costs under cost of revenues. In some cases, we guarantee our Google Network members minimum revenue share payments based on their achieving defined performance terms, such as number of search queries or advertisements displayed. Google Network members do not pay any fees associated with the use of our AdSense program on their web sites.

Our agreements with Google Network members consist largely of uniform online “click-wrap” agreements that members enter into by interacting with our registration web sites. The standard agreements have no stated term and are terminable at will. Agreements with our larger members are individually negotiated. Both the standard agreements and the negotiated agreements contain provisions requiring us to share with the Google Network member most of the advertiser fees generated by users clicking on ads on the Google Network member’s web site or, for advertisers who choose our cost-per-impression pricing, as the ads are displayed on the Google Network member’s web site.

Google TV Ads enables advertisers, operators and programmers to buy, schedule, deliver and measure ads on television. We recognize as revenue the fees charged advertisers each time an ad is displayed on television.

DoubleClick provides us with a platform for delivering display advertising. DoubleClick offers online ad serving and management services to advertisers, ad agencies and web site publishers. Fees derived from hosted or web-based applications are recognized as licensing and other revenues in the period the advertising impressions are delivered.

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

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

•

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

•

The number of searches initiated at our web sites and our Google Network members’ web sites and the underlying purpose of these searches (for instance, whether they are for academic research, to find a news article, or to find a product or service).

•

The number and prominence of ads displayed on our web sites and our Google Network members’ web sites.

•

The number of visits to, and the content of, our Google Network members’ web sites and certain of our web sites and the relevance and quality of the ads we display next to this content.

•

The advertisers’ return on investment from advertising campaigns on our web sites or our Google Network members’ web sites compared to other forms of advertising.

•

The total advertising spending budgets of each advertiser.

•

The number of advertisers and the breadth of items advertised.

•

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

Trends in Our Business

Our business has grown rapidly 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 we expect it will continue to do so as a result of a number of factors including increasing competition, the difficulty of maintaining growth rates as our revenues increase to higher levels and increasing maturity of the online advertising market in certain countries. In addition, the general economic downturn may result in fewer commercial queries by our users and may cause advertisers to reduce the amount they spend on online advertising, including the amount they are willing to pay for each click or impression, which could negatively affect the growth rate of our revenues.

The main focus of our advertising programs is to provide relevant and useful advertising to our users, reflecting our commitment to constantly improve their overall web experience. As a result, we expect to continue to take steps to improve the relevance of the ads displayed on our web sites and our Google Network members’ web sites. These steps include not displaying ads that generate low click-through rates or that send users to irrelevant or otherwise low quality sites and terminating our relationships with those Google Network members whose web sites 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 paid click and average cost-per-click growth rates.

The operating margin we realize on revenues generated from ads placed on our Google Network members’ web sites through our AdSense program is significantly lower than the operating margin we realize from revenues generated from ads placed on our web sites because most of the advertiser fees from ads served on Google Network members’ web sites are shared with our Google Network members. For the past five years, growth in advertising revenues from our web sites has exceeded that from our Google Network members’ web sites. 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 web sites compared to the rate of growth in revenues from our Google Network members’ web sites may vary over time.

We continue to invest in building the necessary employee and systems infrastructures required to manage our growth and develop and promote our products and services, and this may cause our operating margins to decrease. We have generally experienced and expect to continue to experience growth in our operations as we build our research and development programs, expand our base of users, advertisers, Google Network members and content providers, and increase our presence in international markets. Also, we have acquired and expect to continue to acquire businesses and other assets from time to time. These acquisitions generally enhance the breadth and depth of our expertise in engineering and other functional areas, our technologies and our product offerings. Our full-time employee headcount has increased over the last 12 months, growing from 19,156 at March 31, 2008 to 20,164 at March 31, 2009. We have recently made efforts to improve the discipline of our hiring process and to focus on better managing our expense growth. However, we expect to continue to invest in our business, and this may cause our operating margins to decrease.

We expect our cost of revenues to increase in dollars and may increase as a percentage of revenues in future periods, primarily as a result of forecasted increases in traffic acquisition costs, data center costs and credit card and other transaction fees, as well as content acquisition 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 revenue from traffic on our web sites and our Google Network members’ web sites, particularly with those members to whom we have guaranteed minimum revenue share payments.

Our international revenues have grown as a percentage of our total revenues to 52% in the three months ended March 31, 2009 from 50% in the three months ended December 31, 2008 and from 51% in the three months ended March 31, 2008. This increase in the portion of our revenues derived from international markets results largely from increased acceptance of our advertising programs, increases in our direct sales resources and customer support operations and our continued progress in developing localized versions of our products in these international markets. The increase in the proportion of international revenues derived from international markets increases our exposure to fluctuations in foreign currency to U.S. dollar exchange rates. For example, in the first quarter of 2009, the

strengthening of the U.S. dollar relative to foreign currencies (primarily the British pound and the Euro) had an unfavorable impact on our revenues. We have a foreign exchange risk management program that is designed to reduce our exposure to fluctuations in foreign currencies, however this program will not fully offset the effect of fluctuations on our revenues and earnings.

Results of Operations

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


	Three Months Ended
	March 31, 2008		December 31, 2008		March 31, 2009
Consolidated Statements of Income Data:
Revenues	100.0	%	100.0	%	100.0	%
Costs and expenses:
Cost of revenues	40.7		38.4		38.1
Research and development	13.0		12.9		11.6
Sales and marketing	8.6		8.9		7.9
General and administrative	7.9		7.2		8.2

Total costs and expenses	70.2		67.4		65.8

Income from operations	29.8		32.6		34.2
Impairment of equity investments	—		(19.2	)	—
Interest income and other, net	3.2		1.3		0.1

Income before income taxes	33.0		14.7		34.3
Provision for income taxes	7.8		8.0		8.5

Net income	25.2	%	6.7	%	25.8	%

Revenues

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


	Three Months Ended
	March 31, 2008		December 31, 2008		March 31, 2009
Advertising revenues:
Google web sites	$	3,400.4	$	3,811.2	$	3,692.8
Google Network web sites		1,686.1		1,693.4		1,638.1

Total advertising revenues		5,086.5		5,504.6		5,330.9
Licensing and other revenues		99.5		196.3		178.1

Revenues	$	5,186.0	$	5,700.9	$	5,509.0

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


	Three Months Ended
	March 31, 2008		December 31, 2008		March 31, 2009
Advertising revenues:
Google web sites	66	%	67	%	67	%
Google Network web sites	32		30		30

Total advertising revenues	98		97		97
Google web sites as % of advertising revenues	67		69		69
Google Network web sites as % of advertising revenues	33		31		31
Licensing and other revenues	2	%	3	%	3	%

The growth in our advertising revenues in the three months ended March 31, 2009 compared to the three months ended March 31, 2008 resulted from an increase in the number of paid clicks generated 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, certain monetization improvements and the continued global expansion of our products, our advertiser base and our user base. The decrease in the average cost-per-click paid by our advertisers was primarily the result of the strengthening of the U.S. dollar relative to foreign currencies (primarily the British pound and the Euro). In addition, the decrease in the average cost-per-click was due to how we believe advertisers managed their advertising costs in response to the general economic downturn. Specifically, we believe that as a result of the general economic downturn, advertisers, in aggregate, have lowered their bids for keywords in response to a decrease in the sales they are able to make per paid click.

During this period, advertising revenue growth for Google web sites resulted primarily from an increase in aggregate traffic, certain monetization improvements and the continued global expansion of our products, our advertiser base and our user base. The decrease in advertising revenue from Google Network members’ sites resulted primarily from the termination of certain Google Network member relationships whose web sites did not meet our quality requirements, as well as certain other quality improvements, which adversely affected our revenues.

The decline in our advertising revenues in the three months ended March 31, 2009 compared to the three months ended December 31, 2008 resulted from the traditional retail seasonality trends affecting our business as well as a decrease in the average cost-per-click paid by our advertisers, partially offset by the increase in the number of paid clicks generated through our advertising programs. The decrease in the average cost-per-click paid by our advertisers was, in addition to the seasonality trend noted above, the result of how we believe advertisers managed their advertising costs in response to the general economic downturn. The increase in the number of paid clicks through our advertising programs was due to an increase in aggregate traffic both on our web sites and the web sites of our Google Network members, certain monetization improvements and the continued global expansion of our products, our advertiser base and our user base.

Improvements in our ability to ultimately monetize increased traffic primarily relate to enhancing the end user experience, including providing end users with ads that are more relevant to their search queries or to the content on the Google Network members’ web sites they visit. These improvements have included, for instance, a change to the formula used to determine which ads appear at the top of our search results pages, a change to the clickable area around our AdSense for content text-based ads to only the title and URL to reduce the number of accidental clicks, a change to report first-page bids which is an estimate of the bid it would take for an ad to reach the first page of our search results pages, as well as changes to further enhance the accuracy of our quality scoring, which is our measurement of an ad’s click-through rate and other relevancy factors.

Aggregate paid clicks on Google web sites and our Google Network members’ web sites increased 17% from the three months ended March 31, 2008 to the three months ended March 31, 2009 and 3% from the three months ended December 31, 2008 to the three months ended March 31, 2009. Average cost-per-click on Google web sites and our Google Network members’ web sites decreased 14% from the three months ended March 31, 2008 to the three months ended March 31, 2009 and 6% from the three months ended December 31, 2008 to the three months ended March 31, 2009. 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 or may in the future fluctuate because of various factors including the revenue growth rates on our web sites 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, and the general economic downturn. In addition, traffic growth in emerging markets compared to more mature markets and across various advertising verticals 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.

Revenues by Geography

Domestic and international revenues as a percentage of consolidated revenues, determined based on the billing addresses of our advertisers are set forth below (unaudited):


	Three Months Ended
	March 31, 2008		December 31, 2008		March 31, 2009
	(unaudited)
United States	49	%	50	%	48	%
United Kingdom	15	%	12	%	13	%
Rest of the world	36	%	38	%	39	%

The growth in international revenues as a percentage of consolidated revenues in the three months ended March 31, 2009 compared to the three months ended March 31, 2008 resulted largely from increased acceptance of our advertising programs, increases in our direct sales resources and customer support operations in international markets and our continued progress in developing localized versions of our products for these international markets. The growth in international revenues as a percentage of consolidated revenues in the three months ended March 31, 2009 compared to the three months ended December 31, 2008 resulted from seasonally stronger traffic in the United Kingdom and certain other countries.

The strengthening of the U.S. dollar relative to foreign currencies (primarily the British pound and the Euro) in the three months ended March 31, 2009 compared to the three months ended March 31, 2008 had an unfavorable impact on our international revenues (international revenues increased $231.4 million during this period). Had foreign exchange rates remained constant in these periods, our total revenues would have been approximately $429 million, or 7.8%, higher. This is before consideration of hedging gains recognized to revenue of $154.1 million and zero in the three months ended March 31, 2009 and March 31, 2008.

The strengthening of the U.S. dollar relative to foreign currencies (primarily the British pound and the Euro) in the three months ended March 31, 2009 compared to the three months ended December 31, 2008 had an unfavorable impact on our international revenues (international revenues increased $19.1 million during this period). Had foreign exchange rates remained constant in these periods, our total revenues in the three months ended March 31, 2009 would have been approximately $120 million, or 2.2%, higher. This is before consideration of hedging gains recognized to revenue of $154.1 million and $128.9 million in the three months ended March 31, 2009 and December 31, 2008.

Although we expect to continue to make investments in international markets, they may not result in an increase in our international revenues as a percentage of total revenues in 2009 or thereafter. See Note 13 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 web site (collectively referred to as distribution arrangements). These amounts are primarily based on the revenue share arrangements with our Google Network members and distribution partners.

Certain AdSense agreements obligate us to make guaranteed minimum revenue share payments to Google Network members based on their achieving defined performance terms, such as number of search queries or advertisements displayed. These fees may be paid in advance or in arrears and are non-refundable but are subject to adjustment based on the achievement of the defined performance terms. In addition, the arrangements are terminable at will, although under the terms of certain contracts we or our Google Network members may be subject to penalties in the event of early termination. To the extent we expect revenues generated under an arrangement to exceed the guaranteed minimum revenue share payments, we recognize traffic acquisition costs on a contractual revenue share basis or on a basis proportionate to forecasted revenues, whichever is greater. Otherwise, we recognize the guaranteed revenue share payments

as traffic acquisition costs on a straight-line basis over the term of the related agreements. For other AdSense agreements under which we only pay on a contractual revenue share basis, we recognize the revenue share obligations as traffic acquisition costs at the same time the related revenue is recognized. Also, concurrent with the commencement of a small number of AdSense and other agreements, we have purchased certain items from, or provided other consideration to, our Google Network members and partners. We have determined that certain of these amounts are prepaid traffic acquisition costs and are amortized on a straight-line basis over the terms of the related agreements.

In addition, 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. The fees are non-refundable. Further, the 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 (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 revenue.

Cost of revenues also includes the expenses associated with the operation of our data centers, including depreciation, labor, energy and bandwidth costs, credit card and other transaction fees related to processing customer transactions, amortization of acquired 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 web sites and our Google Network members’ web sites from which the content is viewed and share most of the fees these ads generate with the content providers and the Google Network members. To the extent we are obligated to make guaranteed minimum revenue share or other payments to our content providers, we recognize content acquisition costs equal to the greater of the following three amounts: the contractual revenue share amount, if any, an amount that is based on the number of times the content is displayed, or an amount calculated on a straight-line basis over the terms of the agreements. The following tables present our cost of revenues and cost of revenues as a percentage of revenues, and our traffic acquisition costs and traffic acquisition costs as a percentage of advertising revenues for the periods presented (dollars in millions, unaudited):


	Three Months Ended
	March 31, 2008			December 31, 2008			March 31, 2009
	(unaudited)
Cost of revenues	$	2,110.5		$	2,190.0		$	2,101.5
Cost of revenues as a percentage of revenues		40.7	%		38.4	%		38.1	%

	Three Months Ended
	March 31, 2008			December 31, 2008			March 31, 2009
	(unaudited)
Traffic acquisition costs related to AdSense arrangements	$	1,343.2		$	1,293.3		$	1,229.1
Traffic acquisition costs related to distribution arrangements		143.2			190.1			206.9


Total traffic acquisition costs	$	1,486.4		$	1,483.4		$	1,436.0


Traffic acquisition costs as a percentage of advertising revenues		29.2	%		26.9	%		26.9	%

Cost of revenues decreased $9.0 million from the three months ended March 31, 2008 to the three months ended March 31, 2009. Over the same period there was a decrease in traffic acquisition costs of $50.4 million primarily as a result of less revenues generated through our AdSense program. This decrease was also a result of more revenues realized from Google Network members to whom we pay lower revenue share and less revenues realized from those members to whom we pay more revenue share. This decrease was offset by an increase in data center costs of $36.8 million primarily resulting from the depreciation of additional information technology assets and data center buildings and an increase in the amortization of intangible assets of $14.2 million as a result of recognizing a full quarter of amortization expense in the three months ended March 31, 2009 related to our acquisition of DoubleClick. The decrease in traffic acquisition costs as a percentage of advertising revenues was primarily due to an increase in the proportion of advertising revenues coming from our web sites rather than from our Google Network members’ web sites as well as an increase in revenue recognized from gains realized under our foreign exchange risk management program.

Cost of revenues decreased $88.5 million from the three months ended December 31, 2008 to the three months ended March 31, 2009. Over this same period there was a decrease in traffic acquisition costs of $47.4 million primarily as a result of less revenues generated through our AdSense program. This decrease was also a result of more revenues realized from Google Network members to whom we pay lower revenue share and less revenues realized from those members to whom we pay more revenue share. In addition, there was a decrease in data center costs of $31.3 million primarily as a result of a decrease in labor costs. The decrease in labor costs was primarily due to lower annual bonus expense recognized in the three months ended March 31, 2009 compared to the three months ended December 31, 2008.

We expect cost of revenues to increase in dollar amount and may increase as a percentage of revenues in 2009 and in future periods, primarily as a result of forecasted increases in traffic acquisition costs, data center costs, credit card and other transaction fees, content acquisition and other costs. Traffic acquisition costs as a percentage of advertising revenues may fluctuate in the future based on a number of factors, including the following:

•

The relative growth rates of revenues from our web sites and from our Google Network members’ web sites.

•

Whether we are able to enter into more AdSense arrangements that provide for lower revenue share obligations or whether increased competition for arrangements with existing and potential Google Network members results in less favorable revenue share arrangements, including arrangements with guaranteed minimum payments.

•

Whether we are able to continue to improve the monetization of traffic on our web sites and our Google Network members’ web sites, particularly with those members to whom we have guaranteed minimum revenue share payments.

•

The relative growth rates of expenses associated with distribution arrangements and the related revenues generated, including whether we share with certain existing and new distribution partners proportionately more of the aggregate advertising fees that we earn from paid clicks derived from search queries these partners direct to our web sites.

Research and Development.

The following table presents our research and development expenses, and research and development expenses as a percentage of revenues for the periods presented (dollars in millions, unaudited):


	Three Months Ended
	March 31, 2008			December 31, 2008			March 31, 2009
	(unaudited)
Research and development expenses	$	673.1		$	733.3		$	641.6
Research and development expenses as a percentage of revenues		13.0	%		12.9	%		11.6	%

Research and development expenses consist primarily of compensation and related costs for personnel responsible for the research and development of new products and services, as well as significant improvements to existing products and services. We expense research and development costs as they are incurred.

Research and development expenses decreased $31.5 million from the three months ended March 31, 2008 to the three months ended March 31, 2009. This decrease was primarily due to a decrease in stock-based compensation expense of $25.2 million as a result of certain acquisition related equity awards which fully vested during the second quarter of 2008.

Research and development expenses decreased $91.7 million from the three months ended December 31, 2008 to the three months ended March 31, 2009. This decrease was primarily due to lower annual bonus expense recognized in the three months ended March 31, 2009 compared to the three months ended December 31, 2008.

We expect that research and development expenses may increase in dollar amount and as a percentage of revenues in 2009 and future periods because we expect to continue to invest in building the necessary employee and systems infrastructures required to support the development of new, and improve existing, products and services.

Sales and Marketing.

The following table presents our sales and marketing expenses, and sales and marketing expenses as a percentage of revenues for the periods presented (dollars in millions, unaudited):


	Three Months Ended
	March 31, 2008		December 31, 2008		March 31, 2009
	(unaudited)
Sales and marketing expenses	$	446.9	$	506.0

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