Google financial results

Google Inc. (NASDAQ: GOOG) today announced financial results for the quarter and for the fiscal year ended December 31, 2008.

“Google performed well in the fourth quarter, despite an increasingly difficult economic environment. Search query growth was strong, revenues were up in most verticals, and we successfully contained costs,” said Eric Schmidt, CEO of Google. “It’s unclear how long the global downturn will last, but our focus remains on the long term, and we’ll continue to invest in Google’s core search and ads business as well as in strategic growth areas such as display, mobile, and enterprise.”

Google also announced today that it is planning to offer employees a voluntary, one-for-one stock option exchange. This program, intended to create more incentives for employees to remain at Google and contribute to achieving its business objectives, is currently scheduled to begin on January 29, 2009 and end on March 3, 2009, unless Google is required or opts to extend the offer period to a later date. Please see the section “Employee Stock Option Exchange”

Q4 Financial Summary

Google reported revenues of $5.70 billion for the quarter ended December 31, 2008, an increase of 18% compared to the fourth quarter of 2007 and an increase of 3% compared to the third quarter of 2008.
Google reports its revenues, consistent with GAAP, on a gross basis without deducting traffic acquisition costs (TAC). In the fourth quarter of 2008, TAC totaled $1.48 billion, or 27% of advertising revenues.
Google reports operating income, net income, and earnings per share
(EPS) on a GAAP and non-GAAP basis. The non-GAAP measures, as well as free cash flow, an alternative non-GAAP measure of liquidity, are described below and are reconciled to the corresponding GAAP measures in the accompanying financial tables.
GAAP operating income for the fourth quarter of 2008 was $1.86 billion, or 33% of revenues. This compares to GAAP operating income of $1.65 billion, or 30% of revenues, in the third quarter of 2008.
Non-GAAP operating income in the fourth quarter of 2008 was $2.15 billion, or 38% of revenues. This compares to non-GAAP operating income of $2.02 billion, or 37% of revenues, in the third quarter of 2008.

GAAP net income for the fourth quarter of 2008 was $382 million as compared to $1.29 billion in the third quarter of 2008. Non-GAAP net income in the fourth quarter of 2008 was $1.62 billion, compared to
$1.56 billion in the third quarter of 2008.

GAAP EPS for the fourth quarter of 2008 was $1.21 on 317 million diluted shares outstanding, compared to $4.06 for the third quarter of
2008 on 318 million diluted shares outstanding. Non-GAAP EPS in the fourth quarter of 2008 was $5.10, compared to $4.92 in the third quarter of 2008.

Non-GAAP operating income and non-GAAP operating margin exclude the expenses related to stock-based compensation (SBC) and the settlement agreement with the Authors Guild and the Association of American Publishers (“AAP”). Non-GAAP effective tax rate, non-GAAP net income, and non-GAAP EPS exclude the expenses and tax benefits related to SBC, the settlement agreement with the Authors Guild and the AAP and the non-cash impairment charges primarily related to our investments in AOL and Clearwire. In the fourth quarter of 2008, the charge related to SBC was $286 million as compared to $280 million in the third quarter of 2008. Also, in the fourth quarter of 2008, we recognized
$1.09 billion in asset impairment charges related primarily to our investments in AOL and Clearwire. In the third quarter of 2008, we recognized $95 million of expense related to the settlement agreement with the Authors Guild and the AAP. The tax benefit related to SBC was
$65 million in the fourth quarter of 2008 and $63 million in the third quarter of 2008. The tax benefit related to the impairment charges was
$82 million in the fourth quarter of 2008. The tax benefit related to the settlement agreement was $39 million in the third quarter of 2008.
Reconciliations of non-GAAP measures to GAAP operating income, operating margin, effective tax rate, net income, and EPS are included at the end of this release.

Q4 Financial Highlights

Revenues – Google reported revenues of $5.70 billion in the fourth quarter of 2008, representing an 18% increase over fourth quarter 2007 revenues of $4.83 billion and a 3% increase over third quarter 2008 revenues of $5.54 billion. Google reports its revenues, consistent with GAAP, on a gross basis without deducting TAC.

Google Sites Revenues – Google-owned sites generated revenues of $3.81 billion, or 67% of total revenues, in the fourth quarter of 2008.
This represents a 22% increase over fourth quarter 2007 revenues of
$3.12 billion and a 4% increase over third quarter 2008 revenues of
$3.67 billion.

Google Network Revenues – Google’s partner sites generated revenues, through AdSense programs, of $1.69 billion, or 30% of total revenues, in the fourth quarter of 2008. This represents a 4% increase over fourth quarter 2007 network revenues of $1.64 billion and a 1% increase over third quarter 2008 network revenues of $1.68 billion.

International Revenues – Revenues from outside of the United States totaled $2.86 billion, representing 50% of total revenues in the fourth quarter of 2008, compared to 48% in the fourth quarter of 2007 and 51% in the third quarter of 2008. Had foreign exchange rates remained constant from the third quarter of 2008 through the fourth quarter of 2008, our revenues in the fourth quarter of 2008 would have been $334 million higher. Had foreign exchange rates remained constant from the fourth quarter of 2007 through the fourth quarter of 2008, our revenues in the fourth quarter of 2008 would have been $266 million higher.

Revenues from the United Kingdom totaled $685 million, representing 12% of revenue in the fourth quarter of 2008, compared to 14% in the fourth quarter of 2007 and 14% in the third quarter of 2008.

In the fourth quarter, we recognized a benefit of $129 million to revenue through our foreign exchange risk management program.

Paid Clicks – Aggregate paid clicks, which include clicks related to ads served on Google sites and the sites of our AdSense partners, increased approximately 18% over the fourth quarter of 2007 and increased approximately 10% over the third quarter of 2008.

TAC – Traffic Acquisition Costs, the portion of revenues shared with Google’s partners, decreased to $1.48 billion in the fourth quarter of 2008. This compares to TAC of $1.50 billion in the third quarter of 2008. TAC as a percentage of advertising revenues was 27% in the fourth quarter, compared to 28% in the third quarter of 2008.

The majority of TAC expense is related to amounts ultimately paid to our AdSense partners, which totaled $1.29 billion in the fourth quarter of 2008. TAC is also related to amounts ultimately paid to certain distribution partners and others who direct traffic to our website, which totaled $190 million in the fourth quarter of 2008.

Other Cost of Revenues – Other cost of revenues, which is comprised primarily of data center operational expenses, amortization of intangible assets, content acquisition costs as well as credit card processing charges, increased to $707 million, or 12% of revenues, in the fourth quarter of 2008, compared to $678 million, or 12% of revenues, in the third quarter of 2008.

Operating Expenses – Operating expenses, other than cost of revenues, were $1.65 billion in the fourth quarter of 2008, or 29% of revenues, compared to $1.72 billion in the third quarter of 2008, or 31% of revenues. The operating expenses in the fourth quarter of 2008 included $890 million in payroll-related and facilities expenses, compared to $859 million in the third quarter of 2008.

Stock-Based Compensation (SBC) – In the fourth quarter of 2008, the total charge related to SBC was $286 million as compared to $280 million in the third quarter of 2008.

Employee Stock Option Exchange – Our Board of Directors has approved an exchange offer to allow employees the opportunity to exchange all or a portion of their existing stock options for the same number of new options. This program is currently scheduled to commence on January 29, 2009 and end on March 3, 2009 at 6:00 a.m. Pacific Time, unless Google is required or opts to extend the offer period to a later date. Currently, we expect that new options will have an exercise price equal to the closing price per share of our common stock on March 2, 2009 and that stock options with exercise prices above this closing price will be eligible for exchange, but this may change. Generally, all employees with options are eligible to participate in the program (Eric Schmidt, Sergey Brin, and Larry Page do not hold options).

The number of Google shares subject to outstanding options will not change as a result of the exchange offer. We have designed the program so that new options issued as part of this exchange offer will be subject to a new vesting schedule which adds 12 months to the original applicable vesting dates. In addition, new options will vest no sooner than 6 months after the close of the offer period. The expiration dates of the new options will remain the same as the expiration dates of the options being exchanged.

We expect to take a modification charge estimated to be $460 million over the vesting periods of the new options. These vesting periods range from six months to approximately five years. Assuming the offer proceeds according to our planned timeline, this modification charge will be recorded as additional stock based compensation beginning in the first quarter of 2009. This estimate assumes an exchange price of approximately $300 and that all eligible underwater options will be exchanged under the program. As a result, the actual amount of the modification charge is likely to change.

We currently estimate stock-based compensation charges for grants to employees prior to January 1, 2009 to be approximately $1.04 billion for 2009. This estimate does not include expenses to be recognized related to employee stock awards that are granted after January 1,
2009 or non-employee stock awards that have been or may be granted.
It also does not include the estimated $460 million modification charge related to our employee stock option exchange.

Operating Income – GAAP operating income in the fourth quarter of 2008 was $1.86 billion, or 33% of revenues. This compares to GAAP operating income of $1.65 billion, or 30% of revenues, in the third quarter of 2008. Non-GAAP operating income in the fourth quarter of
2008 was $2.15 billion, or 38% of revenues. This compares to non-GAAP operating income of $2.02 billion, or 37% of revenues, in the third quarter of 2008.

Impairment on Equity Investments – We have determined that certain of our assets are impaired and require us to recognize non-cash impairment charges related to those investments. In the fourth quarter of 2008, the impairment charge on these assets was $1.09 billion, including charges of $726 million and $355 million related to our investments in AOL and Clearwire, respectively.
Interest Income and Other, Net – Interest income and other, net increased to $70 million in the fourth quarter of 2008, compared with interest income and other, net of $21 million in the third quarter of 2008.
Income Taxes – Our GAAP effective tax rate was 54% for the fourth quarter of 2008 and 28% for the year, which includes the effect of the impairment on our equity investments of $1.09 billion in the fourth quarter and the legal settlement of $95 million with the Authors Guild and the AAP in the third quarter. Our non-GAAP effective tax rate, defined as our income before income taxes adding back impairment charges, legal settlement, and stock-based compensation divided into the result obtained by subtracting the related tax benefits from our provision for income taxes, for the fourth quarter and for the year was 27% and 24%, respectively.

Net Income – GAAP net income for the fourth quarter of 2008 was $382 million as compared to $1.29 billion in the third quarter of 2008.
Non-GAAP net income was $1.62 billion in the fourth quarter of 2008, compared to $1.56 billion in the third quarter of 2008. GAAP EPS for the fourth quarter of 2008 was $1.21 on 317 million diluted shares outstanding, compared to $4.06 for the third quarter of 2008, on 318 million diluted shares outstanding. Non-GAAP EPS for the fourth quarter of 2008 was $5.10, compared to $4.92 in the third quarter of 2008.

Cash Flow and Capital Expenditures – Net cash provided by operating activities for the fourth quarter of 2008 totaled $2.12 billion as compared to $2.18 billion for the third quarter of 2008. In the fourth quarter of 2008, capital expenditures were $368 million, the majority of which was related to IT infrastructure investments, including data centers, servers, and networking equipment. Free cash flow, an alternative non-GAAP measure of liquidity, is defined as net cash provided by operating activities less capital expenditures. In the fourth quarter of 2008, free cash flow was $1.75 billion.

We expect to continue to make significant capital expenditures.

A reconciliation of free cash flow to net cash provided by operating activities, the GAAP measure of liquidity, is included at the end of this release.

Cash – As of December 31, 2008, cash, cash equivalents, and short-term marketable securities were $15.85 billion.

On a worldwide basis, Google employed 20,222 full-time employees as of December 31, 2008, up from 20,123 full-time employees as of September 30, 2008.