S-1/A 1 ds1a.htm AMENDMENT NO. 5 TO FORM S-1 Amendment No. 5 to Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on November 23, 2004

Registration No. 333-117934


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Amendment No. 5

to

FORM S-1

REGISTRATION STATEMENT

Under

The Securities Act of 1933


GOOGLE INC.

(Exact name of Registrant as specified in its charter)


Delaware   7375   77-0493581

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

1600 Amphitheatre Parkway

Mountain View, CA 94043

(650) 623-4000

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)


Eric Schmidt

Chief Executive Officer

Google Inc.

1600 Amphitheatre Parkway

Mountain View, CA 94043

(650) 623-4000

(Name, address, including zip code, and telephone number, including area code, of agent for service)


Copies to:

Christian E. Montegut, Esq.

Donald S. Harrison, Esq.

Ricardo E. Velez, Esq.

Wilson Sonsini Goodrich & Rosati

Professional Corporation

650 Page Mill Road

Palo Alto, California 94304-1050

(650) 493-9300


Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are being offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), check the following box.  x

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If delivery of the offering circular is expected to be made pursuant to Rule 434, check the following box.  ¨


The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 



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The information in this offering circular is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This offering circular is not an offer to sell these securities and we are not soliciting any offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Offering Circular (Subject to Completion)

Dated November 23, 2004

 

11,684,808 Shares Class A Common Stock

16,966,516 Shares Class B Common Stock

 

LOGO

RESCISSION OFFER

 


 

Google Inc. is a global technology leader focused on improving the ways people connect with information. Our principal executive offices are located at 1600 Amphitheatre Parkway, Mountain View, California 94043.

 

On August 18, 2004, a registration statement relating to our initial public offering of Class A common stock was declared effective by the Securities and Exchange Commission. As a result, 19,605,052 shares of Class A common stock were sold to the public for $85.00 per share (consisting of 14,142,135 sold by us and 5,462,917 shares sold by the selling stockholders identified in the registration statement) and the underwriters subsequently exercised their over-allotment option to purchase an additional 2,929,626 from the selling stockholders identified in the registration statement.

 

Our Class A common stock is quoted on The Nasdaq National Market under the symbol “GOOG.” The range of closing prices for our Class A common stock, as quoted in The Nasdaq National Market from August 19, 2004 to November 22, 2004 has been $100.01 to $196.03. On November 22, 2004, the last reported per share sale price for our Class A common stock on The Nasdaq National Market was $165.10 per share.

 

The Rescission Offer

 

We are offering to repurchase 23,435,945 shares of our common stock (consisting of 9,408,199 shares of Class A common stock and 14,027,746 shares of Class B common stock) from persons who are or were residents of Arkansas, California, Colorado, Connecticut, the District of Columbia, Georgia, Illinois, Maryland, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Texas, Virginia and Washington. These persons are current and former employees and consultants who purchased those shares upon exercise of options we granted to them pursuant to our 1998 Stock Plan, 2003 Stock Plan, 2003 Stock Plan (No. 2) and 2003 Stock Plan (No. 3).

 

We are offering to repurchase unexercised options to purchase 5,215,379 shares of our common stock (consisting of options to purchase 2,276,609 shares of Class A common stock and 2,938,770 shares of Class B common stock) from persons who are or were residents of the above-mentioned states and who are current and former employees and consultants.

 

The repurchase price for the shares of our common stock subject to the rescission offer ranges from $0.30 to $80.00 per share, and is equal to the price paid by those persons who purchased these shares. The repurchase price for unexercised options to purchase shares of our common stock subject to the rescission offer is 20% of the per share exercise price multiplied by the number of shares subject to the options. In each case, if you accept our rescission offer and surrender your shares or options, or both, as the case may be, you will receive interest, based on the repurchase price noted above and calculated from the date you purchased the shares or the date the option was granted to you through the date that the rescission offer expires at the interest rate based on your state of residence as set forth below.

 

Federal law does not provide a specific interest rate to be used in the calculation of the consideration to be received in connection with the repurchases of securities by an issuer in a rescission offer. We intend to use the legal rates of interest for the repurchase of shares and options based on the state of residence of the stockholder or optionee. These interest rates are as follows:

 

State


   Interest Rate

   

State


   Interest Rate

 

Arkansas

   6 %  

Nevada

   6.25 %

California

   7 %  

New Hampshire

   10 %

Colorado

   8 %  

New Jersey

   4 %

Connecticut

   6 %  

New York*

   7 %

District of Columbia

   6 %  

North Carolina

   8 %

Georgia

   6 %  

Pennsylvania

   6 %

Illinois

   10 %  

Texas

   6 %

Maryland

   10 %  

Virginia

   6 %

Massachusetts

   6 %  

Washington

   8 %

Michigan

   6 %           

*   New York law does not provide a specific interest rate. For purposes of the rescission offer, we are applying the rate of interest of California (our principal place of business) to calculate the consideration to be received by New York residents who may be entitled to rescission rights.

 

The rescission offer will expire on December     , 2004.

 

See “ Risk Factors” beginning on page 10 to read about certain factors you should consider before accepting or rejecting the rescission offer.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined whether this offering circular is truthful or complete. Any representation to the contrary is a criminal offense.


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SUPPLEMENTAL NOTES REGARDING THE RESCISSION OFFER

 

    The rescission offer is not an unanticipated development. Rather, our intent to make this rescission offer and the details of the rescission offer were disclosed in the registration statement relating to our initial public offering originally filed in April 2004.

 

    Because we grew rapidly from September 2001 through June 2004, we granted options to purchase common stock with an aggregate value that exceeded the limits set forth in Rule 701 under the Securities Act of 1933. Exceeding these limits can result in potential violations of federal and state securities laws. Rescission offers for such potential violations are commonly made by companies in these situations.

 

    The rescission offer process is proceeding as disclosed in our public filings and as we expect. We intend to commence the rescission offer on November     , 2004. We recognize that there has been increased media coverage resulting from our filing of a registration statement relating to the rescission offer. The filing of the registration statement is a normal part of the rescission offer process.

 

    We do not believe the rescission offer will be accepted by our current and former employees and consultants in an amount that would represent a material expenditure by us. This belief is based on the fact that our rescission offer will offer to repurchase shares and options at a weighted average price of $3.94, while the range of closing prices for our Class A common stock, as quoted on The Nasdaq National Market, from August 19, 2004 to November 22, 2004 has been $100.01 to $196.03. On November 22, 2004 the last business day before the date of this offering circular, the last reported sale price of our Class A common stock on The Nasdaq National Market was $165.10 per share. We cannot give you assurances as to the price at which the Class A common stock will trade in the future.

 

    When the rescission offer expires, any person who did not accept the rescission offer will have freely tradable stock, subject to our lock-up and vesting restrictions.

 

    The rescission offer is merely an offer to repurchase shares and options. No shareholder or option holder is required to accept our rescission offer.

 

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TABLE OF CONTENTS

 

     Page

Questions and Answers About the Rescission Offer

   1

Summary

   7

Risk Factors

   10

Rescission Offer

   31

Material U.S. Federal Income Tax Consequences

   38

Special Note Regarding Forward-Looking Statements

   41

Dividend Policy

   42

Selected Consolidated Financial Data

   43

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   45

Business

   69

Management

   83

Certain Relationships and Related Party Transactions

   96

Principal Stockholders

   98

Description of Capital Stock

   101

Shares Eligible For Future Sale

   107

Legal Matters

   110

Experts

   110

Where You Can Find Additional Information

   110

Index to Consolidated Financial Statements

   F-1

Index to Financial Statements of Applied Semantics, Inc.

   F-39

Index to Condensed Financial Statements of Applied Semantics, Inc.

   F-55

 


 

You should rely only on the information contained in this offering circular. We have not authorized anyone to provide you with information that is different from that contained in this offering circular. We are offering to repurchase shares of our common stock and options to purchase our common stock only in jurisdictions where offers and sales are permitted. The information in this offering circular is complete and accurate only as of the date of the front cover regardless of the time of delivery of this offering circular or of any sale of shares. Except where the context requires otherwise, in this offering circular, the “Company,” “Google,” “we,” “us” and “our” refer to Google Inc., a Delaware corporation, and, where appropriate, its subsidiaries.

 

Only residents of the United States are eligible to participate in the rescission offer.

 

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QUESTIONS AND ANSWERS ABOUT THE RESCISSION OFFER

 

You should read the following questions and answers, together with the more detailed information regarding the rescission offer and the risk factors set forth elsewhere in this offering circular, before deciding whether to accept or reject the rescission offer.

 

General

 

Q:    Why are we making the rescission offer?

 

A:    Certain options we granted during the period from September 2001 through July 2004 may not have been exempt from the registration or qualification requirements under the securities laws of certain states. In addition, certain shares issued upon exercise of options granted during this period may not have been exempt from the registration and qualification requirements under Rule 701 under the Securities Act of 1933 and under those state securities laws that provide an exemption to the extent the requirements under Rule 701 are met. Consequently, these option grants and stock issuances may have violated the Securities Act of 1933 and the state securities laws of Arkansas, California, the District of Columbia, Maryland and New York. The rescission offer is intended to address these federal and state securities laws compliance issues by allowing the holders of the options and shares covered by the rescission offer to rescind the underlying securities transactions and sell those securities back to us.

 

Q:    Which options and shares of common stock are included in the rescission offer?

 

A:    We are offering, upon the terms and conditions described in this offering circular, to rescind:

 

    The sale of 9,408,199 shares of Class A common stock.

 

    The sale of 14,027,746 shares of Class B common stock.

 

    The grant of options to purchase 2,276,609 shares of Class A common stock.

 

    The grant of options to purchase 2,938,770 shares of Class B common stock.

 

The 23,435,945 shares of our common stock subject to the rescission offer are held by 1,320 persons and the outstanding options to purchase 5,215,379 shares of our common stock are held by 282 persons. All of these people are current and former employees and consultants who purchased shares of our common stock pursuant to option agreements or hold outstanding options to purchase our common stock. We granted these options and the options underlying the outstanding common stock subject to the rescission offer between September 2001 and July 2004, at exercise prices ranging from $0.30 to $80.00 per share.

 

Q:    When does the rescission offer expire?

 

A:    Our rescission offer will expire on December     , 2004.

 

Q:    What will I receive if I accept the rescission offer?

 

A:    If you accept our rescission offer with respect to the common stock you purchased by exercising an option we granted to you, we will repurchase the shares you hold that are subject to the rescission offer at the price per share you paid, plus interest at the current statutory rate per year, from the date of exercise through the date the rescission offer expires. If you accept our rescission offer with respect to unexercised options to purchase our common stock, regardless of whether these options are vested, we will repurchase these options at a price equal to 20% of the per share exercise price multiplied by the number of shares subject to the options, plus interest at the current statutory rate per year, from the date of grant through the date the rescission offer expires.

 

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The legal rates of interest for the repurchase of shares and options will be based on the state of residence of the stockholder or optionee. These interest rates are as follows:

 

State


   Interest Rate

   

State


   Interest Rate

 

Arkansas

   6 %  

Nevada

   6.25 %

California

   7 %  

New Hampshire

   10 %

Colorado

   8 %  

New Jersey

   4 %

Connecticut

   6 %  

New York*

   7 %

District of Columbia

   6 %  

North Carolina

   8 %

Georgia

   6 %  

Pennsylvania

   6 %

Illinois

   10 %  

Texas

   6 %

Maryland

   10 %  

Virginia

   6 %

Massachusetts

   6 %  

Washington

   8 %

Michigan

   6 %           

*   New York law does not provide a specific interest rate. For purposes of the rescission offer, we are applying the rate of interest of California (our principal place of business) to calculate the consideration to be received by New York residents who may be entitled to rescission rights.

 

Q:    Can you give me an example of what I will receive if I accept the rescission offer?

 

A:    Common Stock.    We will repurchase outstanding shares of common stock subject to the rescission offer at the price per share you paid, plus interest at the current statutory rate per year, from the date of exercise through the date that the rescission offer expires. If you are a resident of California and hold 1,000 shares of our common stock that you purchased in November 2003 upon exercise of an option that is subject to the rescission offer at a per share price of $4.00 and you accept our rescission offer, you would receive:

 

    The original purchase price = 1,000 X $4.00 = $4,000.

 

    Plus simple interest at 7% per year = $280.

 

    For a total of $4,280.

 

Options.    We will repurchase outstanding, unexercised options subject to the rescission offer at a price equal to 20% of the per share exercise price multiplied by the number of shares subject to the options, plus interest at the current statutory rate per year, from the date of grant through the date the rescission offer expires. If you are a resident of California and hold an unexercised option to purchase 1,000 shares of our common stock at a per share exercise price of $4.00 that was granted in November 2003 and you accept our rescission offer, you would receive:

 

    20% of the exercise price for the total option = 20% * (1,000 X $4.00) = $800.

 

    Plus interest at 7% per year = $56.

 

    For a total of $856.

 

In either case, you will not have any right, title or interest to the shares of common stock or options you will be surrendering upon the closing of the rescission offer, and you will only be entitled to receive the proceeds from our repurchase of the common stock or options, as the case may be.

 

Q:    Have any officers, directors or 5% stockholders advised Google whether they will participate in the rescission offer?

 

A:    One of our officers, who holds 52,783 shares of common stock, all of which shares are subject to rescission is eligible to participate in the rescission offer. We have been advised that this officer does not intend to accept the rescission offer. None of our directors are eligible to participate in this offer. If our eligible officer does not participate in the rescission offer but all other eligible persons accept the rescission offer in full, our officers and directors would not materially increase their respective ownership interests in Google.

 

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Q:    If I do not accept the offer now, can I sell my shares?

 

A:    If you do not accept the rescission offer, you can sell the shares of Class A common stock that were subject to the rescission offer without limitation as to the number or manner of sale; provided, however, that you will remain subject to any market standoff agreements, lockup arrangements, vesting restrictions, Google Insider Trading Policy requirements and any other transfer restrictions entered into with respect to your shares. You may only sell vested shares. To the extent you hold shares of our Class B common stock subject to the rescission offer and wish to sell them, you should notify us that you wish to convert such shares of Class B common stock into Class A common stock. Our Class B common stock is not and will not be publicly traded. Our options are not transferable, although the underlying shares of common stock are transferable in accordance with the description provided above.

 

Q:    What do I need to do now to accept or reject the rescission offer?

 

A:    To accept or reject the rescission offer, you must complete and sign the accompanying election form and return it in the enclosed return envelope to Google, to the attention of Matthew Tolland, Corporate Paralegal, 1600 Amphitheatre Parkway, Mountain View, CA 94043, as soon as practical but in no event later than December     , 2004. If you are accepting the rescission offer, please also include in your return envelope the following:

 

    Common Stock.    With respect to any shares of common stock that you want us to repurchase, (i) a completed and signed election form (see Appendix A) and (ii) a stock power representing the shares you are surrendering for repurchase (see Appendix B).

 

    Options.    With respect to any options that you are surrendering for repurchase, a completed and signed election form (see Appendix A). Please indicate on your election form the grant date of the option that you are surrendering for repurchase and the number of shares underlying the option.

 

Q:    Can I accept the rescission offer in part?

 

A:    If you accept the rescission offer, then you must accept the rescission offer with respect to either an entire option grant or all of the shares of common stock issued under an option grant that has been exercised. You can accept the rescission offer in part to the extent you have received multiple option grants. For example, you can accept the rescission offer with respect to one option grant subject to the rescission offer by returning a completed signed election form with respect to that option grant (see Appendix A). In addition, you can accept the rescission offer with respect to the shares of common stock issued under one option grant subject to the rescission offer by indicating the grant date of the option underlying the shares on the election form and returning this form to us together with a stock power representing the shares you are tendering for repurchase.

 

Q:    What happens if I do not return my rescission offer election form?

 

A:    If you do not return a properly completed election form before the expiration date of our rescission offer, you will be deemed to have rejected our offer.

 

Q:    What remedies or rights do I have now that I will not have after the rescission offer?

 

A:    It is unclear whether or not you will have a right of rescission under federal securities laws after the rescission offer. The staff of the Securities and Exchange Commission is of the opinion that a person’s right of rescission created under the Securities Act of 1933 may survive the rescission offer. Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act of 1933 is one year from the date of the violation upon which the action to enforce liability is based.

 

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The state remedies and statutes of limitations vary and depend upon the state in which you purchased the shares. The following is a summary of the statutes of limitations and the effect of the rescission offer for the states in which the shares covered by this rescission offer were sold. This summary is not complete. For a more detailed description of the various state laws governing rescission rights in the respective states, see “Rescission Offer—Effect of Rescission Offer.”

 

Arkansas

Due in part to our noncompliance with Rule 701 of the Securities Act of 1933, no exemption from the registration requirements of Section 23-42-501 of the Arkansas Securities Act was available to us with respect to certain options and shares issued in Arkansas under our stock plans that are subject to the rescission offer. In addition, we did not register option grants and common stock issuances pursuant to these stock plans under the Arkansas Securities Act. Consequently, these options and shares may have been issued in violation of the Arkansas Securities Act. Generally, the Arkansas statute of limitations for securities laws violations is three years from the effective date of the contract of sale relating to the noncompliant securities issuance. Regardless, if the options or shares were issued to you in Arkansas, you will no longer have any right of rescission under Arkansas law after the expiration of our rescission offer.

 

California

In July 2003, pursuant to an application for qualification of securities pursuant to Section 25113 of the California Corporate Securities Law, the California Department of Corporations issued us a permit that qualified us to offer, sell and issue options and shares of our common stock pursuant to our 2003 Stock Plan (No. 2) and 2003 Stock Plan (No. 3). However, we did not register certain option grants and common stock issuances pursuant to our 1998 Stock Plan and 2003 Stock Plan under the California Corporate Securities Law, nor did we take the steps required to satisfy available exemptions with respect to certain of these options and shares. Consequently, certain options and shares issued pursuant to the 1998 Stock Plan and 2003 Stock Plan may have been issued in violation of the California Corporate Securities Act. Generally, the California statute of limitations for noncompliance with the requirement to register or qualify securities under the California Corporate Securities Law is the earlier of two years after the noncompliance occurred, or one year after discovery of the facts constituting such noncompliance. Regardless, if the shares or options that are the subject of the rescission offer were issued to you in California, you will no longer have any right of rescission or repurchase with respect to these securities under Section 25503 of the California Corporate Securities Law after the expiration of our rescission offer.

 

Colorado

While residents of Colorado that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Colorado were issued pursuant to an exemption from registration or qualification under the Colorado Securities Act.

 

Connecticut

While residents of Connecticut that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Connecticut were issued pursuant to an exemption from registration or qualification under the Connecticut Uniform Securities Act.

 

District of Columbia

We did not register certain option grants and common stock issuances pursuant to our stock plans that are subject to the rescission offer under the District of Columbia Securities Act of 2000, nor did we take affirmative steps to ensure the availability to us of any exemption from registration provided in Section 401 of the District of Columbia Securities Act of 2000. Consequently, these options and shares may have been issued in violation of the District of Columbia Securities Act of 2000. Generally, the statute of limitations for District of Columbia securities laws violations is one year after the registration violation occurred. Regardless, if the options or shares were issued to you in the District of Columbia, you will

 

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no longer have any right of rescission under the law of the District of Columbia after the expiration of our rescission offer.

 

Georgia

While residents of Georgia that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Georgia were issued pursuant to an exemption from registration or qualification under the Georgia Securities Act of 1973.

 

Illinois

While residents of Illinois that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Illinois were issued pursuant to an exemption from registration or qualification under the Illinois Securities Act of 1953.

 

Maryland

We did not take the necessary steps required to satisfy the requirements for reliance upon the exemption provided in Section 11-601(11) of the Maryland Securities Act with respect to certain option grants and common stock issuances pursuant to our stock plans that are subject to the rescission offer. Consequently, these options and shares may have been issued in violation of the Maryland Securities Act. Generally, the Maryland statute of limitations for securities laws violations is one year after the issuance of noncompliant securities. However, if the shares or options were issued to you in Maryland, you will no longer have any right of rescission under Maryland law after our rescission offer.

 

Massachusetts

While residents of Massachusetts that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Massachusetts were issued pursuant to an exemption from registration or qualification under the Massachusetts Uniform Securities Act.

 

Michigan

While residents of Michigan that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Michigan were issued pursuant to an exemption from registration or qualification under the Michigan Uniform Securities Act.

 

Nevada

While residents of Nevada that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Nevada were issued pursuant to an exemption from registration or qualification under the Nevada Uniform Securities Act.

 

New Hampshire

While residents of New Hampshire that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of New Hampshire were issued pursuant to an exemption from registration or qualification under the New Hampshire Uniform Securities Act.

 

New Jersey

While residents of New Jersey that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of New Jersey were issued pursuant to an exemption from registration or qualification under the New Jersey Uniform Securities Laws.

 

New York

We were required to apply for an exemption from the broker-dealer registration and securities issuance requirements with the State of New York to issue the shares and/or options to you without registration or qualification. Because of our failure to apply for an exemption, you have three years to seek a remedy for our failure to register. If shares or options were issued to you in New York, you do not have a right of rescission under New York law. We believe the rescission offer will foreclose any other remedy you may have under New York law for our failure to apply for an exemption and we are not aware of any statutory rights of action you may have under New York law because of our failure to apply for an exemption.

 

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North Carolina

While residents of North Carolina that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of North Carolina were issued pursuant to an exemption from registration or qualification under the North Carolina Securities Act.

 

Pennsylvania

While residents of Pennsylvania that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws. We believe that the options and common stock issued by us in the state of Pennsylvania were issued pursuant to an exemption from registration or qualification under the Pennsylvania Securities Act.

 

Texas

While residents of Texas that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Texas were issued pursuant to an exemption from registration or qualification under the Texas Securities Act.

 

Virginia

While residents of Virginia that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Virginia were issued pursuant to an exemption from registration or qualification under the Virginia Securities Act.

 

Washington

While residents of Washington that hold options and shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the options and common stock issued by us in the state of Washington were issued pursuant to an exemption from registration or qualification under the Securities Act of Washington.

 

We believe that your acceptance of the rescission offer will preclude you from later seeking similar relief. Regardless of whether you accept the rescission offer, we believe that any remedies you may have after the rescission offer expires would not be greater than an amount you would receive in the rescission offer.

 

Q:    How will the rescission offer be funded?

 

A:    The rescission offer will be funded from our existing cash balances. If all persons eligible to participate in the rescission offer accept our offer to the full extent, our results of operations, cash balances or financial condition will not be affected materially.

 

Q:    Can I change my mind after I have mailed my signed election form?

 

A:    Yes. You can change your decision about accepting or rejecting our rescission offer at any time before the expiration date. You can do this by completing and submitting a new election form. Any new election forms must be received by us prior to the expiration date in order to be valid. We will not accept any election forms after the expiration date.

 

Q:    Who can help answer my questions?

 

A:    You can call Stock Administration at Google, at (650) 623-4000, with questions about the rescission offer.

 

Q:    Where can I get more information about Google?

 

A:    You can obtain more information about Google from the filings we make from time to time with the Securities and Exchange Commission. These filings are available on the Securities and Exchange Commission’s website at www.sec.gov.

 

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SUMMARY

 

This summary highlights information contained elsewhere in this offering circular and does not contain all of the information you should consider in deciding whether to accept or reject the rescission offer. You should read this summary together with the more detailed information, including our financial statements and the related notes, elsewhere in this offering circular. You should carefully consider, among other things, the matters discussed in “Risk Factors.”

 

Google Inc.

 

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 destination and our brand one of the most recognized in the world. We maintain the world’s largest online index of web sites and other content, and we make this information freely available to anyone with an Internet connection. Our automated search technology helps people obtain nearly instant access to relevant information from our vast online index.

 

We generate revenue by delivering relevant, cost-effective online advertising. Businesses use our AdWords program to promote their products and services with targeted advertising. In addition, the thousands of third-party web sites that comprise our Google Network use our Google AdSense program to deliver relevant ads that generate revenue and enhance the user experience. Advertisers in our AdWords program pay us a fee each time a user clicks on one of their ads displayed either on our web sites or on the web sites of Google Network members that participate in our AdSense program. When a user clicks on an ad displayed on a web site of a Google Network member, we retain only a small portion of the advertiser fee, while most of the fee is paid to the Google Network member.

 

Our mission is to organize the world’s information and make it universally accessible and useful. We believe that the most effective, and ultimately the most profitable, way to accomplish our mission is to put the needs of our users first. We have found that offering a high-quality user experience leads to increased traffic and strong word-of-mouth promotion. Our dedication to putting users first is reflected in three key commitments we have made to our users:

 

    We will do our best to provide the most relevant and useful search results possible, independent of financial incentives. Our search results will be objective and we will not accept payment for inclusion or ranking in them.

 

    We will do our best to provide the most relevant and useful advertising. Whenever someone pays for something, we will make it clear to our users. Advertisements should not be an annoying interruption.

 

    We will never stop working to improve our user experience, our search technology and other important areas of information organization.

 

We believe that our user focus is the foundation of our success to date. We also believe that this focus is critical for the creation of long-term value. We do not intend to compromise our user focus for short-term economic gain.

 

Corporate Information

 

We were incorporated in California in September 1998. In August 2003, we reincorporated in Delaware. Our principal executive offices are located at 1600 Amphitheatre Parkway, Mountain View, California 94043, and our telephone number is (650) 623-4000. We maintain a number of web sites including www.google.com. The information on our web sites is not part of this offering circular.

 

Google® is a registered trademark in the U.S. and several other countries. Our unregistered trademarks include: AdSense, AdWords, Blogger, Froogle, Gmail, I’m Feeling Lucky and PageRank. All other trademarks, trade names and service marks appearing in this offering circular are the property of their respective holders.

 

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The Rescission Offer

 

Total common stock (including common stock underlying options) subject to rescission offer

   28,651,324 Shares

Class A common stock

   11,684,808 Shares

Class B common stock

   16,966,516 Shares

Total common stock outstanding

   273,415,950 Shares

Class A common stock

   57,857,182 Shares

Class B common stock

   215,558,768 Shares

Use of proceeds

   We will not receive any proceeds from the rescission offer.

Nasdaq symbol

   GOOG

 

The number of shares of Class A common stock and Class B common stock outstanding is based on the number of shares outstanding at October 31, 2004 and excludes:

 

    487,184 shares of Class B common stock issuable upon the exercise of warrants outstanding at October 31, 2004, at a weighted average exercise price of $0.79 per share.

 

    7,746,026 shares of Class A common stock issuable upon the exercise of options outstanding at October 31, 2004, at a weighted average exercise price of $32.12 per share.

 

    10,155,255 shares of Class B common stock issuable upon the exercise of options outstanding at October 31, 2004, at a weighted average exercise price of $3.36 per share.

 

    5,656,830 shares of common stock available for future issuance under our stock option plans at October 31, 2004.

 

Recent Developments

 

On October 21, 2004, we announced our financial results for the quarter ended September 30, 2004. Our revenues were $805.9 million for the quarter ended September 30, 2004, an increase of $411.9 million (or 105%), from $393.9 million for the quarter ended September 30, 2003. Income from operations was $11.1 million, or 1.4% of revenues for the quarter ended September 30, 2004, compared to $66.6 million, or 16.9% of revenues for the quarter ended September 30, 2003. Income from operations for the third quarter of 2004 included a non-recurring, non-cash charge of $201.0 million related to the settlement of disputes with Yahoo. Income from operations for the third quarter of 2004 also included a $68.0 million non-cash, stock-based compensation charge compared to a $73.8 million non-cash, stock-based compensation charge in the third quarter of 2003. Net income in the quarter ended September 30, 2004 was $52.0 million, or 6.5% of revenues, compared to $20.4 million, or 5.2% of revenues, in the quarter ended September 30, 2003. In addition to the $119.0 million settlement charge, after the related tax benefit in the third quarter of 2004, we realized a $46.0 million reduction to our provision for income taxes related to certain stock-based compensation charges recognized prior to our initial public offering. Earnings per share in the quarter ended September 30, 2004 was $0.19 on a diluted basis, an increase of 138%, from earnings per share of $0.08 on a diluted basis in the quarter ended September 30, 2003.

 

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Summary Consolidated Financial Data

 

The following table summarizes financial data regarding our business and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this offering circular.

 

    Year Ended December 31,

 

Nine Months Ended

September 30,


    1999

    2000

    2001

    2002

    2003

  2003

  2004

    (in thousands, except per share data)
                                (unaudited)

Consolidated Statements of Operations Data:

                                                 

Revenues

  $ 220     $ 19,108     $ 86,426     $ 439,508     $ 1,465,934   $ 953,759   $ 2,157,722

Costs and expenses:

                                                 

Cost of revenues

    908       6,081       14,228       131,510       625,854     374,986     1,003,874

Research and development

    2,930       10,516       16,500       31,748       91,228     62,771     138,190

Sales and marketing

    1,677       10,385       20,076       43,849       120,328     79,164     170,193

General and administrative

    1,221       4,357       12,275       24,300       56,699     36,415     87,857

Stock-based compensation

          2,506       12,383       21,635       229,361     144,377     219,215

Non-recurring portion of settlement of disputes with Yahoo

    —         —         —         —         —       —       201,000
   


 


 


 


 

 

 

Total costs and expenses

    6,736       33,845       75,462       253,042       1,123,470     697,713     1,820,329
   


 


 


 


 

 

 

Income (loss) from operations

    (6,516 )     (14,737 )     10,964       186,466       342,464     256,046     337,393

Interest income (expense) and other, net

    440       47       (896 )     (1,551 )     4,190     1,183     2,668
   


 


 


 


 

 

 

Income (loss) before income taxes

    (6,076 )     (14,690 )     10,068       184,915       346,654     257,229     340,061

Provision for income taxes

                3,083       85,259       241,006     178,835     145,042
   


 


 


 


 

 

 

Net income (loss)

  $ (6,076 )   $ (14,690 )   $ 6,985     $ 99,656     $ 105,648   $ 78,394   $ 195,019
   


 


 


 


 

 

 

Net income (loss) per share:

                                                 

Basic

  $ (0.14 )   $ (0.22 )   $ 0.07     $ 0.86     $ 0.77   $ 0.58   $ 1.14

Diluted

  $ (0.14 )   $ (0.22 )   $ 0.04     $ 0.45     $ 0.41   $ 0.31   $ 0.73

Number of shares used in per share calculations:

                                                 

Basic

    42,445       67,032       94,523       115,242       137,697     134,820     170,511

Diluted

    42,445       67,032       186,776       220,633       256,638     254,664     268,394

 

The following table presents a summary of our balance sheet data at September 30, 2004:

 

     At
September 30,
2004


 
     (in thousands)  
     (unaudited)  

Consolidated Balance Sheet Data:

        

Cash, cash equivalents and short-term investments

   $ 1,858,356  

Total assets

     2,888,518  

Total long-term liabilities

     25,025  

Deferred stock-based compensation

     (292,690 )

Total stockholders’ equity

     2,589,023  

 

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RISK FACTORS

 

You should carefully consider the risks described below, together with all of the other information included in this offering circular, before making a decision to accept or reject our rescission offer. If any of the following risks actually occurs, our business, financial condition or operating results could be materially and adversely affected.

 

Risks Related to the Rescission Offer

 

We may continue to have potential liability even after this rescission offer is made.

 

Certain options we granted during the period from September 2001 through July 2004 may not have been exempt from the registration or qualification requirements under the securities laws of certain states. In addition, certain shares issued upon exercise of options granted during this period may not have been exempt from the registration and qualification requirements under Rule 701 under the Securities Act of 1933 and under those state securities laws that provide an exemption to the extent the requirements under Rule 701 are met. In order to address these issues, we are making the rescission offer to all holders of any outstanding options and shares subject to rescission. However, the Securities Act of 1933 does not provide that a rescission offer will extinguish a holder’s right to rescind the grant of an option or the issuance of shares that were not registered or exempt from the registration requirements under the Securities Act of 1933. Consequently, should any recipients of our rescission offer reject the offer, expressly or impliedly, we may remain liable under the Securities Act of 1933 for the purchase price of the options and shares that are subject to the rescission offer.

 

Your federal right of rescission may not survive if you affirmatively reject or fail to accept the rescission offer.

 

If you affirmatively reject or fail to accept the rescission offer, it is unclear whether or not you will have a right of rescission under federal securities laws after the expiration of the rescission offer. The staff of the Securities and Exchange Commission is of the opinion that a person’s right of rescission created under the Securities Act of 1933 may survive the rescission offer.

 

We cannot predict whether the amounts you would receive in the rescission offer would be greater than the fair market value of our securities.

 

The amount you would receive in the rescission offer is fixed and is not tied to the fair market value of our common stock at the time the rescission offer closes. As a result, if you accept the rescission offer, you may receive less than the fair market value of the securities you would be tendering to us.

 

If you do not accept the rescission offer, your shares and the shares you receive from the exercise of your options, although freely tradeable, may still remain subject to limitation on resales.

 

If you affirmatively reject the rescission offer or fail to accept the rescission offer before the expiration of the rescission offer, your shares will be registered under the Securities Act of 1933 and will be fully tradeable, subject to any applicable limitations set forth in Rule 144 or Rule 145 under the Securities Act of 1933; provided, however, that you will also remain subject to any applicable terms and conditions of any agreement under which your shares were issued or otherwise relating to your shares. In addition, you will remain subject to any market standoff agreements, lockup arrangements and any other transfer restrictions entered into with respect to your shares. You may only resell shares acquired upon exercise of vested options; shares underlying unvested options may not be resold.

 

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Risks Related to Our Stock Price

 

The trading price for our Class A common stock may be volatile.

 

The trading price of our Class A common stock has been volatile since our initial public offering and will likely continue to be volatile. The trading price of our Class A common stock may fluctuate widely in response to various factors, some of which are beyond our control. These factors include:

 

    Quarterly variations in our results of operations or those of our competitors.

 

    Announcements by us or our competitors of acquisitions, new products, significant contracts, commercial relationships or capital commitments.

 

    Disruption to our operations or those of our Google Network members or our data centers.

 

    The emergence of new sales channels in which we are unable to compete effectively.

 

    Our ability to develop and market new and enhanced products on a timely basis.

 

    Commencement of, or our involvement in, litigation.

 

    Any major change in our board or management.

 

    Changes in governmental regulations or in the status of our regulatory approvals.

 

    Recommendations by securities analysts or changes in earnings estimates.

 

    Announcements about our earnings that are not in line with analyst expectations, the likelihood of which is enhanced because it is our policy not to give guidance on earnings.

 

    Announcements by our competitors of their earnings that are not in line with analyst expectations.

 

    The volume of shares of Class A common stock available for public sale.

 

    Short sales, hedging and other derivative transactions on shares of our Class A common stock.

 

    General economic conditions and slow or negative growth of related markets.

 

In addition, the stock market in general, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Such fluctuations may be even more pronounced in the trading market shortly following our initial public offering. These broad market and industry factors may seriously harm the market price of our Class A common stock, regardless of our actual operating performance. Fluctuations in the trading price of our Class A common stock may be even more pronounced since we only recently completed our initial public offering. In the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

 

Future sales of shares by our stockholders could cause our stock price to decline.

 

We cannot predict the effect, if any, that market sales of shares or the availability of shares for sale will have on the trading price prevailing from time to time. At October 31, 2004, we had outstanding 273,415,950 shares of common stock. We have entered into contractual lock-up agreements with our officers, directors and certain employees and other securityholders, representing the holders of substantially all of our outstanding capital stock. In addition, our employees can only sell vested shares. Sales of our Class A common stock in the public market after the restrictions set forth in these agreements lapse or once these shares vest, or the perception that those sales may occur, could cause the trading price of our stock to decrease or to be lower than it might be in the absence of those sales or perceptions. We may, in our sole discretion, permit our officers, directors, employees and current stockholders who are subject to contractual lock-up agreements with us to sell shares prior to the expiration of their lock-up agreements. None of our officers, directors, employees or stockholders have entered into contractual lock-up agreements with the underwriters in connection with our initial public offering.

 

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We have filed a registration statement on Form S-8 relating to certain options granted to our officers, directors and employees and we plan to file a registration statement on Form S-1 relating to certain of our options and shares that are subject to rights of rescission in favor of holders of these options and shares. As a result of these registration statements, certain selling restriction agreements between us and our stockholders and the provisions of Rules 144, 144(k) and 701 of the Securities Act of 1933, shares of our Class A common stock first become available for sale in the public market as follows:

 

Date


   Additional Shares
Eligible for Public Sale


After September 2, 2004

   4,667,483

At November 16, 2004 and various times thereafter

   39,071,376

At December 16, 2004 and various times thereafter

   24,874,091

At January 15, 2005 and various times thereafter

   24,874,091

At February 14, 2005 and various times thereafter

   176,794,161

 

At October 31, 2004, 149,268,875 of these shares were held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act of 1933 and various vesting agreements. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. The selling restriction agreements between us and our stockholders will allow significantly more shares to become freely tradeable after our initial public offering than is typical of initial public offerings.

 

In addition, we have agreed with our underwriters not to sell any shares of our common stock for a period of 180 days after August 18, 2004. However, this agreement is subject to a number of exceptions, including an exception that allows us to issue an unlimited number of shares in connection with mergers and acquisition transactions, joint ventures or other strategic transactions. Morgan Stanley & Co. Incorporated and Credit Suisse First Boston LLC, on behalf of the underwriters of our initial public offering, may release us from this lock-up arrangement without notice at any time. After the expiration of the 180-day period, there is no contractual restriction on our ability to issue additional shares. Any sales of common stock by us, or the perception that such sales could occur, could cause our stock price to decline.

 

Risks Related to Our Business and Industry

 

We face significant competition from Microsoft and Yahoo.

 

We face formidable competition in every aspect of our business, and particularly from other companies that seek to connect people with information on the web and provide them with relevant advertising. Currently, we consider our primary competitors to be Microsoft Corporation and Yahoo! Inc. Microsoft recently introduced a test version of a new search engine and has announced plans to develop features that make web search a more integrated part of its Windows operating system. We expect that Microsoft will increasingly use its financial and engineering resources to compete with us. Yahoo has become an increasingly significant competitor, having acquired Overture Services, which offers Internet advertising solutions that compete with our AdWords and AdSense programs, as well as the Inktomi, AltaVista and AllTheWeb search engines.

 

Both Microsoft and Yahoo have more employees than we do (in Microsoft’s case, currently more than 20 times as many). Microsoft also has significantly more cash resources than we do. Both of these companies also have longer operating histories and more established relationships with customers. They can use their experience and resources against us in a variety of competitive ways, including by making acquisitions, investing more aggressively in research and development and competing more aggressively for advertisers and web sites. Microsoft and Yahoo also may have a greater ability to attract and retain users than we do because they operate Internet portals with a broad range of content products and services. If Microsoft or Yahoo are successful in providing similar or better web search results compared to ours or leverage their platforms to make their web search services easier to access than ours, we could experience a significant decline in user traffic. Any such decline in traffic could negatively affect our revenues.

 

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We face competition from other Internet companies, including web search providers, Internet advertising companies and destination web sites that may also bundle their services with Internet access.

 

In addition to Microsoft and Yahoo, we face competition from other web search providers, including companies that are not yet known to us. We compete with Internet advertising companies, particularly in the areas of pay-for-performance and keyword-targeted Internet advertising. Also, we may compete with companies that sell products and services online because these companies, like us, are trying to attract users to their web sites to search for information about products and services.

 

We also compete with destination web sites that seek to increase their search-related traffic. These destination web sites may include those operated by Internet access providers, such as cable and DSL service providers. Because our users need to access our services through Internet access providers, they have direct relationships with these providers. If an access provider or a computer or computing device manufacturer offers online services that compete with ours, the user may find it more convenient to use the services of the access provider or manufacturer. In addition, the access provider or manufacturer may make it hard to access our services by not listing them in the access provider’s or manufacturer’s own menu of offerings. Also, because the access provider gathers information from the user in connection with the establishment of a billing relationship, the access provider may be more effective than we are in tailoring services and advertisements to the specific tastes of the user.

 

There has been a trend toward industry consolidation among our competitors, and so smaller competitors today may become larger competitors in the future. If our competitors are more successful than we are at generating traffic, our revenues may decline.

 

We face competition from traditional media companies, and we may not be included in the advertising budgets of large advertisers, which could harm our operating results.

 

In addition to Internet companies, we face competition from companies that offer traditional media advertising opportunities. Most large advertisers have set advertising budgets, a very small portion of which is allocated to Internet advertising. We expect that large advertisers will continue to focus most of their advertising efforts on traditional media. If we fail to convince these companies to spend a portion of their advertising budgets with us, or if our existing advertisers reduce the amount they spend on our programs, our operating results would be harmed.

 

We expect our growth rates to decline and anticipate downward pressure on our operating margin in the future.

 

We expect that in the future our revenue growth rate will decline over time and anticipate that there will be downward pressure on our operating margin. We believe our revenue growth rate will generally decline as a result of increasing competition and the inevitable decline in growth rates as our revenues increase to higher levels. We believe our operating margin will generally decline as a result of increasing competition and increased expenditures for all aspects of our business as a percentage of our revenues, including product development and sales and marketing expenses. Our operating margin may decline to the extent the proportion of our revenues generated from our Google Network members increases. The margin on revenue we generate from our Google Network members is generally significantly less than the margin on revenue we generate from advertising on our web sites. Additionally, the margin we earn on revenue generated from our Google Network could decrease in the future if our Google Network members demand a greater portion of the advertising fees.

 

Our operating results may fluctuate, which makes our results difficult to predict and could cause our results to fall short of expectations.

 

Our operating results may fluctuate as a result of a number of factors, many of which are outside of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful,

 

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and you should not rely on our past results as an indication of our future performance. Our quarterly and annual expenses as a percentage of our revenues may be significantly different from our historical or projected rates. Our operating results in future quarters may fall below expectations. Any of these events could cause our stock price to fall. Each of the risk factors listed in this “Risk Factors” section, and the following factors, may affect our operating results:

 

    Our ability to continue to attract users to our web sites.

 

    The monetization of (or generation of revenue from) traffic on our web sites and our Google Network members’ web sites.

 

    Our ability to attract advertisers to our AdWords program.

 

    Our ability to attract web sites to our AdSense program.

 

    The mix in our revenues between those generated on our web sites and those generated through our Google Network.

 

    The amount and timing of operating costs and capital expenditures related to the maintenance and expansion of our businesses, operations and infrastructure.

 

    Our focus on long term goals over short term results.

 

    The results of our investments in risky projects.

 

    Payments made in connection with the resolution of litigation matters.

 

    General economic conditions and those economic conditions specific to the Internet and Internet advertising.

 

    Our ability to keep our web sites operational at a reasonable cost and without service interruptions.

 

    Our ability to forecast revenue from agreements under which we guarantee minimum payments.

 

    Geopolitical events such as war, threat of war or terrorist actions.

 

Because our business is changing and evolving, our historical operating results may not be useful to you in predicting our future operating results. In addition, advertising spending has historically been cyclical in nature, reflecting overall economic conditions as well as budgeting and buying patterns. For example, in 1999, advertisers spent heavily on Internet advertising. This was followed by a lengthy downturn in ad spending on the web. Also, user traffic tends to be seasonal. Our rapid growth has masked the cyclicality and seasonality of our business. As our growth slows, we expect that the cyclicality and seasonality in our business may become more pronounced and may in the future cause our operating results to fluctuate.

 

If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, and our revenues and operating results could suffer.

 

Our success depends on providing products and services that people use for a high quality Internet experience. Our competitors are constantly developing innovations in web search, online advertising and providing information to people. As a result, we must continue to invest significant resources in research and development in order to enhance our web search technology and our existing products and services and introduce new high-quality products and services that people can easily and effectively use. If we are unable to ensure that our users and customers have a high quality experience with our products and services then these customers may become dissatisfied and move to competitors’ products. In addition, if we are unable to predict user preferences or industry changes, or if we are unable to modify our products and services on a timely basis, we may lose users, advertisers and Google Network members. Our operating results would also suffer if our innovations are not responsive to the needs of our users, advertisers and Google Network members, are not appropriately timed with market opportunity or are not effectively brought to market. As search technology continues to develop, our

 

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competitors may be able to offer search results that are, or that are perceived to be, substantially similar or better than those generated by our search services. This may force us to compete on bases in addition to quality of search results and to expend significant resources in order to remain competitive.

 

We generate our revenue almost entirely from advertising, and the reduction in spending by or loss of advertisers could seriously harm our business.

 

We generated approximately 97% of our revenues in 2003 and 98% of our revenues in the nine months ended September 30, 2004 from our advertisers. Our advertisers can generally terminate their contracts with us at any time. Advertisers will not continue to do business with us if their investment in advertising with us does not generate sales leads, and ultimately customers, or if we do not deliver their advertisements in an appropriate and effective manner. If we are unable to remain competitive and provide value to our advertisers, they may stop placing ads with us, which would negatively affect our revenues and business.

 

We rely on our Google Network members for a significant portion of our revenues, and otherwise benefit from our association with them. The loss of these members could prevent us from receiving the benefits we receive from our association with these Google Network members, which could adversely affect our business.

 

We provide advertising, web search and other services to members of our Google Network. The revenues generated from the fees advertisers pay us when users click on ads that we have delivered to our Google Network members’ web sites represented approximately 43% of our revenues in 2003, and approximately 49% of our revenues for the nine months ended September 30, 2004. We consider this network to be critical to the future growth of our revenues. However, some of the participants in this network may compete with us in one or more areas. Therefore, they may decide in the future to terminate their agreements with us. If our Google Network members decide to use a competitor’s or their own web search or advertising services, our revenues would decline.

 

Our agreements with a few of the largest Google Network members account for a significant portion of revenues derived from our AdSense program. In addition, advertising and other fees generated from one Google Network member, America Online, Inc., primarily through our AdSense program accounted for approximately 15%, 16% and 13% of our revenues in 2002, 2003 and in the nine months ended September 30, 2004. Also, certain of our key network members operate high-profile web sites, and we derive tangible and intangible benefits from this affiliation. If one or more of these key relationships is terminated or not renewed, and is not replaced with a comparable relationship, our business would be adversely affected.

 

Our business and operations are experiencing rapid growth. If we fail to effectively manage our growth, our business and operating results could be harmed and we may have to incur significant expenditures to address the additional operational and control requirements of this growth.

 

We have experienced, and continue to experience, rapid growth in our headcount and operations, which has placed, and will continue to place, significant demands on our management, operational and financial infrastructure. If we do not effectively manage our growth, the quality of our products and services could suffer, which could negatively affect our brand and operating results. To effectively manage this growth, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. These systems enhancements and improvements will require significant capital expenditures and allocation of valuable management resources. If the improvements are not implemented successfully, our ability to manage our growth will be impaired and we may have to make significant additional expenditures to address these issues, which could harm our financial position. The required improvements include:

 

    Enhancing our information and communication systems to ensure that our offices around the world are well coordinated and that we can effectively communicate with our growing base of users, advertisers and Google Network members.

 

    Enhancing systems of internal controls to ensure timely and accurate reporting of all of our operations.

 

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    Documenting all of our information technology systems and our business processes for our ad systems and our billing systems.

 

    Improving our information technology infrastructure to maintain the effectiveness of our search systems.

 

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.

 

Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our brand and operating results could be harmed. We have in the past discovered, and may in the future discover, areas of our internal controls that need improvement. For example, during our 2002 audit, our external auditors brought to our attention a need to increase restrictions on employee access to our advertising system and automate more of our financial processes. The auditors identified these issues together as a “reportable condition,” which means that these were matters that in the auditors’ judgment could adversely affect our ability to record, process, summarize and report financial data consistent with the assertions of management in the financial statements. In 2003, we devoted significant resources to remediate and improve our internal controls. Although we believe that these efforts have strengthened our internal controls and addressed the concerns that gave rise to the “reportable condition” in 2002, we are continuing to work to improve our internal controls, including in the areas of access and security. We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock.

 

We intend to migrate critical financial functions to a third-party provider. If this potential transition is not successful, our business and operations could be disrupted and our operating results would be harmed.

 

We have entered into an arrangement to transfer our worldwide billing, collection and credit evaluation functions to a third-party service provider, Bertelsmann AG, and are currently in the process of implementing this arrangement; however, we cannot be sure that the arrangement will be completed and implemented. The third-party provider will also track, on an automated basis, a majority of our growing number of AdSense revenue share agreements. These functions are critical to our operations and involve sensitive interactions between us and our advertisers and members of our Google Network. If we do not successfully implement this project, our business, reputation and operating results could be harmed. We have no experience managing and implementing this type of large-scale, cross-functional, international infrastructure project. We also may not be able to integrate our systems and processes with those of the third-party service provider on a timely basis, or at all. Even if this integration is completed on time, the service provider may not perform to agreed upon service levels. Failure of the service provider to perform satisfactorily could result in customer dissatisfaction, disrupt our operations and adversely affect operating results. We will have significantly less control over the systems and processes than if we maintained and operated them ourselves, which increases our risk. If we need to find an alternative source for performing these functions, we may have to expend significant resources in doing so, and we cannot guarantee this would be accomplished in a timely manner or without significant additional disruption to our business.

 

Our business depends on a strong brand, and if we are not able to maintain and enhance our brand, our ability to expand our base of users, advertisers and Google Network members will be impaired and our business and operating results will be harmed.

 

We believe that the brand identity that we have developed has significantly contributed to the success of our business. We also believe that maintaining and enhancing the “Google” brand is critical to expanding our base of users, advertisers and Google Network members. Maintaining and enhancing our brand may require us to make

 

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substantial investments and these investments may not be successful. If we fail to promote and maintain the “Google” brand, or if we incur excessive expenses in this effort, our business, operating results and financial condition will be materially and adversely affected. We anticipate that, as our market becomes increasingly competitive, maintaining and enhancing our brand may become increasingly difficult and expensive. Maintaining and enhancing our brand will depend largely on our ability to be a technology leader and to continue to provide high quality products and services, which we may not do successfully. To date, we have engaged in relatively little direct brand promotion activities. This enhances the risk that we may not successfully implement brand enhancement efforts in the future.

 

People have in the past expressed, and may in the future express, objections to aspects of our products. For example, people have raised privacy concerns relating to the ability of our recently announced Gmail email service to match relevant ads to the content of email messages. Some people have also reacted negatively to the fact that our search technology can be used to help people find hateful or derogatory information on the web. Aspects of our future products may raise similar public concerns. Publicity regarding such concerns could harm our brand. In addition, members of the Google Network and other third parties may take actions that could impair the value of our brand. We are aware that third parties, from time to time, use “Google” and similar variations in their domain names without our approval, and our brand may be harmed if users and advertisers associate these domains with us.

 

Proprietary document formats may limit the effectiveness of our search technology by preventing our technology from accessing the content of documents in such formats which could limit the effectiveness of our products and services.

 

An increasing amount of information on the Internet is provided in proprietary document formats such as Microsoft Word. The providers of the software application used to create these documents could engineer the document format to prevent or interfere with our ability to access the document contents with our search technology. This would mean that the document contents would not be included in our search results even if the contents were directly relevant to a search. These types of activities could assist our competitors or diminish the value of our search results. The software providers may also seek to require us to pay them royalties in exchange for giving us the ability to search documents in their format. If the software provider also competes with us in the search business, they may give their search technology a preferential ability to search documents in their proprietary format. Any of these results could harm our brand and our operating results.

 

New technologies could block our ads, which would harm our business.

 

Technologies may be developed that can block the display of our ads. Most of our revenues are derived from fees paid to us by advertisers in connection with the display of ads on web pages. As a result, ad-blocking technology could, in the future, adversely affect our operating results.

 

Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the innovation, creativity and teamwork fostered by our culture, and our business may be harmed.

 

We believe that a critical contributor to our success has been our corporate culture, which we believe fosters innovation, creativity and teamwork. As our organization grows, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively impact our future success. In addition, our initial public offering has created disparities in wealth among Google employees, which may adversely impact relations among employees and our corporate culture in general.

 

Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand.

 

Our patents, trademarks, trade secrets, copyrights and all of our other intellectual property rights are important assets for us. There are events that are outside of our control that pose a threat to our intellectual

 

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property rights. For example, effective intellectual property protection may not be available in every country in which our products and services are distributed or made available through the Internet. Also, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. Any significant impairment of our intellectual property rights could harm our business or our ability to compete. Also, protecting our intellectual property rights is costly and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and harm our operating results.

 

Although we seek to obtain patent protection for our innovations, it is possible we may not be able to protect some of these innovations. In addition, given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable.

 

We also face risks associated with our trademarks. For example, there is a risk that the word “Google” could become so commonly used that it becomes synonymous with the word “search.” If this happens, we could lose protection for this trademark, which could result in other people using the word “Google” to refer to their own products, thus diminishing our brand.

 

We also seek to maintain certain intellectual property as trade secrets. The secrecy could be compromised by third parties, or intentionally or accidentally by our employees, which would cause us to lose the competitive advantage resulting from these trade secrets.

 

We are, and may in the future be, subject to intellectual property rights claims, which are costly to defend, could require us to pay damages and could limit our ability to use certain technologies in the future.

 

Companies in the Internet, technology and media industries own large numbers of patents, copyrights, trademarks and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property rights claims against us grows. Our technologies may not be able to withstand any third-party claims or rights against their use. Any intellectual property claims, with or without merit, could be time-consuming, expensive to litigate or settle and could divert management resources and attention. In addition, many of our agreements with members of our Google Network require us to indemnify these members for certain third-party intellectual property infringement claims, which would increase our costs as a result of defending such claims and may require that we pay damages if there were an adverse ruling in any such claims. An adverse determination also could prevent us from offering our products and services to others and may require that we procure substitute products or services for these members.

 

With respect to any intellectual property rights claim, we may have to pay damages or stop using technology found to be in violation of a third party’s rights. We may have to seek a license for the technology, which may not be available on reasonable terms and may significantly increase our operating expenses. The technology also may not be available for license to us at all. As a result, we may also be required to develop alternative non-infringing technology, which could require significant effort and expense. If we cannot license or develop technology for the infringing aspects of our business, we may be forced to limit our product and service offerings and may be unable to compete effectively. Any of these results could harm our brand and operating results.

 

From time to time, we receive notice letters from patent holders alleging that certain of our products and services infringe their patent rights. Some of these have resulted in litigation against us. Companies have also 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. A court in France has held us liable for allowing advertisers to select certain trademarked terms as keywords. We have appealed this decision. We were also subject to two lawsuits in Germany on similar matters where the courts held that we are not liable for the actions of our advertisers prior to notification of trademark rights. We are litigating similar issues in other cases in the U.S., France, Germany and Italy.

 

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In order to provide users with more useful ads, we have recently revised our trademark policy in the U.S. and Canada. Under our new policy, we no longer disable ads due to selection by our advertisers of trademarks as keyword triggers for the ads. As a result of this change in policy, we may be subject to more trademark infringement lawsuits. Defending these lawsuits could take time and resources. Adverse results in these lawsuits may result in, or even compel, a change in this practice which could result in a loss of revenue for us, which could harm our business.

 

We have also been notified by third parties that they believe features of certain of our products, including Google WebSearch, Google News and Google Image Search, violate their copyrights. Generally speaking, any time that we have a product or service that links to or hosts material in which others allege to 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, the risk of potential harm from such lawsuits is substantial.

 

Expansion into international markets is important to our long-term success, and our inexperience in the operation of our business outside the U.S. increases the risk that our international expansion efforts will not be successful.

 

We opened our first office outside the U.S. in 2001 and have only limited experience with operations outside the U.S. Expansion into international markets requires management attention and resources. In addition, we face the following additional risks associated with our expansion outside the U.S.:

 

    Challenges caused by distance, language and cultural differences.

 

    Longer payment cycles in some countries.

 

    Credit risk and higher levels of payment fraud.

 

    Legal and regulatory restrictions.

 

    Currency exchange rate fluctuations.

 

    Foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S.

 

    Political and economic instability and export restrictions.

 

    Potentially adverse tax consequences.

 

    Higher costs associated with doing business internationally.

 

These risks could harm our international expansion efforts, which would in turn harm our business and operating results.

 

We compete internationally with local information providers and with U.S. competitors who are currently more successful than we are in various markets, and if we fail to compete effectively in international markets, our business will be harmed.

 

We face different market characteristics and competition outside the U.S. In certain markets, other web search, advertising services and Internet companies have greater brand recognition, more users and more search traffic than we have. Even in countries where we have a significant user following, we may not be as successful in generating advertising revenue due to slower market development, our inability to provide attractive local advertising services or other factors. In order to compete, we need to improve our brand recognition and our selling efforts internationally and build stronger relationships with advertisers. We also need to better understand our international users and their preferences. If we fail to do so, our global expansion efforts may be more costly and less profitable than we expect.

 

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Our business may be adversely affected by malicious third-party applications that interfere with, or exploit security flaws in, our products and services.

 

Our business may be adversely affected by malicious applications that make changes to our users’ computers and interfere with the Google experience. These applications have in the past attempted, and may in the future attempt, to change our users’ Internet experience, including hijacking queries to Google.com, altering or replacing Google search results, or otherwise interfering with our ability to connect with our users. The interference often occurs without disclosure to or consent from users, resulting in a negative experience that users may associate with Google. These applications may be difficult or impossible to uninstall or disable, may reinstall themselves and may circumvent other applications’ efforts to block or remove them. In addition, we offer a number of products and services that our users download to their computers or that they rely on to store information and transmit information to others over the Internet. These products and services are subject to attack by viruses, worms and other malicious software programs, which could jeopardize the security of information stored in a user’s computer or in our computer systems and networks. The ability to reach users and provide them with a superior experience is critical to our success. If our efforts to combat these malicious applications are unsuccessful, or if our products and services have actual or perceived vulnerabilities, our reputation may be harmed and our user traffic could decline, which would damage our business.

 

If we fail to detect click-through fraud, we could lose the confidence of our advertisers, thereby causing our business to suffer.

 

We are exposed to the risk of fraudulent clicks on our ads by persons seeking to increase the advertising fees paid to our Google Network members. We have regularly refunded revenue that our advertisers have paid to us and that was later attributed to click-through fraud, and we expect to do so in the future. Click-through fraud occurs when a person clicks on a Google AdWords ad displayed on a web site in order to generate the revenue share payment to the Google Network member rather than to view the underlying content. If we are unable to stop this fraudulent activity, these refunds may increase. If we find new evidence of past fraudulent clicks we may have to issue refunds retroactively of amounts previously paid to our Google Network members. This would negatively affect our profitability, and these types of fraudulent activities could hurt our brand. If fraudulent clicks are not detected, the affected advertisers may experience a reduced return on their investment in our advertising programs because the fraudulent clicks will not lead to potential revenue for the advertisers. This could lead the advertisers to become dissatisfied with our advertising programs, which could lead to loss of advertisers and revenue.

 

Index spammers could harm the integrity of our web search results, which could damage our reputation and cause our users to be dissatisfied with our products and services.

 

There is an ongoing and increasing effort by “index spammers” to develop ways to manipulate our web search results. For example, because our web search technology ranks a web page’s relevance based in part on the importance of the web sites that link to it, people have attempted to link a group of web sites together to manipulate web search results. We take this problem very seriously because providing relevant information to users is critical to our success. If our efforts to combat these and other types of index spamming are unsuccessful, our reputation for delivering relevant information could be diminished. This could result in a decline in user traffic, which would damage our business.

 

Privacy concerns relating to elements of our technology could damage our reputation and deter current and potential users from using our products and services.

 

From time to time, concerns may be expressed about whether our products and services compromise the privacy of users and others. Concerns about our collection, use or sharing of personal information or other privacy-related matters, even if unfounded, could damage our reputation and operating results. Recently, several groups have raised privacy concerns in connection with our Gmail free email service which we announced in April 2004 and these concerns have attracted a significant amount of public commentary and attention. The

 

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concerns relate principally to the fact that Gmail uses computers to match advertisements to the content of a user’s email message when email messages are viewed using the Gmail service. Privacy concerns have also arisen with our products that provide improved access to personal information that is already publicly available, but that we have made more readily accessible by the public.

 

Our business is subject to a variety of U.S. and foreign laws, which could subject us to claims or other remedies based on the nature and content of the information searched or displayed by our products and services, and could limit our ability to provide information regarding regulated industries and products.

 

The laws relating to the liability of providers of online services for activities of their users are currently unsettled both within the U.S. and abroad. Claims have been threatened and filed under both U.S. and foreign law for defamation, libel, invasion of privacy and other data protection claims, tort, unlawful activity, copyright or trademark infringement, or other theories based on the nature and content of the materials searched and the ads posted or the content generated by our users. From time to time we have received notices from individuals who do not want their names or web sites to appear in our web search results when certain keywords are searched. It is also possible that we could be held liable for misinformation provided over the web when that information appears in our web search results. If one of these complaints results in liability to us, it could be potentially costly, encourage similar lawsuits, distract management and harm our reputation and possibly our business. In addition, increased attention focused on these issues and legislative proposals could harm our reputation or otherwise affect the growth of our business.

 

The application to us of existing laws regulating or requiring licenses for certain businesses of our advertisers, including, for example, distribution of pharmaceuticals, adult content, financial services, alcohol or firearms, can be unclear. Existing or new legislation could expose us to substantial liability, restrict our ability to deliver services to our users, limit our ability to grow and cause us to incur significant expenses in order to comply with such laws and regulations.

 

Several other federal laws could have an impact on our business. Compliance with these laws and regulations is complex and may impose significant additional costs on us. For example, the Digital Millennium Copyright Act has provisions that limit, but do not eliminate, our liability for listing or linking to third-party web sites that include materials that infringe copyrights or other rights, so long as we comply with the statutory requirements of this act. The Children’s Online Protection Act and the Children’s Online Privacy Protection Act restrict the distribution of materials considered harmful to children and impose additional restrictions on the ability of online services to collect information from minors. In addition, the Protection of Children from Sexual Predators Act of 1998 requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances. Any failure on our part to comply with these regulations may subject us to additional liabilities.

 

We also face risks associated with international data protection. The interpretation and application of data protection laws in Europe and elsewhere are still uncertain and in flux. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices. If so, in addition to the possibility of fines, this could result in an order requiring that we change our data practices, which in turn could have a material effect on our business.

 

We also face risks from legislation that could be passed in the future. For example, there is a risk that state legislatures will attempt to regulate the automated scanning of email messages in ways that interfere with our Gmail free advertising-supported web mail service that we recently announced as a test service. Any such legislation could make it more difficult for us to operate or could prohibit the aspects of our Gmail service that uses computers to match advertisements to the content of a user’s email message when email messages are viewed using the service. This could prevent us from implementing the Gmail service in any affected states and impair our ability to compete in the email services market.

 

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If we were to lose the services of Eric, Larry, Sergey or our senior management team, we may not be able to execute our business strategy.

 

Our future success depends in a large part upon the continued service of key members of our senior management team. In particular, our CEO Eric Schmidt and our founders Larry Page and Sergey Brin are critical to the overall management of Google as well as the development of our technology, our culture and our strategic direction. All of our executive officers and key employees are at-will employees, and we do not maintain any key-person life insurance policies. The loss of any of our management or key personnel could seriously harm our business.

 

The initial option grants to many of our senior management and key employees are fully vested. Therefore, these employees may not have sufficient financial incentive to stay with us, we may have to incur costs to replace key employees that leave, and our ability to execute our business model could be impaired if we cannot replace departing employees in a timely manner.

 

Many of our senior management personnel and other key employees have become, or will soon become, substantially vested in their initial stock option grants. While we often grant additional stock options to management personnel and other key employees after their hire dates to provide additional incentives to remain employed by us, their initial grants are usually much larger than follow-on grants. Employees may be more likely to leave us after their initial option grant fully vests, especially if the shares underlying the options have significantly appreciated in value relative to the option exercise price. We have not given any additional grants to Eric, Larry or Sergey. Larry and Sergey are fully vested, and only a small portion of Eric’s stock is subject to future vesting. If any members of our senior management team leave the company, our ability to successfully operate our business could be impaired. We also may have to incur significant costs in identifying, hiring, training and retaining replacements for departing employees.

 

We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to grow effectively.

 

Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization. Competition in our industry for qualified employees is intense, and we are aware that certain of our competitors have directly targeted our employees. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees.

 

We have in the past maintained a rigorous, highly selective and time-consuming hiring process. We believe that our approach to hiring has significantly contributed to our success to date. As we grow, our hiring process may prevent us from hiring the personnel we need in a timely manner. In addition, as we become a more mature company, we may find our recruiting efforts more challenging. The incentives to attract, retain and motivate employees provided by our option grants or by future arrangements, such as through cash bonuses, may not be as effective as in the past. If we do not succeed in attracting excellent personnel or retaining or motivating existing personnel, we may be unable to grow effectively.

 

Our CEO and our two founders run the business and affairs of the company collectively, which may harm their ability to manage effectively.

 

Eric, our CEO, and Larry and Sergey, our founders and presidents, currently provide leadership to the company as a team. Our bylaws provide that our CEO and our presidents will together have general supervision, direction and control of the company, subject to the control of our board of directors. As a result, Eric, Larry and Sergey tend to operate the company collectively and to consult extensively with each other before significant decisions are made. This may slow the decision-making process, and a disagreement among these individuals could prevent key strategic decisions from being made in a timely manner. In the event our CEO and our two founders are unable to continue to work well together in providing cohesive leadership, our business could be harmed.

 

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We have a short operating history and a relatively new business model in an emerging and rapidly evolving market. This makes it difficult to evaluate our future prospects, may increase the risk that we will not continue to be successful.

 

We first derived revenue from our online search business in 1999 and from our advertising services in 2000, and we have only a short operating history with our cost-per-click advertising model, which we launched in 2002. As a result, we have very little operating history for you to evaluate in assessing our future prospects. Also, we derive nearly all of our revenues from online advertising, which is an immature industry that has undergone rapid and dramatic changes in its short history. You must consider our business and prospects in light of the risks and difficulties we will encounter as an early-stage company in a new and rapidly evolving market. We may not be able to successfully address these risks and difficulties, which could materially harm our business and operating results.

 

We may have difficulty scaling and adapting our existing architecture to accommodate increased traffic and technology advances or changing business requirements, which could lead to the loss of users, advertisers and Google Network members, and cause us to incur expenses to make architectural changes.

 

To be successful, our network infrastructure has to perform well and be reliable. The greater the user traffic and the greater the complexity of our products and services, the more computing power we will need. In 2004, we expect to spend substantial amounts to purchase or lease data centers and equipment and to upgrade our technology and network infrastructure to handle increased traffic on our web sites and to roll out new products and services. This expansion is going to be expensive and complex and could result in inefficiencies or operational failures. If we do not implement this expansion successfully, or if we experience inefficiencies and operational failures during the implementation, the quality of our products and services and our users’ experience could decline. This could damage our reputation and lead us to lose current and potential users, advertisers and Google Network members. The costs associated with these adjustments to our architecture could harm our operating results. Cost increases, loss of traffic or failure to accommodate new technologies or changing business requirements could harm our operating results and financial condition.

 

We rely on bandwidth providers, data centers or other third parties for key aspects of the process of providing products and services to our users, and any failure or interruption in the services and products provided by these third parties could harm our ability to operate our business and damage our reputation.

 

We rely on third-party vendors, including data center and bandwidth providers. Any disruption in the network access or co-location services provided by these third-party providers or any failure of these third-party providers to handle current or higher volumes of use could significantly harm our business. Any financial or other difficulties our providers face may have negative effects on our business, the nature and extent of which we cannot predict. We exercise little control over these third party vendors, which increases our vulnerability to problems with the services they provide. We license technology and related databases from third parties to facilitate aspects of our data center and connectivity operations including, among others, Internet traffic management services. We have experienced and expect to continue to experience interruptions and delays in service and availability for such elements. Any errors, failures, interruptions or delays experienced in connection with these third-party technologies and information services could negatively impact our relationship with users and adversely affect our brand and our business and could expose us to liabilities to third parties.

 

Our systems are also heavily reliant on the availability of electricity, which also comes from third-party providers. If we were to experience a major power outage, we would have to rely on back-up generators. These back-up generators may not operate properly through a major power outage and their fuel supply could also be inadequate during a major power outage. This could result in a disruption of our business.

 

Interruption or failure of our information technology and communications systems could impair our ability to effectively provide our products and services, which could damage our reputation and harm our operating results.

 

Our provision of our products and services depends on the continuing operation of our information technology and communications systems. Any damage to or failure of our systems could result in interruptions in

 

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our service. Interruptions in our service could reduce our revenues and profits, and our brand could be damaged if people believe our system is unreliable. Our systems are vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses, computer denial of service attacks or other attempts to harm our systems, and similar events. Some of our data centers are located in areas with a high risk of major earthquakes. Our data centers are also subject to break-ins, sabotage and intentional acts of vandalism, and to potential disruptions if the operators of these facilities have financial difficulties. Some of our systems are not fully redundant, and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, a decision to close a facility we are using without adequate notice for financial reasons or other unanticipated problems at our data centers could result in lengthy interruptions in our service.

 

We have experienced system failures in the past and may in the future. For example, in November 2003 we failed to provide web search results for approximately 20% of our traffic for a period of about 30 minutes. Any unscheduled interruption in our service puts a burden on our entire organization and would result in an immediate loss of revenue. If we experience frequent or persistent system failures on our web sites, our reputation and brand could be permanently harmed. The steps we have taken to increase the reliability and redundancy of our systems are expensive, reduce our operating margin and may not be successful in reducing the frequency or duration of unscheduled downtime.

 

More individuals are using non-PC devices to access the Internet, and versions of our web search technology developed for these devices may not be widely adopted by users of these devices.

 

The number of people who access the Internet through devices other than personal computers, including mobile telephones, hand-held calendaring and email assistants, and television set-top devices, has increased dramatically in the past few years. The lower resolution, functionality and memory associated with alternative devices make the use of our products and services through such devices difficult. If we are unable to attract and retain a substantial number of alternative device users to our web search services or if we are slow to develop products and technologies that are more compatible with non-PC communications devices, we will fail to capture a significant share of an increasingly important portion of the market for online services.

 

If we account for employee stock options using the fair value method, it could significantly reduce our net income.

 

There has been ongoing public debate whether stock options granted to employees should be treated as a compensation expense and, if so, how to properly value such charges. On March 31, 2004, the Financial Accounting Standard Board (FASB) issued an Exposure Draft, “Share-Based Payment—an amendment of FASB Statements No. 123 and 95,” (proposed SFAS 123R) which would require a company to recognize, as an expense, the fair value of stock options and other stock-based compensation to employees beginning on July 1, 2005 and subsequent reporting periods. Prior to our initial public offering, we recorded deferred stock-based compensation to the extent that the reassessed values for accounting purposes of the underlying stock on the dates of grant exceeded the exercise prices of the options. After the initial public offering, options have been granted at exercise prices equal to the fair market value of the underlying stock on the date of option grant. Accordingly, no deferred stock-based compensation has been recognized related to these stock options. We recognize compensation expense as we amortize the deferred stock-based compensation amounts on an accelerated basis over the related vesting periods. If we had used the fair value method of accounting for stock options granted to employees prior to October 1, 2004 using a Black Scholes option valuation formula, our net income would have been $2.4 million less than reported in the year ended December 31, 2003 and $9.8 million less than reported in the nine months ended September 30, 2004. If we elect or are required to record an expense for our stock-based compensation plans using the fair value method as described in the Exposure Draft, we could have on-going accounting charges significantly greater than those we would have recorded under our current method of accounting for stock options.

 

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Payments to certain of our Google Network members has exceeded the related fees we receive from our advertisers.

 

We have entered into, and may continue to enter into, minimum fee guarantee agreements with a small number of Google Network members. In these agreements, we promise to make minimum payments to the Google Network member for a pre-negotiated period of time, typically from three months to a year or more. It is difficult to forecast with certainty the fees that we will earn under our agreements, and sometimes the fees we earn fall short of the minimum guarantee payment amounts. Also, increasing competition for arrangements with web sites that are potential Google Network members could result in our entering into more of these minimum fee guarantee agreements under which guaranteed payments exceed the fees we receive from advertisers whose ads we place on those Google Network member sites. In each period to date, the aggregate fees we have earned under these agreements have exceeded the aggregate amounts we have been obligated to pay these Google Network members. However, individual agreements have resulted in guaranteed minimum and other payments to certain Google Network members in excess of the related fees we receive from advertisers. We expect that some individual agreements will continue to result in guaranteed minimum and other payments to certain Google Network members in excess of the related fees we receive from advertisers, which will adversely affect our profitability. However, we expect that the aggregate fees we will earn under agreements with guaranteed minimum and other payments will exceed the aggregate amounts we will be obligated to pay these Google Network members.

 

To the extent our revenues are paid in foreign currencies, and currency exchange rates become unfavorable, we may lose some of the economic value of the revenues in U.S. dollar terms.

 

As we expand our international operations, more of our customers may pay us in foreign currencies. Conducting business in currencies other than U.S. dollars subjects us to fluctuations in currency exchange rates. If the currency exchange rates were to change unfavorably, the value of net receivables we receive in foreign currencies and later convert to U.S. dollars after the unfavorable change would be diminished. This could have a negative impact on our reported operating results. Hedging strategies, such as forward contracts, options and foreign exchange swaps related to transaction exposures, that we have implemented or may implement to mitigate this risk may not eliminate our exposure to foreign exchange fluctuations. Additionally, hedging programs expose us to risks that could adversely affect our operating results, including the following:

 

    We have limited experience in implementing or operating hedging programs. Hedging programs are inherently risky and we could lose money as a result of poor trades.

 

    We may be unable to hedge currency risk for some transactions because of a high level of uncertainty or the inability to reasonably estimate our foreign exchange exposures.

 

    We may be unable to acquire foreign exchange hedging instruments in some of the geographic areas where we do business, or, where these derivatives are available, we may not be able to acquire enough of them to fully offset our exposure.

 

We may have exposure to greater than anticipated tax liabilities.

 

We are subject to income taxes and non-income taxes in a variety of jurisdictions and our tax structure is subject to review by both domestic and foreign taxation authorities. The determination of our worldwide provision for income taxes and other tax liabilities requires significant judgment and in the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made.

 

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We rely on insurance to mitigate some risks and, to the extent the cost of insurance increases or we are unable or choose not to maintain sufficient insurance to mitigate the risks facing our business, our operating results may be diminished.

 

We contract for insurance to cover certain potential risks and liabilities. In the current environment, insurance companies are increasingly specific about what they will and will not insure. It is possible that we may not be able to get enough insurance to meet our needs, may have to pay very high prices for the coverage we do get or may not be able to acquire any insurance for certain types of business risk. In addition, we have in the past and may in the future choose not to obtain insurance for certain risks facing our business. This could leave us exposed to potential claims. If we were found liable for a significant claim in the future, our operating results could be negatively impacted. Also, to the extent the cost of maintaining insurance increases, our operating results will be negatively affected.

 

Acquisitions could result in operating difficulties, dilution and other harmful consequences.

 

We do not have a great deal of experience acquiring companies and the companies we have acquired have been small. We have evaluated, and expect to continue to evaluate, a wide array of potential strategic transactions. From time to time, we may engage in discussions regarding potential acquisitions. Any of these transactions could be material to our financial condition and results of operations. In addition, the process of integrating an acquired company, business or technology may create unforeseen operating difficulties and expenditures and is risky. The areas where we may face risks include:

 

    The need to implement or remediate controls, procedures and policies appropriate for a larger public company at companies that prior to the acquisition lacked these controls, procedures and policies.

 

    Diversion of management time and focus from operating our business to acquisition integration challenges.

 

    Cultural challenges associated with integrating employees from the acquired company into our organization.

 

    Retaining employees from the businesses we acquire.

 

    The need to integrate each company’s accounting, management information, human resource and other administrative systems to permit effective management.

 

Foreign acquisitions involve unique risks in addition to those mentioned above, including those related to integration of operations across different cultures and languages, currency risks and the particular economic, political and regulatory risks associated with specific countries. Also, the anticipated benefit of many of our acquisitions may not materialize. Future acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could harm our financial condition. Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all.

 

We occasionally become subject to commercial disputes that could harm our business by distracting our management from the operation of our business, by increasing our expenses and, if we do not prevail, by subjecting us to potential monetary damages and other remedies.

 

From time to time we are engaged in disputes regarding our commercial transactions. These disputes could result in monetary damages or other remedies that could adversely impact our financial position or operations. Even if we prevail in these disputes, they may distract our management from operating our business and the cost of defending these disputes would reduce our operating results.

 

We have to keep up with rapid technological change to remain competitive in our rapidly evolving industry.

 

Our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our services to evolving industry standards and to improve the performance and reliability of our services. Our

 

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failure to adapt to such changes would harm our business. New technologies and advertising media could adversely affect us. In addition, the widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require substantial expenditures to modify or adapt our services or infrastructure.

 

Our business depends on increasing use of the Internet by users searching for information, advertisers marketing products and services and web sites seeking to earn revenue to support their web content. If the Internet infrastructure does not grow and is not maintained to support these activities, our business will be harmed.

 

Our success will depend on the continued growth and maintenance of the Internet infrastructure. This includes maintenance of a reliable network backbone with the necessary speed, data capacity and security for providing reliable Internet services. Internet infrastructure may be unable to support the demands placed on it if the number of Internet users continues to increase, or if existing or future Internet users access the Internet more often or increase their bandwidth requirements. In addition, viruses, worms and similar programs may harm the performance of the Internet. The Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure, and it could face outages and delays in the future. These outages and delays could reduce the level of Internet usage as well as our ability to provide our solutions.

 

Shares issued and options granted under our stock plans exceeded limitations in federal and state securities laws, the result of which is that the holders of these shares and/or options may have rescission rights that could require us to reacquire the shares and/or options for an aggregate repurchase price of up to $28.3 million.

 

Shares issued and options granted under our 1998 Stock Plan, our 2003 Stock Plan, our 2003 Stock Plan (No. 2) and our 2003 Stock Plan (No. 3) from September 2001 through July 2004 may not have been exempt from registration or qualification under federal securities laws and the securities laws of certain states. Certain of the shares issued during this period may not have been exempt from registration and qualification requirements under Rule 701 under the Securities Act of 1933 and under those state securities laws that provide an exemption to the extent the requirements under Rule 701 are met. We became aware that we were approaching the numeric limitations prescribed by Rule 701 in September 2002 and thereafter determined that we could not continue to count on being able to rely on Rule 701 to provide an exemption from the registration requirements of the Securities Act of 1933. In addition, continued compliance under Rule 701 would have required broad dissemination of detailed financial information regarding our business, which would have been strategically disadvantageous to our company. In evaluating how to issue stock upon exercise of outstanding options in light of these limitations we determined we would utilize “private placement” exemptions provided by Section 4(2) of the Securities Act of 1933 in order to exempt these issuances from federal registration requirements notwithstanding the factual and legal uncertainties inherent in Section 4(2). These uncertainties arise because analyzing whether or not issuances of securities qualify for the exemptions afforded by Section 4(2) involves a number of subjective determinations including whether the number of offerees constitutes a general solicitation, the financial sophistication of offerees and their access to information regarding the issuer, as well as whether the offering was designed to result in a distribution of shares to the general public. We considered various alternatives in determining to rely on the exemption provided by Section 4(2) despite its inherent uncertainties. We considered ceasing granting options and shares to service providers. However, we determined that this would be detrimental to our development, as equity compensation was an essential ingredient to building our company. We also considered becoming a reporting company for the purposes of federal securities laws. We determined that this too would be contrary to the best interests of our stockholders. We therefore concluded that relying on Section 4(2) despite its uncertainties was in the best interest of our security holders. Because of this uncertainty in relying on Section 4(2), the options we granted and the shares issued upon exercise of these options during this period may have been issued in violation of either federal or state securities laws, or both, and may be subject to rescission. In order to address this issue, we are making a rescission offer to the holders of these shares and options. We will be making this rescission offer to 1,362 persons who are or were residents of Arkansas, California, Colorado, Connecticut, the District of Columbia, Georgia, Illinois,

 

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Maryland, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Texas, Virginia and Washington.

 

If this rescission offer is accepted by all offerees, we could be required to make aggregate payments to the holders of these shares and options of up to $28.3 million, which includes statutory interest. For options, this exposure reflects the costs of offering to rescind the issuance of the outstanding options by paying an amount equal to 20% of the aggregate exercise price for the entire option, plus statutory interest. However, it is possible that an optionholder could argue that this does not represent an adequate remedy for the issuance of the option in violation of applicable securities laws, and if a court were to impose a greater remedy, our exposure as a result of the rescission offer could be higher. For issuances of common stock, this exposure is calculated by reference to the purchase price of the common stock, plus statutory interest. Federal securities laws do not provide that a rescission offer will terminate a purchaser’s right to rescind a sale of stock that was not registered as required or was not otherwise exempt from such registration requirements. If any or all of the offerees reject the rescission offer, we may continue to be liable under federal and state securities laws for up to an amount equal to the value of all options and common stock granted or issued since September 2001 plus any statutory interest we may be required to pay. We also understand that the Securities and Exchange Commission has initiated an informal inquiry into this matter. In addition, certain state regulators, including California, have requested additional information and Georgia has initiated a formal hearing process and, as part of this process, we are responding to their requests for information. If it is determined that we offered securities without properly registering them under federal or state law, or securing an exemption from registration, regulators could impose monetary fines or other sanctions as provided under these laws.

 

If our involvement in a September 2004 magazine article about Google were held to be in violation of the Securities Act of 1933, we could be required to repurchase securities sold in our initial public offering. You should rely only on statements made in this offering circular in determining whether to accept or reject the rescission offer.

 

Information about Google has been published in an article appearing in the September 2004 issue of Playboy Magazine and entitled “Playboy Interview: Google Guys.” The text of the article contains information derived from an interview of Larry and Sergey conducted in April 2004, prior to our initial public offering. The article includes quotations from Larry and Sergey, and has been reprinted by a number of news media outlets. The article presented certain statements about our company in isolation and did not disclose many of the related risks and uncertainties described in this offering circular. As a result, the article should not be considered in isolation and you should decide whether to accept or reject the rescission offer only after reading this entire offering circular carefully.

 

You should carefully evaluate all the information in this offering circular, including the risks described in this section and throughout the offering circular. We have in the past received, and may continue to receive, a high degree of media coverage, including coverage that is not directly attributable to statements made by our officers and employees. You should rely only on the information contained in this offering circular in making your investment decision.

 

We do not believe that our involvement in the Playboy Magazine article constitutes a violation of Section 5 of the Securities Act of 1933. However, if our involvement were held by a court to be in violation of the Securities Act of 1933, we could be required to repurchase the shares sold to purchasers in our initial public offering at the original purchase price, plus statutory interest from the date of purchase, for a period of one year following the date of the violation. We would contest vigorously any claim that a violation of the Securities Act occurred. The SEC has also requested additional information concerning the publication of the article.

 

Investors should be aware of the following modifications and updates to the article’s content:

 

    The article states that our Gmail service, with one gigabyte of storage, has 200 times more storage than our primary competitors. While at the time of its introduction, Gmail had such a substantial storage capacity advantage over competitive offerings, competitors have substantially narrowed the gap.

 

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    The article indicates that we had about 1,000 employees. Currently, we have approximately 2,699 employees.

 

    The article states that more than 65 million people use our search engine each day. We believe that, based on data compiled by an unrelated third party research organization, this number represents monthly, not daily, domestic visitors data.

 

We do not intend to pay dividends on our common stock.

 

We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future.

 

We will incur increased costs as a result of being a public company.

 

As a public company, we have incurred and will continue to incur significant legal, accounting and other expenses that we did not incur as a private company. We will incur costs associated with our public company reporting requirements. We also anticipate that we will incur costs associated with recently adopted corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, as well as new rules implemented by the Securities and Exchange Commission and the NASD. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We also expect these new rules and regulations may make it more difficult and more expensive for us to maintain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

 

The concentration of our capital stock ownership with our founders, executive officers and our directors and their affiliates will limit your ability to influence corporate matters.

 

Our Class B common stock has ten votes per share and our Class A common stock has one vote per share. At October 31, 2004 our founders, executive officers and directors (and their affiliates) together owned approximately 69.2% of our Class B common stock, representing approximately 67.4% of the voting power of our outstanding capital stock. In particular, at October 31, 2004, our two founders and our CEO, Larry, Sergey and Eric, controlled approximately 42.0% of our outstanding Class B common stock, representing approximately 40.9% of the voting power of our outstanding capital stock. Larry, Sergey and Eric therefore have significant influence over management and affairs and over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or its assets, for the foreseeable future. In addition, because of this dual class structure, our founders, directors, executives and employees will continue to be able to control all matters submitted to our stockholders for approval even if they come to own less than 50% of the outstanding shares of our common stock. This concentrated control limits your ability to influence corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial. As a result, the market price of our Class A common stock could be adversely affected.

 

Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable.

 

Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

   

Our certificate of incorporation provides for a dual class common stock structure. As a result of this structure our founders, executives and employees have significant influence over all matters

 

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requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of our company or its assets. This concentrated control could discourage others from initiating any potential merger, takeover or other change of control transaction that other stockholders may view as beneficial.

 

    Our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors.

 

    Our stockholders may not act by written consent. As a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions without holding a stockholders’ meeting.

 

    Our certificate of incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates.

 

    Stockholders must provide advance notice to nominate individuals for election to the board of directors or to propose matters that can be acted upon at a stockholders’ meeting. These provisions may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of our company.

 

    Our board of directors may issue, without stockholder approval, shares of undesignated preferred stock. The ability to authorize undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to acquire us.

 

As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us.

 

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RESCISSION OFFER

 

Background

 

From September 2001 through July 2004, we granted options under our 1998 Stock Plan, 2003 Stock Plan, 2003 Stock Plan (No. 2) and 2003 Stock Plan (No. 3) to residents of the United States to purchase 36,650,648 shares of our common stock with a weighted average per share exercise price of $3.94, of which, 12,555,926 shares remain subject to outstanding options. As of November 2004, we issued 23,639,404 shares of our common stock upon the exercise of certain of these options, of which 23,435,945 shares remain outstanding, subject to our right to repurchase certain of these shares in limited circumstances. Options we granted during this period may not have been exempt from the registration or qualification requirements under the securities laws of some states. In addition, certain shares issued upon exercise of options granted during this period may not have been exempt from the registration or qualification requirements under Rule 701 under the Securities Act of 1933 and under those state securities laws that provide an exemption to the extent the requirements under Rule 701 are met.

 

We became aware that we were approaching the numeric limitations prescribed by Rule 701 in September 2002 and thereafter determined that we could not continue to count on being able to rely on Rule 701 to provide an exemption from the registration requirements of the Securities Act of 1933. In addition, continued compliance under Rule 701 would have required broad dissemination of detailed financial information regarding our business, which would have been strategically disadvantageous to our company. In evaluating how to issue stock upon exercise of outstanding options in light of these limitations we determined we would utilize “private placement” exemptions provided by Section 4(2) of the Securities Act of 1933 in order to exempt these issuances from federal registration requirements notwithstanding the factual and legal uncertainties inherent in Section 4(2). These uncertainties arise because analyzing whether or not issuances of securities qualify for the exemptions afforded by Section 4(2) involves a number of subjective determinations including whether the number of offerees constitutes a general solicitation, the financial sophistication of offerees and their access to information regarding the issuer, as well as whether the offering was designed to result in a distribution of shares to the general public. We considered various alternatives in determining to rely on the exemption provided by Section 4(2) despite its inherent uncertainties. We considered ceasing granting options and shares to service providers. However, we determined that this would be detrimental to our development, as equity compensation was an essential ingredient to building our company. We also considered becoming a reporting company for the purposes of federal securities laws. We determined that this too would be contrary to the best interests of our stockholders. We therefore concluded that relying on Section 4(2) despite its uncertainties was in the best interest of our security holders.

 

Because of the uncertainty in relying on Section 4(2), the options we granted and the shares issued upon exercise of these options during this period may have been issued in violation of either federal or state securities laws, or both, and may be subject to rescission. In order to address this issue, we are making this rescission offer to all holders of any outstanding options and shares who we believe may be entitled to argue for rescission and, pursuant to this rescission offer, we will offer to repurchase these options and shares then outstanding from the holder. We are making this rescission offer to 1,362 persons who are or were residents of Arkansas, California, Colorado, Connecticut, the District of Columbia, Georgia, Illinois, Maryland, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Texas, Virginia and Washington. If our rescission offer is accepted by all offerees, we could be required to make an aggregate payment to the holders of these options and shares of up to approximately $28.3 million, which includes statutory interest.

 

We understand that the Securities and Exchange Commission has initiated an informal inquiry into this matter. In addition, certain state regulators, including California, have requested additional information and Georgia has initiated a formal hearing process and, as part of this process, we are responding to their requests for information.

 

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The following is a description of the stock plans that are subject to the rescission offer and the options and shares granted under these plans:

 

    1998 Stock Plan.    The rescission offer is being made to (i) 130 holders of options to purchase 2,938,770 shares of Class B common stock and (ii) 422 holders of 13,676,132 shares of Class B common stock issued upon exercise of options granted under our 1998 Stock Plan between September 2001 and May 2003. We did not register these options and shares under the Securities Act of 1933 or the California Corporate Securities Law of 1968, or any other state securities laws. In addition, because of the frequency and amount of sales made under the stock plans subject to the rescission offer during this period, we believe that a valid exemption under the Securities Act of 1933 may not have been available for these option grants and stock issuances. In addition, we did not take the steps required to ensure the availability of applicable exemptions from qualification under certain state securities laws with respect to these options and shares. Consequently, these options and shares may have been issued in violation of the Securities Act of 1933 as well as the securities laws of certain states and are subject to the rescission offer.

 

    2003 Stock Plan.    The rescission offer is being made to (i) 152 holders of options to purchase 2,276,609 shares of Class A common stock and (ii) 435 holders of 8,056,901 shares of Class A common stock issued upon exercise of options granted under our 2003 Stock Plan between February 2003 and May 2003. We did not register these options and shares under the Securities Act of 1933 or the California Corporate Securities Law of 1968, or any other state securities laws. In addition, because of the frequency and amount of sales made under the stock plans subject to the rescission offer during this period, we believe that a valid exemption under the Securities Act of 1933 may not have been available for these option grants and stock issuances. In addition, we did not take the steps required to ensure the availability of applicable exemptions from qualification under certain state securities laws with respect to these options and shares. Consequently, these options and shares may have been issued in violation of the Securities Act of 1933 as well as the securities laws of certain states and are subject to the rescission offer.

 

    2003 Stock Plan (No. 2).    The rescission offer is being made to 174 holders of 351,614 shares of Class B common stock issued upon exercise of options granted under our 2003 Stock Plan (No. 2) between July 2003 and July 2004. These shares were duly qualified for sale and issuance pursuant to a permit under Section 25113 of the California Corporate Securities Law of 1968 by the California Department of Corporations. However, we did not take steps required to ensure the availability of applicable exemptions from qualification requirements under certain other state securities laws that may also be applicable with respect to these shares. In addition, because of the frequency and amount of sales made under the stock plans subject to the rescission offer during this period, we believe that a valid exemption under the Securities Act of 1933 may not have been available for these stock issuances because the amount of securities sold exceeded the limits set forth in Rule 701. Consequently, the shares may have been issued in violation of the Securities Act of 1933 and are subject to the rescission offer.

 

    2003 Stock Plan (No. 3).    The rescission offer is being made to 514 holders of 1,351,298 shares of Class A common stock issued upon exercise of options granted under our 2003 Stock Plan (No. 3) between July 2003 and July 2004. These shares were duly qualified for sale and issuance pursuant to a permit under Section 25113 of the California Corporate Securities Law of 1968 by the California Department of Corporations. However, we did not take steps required to ensure the availability of applicable exemptions from qualification requirements under certain other state securities laws that may also be applicable with respect to these shares. In addition, because of the frequency and amount of sales made under the stock plans subject to the rescission offer during this period, we believe that a valid exemption under the Securities Act of 1933 may not have been available for these stock issuances because the amount of securities sold exceeded the limits set forth in Rule 701. Consequently, the shares may have been issued in violation of the Securities Act of 1933 and are subject to the rescission offer.

 

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The rescission offer will cover an aggregate of approximately 23,435,945 shares of common stock issued and outstanding under our 1998 Stock Plan, 2003 Stock Plan, 2003 Stock Plan (No. 2) and 2003 Stock Plan (No. 3), and options outstanding under these plans to purchase 5,215,379 shares of common stock. These options represent all of the options we granted to residents of the United States pursuant to these plans during the period from September 2001 through July 2004 that have not been qualified under state securities laws. In addition, these shares represent all of the shares issued upon exercise of options we granted to residents of the United States pursuant to these plans during this period (other than options and shares returned to these plans, whether by cancellation, repurchase or otherwise), that may not have been qualified or registered under either federal or state securities laws, or both. These options and shares are held by our current and former employees, including one of our executive officers, and our current and former consultants. We are making the rescission offer to the holders of these options and shares. The rescission offer will be kept open for 30 days and will be registered under the Securities Act of 1933 and qualified in each state where such qualification is required under applicable state securities laws.

 

We have received an exemption from Rule 102 of Regulation M under the Securities Exchange Act of 1934 from the Securities and Exchange Commission to conduct the rescission offer in the manner described in this offering circular.

 

Rescission Offer and Price

 

We are offering to rescind certain stock issuances and option grants pursuant to certain of our stock plans. By making this rescission offer, we are not waiving any applicable statutes of limitations.

 

More specifically, we are offering to rescind the sale of 23,435,945 shares of our common stock, which are held by 1,320 persons, and the grants of options, which remain outstanding and are currently held by 282 persons, to purchase 5,215,379 shares of our common stock. This offer will be made to current and former employees and consultants who received options pursuant to the stock plans that are subject to the rescission offer between September 2001 and July 2004 and who are, or were at the time of issuance or grant, residents of Arkansas, California, Colorado, Connecticut, the District of Columbia, Georgia, Illinois, Maryland, Massachusetts, Michigan, Nevada, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Texas, Virginia and Washington, at prices ranging from $0.30 to $80.00 per share.

 

If you accept our rescission offer and you hold shares of our common stock, we will repurchase the shares you hold that are subject to the rescission offer at the price per share paid, plus interest at the current statutory rate per year mandated by your state of residence, from the date of exercise through the date that the rescission offer expires. If you accept our rescission offer and hold unexercised options to acquire our common stock, we will repurchase all unexercised options granted to you at 20% of the per share exercise price multiplied by the number of shares subject to such options, plus interest at the current statutory rate per year, from the date of grant through the date that the rescission offer expires.

 

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If you accept our rescission offer, you will be entitled to receive interest at the applicable statutory interest rate per year in accordance with your state of residence. You will not, however, be entitled to any payments for interest or otherwise unless you affirmatively elect to participate in the offer. We intend to use the legal rates of interest for the repurchase of the shares and options based on the state of residence of the stockholder or optionee. These interest rates are as follows:

 

State


   Interest Rate

   

State


   Interest Rate

 

Arkansas

   6 %   Nevada    6.25 %

California

   7 %   New Hampshire    10 %

Colorado

   8 %   New Jersey    4 %

Connecticut

   6 %   New York*    7 %

District of Columbia

   6 %   North Carolina    8 %

Georgia

   6 %   Pennsylvania    6 %

Illinois

   10 %   Texas    6 %

Maryland

   10 %   Virginia    6 %

Massachusetts

   6 %   Washington    8 %

Michigan

   6 %           

*   New York law does not provide a specific interest rate. For purposes of the rescission offer, we are applying the rate of interest of California (our principal place of business) to calculate the consideration to be received by New York residents who may be entitled to rescission rights.

 

Acceptance

 

You may accept the rescission offer by completing and signing the enclosed election form indicating the shares and options to be repurchased and delivering a stock power representing the shares you are surrendering for repurchase, on or before the close of business on December     , 2004, which date and time we refer to in this document as the expiration date. All acceptances of the rescission offer will be deemed to be effective on the expiration date and the right to accept the rescission offer will terminate on the expiration date. Acceptances or rejections may be revoked in a written notice to us, to the attention of Matthew Tolland, Corporate Paralegal, 1600 Amphitheatre Parkway, Mountain View, CA 94043, which is received prior to the expiration date. Within fifteen business days after the expiration date, we will pay for any securities as to which the rescission offer has been validly accepted.

 

The rescission offer will expire at 5:00 p.m., Pacific Daylight Time, on December     , 2004. If you submit an election form after the expiration time, regardless of whether your form is otherwise complete, your election will not be accepted, and you will be deemed to have rejected our rescission offer.

 

Neither we nor our officers and directors make any recommendations to you with respect to the rescission offer contained herein. You are urged to read the rescission offer carefully and to make an independent evaluation with respect to its terms.

 

IF PERSONS DESIRING TO ACCEPT THE RESCISSION OFFER INTEND TO MAKE USE OF THE MAIL TO RETURN THEIR STOCK POWERS, INSURED REGISTERED MAIL, RETURN RECEIPT REQUESTED, IS RECOMMENDED.

 

Rejection or Failure to Affirmatively Accept

 

If you fail to accept, or if you affirmatively reject the rescission offer by so indicating on the enclosed election form, you will retain ownership of the shares and options in accordance with the terms of our stock plans and you will not receive any cash for those securities in connection with the rescission offer. Your shares and any shares issuable upon the exercise of options will be registered and fully tradeable under the Securities Act of 1933, unless you are an affiliate of Google within the meaning of Rule 144 or Rule 145, as the case may be. Your shares will remain subject to any applicable terms and conditions of the original agreement under which they were issued and any subsequent agreement relating to such shares and options. In addition, you will remain subject to any market standoff agreements, lockup arrangements, vesting restrictions, Google Insider Trading

 

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Policy requirements and any other transfer restrictions entered into with respect to your shares. You may only resell shares acquired upon exercise of vested options; shares underlying unvested options may not be resold.

 

Solicitation

 

We have not retained, nor do we intend to retain, any person to make solicitations or recommendations to you in connection with the rescission offer.

 

Effect of Rescission Offer

 

It is unclear whether the rescission offer will terminate our liability, if any, for failure to register or qualify the issuance of the securities under either federal or state securities laws. Accordingly, should the rescission offer be rejected by any or all offerees, we may continue to be contingently liable under the Securities Act of 1933 and applicable state securities laws for the purchase price of these shares and the value of the options up to an aggregate amount of approximately $28.3 million, which includes statutory interest. If you are a stockholder who acquired shares of our common stock by exercising options under the stock plans that are subject to the rescission offer, it is possible that you may continue to have rights under common law or fraud in the state in which the potential securities violation with respect to your shares occurred. In addition, it is possible that an optionholder could argue that the offer to rescind the issuance of outstanding options for an amount equal to 20% of the aggregate exercise price, plus interest, does not represent an adequate remedy for the potential violation of the applicable securities laws in connection with the issuance of the option. If a court were to impose a greater remedy, our liability as a result of the potential securities violations would be higher.

 

Regardless of whether you accept the rescission offer, we believe that any remedies you may have after the rescission offer expires would not be greater than an amount you would receive in the rescission offer.

 

Below is a discussion of our contingent liability in those states where we may have potential securities laws violations resulting from our issuance of the shares, and our grants of the options relating to the shares, which are covered by the rescission offer. Each state has different laws with respect to rights under common law and fraud and the following discussion of state law does not relate to the antifraud provisions of applicable securities laws or rights under common law or equity. In addition, while certain holders of our options and shares who are residents of Colorado, Connecticut, Georgia, Illinois, Michigan, Nevada, New Hampshire, New Jersey, North Carolina, Pennsylvania, Texas, Virginia and Washington may have a right of rescission under federal securities laws, we believe that the options and shares issued by us in these states were issued pursuant to an exemption from registration or qualification available to us under applicable state securities laws.

 

Arkansas

 

Under Arkansas law, an issuer is civilly liable to a purchaser of its securities sold in violation of the registration requirements of the Arkansas Securities Act. The purchaser may sue to recover the consideration paid for such securities with interest at 6% per year from the date of payment, costs and reasonable attorneys’ fees, less the amount of any income received on the securities, or for damages if the purchaser no longer owns the securities, at any time prior to the three year anniversary of the effective date of the contract of sale.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Arkansas Securities Act by making a written rescission offer, before suit, to refund the consideration paid together with interest at 6% per year from the date of payment less the amount of any income received on the securities. If the purchaser owns the securities and fails to accept such offer within 30 days of its receipt, that purchaser will no longer have any right of rescission under Arkansas law. If the purchaser receives such offer at a time when the purchaser does not own the securities, that purchaser will no longer have any right of rescission under Arkansas law unless the purchaser rejects the offer in writing within 30 days of its receipt.

 

We believe this rescission offer complies in all material respects with the rescission offer requirements of the Arkansas Securities Act.

 

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California

 

Under California law, an issuer is civilly liable to a purchaser of its securities sold in violation of the registration or qualification requirements of the California Corporate Securities Law of 1968. The purchaser may sue to recover the consideration paid for such securities with interest at 7% per year, less the amount of any income received from ownership of the securities, upon the tender of such securities at any time prior to the earlier of the two year anniversary of the noncompliance with the registration or qualification requirements or the one year anniversary of the discovery by the purchaser of the facts constituting such noncompliance.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the California Corporate Securities Law of 1968 by making a written rescission offer before suit is commenced by the purchaser, approved as to form by the California Commissioner of Corporations where the offer:

 

    states the respect in which liability under the registration or qualification requirements may have arisen;

 

    offers to repurchase the securities for a cash price payable upon delivery of the securities or offering to pay the purchaser an amount in cash equal in either case to the amount recoverable by the purchaser, or offering to rescind the transaction by putting the parties back in the same position as before the transaction;

 

    provides that such offer may be accepted by the purchaser at any time within a specified period of not less than 30 days after the date of receipt of the offer unless rejected earlier during such periods by the purchaser;

 

    sets forth the provisions of the rescission offer requirements under the California Corporate Securities Law of 1968; and

 

    contains such other information as the California Commissioner of Corporations may require by rule or order.

 

If the purchaser fails to accept such offer in writing within the specified time period of not less than 30 days after the date of receipt of the offer, that purchaser will no longer have any right of rescission under California law.

 

We must also file with the California Commissioner of Corporations, in such form as the California Commissioner of Corporations prescribes by rule, an irrevocable consent appointing the Commissioner of Corporations or its successor in office to be our attorney to receive services of any lawful process in any noncriminal suit, action or proceeding against us or our successor, which arises under California law after the consent has been filed with the same force and validity as if served personally on us.

 

We believe this rescission offer complies in all material respects with the rescission offer requirements of the California Corporate Securities Law of 1968.

 

District of Columbia

 

Under District of Columbia law, an issuer is civilly liable to a purchaser of its securities sold in violation of the registration or qualification requirements of the District of Columbia Securities Act of 2000. The purchaser may sue to recover at law or in equity the consideration paid for such securities, together with interest at 6% per year from the date of payment, costs and reasonable attorneys’ fees, less any income or distributions received on the securities, or for damages if the purchaser no longer owns the securities, at any time prior to the one year anniversary of the noncompliance with the registration requirements.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the District of Columbia Securities Act of 2000 by making a written rescission offer, before suit, to refund the consideration paid together with interest at 6% from the date of payment, less the amount of any income received on the securities. If

 

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the purchaser owns the securities and fails to accept such offer within 30 days of its receipt, that purchaser will no longer have any right of rescission under District of Columbia law. If the purchaser receives such offer at a time when the purchaser does not own the securities, that purchaser will no longer have any right of rescission under District of Columbia law unless the purchaser rejects the offer in writing within 30 days of its receipt.

 

We believe this rescission offer complies in all material respects with the rescission offer requirements of the District of Columbia Securities Act of 2000.

 

Maryland

 

Under Maryland law, an issuer is civilly liable to a purchaser of its securities sold in violation of the registration or qualification requirements of the Maryland Securities Act. The purchaser may sue either at law or in equity to recover the consideration paid for such securities, together with interest at the rate of 10% per year from the date of payment, costs and reasonable attorneys’ fees, less the amount of any income received on the securities, or for damages if the purchaser no longer owns the securities, at any time prior to the one year anniversary of the noncompliance with the registration or qualification requirements.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the Maryland Securities Act by making a written rescission offer, before suit, to refund the consideration paid together with interest at the rate of 10% per year from the date of payment, less the amount of any income received on the securities. If the purchaser owns the securities and fails to accept such offer within 30 days of its receipt, that purchaser will no longer have any right of rescission under Maryland law. If the purchaser receives such offer at a time when the purchaser does not own the securities, that purchaser will no longer have any right of rescission under Maryland law unless the purchaser rejects the offer in writing within 30 days of its receipt.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Maryland Securities Act.

 

New York

 

Under New York law, there is no requirement to register or qualify securities, and there is no provision for rescission offers. Accordingly, the rescission offer is being made with respect to individuals who purchased shares of our common stock in New York, pursuant only to federal rights of rescission. The acceptance or non-acceptance of the rescission offer by these individuals will have no effect under New York law.

 

Funding the Rescission Offer

 

The rescission offer will be funded from our existing cash balances. If all persons eligible to participate accept our offer to repurchase common stock or options to the full extent, our results of operations, cash balances or financial condition will not be affected materially.

 

Directors, Officers and Major Stockholders

 

One of our officers, who holds 52,783 shares of common stock, all of which shares are subject to rescission is eligible to participate in the rescission offer. We have been advised that this officer does not intend to accept the rescission offer. None of our directors are eligible to participate in this offer. If our eligible officer does not participate in the rescission offer but all other eligible persons accept the rescission offer in full, our officers and directors would not materially increase their respective ownership interests in Google.

 

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MATERIAL U.S. FEDERAL INCOME TAX CONSEQUENCES

 

Tax Consequences of the Rescission Offer

 

In the opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation, the following are the material U.S. federal income tax consequences of the proposed rescission offer to our stockholders or option holders whose stock or options are rescinded pursuant to the rescission offer. However, this discussion does not address all income tax considerations that may be relevant to you in light of your individual circumstances, including if you are a foreign person, a person who is not an individual or a person subject to the alternative minimum tax provisions of the Internal Revenue Code of 1986, as amended. In addition, we do not address the tax consequences of the rescission offer to persons holding shares that are unvested, subject to hedging, conversion or constructive sale transactions or whose tax year is other than a calendar year. Finally, we do not address any foreign, state or local tax considerations. ACCORDINGLY, YOU ARE URGED TO CONSULT YOUR OWN TAX ADVISORS AS TO THE SPECIFIC TAX CONSEQUENCES OF THE RESCISSION OFFER, INCLUDING THE APPLICABLE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES TO YOU OF THE RESCISSION OFFER.

 

Redemption of Shares

 

For United States federal income tax purposes, the rescission offer with respect to shares of our common stock is intended to constitute a taxable redemption of shares for cash, with the redemption price equal to the amount paid for such shares (and including in the redemption price the interest on the original purchase price of such shares). However, the law applicable to the rescission offer is unclear, and we have not received a ruling from the Internal Revenue Service, or IRS, to that effect. Thus, the IRS is not precluded from successfully asserting a contrary position or otherwise recharacterizing the transaction in whole or in part. For example, the IRS may characterize our rescission offer as the return of the original purchase price, which would be nontaxable, plus the payment of interest, which would be taxable as ordinary income.

 

Assuming that our treatment of the rescission offer as a taxable redemption is correct, the amount and character of gain or loss recognized by a person who accepts the rescission offer will depend upon whether the shares held by such person were acquired pursuant to the exercise of an incentive stock option or the exercise of a nonstatutory stock option.

 

Redemption of Shares Received Upon Exercise of Options Generally

 

The following is a brief summary of the effect of United States federal income tax laws upon options, based upon United States federal income tax laws in effect on the date of the rescission offer.

 

This summary is not intended to be exhaustive and does not discuss the tax consequences of your death or the provisions of any income tax laws of any municipality, state or foreign country in which you may reside. You should consult your own tax advisor regarding the taxation of these options.

 

Incentive Stock Options.    If shares were issued to you pursuant to the exercise of an incentive stock option, and if no disqualifying disposition of the shares is made by you within two years after the date of grant or within one year after the issuance of such shares to you, including pursuant to the rescission offer, then the redemption rules of Section 302 of the Internal Revenue Code should apply to determine whether you recognize capital gain, capital loss, or dividend income. Under Section 302 of the Internal Revenue Code, a redemption of shares will be treated as a sale or exchange, and the character of any gain or loss will be treated as a capital gain or loss, if:

 

    it results in a complete redemption of your interest in shares of Google common stock and options to acquire Google common stock under Section 302(b)(3) of the Internal Revenue Code, which would occur if either (1) all of the shares actually and constructively owned by you are sold pursuant to the rescission offer or (2) all of the shares actually owned by you are sold pursuant to the rescission offer and you are eligible to waive and effectively waive constructive ownership of shares under procedures described in Section 302(c) of the Internal Revenue Code; or

 

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    it is substantially disproportionate with respect to you under Section 302(b)(2) of the Internal Revenue Code, which would occur if (1) the percentage of our voting stock owned by you immediately after the repurchase, taking into account all shares purchased by us pursuant to the rescission offer, equals less than 80% of the percentage of our voting stock owned by you immediately before the repurchase and (2) after the repurchase, you own less than 50% of the total combined voting power of all classes of our stock entitled to vote; or

 

    it is not essentially equivalent to a dividend with respect to you under Section 302(b)(1) of the Internal Revenue Code, which would occur if, in light of your individual circumstances, including your relative interest in Google, your sale of shares pursuant to the rescission offer results in a meaningful reduction of your interest in Google, after giving effect to, and thus treating as not outstanding, shares sold by all persons pursuant to the rescission offer. This test may be satisfied irrespective of your failure to satisfy the complete redemption and substantially disproportionate tests.

 

In determining whether any of the redemption tests are satisfied, you must take into account not only shares that are actually owned but also shares that are constructively owned within the meaning of Section 318 of the Internal Revenue Code. Under Section 318 of the Internal Revenue Code, you may constructively own shares actually owned, and in some cases constructively owned, by certain related individuals and shares that you have the right to acquire by the exercise of an option, warrant, or a conversion right. Contemporaneous or related transactions in stock or stock rights of Google also may affect the redemption tests.

 

The redemption tests are applied on a stockholder-by-stockholder basis. If a repurchase does not satisfy any of the redemption tests, we will treat the payment of the proceeds from the sale as a dividend distribution. Because the redemption tests are applied independently to you, it is possible that some persons accepting the rescission offer will be subject to dividend treatment and others will receive capital gain treatment. Because the application of the redemption tests is applied on a stockholder-by-stockholder basis, we urge you to consult your own advisors in connection with the possible United States federal income tax treatment that may apply to your particular case.

 

If the acceptance of the rescission offer fails to qualify as a redemption, then the gross proceeds of such transaction will be characterized as a dividend distribution taxable at ordinary income tax rates to the extent of our current and accumulated earnings and profits, on a pro rata basis with other persons whose sales fail to so qualify. Any excess will be treated as a return of capital and then as a gain from a sale or exchange.

 

A person who receives proceeds that are taxed as a dividend generally should be able to transfer the unrecovered tax basis in the shares sold to any retained (and possibly constructively owned) stock interest in Google.

 

Any gain (other than dividend income) or loss recognized in a sale generally should be capital gain or loss if you hold your shares as capital assets.

 

If you dispose of shares acquired upon the exercise of an incentive stock option in a disqualifying disposition (that is, before the expiration of two years from the date of grant or one year from the date of exercise) including pursuant to the rescission offer, generally:

 

    You will recognize ordinary income in the year of disposition in an amount equal to the excess, if any, of the fair market value of the shares at exercise or, if less, the amount realized on the disposition of the shares, over the option exercise price paid for such shares; and

 

    We will be entitled to a tax deduction in the same amount.

 

Any further gain or loss realized by you will be taxed as short-term or long-term capital gain or loss, as the case may be, and will not result in any deduction by us.

 

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If an option designated as an incentive stock option first becomes exercisable in any calendar year for shares the aggregate fair market value of which exceeds $100,000, such excess shares will be treated for income tax purposes as having been acquired by you pursuant to a nonstatutory stock option. For purposes of this rule:

 

    All incentive stock options we have granted to you are aggregated.

 

    The fair market value of an option share is its value on the date of grant of the option.

 

    Options are taken into account in the order in which they are granted.

 

Alternative Minimum Tax.    The exercise of an incentive stock option may have subjected you to the alternative minimum tax under Section 55 of the Internal Revenue Code. In computing alternative minimum taxable income, shares purchased upon exercise of an incentive stock option are treated as if you had acquired them pursuant to a nonstatutory stock option. See “Nonstatutory Stock Options.”

 

If you pay alternative minimum in excess of your regular tax liability, the amount of such alternative minimum relating to incentive stock options may be carried forward as a credit against any subsequent years’ regular tax in excess of the alternative minimum tax.

 

Nonstatutory Stock Options.    With respect to nonstatutory stock options, you will generally recognize ordinary income on exercise in an amount equal to the difference between the option exercise price paid for the shares and the fair market value of the shares on the date of exercise, and we are entitled to a tax deduction in the same amount. Upon disposition of the shares including pursuant to the rescission offer, any gain or loss is treated as described above under “Incentive Stock Options” with respect to shares as to which no disqualifying disposition has occurred. If you were an employee at the time of grant and when the option vested, any income recognized upon exercise of a nonstatutory stock option will constitute wages for which withholding will be required.

 

Capital Gains.    Capital gains are grouped and netted by holding periods. Net capital gain on assets held for 12 months or less is taxed currently at your highest marginal income tax rate. Net capital gain on assets held for more than 12 months is taxed currently at a maximum federal rate of 15%. Capital losses are first allowed in full against capital gains and then up to $3,000 against other income.

 

Redemption of Unexercised Options

 

If you accept the rescission offer with respect to unexercised options, you will recognize income on the cash that you receive for United States income tax purposes as of the date that it is paid to you. Any applicable withholding taxes or charges on the cash payment will be withheld from your cash payment and paid to the appropriate tax authority, as permitted or required by law. The payment of cash will be treated as ordinary income for United States income tax purposes in the year you receive it, and we will withhold certain income and payroll taxes, including the withholding of income, FICA and Medicare taxes, and other applicable employment taxes. For United States federal income tax purposes, we will withhold at the supplemental rate of 25%. To the extent that you recognize ordinary income, we would be generally entitled to a corresponding federal income tax deduction.

 

THE FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS A SUMMARY, AND IS INCLUDED FOR GENERAL INFORMATION ONLY. YOU ARE URGED TO CONSULT YOUR OWN TAX ADVISOR TO DETERMINE THE PARTICULAR TAX CONSEQUENCES TO YOU OF THE RESCISSION OFFER, IN LIGHT OF YOUR SPECIFIC CIRCUMSTANCES, INCLUDING THE TRANSACTION IN WHICH THE SHARES WERE ACQUIRED.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

In addition to the other information contained or incorporated by reference in this offering circular, you should carefully consider the risk factors disclosed in this offering circular, including those beginning on page 10, in evaluating whether to accept or reject the rescission offer. The information contained or incorporated by reference in this offering circular includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We have in the past and may in the future make forward-looking statements orally to analysts, investors, the media, and others. Forward-looking statements are statements that are not historical facts. The information contained or incorporated by reference in this offering circular includes forward-looking statements concerning:

 

    The effectiveness of our rescission offer to preclude certain holders of our options and stock from seeking relief for alleged violations of securities laws in connection with securities issuances pursuant to our stock plans.

 

    Our strategy and ability to continue to grow and our ability to leverage our technology and user base to generate revenue from the sale of our products and services.

 

    Our distribution of the Google AdSense fees we receive from advertisers.

 

    The effectiveness of our marketing programs.

 

    Competition from existing and new competitors in our market, and our ability to compete with such competitors.

 

    Potential future growth of revenues, the rate of that growth and the effect of that growth on our operating margin.

 

    Anticipated fluctuations in our revenues and cost of revenues.

 

    Anticipated stock based compensation and related charges and our effective tax rate.

 

    Anticipated trends in our base of advertisers and Google Network members.

 

    Anticipated effects of potential acquisition transactions.

 

    Future capital needs and capital expenditures.

 

    The impact of current litigation in which we are involved.

 

    The future effectiveness of our intellectual property rights and potential future litigation involving us regarding intellectual property matters.

 

    Our income tax rates and tax liabilities.

 

    The sufficiency of our cash, cash equivalents, short-term investments and cash generated from operations.

 

Additional forward-looking statements are identified in the documents incorporated herein by reference. These forward-looking statements are based on current expectations, estimates and projections about Google’s industry, management’s beliefs, and certain assumptions made by management. Words such as “anticipates”, “expects”, “intends”, “plans”, “believes”, “seeks”, “estimates” and similar expressions are intended to identify forward-looking statements.

 

There may be events in the future that we are not able to predict accurately or over which we have no control. Consequently, any of these forward-looking statements may not prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including but not limited to the risk factors set forth herein and those described elsewhere in this offering circular. You should carefully review the risk factors included in other reports or documents filed by us from time to time with the Securities and Exchange Commission, particularly our registration statement on Form 10-12G, initially filed on April 29, 2004, as amended (File No. 000-50726), any annual reports on Forms 10-K, any quarterly reports on Forms 10-Q and any current reports on Forms 8-K. All forward-looking statements and reasons why results may differ included in this offering circular are made as of the date hereof, and we assume no obligation to update any such forward-looking statement or reason why actual results might differ, even if new information becomes available or other events occur in the future.

 

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DIVIDEND POLICY

 

We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

 

You should read the following selected consolidated financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this offering circular.

 

The consolidated statements of operations data for the years ended December 31, 2001, 2002 and 2003, and the consolidated balance sheet data at December 31, 2002 and 2003, are derived from our audited consolidated financial statements appearing elsewhere in this offering circular. The consolidated statements of operations data for the years ended December 31, 1999 and December 31, 2000, and the consolidated balance sheet data at December 31, 1999, 2000 and 2001, are derived from our audited consolidated financial statements that are not included in this offering circular. The consolidated statements of operations data for the nine months ended September 30, 2003 and 2004 and the consolidated balance sheet data at September 30, 2004 are derived from our unaudited consolidated financial statements included in this offering circular. The unaudited consolidated financial statements include, in the opinion of management, all adjustments that management considers necessary for the fair presentation of the financial information set forth in those statements. The historical results are not necessarily indicative of the results to be expected in any future period.

 

    Year Ended December 31,

 

Nine Months Ended

September 30,


    1999

    2000

    2001

    2002

    2003

  2003

  2004

    (in thousands, except per share data)
                                (unaudited)

Consolidated Statements of Operations Data:

                                                 

Revenues

  $ 220     $ 19,108     $ 86,426     $ 439,508     $ 1,465,934   $ 953,759   $ 2,157,722

Costs and expenses:

                                                 

Cost of revenues

    908       6,081       14,228       131,510       625,854     374,986     1,003,874

Research and development

    2,930       10,516       16,500       31,748       91,228     62,771     138,190

Sales and marketing

    1,677       10,385       20,076       43,849       120,328     79,164     170,193

General and administrative

    1,221       4,357       12,275       24,300       56,699     36,415     87,857

Stock-based compensation(1)

          2,506       12,383       21,635       229,361     144,377     219,215

Non-recurring portion of settlement of disputes with Yahoo

    —         —         —         —         —       —       201,000
   


 


 


 


 

 

 

Total costs and expenses

    6,736       33,845       75,462       253,042       1,123,470     697,713     1,820,329
   


 


 


 


 

 

 

Income (loss) from operations

    (6,516 )     (14,737 )     10,964       186,466       342,464     256,046     337,393

Interest income (expense) and other, net

    440       47       (896 )     (1,551 )     4,190     1,183     2,668
   


 


 


 


 

 

 

Income (loss) before income taxes

    (6,076 )     (14,690 )     10,068       184,915       346,654     257,229     340,061

Provision for income taxes

                3,083       85,259       241,006     178,835     145,042
   


 


 


 


 

 

 

Net income (loss)

  $ (6,076 )   $ (14,690 )   $ 6,985     $ 99,656     $ 105,648   $ 78,394   $ 195,019
   


 


 


 


 

 

 

Net income (loss) per share(2):

                                                 

Basic

  $ (0.14 )   $ (0.22 )   $ 0.07     $ 0.86     $ 0.77   $ 0.58   $ 1.14

Diluted

  $ (0.14 )   $ (0.22 )   $ 0.04     $ 0.45     $ 0.41   $ 0.31   $ 0.73

Number of shares used in per share calculations(2):

                                                 

Basic

    42,445       67,032       94,523       115,242       137,697     134,820     170,511

Diluted

    42,445       67,032       186,776       220,633       256,638     254,664     268,394

(1)    Stock-based compensation, consisting of amortization of deferred stock-based compensation and the fair value of options issued to non-employees for services rendered, is allocated as follows:

    Year Ended December 31,

  Nine Months Ended
September 30,


    1999

    2000

    2001

    2002

    2003

  2003

  2004

    (in thousands)
                                (unaudited)

Cost of revenues

  $     $ 167     $ 876     $ 1,065     $ 8,557   $ 5,821   $ 9,618

Research and development

          1,573       4,440       8,746       138,377     82,115     134,222

Sales and marketing

          514       1,667       4,934       44,607     30,530     39,156

General and administrative

          252       5,400       6,890       37,820     25,911     36,219
   


 


 


 


 

 

 

    $     $ 2,506     $ 12,383     $ 21,635     $ 229,361   $ 144,377   $ 219,215
   


 


 


 


 

 

 

 

(2)   See Note 1 of Notes to Consolidated Financial Statements included in this offering circular for information regarding the computation of per share amounts.

 

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     At December 31,

   

At

September 30,
2004


 
     1999

   2000

    2001

    2002

    2003

   
     (in thousands)  
                                  (unaudited)  

Consolidated Balance Sheet Data:

                                               

Cash, cash equivalents and short-term investments

   $ 20,038    $ 19,101     $ 33,589     $ 146,331     $ 334,718     $ 1,858,356  

Total assets

     25,808      46,872       84,457       286,892       871,458       2,888,518  

Total long-term liabilities

     3,096      7,397       8,044       9,560       33,365       25,025  

Redeemable convertible preferred stock warrant

                      13,871       13,871        

Deferred stock-based compensation

          (8,457 )     (15,833 )     (35,401 )     (369,668 )     (292,690 )

Total stockholders’ equity

     20,009      27,234       50,152       173,953       588,770       2,589,023  

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with the consolidated financial statements and the notes to those statements included elsewhere in this offering circular. This discussion contains forward-looking statements that involve risks and uncertainties. Google’s actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included elsewhere in this offering circular. You should also carefully review the risk factors set forth in other reports or documents that Google files from time to time with the Securities and Exchange Commission, particularly our registration statement on Form 10-12G, initially filed on April 29, 2004, as amended (File No. 000-50726), any annual reports on Forms 10-K, any quarterly reports on Forms 10-Q and any current reports on Forms 8-K.

 

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 destination 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 our Google AdWords program, an auction-based advertising program that enables them to deliver relevant ads targeted to search results or web content. Our AdWords program provides advertisers with a cost-effective way to deliver ads to customers across Google sites and through the Google Network under our AdSense program.

 

    Web sites.    We provide members of our Google Network our Google AdSense program, which allows these members to deliver AdWords ads that are relevant to the search results or content on their web sites. We share most of the fees these ads generate with our Google Network members—creating an important revenue stream for them.

 

We were incorporated in California in September 1998 and reincorporated in Delaware in August 2003. We began licensing our WebSearch product in the first quarter of 1999. We became profitable in 2001 following the launch of our Google AdWords program.

 

How We Generate Revenue

 

We derive most of our revenues from fees we receive from our advertisers.

 

Our original business model consisted of licensing our search engine services to other web sites. In the first quarter of 2000, we introduced our first advertising program. Through our direct sales force we offered advertisers the ability to place text-based ads on our web sites targeted to our users’ search queries under a program called Premium Sponsorships. Advertisers paid us based on the number of times their ads were displayed on users’ search results pages, and we recognized revenue at the time these ads appeared. In the fourth quarter of 2000, we launched Google AdWords, an online self-service program that enables advertisers to place targeted text-based ads on our web sites. AdWords customers originally paid us based on the number of times their ads appeared on users’ search results pages. In the first quarter of 2002, we began offering AdWords exclusively on a cost-per-click basis, which means that an advertiser pays us only when a user clicks on one of its ads. AdWords is also available through our direct sales force. Our AdWords agreements are generally terminable at any time by our advertisers. We recognize as revenue the fees charged advertisers each time a user clicks on one of the text-based ads that appears next to the search results on our web sites.

 

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Effective January 1, 2004, we terminated the Premium Sponsorships program and now offer a single pricing structure to all of our advertisers based on the AdWords cost-per-click model. We do not expect that this change to a single pricing structure will have a negative effect on our revenues because most of our advertisers switched to the AdWords cost-per-click model. Our AdWords cost-per-click program is the advertising program through which we generate revenues by serving ads on our web sites and on Google Network member web sites through our AdSense program.

 

Google AdSense is the program through which we distribute our advertisers’ AdWords ads for display on the web sites of our Google Network members. Our AdSense program includes AdSense for search and AdSense for content. AdSense for search, launched in the first quarter of 2002, is our service for distributing relevant ads from our advertisers for display with search results on our Google Network members’ sites. AdSense for content, launched in the first quarter of 2003, is our service for distributing ads from our advertisers that are relevant to content on our Google Network members’ sites. Our advertisers pay us a fee each time a user clicks on one of our advertisers’ ads displayed on Google Network members’ web sites. In the past, we have paid most of these advertiser fees to the members of the Google Network, 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 cost of revenue. In some cases, we guarantee our Google Network members minimum revenue share payments. Members of the Google Network do not pay any fees associated with the use of our AdSense program on their web sites. Some of our Google Network members separately license our web search technology and pay related licensing fees to us. 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. Agreements with our larger members are individually negotiated. The standard agreements have no stated term and are terminable at will. The negotiated agreements vary in duration. Both the standard agreements and the negotiated agreements contain provisions requiring us to share with the Google Network member a portion of the advertiser fees generated by users clicking on ads on the Google Network member’s web site. The standard agreements have uniform revenue share terms. The negotiated agreements vary as to revenue share terms and are heavily negotiated.

 

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

 

    The relevance, objectivity and quality of our search results.

 

    The number and type of searches initiated at our web sites or our Google Network members’ web sites.

 

    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 number of advertisers.

 

    The total and per click advertising spending budgets of an advertiser.

 

    The monetization of (or generation of revenue from) traffic on our web sites and our Google Network members’ web sites.

 

We believe that the monetization of traffic on our web sites and our Google Network members’ web sites is affected by the following factors:

 

    The relevance and quality of advertisements displayed with each search results on our web sites and our Google Network members’ web sites, as well as with each content page on our Google Network members’ web sites.

 

    The number and prominence of advertisements displayed with each search results page on our web sites and our Google Network members’ web sites, as well as with each content page on our Google Network members’ web sites.

 

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    The total number of advertisements displayed on our web sites and on our Google Network members’ web sites.

 

    The rate at which our users and users of our Google Network members’ web sites click on advertisements.

 

    Our minimum fee per click, which is currently $0.05.

 

Advertising revenues made up 77%, 94%, 97% and 98% of our revenues in 2001, 2002, 2003 and in the nine months ended September 30, 2004. We derive the balance of our revenues from the license of our web search technology, the license of our search solutions to enterprises and the sale and license of other products and services.

 

Trends in Our Business

 

Our business has grown rapidly since inception, and we expect that our business will continue to grow. This growth has been characterized by substantially increased revenues. However, although our revenue growth rate increased in the third quarter of 2004 compared to the second quarter of 2004, our revenue growth rate has generally declined, and we expect it will continue to do so as a result of increasing competition and the inevitable decline in growth rates as our revenues increase to higher levels. Consequently, we believe that our revenue growth rate from the second quarter to the third quarter of 2004 may not be sustainable into the fourth quarter of this year and in future periods. In addition, 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, and therefore steps we take to improve the relevance of the ads displayed on our web sites, such as removing ads that generate low click-through rates, could negatively affect our near-term advertising revenues.

 

We expect that our operating margin will decline in 2004 compared to 2003 primarily as a result of a $201.0 million non-recurring charge taken in the third quarter of 2004 related to the settlement of disputes with Yahoo. Our operating margin before this charge was slightly greater in the nine months ended September 30, 2004 compared to the year ended December 31, 2003 primarily as a result of a decrease in stock-based compensation as a percentage of revenues. We also expect that our operating margin before this charge will be slightly greater in 2004 compared to 2003 primarily because we expect that our stock-based compensation charges will continue to decrease as a percentage of revenues, at least in the near term. See Note 1 of Notes to Consolidated Financial Statements included in this offering circular for a presentation of certain of our expected future stock-based compensation charges. Anticipated changes to the accounting rules for stock-based compensation, as well as any changes to our equity compensation model, will affect the level of stock-based compensation we expect to recognize and, correspondingly, our operating margins in the future.

 

The increase in our operating margin before the charge related to the settlement of disputes with Yahoo in the nine months ended September 30, 2004 compared to the year ended December 31, 2003, which was primarily as a result of a decrease in stock-based compensation charges as a percentage of revenues, was substantially offset by an increase in traffic acquisition costs as a percentage of revenues. This is because a greater portion of our revenues in the nine months ended September 30, 2004 compared to the year ended December 31, 2003 was from our Google Network members’ web sites rather than from our Google web sites. The operating margin we realize on revenues generated from the web sites of our Google Network members through our AdSense program is significantly lower than that generated from paid clicks on our web sites. This lower operating margin arises because most of the advertiser fees from our AdSense agreements are shared with our Google Network members, leaving only a portion of these fees for us. The growth in advertising revenues from our Google Network members’ web sites has until recently exceeded that from our web sites. This has resulted in an increased portion of our revenue being derived from our Google Network members’ web sites and has had a negative impact on operating margins. 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. For example, in the second and third quarters of 2004, growth in advertising revenues from our web sites exceeded that from our Google Network members’ web sites and we expect that it will continue to do so in the foreseeable future.

 

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Our operating margin may experience downward pressure in the future as we build the necessary employee and systems infrastructures required to manage our anticipated growth and we expect that the growth rate of our costs and expenses, other than stock-based compensation and the non-recurring charge related to the settlement of disputes with Yahoo, may exceed the growth rate of our revenues during 2004 and beyond. We have experienced and expect to continue to experience substantial growth in our operations as we seek to expand our user, advertiser and Google Network members bases and continue to expand our presence in international markets. This growth has required the continued expansion of our human resources and substantial investments in property and equipment. Our full-time employee headcount has grown from 1,628 at December 31, 2003 to 2,668 at September 30, 2004. In addition, we have employed a significant number of temporary employees in the past and expect to continue to do so in the foreseeable future. Our capital expenditures have grown from $120.3 million in the nine months ended September 30, 2003 to $259.9 million in the nine months ended September 30, 2004. We expect to spend over $300 million on capital equipment, including information technology infrastructure, to manage our operations during 2004. Management of this growth will continue to require the devotion of significant employee and other resources and we may not be able to manage this growth effectively.

 

The portion of our revenues derived from international markets has increased. Our international revenues have grown as a percentage of our total revenues from 30% in the three months ended September 30, 2003 to 35% in the three months ended September 30, 2004, and have grown from 29% in the nine months ended September 30, 2003 to 33% in the nine months ended September 30, 2004. This increase in the portion of our revenues derived from international markets results largely from increased acceptance of our advertising programs in international markets, an increase in our direct sales resources and customer support operations in international markets and our continued progress in developing versions of our products tailored for these markets.

 

Results of Operations

 

The following is a more detailed discussion of our financial condition and results of operations for the periods presented.

 

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

 

     Year Ended December 31,

   

Three Months

Ended


    Nine Months Ended
September 30,


 
     2001

    2002

    2003

    June 30,
2004


    September 30,
2004


        2003    

        2004    

 
                       (unaudited)     (unaudited)  

Consolidated Statements of Income Data:

                                          

Revenues

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Costs and expenses:

                                          

Cost of revenues

   16.5     29.9     42.7     46.6     44.9     39.3     46.5  

Research and development

   19.1     7.2     6.2     6.5     7.1     6.6     6.4  

Sales and marketing

   23.2     10.0     8.2     8.1     8.1     8.3     7.9  

General and administrative

   14.2     5.5     3.9     3.7     5.1     3.8     4.1  

Stock-based compensation

   14.3     4.9     15.6     10.7     8.5     15.1     10.2  

Non-recurring portion of settlement of disputes with Yahoo

   —       —       —       —       24.9     —       9.3  
    

 

 

 

 

 

 

Total costs and expenses

   87.3     57.5     76.6     75.6     98.6     73.1     84.4  
    

 

 

 

 

 

 

Income from operations

   12.7     42.5     23.4     24.4     1.4     26.9     15.6  

Interest income (expense) and other, net

   (1.0 )   (0.4 )   0.2     (0.2 )   0.5     0.1     0.1  
    

 

 

 

 

 

 

Income before income taxes

   11.7     42.1     23.6     24.2     1.9     27.0     15.7  

Provision (benefit) for income taxes

   3.6     19.4     16.4     12.9     (4.6 )   18.8     6.7  
    

 

 

 

 

 

 

Net income

   8.1 %   22.7 %   7.2 %   11.3 %   6.5 %   8.2 %   9.0 %
    

 

 

 

 

 

 

 

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Revenues

 

The following table presents our revenues, by revenue source, for the periods presented:

 

     Year Ended December 31,

   Three Months Ended

   Nine Months Ended
September 30,


        June 30,
2004


   September 30,
2004


  
     2001

   2002

   2003

         2003

   2004

                    (unaudited)    (unaudited)
     (in thousands)

Advertising revenues:

                                                

Google web sites

   $ 66,932    $ 306,978    $ 792,063    $ 343,442    $ 411,671    $ 548,240    $ 1,058,645

Google Network web sites

          103,937      628,600      346,226      384,285      373,246      1,064,263
    

  

  

  

  

  

  

Total advertising revenues

     66,932      410,915      1,420,663      689,668      795,956      921,486      2,122,908

Licensing and other revenues

     19,494      28,593      45,271      10,544      9,931      32,273      34,814
    

  

  

  

  

  

  

Revenues

   $ 86,426    $ 439,508    $ 1,465,934    $ 700,212    $ 805,887    $ 953,759    $ 2,157,722
    

  

  

  

  

  

  

 

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

 

    

Year Ended

December 31,


    Three Months Ended

   

Nine Months Ended

September 30,


 
     2001

    2002

    2003

   

June 30,

2004


    September 30,
2004


    2003

    2004

 
                
                       (unaudited)     (unaudited)  

Advertising revenues:

                                          

Google web sites

   77 %   70 %   54 %   49 %   51 %   58 %   49 %

Google Network web sites

       24     43     49     48     39     49  
    

 

 

 

 

 

 

Total advertising revenues

   77     94     97     98     99     97     98  

Google web sites as % of advertising revenues

   100     75     56     50     52     60     50  

Google Network web sites as % of advertising revenues

       25     44     50     48     40     50  

Licensing and other revenues

   23 %   6 %   3 %   2 %   1 %   3 %   2 %

 

Growth in our revenues from 2002 to 2003, and from the nine months ended September 30, 2003 to the nine months ended September 30, 2004, resulted primarily from growth in advertising revenues from ads on our Google Network members web sites and growth in revenues from ads on our web sites. The advertising revenue growth resulted primarily from increases in the total number of paid clicks and advertisements displayed through our programs, rather than from changes in the fees charged. The increase in the number of paid clicks was due to an increase in the number of Google Network members and aggregate traffic at their web sites and on our web sites and improvements in our ability to monetize increased traffic on our web sites.

 

Growth in our revenues from the three months ended June 30, 2004 to the three months ended September 30, 2004 resulted primarily from growth in advertising revenues from ads on our web sites and growth in revenues from ads on our Google Network members’ web sites. The advertising revenue growth resulted primarily from increases in the total number of paid clicks rather than from changes in the fees charged. Our revenues grew by 7.5% from the three month period ended March 31, 2004 to the three month period ended June 30, 2004, but grew by 15.1% from the three month period ended June 30, 2004 to the three month period ended September 30, 2004. The reasons for the increases in the sequential quarter revenue growth rates are described in the following paragraphs.

 

Growth in advertising revenues from our Google Network members’ web sites from the three months ended June 30, 2004 to the three months ended September 30, 2004 was $38.1 million or 11.0%, compared to $12.5 million or 3.7% from the three months ended March 31, 2004 to the three months ended June 30, 2004. The increase in the growth rate is attributable to growth in the number of page views and search queries, and

 

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ultimately paid clicks. The growth in the number of page views and ultimately paid clicks is primarily attributable to more aggregate advertisements displayed on the content pages of Google Network members’ web sites under AdSense for content agreements. This is a result of our entering into more of these agreements over the second and third quarters compared to the first and second quarters of this year. Nevertheless, these growth rates are much less than the 30.7% growth rate we realized in the three months ended March 31, 2004 compared to the three months ended December 31, 2003 as a result of slower growth in the number of paid clicks on our Google Network member web sites due primarily to our entering into no new significant AdSense for search agreements in the six months ended September 30, 2004 and as a result of seasonality during the summer months. Although we entered into a significant new AdSense for search agreement in October 2004, the growth in advertising revenues from our Google Network members’ web sites is expected to be less than the growth in revenues from our web sites for the foreseeable future.

 

Growth in advertising revenues from our web sites from the three months ended June 30, 2004 to the three months ended September 30, 2004 was $68.3 million or 19.9% compared to $39.9 million or 13.2% from the three months ended March 31, 2004 to the three months ended June 30, 2004. The increase in the growth rate for the third quarter of 2004 is primarily attributable to growth in the number of paid clicks which may be a result of increased traffic due to publicity around our initial public offering completed during this period and improvements in our ability to monetize this increased traffic.

 

Growth in our revenues from 2001 to 2002 resulted primarily from growth in advertising revenues from ads on our web sites. The growth in advertising revenues resulted primarily from increases in the total number of paid clicks under our cost-per-click programs and the total number of advertisements displayed through our cost-per-displayed ad programs, rather than from changes in the fees charged. The revenue growth was driven in part by our introduction of our cost-per-click revenue model in the early part of 2002, which contributed to a significant increase in the number of our advertisers and by our introduction of AdSense for search in the first quarter of 2002.

 

We believe that the increase in the number of paid clicks was the result of the relevance and quality of both the search results and advertisements displayed, which resulted in more searches, advertisers and Google Network members, and ultimately, more paid clicks. We expect our revenue growth rates will generally decline in the future as a result of increasing competition and the inevitable decline in growth rates as our revenues increase to higher levels. Furthermore, our revenue growth rate from the second to the third quarter of 2004 may not be sustainable into the fourth quarter of this year and beyond.

 

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.

 

    

Year Ended

December 31,


    Three Months Ended

   

Nine Months Ended

September 30,


 
     2001

    2002

    2003

    June 30,
2004


    September 30,
2004


   
               2003

    2004

 
                       (unaudited)     (unaudited)  

United States

   82 %   78 %   71 %   69 %   65 %   71 %   67 %

International

   18 %   22 %   29 %   31 %   35 %   29 %   33 %

 

The growth in international revenues is the result of our efforts to provide search results to international users and deliver more ads from non-U.S. advertisers. We expect that international revenues will continue to grow as a percentage of our total revenues in the future. While international revenues accounted for approximately 29% of our total revenues in 2003 and 33% in the nine months ended September 30, 2004, more than half of our user traffic came from outside the U.S. See Note 12 of Notes to Consolidated Financial Statements included as part of this offering circular for additional information about geographic areas.

 

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Costs and Expenses

 

Cost of Revenues.    Cost of revenues consists primarily of traffic acquisition costs. Traffic acquisition costs consist of amounts owed to our Google Network members. These amounts owed are primarily based on revenue share arrangements under which we pay our Google Network members most of the fees we receive from our advertisers whose ads we place on those Google Network member sites. In addition, 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. We amortize guaranteed minimum revenue share prepayments (or accrete an amount payable to our Google Network member if the payment is due in arrears) based on the number of search queries or advertisements displayed on the Google Network member’s web site. In addition, concurrent with the commencement of certain AdSense agreements we have purchased certain items from, or provided other consideration to, our Google Network members. These amounts are amortized on a pro-rata basis over the related term of the agreement.

 

The following table presents our traffic acquisition costs (in millions), traffic acquisition costs as a percentage of advertising revenues from Google Network web sites and traffic acquisition costs as a percentage of advertising revenues, for the periods presented.

 

   

Year Ended

December 31,


  Three Months Ended

  Nine Months Ended

    2001

  2002

  2003

  June 30,
2004


  September 30,
2004


  September 30,
2003


  September 30,
2004


    (unaudited)   (unaudited)   (unaudited)

Traffic acquisition costs

    $ 94.5   $ 526.5   $ 277.0   $ 302.9   $ 310.2   $ 851.0

Traffic acquisition costs as a percentage of advertising revenues from Google Network web sites

      91%     84%     80%     79%     83%     80%

Traffic acquisition costs as a percentage of advertising revenues

      23%     37%     40%     38%     34%     40%

 

In addition, cost of revenues consists of the expenses associated with the operation of our data centers, including depreciation, labor, energy and bandwidth costs. Cost of revenues also includes credit card and other transaction fees related to processing customer transactions, as well as amortization of expenses related to purchased and licensed technologies.

 

Cost of revenues increased by $35.7 million to $362.1 million (or 44.9% of revenues) in the three months ended September 30, 2004, from $326.4 million (or 46.6% of revenues) in the three months ended June 30, 2004. This increase in dollars was primarily the result of additional traffic acquisition costs and the depreciation of additional information technology assets purchased in the current and prior periods and additional data center costs required to manage more Internet traffic, advertising transactions and new products and services. There was an increase in traffic acquisition costs of $25.9 million and an increase in data center costs of $6.1 million primarily resulting from the depreciation of additional information technology assets purchased in the current and prior periods.

 

Traffic acquisition costs decreased as a percentage of advertising revenues from Google Network web sites in the three months ended September 30, 2004 compared to the prior quarter because more of these revenues came from members with whom we generally have lower revenue share obligations. Also, the aggregate dollar amount by which guaranteed revenue share and other payments to Google Network members exceeded the fees we received from advertisers under certain AdSense agreements was less in the three months ended September 30, 2004 compared to the three months ended June 30, 2004, which contributed to the decrease in traffic acquisition costs as a percentage of advertising revenues from Google Network web sites. In addition, traffic acquisition costs decreased as a percentage of advertising revenues in the three months ended September 30, 2004, primarily because of proportionately lower advertising revenues from ads on our Google Network members’ web sites compared to Google web sites and as a result of the reasons noted above.

 

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Cost of revenues increased by $628.9 million to $1,003.9 million (or 46.5% of revenues) in the nine months ended September 30, 2004, from $375.0 million (or 39.3% of revenues) in the nine months ended September 30, 2003. This increase was primarily the result of additional traffic acquisition costs and the depreciation of additional information technology assets purchased in the current and prior periods and additional data center costs required to manage more Internet traffic, advertising transactions and new products and services. There was an increase in traffic acquisition costs of $540.8 million and in data center costs of $62.5 million primarily resulting from the depreciation of additional information technology assets purchased in the current and prior periods. In addition, there was an increase in credit card and other transaction processing fees of $19.3 million resulting from more advertiser fees generated through AdWords.

 

Cost of revenues increased by $494.4 million to $625.9 million (or 42.7% of revenues) in 2003, from $131.5 million (or 29.9% of revenues) in 2002. This increase was primarily the result of increased traffic acquisition costs and additional data center costs required to manage more Internet traffic, advertising transactions and new products and services. Traffic acquisition costs increased $432.0 million due to an increase in the number of paid clicks on our Google Network members web sites. There was an increase in data center costs of $39.9 million primarily resulting from depreciation of additional information technology assets purchased in current and prior periods. In addition, there was an increase of $15.7 million in credit card and other transaction processing fees and an increase of $4.9 million related to amortization of developed technology resulting from acquisitions in 2003.

 

Cost of revenues increased by $117.3 million to $131.5 million (or 29.9% of revenues) in 2002, from $14.2 million (or 16.5% of revenues) in 2001. This increase was primarily the result of traffic acquisition costs and additional data center costs required to manage more Internet traffic, advertising transactions and new products and services. Traffic acquisition costs related to AdSense first introduced in 2002 totaled $94.5 million. There was an increase in data center costs of $15.3 million primarily resulting from depreciation of additional information technology assets purchased in current and prior periods. In addition, there was an increase in credit card and other transactional processing fees of $6.7 million.

 

We expect cost of revenues to continue to increase in dollars and as a percentage of revenues in 2004 compared to 2003 primarily as a result of forecasted increases in traffic acquisition costs, and in our data center costs required to manage increased traffic, advertising transactions and new products and services. Although traffic acquisition costs decreased as a percentage of revenues in the third quarter of 2004 as compared to the second quarter of 2004, we expect traffic acquisition costs to increase as a percentage of revenues in 2004 compared to 2003, primarily as a result of forecasted proportionately greater advertising revenues from ads on our Google Network members’ web sites compared to Google web sites. Also, increasing competition for arrangements with web sites that are potential Google Network members could result in our entering into more AdSense agreements under which guaranteed revenue share and other payments to Google Network members exceed the fees we receive from advertisers.

 

Research and Development.    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 increased by $11.6 million to $57.4 million (or 7.1% of revenues) in the three months ended September 30, 2004, from $45.8 million (or 6.5% of revenues) in the three months ended June 30, 2004. This increase was primarily due to an increase in labor and facilities related costs of $9.5 million as a result of a 23% increase in research and development headcount. In addition, depreciation and related expenses increased by $2.2 million primarily as a result of additional information technology assets purchased over the six months ended September 30, 2004.

 

Research and development expenses increased by $75.4 million to $138.2 million (or 6.4% of revenues) in the nine months ended September 30, 2004, from $62.8 million (or 6.6% of revenues) in the nine months ended September 30, 2003. This increase in dollars was primarily due to an increase in labor and facilities related costs

 

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of $61.8 million as a result of a 97% increase in research and development headcount. In addition, depreciation and related expenses increased by $19.4 million primarily as a result of additional information technology assets purchased over the twenty one-month period ended September 30, 2004. These increases were partially offset by a decrease of $10.6 million in in-process research and development.

 

Research and development expenses increased by $59.5 million to $91.2 million (or 6.2% of revenues) in 2003, from $31.7 million (or 7.2% of revenues) in 2002. This increase in dollars was primarily due to an increase in labor and facilities related costs of $34.3 million as a result of a 101% increase in research and development headcount. In addition, we recognized $11.6 million of in-process research and development expenses during 2003 as a result of an acquisition. Note 4 of Notes to Consolidated Financial Statements included as part of this offering circular describes further purchased in-process research and development expenses and other acquisitions.

 

Research and development expenses increased by $15.2 million to $31.7 million (or 7.2% of revenues) in 2002, from $16.5 million (or 19.1% of revenues) in 2001. This increase was primarily due to an increase in labor and facilities related costs of $13.2 million, principally as a result of an 83% increase in research and development headcount.

 

We anticipate that research and development expenses will continue to increase in dollar amount and may increase as a percentage of revenues in 2004 and future periods because we expect to hire more research and development personnel and build the infrastructure required to support the development of new, and improve existing, products and services.

 

Sales and Marketing.    Sales and marketing expenses consist primarily of compensation and related costs for personnel engaged in customer service and sales and sales support functions, as well as advertising and promotional expenditures.

 

Sales and marketing expenses increased $8.7 million to $65.5 million (or 8.1% of revenues) in the three months ended September 30, 2004, from $56.8 million (or 8.1% of revenues) in the three months ended June 30, 2004. This increase in dollars was primarily due to an increase in labor and facilities related costs of $5.5 million mostly as a result of a 16% increase in sales and marketing headcount. In addition, advertising and promotional expenses increased $1.1 million. The increase in sales and marketing personnel and advertising and promotional expenses was a result of our on-going efforts to secure new, and to provide support to our existing users, advertisers and Google Network members, on a worldwide basis.

 

Sales and marketing expenses increased $91.0 million to $170.2 million (or 7.9% of revenues) in the nine months ended September 30, 2004, from $79.2 million (or 8.3% of revenues) in the nine months ended September 30, 2003. This increase in dollars was primarily due to an increase in labor and facilities related costs of $65.0 million mostly as a result of an 88% increase in sales and marketing headcount. In addition, advertising and promotional expenses increased $13.1 million and travel-related expenses increased $2.6 million.

 

Sales and marketing expenses increased $76.5 million to $120.3 million (or 8.2% of revenues) in 2003, from $43.8 million (or 10.0% of revenues) in 2002. This increase in dollars was primarily due to an increase in labor and facilities related costs of $54.4 million mostly as a result of a 149% increase in sales and marketing headcount. In addition, advertising and promotional expenses increased $12.9 million and travel related expenses increased $3.2 million, primarily in the second half of 2003. The increase in sales and marketing personnel and advertising, promotional and travel-related expenses was a result of our on-going efforts to secure new, and to provide support to our existing, advertisers and Google Network members, on a worldwide basis. For instance, we have hired personnel to help our advertisers maximize their return on investment through the selection of appropriate keywords and have promoted the distribution of the Google Toolbar to Internet users in order to make our search services easier to access.

 

Sales and marketing expenses increased $23.7 million to $43.8 million (or 10.0% of revenues) in 2002, from $20.1 million (or 23.2% of revenues) in 2001. This increase in dollars was primarily due to increases in labor and

 

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facilities related costs of $19.5 million, primarily as a result of a 202% increase in headcount. Also, advertising and promotional expenses increased $1.7 million and travel related expenses increased $1.3 million.

 

We anticipate sales and marketing expenses will continue to increase in dollar amount and may increase as a percentage of revenues in 2004 and future periods as we continue to expand our business on a worldwide basis. A significant portion of these increases relate to our plan to add support personnel to increase the level of service we provide to our advertisers and Google Network members.

 

General and Administrative.    General and administrative expenses consist primarily of compensation and related costs for personnel and facilities related to our finance, human resources, facilities, information technology and legal organizations, and fees for professional services. Professional services are principally comprised of outside legal, audit and information technology consulting. To date, we have not experienced any significant amount of bad debts.

 

General and administrative expenses increased $15.2 million to $40.8 million (or 5.1% of revenues) in the three months ended September 30, 2004, from $25.6 million (or 3.7% of revenues) in the three months ended June 30, 2004. This increase was primarily due to an increase in labor and facilities related costs of $7.5 million, primarily as a result of a 9% increase in headcount, and an increase in professional services fees of $3.9 million. The additional personnel and professional services fees are primarily the result of our on-going efforts to build the legal, finance, human resources, recruiting and information technology functions required of a growing public company.

 

General and administrative expenses increased $51.7 million to $88.1 million (or 4.1% of revenues) in the nine months ended September 30, 2004, from $36.4 million (or 3.8% of revenues) in the nine months ended September 30, 2003. This increase in dollars was primarily due to an increase in labor and facilities related costs of $25.8 million, primarily as a result of an 83% increase in headcount, and an increase in professional services fees of $14.5 million.

 

General and administrative expenses increased $32.4 million to $56.7 million (or 3.9% of revenues) in 2003, from $24.3 million (or 5.5% of revenues) in 2002. This increase in dollars was primarily due to an increase in labor and facilities related costs of $16.7 million, primarily as a result of a 194% increase in headcount, and an increase in professional services fees of $10.0 million, primarily in the second half of 2003. The additional personnel and professional services fees are the result of the growth of our business.

 

General and administrative expenses increased $12.0 million to $24.3 million (or 5.5% of revenues) in 2002, from $12.3 million (or 14.2% of revenues) in 2001. This increase in dollars was primarily due to an increase in labor and facilities related costs of $7.8 million, mostly as a result of a 96% increase in headcount and an increase in professional services fees of $3.9 million. The additional personnel and professional services fees are the result of the growth of our business.

 

As we expand our business and incur additional expenses associated with being a public company, we believe general and administrative expenses will continue to increase in dollar amount and may increase as a percentage of revenues in 2004 and in future periods.

 

Stock-Based Compensation. Prior to the date of our initial public offering, we typically granted stock options at exercise prices equal to or less than the value of the underlying stock as determined by our board of directors on the date of option grant. For purposes of financial accounting, we have applied hindsight within each year or quarter to arrive at reassessed values for the shares underlying these options. We recorded the difference between the exercise price of an option awarded to an employee and the reassessed value of the underlying shares on the date of grant as deferred stock-based compensation. The determination of the reassessed value of stock underlying options is discussed in detail below in “Critical Accounting Policies and Estimates—Stock-Based Compensation.” We recognize compensation expense as we amortize the deferred stock-based compensation amounts on an accelerated basis over the related vesting periods, generally four or five years. After the initial public offering, options have been granted at exercise prices equal to the fair market value of the

 

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underlying stock on the date of option grant. In addition, we have awarded options to non-employees to purchase our common stock. Stock-based compensation related to non-employees is measured on a fair-value basis using the Black-Scholes valuation model as the options are earned.

 

Stock-based compensation in the three months ended September 30, 2004 decreased $6.8 million to $68.0 million (or 8.4% of revenues) from $74.8 million (or 10.7% of revenues) in the three months ended June 30, 2004. The decrease in dollars was primarily due to a decrease in the level of stock option grants and smaller differences between the exercise prices and the reassessed values of the underlying common stock on the dates of grant in the three months ended September 30, 2004, as well as less amortization of deferred stock-based compensation amounts from prior periods recognized in the current period. In addition, after the initial public offering, options were granted at exercise prices equal to the fair market value of the underlying stock on the date of grant. As a result, these options were granted with no intrinsic value and, accordingly, no related stock-based compensation will be recognized under the current accounting rules.

 

Stock-based compensation in the nine months ended September 30, 2004 increased $74.8 million to $219.2 million (or 10.2% of revenues) from $144.4 million (or 15.1% of revenues) in the nine months ended September 30, 2003. The increase in dollars was primarily driven by the larger differences between the exercise prices and the reassessed values of the underlying common stock on the dates of grant, partially offset by a decrease in the level of stock option grants, in recent periods. The increase was also driven by the recognition of $3.9 million of stock-based compensation related to the modification of terms of former employees’ stock option agreements in the nine months ended September 30, 2004. No such modifications were made in the nine months ended September 30, 2003.

 

Stock-based compensation increased $207.8 million to $229.4 million (or 15.6% of revenues) in 2003 from $21.6 million (or 4.9% of revenues) in 2002. The increase was primarily driven by the the larger differences between the exercise prices and the reassessed values of the underlying common stock on the dates of grant and, to a lesser extent, an increase in the level of stock option grants in 2003. Stock-based compensation increased $9.2 million to $21.6 million (or 4.9% of revenues) in 2002 from $12.4 million (or 14.3% of revenues) in 2001. The increase in dollars was primarily driven by the larger differences between the exercise prices and the reassessed values of the underlying common stock on the dates of grant, partially offset by a decrease in the level of stock option grants in 2002.

 

We expect stock-based compensation to be $54.6 million for the remaining three months of 2004, $139.2 million in 2005, $67.5 million in 2006, $24.4 million in 2007, $5.3 million in 2008 and $1.7 million thereafter, related to the deferred stock-based compensation on the balance sheet at September 30, 2004. These amounts do not include stock-based compensation related to options granted to non-employees and any options that may be granted to employees and directors subsequent to September 30, 2004 at exercise prices less than the fair market value on the date of grant and any additional compensation expense that may be required as a result of any changes in the stock option accounting rules or changes to our equity compensation model. These amounts also assume the continued employment throughout the referenced periods of the recipient of the options that gave rise to the deferred stock-based compensation.

 

At December 31, 2003, there were 500,150 unvested options held by non-employees with a weighted average exercise price of $0.69, a weighted average 48-month remaining vesting period and a weighted average 4-year remaining expected life. The options generally vest on a monthly and ratable basis subsequent to December 31, 2003. Depending on the fair market value of these options on their vesting dates, which will depend in significant part on the then current trading price of our Class A common stock, the related charge could be significant during 2004 and subsequent periods. We recognized $8.2 million of stock-based compensation related to these options that vest over time in the nine months ended September 30, 2004. No options that vest over time were granted to non-employees in the nine months ended September 30, 2004.

 

See Note 1 of Notes to Consolidated Financial Statements included in this offering circular for additional information about stock-based compensation.

 

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Non-recurring Portion of Settlement of Disputes with Yahoo

 

On August 9, 2004, we and Yahoo entered into a settlement agreement resolving two disputes that had been pending between us. The first dispute concerned a lawsuit filed by Yahoo’s wholly-owned subsidiary, Overture Services, Inc., against us in April 2002 asserting that certain services infringed Overture’s U.S. Patent No. 6,269,361. In our court filings, we denied that we infringed the patent and alleged that the patent was invalid and unenforceable.

 

The second dispute concerned a warrant held by Yahoo to purchase 3,719,056 shares of our stock in connection with a June 2000 services agreement. Pursuant to a conversion provision in the warrant, in June 2003 we issued 1,229,944 shares to Yahoo. Yahoo contended it was entitled to a greater number of shares, while we contended that we had fully complied with the terms of the warrant.

 

As part of the settlement, Overture dismissed its patent lawsuit against us and has granted us a fully-paid, perpetual license to the patent that was the subject of the lawsuit and several related patent applications held by Overture. The parties also mutually released any claims against each other concerning the warrant dispute. In connection with the settlement of these two disputes, we issued to Yahoo 2,700,000 shares of Class A common stock.

 

We incurred a non-recurring non-cash charge of $201.0 million in the third quarter of 2004 related to this settlement. The non-cash charge included among other items, the value of shares associated with the settlement of the warrant dispute. See Note 4 of Notes to Consolidated Financial Statements included in this offering circular for additional information about the settlement of disputes with Yahoo.

 

Interest Income (Expense) and Other, Net

 

Interest income (expense) and other of $3.9 million in the three months ended September 30, 2004 was primarily the result of $4.1 million of interest income earned on our significant larger cash, cash equivalents and short-term investments balances. This was partially offset by approximately $200,000 of interest expense incurred on equipment leases, including the amortization of the fair value of warrants issued to lenders in prior years.

 

Interest income (expense) and other of $1.2 million in the nine months ended September 30, 2003 was primarily the result of approximately $1.8 million of interest income earned on cash, cash equivalents and short-term investments balances and $1.2 million of other income recognized, primarily related to a gain recorded for certain upfront fees paid by advertisers whose ads were not delivered during the related contract periods. These income sources were partially offset by approximately $1.4 million of interest expense incurred on equipment loans and leases, including the amortization of the fair value of warrants issued to lenders in prior years, approximately $200,000 of foreign exchange losses from net receivables denominated in currencies other than U.S. dollars as a result of generally weakening foreign currencies against the U.S. dollar during the nine months ended September 30, 2003, and approximately $200,000 of losses incurred on the disposal of certain assets.

 

Interest income (expense) and other of $4.2 million in 2003 was primarily the result of $2.7 million of interest income earned on cash, cash equivalents and short-term investments balances, and $2.1 million of net foreign exchange gains from net receivables denominated in currencies other than U.S. dollars as a result of generally strengthening foreign currencies against the U.S. dollar throughout 2003. In addition, we recognized $1.4 million of other income in 2003, primarily related to a gain recorded for certain upfront fees paid by advertisers whose ads were not delivered during the related contract periods. These income sources were partially offset by $1.9 million of interest expense incurred on equipment loans and leases, including the amortization of the fair value of warrants issued to lenders in prior years.

 

Interest income (expense) and other of $900,000 of expense and $1.6 million of expense in 2001 and 2002 was primarily the result of interest expense incurred on equipment loans and leases, including the amortization of the fair value of warrants issued to lenders, partially offset by interest income on cash, cash equivalents and short-term investments balances.

 

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Provision for Income Taxes

 

We recorded an income taxes benefit of $37.0 million in the three months ended September 30, 2004 compared to a $90.4 million provision for income taxes and a 53% effective tax rate in the three months ended June 30, 2004, primarily as a result of a $46.0 million benefit recorded in the third quarter related to certain stock-based compensation charges recognized prior to the initial public offering. No reductions had been made previously to our provision for income taxes related to such charges and the associated tax benefit is only now being recognized as a result of our transformation from a private to a publicly-held company. As the accounting reflects a change in estimate to our provision for income taxes for the remainder of 2004, we will record an additional reduction to our provision for income taxes in the fourth quarter related to these stock-based compensation charges recognized prior to the initial public offering. In addition, as we continue to recognize stock-based compensation related to these options, we will also record a reduction to our provision for income taxes. We expect our effective tax rate for the fourth quarter and all of 2004 to be significantly lower than the 53% effective tax rate in the second quarter.

 

Our provision for income taxes decreased to $145.0 million, or an effective tax rate of 43% in the nine months ended September 30, 2004, from $178.8 million or an effective tax rate of 70% in the nine months ended September 30, 2003 primarily due to the reasons noted above and as a result of lower stock-based compensation charges in relation to income before income taxes.

 

Our provision for income taxes increased to $241.0 million or an effective tax rate of 70% during 2003, from $85.3 million or an effective tax rate of 46% during 2002, and from $3.1 million or an effective tax rate of 31% during 2001. The increases in provision for income taxes primarily resulted from increases in Federal and state income taxes, driven by higher taxable income year over year. Our effective tax rate is our provision for income taxes expressed as a percentage of our income before income taxes. Our effective tax rate is higher than the statutory rate because, in arriving at income before income taxes, we include in our costs and expenses significant non-cash expenses related to stock-based compensation, which are recognized for financial reporting purposes, but are not deductible for income tax purposes. The increases in our effective tax rates over each of 2001, 2002 and 2003 were primarily the result of an increase in stock-based compensation amounts.

 

A reconciliation of the federal statutory income tax rate to our effective tax rate is set forth in Note 11 of Notes to Consolidated Financial Statements included in this offering circular.

 

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Quarterly Results of Operations

 

You should read the following tables presenting our quarterly results of operations in conjunction with the consolidated financial statements and related notes contained elsewhere in this offering circular. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. You should also keep in mind, as you read the following tables, that our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year.

 

The following table presents our unaudited quarterly results of operations for the eleven quarters ended September 2004. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for fair presentation of our financial position and operating results for the quarters presented. We believe that we experience increased levels of Internet traffic focused on commercial transactions in the fourth quarter and decreased levels of Internet traffic in the summer months. Prior to the second quarter of 2004, these seasonal trends may have been masked by the substantial quarter over quarter growth in our revenues.

 

    Quarter Ended

 
    Mar 31,
2002


    Jun 30,
2002


    Sep 30,
2002


    Dec 31,
2002


    Mar 31,
2003


    Jun 30,
2003


  Sep 30,
2003


  Dec 31,
2003


  Mar 31,
2004


  Jun 30,
2004


   

Sep 30,

2004


 
    (in thousands, except per share amounts)  
    (unaudited)  

Consolidated Statements of Income Data:

                                                                               

Revenues

  $ 42,285     $ 78,525     $ 130,787     $ 187,911     $ 248,618     $ 311,199   $ 393,942   $ 512,175   $ 651,623   $ 700,212     $ 805,887  

Costs and expenses:

                                                                               

Cost of revenues

    5,692       20,407       39,622       65,789       87,195       117,401     170,390     250,868     315,398     326,377       362,099  

Research and development(1)

    6,183       6,457       9,053       10,055       12,505       17,492     32,774     28,457     35,019     45,762       57,409  

Sales and marketing

    7,294       11,176       11,704       13,675       17,767       24,822     36,575     41,164     47,904     56,777       65,512  

General and administrative

    4,135       5,653       7,313       7,199       10,027       12,535     13,853     20,284     21,506     25,577       40,774  

Stock-based compensation(2)

    3,774       3,735       6,182       7,944       36,418       34,165     73,794     84,984     76,473     74,761       67,981  

Non-recurring portion of settlement of disputes with Yahoo

                                                        201,000  
   


 


 


 


 


 

 

 

 

 


 


Total costs and expenses

    27,078       47,428       73,874       104,662       163,912       206,415     327,386     425,757     496,300     529,254       794,775  
   


 


 


 


 


 

 

 

 

 


 


Income from operations

    15,207       31,097       56,913       83,249       84,706       104,784     66,556     86,418     155,323     170,958       11,112  

Interest income, expense and other, net

    (501 )     (310 )     (677 )     (63 )     (47 )     766     464     3,007     300     (1,498 )     3,866  
   


 


 


 


 


 

 

 

 

 


 


Income before income taxes

    14,706       30,787       56,236       83,186       84,659       105,550     67,020     89,425     155,623     169,460       14,978  

Provision (benefit) for income taxes

    6,780       14,194       25,929       38,356       58,859       73,382     46,594     62,171     91,650     90,397       (37,005 )
   


 


 


 


 


 

 

 

 

 


 


Net income

  $ 7,926     $ 16,593     $ 30,307     $ 44,830     $ 25,800     $ 32,168   $ 20,426   $ 27,254   $ 63,973   $ 79,063     $ 51,983  
   


 


 


 


 


 

 

 

 

 


 


Net income per share:

                                                                               

Basic

  $ 0.07     $ 0.15     $ 0.26     $ 0.37     $ 0.20     $ 0.24   $ 0.14   $ 0.19   $ 0.42   $ 0.51     $ 0.25  
   


 


 


 


 


 

 

 

 

 


 


Diluted

  $ 0.04     $ 0.08     $ 0.13     $ 0.19     $ 0.10     $ 0.12   $ 0.08   $ 0.10   $ 0.24   $ 0.30     $ 0.19  
   


 


 


 


 


 

 

 

 

 


 



(1)   The results for the quarter ended September 30, 2003 includes $11.6 million of in-process research and development expense related to an acquisition.

 

(2)   Stock-based compensation, consisting of amortization of deferred stock-based compensation and the reassessed values of options issued to non-employees for services rendered, is allocated in the table that follows. Stock-based compensation in any quarter is affected by the number of grants in the current and prior quarters, and the difference between the values of the underlying stock determined by the board of directors on the date of grant and the reassessed values used for financial accounting purposes for stock options granted prior to the date of our initial public offering. After the initial public offering, options have been granted at exercise prices equal to the fair market value of the underlying stock on the date of grant. The use of the accelerated basis of amortization results in significantly greater stock-based compensation in the first year of vesting compared to subsequent years.

 

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    Quarter Ended

    Mar 31,
2002


  Jun 30,
2002


  Sep 30,
2002


  Dec 31,
2002


  Mar 31,
2003


  Jun 30,
2003


  Sep 30,
2003


  Dec 31,
2003


  Mar 31,
2004


  Jun 30,
2004


 

Sep 30,

2004


    (in thousands)
    (unaudited)

Cost of revenues

  $ 146   $ 158   $ 343   $ 418   $ 1,452   $ 1,361   $ 3,008   $ 2,736   $ 5,076   $ 2,546   $ 1,996

Research and development

    1,242     1,415     2,802     3,287     19,423     18,814     43,878     56,262     46,265     45,836     42,120

Sales and marketing

    473     827     1,528     2,106     7,618     7,093     15,819     14,077     14,146     13,431     11,580

General and administrative

    1,913     1,335     1,509     2,133     7,925     6,897     11,089     11,909     10,986     12,948     12,285
   

 

 

 

 

 

 

 

 

 

 

    $   3,774   $   3,735   $   6,182   $   7,944   $   36,418   $   34,165   $   73,794   $   84,984   $   76,473   $   74,761   $ 67,981
   

 

 

 

 

 

 

 

 

 

 

 

The following table presents our unaudited quarterly results of operations as a percentage of revenues for the eleven quarters ended September 30, 2004.

 

    Quarter Ended

 
    Mar 31,
2002


    Jun 30,
2002


    Sep 30,
2002


    Dec 31,
2002


    Mar 31,
2003


    Jun 30,
2003


    Sep 30,
2003


    Dec 31,
2003


    Mar 31,
2004


    Jun 30,
2004


    Sep 30,
2004


 

As Percentage of Revenues:

                                                                 

Revenues

  100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Costs and expenses:

                                                                 

Cost of revenues

  13.5     26.0     30.3     35.0     35.1     37.7     43.3     49.0     48.4     46.6     44.9  

Research and development(1)

  14.6     8.2     6.9     5.4     5.0     5.6     8.3     5.5     5.4     6.5     7.1  

Sales and marketing

  17.2     14.2     9.0     7.3     7.2     8.0     9.3     8.0     7.4     8.1     8.1  

General and administrative

  9.8     7.2     5.6     3.8     4.0     4.0     3.5     4.0     3.3     3.7     5.1  

Stock-based compensation(2)

  8.9     4.8     4.7     4.2     14.6     11.0     18.7     16.6     11.7     10.7     8.5  

Non-recurring portion of settlement of disputes with Yahoo

                                          24.9  
   

 

 

 

 

 

 

 

 

 

 

Total costs and expenses

  64.0     60.4     56.5     55.7     65.9     66.3     83.1     83.1     76.2     75.6     98.6  
   

 

 

 

 

 

 

 

 

 

 

Income from operations

  36.0     39.6     43.5     44.3     34.1     33.7     16.9     16.9     23.8     24.4     1.4  

Interest income, expense and other, net

  (1.2 )   (0.4 )   (0.5 )   (0.0 )   (0.0 )   0.2     0.1     0.6     0.1     (0.2 )   0.5  
   

 

 

 

 

 

 

 

 

 

 

Income before income taxes

  34.8     39.2     43.0     44.3     34.1     33.9     17.0     17.5     23.9     24.2     1.9  
   

 

 

 

 

 

 

 

 

 

 

Net income

  18.7 %   21.1 %   23.2 %   23.9 %   10.4 %   10.3 %   5.2 %   5.3 %   9.8 %   11.3 %   6.5 %
   

 

 

 

 

 

 

 

 

 

 


(1)   The results for the quarter ended September 30, 2003 includes $11.6 million of in-process research and development expense related to an acquisition.

 

(2)   Stock-based compensation, consisting of amortization of deferred stock-based compensation and the reassessed values of options issued to non-employees for services rendered, is allocated in the table that follows. Stock-based compensation in any quarter is affected by the number of grants in the current and prior quarters, and the difference between the values of the underlying stocks determined by the board of directors on the date of grant and the reassessed values used for financial accounting purposes for stock options granted prior to the date of our initial public offering. After the initial public offering, options have been granted at exercise prices equal to the fair market value of the underlying stock on the date of the grant. The use of the accelerated basis of amortization results in significantly greater stock-based compensation in the first year of vesting compared to subsequent years.

 

    Quarter Ended

 
    Mar 31,
2002


    Jun 30,
2002


    Sep 30,
2002


    Dec 31,
2002


    Mar 31,
2003


    Jun 30,
2003


    Sep 30,
2003


    Dec 31,
2003


    Mar 31,
2004


    Jun 30,
2004


    Sep 30,
2004


 

Cost of revenues

  0.4 %   0.2 %   0.3 %   0.2 %   0.6 %   0.4 %   0.8 %   0.5 %   0.8 %   0.4 %   0.3 %

Research and development

  2.9     1.8     2.1     1.8     7.8     6.1     11.1     11.0     7.1     6.5     5.2  

Sales and marketing

  1.1     1.1     1.2     1.1     3.0     2.3     4.0     2.8     2.1     1.9     1.5  

General and administrative

  4.5     1.7     1.1     1.1     3.2     2.2     2.8     2.3     1.7     1.9     1.5  
   

 

 

 

 

 

 

 

 

 

 

    8.9 %   4.8 %   4.7 %   4.2 %   14.6 %   11.0 %   18.7 %   16.6 %   11.7 %   10.7 %   8.5 %
   

 

 

 

 

 

 

 

 

 

 

 

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Liquidity and Capital Resources

 

In summary, our cash flows were:

 

     Year Ended December 31,

   

Nine Months Ended

September 30,


 
     2001

    2002

    2003

    2003

    2004

 
     (in thousands)  
                       (unaudited)  

Net cash provided by operating activities

   $ 31,089     $ 155,265     $ 395,445     $ 308,902     $ 608,947  

Net cash used in investing activities

     (29,091 )     (109,717 )     (313,954 )     (135,348 )     (1,604,722 )

Net cash provided by (used in) financing activities

     (2,439 )     (5,473 )     8,090       4,214       1,194,328  

 

Since inception, we have financed our operations primarily through internally generated funds, private sales of preferred stock totaling $37.6 million and the use of our lines of credit with several financial institutions. At June 30, 2004, we had $548.7 million of cash, cash equivalents and short-term investments, compared to $334.7 million, $146.3 million and $33.6 million at December 31, 2003, 2002 and 2001, respectively. Cash equivalents and short-term investments are comprised of highly liquid debt instruments of the U.S. government and its agencies and municipalities. Note 2 of Notes to Consolidated Financial Statements included as part of this offering circular describes further the composition of our short-term investments.

 

Since inception and through the completion of our initial public offering, we financed our operations primarily through internally generated funds, private sales of preferred stock and stock warrants totaling $59.5 million and the use of our lines of credit with several financial institutions. As a result of the completion of our initial public offering in August 2004, we raised $1,161.4 million of net proceeds. At September 30, 2004, we had $1,858.4 million of cash, cash equivalents and short-term investments. Cash equivalents and short-term investments are comprised of highly liquid debt instruments of the U.S. corporations, municipalities and the U.S. government and its agencies. Note 2 of Notes to Consolidated Financial Statements included as part of this offering circular describes further the composition of our short-term investments.

 

Our principal sources of liquidity are our cash, cash equivalents and short-term investments, as well as the cash flow that we generate from our operations. At September 30, 2004 and December 31, 2003, we had unused letters of credit for approximately $14.9 million and $12.2 million. We believe that our existing cash, cash equivalents, short-term investments and cash generated from operations will be sufficient to satisfy our currently anticipated cash requirements through at least the next 12 months. Our liquidity could be negatively affected by a decrease in demand for our products and services. In addition, we may make acquisitions or license products and technologies complementary to our business and may need to raise additional capital through future debt or equity financing to the extent necessary to fund any such acquisitions and licensing activities. Additional financing may not be available at all or on terms favorable to us.

 

Cash provided by operating activities primarily consisted of net income adjusted for certain non-cash items including depreciation, amortization, stock-based compensation, tax benefits from exercise of warrants, the non-recurring portion of our settlement of disputes with Yahoo and the effect of changes in working capital and other activities. Cash provided by operating activities in the nine months ended September 30, 2004 was $608.9 million and consisted of net income of $195.0 million, adjustments for non-cash items of $662.1 million and offset by $248.2 million used in working capital and other activities. Adjustments for non-cash items primarily included $219.2 million of stock-based compensation, $145.0 million of tax benefits from exercise of warrants, which resulted in a decrease to our income tax obligation, and $201.0 million related to the non-recurring portion of the settlement of disputes with Yahoo. Working capital activities primarily consisted of a net increase in income taxes receivable and deferred income taxes of $182.4 million primarily due to the exercises of warrants and a tax benefit related to certain stock-based compensation charges recognized prior to the initial public offering. In addition, working capital activities consisted of an increase of $78.4 million in accounts receivable due to the growth in fees billed to our advertisers.

 

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Cash provided by operating activities in the nine months ended September 30, 2003 was $308.9 million and consisted of net income of $78.4 million, adjustments for non-cash items of $193.2 million and $37.3 million provided by working capital and other activities. Adjustments for non-cash items primarily included $144.4 million of stock-based compensation. Working capital and other activities primarily consisted of an increase of $35.2 million in accounts payable and an increase of $58.0 million in accrued revenue share due to the growth in our AdSense programs and the timing of payments made to our Google Network members, partially offset by an increase of $54.5 million in accounts receivable due to the growth in fees billed our advertisers.

 

Cash provided by operating activities in 2003 was $395.4 million and consisted of net income of $105.6 million, adjustments for non-cash items of $296.0 million and $6.2 million used by working capital and other activities. Working capital and other activities primarily consisted of an increase of $90.4 million in accounts receivable due to the growth in fees billed our advertisers and an increase of $58.9 million in prepaid revenue share, expenses and other assets, due primarily to an increase of $35.5 million related to prepaid revenue share, as a result of several significant prepayments made in the fourth quarter of 2003, as well as an increase of $11.0 million of restricted cash relating to our operating leases. This was partially offset by an increase of $74.6 million in accrued revenue share due to the growth in our AdSense programs and the timing of payments made to our Google Network members and an increase of $31.1 million in accrued expenses and other liabilities primarily due to an increase in annual bonuses as a result of the growth in the number of employees. These bonuses were paid in the first quarter of 2004.

 

Cash provided by operating activities in 2002 was $155.3 million and consisted of net income of $99.7 million, adjustments for non-cash items of $50.6 million and $5.0 million provided by working capital and other activities. Cash provided by operating activities in 2001 was $31.1 million and consisted of net income of $7.0 million, adjustments for non-cash items of $26.6 million and $2.5 million used by working capital and other activities.

 

As warrants to purchase an additional 487,184 shares of our stock, and as certain options to purchase additional shares of Class A and Class B common stock are exercised as anticipated over the current and future years, we expect to realize additional reductions in our tax liabilities. The reduction in our tax liability is computed based on the applicable statutory rates and the difference between the value of our stock on the date of exercise or issuance, as determined by the market, and the price paid for those shares.

 

Also, as we expand our business internationally, we may offer payment terms to certain advertisers that are standard in their locales, but longer than terms we would generally offer to our domestic advertisers. This may increase our working capital requirements and may have a negative effect on cash flow provided by our operating activities. In addition, we expect that, now that we have become a public company, our cash-based compensation per employee will likely increase (in the form of variable bonus awards and other incentive arrangements) in order to retain and attract employees.

 

Cash used in investing activities in the nine months ended September 30, 2004 of $1,604.7 million was attributable to net purchases of short-term investments of $1,329.0 million, capital expenditures of $259.9 million and cash consideration used in acquisitions and other investments of $15.8 million. Cash used in investing activities in the nine months ended September 30, 2003 of $135.3 million was attributable to capital expenditures of $120.3 million, cash consideration used in acquisitions of $40.0 million, partially offset by net maturities of short-term investments of $24.9 million. Cash used in investing activities in 2003 of $314.0 million was attributable to capital expenditures of $176.8 million, net purchases of short-term investments of $97.2 million and net cash consideration used in acquisitions of $40.0 million. Cash used in investing activities in 2002 of $109.7 million was primarily attributable to net purchases of short-term investments of $72.6 million and capital expenditures of $37.2 million. Cash used in investing activities in 2001 of $29.1 million was primarily attributable to net purchases of short-term investments of $14.9 million and capital expenditures of $13.1 million.

 

Capital expenditures are mainly for the purchase of information technology assets. In order to manage expected increases in Internet traffic, advertising transactions and new products and services, and to support our overall global business expansion, we will continue to invest heavily in data center operations, technology,

 

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corporate facilities and information technology infrastructure. We expect to spend over $300 million on capital equipment, including information technology infrastructure comprised primarily of production servers and network equipment, to manage our operations during 2004.

 

Cash provided by financing activities in the nine months ended September 30, 2004 of $1,194.3 million was due primarily to net proceeds from the initial public offering of $1,161.4 million. Costs related to our initial public offering were approximately $40.6 million. Cash provided by financing activities in the nine months ended September 30, 2003 of $4.2 million was due to proceeds from the issuance of common stock pursuant to stock option exercises of $10.6 million, net of repurchases, offset by repayment of equipment loans and capital lease obligations of $6.4 million. Cash provided by financing activities in 2003 of $8.1 million was due to proceeds from the issuance of common stock pursuant to stock option exercises of $15.5 million, net of repurchases, offset by repayment of equipment loan and lease obligations of $7.4 million. Cash used in financing activities in 2002 of $5.5 million was due to repayment of equipment loan and capital lease obligations of $7.7 million, partially offset by proceeds from the issuance of common stock pursuant to stock option exercises of $2.3 million, net of repurchases. Cash used in financing activities in 2001 of $2.4 million was primarily due to repayment of equipment loan and capital lease obligations of $4.5 million partially offset by proceeds from the issuance of convertible preferred stock of $1.0 million and the issuance of common stock pursuant to stock option exercises of $1.0 million, net of repurchases.

 

Contractual Obligations

 

Contractual obligations at December 31, 2003 are as follows:

 

     Payments due by period

     Total

   Less than
12 months


   13-48
months


   49-60
months


   More than
60 months


     (in millions)
     (unaudited)

Guaranteed minimum revenue share payments

   $ 477.0    $ 205.1    $ 271.9    $    $

Capital lease obligations

     7.4      5.3      2.1          

Operating lease obligations

     146.7      7.4      50.9      18.8      69.6

Purchase obligations

     11.9      8.8      3.1          

Other long-term liabilities reflected on our balance sheet under GAAP

     1.5           0.2      0.2      1.1
    

  

  

  

  

Total contractual obligations

   $ 644.5    $ 226.6    $ 328.2    $ 19.0    $ 70.7
    

  

  

  

  

 

Guaranteed Minimum Revenue Share Payments

 

In connection with our AdSense revenue share agreements, we are periodically required to make non-cancelable guaranteed minimum revenue share payments to a small number of our Google Network members over the term of the respective contracts. Under our contracts, these guaranteed payments can vary based on our Google Network members achieving defined performance terms, such as number of advertisements displayed or search queries. In some cases, certain guaranteed amounts will be adjusted downward if our Google Network members do not meet their performance terms and, in some cases, these amounts will be adjusted upward if they exceed their performance terms. Upward adjustments are capped at total advertiser fees generated under an AdSense agreement during the guarantee period. The amounts included in the table above assume that the historical upward performance adjustments with respect to each contract will continue, but do not make a similar assumption with respect to downward adjustments. We believe these amounts best represent a reasonable estimate of the future minimum guaranteed payments. Actual guaranteed payments may differ from the estimates presented above. To date, total advertiser fees generated under these AdSense agreements have exceeded the total guaranteed minimum revenue share payments. Five of our Google Network members account for approximately 70% of the total future guaranteed minimum revenue share payments and 10 of our Google Network members account for 91% of these payments. In 2003, we made $108.8 million of non-cancellable minimum guaranteed revenue payments. At October 31, 2004, our aggregate outstanding non-cancellable minimum guarantee commitments totaled $461.0 million and these commitments are expected to be settled through 2007.

 

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In addition, in connection with some other AdSense agreements, we have agreed to make an aggregate of $51.9 million of minimum revenue share payments through 2006. This amount is not included in the above table since we generally have the right to cancel these agreements at any time. Because we sometimes cancel agreements that perform poorly, we do not expect to make all of these minimum revenue share payments. At September 30, 2004, this amount had decreased to $8.9 million.

 

Capital Lease Obligations

 

At December 31, 2003, we had capital lease obligations of $7.4 million (comprised of $6.6 million of principal and $800,000 of interest) related to several of our equipment leases. These amounts will come due under the terms of the arrangements at various dates through October 2005.

 

Operating Leases

 

During 2003, we entered into a nine-year sublease for our headquarters in Mountain View, California. According to the terms of the sublease, we will begin making payments in July 2005 and payments will increase at 3% per annum thereafter. We recognize rent expense on our operating leases on a straight-line basis as of the commencement of the lease. The lease terminates on December 31, 2012; however, we may exercise two five- year renewal options at our discretion. We have an option to purchase the property for approximately $172.4 million, which is exercisable in 2006.

 

In addition, we have entered into various other non-cancelable operating lease agreements for our offices and certain of our data centers throughout the U.S. and internationally with original lease periods expiring between 2004 and 2015. We recognize rent expense on our operating leases on a straight-line basis at the commencement of the lease. Certain of these leases have free or escalating rent payment provisions. We recognize rent expense under such leases on a straight-line basis. Total payments relating to leases having an initial or remaining non-cancelable term of less than one year are $2.3 million and are not included in the table above.

 

Purchase Obligations

 

Purchase obligations in the above table represent non-cancelable contractual obligations at December 31, 2003. In addition, we had $24.9 million of open purchase orders for which we have not received the related services or goods at December 31, 2003. This amount is not included in the above table since we have the right to cancel the purchase orders upon 10 days notice prior to the date of delivery. The majority of our purchase obligations are related to data center operations.

 

Acquisition of Applied Semantics

 

In April 2003, we acquired all of the outstanding capital stock of Applied Semantics, Inc., a privately held provider of content-targeted advertising programs. The total purchase price consisted of a cash payment of $41.5 million and 2,382,800 shares of, and options to purchase, Class A common stock. The transaction was accounted for as a business combination. For additional information, see Note 4 of Notes to Consolidated Financial Statements included as part of this offering circular.

 

Off-Balance Sheet Entities

 

At December 31, 2003 and 2002, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

 

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Critical Accounting Policies and Estimates

 

We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the U.S. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues and expenses, as well as related disclosure of contingent assets and liabilities. In many cases, we could reasonably have used different accounting policies and estimates. In some cases changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. Our management has reviewed our critical accounting policies and estimates with our board of directors.

 

Stock-Based Compensation

 

Accounting for Stock-Based Awards to Employees

 

Prior to the initial public offering, we typically granted stock options at exercise prices equal to or less than the value of the underlying stock as determined by our board of directors on the date of option grant. For purposes of financial accounting, we have applied hindsight within each year or quarter to arrive at reassessed values for the shares underlying these options. After the initial public offering, we have granted options at exercise prices equal to the fair market value of the underlying stock on the date of option grant. There are two measures of value of our common stock that were relevant to our accounting for equity compensation relating to our compensatory equity grants prior to our initial public offering:

 

    The “board-determined value” is the per share value of our common stock determined by our board of directors at the time the board made an equity grant, taking into account a variety of factors, including our historical and projected financial results, comparisons of comparable companies, risks facing us, as well as the liquidity of the common stock.

 

    The “reassessed value” is the per share value of our common stock determined by us in hindsight solely for the purpose of financial accounting for employee stock-based compensation.

 

We recorded deferred stock-based compensation to the extent that the reassessed value of the stock at the date of grant exceeded the exercise price of the option. The reassessed values for accounting purposes were determined based on a number of factors and methodologies. One of the significant methods we used to determine the reassessed values for the shares underlying options is through a comparison of price multiples of our historical and forecasted earnings to certain public companies involved in the same or similar lines of business. The market capitalizations of these companies increased significantly from January 2003 through July 2004 which contributed significantly to the increase in the reassessed values of our shares. We also considered our financial performance and growth, primarily since January 2003. Our revenue and earnings growth rates contributed significantly to the increase in the reassessed values of our shares. The reassessed values of our shares increased more significantly in dollar and percentage terms in earlier periods compared to later ones which are reflective of the related revenue and earnings growth rates. We also retained third party advisors to provide two contemporaneous valuation analyses since January 2003 and used this information to support our own valuation analyses. Please note that these reassessed values are inherently uncertain and highly subjective. If we had made different assumptions, our deferred stock-based compensation amount, stock-based compensation expense, in-process research and development expense, net income, net income per share and recorded goodwill amounts could have been significantly different.

 

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The table below shows the computation of deferred stock-based compensation amounts arising from restricted shares and unvested stock options granted to employees for each of the three month periods set forth below:

 

    Three Months Ended

 

2003 Total


  Three Months Ended

  March 31,
2003


 

June 30,

2003


  September 30,
2003


  December 31,
2003


    March 31,
2004


 

June 30,

2004


  September 30,
2004


    (unaudited)   (unaudited)   (unaudited)   (unaudited)       (unaudited)   (unaudited)   (unaudited)

Options granted to employees

    10,262,100     1,431,552     5,785,185     1,281,895     18,760,732     1,004,780     965,520     635,371

Weighted average exercise price

  $ 0.49   $ 3.30   $ 5.17   $ 9.62         $ 16.27   $ 38.43   $ 77.86

Weighted average reassessed or fair market value of underlying stock

  $ 13.09   $ 33.99   $ 52.33   $ 75.05         $ 88.13   $ 97.03   $ 85.00

Weighted average reassessed deferred stock-based compensation per option

  $ 12.60   $ 30.69   $ 47.16   $ 65.43         $ 71.86   $ 58.60   $ 7.14

Deferred stock-based compensation related to options (in millions)

  $ 129.3   $ 43.9   $ 272.8   $ 83.9   $ 529.9   $ 72.2   $ 56.6   $ 4.5

Restricted shares granted to employees

          120,000     114,999           234,999           16,175     —  

Weighted average reassessed value of restricted shares

        $ 25.96   $ 66.41                     $ 95.09     —  

Deferred stock-based compensation related to restricted shares (in millions)

        $ 3.1   $ 7.6         $ 10.7         $ 1.5     —  

Deferred stock-based compensation related to option modifications (in millions)

                    $ 10.8   $ 10.8   $ 3.9           —  
   

 

 

 

 

 

 

 

Total deferred stock-based compensation (in millions)

  $ 129.3   $ 47.0   $ 280.4   $ 94.7   $ 551.4   $ 76.1   $ 58.1   $ 4.5
   

 

 

 

 

 

 

 

 

The above table does not include options granted at exercise prices equal to the fair market value of the underlying stock at the time of, and subsequent to, the initial public offering. Also, it does not include options granted at exercise prices equal to or in excess of the reassessed values of the underlying stock prior to the initial public offering. These options were granted with no intrinsic value and, accordingly, no deferred stock-based compensation has been recorded.

 

We recognize compensation expense as we amortize the deferred stock-based compensation amounts on an accelerated basis over the related vesting periods. The table below shows employee and non-employee stock-based compensation expense recognized during 2001, 2002, 2003 and through the nine months ended September 30, 2004. In addition, the table presents the expected stock-based compensation expense for options granted to employees prior to October 1, 2004, for the last quarter of 2004 and for each of the next four years and

 

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thereafter, assuming no change in the stock option accounting rules and assuming all employees remain employed by us for their remaining vesting periods. These amounts are compared to the expense and expected expense we would have recognized had we amortized deferred stock-based compensation on a straight-line basis.

 

   

Stock-based compensation expense

Year Ended December 31,


    2001

  2002

  2003

  2004

  2005

  2006

  2007

  2008

  thereafter

    (in millions)

Accelerated basis

  $ 12.4   $ 21.6   $ 229.4   $ 273.8   $ 139.2   $ 67.5   $ 24.4   $ 5.3   $ 1.7

Straight-line basis

  $ 5.9   $ 13.3   $ 120.5   $ 199.8   $ 171.2   $ 147.2   $ 87.6   $ 25.5   $ 5.8

 

Accounting for Stock-Based Awards to Non-employees

 

We measure the fair value of options to purchase our common stock granted to non-employees throughout the vesting period as they are earned, at which time we recognize a charge to stock-based compensation. The fair value is determined using the Black-Scholes option-pricing model, which considers the exercise price relative to the reassessed value (for periods before the initial public offering) or the fair market value (for periods after the initial public offering) of the underlying stock, the expected stock price volatility, the risk-free interest rate and the dividend yield. As discussed above, the reassessed value of the underlying stock were based on assumptions of matters that are inherently highly uncertain and subjective. As there has been no public market for our stock for most periods presented, and little meaningful empirical public market trading data for the period of time there was a public market for our stock, our assumptions about stock-price volatility are based on the volatility rates of comparable publicly held companies. These rates may or may not reflect our stock-price volatility after we have been a publicly held company for a meaningful period of time. If we had made different assumptions about the reassessed value of our stock or stock-price volatility rates, the related stock-based compensation expense and our net income and net income per share amounts could have been significantly different.

 

Effect of Recent Accounting Pronouncements

 

In November 2002, the EITF reached a consensus on Issue 00-21, Accounting for Multiple Element Revenue Arrangements, addressing how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The guidance in Issue 00-21 is effective for revenue arrangements entered into in fiscal periods after June 15, 2003. The adoption of Issue 00-21 did not have an impact on our financial statements. See the further discussion in Note 1 of Notes to the Consolidated Financial Statements included as part of this offering circular.

 

During November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34 (FIN 45). FIN 45 elaborates on the existing disclosure requirements for a guarantor in its interim and annual financial statements regarding its obligations under guarantees issued. It also clarifies that at the time a guarantee is issued, the guarantor must recognize an initial liability for the fair value of the obligations it assumes under the guarantee and must disclose that information in its financial statements. The initial recognition and measurement provisions apply on a prospective basis to guarantees of third party obligations issued or modified after December 31, 2002, and the disclosure requirements apply to such guarantees outstanding at December 31, 2002. The Company adopted the provisions of FIN 45 at January 1, 2003. The adoption of this Interpretation did not have an impact on our operating results. See further discussion regarding indemnifications in Note 7 to the Notes to the Consolidated Financial Statements included with this offering circular.

 

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In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities. Interpretation No. 46 clarifies the application of Accounting Research Bulletin No. 51. This Interpretation requires variable interest entities to be consolidated if the equity investment at risk is not sufficient to permit an entity to finance its activities without support from other parties or the equity investors lack specified characteristics. We do not have any variable interest entities.

 

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how a company classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify certain financial instruments as a liability (or as an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have an impact on our financial statements.

 

Qualitative and Quantitative Disclosures about Market Risk

 

We are exposed to financial market risks, including changes in currency exchange rates, interest rates and marketable equity security prices.

 

Foreign Exchange Risk

 

Our exposure to foreign currency transaction gains and losses is the result of certain net receivables due from our foreign subsidiaries and customers being denominated in currencies other than the U.S. dollar, primarily the British Pound, the Euro and the Japanese Yen. Our foreign subsidiaries conduct their businesses in local currency. Effective January 2004, we began to bill our international online sales through a foreign subsidiary, which will lower our exposure to foreign currency transaction gains and losses. In addition, effective January 2004 our board of directors approved a foreign exchange hedging program designed to minimize the future potential impact due to changes in foreign currency exchange rates. The program allows for the hedging of transaction exposures. The types of derivatives that can be used under the policy are forward contracts, options and foreign exchange swaps. The primary vehicle we expect to use will be forward contracts. We also generate revenue in certain countries in Asia where there are limited forward currency exchange markets, thus making these exposures difficult to hedge. In the three months ended September 30, 2004, we entered into forward foreign exchange contracts to offset the foreign exchange risk on certain existing intercompany assets. The notional principal of forward exchange contracts to purchase U.S. dollars with Euros was $173.3 million at September 30, 2004. There were no other forward exchange contracts outstanding at September 30, 2004.

 

Our exposure to foreign currency translation gains and losses arises from the translation of net assets of our subsidiaries to U.S. dollars during consolidation. To date, translation gains and losses have not been material.

 

We considered the historical trends in currency exchange rates and determined that it was reasonably possible that adverse changes in exchange rates of 10% for all currencies could be experienced in the near term. These changes would have resulted in an adverse impact on income before taxes of approximately $19.9 million and $4.5 million at September 30, 2004 and December 31, 2003. The adverse impact at September 30, 2004 is after consideration of the offsetting effect of approximately $14.9 million from our outstanding forward exchange contracts. These reasonably possible adverse changes in exchange rates of 10% were applied to total monetary assets denominated in currencies other than the local currencies at the balance sheet dates to compute the adverse impact these changes would have had on our income before taxes in the near term. The increase in the reasonably possible adverse impact of $19.9 million at September 30, 2004 from $4.5 million at December 31, 2003 was primarily the result of an increase in accounts receivable, intercompany receivables and cash held by our Irish subsidiary denominated in foreign currencies, offset by the positive impact from our outstanding forward exchange contracts.

 

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Interest Rate Risk

 

We invest in a variety of securities, consisting primarily of investments in interest-bearing demand deposit accounts with financial institutions, tax-exempt money market funds and highly liquid debt securities of corporations and municipalities. By policy, we limit the amount of credit exposure to any one issuer.

 

Investments in both fixed rate and floating rate interest earning products carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Due in part to these factors, our income from investments may decrease in the future.

 

We considered the historical volatility of short term interest rates and determined that it was reasonably possible that an adverse change of 100 basis points could be experienced in the near term. A hypothetical 1.00% (100 basis-point) increase in interest rates would have resulted in a decrease in the fair values of our investment securities of approximately $14.5 million and $1.9 million at September 30, 2004 and December 31, 2003. The increase in this amount from December 31, 2003 to September 30, 2004 is due to the substantial increase in our investment securities balances as a result of proceeds from our initial public offering completed in August 2004.

 

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BUSINESS

 

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 destination and our brand one of the most recognized in the world. We maintain the world’s largest online index of web sites and other content, and we make this information freely available to anyone with an Internet connection. Our automated search technology helps people obtain nearly instant access to relevant information from our vast online index.

 

We generate revenue by delivering relevant, cost-effective online advertising. Businesses use our AdWords program to promote their products and services with targeted advertising. In addition, the thousands of third-party web sites that comprise our Google Network use our Google AdSense program to deliver relevant ads that generate revenue and enhance the user experience.

 

Our Mission

 

Our mission is to organize the world’s information and make it universally accessible and useful. We believe that the most effective, and ultimately the most profitable, way to accomplish our mission is to put the needs of our users first. We have found that offering a high-quality user experience leads to increased traffic and strong word-of-mouth promotion. Our dedication to putting users first is reflected in three key commitments we have made to our users:

 

    We will do our best to provide the most relevant and useful search results possible, independent of financial incentives. Our search results will be objective and we will not accept payment for inclusion or ranking in them.

 

    We will do our best to provide the most relevant and useful advertising. If any element on a result page is influenced by payment to us, we will make it clear to our users. Advertisements should not be an annoying interruption.

 

    We will never stop working to improve our user experience, our search technology and other important areas of information organization.

 

We believe that our user focus is the foundation of our success to date. We also believe that this focus is critical for the creation of long-term value. We do not intend to compromise our user focus for short-term economic gain.

 

How We Provide Value to Users, Advertisers and Web Sites

 

Our Users

 

We serve our users by developing products that enable people to more quickly and easily find, create and organize information. We place a premium on products that matter to many people and have the potential to improve their lives, especially in areas in which our expertise enables us to excel.

 

Search is one such area. People use search frequently and the results are often of great importance to them. For example, people search for information on medical conditions, purchase decisions, technical questions, long-lost friends and other topics about which they care a great deal. Delivering quality search results requires significant computing power, advanced software and complex processes—areas in which we have expertise and a high level of focus.

 

Communication is another such area. People increasingly rely on the Internet to communicate with each other. Gmail, our new email service (still in test mode), offers a gigabyte of free storage for each user, along with email search capabilities and relevant advertising. Delivering an improved user experience in Gmail has similar computing and software requirements as our search service.

 

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Some of the key benefits we offer to users include:

 

Relevant and Useful Information.    Our technologies sort through a vast and growing amount of information to deliver relevant and useful search results in response to user queries. This is an area of continual development for us. When we started the company five years ago, our web index contained approximately 30 million documents. We now index more than 4 billion web pages, or more than 100 times as much information. We are also constantly developing new functionality. Recent enhancements include personalization, which lets users specify interests to help our technology generate customized search results; and local search, which lets users look for web pages and businesses based on a certain geographic location. We also provide convenient links to specialized information, such as definitions, maps and travel information.

 

Objectivity.    We believe it is very important that the results users get from Google are produced with only their interests in mind. We do not accept money for search result ranking or inclusion. We do accept fees for advertising, but it does not influence how we generate our search results. The advertising is clearly marked and separated. This is similar to a newspaper, where the articles are independent of the advertising. Some of our competitors charge web sites for inclusion in their indices or for more frequent updating of pages. Inclusion and frequent updating in our index are open to all sites free of charge. We apply these principles to each of our products and services. We believe it is important for users to have access to the best available information and research, not just the information that someone pays for them to see.

 

Global Access.    We strive to provide Google to everyone in the world. Users from around the world visit our destination sites at Google.com and our 103 other international domains, such as Google.de, Google.fr, Google.co.uk, Google.co.jp and Google.ca. The Google interface is available in more than 100 languages. Through Google News, we offer an automated collection of frequently updated news stories tailored to 10 international audiences. We also offer automatic translation of content between various languages. We provide localized versions of Google in many developing countries. Although we do not currently recover our costs in these countries, we believe providing our products and services is an important social good and a valuable long-term business investment.

 

Ease of Use.    We have always believed that the most useful and powerful search technology hides its complexity from users and provides them with a simple, intuitive way to get the information they want. We have devoted significant efforts to create a streamlined and easy-to-use interface based on a clean search box set prominently on a page free of commercial clutter. We have also created many features that enhance the user experience. Our products present these features when we believe they will be most useful, rather than promoting them unnecessarily. For example, Google WebSearch offers maps when a search appears to be for a geographic location.

 

Pertinent, Useful Commercial Information.    The search for information online often involves an interest in commercial information—researching a purchase, comparing products and services or actively shopping. We help people find commercial information through our search services and by presenting ads that are relevant to the information people seek. To ensure we display only the most relevant commercial information, our technology automatically rewards ads that users prefer and removes ads that users do not find helpful. For example, among our search services, we offer Froogle, a search engine for finding products for sale online.

 

Our Advertisers

 

As more people spend additional time and money online, advertisers are increasingly turning to the Internet to market their products and services to consumers. For these advertisers, we offer Google AdWords, an auction-based advertising program that enables them to deliver relevant ads targeted to search results or web content. Our AdWords program provides advertisers with a cost-effective way to deliver ads to customers across Google sites and through the Google Network. The advertisers using AdWords range from small businesses targeting local customers to many of the world’s largest global enterprises.

 

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The AdWords program offers advertisers the following benefits:

 

Effective Return on Investment.    Many advertising dollars are wasted because they are spent delivering messages that are ignored or that reach too broad an audience. With Google AdWords, businesses can achieve greater cost-effectiveness with their marketing budgets for two reasons—AdWords shows ads only to people seeking information related to what the advertisers are selling, and advertisers pay us only when a user clicks on one of their ads. Because we offer a simple ad format, advertisers can avoid incurring significant design, copywriting or other production costs associated with creating ads. As a result, even small advertisers find AdWords cost-effective for connecting with potential customers. In addition, advertisers can easily create many different ads, increasing the likelihood that an ad is exactly suited to a user’s search. Users can find advertisements for exactly what they are seeking, and advertisers can find users who want exactly what they are offering. When the interests of users and advertisers align, both are well served.

 

Access to the Google Network.    We serve AdWords ads to the thousands of third-party web sites that make up the Google Network. As a result, advertisers that use our AdWords program can target users on our sites and on search and content sites across the web. This gives advertisers increased exposure to people who are likely to be interested in their offerings. The Google Network significantly enhances our ability to attract interested users.

 

Precise Campaign Control.    Google AdWords gives advertisers hands-on control over most elements of their ad campaigns. Advertisers can specify the relevant search or content topics for each of their ads. Advertisers can also manage expenditures by setting a maximum daily budget and determining how much they are willing to pay whenever a user clicks on an ad. Our online tracking tools and reports give advertisers timely updates on how well their campaigns are performing and enable them to make changes or refinements quickly. Advertisers can also target their campaigns by neighborhood, city, country, region or language.

 

Global Support.    We provide customer service to our advertiser base through our global support organization as well as through field sales offices in 12 countries. AdWords is available on a self-service basis with email support. Advertisers with more extensive needs and budgets can request strategic support services, which include an account team of experienced professionals to help them set up, manage and optimize their campaigns.

 

Web Sites

 

Nearly every web site in the world is indexed and made searchable by Google. Our users do searches and are directed to relevant web sites. Google provides a significant amount of traffic to web sites with which we have no business relationship. Many web sites are able to generate revenue from that traffic, but others have difficulty doing so. We are enthusiastic about helping sites make money and thereby facilitating the creation of better content to search. If there is better content on the web, people are likely to do more searches, and we expect that will be good for our business and for users. To address this opportunity, we created Google AdSense. Our Google AdSense program enables the web sites—large and small—that make up the Google Network to deliver AdWords ads that are relevant to the search results or content on their pages. We share most of the revenue generated from ads shown by a member of the Google Network with that member—creating an additional revenue stream for them. Web sites can also license our Google WebSearch product to offer the Google search experience to their users. The key benefits we offer to web sites in the Google Network include:

 

Access to Advertisers.    Many small web site companies do not have the time or resources to develop effective programs for generating revenue from online advertising. Even larger sites, with dedicated sales teams, may find it difficult to generate revenue from pages with specialized content. We believe that Google AdSense enables Google Network members to generate revenue from their sites more effectively and efficiently. Google AdSense promotes effective revenue generation by providing Google Network members immediate access to Google’s base of advertisers and their broad collection of ads. As soon as a web site joins the Google Network, our technology automatically begins delivering ads for posting on the member’s web site. The automated nature of our advertising programs promotes efficient revenue generation. Our online registration systems enable web

 

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sites to easily join the Google Network and our ad serving technology allows automated delivery of ads for posting on the member’s site. The Google Network member determines the placement of the ads on its web site and controls and directs the nature of ad content.

 

Improved User Satisfaction.    In their quest for revenue, many Internet companies have cluttered their web sites with intrusive or untargeted advertising that may distract or confuse users and may undermine users’ ability to find the information they want. Some web sites have adopted practices we consider to be abusive, including pop-up ads or ads that take over web pages. We believe these tactics can cause dissatisfaction with Internet advertising and reduce use of the Internet overall. Our AdSense program extends our commitment to improving the overall web experience for users by enabling web sites to display AdWords ads in a fashion that we believe people find useful rather than disruptive.

 

Products and Services

 

Our product development philosophy is centered on rapid and continuous innovation, with frequent releases of test products that we seek to improve with every iteration. We often make products available early in their development stages by posting them on Google Labs, at test locations online or directly on Google.com. If our users find a product useful, we promote it to “beta” status for additional testing. Our beta testing periods often last a year or more. Once we are satisfied that a product is of high quality and utility, we remove the beta label and make it a core Google product. Our current principal products and services are described below.

 

Google.com

 

We are focused on building products and services that benefit our users and enable them to find relevant information quickly and easily. We offer, free of charge, all of the following services at Google.com and many of them at our international sites.

 

Google WebSearch.    In addition to providing easy access to more than 4 billion web pages, we have integrated special features into Google WebSearch to help people find exactly what they are looking for on the web. The Google.com search experience also includes:

 

    Advanced Search Functionality—enables users to construct more complex queries, for example by using Boolean logic or restricting results to languages, countries or web sites.

 

    Spell Checker—suggests alternate search terms when a search appears to contain misspellings or typing errors.

 

    Web Page Translation—automatically translates web pages published in French, German, Italian, Portuguese and Spanish into English, or vice versa.

 

    Stock Quotes—provides links to stock and mutual fund information.

 

    Street Maps—provides links to street maps and directions.

 

    Calculator—solves math problems involving basic arithmetic, complicated math or physical constants and converts between units of measure.

 

    Definitions—provides definitions for words or phrases based on content we have indexed.

 

    PhoneBook—provides U.S. street addresses and phone numbers for U.S. businesses and residences.

 

    Search by Number—enables people to conduct quick searches by entering FedEx, UPS and USPS package tracking numbers, vehicle ID numbers, product codes, telephone area codes, patent numbers, FAA airplane registration numbers and FCC equipment ID numbers.

 

    Travel Information—enables people to check the status of U.S. airline flights and see delays and weather conditions at U.S. airports.

 

    Cached Links—provides snapshots of web pages taken when the pages were indexed, enabling web users to view web pages that are no longer available.

 

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Google Image Search.    Google Image Search is our searchable index of more than 880 million images found across the web. To extend the usefulness of Google Image Search, we offer advanced features, such as searching by image size, format and coloration and restricting searches to specific web sites or domains.

 

Google News.    Google News gathers information from nearly 10,000 news sources worldwide and presents news stories in a searchable format within minutes of their publication on the web. The leading stories are presented as headlines on the Google News home page. These headlines are selected for display entirely by a computer algorithm, without regard to political viewpoint or ideology. Google News uses an automated process to pull together related headlines, which enables people to see many different viewpoints on the same story. Because topics are updated continuously throughout the day, people generally see new stories each time they check Google News. We currently provide our Google News service tailored to 15 international audiences.

 

Google Toolbar.    The Google Toolbar makes our search technology constantly and easily available as people browse the web. The Google Toolbar is available as a free, fast download and can improve people’s web experience through several innovative features, including:

 

LOGO

 

    Pop-up Blocker—blocks pop-up advertising while people use the web.

 

    PageRank Indicator—displays Google’s ranking of any page on the web.

 

    AutoFill—completes web forms with information saved securely on a user’s own computer.

 

    Highlight—highlights search terms where they appear on a web page, with each term marked in a different color.

 

    Word Find—finds search terms wherever they appear on a web page.

 

Froogle.    Froogle enables people to easily find products for sale online. By focusing entirely on product search, Froogle applies the power of our search technology to a very specific task—locating stores that sell the items users seek and pointing them directly to the web sites where they can shop. Froogle users can sort results by price, specify a desired price range and view product photos. Froogle accepts data feeds directly from merchants to ensure that product information is up-to-date and accurate. Most online merchants are also automatically included in Froogle’s index of shopping sites. Because we do not charge merchants for inclusion in Froogle, our users can browse product categories or conduct product searches with confidence that the results we provide are relevant and unbiased. As with many of our products, Froogle displays relevant advertising separately from search results.

 

Google Groups.    Google Groups enables easy participation in Internet discussion groups by providing users with tools to search, read and browse these groups and to post messages of their own. Google Groups contains the entire archive of Usenet Internet discussion groups dating back to 1981—more than 845 million posted messages. The discussions in these groups cover a broad range of discourse and provide a comprehensive look at evolving viewpoints, debate and advice on many subjects.

 

Google Wireless.    Google Wireless offers people the ability to search and view both the “mobile web,” consisting of more than 7 million pages created specifically for wireless devices, and the entire Google index of

 

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more than 4 billion web pages. Google Wireless works on devices that support WAP, WAP 2.0, i-mode or j-sky mobile Internet protocols. Google Wireless is available through many wireless and mobile phone services worldwide.

 

Google Web Directory.    Google Web Directory enables people to browse and search through web sites that have been organized into categories. Our directory combines Google’s search technology with the categorization developed by the Open Directory Project and is available in 75 languages.

 

Google Local.    Google Local enables users to find relevant local information based on zip codes, cities or specific addresses. Google Local results include neighborhood business listings, addresses, phone numbers, maps and directions.

 

Google Answers.    Google Answers provides people with help finding information and answering questions. Users set a fee they are willing to pay and submit questions to the Google Answers service. One of more than 500 carefully screened freelance researchers responds, usually within 24 hours. Google Answers researchers are experienced web searchers with strong communication skills who often have expertise in various fields. An extensive collection of past responses is available to our users free of charge.

 

Google Catalogs.    With Google Catalogs, we provide access to the full content of more than 6,600 mail-order catalogs, many of which were previously unavailable online.

 

Google Print.    Google Print brings information online that had previously not been available to web searchers. Under this program, we have been experimenting with a number of publishers to host their content and rank their publications in our search results using the same technology we use to evaluate web sites. On Google Print pages, we provide links to book sellers that may offer the full versions of these publications for sale, and we show content-targeted ads that are served through the Google AdSense program.

 

Google Desktop Search.    Google Desktop Search enables our users to perform a full text search on the contents of their own computer, including email, files, instant messenger chats and web browser history. Users can use this service to view web pages they have visited even when they are not online.

 

Google Alerts.    Google Alerts are email updates of the latest relevant Google results (web, news, etc.) based on the user’s choice of query or topic. Typical uses include monitoring a developing news story, keeping current on a competitor or industry, getting the latest on a celebrity or event, or keeping tabs on a favorite sports team.

 

Google Labs.    Google Labs is our playground for our engineers and for adventurous Google users. On Google Labs, we post product prototypes and solicit feedback on how the technology could be used or improved. Current Google Labs examples include:

 

    Google Personalized Search—provides customized search results based on an individual user’s interests.

 

    Google Deskbar—enables people to search with Google from the taskbar of their computer without launching a web browser.

 

    Voice Search—enables people to dial a phone number, tell our system what they are looking for and hear Google search results read to them by a computer.

 

    Froogle Wireless—gives people the ability to search for product information from their mobile phones and other wireless devices.

 

Blogger.    Blogger is a leading web-based publishing tool that gives people the ability to publish to the web instantly using weblogs, or “blogs.” Blogs are web pages usually made up of short, informal, frequently updated posts that are arranged chronologically. Blogs can facilitate communications among small groups or to a worldwide audience in a way that is simpler and easier to follow than traditional email or discussion forums.

 

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Picasa.    We recently acquired Picasa, Inc., a digital photo management company. Picasa enables users to manage and share digital photographs and helps support our mission of making information universally accessible and useful.

 

Limited Availability Services.    Some of our product offerings are in their initial test phases and are currently available to limited audiences. Examples include Gmail, our free email service, and Orkut, an invitation-based online meeting place where people can socialize, make new acquaintances and find others who share their interests.

 

Google AdWords

 

Google AdWords is our global advertising program, which enables advertisers to present ads to people at the precise moment those people are looking for information related to what the advertiser has to offer. Advertisers use our automated tools, often with little or no assistance from us, to create text-based ads, bid on the keywords that will trigger the display of their ads and set daily spending budgets. AdWords features an automated, low-cost online signup process that enables advertisers to implement ad campaigns that can become live in 15 minutes or less. The total sign-up cost for becoming an AdWords advertiser is only $5.00.

 

Ads are ranked for display in AdWords based on a combination of the maximum cost per click (CPC) set by the advertiser and click-through rates and other factors used to determine the relevance of the ads. This favors the ads that are most relevant to users, improving the experience for both the person looking for information and the advertiser looking for interested customers. AdWords has many features that make it easy to set up and manage ad campaigns for maximum efficiency and effectiveness:

 

    Campaign management.    Advertisers can target multiple ads to a given keyword and easily track individual ad performance to see which ads are the most effective. The campaign management tools built into AdWords enable advertisers to quickly shift their budgets to ads that deliver the best results.

 

    Keyword targeting.    Businesses can deliver targeted ads based on specific search terms (keywords) entered by users or found in the content on a web page. We also offer tools that suggest synonyms and useful phrases to use as keywords or ad text. These suggestions can improve ad click-through rates and the likelihood of a user becoming a customer of the advertiser.

 

    Traffic estimator.    This tool estimates the number of searches and potential costs related to advertising on a particular keyword or set of keywords. These estimates can help advertisers optimize their campaigns.

 

    Budgeted delivery.    Advertisers can set daily budgets for their campaigns and control the timing for delivery of their ads.

 

    Performance reports.    We provide continuous, timely reporting of the effectiveness of each ad campaign.

 

    Multiple payment options.    We accept credit and debit cards and, for selected advertisers, we offer several options for credit terms and monthly invoicing. We accept payments in 48 currencies.

 

    AdWords discounter.    This feature gives advertisers the freedom to increase their maximum CPCs because it automatically adjusts pricing so that they never pay more than one cent over the next highest bid. The AdWords discounter is described in detail below under the heading “Technology—Advertising Technology—Google AdWords Action System.”

 

For larger advertisers, we offer additional services that help to maximize returns on their Internet marketing investments and improve their ability to run large, dynamic campaigns. These include:

 

    Creative maximization.    Our AdWords specialists help advertisers select relevant keywords and create more effective ads. This can improve advertisers’ ability to target customers and to increase the click-through rates and conversion rates for their ads.

 

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    Vertical market experts.    Specialists with experience in particular industries offer guidance on how to most effectively target potential customers.

 

    Bulk posting.    We assist businesses in launching and managing large ad campaigns with hundreds or even thousands of targeted keywords.

 

    Dedicated client service representatives.    These staff members continuously look for ways to better structure their clients’ campaigns and to address the challenges large advertisers face.

 

Google AdSense

 

Our Google AdSense program enables the web sites in our Google Network to serve targeted ads from our AdWords advertisers. Targeting can be based on search results or on web content. We share most of the revenue generated from ads shown by a member of the Google Network with that member. Most of the web sites that make up the Google Network sign up with us online, under agreements with no required term. We also engage in direct selling efforts to convince web sites with significant traffic to join the Google Network, under agreements that vary in duration. For our network members, we offer:

 

Google AdSense for search.    For Internet companies with potentially large search audiences, we offer Google AdSense for search. Web sites use AdSense for search to generate additional revenue by serving relevant AdWords ads targeted to search results. Because we also offer to license our web search technology along with Google AdSense for search, companies without their own search service can offer Google WebSearch to improve the usefulness of their web sites for their users while increasing their revenue.

 

Google AdSense for content.    Google AdSense for content enables web sites to generate revenue from advertising by serving relevant AdWords ads targeted to web content. Our automated technology analyzes the meaning of web content and serves relevant advertising, usually in a fraction of a second. We believe that some of the best content on the web comes from web sites aiming to reach small but highly targeted audiences. AdSense for content can help these web sites offset some of their publishing costs. We believe this may help them continue to publish by tapping into the value of their content. There is no charge for web sites to participate in our AdSense for content program. Using our automated sign-up process, web sites can quickly display AdWords ads on their sites. We share the majority of the revenues generated from click-throughs on these ads with the Google Network members that display the ads. For web sites with more than 20 million page views per month, we provide customization services.

 

Google Search Appliance

 

We provide our search technology for use within enterprises through the Google Search Appliance (GSA). The GSA is a complete software and hardware solution that companies can easily implement to extend Google’s search performance to their internal or external information. The GSA can often be installed and launched in as little as one day. It leverages our search technology to identify the most relevant pages on intranet and public web sites, making it easy for people to find the information they need. The GSA offers several useful features, including automated spell-checking, cached pages, dynamic snippets, indented results and automatic conversion of Microsoft Office and PDF files to HTML. The GSA is available in three models: the GB-1001, for departments and mid-sized companies; the GB-5005, for dedicated, high-priority search services such as customer-facing web sites and company-wide intranet applications; and the GB-8008, for centralized deployments supporting global business units. List prices for our GSA models start at $32,000 for the GB-1001, $230,000 for the GB-5005 and $525,000 for the GB-8008.

 

Technology

 

We began as a technology company and have evolved into a software, technology, Internet, advertising and media company all rolled into one. We take technology innovation very seriously. We compete aggressively for

 

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talent, and our people drive our innovation, technology development and operations. We strive to hire the best computer scientists and engineers to help us solve very significant challenges across systems design, artificial intelligence, machine learning, data mining, networking, software engineering, testing, distributed systems, cluster design and other areas. We work hard to provide an environment where these talented people can have fulfilling jobs and produce technological innovations that have a positive effect on the world through daily use by millions of people. We employ technology whenever possible to increase the efficiency of our business and to improve the experience we offer our users.

 

We provide our web search and targeted advertising technology using a large network of commodity computers running custom software developed in-house. Some elements of our technology include:

 

Web Search Technology

 

Our web search technology uses a combination of techniques to determine the importance of a web page independent of a particular search query and to determine the relevance of that page to a particular search query. We do not explain how we do ranking in great detail because some people try to manipulate our search results for their own gain, rather than in an attempt to provide high-quality information to users.

 

PageRank and Ranking Technology.    One element of our technology for ranking web pages is called PageRank. While we developed much of our ranking technology after the company was formed, PageRank was developed at Stanford University with the involvement of our founders, and was therefore published as research. Most of our current ranking technology is protected as trade-secret. PageRank is a query-independent technique for determining the importance of web pages by looking at the link structure of the web. PageRank treats a link from web page A to web page B as a “vote” by page A in favor of page B. The PageRank of a page is the sum of the PageRank of the pages that link to it. The PageRank of a web page also depends on the importance (or PageRank) of the other web pages casting the votes. Votes cast by important web pages with high PageRank weigh more heavily and are more influential in deciding the PageRank of pages on the web.

 

Text-Matching Techniques.    Our technology employs text-matching techniques that compare search queries with the content of web pages to help determine relevance. Our text-based scoring techniques do far more than count the number of times a search term appears on a web page. For example, our technology determines the proximity of individual search terms to each other on a given web page, and prioritizes results that have the search terms near each other. Many other aspects of a page’s content are factored into the equation, as is the content of pages that link to the page in question. By combining query independent measures such as PageRank with our text-matching techniques, we are able to deliver search results that are relevant to what people are trying to find.

 

Advertising Technology

 

Our advertising program serves millions of relevant, targeted ads each day based on search terms people enter or content they view on the web. The key elements of our advertising technology include:

 

Google AdWords Auction System.    We use the Google AdWords auction system to enable advertisers to automatically deliver relevant, targeted advertising. Every search query we process involves the automated execution of an auction, resulting in our advertising system often processing hundreds of millions of auctions per day. To determine whether an ad is relevant to a particular query, this system weighs an advertiser’s willingness to pay for prominence in the ad listings (the CPC) and interest from users in the ad as measured by the click-through rate and other factors. If an ad does not attract user clicks, it moves to a less prominent position on the page, even if the advertiser offers to pay a high amount. This prevents advertisers with irrelevant ads from “squatting” in top positions to gain exposure. Conversely, more relevant, well-targeted ads that are clicked on frequently move up in ranking, with no need for advertisers to increase their bids. Because we are paid only when users click on ads, the AdWords ranking system aligns our interests equally with those of our advertisers and our users. The more relevant and useful the ad, the better for our users, for our advertisers and for us.

 

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The AdWords auction system also incorporates our AdWords discounter, which automatically lowers the amount advertisers actually pay to the minimum needed to maintain their ad position. Consider a situation where there are three advertisers—Pat, Betty and Joe—each bidding on the same keyword for ads that will be displayed on Google.com. These advertisers have ads with equal click-through rates and bid $1.00 per click, $0.60 per click and $0.50 per click, respectively. With our AdWords discounter, Pat would occupy the first ad position and pay only $0.61 per click, Betty would occupy the second ad position and pay only $0.51 per click, and Joe would occupy the third ad position and pay the minimum bid of $0.05 per click. The AdWords discounter saves money for advertisers by minimizing the price they pay per click, while relieving them of the need to constantly monitor and adjust their CPCs. Advertisers can experience greater discounts through the application of our smart pricing technology introduced in April 2004. This technology can reduce the price of clicks for ads served across the Google Network based on the expected value of the click to the advertiser.

 

AdSense Contextual Advertising Technology.    Our AdSense technology employs techniques that consider factors such as keyword analysis, word frequency, font size and the overall link structure of the web to analyze the content of individual web pages and to match ads to them almost instantaneously. With this ad targeting technology, we can automatically serve contextually relevant ads. To do this, Google Network members embed a small amount of custom HTML code on web pages that generates a request to Google’s AdSense service whenever a user views the web page. Upon receiving a request, our software examines the content of web pages and performs a matching process that identifies advertisements that we believe are relevant to the content of the specific web page. The relevant ads are then returned to the web pages in response to the request. We employ similar techniques for matching advertisements to other forms of textual content, such as email messages and Google Groups postings. For example, our technology can serve ads offering tickets to fans of a specific sports team on a news story about that team.

 

Large-Scale Systems Technology

 

Our business relies on our software and hardware infrastructure, which provides substantial computing resources at low cost. We currently use a combination of off-the-shelf and custom software running on clusters of commodity computers. Our considerable investment in developing this infrastructure has produced several key benefits. It simplifies the storage and processing of large amounts of data, eases the deployment and operation of large-scale global products and services and automates much of the administration of large-scale clusters of computers.

 

Although most of this infrastructure is not directly visible to our users, we believe it is important for providing a high-quality user experience. It enables significant improvements in the relevance of our search and advertising results by allowing us to apply superior search and retrieval algorithms that are computationally intensive. We believe the infrastructure also shortens our product development cycle and allows us to pursue innovation more cost effectively.

 

We constantly evaluate new hardware alternatives and software techniques to help further reduce our computational costs. This allows us to improve our existing products and services and to more easily develop, deploy and operate new global products and services.

 

Sales and Support

 

We have put significant effort into developing our sales and support infrastructure. We maintain 25 sales offices in 12 countries, and we deploy specialized sales teams across 13 vertical markets. We bring businesses into our advertising network through both online and direct sales channels. In all cases, we use technology and automation wherever possible to improve the experience for our advertisers and to grow our business cost-effectively. The vast majority of our advertisers use our automated online AdWords program to establish accounts, create ads, target users and launch and manage their advertising campaigns. Our direct advertising sales team focuses on attracting and supporting companies around the world with sizeable advertising budgets. Our AdSense program follows a similar model. Most of the web sites in the Google Network sign up for AdSense

 

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using an automated online process. Our direct sales force focuses on building AdSense relationships with leading Internet companies. Our global support organization concentrates on helping our advertisers and Google Network members get the most out of their relationships with us.

 

Marketing

 

We have always believed that building a trusted, highly-recognized brand begins with providing high-quality products and services that make a notable difference in people’s lives. Our user base has grown primarily by word-of-mouth, which can work very well for products that inspire a high level of user loyalty because users are likely to share their positive experiences with their friends and families. Our early marketing efforts focused on feeding this word-of-mouth momentum and used public relations efforts to accelerate it. Through these efforts and people’s increased usage of Google worldwide, we have been able to build our brand with relatively low marketing costs as a percentage of our revenues. Today, we use the quality of our own products and services as our most effective marketing tool, and word-of-mouth momentum continues to drive consumer awareness and user loyalty worldwide. We do not promote products before they are successful for our users, preferring to test them until they achieve broad acceptance. We also engage in targeted marketing efforts, such as those we deliver to our advertising clients, designed to inform potential advertisers, Google Network members and enterprises of the benefits they can achieve through Google. In addition, we sponsor industry conferences and have promoted the distribution of the Google Toolbar to Internet users in order to make our search services easier to access.

 

Competition

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