10-Q 1 goog10-qq22013.htm FORM 10-Q GOOG 10-Q Q2 2013


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________________
FORM 10-Q
___________________________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number: 000-50726
___________________________________________________
Google Inc.
(Exact name of registrant as specified in its charter)
___________________________________________________
Delaware
77-0493581
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
1600 Amphitheatre Parkway
Mountain View, CA 94043
(Address of principal executive offices, including zip code)
(650) 253-0000
(Registrant’s telephone number, including area code) 
___________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
  
Large accelerated filer  ý
  
Accelerated filer  ¨
  
 
Non-accelerated filer (Do not check if a smaller reporting company)  ¨             Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
At July 18, 2013, there were 273,938,171 shares of Google’s Class A common stock outstanding and 59,082,802 shares of Google’s Class B common stock outstanding.





Google Inc.
Form 10-Q
For the Quarterly Period Ended June 30, 2013
TABLE OF CONTENTS

 
 
Page No.
Item 1
 
 
 
 
 
Item 2
Item 3
Item 4
Item 1
Item 1A
Item 2
Item 6
 
 
 


i


NOTE ABOUT FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, among other things, statements regarding:

the growth of our business and revenues and our expectations about the factors that influence our success and trends in our business;
seasonal fluctuations in internet usage and advertiser expenditures, traditional retail seasonality and macroeconomic conditions, which are likely to cause fluctuations in our quarterly results;
our plans to continue to invest in new products and technologies, systems, facilities, and infrastructure, to increase our hiring and provide competitive compensation programs, as well as to continue our current pace of acquisitions;
the potential for declines in our revenue growth rate;
our expectation that growth in advertising revenues from our websites will continue to exceed that from our Google Network Members’ websites, which will have a positive impact on our operating margins;
our expectation that we will continue to pay most of the fees we receive from advertisers to our Google Network Members;
our expectation that we will continue to take steps to improve the relevance of the ads we deliver and to reduce the number of accidental clicks;
fluctuations in aggregate paid clicks and average cost-per-click;
our belief that our foreign exchange risk management program will not fully offset our net exposure to fluctuations in foreign currency exchange rates;
the expected increase of costs related to hedging activities under our foreign exchange risk management program;
our expectation that our cost of revenues, research and development expenses, sales and marketing expenses, and general and administrative expenses will increase in dollars and may increase as a percentage of revenues;
our potential exposure in connection with pending investigations and proceedings;
our expectation about our board of directors’ intention to declare a dividend of shares of the new Class C capital stock, as well as the timing of that dividend, if declared and paid;
our expectation that our traffic acquisition costs will fluctuate in the future;
our continued investments in international markets;
estimates of our future compensation expenses;
fluctuations in our effective tax rate;
the sufficiency of our sources of funding;
our payment terms to certain advertisers, which may increase our working capital requirements;
fluctuations in our capital expenditures;
as well as other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements may appear throughout this report, including without limitation, the following sections: Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 1A, “Risk Factors.” Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q, and in particular, the risks discussed under the caption “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission (SEC). We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
As used herein, “Google,” “we,” “our,” and similar terms include Google Inc. and its subsidiaries, unless the context indicates otherwise.

1


“Google” and other trademarks of ours appearing in this report are our property. This report contains additional trade names and trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies.

2


PART I - FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS
Google Inc.
CONSOLIDATED BALANCE SHEETS
(In millions, except share and par value amounts which are reflected in thousands,
and par value per share amounts)
 
As of
December 31,
2012
 
As of
June 30,
2013
 
 
 
(unaudited)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
14,778

 
$
16,164

Marketable securities
33,310

 
38,268

Total cash, cash equivalents, and marketable securities (including securities loaned of $3,160 and $4,791)
48,088

 
54,432

Accounts receivable, net of allowance of $581 and $505
7,885

 
7,321

Inventories
505

 
342

Receivable under reverse repurchase agreements
700

 
770

Deferred income taxes, net
1,144

 
1,148

Income taxes receivable, net
0

 
72

Prepaid revenue share, expenses and other assets
2,132

 
2,776

Total current assets
60,454

 
66,861

Prepaid revenue share, expenses and other assets, non-current
2,011

 
1,891

Non-marketable equity investments
1,469

 
1,564

Property and equipment, net
11,854

 
12,912

Intangible assets, net
7,473

 
6,558

Goodwill
10,537

 
11,396

Total assets
$
93,798

 
$
101,182

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
2,012

 
$
1,758

Short-term debt
2,549

 
3,000

Accrued compensation and benefits
2,239

 
1,803

Accrued expenses and other current liabilities
3,258

 
3,300

Accrued revenue share
1,471

 
1,458

Securities lending payable
1,673

 
3,211

Deferred revenue
895

 
799

Income taxes payable, net
240

 
0

Total current liabilities
14,337

 
15,329

Long-term debt
2,988

 
1,989

Deferred revenue, non-current
100

 
132

Income taxes payable, non-current
2,046

 
2,271

Deferred income taxes, net, non-current
1,872

 
1,905

Other long-term liabilities
740

 
704

Stockholders’ equity:
 
 
 
Convertible preferred stock, $0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding
0

 
0

Class A and Class B common stock and additional paid-in capital, $0.001 par value per share: 12,000,000 shares authorized (Class A 9,000,000, Class B 3,000,000); 329,979 (Class A 267,448, Class B 62,531) and par value of $330 (Class A $267, Class B $63) and 333,134 (Class A 273,852, Class B 59,282) and par value of $333 (Class A $274, Class B $59) shares issued and outstanding
22,835

 
24,334

Class C capital stock, $0.001 par value per share: 3,000,000 shares authorized; no shares issued and outstanding
0

 
0

Accumulated other comprehensive income (loss)
538

 
(398
)
Retained earnings
48,342

 
54,916

Total stockholders’ equity
71,715

 
78,852

Total liabilities and stockholders’ equity
$
93,798

 
$
101,182

See accompanying notes.

3


Google Inc.
CONSOLIDATED STATEMENTS OF INCOME
(In millions, except share amounts which are reflected in thousands and per share amounts)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2013
 
2012
 
2013
 
(unaudited)
Revenues:
 
 
 
 
 
 
 
Google (advertising and other)
$
10,964

 
$
13,107

 
$
21,609

 
$
26,058

Motorola Mobile (hardware and other)
843

 
998

 
843

 
2,016

Total revenues
11,807

 
14,105

 
22,452

 
28,074

Costs and expenses:
 
 
 
 
 
 
 
Cost of revenues - Google (advertising and other) (1)
3,984

 
5,195

 
7,773

 
10,331

Cost of revenues - Motorola Mobile (hardware and other) (1)
693

 
868

 
693

 
1,676

Research and development (1)
1,538

 
1,987

 
2,979

 
3,824

Sales and marketing (1)
1,413

 
1,735

 
2,682

 
3,321

General and administrative (1)
942

 
1,197

 
1,699

 
2,322

Total costs and expenses
8,570

 
10,982

 
15,826

 
21,474

Income from operations
3,237

 
3,123

 
6,626

 
6,600

Interest and other income, net
253

 
247

 
409

 
381

Income from continuing operations before income taxes
3,490

 
3,370

 
7,035

 
6,981

Provision for income taxes
657

 
816

 
1,312

 
1,103

Net income from continuing operations
2,833

 
2,554

 
5,723

 
5,878

Net income (loss) from discontinued operations
(48
)
 
674

 
(48
)
 
696

Net income
$
2,785

 
$
3,228

 
$
5,675

 
$
6,574

Net income (loss) per share of Class A and Class B common stock - basic:
 
 
 
 
 
 
 
Continuing operations
$
8.68

 
$
7.68

 
$
17.56

 
$
17.73

Discontinued operations
(0.14
)
 
2.03

 
(0.14
)
 
2.10

Net income (loss) per share of Class A and Class B common stock - basic
$
8.54

 
$
9.71

 
$
17.42

 
$
19.83

Net income (loss) per share of Class A and Class B common stock - diluted:
 
 
 
 
 
 
 
Continuing operations
$
8.56

 
$
7.55

 
$
17.31

 
$
17.42

Discontinued operations
(0.14
)
 
1.99

 
(0.14
)
 
2.06

Net income (loss) per share of Class A and Class B common stock - diluted
$
8.42

 
$
9.54

 
$
17.17

 
$
19.48

 
 
 
 
 
 
 
 
Shares used in per share calculation - basic
326,272

 
332,480

 
325,786

 
331,467

Shares used in per share calculation - diluted
330,793

 
338,337

 
330,464

 
337,500

______________________
 
 
 
 
 
 
 
(1) Includes stock-based compensation expense as follows:
 
 
 
 
 
 
 
Cost of revenues - Google (advertising and other)
$
82

 
$
110

 
$
156

 
$
209

Cost of revenues - Motorola Mobile (hardware and other)
4

 
5

 
4

 
10

Research and development
289

 
421

 
588

 
782

Sales and marketing
118

 
134

 
215

 
259

General and administrative
142

 
113

 
228

 
220

 
$
635

 
$
783

 
$
1,191

 
$
1,480

See accompanying notes.

4



Google Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2013
 
2012
 
2013
 
(unaudited)
Net income
$
2,785

 
$
3,228

 
$
5,675

 
$
6,574

Other comprehensive loss:
 
 
 
 
 
 
 
Change in foreign currency translation adjustment
(433
)
 
(36
)
 
(318
)
 
(204
)
Available-for-sale investments:
 
 
 
 
 
 
 
Change in net unrealized gains (losses)
14

 
(604
)
 
210

 
(659
)
Less: reclassification adjustment for net gains included in net income
(41
)
 
(108
)
 
(148
)
 
(154
)
Net change (net of tax effect of $28, $202, $10 and $239)
(27
)
 
(712
)
 
62

 
(813
)
Cash flow hedges:
 
 
 
 
 
 
 
Change in net unrealized gains
174

 
16

 
139

 
125

Less: reclassification adjustment for net gains included in net income
(52
)
 
(22
)
 
(75
)
 
(44
)
Net change (net of tax effect of $72, $4, $38 and $47)
122

 
(6
)
 
64

 
81

Other comprehensive loss
(338
)
 
(754
)
 
(192
)
 
(936
)
Comprehensive income
$
2,447

 
$
2,474

 
$
5,483

 
$
5,638

See accompanying notes.

5


Google Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
 
Six Months Ended
 
June 30,
 
2012
 
2013
 
(unaudited)
Operating activities
 
 
 
Net income
$
5,675

 
$
6,574

Adjustments:
 
 
 
Depreciation and amortization of property and equipment
851

 
1,331

Amortization of intangible and other assets
330

 
598

Stock-based compensation expense
1,214

 
1,555

Excess tax benefits from stock-based award activities
(55
)
 
(198
)
Deferred income taxes
191

 
265

Gain on divestiture of businesses
(188
)
 
(690
)
Other
(56
)
 
(54
)
Changes in assets and liabilities, net of effects of acquisitions:
 
 
 
Accounts receivable
79

 
62

Income taxes, net
1,169

 
(156
)
Inventories
170

 
(158
)
Prepaid revenue share, expenses and other assets
(1,188
)
 
(348
)
Accounts payable
(80
)
 
(72
)
Accrued expenses and other liabilities
(243
)
 
(363
)
Accrued revenue share
23

 
8

Deferred revenue
54

 
(16
)
Net cash provided by operating activities
7,946

 
8,338

Investing activities
 
 
 
Purchases of property and equipment
(1,381
)
 
(2,814
)
Purchases of marketable securities
(15,542
)
 
(22,782
)
Maturities and sales of marketable securities
22,657

 
17,006

Investments in non-marketable equity investments
(202
)
 
(172
)
Cash collateral related to securities lending
(91
)
 
1,538

Investments in reverse repurchase agreements
270

 
(70
)
Proceeds from divestiture of businesses
201

 
2,351

Acquisitions, net of cash acquired, and purchases of intangibles and other assets
(10,147
)
 
(1,301
)
Net cash used in investing activities
(4,235
)
 
(6,244
)
Financing activities
 
 
 
Net payments related to stock-based award activities
(184
)
 
(268
)
Excess tax benefits from stock-based award activities
55

 
198

Proceeds from issuance of debt, net of costs
7,751

 
5,651

Repayments of debt
(5,753
)
 
(6,203
)
Net cash provided by (used in) financing activities
1,869

 
(622
)
Effect of exchange rate changes on cash and cash equivalents
(126
)
 
(86
)
Net increase in cash and cash equivalents
5,454

 
1,386

Cash and cash equivalents at beginning of period
9,983

 
14,778

Cash and cash equivalents at end of period
$
15,437

 
$
16,164

 
 
 
 
Supplemental disclosures of cash flow information
 
 
 
Cash paid for taxes
$
1,003

 
$
796

Cash paid for interest
$
37

 
$
35

Non-cash investing activity:
 
 
 
Receipt of Arris shares in connection with divestiture of Motorola Home
$
0

 
$
175

Non-cash financing activity:
 
 
 
Fair value of stock-based awards assumed in connection with acquisition of Motorola
$
41

 
$
0

 
 
 
 
See accompanying notes.


6


Google Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Google Inc. and Summary of Significant Accounting Policies
We were incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. We generate revenues primarily by delivering relevant, cost-effective online advertising in our Google segment. To a lesser extent, we generate revenues primarily from sales of mobile devices in our Motorola Mobile segment.
In April 2013, we completed the sale of our Motorola Home segment to Arris Group, Inc. (Arris) and certain other persons. See Note 8 for further discussion of the sale of Motorola Home.
Basis of Consolidation
The consolidated financial statements include the accounts of Google Inc. and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.
Unaudited Interim Financial Information
The accompanying Consolidated Balance Sheet as of June 30, 2013, the Consolidated Statements of Income for the three and six months ended June 30, 2012 and 2013, the Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2012 and 2013, and the Consolidated Statements of Cash Flows for the six months ended June 30, 2012 and 2013 are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (GAAP). In our opinion, the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of our financial position as of June 30, 2013, our results of operations for the three and six months ended June 30, 2012 and 2013, and our cash flows for the six months ended June 30, 2012 and 2013. The results of operations for the three and six months ended June 30, 2013 are not necessarily indicative of the results to be expected for the year ending December 31, 2013.
These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on January 29, 2013.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the accounts receivable and sales allowances, fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, fair values of stock-based awards, inventory valuations, income taxes, and contingent liabilities, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
In the second quarter of 2013, we revised the estimated useful lives of certain types of property and equipment which resulted in an additional depreciation expense of $121 million during the three months ended June 30, 2013.
Prior Period Reclassifications
Certain reclassifications of prior period amounts have been made to conform to the current period presentation.


7


Note 2. Net Income Per Share of Class A and Class B Common Stock
The following table sets forth the computation of basic and diluted net income per share of Class A and Class B common stock (in millions, except share amounts which are reflected in thousands and per share amounts):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2013
 
2012
 
2013
 
(unaudited)
 
Class A
 
Class B
 
Class A
 
Class B
 
Class A
 
Class B
 
Class A
 
Class B
Basic net income (loss) per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allocation of undistributed earnings - continuing operations
$
2,261

 
$
572

 
$
2,093

 
$
461

 
$
4,557

 
$
1,166

 
$
4,798

 
$
1,080

Allocation of undistributed earnings - discontinued operations
(38
)
 
(10
)
 
552

 
122

 
(38
)
 
(10
)
 
568

 
128

Total
$
2,223

 
$
562

 
$
2,645

 
$
583

 
$
4,519

 
$
1,156

 
$
5,366

 
$
1,208

Denominator
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
260,390

 
65,882

 
272,417

 
60,063

 
259,417

 
66,369

 
270,582

 
60,885

Number of shares used in per share computation
260,390

 
65,882

 
272,417

 
60,063

 
259,417

 
66,369

 
270,582

 
60,885

Basic net income (loss) per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Continuing operations
$
8.68

 
$
8.68

 
$
7.68

 
$
7.68

 
$
17.56

 
$
17.56

 
$
17.73

 
$
17.73

Discontinued operations
(0.14
)
 
(0.14
)
 
2.03

 
2.03

 
(0.14
)
 
(0.14
)
 
2.10

 
2.10

Basic net income per share
$
8.54

 
$
8.54

 
$
9.71

 
$
9.71

 
$
17.42

 
$
17.42

 
$
19.83

 
$
19.83

Diluted net income (loss) per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Numerator
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allocation of undistributed earnings for basic computation - continuing operations
$
2,261

 
$
572

 
$
2,093

 
$
461

 
$
4,557

 
$
1,166

 
$
4,798

 
$
1,080

Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares
572

 
0

 
461

 
0

 
1,166

 
0

 
1,080

 
0

Reallocation of undistributed earnings to Class B shares
0

 
(7
)
 
0

 
(8
)
 
0

 
(16
)
 
0

 
(19
)
Allocation of undistributed earnings - continuing operations
$
2,833

 
$
565

 
$
2,554

 
$
453

 
$
5,723

 
$
1,150

 
$
5,878

 
$
1,061

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allocation of undistributed earnings for basic computation - discontinued operations
$
(38
)
 
$
(10
)
 
$
552

 
$
122

 
$
(38
)
 
$
(10
)
 
$
568

 
$
128

Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares
(10
)
 
0

 
122

 
0

 
(10
)
 
0

 
128

 
0

Reallocation of undistributed earnings to Class B shares
0

 
0

 
0

 
(2
)
 
0

 
0

 
0

 
(2
)
Allocation of undistributed earnings - discontinued operations
$
(48
)
 
$
(10
)
 
$
674

 
$
120

 
$
(48
)
 
$
(10
)
 
$
696

 
$
126

Denominator
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of shares used in basic computation
260,390

 
65,882

 
272,417

 
60,063

 
259,417

 
66,369

 
270,582

 
60,885

Weighted-average effect of dilutive securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Add:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Conversion of Class B to Class A common shares outstanding
65,882

 
0

 
60,063

 
0

 
66,369

 
0

 
60,885

 
0

Employee stock options, including warrants issued under Transferable Stock Option program
2,857

 
38

 
2,664

 
4

 
2,907

 
40

 
2,896

 
8


8


Restricted stock units
1,664

 
0

 
3,193

 
0

 
1,771

 
0

 
3,137

 
0

Number of shares used in per share computation
330,793

 
65,920

 
338,337

 
60,067

 
330,464

 
66,409

 
337,500

 
60,893

Diluted net income (loss) per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Continuing operations
$
8.56

 
$
8.56

 
$
7.55

 
$
7.55

 
$
17.31

 
$
17.31

 
$
17.42

 
$
17.42

Discontinued operations
(0.14
)
 
(0.14
)
 
1.99

 
1.99

 
(0.14
)
 
(0.14
)
 
2.06

 
2.06

Diluted net income per share
$
8.42

 
$
8.42

 
$
9.54

 
$
9.54

 
$
17.17

 
$
17.17

 
$
19.48

 
$
19.48

The net income per share amounts are the same for Class A and Class B common stock because the holders of each class are legally entitled to equal per share distributions whether through dividends or in liquidation.


Note 3. Financial Instruments

Fair Value Measurements
We measure our cash equivalents, marketable securities, and foreign currency and interest rate derivative contracts at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:
Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2—Include other inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings.
Level 3—Unobservable inputs that are supported by little or no market activities.
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
Based on the fair value hierarchy, we classify our cash equivalents and marketable securities within Level 1 or Level 2. This is because we value our cash equivalents and marketable securities using quoted market prices or alternative pricing sources and models utilizing market observable inputs. We classify our foreign currency and interest rate derivative contracts primarily within Level 2 as the valuation inputs are based on quoted prices and market observable data of similar instruments.

Cash, Cash Equivalents and Marketable Securities
 The following tables summarize our cash, cash equivalents and marketable securities by significant investment categories as of December 31, 2012 and June 30, 2013 (in millions):

9


 
 
As of December 31, 2012
 
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Cash and
Cash
Equivalents
 
Marketable
Securities
Cash
 
$
8,066

 
$
0

 
$
0

 
$
8,066

 
$
8,066

 
$
0

Level 1:
 
 
 
 
 
 
 
 
 
 
 
 
Money market and other funds
 
5,221

 
0

 
0

 
5,221

 
5,221

 
0

U.S. government notes
 
10,853

 
77

 
(1
)
 
10,929

 
0

 
10,929

Marketable equity securities
 
12

 
88

 
0

 
100

 
0

 
100

 
 
16,086

 
165

 
(1
)
 
16,250

 
5,221

 
11,029

Level 2:
 
 
 
 
 
 
 
 
 
 
 
 
Time deposits
 
984

 
0

 
0

 
984

 
562

 
422

Money market and other funds (1)
 
929

 
0

 
0

 
929

 
929

 
0

U.S. government agencies
 
1,882

 
20

 
0

 
1,902

 
0

 
1,902

Foreign government bonds
 
1,996

 
81

 
(3
)
 
2,074

 
0

 
2,074

Municipal securities
 
2,249

 
23

 
(6
)
 
2,266

 
0

 
2,266

Corporate debt securities
 
7,200

 
414

 
(14
)
 
7,600

 
0

 
7,600

Agency residential mortgage-backed securities
 
7,039

 
136

 
(6
)
 
7,169

 
0

 
7,169

Asset-backed securities
 
847

 
1

 
0

 
848

 
0

 
848

 
 
23,126

 
675

 
(29
)
 
23,772

 
1,491

 
22,281

Total
 
$
47,278

 
$
840

 
$
(30
)
 
$
48,088

 
$
14,778

 
$
33,310

 
 
As of June 30, 2013
 
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Cash and
Cash
Equivalents
 
Marketable
Securities
 
(unaudited)
Cash
 
$
9,451

 
$
0

 
$
0

 
$
9,451

 
$
9,451

 
$
0

Level 1:
 
 
 
 
 
 
 
 
 
 
 
 
Money market and other funds
 
3,183

 
0

 
0

 
3,183

 
3,183

 
0

U.S. government notes
 
12,127

 
37

 
(57
)
 
12,107

 
151

 
11,956

Marketable equity securities
 
218

 
41

 
(24
)
 
235

 
0

 
235

 
 
15,528

 
78

 
(81
)
 
15,525

 
3,334

 
12,191

Level 2:
 
 
 
 
 
 
 
 
 
 
 
 
Time deposits
 
1,774

 
0

 
0

 
1,774

 
1,327

 
447

Money market and other funds (1)
 
2,052

 
0

 
0

 
2,052

 
2,052

 
0

U.S. government agencies
 
2,780

 
5

 
(8
)
 
2,777

 
0

 
2,777

Foreign government bonds
 
2,243

 
15

 
(52
)
 
2,206

 
0

 
2,206

Municipal securities
 
3,501

 
7

 
(65
)
 
3,443

 
0

 
3,443

Corporate debt securities
 
8,114

 
137

 
(164
)
 
8,087

 
0

 
8,087

Agency residential mortgage-backed securities
 
8,245

 
62

 
(176
)
 
8,131

 
0

 
8,131

Asset-backed securities
 
990

 
0

 
(4
)
 
986

 
0

 
986

 
 
29,699

 
226

 
(469
)
 
29,456

 
3,379

 
26,077

Total
 
$
54,678

 
$
304

 
$
(550
)
 
$
54,432

 
$
16,164

 
$
38,268


(1)
The balances at December 31, 2012 and June 30, 2013 were related to cash collateral received in connection with our securities lending program, which was invested in reverse repurchase agreements maturing within three months. See below for further discussion of this program.

During the second quarter of 2013, we received approximately $175 million in Arris' common stock of 10.6 million shares in connection with the sale of the Motorola Home segment (see details in Note 8). These shares are accounted for as available-for-sale marketable equity securities.

10



We determine realized gains or losses on the sale of marketable securities on a specific identification method. We recognized gross realized gains of $76 million and $209 million for the three and six months ended June 30, 2012 and $185 million and $260 million for the three and six months ended June 30, 2013. We recognized gross realized losses of $21 million and $34 million for the three and six months ended June 30, 2012 and $41 million and $56 million for the three and six months ended June 30, 2013. We reflect these gains and losses as a component of interest and other income, net, in the accompanying Consolidated Statements of Income.
The following table summarizes the estimated fair value of our investments in marketable securities, excluding marketable equity securities, designated as available-for-sale and classified by the contractual maturity date of the securities (in millions):
 
As of
June 30,
2013
 
(unaudited)
Due in 1 year
$
4,085

Due in 1 year through 5 years
17,207

Due in 5 years through 10 years
8,338

Due after 10 years
8,403

Total
$
38,033

The following tables present gross unrealized losses and fair values for those investments that were in an unrealized loss position as of December 31, 2012 and June 30, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions):
 
 
As of December 31, 2012
 
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
U.S. government notes
 
$
842

 
$
(1
)
 
$
0

 
$
0

 
$
842

 
$
(1
)
Foreign government bonds
 
509

 
(2
)
 
12

 
(1
)
 
521

 
(3
)
Municipal securities
 
686

 
(6
)
 
9

 
0

 
695

 
(6
)
Corporate debt securities
 
820

 
(10
)
 
81

 
(4
)
 
901

 
(14
)
Agency residential mortgage-backed securities
 
1,300

 
(6
)
 
0

 
0

 
1,300

 
(6
)
Total
 
$
4,157

 
$
(25
)
 
$
102

 
$
(5
)
 
$
4,259

 
$
(30
)
 
 
As of June 30, 2013
 
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
 
 
 
 
 
(unaudited)
 
 
 
 
U.S. government notes
 
$
5,827

 
$
(57
)
 
$
0

 
$
0

 
$
5,827

 
$
(57
)
U.S. government agencies
 
828

 
(8
)
 
0

 
0

 
828

 
(8
)
Foreign government bonds
 
1,547

 
(52
)
 
0

 
0

 
1,547

 
(52
)
Municipal securities
 
2,428

 
(65
)
 
0

 
0

 
2,428

 
(65
)
Corporate debt securities
 
4,742

 
(160
)
 
56

 
(4
)
 
4,798

 
(164
)
Agency residential mortgage-backed securities
 
6,004

 
(175
)
 
61

 
(1
)
 
6,065

 
(176
)
Asset-backed securities
 
1,042

 
(4
)
 
0

 
0

 
1,042

 
(4
)
Marketable equity securities
 
154

 
(24
)
 
0

 
0

 
154

 
(24
)
Total
 
$
22,572

 
$
(545
)
 
$
117

 
$
(5
)
 
$
22,689

 
$
(550
)

11


We periodically review our marketable debt and equity securities for other-than-temporary impairment. We consider factors such as the duration, severity and the reason for the decline in value, the potential recovery period and our intent to sell. For marketable debt securities, we also consider whether (i) it is more likely than not that we will be required to sell the debt securities before recovery of their amortized cost basis, and (ii) the amortized cost basis cannot be recovered as a result of credit losses. During the three and six months ended June 30, 2013, we did not recognize any other-than-temporary impairment loss.
Securities Lending Program
From time to time, we enter into securities lending agreements with financial institutions to enhance investment income. We loan selected securities which are collateralized in the form of cash or securities. Cash collateral is invested in reverse repurchase agreements which are collateralized in the form of securities.
We classify loaned securities as cash equivalents or marketable securities and record the cash collateral as an asset with a corresponding liability in the accompanying Consolidated Balance Sheets. We classify reverse repurchase agreements maturing within three months as cash equivalents and those longer than three months as receivable under reverse repurchase agreements in the accompanying Consolidated Balance Sheets. For security collateral received, we do not record an asset or liability except in the event of counterparty default.
Derivative Financial Instruments
We recognize derivative instruments as either assets or liabilities in the accompanying Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the accompanying Consolidated Statements of Income as interest and other income, net, as part of revenues, or as a component of accumulated other comprehensive income (AOCI) in the accompanying Consolidated Balance Sheets, as discussed below.
We enter into foreign currency contracts with financial institutions to reduce the risk that our cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations. We use certain interest rate derivative contracts to hedge interest rate exposures on our fixed income securities and our anticipated debt issuance. Our program is not used for trading or speculative purposes.
We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. To further reduce credit risk, we enter into collateral security arrangements under which the counterparty is required to provide collateral when the net fair value of certain financial instruments fluctuates from contractually established thresholds. We can take possession of the collateral in the event of counterparty default. At December 31, 2012 and June 30, 2013, we received cash collateral related to the derivative instruments under our collateral security arrangements of $43 million and $94 million.
Cash Flow Hedges
We use options designated as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. The notional principal of these contracts was approximately $9.5 billion and $6.9 billion as of December 31, 2012 and June 30, 2013. These foreign exchange contracts have maturities of 36 months or less.
In 2012, we entered into forward-starting interest rate swaps that effectively locked in an interest rate on our anticipated debt issuance of $1.0 billion in 2014. The total notional amount of these forward-starting interest swaps was $1.0 billion as of December 31, 2012 and June 30, 2013 with terms calling for us to receive interest at a variable rate and to pay interest at a fixed rate.
We initially report any gain or loss on the effective portion of a cash flow hedge as a component of AOCI and subsequently reclassify cumulative gains and losses to revenues or interest expense when the hedged transactions are recorded. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI would be reclassified to interest and other income, net. Further, we exclude the change in the time value of the options from our assessment of hedge effectiveness. We record the premium paid or time value of an option on the date of purchase as an asset. Thereafter, we recognize any change to this time value in interest and other income, net.
As of June 30, 2013, the effective portion of our cash flow hedges before tax effect was $139 million, of which $64 million is expected to be reclassified from AOCI to revenues within the next 12 months.


12


Fair Value Hedges
We use forward contracts designated as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. Gains and losses on these contracts are recognized in interest and other income, net, along with the offsetting losses and gains of the related hedged items. We exclude changes in the time value for forward contracts from the assessment of hedge effectiveness. The notional principal of these contracts was $1.1 billion and $1.5 billion as of December 31, 2012 and June 30, 2013.
Other Derivatives
Other derivatives not designated as hedging instruments consist of forward and option contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the local currency of a subsidiary. We recognize gains and losses on these contracts, as well as the related costs in interest and other income, net, along with the foreign currency gains and losses on monetary assets and liabilities. The notional principal of foreign exchange contracts outstanding was $6.6 billion and $6.2 billion at December 31, 2012 and June 30, 2013.
We also use exchange-traded interest rate futures contracts and “To Be Announced” (TBA) forward purchase commitments of mortgage-backed assets to hedge interest rate risks on certain fixed income securities. The TBA contracts meet the definition of derivative instruments in cases where physical delivery of the assets is not taken at the earliest available delivery date. Our interest rate futures and TBA contracts (together interest rate contracts) are not designated as hedging instruments. We recognize gains and losses on these contracts, as well as the related costs in interest and other income, net. The gains and losses are generally economically offset by unrealized gains and losses in the underlying available-for-sale securities, which are recorded as a component of AOCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are moved from AOCI into interest and other income, net. The total notional amounts of interest rate contracts outstanding were $25 million at both December 31, 2012 and June 30, 2013.
The fair values of our outstanding derivative instruments were as follows (in millions):

 
 
 
 
As of December 31, 2012
 
 
  
 
Balance Sheet Location
 
Fair Value of
Derivatives
Designated as
Hedging Instruments
 
Fair Value of
Derivatives Not
Designated as
Hedging Instruments
 
Total Fair
Value
Derivative Assets:
 
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
Prepaid revenue share, expenses and other assets, current and non-current
 
$
164

 
$
13

 
$
177

Interest rate contracts
 
Prepaid revenue share, expenses and other assets, current and non-current
 
1

 
0

 
1

Total
 
 
 
$
165

 
$
13

 
$
178

Derivative Liabilities:
 
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
Accrued expenses and other current liabilities
 
$
3

 
$
4

 
$
7



13


 
 
 
 
As of June 30, 2013
 
 
  
 
Balance Sheet Location
 
Fair Value of
Derivatives
Designated as
Hedging Instruments
 
Fair Value of
Derivatives Not
Designated as
Hedging Instruments
 
Total Fair
Value
 
 
 

(unaudited)
Derivative Assets:
 
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
Prepaid revenue share, expenses and other assets, current and non-current
 
$
214

 
$
10

 
$
224

Interest rate contracts
 
Prepaid revenue share, expenses and other assets, current and non-current
 
69

 
0

 
69

Total
 
 
 
$
283

 
$
10

 
$
293

The effect of derivative instruments in cash flow hedging relationships on income and other comprehensive income is summarized below (in millions):
 
 
 
Gains (Losses) Recognized in OCI
on Derivatives Before Tax Effect (Effective Portion)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationship
 
2012
 
2013
 
2012
 
2013
 
 
(unaudited)
Foreign exchange contracts
 
$
275

 
$
(33
)
 
$
220

 
$
130

Interest rate contracts
 
0

 
58

 
0

 
68

Total
 
$
275

 
$
25

 
$
220

 
$
198

 
 
 
Gains Reclassified from AOCI into Income (Effective Portion)
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationship
 
Location
 
2012
 
2013
 
2012
 
2013
 
 
 
 
(unaudited)
Foreign exchange contracts
 
Revenues
 
$
81

 
$
35

 
$
119

 
$
70

 
 
 
Gains (Losses) Recognized in Income on Derivatives (Amount
Excluded from  Effectiveness Testing and Ineffective Portion) (1)
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Derivatives in Cash Flow Hedging Relationship
 
Location
 
2012
 
2013
 
2012
 
2013
 
 
 
 
(unaudited)
Foreign exchange contracts
 
Interest and
other income, net
 
$
(120
)
 
$
(38
)
 
$
(246
)
 
$
(89
)
 
(1) 
Gains (losses) related to the ineffective portion of the hedges were not material in all periods presented.




14


The effect of derivative instruments in fair value hedging relationships on income is summarized below (in millions):
 
 
 
Gains (Losses) Recognized in Income on Derivatives(2)
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Derivatives in Fair Value Hedging Relationship
 
Location
 
2012
 
2013
 
2012
 
2013
 
 
 
 
(unaudited)
Foreign exchange contracts
 
Interest and
other income, net
 
$
36

 
$
25

 
$
16

 
$
62

Hedged item
 
Interest and
other income, net
 
(38
)
 
(27
)
 
(21
)
 
(65
)
Total
 
 
 
$
(2
)
 
$
(2
)
 
$
(5
)
 
$
(3
)
 
(2) 
Losses related to the amount excluded from effectiveness testing of the hedges were $2 million and $5 million for the three and six months ended June 30, 2012 and $2 million and $3 million for the three and six months ended June 30, 2013.
The effect of derivative instruments not designated as hedging instruments on income is summarized below (in millions):
 
 
 
Gains (Losses) Recognized in Income on Derivatives
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Derivatives Not Designated As Hedging Instruments
 
Location
 
2012
 
2013
 
2012
 
2013
 
 
 
 
(unaudited)
Foreign exchange contracts
 
Interest and
other income, net
 
$
0

 
$
70

 
$
(25
)
 
$
157

Interest rate contracts
 
Interest and
other income, net
 
(7
)
 
0

 
(5
)
 
0

Total
 
 
 
$
(7
)
 
$
70

 
$
(30
)
 
$
157



Offsetting of Derivatives, Securities Lending and Reverse Repurchase Agreements

We present our derivatives, securities lending and reverse repurchase agreements at gross fair values in the Consolidated Balance Sheets. However, our master netting and other similar arrangements allow net settlements under certain conditions. As of December 31, 2012 and June 30, 2013, information related to these offsetting arrangements was as follows (in millions, unaudited):

15


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Offsetting of Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
 
 
Description
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Presented in the Consolidated Balance Sheets
 
Financial Instruments
 
 Cash Collateral Received
 
Non-Cash Collateral Received
 
Net Assets Exposed
Derivatives
 
$
178

 
$
0

 
$
178

 
$
(4
)
(1) 
$
(40
)
 
$
(12
)
 
$
122

Reverse repurchase agreements
 
1,629

 
0

 
1,629

(2) 
0

 
0

 
(1,629
)
 
0

Total
 
$
1,807

 
$
0

 
$
1,807

 
$
(4
)
 
$
(40
)
 
$
(1,641
)
 
$
122

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of June 30, 2013
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
 
 
Description
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Presented in the Consolidated Balance Sheets
 
Financial Instruments
 
Cash Collateral Received
 
Non-Cash Collateral Received
 
Net Assets Exposed
Derivatives
 
$
293

 
$
0

 
$
293

 
$
0

(1) 
$
(91
)
 
$
(91
)
 
$
111

Reverse repurchase agreements
 
2,822

 
0

 
2,822

(2) 
0

 
0

 
(2,822
)
 
0

Total
 
$
3,115

 
$
0

 
$
3,115

 
$
0

 
$
(91
)
 
$
(2,913
)
 
$
111

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(1) The balances at December 31, 2012 and June 30, 2013 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements.

(2) The balances at December 31, 2012 and June 30, 2013 included $929 million and $2,052 million recorded in cash and cash equivalents, respectively, and $700 million and $770 million recorded in receivable under reverse repurchase agreements, respectively.



16


Offsetting of Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
 
 
Description
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Presented in the Consolidated Balance Sheets
 
Financial Instruments
 
 Cash Collateral Pledged
 
Non-Cash Collateral Pledged
 
Net Liabilities
Derivatives
 
$
7

 
$
0

 
$
7

 
$