10-Q 1 goog10-qq22018.htm 10-Q Document



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, 2018
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: 001-37580
________________________________________________________________________________________
Alphabet Inc.
(Exact name of registrant as specified in its charter)
________________________________________________________________________________________
Delaware
61-1767919
(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 website, 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth 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
¨
Emerging growth company
¨
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨    No ý
As of July 18, 2018, there were 298,914,199 shares of Alphabet’s Class A common stock outstanding, 46,880,076 shares of Alphabet's Class B common stock outstanding, and 349,883,498 shares of Alphabet's Class C capital stock outstanding.




Alphabet Inc.

Alphabet Inc.
Form 10-Q
For the Quarterly Period Ended June 30, 2018
TABLE OF CONTENTS
 
 
Page No.
 
Item 1
 
 
 
 
 
Item 2
Item 3
Item 4
 
 
 
Item 1
Item 1A
Item 2
Item 6
 

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Alphabet Inc.

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;
our plans to continue to invest in new businesses, products, services and technologies, systems, facilities, and infrastructure, to continue to hire aggressively and provide competitive compensation programs, as well as to continue to invest in acquisitions;
seasonal fluctuations in internet usage and advertiser expenditures, underlying business trends such as traditional retail seasonality, and macroeconomic conditions, which are likely to cause fluctuations in our quarterly results;
the potential for declines in our revenue growth rate;
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 our revenue growth, as well as the change in paid clicks and cost-per-click on Google properties and the change in impressions and cost-per-impression on Google Network Members’ properties, and various factors contributing to such fluctuations;
our expectation that our foreign exchange risk management program will not fully offset our net exposure to fluctuations in foreign currency exchange rates;
the expected variability of costs related to hedging activities under our foreign exchange risk management program;
the anticipated effect of, and our response to, new accounting pronouncements;
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, proceedings, and other contingencies;
our expectation that our monetization trends will fluctuate, which could affect our revenues and margins in the future;
our expectation that our traffic acquisition costs (TAC) and the associated TAC rates will increase in the future;
our expectation that our results will be affected by our performance in international markets as users in developing economies increasingly come online;
our expectation that the portion of our revenues that we derive from non-advertising revenues will continue to increase and may affect margins;
our expectation that our other income (expense), net, will fluctuate in the future, as it is largely driven by market dynamics;
estimates of our future compensation expenses;
fluctuations in our effective tax rate;
the effect of the U.S. Tax Cuts and Jobs Act (Tax Act);
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;
our expectations related to the operating structure implemented pursuant to the Alphabet holding company reorganization;
the expected timing and amount of Alphabet Inc.'s share repurchases;
as well as other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements may appear throughout this report and other documents we file with the Securities and Exchange Commission (SEC), including without limitation, the following sections: Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Quarterly Report on Form 10-Q and Part I, Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, as may be updated in our subsequent Quarterly Reports on Form 10-Q. Forward-looking statements generally can be identified by words such as "anticipates," "believes," "estimates," "expects," "intends," "plans," "predicts," "projects," "will be," "will continue," "may," "could," "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 in Part I, Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, and those discussed in other documents we file with the SEC. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required

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Alphabet Inc.

by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
As used herein, "Alphabet," "the company," "we," "us," "our," and similar terms include Alphabet Inc. and its subsidiaries, unless the context indicates otherwise.
"Alphabet," "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.


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Alphabet Inc.

PART I.
FINANCIAL INFORMATION
ITEM 1.
FINANCIAL STATEMENTS
Alphabet Inc.
CONSOLIDATED BALANCE SHEETS
(in millions, except share amounts which are reflected in thousands, and par value per share amounts)
 
As of
December 31, 2017
 
As of
June 30, 2018
 
 
 
(unaudited)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
10,715

 
$
14,148

Marketable securities
91,156

 
88,106

Total cash, cash equivalents, and marketable securities
101,871

 
102,254

Accounts receivable, net of allowance of $674 and $630
18,336

 
17,043

Income taxes receivable, net
369

 
201

Inventory
749

 
698

Other current assets
2,983

 
3,961

Total current assets
124,308

 
124,157

Non-marketable investments
7,813

 
11,487

Deferred income taxes
680

 
685

Property and equipment, net
42,383

 
51,672

Intangible assets, net
2,692

 
2,662

Goodwill
16,747

 
17,895

Other non-current assets
2,672

 
3,052

Total assets
$
197,295

 
$
211,610

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
3,137

 
$
3,369

Accrued compensation and benefits
4,581

 
4,642

Accrued expenses and other current liabilities
10,177

 
15,261

Accrued revenue share
3,975

 
3,728

Deferred revenue
1,432

 
1,714

Income taxes payable, net
881

 
1,189

Total current liabilities
24,183

 
29,903

Long-term debt
3,969

 
3,981

Deferred revenue, non-current
340

 
358

Income taxes payable, non-current
12,812

 
11,652

Deferred income taxes
430

 
479

Other long-term liabilities
3,059

 
3,237

Total liabilities
44,793

 
49,610

Commitments and Contingencies (Note 9)

 

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 Class C capital stock and additional paid-in capital, $0.001 par value per share: 15,000,000 shares authorized (Class A 9,000,000, Class B 3,000,000, Class C 3,000,000); 694,783 (Class A 298,470, Class B 46,972, Class C 349,341) and 695,946 (Class A 298,895, Class B 46,891, Class C 350,160) shares issued and outstanding
40,247

 
42,243

Accumulated other comprehensive loss
(992
)
 
(1,525
)
Retained earnings
113,247

 
121,282

Total stockholders’ equity
152,502

 
162,000

Total liabilities and stockholders’ equity
$
197,295

 
$
211,610

See accompanying notes.

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Alphabet Inc.

Alphabet Inc.
CONSOLIDATED STATEMENTS OF INCOME
(in millions, except per share amounts; unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2018
 
2017
 
2018
Revenues
$
26,010

 
$
32,657

 
$
50,760

 
$
63,803

Costs and expenses:
 
 
 
 
 
 
 
Cost of revenues
10,373

 
13,883

 
20,168

 
27,350

Research and development
4,172

 
5,114

 
8,114

 
10,153

Sales and marketing
2,897

 
3,780

 
5,541

 
7,384

General and administrative
1,700

 
2,002

 
3,501

 
4,037

European Commission fines
2,736

 
5,071

 
2,736

 
5,071

Total costs and expenses
21,878

 
29,850

 
40,060

 
53,995

Income from operations
4,132

 
2,807

 
10,700

 
9,808

Other income (expense), net
245

 
1,408

 
496

 
4,950

Income before income taxes
4,377

 
4,215

 
11,196

 
14,758

Provision for income taxes
853

 
1,020

 
2,246

 
2,162

Net income
$
3,524

 
$
3,195

 
$
8,950

 
$
12,596

 
 
 
 
 
 
 
 
Basic net income per share of Class A and B common stock and Class C capital stock
$
5.09

 
$
4.60

 
$
12.94

 
$
18.13

Diluted net income per share of Class A and B common stock and Class C capital stock
$
5.01

 
$
4.54

 
$
12.74

 
$
17.89

See accompanying notes.

4

Alphabet Inc.

Alphabet Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions; unaudited)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2018
 
2017
 
2018
Net income
$
3,524

 
$
3,195

 
$
8,950

 
$
12,596

Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in foreign currency translation adjustment
565

 
(1,142
)
 
1,016

 
(485
)
Available-for-sale investments:
 
 
 
 
 
 
 
Change in net unrealized gains (losses)
86

 
(148
)
 
225

 
(356
)
Less: reclassification adjustment for net (gains) losses included in net income
26

 
(6
)
 
51

 
33

Net change (net of tax effect of $0, $60, $0, and $60)
112

 
(154
)
 
276

 
(323
)
Cash flow hedges:
 
 
 
 
 
 
 
Change in net unrealized gains (losses)
(230
)
 
363

 
(459
)
 
101

Less: reclassification adjustment for net (gains) losses included in net income
(6
)
 
78

 
(159
)
 
272

Net change (net of tax effect of $143, $109, $292, and $97)
(236
)
 
441

 
(618
)
 
373

Other comprehensive income (loss)
441

 
(855
)
 
674

 
(435
)
Comprehensive income
$
3,965

 
$
2,340

 
$
9,624

 
$
12,161

See accompanying notes.

5

Alphabet Inc.

Alphabet Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions; unaudited)
 
Six Months Ended
 
June 30,
 
2017
 
2018
Operating activities
 
 
 
Net income
$
8,950

 
$
12,596

Adjustments:
 
 
 
Depreciation and impairment of property and equipment
2,711

 
3,653

Amortization and impairment of intangible assets
417

 
447

Stock-based compensation expense
4,012

 
4,870

Deferred income taxes
538

 
(157
)
(Gain) loss on debt and equity securities, net
22

 
(4,060
)
Other
96

 
(120
)
Changes in assets and liabilities, net of effects of acquisitions:
 
 
 
Accounts receivable
431

 
1,388

Income taxes, net
(1,779
)
 
(656
)
Other assets
(454
)
 
(756
)
Accounts payable
119

 
(23
)
Accrued expenses and other liabilities
1,687

 
4,600

Accrued revenue share
6

 
(303
)
Deferred revenue
195

 
295

Net cash provided by operating activities
16,951

 
21,774

Investing activities
 
 
 
Purchases of property and equipment
(5,339
)
 
(12,776
)
Proceeds from disposals of property and equipment
54

 
49

Purchases of marketable securities
(39,676
)
 
(23,041
)
Maturities and sales of marketable securities
34,238

 
25,523

Purchases of non-marketable investments
(694
)
 
(732
)
Maturities and sales of non-marketable investments
118

 
1,191

Acquisitions, net of cash acquired, and purchases of intangible assets
(143
)
 
(1,434
)
Proceeds from collection of notes receivable
1,419

 
0

Net cash used in investing activities
(10,023
)
 
(11,220
)
Financing activities
 
 
 
Net payments related to stock-based award activities
(2,093
)
 
(2,699
)
Repurchases of capital stock
(2,745
)
 
(4,225
)
Proceeds from issuance of debt, net of costs
0

 
6,236

Repayments of debt
(56
)
 
(6,267
)
Proceeds from sale of subsidiary shares
480

 
0

Net cash used in financing activities
(4,414
)
 
(6,955
)
Effect of exchange rate changes on cash and cash equivalents
279

 
(166
)
Net increase in cash and cash equivalents
2,793

 
3,433

Cash and cash equivalents at beginning of period
12,918

 
10,715

Cash and cash equivalents at end of period
$
15,711

 
$
14,148

See accompanying notes.

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Alphabet Inc.

Alphabet Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Google was incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. In 2015, we implemented a holding company reorganization, and as a result, Alphabet Inc. (Alphabet) became the successor issuer to Google.
We generate revenues primarily by delivering relevant, cost-effective online advertising.
Basis of Consolidation
The consolidated financial statements of Alphabet include the accounts of Alphabet and entities consolidated under the variable interest and voting models. All intercompany balances and transactions have been eliminated.
Unaudited Interim Financial Information
The Consolidated Balance Sheets as of June 30, 2018, the Consolidated Statements of Income for the three and six months ended June 30, 2017 and 2018, the Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2017 and 2018, and the Consolidated Statements of Cash Flows for the six months ended June 30, 2017 and 2018 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, 2018, our results of operations for the three and six months ended June 30, 2017 and 2018, and our cash flows for the six months ended June 30, 2017 and 2018. The results of operations for the three and six months ended June 30, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018.
These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, filed with the SEC on February 5, 2018.
Use of Estimates
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, sales allowances, fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, and contingent liabilities, among others. We base our estimates on assumptions, both historical and forward looking, that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
Fair Value of Financial Instruments
Our financial assets and liabilities that are measured at fair value on a recurring basis include cash equivalents, marketable securities, derivative contracts, and non-marketable debt securities. Our financial assets that are measured at fair value on a nonrecurring basis include non-marketable equity securities measured at fair value when observable price changes are identified or are impaired. Other financial assets and liabilities are carried at cost with fair value disclosed, if required.
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 is determined based on assumptions that market participants would use in pricing an asset or a liability. Assets and liabilities recorded at fair value are measured and classified in accordance with a three-tier fair value hierarchy based on the observability of the inputs available in the market used to measure fair value:
Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - 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,

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Alphabet Inc.

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 requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
Recent Accounting Pronouncements
Recently issued accounting pronouncements not yet adopted
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-02 (Topic 842) "Leases." Topic 842 supersedes the lease requirements in Accounting Standards Codification (ASC) Topic 840, "Leases." Under Topic 842, lessees are required to recognize assets and liabilities on the balance sheet for most leases and provide enhanced disclosures. Leases will continue to be classified as either finance or operating. As currently issued, entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. There are additional optional practical expedients that an entity may elect to apply. Based on our current portfolio of leases, approximately $8 billion of lease assets and liabilities would be recognized on our balance sheet, primarily relating to real estate. We are in the process of implementing changes to our systems and processes in conjunction with our review of lease agreements. We will adopt Topic 842 effective January 1, 2019 and expect to elect certain available transitional practical expedients.
In June 2016, the FASB issued Accounting Standards Update No. 2016-13 (ASU 2016-13) "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost. ASU 2016-13 replaces the existing incurred loss impairment model with an expected loss model. It also eliminates the concept of other-than-temporary impairment and requires credit losses related to available-for-sale debt securities to be recorded through an allowance for credit losses rather than as a reduction in the amortized cost basis of the securities. These changes will result in earlier recognition of credit losses. ASU 2016-13 is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2019. We are currently in the process of evaluating the effect of the adoption of ASU 2016-13 on our consolidated financial statements.
Recently adopted accounting pronouncements
In January 2016, the FASB issued Accounting Standards Update No. 2016-01 (ASU 2016-01) "Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities," which amends various aspects of the recognition, measurement, presentation, and disclosure of financial instruments. We adopted ASU 2016-01 as of January 1, 2018 using the modified retrospective method for our marketable equity securities and the prospective method for our non-marketable equity securities. This resulted in a $98 million reclassification of net unrealized gains from accumulated other comprehensive income (AOCI) to opening retained earnings. We have elected to use the measurement alternative for our non-marketable equity securities, defined as cost adjusted for changes from observable transactions for identical or similar investments of the same issuer, less impairment. The adoption of ASU 2016-01 increases the volatility of our other income (expense), net, as a result of the remeasurement of our equity securities. For further information on unrealized gains from equity securities, see Note 3.
In October 2016, the FASB issued Accounting Standards Update No. 2016-16 (ASU 2016-16) "Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory." ASU 2016-16 generally accelerates the recognition of income tax consequences for asset transfers between entities under common control. We adopted ASU 2016-16 as of January 1, 2018 using a modified retrospective transition method, resulting in a $701 million reclassification of unrecognized income tax effects related to asset transfers that occurred prior to adoption from other current and non-current assets to opening retained earnings.
Prior Period Reclassifications
Certain amounts in prior periods have been reclassified to conform with current period presentation.
Note 2. Revenues
Revenue Recognition
Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

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The following table presents our revenues disaggregated by revenue source (in millions, unaudited). Sales and usage-based taxes are excluded from revenues.
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2018
 
2017
 
2018
Google properties
$
18,425

 
$
23,262

 
$
35,828

 
$
45,260

Google Network Members' properties
4,247

 
4,825

 
8,255

 
9,469

Google advertising revenues
22,672

 
28,087

 
44,083

 
54,729

Google other revenues
3,241

 
4,425

 
6,448

 
8,779

Other Bets revenues
97

 
145

 
229

 
295

Total revenues(1)
$
26,010

 
$
32,657

 
$
50,760

 
$
63,803

(1) 
Revenues include hedging gains (losses) of $3 million and $(103) million for the three months ended June 30, 2017 and 2018, respectively, and $220 million and $(342) million for the six months ended June 30, 2017 and 2018, respectively, which do not represent revenues recognized from contracts with customers.
The following table presents our revenues disaggregated by geography, based on the billing addresses of our customers (in millions, unaudited):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2018
 
2017
 
2018
United States
$
12,322

 
$
14,933

 
$
24,091

 
$
29,077

EMEA(1)
8,545

 
10,785

 
16,636

 
21,259

APAC(1)
3,730

 
5,090

 
7,349

 
9,894

Other Americas(1)
1,413

 
1,849

 
2,684

 
3,573

Total revenues(2)
$
26,010

 
$
32,657

 
$
50,760

 
$
63,803

(1) 
Regions represent Europe, the Middle East, and Africa (EMEA); Asia-Pacific (APAC); and Canada and Latin America (Other Americas).
(2) 
Revenues include hedging gains (losses) for the three and six months ended June 30, 2017 and 2018.
Advertising Revenues
We generate revenues primarily by delivering advertising on Google properties and Google Network Members’ properties.
Google properties revenues consist primarily of advertising revenues generated on Google.com, the Google Search app, and other Google owned and operated properties like Gmail, Google Maps, Google Play, and YouTube.
Google Network Members’ properties revenues consist primarily of advertising revenues generated on Google Network Members’ properties.
Our customers generally purchase advertising inventory through AdWords, DoubleClick AdExchange, and DoubleClick Bid Manager, among others.
We offer advertising on a cost-per-click basis, which means that an advertiser pays us only when a user clicks on an ad on Google properties or Google Network Members' properties or when a user views certain YouTube engagement ads. For these customers, we recognize revenue each time a user clicks on the ad or when a user views the ad for a specified period of time.
We also offer advertising on other bases such as cost-per-impression, which means an advertiser pays us based on the number of times their ads are displayed on Google properties or Google Network Members’ properties. For these customers, we recognize revenue each time an ad is displayed.
Certain customers may receive cash-based incentives or credits, which are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenues recognized. We believe that there will not be significant changes to our estimates of variable consideration.
For ads placed on Google Network Members’ properties, we evaluate whether we are the principal (i.e., report revenues on a gross basis) or agent (i.e., report revenues on a net basis). Generally, we report advertising revenues for ads placed on Google Network Members’ properties on a gross basis, that is, the amounts billed to our customers

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are recorded as revenues, and amounts paid to Google Network Members are recorded as cost of revenues. Where we are the principal, we control the advertising inventory before it is transferred to our customers. Our control is evidenced by our sole ability to monetize the advertising inventory before it is transferred to our customers, and is further supported by us being primarily responsible to our customers and having a level of discretion in establishing pricing.
Other Revenues
Google other revenues and Other Bets revenues consist primarily of revenues from:
Apps, in-app purchases, and digital content in the Google Play store;
Google Cloud offerings;
Hardware; and
Other miscellaneous products and services.
As it relates to Google other revenues, the most significant judgment is determining whether we are the principal or agent for app sales and in-app purchases through the Google Play store. We report revenues from these transactions on a net basis because our performance obligation is to facilitate a transaction between app developers and end users, for which we earn a commission. Consequently, the portion of the gross amount billed to end users that is remitted to app developers is not reflected as revenues.
Arrangements with Multiple Performance Obligations
Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate revenues to each performance obligation based on its relative standalone selling price. We generally determine standalone selling prices based on the prices charged to customers or using expected cost plus margin.
Deferred Revenues
We record deferred revenues when cash payments are received or due in advance of our performance, including amounts which are refundable. The increase in the deferred revenue balance for the six months ended June 30, 2018 is primarily driven by cash payments received or due in advance of satisfying our performance obligations, offset by $1.0 billion of revenues recognized that were included in the deferred revenue balance as of December 31, 2017.
Our payment terms vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer.
Practical Expedients and Exemptions
We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses.
We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.
Note 3. Financial Instruments
Debt Securities
We classify our marketable debt securities within Level 2 in the fair value hierarchy because we use quoted market prices to the extent available or alternative pricing sources and models utilizing market observable inputs to determine fair value. We reclassified our U.S. government notes included in marketable debt securities from Level 1 to Level 2 within the fair value hierarchy as these securities are priced based on a combination of quoted prices for identical or similar instruments in active markets and models with significant observable market inputs. Prior period amounts have been reclassified to conform with current period presentation. The vast majority of our government bond holdings are highly liquid U.S. government notes.
We classify our non-marketable debt securities within Level 3 in the fair value hierarchy because they are primarily preferred stock and convertible notes issued by private companies without quoted market prices. To estimate the fair value of our non-marketable debt securities, we use a combination of valuation methodologies, including market and income approaches based on prior transaction prices; estimated timing, probability, and amount of cash flows; and illiquidity considerations. Financial information of private companies may not be available and consequently we will estimate the fair value based on the best available information at the measurement date.

10

Alphabet Inc.

The following tables summarize our debt securities by significant investment categories as of December 31, 2017 and June 30, 2018 (in millions):
 
As of December 31, 2017
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Cash and Cash
Equivalents
 
Marketable
Securities
 
Non-Marketable
Securities
Level 2:
 
 
 
 
 
 
 
 
 
 
 
 
 
Time deposits(1)
$
359

 
$
0

 
$
0

 
$
359

 
$
357

 
$
2

 
$
0

Government bonds(2)
51,548

 
10

 
(406
)
 
51,152

 
1,241

 
49,911

 
0

Corporate debt securities
24,269

 
21

 
(135
)
 
24,155

 
126

 
24,029

 
0

Mortgage-backed and asset-backed securities
16,789

 
13

 
(180
)
 
16,622

 
0

 
16,622

 
0

 
92,965

 
44

 
(721
)
 
92,288

 
1,724

 
90,564

 
0

Level 3:
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-marketable debt securities
1,083

 
811

 
0

 
1,894

 
0

 
0

 
1,894

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
94,048

 
$
855

 
$
(721
)
 
$
94,182

 
$
1,724

 
$
90,564

 
$
1,894

 
As of June 30, 2018
 
Adjusted
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
Cash and Cash
Equivalents
 
Marketable
Securities
 
Non-Marketable
Securities
 
(unaudited)
Level 2:
 
 
 
 
 
 
 
 
 
 
 
 
 
Time deposits(1)
$
252

 
$
0

 
$
0

 
$
252

 
$
251

 
$
1

 
$
0

Government bonds(2)
48,567

 
11

 
(575
)
 
48,003

 
783

 
47,220

 
0

Corporate debt securities
24,490

 
10

 
(383
)
 
24,117

 
21

 
24,096

 
0

Mortgage-backed and asset-backed securities
15,746

 
3

 
(398
)
 
15,351

 
12

 
15,339

 
0

 
89,055

 
24

 
(1,356
)
 
87,723

 
1,067

 
86,656

 
0

Level 3:
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-marketable debt securities
1,026

 
1,184

 
0

 
2,210

 
0

 
0

 
2,210

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
90,081

 
$
1,208

 
$
(1,356
)
 
$
89,933

 
$
1,067

 
$
86,656

 
$
2,210

(1) 
The majority of our time deposits are foreign deposits.
(2) 
Government bonds are comprised primarily of U.S. government notes, and also includes U.S. government agencies, foreign government bonds, and municipal securities.   
We determine realized gains or losses on the sale of debt securities on a specific identification method. We recognized gross realized gains of $17 million and $37 million for the three months ended June 30, 2017 and 2018, respectively, and $162 million and $39 million for the six months ended June 30, 2017 and 2018, respectively. We recognized gross realized losses of $43 million and $31 million for the three months ended June 30, 2017 and 2018, respectively, and $213 million and $72 million for the six months ended June 30, 2017 and 2018, respectively. We reflect these gains and losses as a component of other income (expense), net, in the Consolidated Statements of Income.

11

Alphabet Inc.

The following table summarizes the estimated fair value of our investments in marketable debt securities with stated contractual maturity dates, accounted for as available-for-sale securities and classified by the contractual maturity date of the securities (in millions, unaudited):
 
As of
June 30, 2018
Due in 1 year
$
15,357

Due in 1 year through 5 years
57,525

Due in 5 years through 10 years
2,429

Due after 10 years
11,345

Total
$
86,656

The following tables present gross unrealized losses and fair values for those investments that were in an unrealized loss position as of December 31, 2017 and June 30, 2018, 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, 2017
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
Government bonds(1)
$
28,836

 
$
(211
)
 
$
17,660

 
$
(195
)
 
$
46,496

 
$
(406
)
Corporate debt securities
18,300

 
(114
)
 
1,710

 
(21
)
 
20,010

 
(135
)
Mortgage-backed and asset-backed securities
11,061

 
(105
)
 
3,449

 
(75
)
 
14,510

 
(180
)
Total
$
58,197

 
$
(430
)
 
$
22,819

 
$
(291
)
 
$
81,016

 
$
(721
)
 
As of June 30, 2018
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
Fair Value
 
Unrealized
Loss
 
(unaudited)
Government bonds(1)
$
32,284

 
$
(414
)
 
$
8,144

 
$
(161
)
 
$
40,428

 
$
(575
)
Corporate debt securities
19,955

 
(357
)
 
1,153

 
(26
)
 
21,108

 
(383
)
Mortgage-backed and asset-backed securities
11,139

 
(282
)
 
2,742

 
(116
)
 
13,881

 
(398
)
Total
$
63,378

 
$
(1,053
)
 
$
12,039

 
$
(303
)
 
$
75,417

 
$
(1,356
)
(1) 
Government bonds are comprised primarily of U.S. government notes, and also includes U.S. government agencies, foreign government bonds and municipal securities.   
During the three and six months ended June 30, 2017 and 2018, we did not recognize any significant other-than-temporary impairment losses. Losses on impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 6 for further details on other income (expense), net.

12

Alphabet Inc.

The following table presents a reconciliation for our non-marketable debt securities measured and recorded at fair value on a recurring basis, using significant unobservable inputs (Level 3) (in millions, unaudited):
 
Six Months Ended
 
June 30,
 
2017
 
2018
Beginning balance
$
1,165

 
$
1,894

Total net gains (losses)
 
 
 
    Included in earnings
(5
)
 
10

    Included in other comprehensive income
126

 
395

Purchases
70

 
12

Sales
(1
)
 
(41
)
Settlements
(3
)
 
(60
)
Ending balance
$
1,352

 
$
2,210

Equity Investments
The following discusses our marketable equity securities, non-marketable equity securities, realized and unrealized gains and losses on marketable and non-marketable equity securities, as well as our equity method investments.
Marketable equity securities
Our marketable equity securities are publicly traded stocks or funds measured at fair value and classified within Level 1 and 2 in the fair value hierarchy because we use quoted prices for identical assets in active markets or inputs that are based upon quoted prices for similar instruments in active markets.
Prior to January 1, 2018, we accounted for the majority of our marketable equity securities at fair value with unrealized gains and losses recognized in accumulated other comprehensive income on the balance sheet. Realized gains and losses on marketable equity securities sold or impaired were recognized in other income (expense), net.
On January 1, 2018, we adopted ASU 2016-01. Our marketable equity securities are measured at fair value. Starting January 1, 2018, unrealized gains and losses are recognized in other income (expense), net. Upon adoption, we reclassified $98 million net unrealized gains related to marketable equity securities from accumulated other comprehensive income to opening retained earnings.
The following table summarizes marketable equity securities measured at fair value by significant investment categories as of December 31, 2017 and June 30, 2018 (in millions):
 
 
As of December 31, 2017
 
 
Cash and
Cash
Equivalents
 
Marketable
Securities
Level 1:
 
 
 
 
Money market funds
 
$
1,833

 
$
0

Marketable equity securities
 
0

 
340

 
 
1,833

 
340

Level 2:
 
 
 
 
Mutual funds(1)
 
0

 
252

Total
 
$
1,833

 
$
592

(1) 
The fair value option was elected for mutual funds with gains (losses) recognized in other income (expense), net.

13

Alphabet Inc.

 
 
As of June 30, 2018
 
 
(unaudited)
 
 
Cash and Cash Equivalents
 
Marketable Securities
Level 1:
 
 
 
 
Money market funds
 
$
3,698

 
$
0

Marketable equity securities
 
0

 
1,211

 
 
3,698

 
1,211

Level 2:
 
 
 
 
Mutual funds
 
0

 
239

Total
 
$
3,698

 
$
1,450

Non-marketable equity securities
Our non-marketable equity securities are investments in privately held companies without readily determinable market values.
Prior to January 1, 2018, we accounted for our non-marketable equity securities at cost less impairment. Realized gains and losses on non-marketable securities sold or impaired were recognized in other income (expense), net. As of December 31, 2017, non-marketable equity securities accounted for under the cost method had a carrying value of $4.5 billion and a fair value of approximately $8.8 billion.
On January 1, 2018, we adopted ASU 2016-01 which changed the way we account for non-marketable securities. The carrying value of our non-marketable equity securities is adjusted to fair value for observable transactions for identical or similar investments of the same issuer or impairment (referred to as the measurement alternative). All gains and losses on non-marketable equity securities, realized and unrealized, are recognized in other income (expense), net. Because we adopted ASU 2016-01 prospectively, we recognize unrealized gains that occurred in prior periods in the first period after January 1, 2018 when there is an observable transaction for our securities. Non-marketable equity securities remeasured during the six months ended June 30, 2018 are classified within Level 3 in the fair value hierarchy because we estimate the value based on valuation methods using the observable transaction price at the transaction date and other unobservable inputs including volatility, rights, and obligations of the securities we hold.
The following is a summary of unrealized gains and losses recorded in other income (expense), net, and included as adjustments to the carrying value of non-marketable equity securities held as of June 30, 2018 (in millions, unaudited):
 
Three Months Ended June 30, 2018
 
Six Months Ended
June 30, 2018
Upward adjustments
$
572

 
$
3,080

Downward adjustments (including impairment)
(81
)
 
(104
)
Total unrealized gain (loss) for non-marketable equity securities
$
491

 
$
2,976

The following table summarizes the total carrying value of our non-marketable equity securities held as of June 30, 2018 including cumulative unrealized upward and downward adjustments made to the initial cost basis of the securities (in millions, unaudited):
Initial cost basis
 
$
4,952

Upward adjustments
 
3,080

Downward adjustments (including impairment)
 
(104
)
Total carrying value at the end of the period
 
$
7,928

During the three months ended June 30, 2018, included in the $7.9 billion of non-marketable equity securities, $1.6 billion were measured at fair value based on observable market transactions, resulting in a net unrealized gain of $491 million.

14

Alphabet Inc.

Gains and losses on marketable and non-marketable equity securities
Realized and unrealized gains and losses for our marketable and non-marketable equity securities for the three and six months ended June 30, 2018 are summarized below (in millions, unaudited):
 
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
Realized gain (loss) for equity securities sold during the period
$
515

 
$
900

Unrealized gain (loss) on equity securities held as of the end of the period(1)
547

 
3,193

Total gain (loss) recognized in other income (expense), net
$
1,062

 
$
4,093

(1) 
Includes $491 million and $2,976 million related to non-marketable equity securities for the three and six months ended June 30, 2018, respectively.
Investments accounted for under the Equity Method
As of December 31, 2017 and June 30, 2018, investments accounted for under the equity method had a carrying value of approximately $1.4 billion and $1.3 billion, respectively. Our share of gains and losses in equity method investments including impairment are included as a component of other income (expense), net, in the Consolidated Statements of Income. See Note 6 for further details on other income (expense), net.
Derivative Financial Instruments
We classify our foreign currency and interest rate derivative contracts primarily within Level 2 in the fair value hierarchy as the valuation inputs are based on quoted prices and market observable data of similar instruments.
We recognize derivative instruments as either assets or liabilities in the Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the Consolidated Statements of Income as either other income (expense), net, or revenues, or in the Consolidated Balance Sheets in AOCI, as discussed below. As a result of our adoption of Accounting Standard Update No. 2017-12 (ASU 2017-12) "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities," the components excluded from the assessment of hedge effectiveness are recognized in the same income statement line as the hedged item beginning January 1, 2018.
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 also use interest rate derivative contracts to hedge interest rate exposures on our fixed income securities and debt issuances. 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. As of December 31, 2017 and June 30, 2018, we received cash collateral related to the derivative instruments under our collateral security arrangements of $15 million and $443 million, respectively, which was included in other current assets.
Cash Flow Hedges
We use foreign currency forwards and option contracts, including collars (an option strategy comprised of a combination of purchased and written 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 $11.7 billion and $11.8 billion as of December 31, 2017 and June 30, 2018, respectively. These contracts have maturities of 24 months or less.
For forwards and option contracts, we exclude the change in the forward points and time value from our assessment of hedge effectiveness. The initial value of the excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in revenues. The difference between fair value changes of the excluded component and the amount amortized to revenues is recorded in AOCI. We reflect the gains or losses of a cash flow hedge included in our hedge effective assessment as a component of AOCI and subsequently reclassify these gains and losses to revenues when the hedged transactions are recorded. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI are immediately reclassified to other income (expense), net.

15

Alphabet Inc.

As of June 30, 2018, the net gain or loss of our foreign currency cash flow hedges before tax effect was a net accumulated gain of $248 million, of which a net gain of $248 million is expected to be reclassified from AOCI into earnings within the next 12 months.
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. We exclude changes in forward points for the forward contracts from the assessment of hedge effectiveness. We recognize changes in the excluded component in other income (expense), net. The notional principal of these contracts was $2.9 billion and $1.5 billion as of December 31, 2017 and June 30, 2018, respectively.
Gains and losses on these forward contracts are recognized in other income (expense), net, along with the offsetting gains and losses of the related hedged items.
Other Derivatives
Other derivatives not designated as hedging instruments consist of foreign currency forward 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 other income (expense), net, along with the foreign currency gains and losses on monetary assets and liabilities. The notional principal of the outstanding foreign exchange contracts was $15.2 billion and $16.0 billion as of December 31, 2017 and June 30, 2018, respectively.
The fair values of our outstanding derivative instruments were as follows (in millions):
 
 
 
As of December 31, 2017
  
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
Other current and non-current assets
 
$
51

 
$
29

 
$
80

Total
 
 
$
51

 
$
29

 
$
80

Derivative Liabilities:
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
Foreign exchange contracts
Accrued expenses and other liabilities, current and non-current
 
$
230

 
$
122

 
$
352

Total
 
 
$
230

 
$
122

 
$
352


16

Alphabet Inc.

 
 
 
As of June 30, 2018
  
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
Other current and non-current assets
 
$
310

 
$
111

 
$
421

Total
 
 
$
310

 
$
111

 
$
421

Derivative Liabilities:
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
Foreign exchange contracts
Accrued expenses and other liabilities, current and non-current
 
$
2

 
$
221

 
$
223

Total
 
 
$
2

 
$
221

 
$
223

The gains (losses) on derivatives in cash flow hedging relationships recognized in other comprehensive income (OCI) is summarized below (in millions, unaudited):
 
Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
Derivatives in Cash Flow Hedging Relationship
2017
 
2018
 
2017
 
2018
Foreign exchange contracts
 
 
 
 
 
 
 
Amount included in the assessment of effectiveness
$
(374
)
 
$
443

 
$
(687
)
 
$
124

Amount excluded from the assessment of effectiveness
0

 
8

 
0

 
1

Total
$
(374
)
 
$
451

 
$
(687
)
 
$
125

 
The effect of derivative instruments on income is summarized below (in millions, unaudited):

17

Alphabet Inc.

 
 
Gains (Losses) Recognized in Income
 
 
Three Months Ended
 
 
June 30,
 
 
2017
 
2018
 
 
Revenues
 
Other income (expense), net
 
Revenues
 
Other income (expense), net
Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded
 
$
26,010

 
$
245

 
$
32,657

 
$
1,408

 
 
 
 
 
 
 
 
 
Gains (Losses) on Derivatives in Cash Flow Hedging Relationship:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
 
Amount of gains (losses) reclassified from AOCI to income
 
$
3

 
$
0

 
$
(101
)
 
$
0

Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach
 
0

 
0

 
(2
)
 
0

Amount excluded from the assessment of effectiveness
 
0

 
20

 
0

 
0

Gains (Losses) on Derivatives in Fair Value Hedging Relationship:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
 
Hedged items
 
0

 
85

 
0

 
(158
)
Derivatives designated as hedging instruments
 
0

 
(85
)
 
0

 
158

Amount excluded from the assessment of effectiveness
 
0

 
5

 
0

 
10

Gains (Losses) on Derivatives Not Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
0

 
(22
)
 
0

 
200

Total gains (losses)
 
$
3

 
$
3

 
$
(103
)
 
$
210


18

Alphabet Inc.

 
 
Gains (Losses) Recognized in Income
 
 
Six Months Ended
 
 
June 30,
 
 
2017
 
2018
 
 
Revenues
 
Other income (expense), net
 
Revenues
 
Other income (expense), net
Total amounts presented in the Consolidated Statements of Income in which the effects of cash flow and fair value hedges are recorded
 
$
50,760

 
$
496

 
$
63,803

 
$
4,950

 
 
 
 
 
 
 
 
 
Gains (Losses) on Derivatives in Cash Flow Hedging Relationship:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
 
Amount of gains (losses) reclassified from AOCI to income
 
$
220

 
$
0

 
$
(348
)
 
$
0

Amount excluded from the assessment of effectiveness recognized in earnings based on an amortization approach
 
0

 
0

 
6

 
0

Amount excluded from the assessment of effectiveness
 
0

 
46

 
0

 
0

Gains (Losses) on Derivatives in Fair Value Hedging Relationship:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
 
Hedged items
 
0

 
136

 
0

 
(45
)
Derivatives designated as hedging instruments
 
0

 
(136
)
 
0

 
45

Amount excluded from the assessment of effectiveness
 
0

 
9

 
0

 
21

Gains (Losses) on Derivatives Not Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
 
 
 
 
 
 
 
Derivatives not designated as hedging instruments
 
0

 
(224
)
 
0

 
100

Total gains (losses)
 
$
220

 
$
(169
)
 
$
(342
)
 
$
121


19

Alphabet Inc.

Offsetting of Derivatives
We present our forwards and purchased options at gross fair values in the Consolidated Balance Sheets. For foreign currency collars, we present at net fair values where both purchased and written options are with the same counterparty. Our master netting and other similar arrangements allow net settlements under certain conditions. As of December 31, 2017 and June 30, 2018, information related to these offsetting arrangements were as follows (in millions):
Offsetting of Assets
 
As of December 31, 2017
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
 
 
 
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
$
102

 
$
(22
)
 
$
80

 
$
(64
)
(1) 
$
(4
)
 
$
(2
)
 
$
10

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of June 30, 2018
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
 
 
 
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
 
(unaudited)
Derivatives
$
451

 
$
(30
)
 
$
421

 
$
(95
)
(1) 
$
(300
)
 
$
0

 
$
26

(1) 
The balances as of December 31, 2017 and June 30, 2018 were related to derivative liabilities which are allowed to be net settled against derivative assets in accordance with our master netting agreements.
Offsetting of Liabilities
 
As of December 31, 2017
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
 
 
 
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
$
374

 
$
(22
)
 
$
352

 
$
(64
)
(2) 
$
0

 
$
0

 
$
288

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of June 30, 2018
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
 
 
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
 
(unaudited)
Derivatives
$
253

 
$
(30
)
 
$
223

 
$
(95
)
(2) 
$
0

 
$
0

 
$
128

(2) 
The balances as of December 31, 2017 and June 30, 2018 were related to derivative assets which are allowed to be net settled against derivative liabilities in accordance with our master netting agreements.
Note 4. Variable Interest Entities (VIEs)
Consolidated VIEs
We consolidate VIEs in which we hold a variable interest and are the primary beneficiary. We are the primary beneficiary because we have the power to direct activities that most significantly affect their economic performance and have the obligation to absorb the majority of their losses or benefits. The results of operations and financial position of these VIEs are included in our consolidated financial statements.

20

Alphabet Inc.

For certain consolidated VIEs, their assets are not available to us and their creditors do not have recourse to us. As of December 31, 2017 and June 30, 2018, assets that can only be used to settle obligations of these VIEs were $1.7 billion and $1.5 billion, respectively, and the liabilities for which creditors do not have recourse to us were $997 million and $949 million, respectively.
Calico
Calico is a life science company with a mission to harness advanced technologies to increase our understanding of the biology that controls lifespan.
In September 2014, AbbVie Inc. (AbbVie) and Calico entered into a research and development collaboration agreement intended to help both companies discover, develop, and bring to market new therapies for patients with age-related diseases, including neurodegeneration and cancer. In the second quarter of 2018, AbbVie and Calico amended the collaboration agreement resulting in an increase in total commitments. As of June 30, 2018, AbbVie has contributed $750 million to fund the collaboration pursuant to the agreement and is committed to an additional $500 million which will be paid by the fourth quarter of 2019. As of June 30, 2018, Calico has contributed $250 million and has committed up to an additional $1.0 billion.
Calico has used its scientific expertise to establish a world-class research and development facility, with a focus on drug discovery and early drug development; and AbbVie provides scientific and clinical development support and its commercial expertise to bring new discoveries to market. Both companies share costs and profits for projects covered under this agreement equally. AbbVie's contribution has been recorded as a liability on Calico's financial statements, which is reduced and reflected as a reduction to research and development expense as eligible research and development costs are incurred by Calico.
As of June 30, 2018, we have contributed $240 million to Calico in exchange for Calico convertible preferred units and are committed to fund up to an additional $990 million on an as-needed basis and subject to certain conditions.
Verily
Verily is a life science company with a mission to make the world's health data useful so that people enjoy healthier lives.
In 2017, Temasek, a Singapore-based investment company, purchased a noncontrolling interest in Verily for an aggregate of $800 million in cash. The transaction was accounted for as an equity transaction and no gain or loss was recognized. Noncontrolling interest and net loss attributable to noncontrolling interest were not separately presented on our consolidated financial statements as of and for the three and six months ended June 30, 2018 as the amounts were not material.
Unconsolidated VIEs
Certain renewable energy investments included in our non-marketable equity investments accounted for under the equity method are VIEs. These entities' activities involve power generation using renewable sources. We have determined that the governance structures of these entities do not allow us to direct the activities that would significantly affect their economic performance such as setting operating budgets. Therefore, we do not consolidate these VIEs in our consolidated financial statements. The carrying value and maximum exposure of these VIEs were $896 million and $759 million as of December 31, 2017 and June 30, 2018, respectively. The maximum exposure is based on current investments to date. We have determined the single source of our exposure to these VIEs is our capital investment in them.
Other unconsolidated VIEs were not material as of December 31, 2017 and June 30, 2018.
Note 5. Debt
Short-Term Debt
We have a debt financing program of up to $5.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. We had no commercial paper outstanding as of December 31, 2017 and June 30, 2018, respectively.

21

Alphabet Inc.

Long-Term Debt
Google issued $3.0 billion of senior unsecured notes in three tranches (collectively, 2011 Notes) in May 2011, due in 2014, 2016, and 2021, as well as $1.0 billion of senior unsecured notes (2014 Notes) in February 2014 due in 2024.
In April 2016, we completed an exchange offer with eligible holders of Google’s 2011 Notes due 2021 and 2014 Notes due 2024 (collectively, the Google Notes). An aggregate principal amount of approximately $1.7 billion of the Google Notes was exchanged for approximately $1.7 billion of Alphabet notes with identical interest rate and maturity. Because the exchange was between a parent and the subsidiary company and for substantially identical notes, the change was treated as a debt modification for accounting purposes with no gain or loss recognized.
In August 2016, Alphabet issued $2.0 billion of senior unsecured notes (2016 Notes) due 2026. The net proceeds from the issuance of the 2016 Notes were used for general corporate purposes, including the repayment of outstanding commercial paper. The Alphabet notes due in 2021, 2024, and 2026 rank equally with each other and are structurally subordinate to the outstanding Google Notes.
The total outstanding long-term debt is summarized below (in millions):
 
As of
December 31, 2017
 
As of
June 30, 2018
 
 
 
(unaudited)
Long-term debt
 
 
 
3.625% Notes due on May 19, 2021
$
1,000

 
$
1,000

3.375% Notes due on February 25, 2024
1,000

 
1,000

1.998% Notes due on August 15, 2026
2,000

 
2,000

Unamortized discount for the Notes above
(57
)
 
(53
)
Subtotal(1)
$
3,943

 
$
3,947

Capital lease obligation
26

 
34

Total long-term debt
$
3,969

 
$
3,981

(1) 
Includes the outstanding (and unexchanged) Google Notes issued in 2011 and 2014 and the Alphabet notes exchanged in 2016.
The effective interest yields based on proceeds received from the outstanding notes due in 2021, 2024, and 2026 were 3.734%, 3.377%, and 2.231%, respectively, with interest payable semi-annually. We may redeem these notes at any time in whole or in part at specified redemption prices. The total estimated fair value of all outstanding notes was approximately $4.0 billion as of December 31, 2017 and $3.8 billion as of June 30, 2018. The fair value was determined based on observable market prices of identical instruments in less active markets and is categorized accordingly as Level 2 in the fair value hierarchy.
Credit Facility
As of June 30, 2018, we have a $4.0 billion revolving credit facility which expires in February 2021. The interest rate for the credit facility is determined based on a formula using certain market rates. No amounts were outstanding under the credit facility as of December 31, 2017 and June 30, 2018.

22

Alphabet Inc.

Note 6. Supplemental Financial Statement Information
Property and Equipment, Net
Property and equipment, net, consisted of the following (in millions):
 
As of
December 31, 2017
 
As of
June 30, 2018
 
 
 
(unaudited)
Land and buildings
$
23,183

 
$
27,253

Information technology assets
21,429

 
26,148

Construction in progress
10,491

 
13,669

Leasehold improvements
4,496

 
4,758

Furniture and fixtures
48

 
48

Property and equipment, gross
59,647

 
71,876

Less: accumulated depreciation
(17,264
)
 
(20,204
)
Property and equipment, net
$
42,383

 
$
51,672

As of December 31, 2017 and June 30, 2018, assets under capital lease with a cost basis of $390 million and $520 million were included in property and equipment, respectively.
Accrued expenses and other current liabilities
Accrued expenses and other current liabilities consisted of the following (in millions):
 
As of
December 31, 2017
 
As of
June 30, 2018
 
 
 
(unaudited)
European Commission fines(1)
$
2,874

 
$
7,914

Accrued customer liabilities
1,489

 
1,445

Other accrued expenses and current liabilities
5,814

 
5,902

Accrued expenses and other current liabilities
$
10,177

 
$
15,261

(1) 
Includes the effects of foreign exchange and interest. See Note 9 for further details.
Accumulated Other Comprehensive Income (Loss)
The components of AOCI, net of tax, were as follows (in millions, unaudited):
 
Foreign Currency Translation Adjustments
 
Unrealized Gains (Losses) on Available-for-Sale Investments
 
Unrealized Gains (Losses) on Cash Flow Hedges
 
Total
Balance as of December 31, 2016
$
(2,646
)
 
$
(179
)
 
$
423

 
$
(2,402
)
Other comprehensive income (loss) before reclassifications
1,016

 
225

 
(459
)
 
782

Amounts reclassified from AOCI
0

 
51

 
(159
)
 
(108
)
Other comprehensive income (loss)
1,016

 
276

 
(618
)
 
674

Balance as of June 30, 2017
$
(1,630
)
 
$
97

 
$
(195
)
 
$
(1,728
)

23

Alphabet Inc.

 
Foreign Currency Translation Adjustments
 
Unrealized Gains (Losses) on Available-for-Sale Investments
 
Unrealized Gains (Losses) on Cash Flow Hedges
 
Total
Balance as of December 31, 2017
$
(1,103
)
 
$
233

 
$
(122
)
 
$
(992
)
Other comprehensive income (loss) before reclassifications(1)
(485
)
 
(454
)
 
100

 
(839
)
Amounts excluded from the assessment of hedge effectiveness recorded in AOCI
0

 
0

 
1

 
1

Amounts reclassified from AOCI
0

 
33

 
272

 
305

Other comprehensive income (loss)
(485
)
 
(421
)
 
373

 
(533
)
Balance as of June 30, 2018
$
(1,588
)
 
$
(188
)
 
$
251

 
$
(1,525
)
(1) 
The change in unrealized gains (losses) on available-for-sale investments included a $98 million reclassification of net unrealized gains related to marketable equity securities from AOCI to opening retained earnings as a result of the adoption of ASU 2016-01 on January 1, 2018.

The effects on net income of amounts reclassified from AOCI were as follows (in millions, unaudited):
 
 
 
 
Gains (Losses) Reclassified from AOCI to the Consolidated Statements of Income
 
 
 
 
Three Months Ended
 
Six Months Ended
 
 
 
 
June 30,
 
June 30,
 AOCI Components
 
Location
 
2017
 
2018
 
2017
 
2018
Unrealized gains (losses) on available-for-sale investments
 
 
 
 
 
 
 
 
 
 
Other income (expense), net
 
$
(26
)
 
$
6

 
$
(51
)
 
$
(33
)
 
 
Provision for income taxes
 
0

 
0

 
0

 
0

 
 
Net of tax
 
$
(26
)
 
$
6

 
$
(51
)
 
$
(33
)
Unrealized gains (losses) on cash flow hedges
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
Revenue
 
$
3

 
$
(101
)
 
$
220

 
$
(348
)
Interest rate contracts
 
Other income (expense), net
 
2

 
1

 
3

 
2

 
 
Benefit (provision) for income taxes
 
1

 
22

 
(64
)
 
74

 
 
Net of tax
 
$
6

 
$
(78
)
 
$
159

 
$
(272
)
Total amount reclassified, net of tax
 
$
(20
)
 
$
(72
)
 
$
108

 
$
(305
)
Other Income (Expense), Net
The components of other income (expense), net, were as follows (in millions, unaudited):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2017
 
2018
 
2017
 
2018
Interest income
$
294

 
$
456

 
$
606

 
$
855

Interest expense(1)
(21
)
 
(27
)
 
(46
)
 
(57
)
Foreign currency exchange losses, net
(46
)
 
(33
)
 
(48
)
 
(57
)
Gain (loss) on debt securities, net
(26
)
 
6

 
(51
)
 
(33
)
Gain on equity securities, net
23

 
1,062

 
29

 
4,093

Loss and impairment from equity method investments, net
(13
)
 
(105
)
 
(62
)
 
(112
)
Other
34

 
49

 
68

 
261

Other income (expense), net
$
245

 
$
1,408

 
$
496

 
$
4,950

(1) 
Interest expense is net of $12 million and $23 million of interest capitalized for the three months ended June 30, 2017 and 2018, respectively, and $19 million and $39 million for the six months ended June 30, 2017 and 2018, respectively.

24

Alphabet Inc.

Note 7. Acquisitions
Agreement with HTC Corporation (HTC)
In January 2018, we completed the acquisition of a team of engineers and a non-exclusive license of intellectual property from HTC for $1.1 billion in cash. In aggregate, $10 million was cash acquired, $165 million was attributed to intangible assets, $934 million was attributed to goodwill, and $9 million was attributed to net liabilities assumed. Goodwill, which was included in Google, is not deductible for tax purposes. We expect this transaction to accelerate Google’s ongoing hardware efforts. The transaction was accounted for as a business combination.
Other Acquisitions
During the six months ended June 30, 2018, we completed other acquisitions and purchases of intangible assets for total consideration of approximately $520 million. In aggregate, $10 million was cash acquired, $273 million was attributed to intangible assets, $268 million was attributed to goodwill, and $31 million was attributed to net liabilities assumed. These acquisitions generally enhance the breadth and depth of our offerings and expand our expertise in engineering and other functional areas. The amount of goodwill expected to be deductible for tax purposes is approximately $78 million.
Pro forma results of operations for these acquisitions, including HTC, have not been presented because they are not material to the consolidated results of operations, either individually or in the aggregate.
For all intangible assets acquired and purchased during the six months ended June 30, 2018, patents and developed technology have a weighted-average useful life of 3.8 years, customer relationships have a weighted-average useful life of 2.2 years, and trade names and other have a weighted-average useful life of 3.7 years.
Note 8. Goodwill and Other Intangible Assets
Goodwill
Changes in the carrying amount of goodwill for the six months ended June 30, 2018 were as follows (in millions, unaudited):
 
Google
 
Other Bets
 
Total Consolidated
Balance as of December 31, 2017
$
16,295