News Column

GOOGLE INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

February 12, 2014

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes included under Item 8 of this Annual Report on Form 10-K. Overview Google is a global technology leader focused on improving the ways people connect with information. We aspire to build products and provide services that improve the lives of billions of people globally. Our mission is to organize the world's information and make it universally accessible and useful. Our innovations in web search and advertising have made our website a top internet property and our brand one of the most recognized in the world. Our Google segment generates revenues primarily by delivering relevant, cost-effective online advertising. Businesses use our AdWords program and AdSense program to promote their products and services with advertising on both Google-owned properties and publishers' sites across the web. Our Motorola Mobile segment is focused on mobile wireless devices and related products and services and generates revenues primarily by selling hardware products. In January 2014, we entered into an agreement with Lenovo providing for the disposition of the Motorola Mobile segment. The transaction is expected to close in 2014. The Motorola Home segment was focused on technologies and devices that provide video entertainment services to consumers by enabling subscribers to access a variety of interactive digital television services. In December 2012, we entered into an agreement for the disposition of the Motorola Home segment. The transaction closed on April 17, 2013. All financial results related to Motorola Home were presented as net income (loss) from discontinued operations on the Consolidated Statements of Income. Trends in Our Businesses Advertising transactions continue to shift from offline to online as the digital economy evolves. This has contributed to the rapid growth of our business since inception, resulting in substantially increased revenues, and we expect that our business will continue to grow. However, our revenue growth rate has generally declined over time, and it could do so in the future as a result of a number of factors, including increasing competition, our investments in new business strategies, products, services, and technologies, changes in our product mix, shifts in the geographic mix of our revenues, query growth rates and how users make queries, challenges in maintaining our growth rate as our revenues increase to higher levels, and the evolution of the online advertising market, including the increasing variety of online platforms for advertising, and other markets in which we participate. Our users are increasingly connected to the internet and using multiple devices to access our products and services, a trend that has increased our global search queries and changed our platform mix. We expect that our revenue growth rate will continue to be affected by evolving consumer preferences, as well as by advertising trends, the acceptance by users of our products and services as they are delivered on diverse devices, and our ability to create a seamless experience for both users and advertisers in this multi-screen environment. The main focus of our advertising programs is to help businesses reach people in the moments that matter across all devices with smarter ads that are relevant to their intent and context, reflecting our commitment to constantly improve their overall web experience. As a result, we expect to continue to take steps to improve the relevance of the ads displayed on our websites and our Google Network Members' websites. These steps include not displaying ads that generate low click-through rates or that send users to irrelevant or otherwise low-quality websites, updating our advertising policies and ensuring their compliance, and terminating our relationships with those Google Network Members whose websites do not meet our quality requirements. We may also continue to take steps to reduce the number of accidental clicks by our users. These steps could negatively affect the growth rate of our revenues. Both seasonal fluctuations in internet usage and traditional retail seasonality have affected, and are likely to continue to affect, our business. Internet usage generally slows during the summer months, and commercial queries typically increase significantly in the fourth quarter of each year. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenues, as well as aggregate paid clicks and average cost-per-click growth rates. The operating margin we realize on revenues generated from ads placed on our Google Network Members' websites through our AdSense program is significantly lower than the operating margin we realize from revenues generated from ads placed on our websites because most of the advertiser fees from ads served on Google Network Members' websites are shared with our Google Network Members. For the past five years, growth in advertising 25



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revenues from our websites has generally exceeded that from our Google Network Members' websites. This trend has had a positive impact on our operating margins, and we expect that this will continue for the foreseeable future, although the relative rate of growth in revenues from our websites compared to the rate of growth in revenues from our Google Network Members' websites may vary over time. Also, the margins on advertising revenues from mobile phones and other newer advertising formats are generally lower than those from desktop computers and tablets. We expect this trend to continue to pressure our margins, particularly if we fail to realize the opportunities we anticipate with the transition to a dynamic multi-screen environment. We conduct our Motorola Mobile business in highly competitive markets, facing both new and established competitors. The markets for many of our products are characterized by rapidly changing technologies, frequent new product introductions, changing consumer trends, short product life cycles, consumer loyalty and evolving industry standards. Market disruptions caused by new technologies, the entry of new competitors, consolidations among our customers and competitors, changes in regulatory requirements, changes in economic conditions, supply chain interruptions or other factors, can introduce volatility into our businesses. Meeting all of these challenges requires consistent operational planning and execution and investment in technology, resulting in innovative products that meet the needs of our customers around the world. From an overall business perspective, we continue to invest aggressively in areas of strategic focus, our systems, data centers, corporate facilities, information technology infrastructure, and employees. We expect to continue to hire aggressively for 2014 and provide competitive compensation programs to our employees. Our full-time employee headcount was 53,861 (including 11,113 headcount from Motorola Mobile and 5,204 from Motorola Home) at December 31, 2012, and 47,756 (including 3,894 headcount from Motorola Mobile) at December 31, 2013. Acquisitions will also remain an important component of our strategy and use of capital. We expect our cost of revenues will increase in dollars and may increase as a percentage of revenues in future periods, primarily as a result of forecasted increases in traffic acquisition costs, manufacturing and inventory-related costs, data center costs, content acquisition costs, credit card and other transaction fees, and other costs. In particular, traffic acquisition costs as a percentage of advertising revenues may increase in the future if we are unable to continue to improve the monetization or generation of revenues from traffic on our websites and our Google Network Members' websites. As we expand our advertising programs and other products to international markets, we continue to increase our exposure to fluctuations in foreign currency to U.S. dollar exchange rates. We have a foreign exchange risk management program that is designed to reduce our exposure to fluctuations in foreign currency exchange rates. However, this program will not fully offset the effect of fluctuations on our revenues and earnings. Other revenues consist of non-advertising revenues including licensing, hardware and digital content. We expect other revenues to continue to grow. However, operating margin on other revenues is generally lower than that on advertising revenues. Results of Operations We completed our acquisition of Motorola on May 22, 2012 (the acquisition date). In December 2012, we entered into an agreement for the disposition of the Motorola Home segment, and consequently, financial results related to Motorola Home were presented as net income (loss) from discontinued operations in the Consolidated Statements of Income in all periods presented. In April 2013, we completed the disposition of the Motorola Home segment. In January 2014, we entered into an agreement with Lenovo providing for the disposition of the Motorola Mobile segment. The transaction is expected to close in 2014. As we evaluate the impact of this agreement, we expect financial results of Motorola Mobile will be presented as net income (loss) from discontinued operations on the Consolidated Statements of Income and assets and liabilities of Motorola Mobile to be disposed of will be presented as held for sale on the Consolidated Balance Sheets beginning in the first quarter of 2014. Subsequent to the acquisition of Motorola, we initiated a restructuring plan of our Motorola business. See Note 9 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further discussion of this restructuring plan and the associated restructuring charges. The following table presents our historical operating results as a percentage of revenues for the periods indicated: 26



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Table of Contents Year Ended December 31, 2011 2012 2013 Consolidated Statements of Income Data: Revenues: Google (advertising and other) 100.0 % 91.8 % 92.8 % Motorola Mobile (hardware and other) 0.0 8.2



7.2

Total revenues 100.0 % 100.0 % 100.0 % Costs and expenses: Cost of revenues - Google (advertising and other) 34.8 34.2



36.8

Cost of revenues - Motorola Mobile (hardware and other) 0.0 6.9 6.5 Research and development 13.6 13.5 13.3 Sales and marketing 12.1 12.2 12.1 General and administrative 7.2 7.8 8.0 Charge related to the resolution of Department of Justice investigation 1.3 0 0 Total costs and expenses 69.0 % 74.6 % 76.7 % Income from operations 31.0 25.4 23.3 Interest and other income, net 1.5 1.3



0.9

Income from continuing operations before income taxes 32.5 26.7



24.2

Provision for income taxes 6.8 5.2



3.8

Net income from continuing operations 25.7 21.5



20.4

Net income (loss) from discontinued operations 0.0 (0.1 )

1.2 Net income 25.7 % 21.4 % 21.6 % Revenues by Segment The following table presents our segment revenues, by revenue source, for the periods presented (in millions): Year Ended December 31, 2011 2012 2013 Advertising revenues: Google websites $ 26,145$ 31,221$ 37,453



Google Network Members' websites 10,386 12,465 13,125 Total advertising revenues 36,531 43,686 50,578 Other revenues

1,374 2,353 4,972



Google segment revenues $ 37,905$ 46,039$ 55,550

Motorola Mobile segment revenues 0 4,136 4,443

Elimination and other 0 0 (168 ) Total revenues $ 37,905$ 50,175$ 59,825 Google segment The following table presents our Google segment revenues, by revenue source, as a percentage of total Google segment revenues for the periods presented: 27



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Table of Contents Year Ended December 31, 2011 2012 2013 Advertising revenues: Google websites 69.0 % 67.8 % 67.4 % Google Network Members' websites 27.4 27.1 23.6 Total advertising revenues 96.4 % 94.9 % 91.0 % Other revenues 3.6 5.1 9.0 Total revenues 100.0 % 100.0 % 100.0 %



Google websites as % of advertising revenues 71.6 % 71.5 %

74.0 % Google Network Members' websites as % of advertising revenues 28.4 % 28.5 % 26.0 % Our Google segment revenues increased $9,511 million from 2012 to 2013. This increase resulted primarily from an increase in advertising revenues generated by Google websites and an increase in other revenues, and to a lesser extent, an increase in advertising revenues generated by Google Network Members' websites. The increase in other revenues was mainly driven by higher sales related to digital content and hardware products. The increase in advertising revenues for Google websites and Google Network Members' websites resulted primarily from an increase in the number of paid clicks through our advertising programs, as paid clicks on Google websites and Google Network Members' websites increased approximately 25% from 2012 to 2013. The increase in the number of paid clicks generated through our advertising programs was due to certain monetization improvements including new and richer ad formats, an increase in aggregate traffic across all platforms, the continued global expansion of our products, advertisers, and user base, as well as an increase in the number of Google Network Members, partially offset by certain advertising policy changes. The impact from the increase in paid clicks on our revenue growth was partially offset by a decrease in the average cost-per-click paid by our advertisers. Average cost-per-click on Google websites and Google Network Members' websites decreased approximately 8% from 2012 to 2013. The decrease in the average cost-per-click paid by our advertisers was driven by various factors, such as the introduction of new products as well as changes in property mix, platform mix and geographical mix, and the general strengthening of the U.S. dollar compared to certain foreign currencies. Our Google segment revenues increased $8,134 million from 2011 to 2012. This increase resulted primarily from an increase in advertising revenues generated by Google websites and Google Network Members' websites and, to a lesser extent, an increase in other revenues driven by hardware product sales. The increase in advertising revenues for Google websites and Google Network Members' websites resulted primarily from an increase in the number of paid clicks through our advertising programs, as aggregate paid clicks on Google websites and Google Network Members' websites increased approximately 34% from 2011 to 2012. The increase in the number of paid clicks generated through our advertising programs was due to an increase in aggregate traffic across all platforms, certain monetization improvements including new ad formats, the continued global expansion of our products, advertisers, and user base, as well as an increase in the number of Google Network Members. The impact of this increase was partially offset by a decrease in the average cost-per-click paid by our advertisers. Average cost-per-click on Google websites and Google Network Members' websites decreased approximately 12% from 2011 to 2012. The decrease in the average cost-per-click paid by our advertisers was driven by various factors, such as introduction of new products as well as changes in property mix, platform mix and geographical mix, and the general strengthening of the U.S. dollar compared to certain foreign currencies. The rate of change in aggregate paid clicks and average cost-per-click, and their correlation with the rate of change in revenues, has fluctuated and may fluctuate in the future because of various factors, including the revenue growth rates on our websites compared to those of our Google Network Members, advertiser competition for keywords, changes in foreign currency exchange rates, seasonality, the fees advertisers are willing to pay based on how they manage their advertising costs, changes in advertising quality or formats, and general economic conditions. In addition, traffic growth in emerging markets compared to more mature markets and across various advertising verticals and channels also contributes to these fluctuations. Changes in aggregate paid clicks and average cost-per-click may not be indicative of our performance or advertiser experiences in any specific geographic market, vertical, or industry. Improvements in our ability to monetize increased traffic primarily relate to enhancing the end user experience, including providing end users with ads that are more relevant to their search queries or to the content on the Google Network Members' websites they visit. For instance, these improvements include displaying advertiser-nominated images that are relevant to the user query and creating a more engaging user shopping experience by enhancing 28



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search ads to include richer product information, such as product image, price, and merchant name. We believe that the increase in the number of paid clicks on Google websites and Google Network Members' websites is substantially the result of our commitment to improving the relevance and quality of both our search results and the advertisements displayed, which we believe results in a better user experience, which in turn results in more searches, advertisers, Google Network Members and other partners. Other revenues in our Google segment increased $2,619 million from 2012 to 2013 and also increased as a percentage of the segment revenues. The increase was primarily due to growth of our digital content products, such as apps, music and movies. Additionally, we experienced an increase in our hardware revenues due to Chromecast, directly-sold Nexus products and Chrome OS devices. In 2011, other revenue was not a significant driver of overall Google segment revenues. Motorola Mobile segment Our Motorola Mobile segment revenues increased $307 million from 2012 to 2013. The increase was due to approximately seven months of results being included in 2012 while twelve months of results were included in 2013 and a 14% increase in average selling price ("ASP") related to new product launches and changes in product mix during the year, partially offset by a 6% decrease in units shipped during 2013. We note that results between 2012 and 2013 are not comparable due to the significant restructuring efforts to simplify the product portfolio completed over the nineteen-month period. The increase in the Motorola Mobile segment revenues from 2011 to 2012 resulted from the inclusion of revenues from the Motorola Mobile segment of $4,136 million subsequent to the acquisition in May 2012. Elimination and other Beginning in the third quarter of 2013, Google and Motorola Mobile segment revenues have been impacted by intersegment transactions that are eliminated in consolidation. Additionally, segment revenues associated with certain products were recognized during the year in our segment results, but deferred to future periods in our consolidated financial statements. This presentation is consistent with what is provided to the chief operating decision maker for purposes of making decisions about allocating resources to each segment and assessing their performance. Revenues by Geography The following table presents our Google segment domestic and international revenues as a percentage of Google segment revenues, determined based on the billing addresses of our customers for our Google segment: Year Ended December 31, 2011 2012 2013 United States 46 % 46 % 45 % United Kingdom 11 % 11 % 10 % Rest of the world 43 % 43 % 45 %



The following table presents our consolidated domestic and international revenues as a percentage of consolidated revenues, determined based on the billing addresses of our customers for our Google segment, and ship-to addresses of our customers for our Motorola Mobile segment:

Year Ended December 31, 2011 2012 2013 United States 46 % 47 % 45 % United Kingdom 11 % 10 % 9 % Rest of the world 43 % 43 % 46 % The growth in revenues from the rest of the world as a percentage of the Google segment and consolidated revenues from 2012 to 2013 resulted largely from increased acceptance of our advertising programs, and our continued progress in developing localized versions of our products for the international markets as well as increased revenues from the rest of the world in our Motorola Mobile segment in 2013 as compared to 2012. 29



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Foreign Exchange Impact on Revenues The general strengthening of the U.S. dollar relative to certain foreign currencies (primarily the Japanese yen and Brazilian real) from 2012 to 2013 had an unfavorable impact on our international revenues, which was partially offset by the general weakening of the U.S. dollar relative to other foreign currencies (primarily the Euro). Had foreign exchange rates remained constant in these periods, our revenues from the United Kingdom would have been $67 million or 1.2% higher and our revenues from the rest of the world would have been approximately $613 million or 2.2% higher in 2013. This is before consideration of hedging gains of $63 million and $32 million recognized to revenues from the United Kingdom and the rest of the world in 2013. The general strengthening of the U.S. dollar relative to certain foreign currencies (primarily the Euro) from 2011 to 2012 had an unfavorable impact on our international revenues. Had foreign exchange rates remained constant in these periods, our revenues from the United Kingdom would have been $68 million or 1.4% higher and our revenues from the rest of the world would have been approximately $1,211 million or 5.6% higher in 2012. This is before consideration of hedging gains of $18 million and $199 million recognized to revenues from the United Kingdom and the rest of the world in 2012. Although we expect to continue to make investments in international markets, these investments may not result in an increase in our international revenues as a percentage of total revenues in 2014 or thereafter. See Note 15 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information about geographic areas. Costs and Expenses Cost of Revenues Cost of revenues consists primarily of traffic acquisition costs. Traffic acquisition costs consist of amounts paid to our Google Network Members under AdSense arrangements and to certain other partners (our distribution partners) who distribute our toolbar and other products (collectively referred to as access points) or otherwise direct search queries to our website (collectively referred to as distribution arrangements). These amounts are primarily based on the revenue share and fixed fee arrangements with our Google Network Members and distribution partners. Certain distribution arrangements require us to pay our partners based on a fee per access point delivered and not exclusively - or at all - based on revenue share. These fees are non-refundable. Further, these arrangements are terminable at will, although under the terms of certain contracts we or our distribution partners may be subject to penalties in the event of early termination. We recognize fees under these arrangements over the estimated useful lives of the access points to the extent we can reasonably estimate those lives and they are one year or longer, or based on any contractual revenue share, if greater. Otherwise, the fees are charged to expense as incurred. The estimated useful life of the access points is based on the historical average period of time they generate traffic and revenues. Cost of revenues also includes the expenses associated with the operation of our data centers, including depreciation, labor, energy, and bandwidth costs; hardware inventory costs; credit card and other transaction fees related to processing customer transactions; amortization of acquisition-related intangible assets; and content acquisition costs. We have entered into arrangements with certain content providers under which we distribute or license their video and other content. In a number of these arrangements, we display ads on the pages of our websites from which the content is viewed and share most of the fees these ads generate with the content providers. We also license content on the pages of our websites from which the content is sold and share most of the fees these sales generate with content providers. To the extent we are obligated to make guaranteed minimum revenue share payments to our content providers, we recognize as content acquisition costs the contractual revenue share amount or the amount determined on a straight-line basis, whichever is greater, over the term of the agreements. In addition, cost of revenues includes manufacturing and inventory-related costs primarily from our Motorola Mobile segment. The following tables present our cost of revenues by operating segment, our traffic acquisition costs, and traffic acquisition costs as a percentage of advertising revenues in the Google segment, for the periods presented (dollars in millions): 30



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Year Ended December 31, 2011 2012 2013 Google $ 12,939$ 16,816$ 21,524 Motorola Mobile 0 3,294 3,773 Unallocated items 249 524 561 Total $ 13,188$ 20,634$ 25,858 Year Ended December 31, 2011 2012 2013 Traffic acquisition costs related to AdSense arrangements $ 7,294$ 8,791$ 9,293 Traffic acquisition costs related to distribution arrangements 1,517 2,165



2,965

Traffic acquisition costs $ 8,811$ 10,956$ 12,258 Traffic acquisition costs as a percentage of Google segment advertising revenues 24.1 % 25.1



% 24.2 %

Google segment Cost of revenues for the Google segment increased $4,708 million from 2012 to 2013. The increase was due to increases in traffic acquisition costs of $1,302 million resulting from more distribution fees paid, more fees paid for additional traffic directed to our websites, as well as more advertiser fees generated through our AdSense program. The remaining increase was primarily driven by an increase in data center costs, hardware inventory costs as a result of increased hardware sales, content acquisition costs as a result of increased activities related to YouTube and digital content, and revenue share payments to mobile carriers and original equipment manufacturers (OEMs). The decrease in traffic acquisition costs as a percentage of advertising revenues was primarily as a result of a shift of mix between Google website revenue and Google Network Members' websites. Cost of revenues for the Google segment increased $3,877 million from 2011 to 2012. The increase was primarily related to an increase in traffic acquisition costs of $2,145 million resulting from more advertiser fees generated through our AdSense program, more traffic directed to our websites, as well as more distribution fees paid. The remaining increase was primarily driven by increases in data center costs, hardware inventory costs and content acquisition costs. The increase in traffic acquisition costs as a percentage of advertising revenues was primarily the result of a greater increase in traffic acquisition costs related to distribution arrangements compared to the increase in advertising revenues generated by Google websites. Motorola Mobile segment Cost of revenues for the Motorola Mobile segment were not comparable between 2012 and 2013 because approximately seven months of results were included in 2012 while twelve months of results were included in 2013. Additionally, we conducted various restructuring activities to simplify the Motorola Mobile product portfolio subsequent to the acquisition in May 2012. Unallocated Items Unallocated items, including stock-based compensation expense, as well as restructuring and related charges, are not allocated to each segment because we do not include this information in our measurement of the performance of our operating segments. We expect cost of revenues will increase in dollar amount and may increase as a percentage of total revenues in 2014 and in future periods, primarily as a result of increases in traffic acquisition costs, data center costs, hardware and inventory costs, manufacturing and inventory-related costs, content acquisition costs, credit card and other transaction fees, and other costs. Traffic acquisition costs as a percentage of advertising revenues may fluctuate in the future based on a number of factors, including the following:



The relative growth rates of revenues from our websites and from our Google

Network Members' websites.

Whether we are able to enter into more AdSense arrangements that provide

for lower revenue share obligations or whether increased competition for

arrangements with existing and potential Google Network Members results in

less favorable revenue share arrangements. 31



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Whether we are able to continue to improve the monetization of traffic on

our websites and our Google Network Members' websites. The relative growth rates of expenses associated with distribution



arrangements and the related revenues generated, including whether we share

with certain existing and new distribution partners proportionately more of

the aggregate advertising fees that we earn from paid clicks derived from

search queries these partners direct to our websites.

Research and Development The following table presents our research and development expenses by operating segment for the periods presented (dollars in millions): Year Ended December 31, 2011 2012 2013 Google $ 4,101$ 4,809$ 5,496 Motorola Mobile 0 474 702 Unallocated items 1,061 1,510 1,754 Total $ 5,162$ 6,793$ 7,952 Research and development expenses consist primarily of compensation and related costs for personnel responsible for the research and development activities relating to new and existing products and services, as well as depreciation and equipment-related costs. We expense research and development costs as incurred. Google segment Research and development expenses for the Google segment increased $687 million from 2012 to 2013 and as a percentage of Google segment revenues remained relatively flat from 2012 to 2013. The increase in expenses was primarily due to an increase in labor and facilities-related costs of $596 million, largely as a result of an 18% increase in research and development headcount. Research and development expenses for the Google segment increased $708 million from 2011 to 2012 and as a percentage of Google segment revenues remained relatively flat from 2011 to 2012. The increase in expenses was primarily due to an increase in labor and facilities-related costs of $359 million, largely as a result of a 15% increase in research and development headcount, an increase in depreciation and equipment-related expenses of $147 million, and an increase in professional services expense of $66 million. Motorola Mobile segment Research and development expenses for the Motorola Mobile segment were not comparable between 2012 and 2013 because approximately seven months of results were included in 2012 while twelve months of results were included in 2013. Additionally, we conducted various restructuring activities to simplify the Motorola Mobile product portfolio subsequent to the acquisition in May 2012. Unallocated Items Unallocated items, including stock-based compensation expense, as well as restructuring and related charges, are not allocated to each segment because we do not include this information in our measurement of the performance of our operating segments. We expect that research and development expenses will increase in dollar amount in 2014 and future periods because we expect to continue to invest in building the necessary employee and system infrastructure required to support the development of new, and to improve existing, products and services. Sales and Marketing The following table presents our sales and marketing expenses by operating segment for the periods presented (dollars in millions): 32



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Table of Contents Year Ended December 31, 2011 2012 2013 Google $ 4,228$ 5,017$ 6,002 Motorola Mobile 0 524 678 Elimination and unallocated items 361 602 573 Total $ 4,589$ 6,143$ 7,253 Sales and marketing expenses consist primarily of compensation and related costs for personnel engaged in customer service, sales, and sales support functions, as well as advertising and promotional expenditures. Google segment Sales and marketing expenses for the Google segment increased $985 million from 2012 to 2013 and as a percentage of Google segment revenues remained flat from 2012 to 2013. The increase in expenses was primarily due to an increase in advertising and promotional expenses of $674 million, as well as an increase in labor and facilities-related costs of $233 million, largely as a result of a 13% increase in sales and marketing headcount. Sales and marketing expenses for the Google segment increased $789 million from 2011 to 2012 and as a percentage of Google segment revenues remained flat from 2011 to 2012. The increase in expenses was primarily due to an increase in labor and facilities-related costs of $390 million, largely as a result of a 14% increase in sales and marketing headcount, as well as an increase in advertising and promotional expenses of $288 million. Motorola Mobile segment Sales and marketing expenses for the Motorola Mobile segment were not comparable between 2012 and 2013 because approximately seven months of results were included in 2012 while twelve months of results were included in 2013. Additionally, we conducted various restructuring activities to simplify the Motorola Mobile product portfolio subsequent to the acquisition in May 2012. Elimination and Unallocated Items Elimination items represent intersegment transactions that are eliminated in consolidation. Unallocated items, including stock-based compensation expense, as well as restructuring and related charges, are not allocated to each segment because we do not include this information in our measurement of the performance of our operating segments. We expect that sales and marketing expenses will increase in dollar amount and may increase as a percentage of total revenues in 2014 and future periods, as we expand our business globally, increase advertising and promotional expenditures in connection with new and existing products, and increase the level of service we provide to our advertisers, Google Network Members, and other partners. General and Administrative The following table presents our general and administrative expenses by operating segment for the periods presented (dollars in millions): Year Ended December 31, 2011 2012 2013 Google $ 2,421$ 3,090$ 3,967 Motorola Mobile 0 236 319 Unallocated items 303 519 510 Total $ 2,724$ 3,845$ 4,796 General and administrative expenses consist primarily of compensation and related costs for personnel and facilities, and include costs related to our facilities, finance, human resources, information technology and legal organizations, as well as fees for professional services. Professional services are principally comprised of outside legal, audit, information technology consulting, and outsourcing services. General and administrative expenses also include amortization of certain acquisition-related intangible assets. Google segment 33



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General and administrative expenses for the Google segment increased $877 million from 2012 to 2013 and as a percentage of Google segment revenues remained relatively flat from 2012 to 2013. The increase in expenses was primarily due to an increase in labor and facilities-related costs of $396 million, largely as a result of a 15% increase in general and administrative headcount, an increase in depreciation and equipment-related expense of $222 million, as well as an increase in amortization of acquired intangible assets of $157 million. General and administrative expenses for the Google segment increased $669 million from 2011 to 2012 and as a percentage of Google segment revenues remained relatively flat from 2011 to 2012. This increase in expenses was primarily due to an increase in amortization of acquired intangible assets of $274 million, an increase in professional services expense of $147 million, the majority of which was related to legal costs, and an increase in labor and facilities-related costs of $122 million, primarily as a result of an 11% increase in general and administrative headcount. Motorola Mobile segment General and administrative expenses for the Motorola Mobile segment were not comparable between 2012 and 2013 because approximately seven months of results were included in 2012 while twelve months of results were included in 2013. Additionally, we conducted various restructuring activities to simplify the Motorola Mobile product portfolio subsequent to the acquisition in May 2012. Unallocated Items Unallocated items, including stock-based compensation expense, as well as restructuring and related charges, are not allocated to each segment because we do not include this information in our measurement of the performance of our operating segments. As we expand our business and incur additional expenses, we expect general and administrative expenses will increase in dollar amount and may increase as a percentage of total revenues in 2014 and in future periods. Charge Related to the Resolution of Department of Justice Investigation In connection with a resolution of an investigation by the United States Department of Justice into the use of Google advertising by certain advertisers, we accrued $500 million during the first quarter of 2011, which was paid in August 2011 upon final resolution of that matter. Restructuring and related charges The following table presents our restructuring and related charges for the periods presented (dollars in millions): Year Ended December 31, 2011 2012 2013 Restructuring and related charges (1) $ 0$ 632$ 182 (1) These amounts are included in the previously discussed sections above, as unallocated items related to cost of revenues, research and development, sales and marketing, and general and administrative expenses. Restructuring and related charges decreased $450 million from 2012 to 2013 because we completed the majority of our restructuring and related activities related to Motorola in 2012. Stock-Based Compensation The following table presents our stock-based compensation for the periods presented (dollars in millions): Year Ended December 31, 2011 2012 2013



Stock-based compensation (1) (2) $ 1,974$ 2,523$ 3,247

(1) These amounts are included in the previously discussed sections above, as unallocated items related to cost of revenues, research and development, sales and marketing, and general and administrative expenses. (2) Stock-based compensation expenses of $126 million and $21 million are included in "restructuring and related charges" above for the years ended December 31, 2012 and 2013. 34



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Stock-based compensation increased $724 million from 2012 to 2013 and as a percentage of consolidated revenues remained flat from 2012 to 2013. This increase in expenses was primarily due to an increase in headcount to support our growing business. Stock-based compensation increased $549 million from 2011 to 2012 and as a percentage of consolidated revenues remained flat from 2011 to 2012. This increase in expenses was primarily due to additional stock awards issued to existing and new employees, as well as awards issued in connection with the acquisition of Motorola. Stock-based compensation expense for the Motorola Home segment was included in net income (loss) from discontinued operations. We estimate stock-based compensation related to awards granted through December 31, 2013 to be approximately $3.1 billion in 2014 and $3.2 billion thereafter. This estimate does not include expenses to be recognized related to employee stock awards that are granted after December 31, 2013 or non-employee stock awards that have been or may be granted. In addition, to the extent forfeiture rates are different from what we have anticipated, stock-based compensation related to these awards will be different from our expectations. Interest and Other Income, Net Interest and other income, net, decreased $96 million from 2012 to 2013. This decrease was primarily driven by a decrease in the gain on divestiture of businesses (other than Motorola Home) of $245 million and a decrease in the realized gain on investments of $81 million, partially offset by a decrease in foreign currency exchange loss of $152 million and an increase in interest income of $72 million. Interest and other income, net, increased $42 million from 2011 to 2012. This increase was primarily driven by a gain on divestiture of business of $188 million in 2012, an impairment charge related to equity investments of $110 million in 2011, partially offset by an increase in foreign currency exchange loss of $152 million and a decrease in interest income of $99 million. The costs of our foreign exchange hedging activities that we recognized to interest and other income, net, are primarily a function of the notional amount of the option and forward contracts and their related duration, the movement of the foreign exchange rates relative to the strike prices of the contracts, as well as the volatility of the foreign exchange rates. As we expand our international business, we believe costs related to hedging activities under our foreign exchange risk management program may increase in dollar amount in 2014 and future periods. Provision for Income Taxes The following table presents our provision for income taxes, and effective tax rate for the periods presented (dollars in millions): Year Ended December 31, 2011 2012 2013



Provision for income taxes $ 2,589$ 2,598$ 2,282 Effective tax rate

21.0 % 19.4 % 15.7 % The federal research and development credit expired on December 31, 2011. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law. Under this act, the federal research and development credit was retroactively extended for amounts paid or incurred after December 31, 2011 and before January 1, 2014. The effects of these changes in the tax law have resulted in a tax benefit which was recognized in the first quarter of 2013, the quarter in which the law was enacted. Our provision for income taxes and our effective tax rate decreased from 2012 to 2013, primarily as a result of proportionately more earnings realized in countries that have lower statutory tax rates as well as the federal research and development credit related to the American Taxpayer Relief Act of 2012. Our provision for income taxes increased from 2011 to 2012, primarily as a result of increases in federal income taxes, driven by higher taxable income year over year and expiration of the federal research and development credit, partially offset by proportionately more earnings realized in countries that have lower statutory tax rates. Our effective tax rate decreased from 2011 to 2012, primarily as a result of proportionately more earnings realized in countries that 35



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have lower statutory tax rates as well as a discrete item related to an investigation by the Department of Justice recognized in 2011, which was not deductible for income tax purposes. Our effective tax rate could fluctuate significantly on a quarterly basis and could be adversely affected to the extent earnings are lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates. Our effective tax rate could also fluctuate due to the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, by changes in the valuation of our deferred tax assets or liabilities, or by changes in tax laws, regulations, or accounting principles, as well as certain discrete items. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service (IRS) and other tax authorities, including European governments. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. See Critical Accounting Policies and Estimates below for additional information about our provision for income taxes. A reconciliation of the federal statutory income tax rate to our effective tax rate is set forth in Note 14 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Net Income (Loss) from Discontinued Operations On April 17, 2013, we completed the disposition of the Motorola Home segment to Arris and certain other persons for consideration of approximately $2,412 million in cash, including cash of $2,238 million received on the closing date and certain post-closing adjustments of $174 million received in the third quarter of 2013, and approximately $175 million in Arris' common stock (10.6 million shares). Subsequent to the transaction, we own approximately 7.8% of the outstanding shares of Arris. Additionally, in connection with the disposition, we agreed to indemnify Arris for potential liability from certain intellectual property infringement litigation, for which we recorded an indemnification liability of $175 million, the majority of which was settled during 2013. The disposition resulted in a net gain of $757 million, which was presented as part of net income from discontinued operations in the Consolidated Statements of Income for the year ended December 31, 2013. The Motorola Home segment results have been presented as a discontinued operation for the years ended December 31, 2012 and 2013. The following table provides the financial results included in net income (loss) from discontinued operations during the periods presented (in millions): Year ended December 31, 2012 2013 Revenues $ 2,028$ 804



Loss from discontinued operations before income taxes (22 )

(67 ) (Provision for)/Benefits from income taxes (29 )



16

Gain on disposal 0



757

Net (loss) income from discontinued operations $ (51 ) $

706

Quarterly Results of Operations The following tables presenting our quarterly results of operations should be read in conjunction with the consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K. We have prepared the unaudited information on the same basis as our audited consolidated financial statements. Our operating results for any quarter are not necessarily indicative of results for any future quarters or for a full year. Please note that previously reported quarters have been adjusted to show discontinued operations for the disposition of the Motorola Home business. The following table presents our unaudited quarterly results of operations for the eight quarters ended December 31, 2013. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for fair presentation of our consolidated financial position and operating results for the quarters presented. Both seasonal fluctuations in internet usage and traditional retail seasonality have affected, and are likely to continue to affect, our business. Internet usage generally slows during the summer months, and commercial queries typically 36



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increase significantly in the fourth quarter of each year. These seasonal trends have caused and will likely continue to cause, fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates. Quarter Ended Mar 31, Jun 30, Sep 30, Dec 31, Mar 31, Jun 30, Sep 30, Dec 31, 2012 2012 2012 2012 2013 2013 2013 2013 (In millions, except per share amounts) (unaudited) Consolidated Statements of Income Data: Revenues: Google (advertising and other) $ 10,645$ 10,964$ 11,526$ 12,905$ 12,951$ 13,107$ 13,754$ 15,707 Motorola Mobile (hardware and other) 0 843 1,778 1,514 1,018 998 1,139 1,151 Total revenues 10,645 11,807 13,304 14,419 13,969 14,105 14,893 16,858 Costs and expenses: Cost of revenues - Google (advertising and other) 3,789 3,984 4,440 4,963 5,136 5,195 5,409 6,253 Cost of revenues - Motorola Mobile (hardware and other) 0 693 1,515 1,250 808 868 1,004 1,185 Research and development 1,441 1,538 1,879 1,935 1,837 1,987 2,017 2,111 Sales and marketing 1,269 1,413 1,710 1,751 1,586 1,735 1,806 2,126 General and administrative 757 942 1,020 1,126 1,125 1,197 1,213 1,261 Total costs and expenses 7,256 8,570 10,564 11,025 10,492 10,982 11,449 12,936 Income from operations 3,389 3,237 2,740 3,394 3,477 3,123 3,444 3,922 Interest and other income, net 156 253 65 152 134 247 24 125 Income from continuing operations before income taxes 3,545 3,490 2,805 3,546 3,611 3,370 3,468 4,047 Provision for income taxes 655 657 647 639 287 816 513 666 Net income from continuing operations $ 2,890$ 2,833$ 2,158$ 2,907$ 3,324$ 2,554$ 2,955$ 3,381 Net income (loss) from discontinued operations 0 (48 ) 18 (21 ) 22 674 15 (5 ) Net income $ 2,890$ 2,785$ 2,176$ 2,886$ 3,346$ 3,228$ 2,970$ 3,376 Net income (loss) per share - basic: Continuing operations $ 8.88$ 8.68$ 6.59$ 8.83$ 10.06$ 7.68$ 8.86$ 10.10 Discontinued operations 0 (0.14 ) 0.05 $ (0.06 )$ 0.07$ 2.03$ 0.04$ (0.02 ) Net income per share - basic $ 8.88$ 8.54$ 6.64$ 8.77$ 10.13$ 9.71$ 8.90$ 10.08 Net income (loss) per share - diluted: Continuing operations $ 8.75$ 8.56$ 6.48$ 8.68$ 9.87$ 7.55$ 8.71$ 9.91 Discontinued operations 0 (0.14 ) 0.05 (0.06 ) 0.07 1.99 0.04 (0.01 ) Net income per share - diluted $ 8.75$ 8.42$ 6.53$ 8.62



$ 9.94$ 9.54$ 8.75$ 9.90

The following table presents our unaudited quarterly results of operations as a percentage of revenues for the eight quarters ended December 31, 2013:

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Table of Contents Quarter Ended Mar 31, Jun 30, Sep 30, Dec 31, Mar 31, Jun 30, Sep 30, Dec 31, 2012 2012 2012 2012 2013 2013 2013 2013 Revenues: Google (advertising and other) 100.0 % 92.9 % 86.6 % 89.5 % 92.7 % 92.9 % 92.4 % 93.2 % Motorola Mobile (hardware and other) 0 7.1 13.4 10.5 7.3 7.1 7.6 6.8 Total revenues 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % Costs and expenses: Cost of revenues - Google (advertising and other) 35.6 33.7 33.4 34.4 36.8 36.8 36.3 37.1 Cost of revenues - Motorola Mobile (hardware and other) 0 5.9 11.3 8.7 5.7 6.2 6.7 7.0 Research and development 13.5 13.0 14.1 13.4 13.2 14.1 13.5 12.5 Sales and marketing 11.9 12.0 12.9 12.2 11.4 12.3 12.1 12.6 General and administrative 7.2 8.0 7.7 7.8 8.0 8.5 8.3 7.5 Total costs and expenses 68.2 72.6 79.4 76.5 75.1 77.9 76.9 76.7 Income from operations 31.8 27.4 20.6 23.5 24.9 22.1 23.1 23.3 Interest and other income, net 1.5 2.1 0.5 1.1 1.0 1.8 0.2 0.7 Income from continuing operations before income taxes 33.3 29.5 21.1 24.6 25.9 23.9 23.3 24.0 Provision for income taxes 6.2 5.5 4.9 4.4 2.1 5.8 3.4 4.0 Net income from continuing operations 27.1 % 24.0 % 16.2 % 20.2 % 23.8 % 18.1 % 19.9 % 20.0 % Net income (loss) from discontinued operations 0 % (0.4 )% 0.1 % (0.2 )% 0.2 % 4.8 % 0.1 % 0 % Net income 27.1 % 23.6 % 16.3 % 20.0 % 24.0 % 22.9 % 20.0 % 20.0 % Liquidity and Capital Resources As of December 31, 2013, we had $58.7 billion of cash, cash equivalents, and marketable securities. Cash equivalents and marketable securities are comprised of time deposits, money market and other funds, including cash collateral received related to our securities lending program, highly liquid debt instruments of the U.S. government and its agencies, debt instruments issued by foreign governments, debt instruments issued by municipalities in the U.S., corporate securities, mortgage-backed securities and asset-backed securities. As of December 31, 2013, $33.6 billion of the $58.7 billion of cash, cash equivalents, and marketable securities was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds. However, our intent is to permanently reinvest these funds outside of the U.S. and our current plans do not demonstrate a need to repatriate them to fund our U.S. operations. Our principal sources of liquidity are our cash, cash equivalents, and marketable securities, as well as the cash flow that we generate from our operations. At December 31, 2013, we had unused letters of credit for approximately $173 million. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements through at least the next 12 months. Our liquidity could be negatively affected by a decrease in demand for our products and services. In addition, we may make acquisitions or license products and technologies complementary to our business and may need to raise additional capital through future debt or equity financing to provide for greater flexibility to fund any such acquisitions and licensing activities. Additional financing may not be available at all or on terms favorable to us. 38



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We have a debt financing program of up to $3.0 billion through the issuance of commercial paper. Net proceeds from this program are used for general corporate purposes. As of December 31, 2013, we had $2.0 billion of commercial paper outstanding recorded as short-term debt, with a weighted-average interest rate of 0.1% that mature at various dates through June 2014. Average commercial paper borrowings during the year were $2.1 billion and the maximum amount outstanding during the year was $2.5 billion. In conjunction with this program, we have a $3.0 billion revolving credit facility expiring in July 2016. The interest rate for the credit facility is determined based on a formula using certain market rates. As of December 31, 2013, we were in compliance with the financial covenant in the credit facility and no amounts were outstanding. In May 2011, we issued $3.0 billion of unsecured senior notes in three equal tranches, due in 2014, 2016, and 2021, with stated interest rates of 1.25%, 2.125%, and 3.625%. The net proceeds from the sale of the notes were used to repay a portion of our outstanding commercial paper and for general corporate purposes. In May 2013, we reclassified the first tranche of $1.0 billion unsecured senior notes due in May 2014 as short-term debt. We plan to issue $1.0 billion of long-term debt when this note matures in 2014. As of December 31, 2013, the total carrying value and estimated fair value of these notes were $3.0 billion and $3.1 billion. The estimated fair value was based on quoted prices for our publicly-traded debt as of December 31, 2013. We are not subject to any financial covenants under the notes. In August 2013, we entered into a $258 million capital lease obligation on certain property expiring in 2028 with an option to purchase in 2016. The effective rate of the capital lease obligation approximates the market rate. The estimated fair value of the capital lease obligation approximated its carrying value at December 31, 2013.



In summary, our cash flows are as follows (in millions):

Year Ended



December 31,

2011 2012



2013

Net cash provided by operating activities $ 14,565$ 16,619$ 18,659 Net cash used in investing activities (19,041 ) (13,056 ) (13,679 ) Net cash provided by (used in) financing activities 807 1,229



(857 )

Cash Provided by Operating Activities Our largest source of cash provided by operating cash flows is advertising revenues generated by Google websites and Google Network Members' websites. We also generate cash from the sale of our hardware products, primarily in the Motorola Mobile segment. Our primary uses of cash from operating activities include payments to our Google Network Members and distribution partners, which are based on the revenue share or fixed fee arrangements, as well as payments for manufacturing and inventory-related costs primarily for the Motorola Mobile segment. In addition, uses of cash from operating activities include compensation and related costs, other general corporate expenditures and income taxes. Cash provided by operating activities consist of net income adjusted for certain non-cash items, including stock-based compensation expense, depreciation, amortization, deferred income taxes, excess tax benefits from stock-based award activities, as well as the effect of changes in working capital and other activities. Net cash provided by operating activities increased from 2012 to 2013, primarily due to increased net income adjusted for gain on divestiture of businesses, depreciation and amortization expense on property and equipment, stock-based compensation expense, and amortization of intangible assets. These increases were partially offset by the net decrease in cash from changes in working capital primarily as a result of a decrease in income taxes, an increase in accounts receivable and inventories, offset by an increase in accounts payable. Net cash provided by operating activities increased from 2011 to 2012, primarily due to increased net income adjusted for gain on divestiture of businesses, stock-based compensation expense, depreciation and amortization expense on property and equipment and amortization of intangible assets. In addition, there was a net increase in cash from changes in working capital primarily driven by an increase in income taxes and a decrease in accounts receivable and inventories. These increases were partially offset by the net increase in prepaid and other assets and a decrease in accounts payable. 39



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As we expand our business internationally, we have offered payment terms to certain advertisers that are standard in their locales but longer than terms we would generally offer to our domestic advertisers. This may increase our working capital requirements and may have a negative effect on cash provided by our operating activities. Cash Used In Investing Activities Cash provided by or used in investing activities primarily consist of purchases, maturities, and sales of marketable securities, acquisitions of businesses and intangible assets, divestiture of businesses, and purchases of property and equipment. In addition, cash provided by or used in investing activities include our investments in reverse repurchase agreements and the cash collateral received or returned from our securities lending program. Cash used in investing activities increased from 2012 to 2013, primarily attributable to a net increase in purchases of marketable securities and an increase in capital expenditures primarily related to our production equipment, data centers, and real estate purchases. This increase was partially offset by lower spend related to acquisitions and an increase in proceeds received from divestiture of businesses. Cash used in investing activities decreased from 2011 to 2012, primarily attributable to a decrease in purchases of marketable securities, partially offset by a decrease in maturities and sales of marketable securities and an increase in spend related to acquisitions due to the purchase of Motorola in 2012. In order to manage expected increases in internet traffic, advertising transactions, and new products and services, and to support our overall global business expansion, we expect to make significant investments in production equipment, our systems, data centers, corporate facilities, and information technology infrastructure in 2014 and thereafter. However, the amount of our capital expenditures has fluctuated and may continue to fluctuate on a quarterly basis. In addition, we expect to continue to spend cash on acquisitions and other investments. These acquisitions generally enhance the breadth and depth of our expertise in engineering and other functional areas, our technologies, and our product and service offerings. Cash Provided by (Used in) Financing Activities Cash provided by or used in financing activities consists primarily of net proceeds or payments from issuance or repayments of short-term debt under our commercial paper program and net proceeds or payments and excess tax benefits from stock-based award activities. Cash used in financing activities increased from 2012 to 2013, primarily driven by an increase in net cash payments related to debt and, to a lesser extent, an increase in net payments for stock-based award activities. Cash provided by financing activities increased from 2011 to 2012, primarily driven by an increase in net cash proceeds received related to debt, partially offset by an increase in net payments for stock-based award activities. Contractual Obligations as of December 31, 2013 Payments due by period Less than 1-3 3-5 More than Total 1 year years years 5 years (in millions) Operating lease obligations, net of sublease income amounts $ 4,038$ 499$ 915$ 788$ 1,836 Purchase obligations and other 3,293 2,407 680 80 126 Long-term debt obligations, including capital lease obligations 3,601 1,079 1,358 73 1,091 Other long-term liabilities reflected on our balance sheet 251 114 48 55 34



Total contractual obligations $ 11,183$ 4,099$ 3,001

$ 996$ 3,087 40



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Operating Leases We have entered into various non-cancelable operating lease agreements for certain of our offices, land, and data centers throughout the world with original lease periods expiring primarily between 2014 and 2063. We are committed to pay a portion of the related operating expenses under certain of these lease agreements. These operating expenses are not included in the above table. Certain of these leases have free or escalating rent payment provisions. We recognize rent expense under such leases on a straight-line basis over the term of the lease. Certain leases have adjustments for market provisions. Purchase Obligations Purchase obligations represent non-cancelable contractual obligations at December 31, 2013. These contracts are primarily related to certain of our distribution arrangements, video and other content licensing revenue sharing arrangements, data center operations and facility build-outs, as well as purchase of inventory. Long-term Debt Obligations Long-term debt obligations represent principal and interest payments to be made over the life of our unsecured senior notes issued in May 2011 and our capital lease obligation incurred in August 2013. Please see Note 4 of the Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for further details. Other Long-Term Liabilities Other long-term liabilities represent cash obligations recorded on our consolidated balance sheets, including the short-term portion of these long-term liabilities and consist primarily of payments owed in connection with certain investments and asset retirement obligations. In addition to the amounts above, we had long-term taxes payable of $2.7 billion as of December 31, 2013 related to tax positions for which the timing of the ultimate resolution is uncertain. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. As a result, this amount is not included in the above table. Off-Balance Sheet Entities As of December 31, 2013, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by the SEC, that have or are reasonably likely to have a current or future effect on our financial condition, changes in our financial condition, revenues, or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. Critical Accounting Policies and Estimates We prepare our consolidated financial statements in accordance with U.S. Generally Accepted Accounting Principles (GAAP.) In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, and expenses, as well as related disclosure of contingent assets and liabilities. In some cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss further below. We have reviewed our critical accounting policies and estimates with the audit committee of our board of directors. Income Taxes We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income 41



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taxes in the period in which such determination is made. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest and penalties. Our effective tax rates have differed from the statutory rate primarily due to the tax impact of foreign operations, state taxes, certain benefits realized related to stock-based award activities, and research and development tax credits. The effective tax rates were 21.0%, 19.4%, and 15.7% for 2011, 2012, and 2013. Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries that have lower statutory rates and higher than anticipated in countries that have higher statutory rates, the net gains and losses recognized by legal entities on certain hedges and related hedged intercompany and other transactions under our foreign exchange risk management program, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws, regulations, or accounting principles, as well as certain discrete items. In addition, we are subject to the continuous examination of our income tax returns by the IRS and other tax authorities which may assert assessments against us. We regularly assess the likelihood of adverse outcomes resulting from these examinations and assessments to determine the adequacy of our provision for income taxes. Loss Contingencies We are regularly subject to claims, suits, government investigations, and other proceedings involving competition and antitrust, intellectual property, privacy, indirect taxes, labor and employment, commercial disputes, content generated by our users, goods and services offered by advertisers or publishers using our platforms, and other matters. Certain of these matters include speculative claims for substantial or indeterminate amounts of damages. We record a liability when we believe that it is both probable that a loss has been incurred, and the amount can be reasonably estimated. If we determine that a loss is possible and a range of the loss can be reasonably estimated, we disclose the range of the possible loss in the Notes to the Consolidated Financial Statements. We evaluate, on a monthly basis, developments in our legal matters that could affect the amount of liability that has been previously accrued, and the matters and related ranges of possible losses disclosed, and make adjustments and changes to our disclosures as appropriate. Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Should any of our estimates and assumptions change or prove to have been incorrect, it could have a material impact on our business, consolidated financial position, results of operations, or cash flows. See Note 11 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for additional information regarding contingencies. Business Combinations We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed and intangible assets acquired based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these identifiable assets and liabilities is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, management makes significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing certain intangible assets include but are not limited to future expected cash flows from customer relationships and acquired patents and developed technology; and discount rates. Management's estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Other estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed, as more fully discussed in Note 6 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Goodwill Goodwill is allocated to reporting units expected to benefit from the business combination. We test goodwill for impairment at the reporting unit level at least annually, or more frequently if events or changes in circumstances occur that would more likely than not reduce the fair value of a reporting unit below its carrying value. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill impairment tests require judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. As of December 31, 2013, no impairment of goodwill has been identified. 42



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Impairment of Marketable and Non-Marketable Securities We periodically review our marketable and non-marketable securities for impairment. If we conclude that any of these investments are impaired, we determine whether such impairment is other-than-temporary. Factors we consider to make such determination include the duration and severity of the impairment, the reason for the decline in value and the potential recovery period and our intent to sell. For marketable debt securities, we also consider whether (1) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis, and (2) the amortized cost basis cannot be recovered as a result of credit losses. If any impairment is considered other-than-temporary, we will write down the asset to its fair value and record the corresponding charge as interest and other income, net.


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