Google Announces Third Quarter 2006 Results

October 20, 2006; 01:16 AM
Google Inc. (NASDAQ: GOOG) announced financial results for the quarter ended September 30, 2006.

"Our third quarter results are a testament to the strength of our network of advertisers and partners, as well as our continuing focus on users," said Eric Schmidt, CEO of Google. "We were particularly pleased with the contributions of our international business in a seasonally weaker quarter. In addition, we continued to forge significant partnerships with companies such as eBay, Fox Interactive Media, and Intuit that will be of great value to all involved."

Q3 Financial Summary

Google reported revenues of $2.69 billion for the quarter ended September 30, 2006, an increase of 70% compared to the third quarter of 2005 and an increase of 10% compared to the second quarter of 2006. Google reports its revenues, consistent with GAAP, on a gross basis without deducting traffic acquisition costs, or TAC. In the third quarter of 2006, TAC totaled $825 million, or 31% of advertising revenues.

Google reports operating income, net income, and earnings per share (EPS) on a GAAP and non-GAAP basis. The non-GAAP measures are described below and are reconciled to the corresponding GAAP measures in the accompanying financial tables.

• GAAP operating income for the third quarter of 2006 was $931 million, or 35% of revenues. This compares to GAAP operating income of $815 million, or 33% of revenues, in the second quarter of 2006. Non-GAAP operating income in the third quarter was $1.03 billion, or 38% of revenues. This compares to non-GAAP operating income of $925 million, or 38% of revenues, in the second quarter.

• GAAP net income for the third quarter of 2006 was $733 million as compared to $721 million in the second quarter. Non-GAAP net income in the third quarter was $812 million, compared to $772 million in the second quarter.
  

• GAAP EPS for the third quarter of 2006 was $2.36 on 311 million diluted shares outstanding, compared to $2.33 for the second quarter, on 310 million diluted shares outstanding. Non-GAAP EPS in the third quarter was $2.62, compared to $2.49 in the second quarter.

• Non-GAAP operating income, non-GAAP net income, and non-GAAP EPS are computed net of stock-based compensation (SBC). In addition, in the second quarter, we excluded investment gains of $55 million related to the sale of our investment in Baidu from the calculation of non-GAAP net income and non-GAAP EPS. In the third quarter of 2006, the charge related to stock-based compensation was $100 million as compared to $109 million in the second quarter. Tax effects related to SBC charges and the sale of the investment in Baidu have also been excluded from non-GAAP net income and non-GAAP EPS. The tax benefit related to SBC was $21 million in the third quarter and $26 million in the second quarter. The tax expense related to the investment gains from the sale of the Baidu investment in the second quarter was $23 million. Reconciliations of non-GAAP measures to GAAP operating income, net income, and EPS are included at the end of this release.

Q3 Financial Highlights

Revenues – Google reported revenues of $2.69 billion for the quarter ended September 30, 2006, representing a 70% increase over third quarter 2005 revenues of $1.58 billion and a 10% increase over second quarter 2006 revenues of $2.46 billion. Google reports its revenues, consistent with GAAP, on a gross basis without deducting traffic acquisition costs, or TAC.

Google Sites Revenues - Google-owned sites generated revenues of $1.63 billion, or 60% of total revenues, in the third quarter of 2006. This represents an 84% increase over third quarter 2005 revenues of $885 million and a 14% increase over second quarter 2006 revenues of $1.43 billion.

Google Network Revenues - Google's partner sites generated revenues, through AdSense programs, of $1.04 billion, or 39% of total revenues, in the third quarter of 2006. This is a 54% increase over network revenues of $675 million generated in the third quarter of 2005 and a 4% increase over second quarter 2006 revenues of $997 million.

International Revenues - Revenues from outside of the United States contributed 44% of total revenues in the third quarter of 2006, compared to 42% in the second quarter of 2006 and 39% in the third quarter of 2005. Had foreign exchange rates remained constant from the second quarter through the third quarter of 2006, our revenues in the third quarter of 2006 would have been $19 million lower. Had foreign exchange rates remained constant from the third quarter of 2005 through the third quarter of 2006, our revenues in the third quarter of 2006 would have been $35 million lower.

TAC - Traffic Acquisition Costs, the portion of revenues shared with Google's partners, increased to $825 million in the third quarter of 2006. This compares to TAC of $785 million in the second quarter. TAC as a percentage of advertising revenues decreased to 31% in the third quarter from 32% in the second quarter.

The majority of TAC expense is related to amounts ultimately paid to our AdSense partners, which totaled $780 million in the third quarter of 2006. TAC is also related to amounts ultimately paid to certain distribution partners and others who direct traffic to our website, which totaled $45 million in the third quarter of 2006.

Other Cost of Revenues - Other cost of revenues, which is comprised primarily of data center operational expenses, as well as credit card processing charges, increased to $223 million, or 8% of revenues, in the third quarter of 2006, compared to $204 million, or 8% of revenues, in the second quarter. Other cost of revenues also included stock-based compensation of $2 million in the third quarter of 2006, compared to $2 million in the second quarter of 2006.

Operating Expenses - Operating expenses, other than cost of revenues, were $710 million in the third quarter. These operating expenses included $382 million in payroll-related and facilities expenses, $98 million in stock-based compensation, and $50 million in advertising and promotional expenses, of which $14 million was related to certain distribution deals.

Stock-Based Compensation – In the third quarter, the total charge related to stock-based compensation was $100 million as compared to $109 million in the second quarter.

For the full year, we expect stock-based compensation charges for grants to employees prior to October 1, 2006 to be $377 million. This does not include expenses to be recognized over the remainder of the year related to employee stock awards that are granted after October 1, 2006 or non-employee stock awards that have been or may be granted. We currently anticipate that dilution related to all equity grants to employees will be approximately 1% to 1.5% per year.

Operating Income - GAAP operating income in the third quarter of 2006 was $931 million, or 35% of revenues. This compares to GAAP operating income of $815 million, or 33% of revenues, in the second quarter. Non-GAAP operating income in the third quarter was $1.03 billion, or 38% of revenues. This compares to non-GAAP operating income of $925 million, or 38% of revenues, in the second quarter.

Net Income – GAAP net income for the third quarter of 2006 was $733 million as compared to $721 million in the second quarter. Non-GAAP net income was $812 million in the third quarter, compared to $772 million in the second quarter. GAAP EPS for the third quarter was $2.36 on 311 million diluted shares outstanding, compared to $2.33 for the second quarter, on 310 million diluted shares outstanding. Non-GAAP EPS for the third quarter was $2.62, compared to $2.49 in the second quarter.

Income Taxes – Our effective tax rate was 29% for the third quarter. We currently anticipate that our effective tax rate for the full year will be at or below 30%.

Cash Flow and Capital Expenditures – Net cash provided by operating activities for the third quarter of 2006 totaled $1 billion as compared to $841 million for the second quarter. In the third quarter of 2006, capital expenditures were $492 million, the majority of which was related to IT infrastructure investments, including data centers, servers, and networking equipment. Free cash flow, an alternative non-GAAP measure of liquidity, is defined as net cash provided by operating activities less capital expenditures. In the third quarter, free cash flow was $512 million.

We continue to expect that the growth rate in capital expenditures in 2006 will be substantially greater than the revenue growth rate for the year.

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

Cash – As of September 30, 2006, cash, cash equivalents, and marketable securities were $10.4 billion.

On a worldwide basis, Google employed 9,378 full-time employees as of September 30, 2006, up from 7,942 full time employees as of June 30, 2006.

WEBCAST AND CONFERENCE CALL INFORMATION

A live audio webcast of Google's third quarter 2006 earnings release call will be available at http://investor.google.com/webcast.html. The call begins today at 1:30 PM (PT) / 4:30 PM (ET). This press release, the financial tables, as well as other supplemental information including the reconciliations of certain non-GAAP measures to their nearest comparable GAAP measures, are also available at that site. A replay of the call will be available beginning at 7:30 PM (ET) today through midnight Thursday, October 26, 2006 by calling 888-203-1112 in the United States or 719-457-0820 for calls from outside the United States. The required confirmation code for the replay is 2704080.