Google Announces Fourth Quarter And Fiscal Year 2006 Results

February 1, 2007; 01:47 AM

MOUNTAIN VIEW, Calif. - Google Inc. (NASDAQ: GOOG) announced financial results for the quarter and fiscal year ended December 31, 2006.

"Our impressive performance in the fourth quarter demonstrates the continuing strength of our business model across Google properties and those of our partners," said Eric Schmidt, CEO of Google. "Our growing organization allows us to deliver ever increasing amounts of information and content to our users both through investments in search and ads as well as through strategic partnerships."

Q4 Financial Summary

Google reported revenues of $3.21 billion for the quarter ended December 31, 2006, an increase of 67% compared to the fourth quarter of 2005 and an increase of 19% compared to the third quarter of 2006. Google reports its revenues, consistent with GAAP, on a gross basis without deducting traffic acquisition costs, or TAC. In the fourth quarter of 2006, TAC totaled $976 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 fourth quarter of 2006 was $1.06 billion, or 33% of revenues. This compares to GAAP operating income of $931 million, or 35% of revenues, in the third quarter of 2006. Non-GAAP operating income in the fourth quarter was $1.20 billion, or 37% of revenues. This compares to non-GAAP operating income of $1.03 billion, or 38% of revenues, in the third quarter.
  
  
• GAAP net income for the fourth quarter of 2006 was $1.03 billion as compared to $733 million in the third quarter. Non-GAAP net income in the fourth quarter was $997 million, compared to $812 million in the third quarter.
  
  
• GAAP EPS for the fourth quarter of 2006 was $3.29 on 313 million diluted shares outstanding, compared to $2.36 for the third quarter, on 311 million diluted shares outstanding. Non-GAAP EPS in the fourth quarter was $3.18, compared to $2.62 in the third quarter.
  
  
• The effective tax rate was 13% for the fourth quarter of 2006 and 23% for the full year. In December 2006, Google entered into an Advanced Pricing Agreement ("APA") with the IRS in connection with certain intercompany transfer pricing arrangements. The APA applies to the taxation years beginning in 2003. As a result of the APA, we reduced certain of our income tax contingency reserves and recognized an income tax benefit of $90 million in the fourth quarter. This amount is excluded from our non-GAAP results for the quarter and for the year. In addition, in the fourth quarter, the 2006 R&D tax credit was enacted, which resulted in a $78 million benefit to our provision for income taxes. $43 million of this benefit pertained to the first three quarters of 2006 and is excluded from our non-GAAP results for the fourth quarter. Without these discrete items, our non-GAAP effective tax rate for the fourth quarter of 2006 and for the full year 2006 was 24% and 26%, respectively.
  
  
• Non-GAAP operating income, non-GAAP net income, and non-GAAP EPS are computed net of stock-based compensation (SBC). In addition, in the fourth quarter of 2006, we excluded tax benefits of $90 million related to the APA and $43 million related to the 2006 R&D tax credit from the calculation of non-GAAP net income and EPS. Also, for 2006, we excluded tax benefits of $90 million related to the APA from the calculation of our non-GAAP net income and EPS. In the fourth quarter of 2006, the charge related to SBC was $134 million as compared to $100 million in the third quarter. Tax effects related to SBC have also been excluded from these non-GAAP measures. The tax benefit related to SBC was $35 million in the fourth quarter and $21 million in the third quarter. Reconciliations of non-GAAP measures to GAAP operating income, net income, EPS, and our effective tax rate are included at the end of this release.

Google Sites Revenues - Google-owned sites generated revenues of $1.98 billion, or 62% of total revenues, in the fourth quarter of 2006. This represents an 80% increase over fourth quarter 2005 revenues of $1.10 billion and a 22% increase over third quarter 2006 revenues of $1.63 billion.

Google Network Revenues - Google's partner sites generated revenues, through AdSense programs, of $1.20 billion, or 37% of total revenues, in the fourth quarter of 2006. This is a 50% increase over network revenues of $799 million generated in the fourth quarter of 2005 and a 16% increase over third quarter 2006 revenues of $1.04 billion.

International Revenues - Revenues from outside of the United States contributed 44% of total revenues in the fourth quarter of 2006, compared to 44% in the third quarter of 2006 and 38% in the fourth quarter of 2005. Had foreign exchange rates remained constant from the third quarter through the fourth quarter of 2006, our revenues in the fourth quarter of 2006 would have been $18 million lower. Had foreign exchange rates remained constant from the fourth quarter of 2005 through the fourth quarter of 2006, our revenues in the fourth quarter of 2006 would have been $81 million lower.

Paid Clicks - Aggregate paid clicks, which include clicks related to ads served on Google sites and our AdSense partners, increased approximately 61% over the fourth quarter of 2005 and approximately 22% over the third quarter of 2006.

TAC - Traffic Acquisition Costs, the portion of revenues shared with Google's partners, increased to $976 million in the fourth quarter of 2006. This compares to TAC of $825 million in the third quarter. TAC as a percentage of advertising revenues was 31% in both the fourth quarter and the third quarter.

The majority of TAC expense is related to amounts ultimately paid to our AdSense partners, which totaled $916 million in the fourth 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 $60 million in the fourth 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 $307 million, or 10% of revenues, in the fourth quarter of 2006, compared to $223 million, or 8% of revenues, in the third quarter.

Operating Expenses - Operating expenses, other than cost of revenues, were $862 million in the fourth quarter. These operating expenses included $493 million in payroll-related and facilities expenses.

Stock-Based Compensation - In the fourth quarter, the total charge related to stock-based compensation was $134 million as compared to $100 million in the third quarter.

We currently anticipate that we will launch our employee transferable stock options (TSO) program in the second quarter of 2007. Because all outstanding stock options granted under our 2004 Stock Plan after our initial public offering to employees other than our Executive Management Group will be modified to allow selling under the program, we expect to incur a modification charge in accordance with GAAP of approximately $90 million in the second quarter of 2007 related to vested options as of the end of that quarter and a charge of approximately $160 million over their remaining vesting periods of up to approximately four years related to unvested options.

The market value of our stock used to compute the above forecasted modification charges was $494 per share. The actual charge will be different to the extent the number of options outstanding at the time we launch the TSO program is different than our expectations, or to the extent the variables used to revalue these options, including the market value and volatility of our stock, are different.

Also, the fair value of each option granted under the TSO program in the future will be greater, resulting in more stock-based compensation per option.

Before these incremental charges related to the TSO program, we currently estimate stock-based compensation charges for grants to employees prior to January 1, 2007 to be approximately $621 million for 2007. This does not include expenses to be recognized related to employee stock awards that are granted after January 1, 2007 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 at or below 2% per year.

Operating Income - GAAP operating income in the fourth quarter of 2006 was $1.06 billion, or 33% of revenues. This compares to GAAP operating income of $931 million, or 35% of revenues, in the third quarter. Non-GAAP operating income in the fourth quarter was $1.20 billion, or 37% of revenues. This compares to non-GAAP operating income of $1.03 billion, or 38% of revenues, in the third quarter.

Net Income - GAAP net income for the fourth quarter of 2006 was $1.03 billion as compared to $733 million in the third quarter. Non-GAAP net income was $997 million in the fourth quarter, compared to $812 million in the third quarter. GAAP EPS for the fourth quarter was $3.29 on 313 million diluted shares outstanding, compared to $2.36 for the third quarter, on 311 million diluted shares outstanding. Non-GAAP EPS for the fourth quarter was $3.18, compared to $2.62 in the third quarter.

Income Taxes - Our effective tax rate was 13% for the fourth quarter of 2006 and 23% for the full year 2006.

In December 2006, Google entered into an Advanced Pricing Agreement ("APA") with the IRS in connection with certain intercompany transfer pricing arrangements. The APA applies to the taxation years beginning in 2003. As a result of the APA, we reduced certain of our income tax contingency reserves and recognized an income tax benefit of $90 million in the fourth quarter. This amount is excluded from our non-GAAP results for the quarter and for the year.

Also, in the fourth quarter, the 2006 R&D tax credit was signed into federal law, which resulted in a $78 million benefit to our provision for income taxes. $43 million of this benefit pertained to the first three quarters of 2006 and is excluded from our non-GAAP results for the fourth quarter.

Our non-GAAP effective tax rate, defined as our income before income taxes divided into the sum obtained by adding the applicable aforementioned discrete items to our provision for income taxes, for the fourth quarter and for the year was 24% and 26%, respectively. Our effective tax rate will be greater in 2007 under the APA than it would have been without it. However, we expect our effective tax rate for 2007 will be at or below 30%.

Cash Flow and Capital Expenditures - Net cash provided by operating activities for the fourth quarter of 2006 totaled $911 million as compared to $1 billion for the third quarter. In the fourth quarter of 2006, capital expenditures were $367 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 fourth quarter, free cash flow was $544 million.

In 2007, we expect to continue to make significant capital expenditures.

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 December 31, 2006, cash, cash equivalents, and marketable securities were $11.2 billion.

On a worldwide basis, Google employed 10,674 full-time employees as of December 31, 2006, up from 9,378 full time employees as of September 30, 2006.