Edgar Filing: Google Inc.

Large accelerated filer ý

Accelerated filer ¨

Non-accelerated filer (Do not check if a smaller reporting company) ¨ Smaller reporting company ¨

GOOG 10-Q Q3 2013

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

___________________________________________________

FORM 10-Q

___________________________________________________

(Mark One)



ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 000-50726

___________________________________________________

Google Inc.

(Exact name of registrant as specified in its charter)

___________________________________________________



Delaware	77-0493581
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

1600 Amphitheatre Parkway

Mountain View, CA 94043

(Address of principal executive offices, including zip code)

(650) 253-0000

(Registrant’s telephone number, including area code)

___________________________________________________

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý

At October 17, 2013, there were 276,721,703 shares of Google’s Class A common stock outstanding and 57,365,706 shares of Google’s Class B common stock outstanding.

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Google Inc.

Form 10-Q

For the Quarterly Period Ended September 30, 2013

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		Page No.
Note About Forward-Looking Statements		1
PART I. FINANCIAL INFORMATION
Item 1	Financial Statements	3
	Consolidated Balance Sheets - December 31, 2012 and September 30, 2013 (unaudited)	3
	Consolidated Statements of Income - Three and Nine Months Ended September 30, 2012 and 2013 (unaudited)	4
	Consolidated Statements of Comprehensive Income - Three and Nine Months Ended September 30, 2012 and 2013 (unaudited)	5
	Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2012 and 2013 (unaudited)	6
	Notes to Consolidated Financial Statements (unaudited)	7
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29
Item 3	Quantitative and Qualitative Disclosures About Market Risk	44
Item 4	Controls and Procedures	45
PART II. OTHER INFORMATION
Item 1	Legal Proceedings	46
Item 1A	Risk Factors	46
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	58
Item 6	Exhibits	59
	Signature	60
	Exhibit Index	61

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NOTE ABOUT FORWARD-LOOKING STATEMENTS

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


•	the growth of our business and revenues and our expectations about the factors that influence our success and trends in our business;


•	seasonal fluctuations in internet usage and advertiser expenditures, traditional retail seasonality and macroeconomic conditions, which are likely to cause fluctuations in our quarterly results;


•	our plans to continue to invest in new businesses, products and technologies, systems, facilities, and infrastructure, to increase our hiring and provide competitive compensation programs, as well as to continue our current pace of acquisitions;


•	the potential for declines in our revenue growth rate;


•	our expectation that growth in advertising revenues from our websites will continue to exceed that from our Google Network Members’ websites, which will have a positive impact on our operating margins;


•	our expectation that we will continue to pay most of the fees we receive from advertisers to our Google Network Members;


•	our expectation that we will continue to take steps to improve the relevance of the ads we deliver and to reduce the number of accidental clicks;


•	fluctuations in aggregate paid clicks and average cost-per-click;


•	our belief that our foreign exchange risk management program will not fully offset our net exposure to fluctuations in foreign currency exchange rates;


•	the expected increase of costs related to hedging activities under our foreign exchange risk management program;


•	our expectation that our cost of revenues, research and development expenses, sales and marketing expenses, and general and administrative expenses will increase in dollars and may increase as a percentage of revenues;


•	our potential exposure in connection with pending investigations, proceedings, and other contingencies;


•	our expectation about our board of directors’ intention to declare a dividend of shares of the new Class C capital stock, as well as the timing of that dividend, if declared and paid;


•	our expectation that our traffic acquisition costs will fluctuate in the future;


•	our continued investments in international markets;


•	estimates of our future compensation expenses;


•	fluctuations in our effective tax rate;


•	the sufficiency of our sources of funding;


•	our payment terms to certain advertisers, which may increase our working capital requirements; and


•	fluctuations in our capital expenditures;

as well as other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements may appear throughout this report, including without limitation, the following sections: Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 1A, “Risk Factors.” Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q, and in particular, the risks discussed under the caption “Risk Factors” in Part II, Item 1A of this report and those discussed in other documents we file with the Securities and Exchange Commission (SEC). We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

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As used herein, “Google,” “we,” “our,” and similar terms include Google Inc. and its subsidiaries, unless the context indicates otherwise.

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

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PART I - FINANCIAL INFORMATION


ITEM 1.	FINANCIAL STATEMENTS

Google Inc.

CONSOLIDATED BALANCE SHEETS

(In millions, except share and par value amounts which are reflected in thousands,

and par value per share amounts)



	As of December 31, 2012		As of September 30, 2013
			(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	14,778	$	15,242
Marketable securities	33,310		41,281
Total cash, cash equivalents, and marketable securities (including securities loaned of $3,160 and $5,103)	48,088		56,523
Accounts receivable, net of allowance of $581 and $486	7,885		7,921
Inventories	505		235
Receivable under reverse repurchase agreements	700		100
Deferred income taxes, net	1,144		1,154
Income taxes receivable, net	0		571
Prepaid revenue share, expenses and other assets	2,132		2,354
Total current assets	60,454		68,858
Prepaid revenue share, expenses and other assets, non-current	2,011		1,784
Non-marketable equity investments	1,469		1,843
Property and equipment, net	11,854		14,867
Intangible assets, net	7,473		6,290
Goodwill	10,537		11,426
Total assets	$	93,798	$	105,068
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	2,012	$	2,124
Short-term debt	2,549		3,009
Accrued compensation and benefits	2,239		1,999
Accrued expenses and other current liabilities	3,258		3,071
Accrued revenue share	1,471		1,472
Securities lending payable	1,673		1,893
Deferred revenue	895		907
Income taxes payable, net	240		0
Total current liabilities	14,337		14,475
Long-term debt	2,988		2,238
Deferred revenue, non-current	100		125
Income taxes payable, non-current	2,046		2,434
Deferred income taxes, net, non-current	1,872		2,097
Other long-term liabilities	740		710
Stockholders’ equity:
Convertible preferred stock, $0.001 par value per share, 100,000 shares authorized; no shares issued and outstanding	0		0
Class A and Class B common stock and additional paid-in capital, $0.001 par value per share: 12,000,000 shares authorized (Class A 9,000,000, Class B 3,000,000); 329,979 (Class A 267,448, Class B 62,531) and par value of $330 (Class A $267, Class B $63) and 334,157 (Class A 276,681, Class B 57,476) and par value of $334 (Class A $277, Class B $57) shares issued and outstanding	22,835		25,004
Class C capital stock, $0.001 par value per share: 3,000,000 shares authorized; no shares issued and outstanding	0		0
Accumulated other comprehensive income	538		99
Retained earnings	48,342		57,886
Total stockholders’ equity	71,715		82,989
Total liabilities and stockholders’ equity	$	93,798	$	105,068

See accompanying notes.

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Google Inc.

CONSOLIDATED STATEMENTS OF INCOME

(In millions, except share amounts which are reflected in thousands and per share amounts)



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2013		2012			2013
	(unaudited)
Revenues:
Google (advertising and other)	$	11,526	$	13,754	$	33,135		$	39,812
Motorola Mobile (hardware and other)	1,778		1,139		2,621			3,155
Total revenues	13,304		14,893		35,756			42,967
Costs and expenses:
Cost of revenues - Google (advertising and other) ⁽¹⁾	4,440		5,409		12,213			15,740
Cost of revenues - Motorola Mobile (hardware and other)⁽¹⁾	1,515		1,004		2,208			2,680
Research and development ⁽¹⁾	1,879		2,017		4,858			5,841
Sales and marketing ⁽¹⁾	1,710		1,806		4,392			5,127
General and administrative ⁽¹⁾	1,020		1,213		2,719			3,535
Total costs and expenses	10,564		11,449		26,390			32,923
Income from operations	2,740		3,444		9,366			10,044
Interest and other income, net	65		24		474			405
Income from continuing operations before income taxes	2,805		3,468		9,840			10,449
Provision for income taxes	647		513		1,959			1,616
Net income from continuing operations	2,158		2,955		7,881			8,833
Net income (loss) from discontinued operations	18		15		(30		)	711
Net income	$	2,176	$	2,970	$	7,851		$	9,544
Net income (loss) per share of Class A and Class B common stock - basic:
Continuing operations	$	6.59	$	8.86	$	24.14		$	26.59
Discontinued operations	0.05		0.04		(0.09		)	2.14
Net income (loss) per share of Class A and Class B common stock - basic	$	6.64	$	8.90	$	24.05		$	28.73
Net income (loss) per share of Class A and Class B common stock - diluted:
Continuing operations	$	6.48	$	8.71	$	23.78		$	26.13
Discontinued operations	0.05		0.04		(0.09		)	2.10
Net income (loss) per share of Class A and Class B common stock - diluted	$	6.53	$	8.75	$	23.69		$	28.23

Shares used in per share calculation - basic	327,785		333,616		326,452			332,183
Shares used in per share calculation - diluted	333,314		339,235		331,414			338,078
______________________
⁽¹⁾ Includes stock-based compensation expense as follows:
Cost of revenues - Google (advertising and other)	$	103	$	133	$	259		$	342
Cost of revenues - Motorola Mobile (hardware and other)	6		4		10			14
Research and development	373		453		961			1,235
Sales and marketing	152		160		367			419
General and administrative	116		136		344			356
	$	750	$	886	$	1,941		$	2,366

See accompanying notes.

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Google Inc.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In millions)



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2013			2012			2013
	(unaudited)
Net income	$	2,176		$	2,970		$	7,851		$	9,544
Other comprehensive income (loss):
Change in foreign currency translation adjustment	220			261			(98		)	57
Available-for-sale investments:
Change in net unrealized gains (losses)	198			257			408			(402		)
Reclassification adjustment for net (gains) losses included in net income	(21		)	21			(169		)	(133		)
Net change (net of tax effect of $73, $31, $83, and $208)	177			278			239			(535		)
Cash flow hedges:
Change in net unrealized gains (losses)	(74		)	(28		)	65			97
Less: reclassification adjustment for net (gains) losses included in net income	(39		)	(14		)	(114		)	(58		)
Net change (net of tax effect of $67, $24, $29, and $23)	(113		)	(42		)	(49		)	39
Other comprehensive income (loss)	284			497			92			(439		)
Comprehensive income	$	2,460		$	3,467		$	7,943		$	9,105

See accompanying notes.

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Google Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)



	Nine Months Ended
	September 30,
	2012			2013
	(unaudited)
Operating activities
Net income	$	7,851		$	9,544
Adjustments:
Depreciation and amortization of property and equipment	1,358			2,024
Amortization of intangible and other assets	651			879
Stock-based compensation expense	1,976			2,441
Excess tax benefits from stock-based award activities	(113		)	(302		)
Deferred income taxes	23			125
Gain on divestiture of businesses	(188		)	(705		)
Other	(24		)	44
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable	(228		)	(454		)
Income taxes, net	1,336			(79		)
Inventories	188			(46		)
Prepaid revenue share, expenses and other assets	(1,215		)	(149		)
Accounts payable	(274		)	285
Accrued expenses and other liabilities	484			(270		)
Accrued revenue share	(57		)	8
Deferred revenue	182			76
Net cash provided by operating activities	11,950			13,421
Investing activities
Purchases of property and equipment	(2,253		)	(5,103		)
Purchases of marketable securities	(24,246		)	(31,746		)
Maturities and sales of marketable securities	29,800			23,241
Investments in non-marketable equity investments	(246		)	(471		)
Cash collateral related to securities lending	(321		)	220
Investments in reverse repurchase agreements	195			600
Proceeds from divestiture of businesses	201			2,525
Acquisitions, net of cash acquired, and purchases of intangibles and other assets	(10,672		)	(1,328		)
Net cash used in investing activities	(7,542		)	(12,062		)
Financing activities
Net payments related to stock-based award activities	(189		)	(637		)
Excess tax benefits from stock-based award activities	113			302
Proceeds from issuance of debt, net of costs	12,125			8,350
Repayments of debt	(10,128		)	(8,904		)
Net cash provided by (used in) financing activities	1,921			(889		)
Effect of exchange rate changes on cash and cash equivalents	(52		)	(6		)
Net increase in cash and cash equivalents	6,277			464
Cash and cash equivalents at beginning of period	9,983			14,778
Cash and cash equivalents at end of period	$	16,260		$	15,242

Supplemental disclosures of cash flow information
Cash paid for taxes	$	1,684		$	1,304
Cash paid for interest	$	38		$	36
Non-cash investing and financing activities:
Receipt of Arris shares in connection with divestiture of Motorola Home	$	0		$	175
Fair value of stock-based awards assumed in connection with acquisition of Motorola	$	41		$	0
Property under capital lease	$	0		$	258

See accompanying notes.

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Google Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Google Inc. and Summary of Significant Accounting Policies

We were incorporated in California in September 1998 and re-incorporated in the State of Delaware in August 2003. We generate revenues primarily by delivering relevant, cost-effective online advertising in our Google segment. To a lesser extent, we generate revenues primarily from sales of mobile devices in our Motorola Mobile segment.

In April 2013, we completed the sale of our Motorola Home segment to Arris Group, Inc. (Arris) and certain other persons. See Note 8 for further discussion of the sale of Motorola Home.

Basis of Consolidation

The consolidated financial statements include the accounts of Google Inc. and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.

Unaudited Interim Financial Information

The accompanying Consolidated Balance Sheet as of September 30, 2013, the Consolidated Statements of Income for the three and nine months ended September 30, 2012 and 2013, the Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2012 and 2013, and the Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2013 are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (GAAP). In our opinion, the unaudited interim consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of our financial position as of September 30, 2013, our results of operations for the three and nine months ended September 30, 2012 and 2013, and our cash flows for the nine months ended September 30, 2012 and 2013. The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the year ending December 31, 2013.

These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed with the SEC on January 29, 2013.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the accounts receivable and sales allowances, fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, fair values of stock-based awards, inventory valuations, income taxes, and contingent liabilities, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

In the second quarter of 2013, we revised the estimated useful lives of certain types of property and equipment which resulted in an additional depreciation expense of $48 million and $169 million during the three and nine months ended September 30, 2013.

Prior Period Reclassifications

Certain reclassifications of prior period amounts have been made to conform to the current period presentation.

Note 2. Net Income Per Share of Class A and Class B Common Stock

The following table sets forth the computation of basic and diluted net income per share of Class A and Class B common stock (in millions, except share amounts which are reflected in thousands and per share amounts):

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	Three Months Ended										Nine Months Ended
	September 30,										September 30,
	2012					2013					2012						2013
	(unaudited)
	Class A		Class B			Class A		Class B			Class A			Class B			Class A		Class B
Basic net income (loss) per share:
Numerator
Allocation of undistributed earnings - continuing operations	$	1,732	$	426		$	2,438	$	517		$	6,293		$	1,588		$	7,237	$	1,596
Allocation of undistributed earnings - discontinued operations	14		4			12		3			(24		)	(6		)	582		129
Total	$	1,746	$	430		$	2,450	$	520		$	6,269		$	1,582		$	7,819	$	1,725
Denominator
Number of shares used in per share computation	263,086		64,699			275,237		58,379			260,666			65,786			272,150		60,033
Basic net income (loss) per share:
Continuing operations	$	6.59	$	6.59		$	8.86	$	8.86		$	24.14		$	24.14		$	26.59	$	26.59
Discontinued operations	0.05		0.05			0.04		0.04			(0.09		)	(0.09		)	2.14		2.14
Basic net income per share	$	6.64	$	6.64		$	8.90	$	8.90		$	24.05		$	24.05		$	28.73	$	28.73
Diluted net income (loss) per share:
Numerator
Allocation of undistributed earnings for basic computation - continuing operations	$	1,732	$	426		$	2,438	$	517		$	6,293		$	1,588		$	7,237	$	1,596
Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares	426		0			517		0			1,588			0			1,596		0
Reallocation of undistributed earnings to Class B shares	0		(7		)	0		(8		)	0			(23		)	0		(27		)
Allocation of undistributed earnings - continuing operations	$	2,158	$	419		$	2,955	$	509		$	7,881		$	1,565		$	8,833	$	1,569
Allocation of undistributed earnings for basic computation - discontinued operations	$	14	$	4		$	12	$	3		$	(24	)	$	(6	)	$	582	$	129
Reallocation of undistributed earnings as a result of conversion of Class B to Class A shares	4		0			3		0			(6		)	0			129		0
Reallocation of undistributed earnings to Class B shares	0		0			0		0			0			0			0		(3		)
Allocation of undistributed earnings - discontinued operations	$	18	$	4		$	15	$	3		$	(30	)	$	(6	)	$	711	$	126
Denominator
Number of shares used in basic computation	263,086		64,699			275,237		58,379			260,666			65,786			272,150		60,033
Weighted-average effect of dilutive securities
Add:
Conversion of Class B to Class A common shares outstanding	64,699		0			58,379		0			65,786			0			60,033		0
Employee stock options, including warrants issued under Transferable Stock Option program	3,015		36			2,607		1			2,943			39			2,800		5
Restricted stock units	2,514		0			3,012		0			2,019			0			3,095		0
Number of shares used in per share computation	333,314		64,735			339,235		58,380			331,414			65,825			338,078		60,038
Diluted net income (loss) per share:
Continuing operations	$	6.48	$	6.48		$	8.71	$	8.71		$	23.78		$	23.78		$	26.13	$	26.13
Discontinued operations	0.05		0.05			0.04		0.04			(0.09		)	(0.09		)	2.10		2.10
Diluted net income per share	$	6.53	$	6.53		$	8.75	$	8.75		$	23.69		$	23.69		$	28.23	$	28.23

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

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Note 3. Financial Instruments

Fair Value Measurements

We measure our cash equivalents, marketable securities, and foreign currency and interest rate derivative contracts at fair value on a recurring basis. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:

Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2—Include other inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign exchange rates, and credit ratings.

Level 3—Unobservable inputs that are supported by little or no market activities.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Based on the fair value hierarchy, we classify our cash equivalents and marketable securities within Level 1 or Level 2. This is because we value our cash equivalents and marketable securities using quoted market prices or alternative pricing sources and models utilizing market observable inputs. We classify our foreign currency and interest rate derivative contracts primarily within Level 2 as the valuation inputs are based on quoted prices and market observable data of similar instruments.

Cash, Cash Equivalents and Marketable Securities

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

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	As of December 31, 2012
	Adjusted Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Cash and Cash Equivalents		Marketable Securities
Cash	$	8,066	$	0	$	0		$	8,066	$	8,066	$	0
Level 1:
Money market and other funds	5,221		0		0			5,221		5,221		0
U.S. government notes	10,853		77		(1		)	10,929		0		10,929
Marketable equity securities	12		88		0			100		0		100
	16,086		165		(1		)	16,250		5,221		11,029
Level 2:
Time deposits	984		0		0			984		562		422
Money market and other funds ⁽¹⁾	929		0		0			929		929		0
U.S. government agencies	1,882		20		0			1,902		0		1,902
Foreign government bonds	1,996		81		(3		)	2,074		0		2,074
Municipal securities	2,249		23		(6		)	2,266		0		2,266
Corporate debt securities	7,200		414		(14		)	7,600		0		7,600
Agency residential mortgage-backed securities	7,039		136		(6		)	7,169		0		7,169
Asset-backed securities	847		1		0			848		0		848
	23,126		675		(29		)	23,772		1,491		22,281
Total	$	47,278	$	840	$	(30	)	$	48,088	$	14,778	$	33,310



		As of September 30, 2013
		Adjusted Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		Cash and Cash Equivalents		Marketable Securities
	(unaudited)
Cash		$	7,822	$	0	$	0		$	7,822	$	7,822	$	0
Level 1:
Money market and other funds		3,940		0		0			3,940		3,940		0
U.S. government notes		13,567		38		(30		)	13,575		402		13,173
Marketable equity securities		241		173		0			414		0		414
		17,748		211		(30		)	17,929		4,342		13,587
Level 2:
Time deposits		1,753		0		0			1,753		1,294		459
Money market and other funds⁽¹⁾		1,784		0		0			1,784		1,784		0
U.S. government agencies		2,330		5		(3		)	2,332		0		2,332
Foreign government bonds		2,408		13		(49		)	2,372		0		2,372
Municipal securities		3,579		13		(48		)	3,544		0		3,544
Corporate debt securities		9,323		163		(140		)	9,346		0		9,346
Agency residential mortgage-backed securities		8,597		80		(152		)	8,525		0		8,525
Asset-backed securities		1,118		0		(2		)	1,116		0		1,116
		30,892		274		(394		)	30,772		3,078		27,694
Total		$	56,462	$	485	$	(424	)	$	56,523	$	15,242	$	41,281


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

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

We determine realized gains or losses on the sale of marketable securities on a specific identification method. We recognized gross realized gains of $82 million and $290 million for the three and nine months ended September 30, 2012 and $35 million and $295 million for the three and nine months ended September 30, 2013. We recognized gross realized losses of $46 million and $79 million for the three and nine months ended September 30, 2012 and $61 million and $117 million for the three and nine months ended September 30, 2013. We reflect these gains and losses as a component of interest and other income, net, in the accompanying Consolidated Statements of Income.

The following table summarizes the estimated fair value of our investments in marketable securities, excluding marketable equity securities, designated as available-for-sale and classified by the contractual maturity date of the securities (in millions):



	As of September 30, 2013
	(unaudited)
Due in 1 year	$	4,809
Due in 1 year through 5 years	18,819
Due in 5 years through 10 years	8,375
Due after 10 years	8,864
Total	$	40,867

The following tables present gross unrealized losses and fair values for those investments that were in an unrealized loss position as of December 31, 2012 and September 30, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous loss position (in millions):



	As of December 31, 2012
	Less than 12 Months					12 Months or Greater					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. government notes	$	842	$	(1	)	$	0	$	0		$	842	$	(1	)
Foreign government bonds	509		(2		)	12		(1		)	521		(3		)
Municipal securities	686		(6		)	9		0			695		(6		)
Corporate debt securities	820		(10		)	81		(4		)	901		(14		)
Agency residential mortgage-backed securities	1,300		(6		)	0		0			1,300		(6		)
Total	$	4,157	$	(25	)	$	102	$	(5	)	$	4,259	$	(30	)



	As of September 30, 2013
	Less than 12 Months					12 Months or Greater					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
						(unaudited)
U.S. government notes	$	4,329	$	(30	)	$	0	$	0		$	4,329	$	(30	)
U.S. government agencies	849		(3		)	0		0			849		(3		)
Foreign government bonds	1,563		(47		)	38		(2		)	1,601		(49		)
Municipal securities	1,845		(47		)	9		(1		)	1,854		(48		)
Corporate debt securities	4,667		(136		)	48		(4		)	4,715		(140		)
Agency residential mortgage-backed securities	4,974		(149		)	224		(3		)	5,198		(152		)
Asset-backed securities	734		(2		)	0		0			734		(2		)
Total	$	18,961	$	(414	)	$	319	$	(10	)	$	19,280	$	(424	)

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We periodically review our marketable debt and equity securities for other-than-temporary impairment. We consider factors such as the duration, severity and the reason for the decline in value, the potential recovery period and our intent to sell. For marketable debt securities, we also consider whether (i) it is more likely than not that we will be required to sell the debt securities before recovery of their amortized cost basis, and (ii) the amortized cost basis cannot be recovered as a result of credit losses. During the three and nine months ended September 30, 2013, we did not recognize any other-than-temporary impairment loss.

Securities Lending Program

From time to time, we enter into securities lending agreements with financial institutions to enhance investment income. We loan selected securities which are collateralized in the form of cash or securities. Cash collateral is invested in reverse repurchase agreements which are collateralized in the form of securities.

We classify loaned securities as cash equivalents or marketable securities and record the cash collateral as an asset with a corresponding liability in the accompanying Consolidated Balance Sheets. We classify reverse repurchase agreements maturing within three months as cash equivalents and those longer than three months as receivable under reverse repurchase agreements in the accompanying Consolidated Balance Sheets. For security collateral received, we do not record an asset or liability except in the event of counterparty default.

Derivative Financial Instruments

We recognize derivative instruments as either assets or liabilities in the accompanying Consolidated Balance Sheets at fair value. We record changes in the fair value (i.e., gains or losses) of the derivatives in the accompanying Consolidated Statements of Income as interest and other income, net, as part of revenues, or as a component of accumulated other comprehensive income (AOCI) in the accompanying Consolidated Balance Sheets, as discussed below.

We enter into foreign currency contracts with financial institutions to reduce the risk that our cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations. We use certain interest rate derivative contracts to hedge interest rate exposures on our fixed income securities and our anticipated debt issuance. Our program is not used for trading or speculative purposes.

We enter into master netting arrangements, which reduce credit risk by permitting net settlement of transactions with the same counterparty. To further reduce credit risk, we enter into collateral security arrangements under which the counterparty is required to provide collateral when the net fair value of certain financial instruments fluctuates from contractually established thresholds. We can take possession of the collateral in the event of counterparty default. As of December 31, 2012 and September 30, 2013, we received cash collateral related to the derivative instruments under our collateral security arrangements of $43 million and $12 million.

Cash Flow Hedges

We use options designated as cash flow hedges to hedge certain forecasted revenue transactions denominated in currencies other than the U.S. dollar. The notional principal of these contracts was approximately $9.5 billion and $7.0 billion as of December 31, 2012 and September 30, 2013. These foreign exchange contracts have maturities of 36 months or less.

In 2012, we entered into forward-starting interest rate swaps that effectively locked in an interest rate on our anticipated debt issuance of $1.0 billion in 2014. The total notional amount of these forward-starting interest swaps was $1.0 billion as of December 31, 2012 and September 30, 2013 with terms calling for us to receive interest at a variable rate and to pay interest at a fixed rate.

We initially report any gain or loss on the effective portion of a cash flow hedge as a component of AOCI and subsequently reclassify cumulative gains and losses to revenues or interest expense when the hedged transactions are recorded. If the hedged transactions become probable of not occurring, the corresponding amounts in AOCI would be reclassified to interest and other income, net. Further, we exclude the change in the time value of the options from our assessment of hedge effectiveness. We record the premium paid or time value of an option on the date of purchase as an asset. Thereafter, we recognize any change to this time value in interest and other income, net.

As of September 30, 2013, the effective portion of our cash flow hedges before tax effect was $73 million, of which $7 million is expected to be reclassified from AOCI into earnings within the next 12 months.

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Fair Value Hedges

We use forward contracts designated as fair value hedges to hedge foreign currency risks for our investments denominated in currencies other than the U.S. dollar. Gains and losses on these contracts are recognized in interest and other income, net, along with the offsetting losses and gains of the related hedged items. We exclude changes in the time value for forward contracts from the assessment of hedge effectiveness. The notional principal of these contracts was $1.1 billion and $1.6 billion as of December 31, 2012 and September 30, 2013.

Other Derivatives

Other derivatives not designated as hedging instruments consist of forward and option contracts that we use to hedge intercompany transactions and other monetary assets or liabilities denominated in currencies other than the local currency of a subsidiary. We recognize gains and losses on these contracts, as well as the related costs in interest and other income, net, along with the foreign currency gains and losses on monetary assets and liabilities. The notional principal of foreign exchange contracts outstanding was $6.6 billion and $6.1 billion at December 31, 2012 and September 30, 2013.

We also use exchange-traded interest rate futures contracts and “To Be Announced” (TBA) forward purchase commitments of mortgage-backed assets to hedge interest rate risks on certain fixed income securities. The TBA contracts meet the definition of derivative instruments in cases where physical delivery of the assets is not taken at the earliest available delivery date. Our interest rate futures and TBA contracts (together interest rate contracts) are not designated as hedging instruments. We recognize gains and losses on these contracts, as well as the related costs in interest and other income, net. The gains and losses are generally economically offset by unrealized gains and losses in the underlying available-for-sale securities, which are recorded as a component of AOCI until the securities are sold or other-than-temporarily impaired, at which time the amounts are moved from AOCI into interest and other income, net. The total notional amounts of interest rate contracts outstanding were $25 million at December 31, 2012 and $75 million at September 30, 2013.

The fair values of our outstanding derivative instruments were as follows (in millions):



		As of December 31, 2012
	Balance Sheet Location	Fair Value of Derivatives Designated as Hedging Instruments		Fair Value of Derivatives Not Designated as Hedging Instruments		Total Fair Value
Derivative Assets:
Level 2:
Foreign exchange contracts	Prepaid revenue share, expenses and other assets, current and non-current	$	164	$	13	$	177
Interest rate contracts	Prepaid revenue share, expenses and other assets, current and non-current	1		0		1
Total		$	165	$	13	$	178
Derivative Liabilities:
Level 2:
Foreign exchange contracts	Accrued expenses and other current liabilities	$	3	$	4	$	7

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		As of September 30, 2013
	Balance Sheet Location	Fair Value of Derivatives Designated as Hedging Instruments		Fair Value of Derivatives Not Designated as Hedging Instruments		Total Fair Value
		(unaudited)
Derivative Assets:
Level 2:
Foreign exchange contracts	Prepaid revenue share, expenses and other assets, current and non-current	$	67	$	3	$	70
Interest rate contracts	Prepaid revenue share, expenses and other assets, current and non-current	68		0		68
Total		$	135	$	3	$	138

Derivative Liabilities:
Level 2:
Foreign exchange contracts	Accrued expenses and other current liabilities	$	15	$	0	$	15
Total		$	15	$	0	$	15

The effect of derivative instruments in cash flow hedging relationships on income and other comprehensive income (OCI) is summarized below (in millions):



	Gains (Losses) Recognized in OCI on Derivatives Before Tax Effect (Effective Portion)
	Three Months Ended September 30,						Nine Months Ended September 30,
Derivatives in Cash Flow Hedging Relationship	2012			2013			2012			2013
	(unaudited)
Foreign exchange contracts	$	(110	)	$	(43	)	$	110		$	87
Interest rate contracts	(8		)	(1		)	(8		)	67
Total	$	(118	)	$	(44	)	$	102		$	154



	Gains Reclassified from AOCI into Income (Effective Portion)
		Three Months Ended September 30,				Nine Months Ended September 30,
Derivatives in Cash Flow Hedging Relationship	Location	2012		2013		2012		2013
		(unaudited)
Foreign exchange contracts	Revenues	$	62	$	22	$	180	$	92

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	Gains (Losses) Recognized in Income on Derivatives (Amount Excluded from Effectiveness Testing and Ineffective Portion) ⁽¹⁾
		Three Months Ended September 30,						Nine Months Ended September 30,
Derivatives in Cash Flow Hedging Relationship	Location	2012			2013			2012			2013
		(unaudited)
Foreign exchange contracts	Interest and other income, net	$	(124	)	$	(135	)	$	(370	)	$	(224	)


⁽¹⁾	Gains (losses) related to the ineffective portion of the hedges were not material in all periods presented.

The effect of derivative instruments in fair value hedging relationships on income is summarized below (in millions):



	Gains (Losses) Recognized in Income on Derivatives⁽²⁾
		Three Months Ended September 30,						Nine Months Ended September 30,
Derivatives in Fair Value Hedging Relationship	Location	2012			2013			2012			2013
		(unaudited)
Foreign exchange contracts	Interest and other income, net	$	(38	)	$	(49	)	$	(22	)	$	13
Hedged item	Interest and other income, net	36			46			15			(19		)
Total		$	(2	)	$	(3	)	$	(7	)	$	(6	)


⁽²⁾	Losses related to the amount excluded from effectiveness testing of the hedges were $2 million and $7 million for the three and nine months ended September 30, 2012 and $3 million and $6 million for the three and nine months ended September 30, 2013.

The effect of derivative instruments not designated as hedging instruments on income is summarized below (in millions):



	Gains (Losses) Recognized in Income on Derivatives
		Three Months Ended September 30,						Nine Months Ended September 30,
Derivatives Not Designated As Hedging Instruments	Location	2012			2013			2012			2013
		(unaudited)
Foreign exchange contracts	Interest and other income, net	$	(82	)	$	(55	)	$	(107	)	$	102
Interest rate contracts	Interest and other income, net	0			2			(5		)	2
Total		$	(82	)	$	(53	)	$	(112	)	$	104

Offsetting of Derivatives, Securities Lending and Reverse Repurchase Agreements

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

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Offsetting of Assets
	As of December 31, 2012
								Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
Description	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheets		Net Presented in the Consolidated Balance Sheets			Financial Instruments				Cash Collateral Received			Non-Cash Collateral Received			Net Assets Exposed
Derivatives	$	178	$	0	$	178		$	(4	)	⁽¹⁾	$	(40	)	$	(12	)	$	122
Reverse repurchase agreements	1,629		0		1,629		⁽²⁾	0				0			(1,629		)	0
Total	$	1,807	$	0	$	1,807		$	(4	)		$	(40	)	$	(1,641	)	$	122


	As of September 30, 2013
								Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
Description	Gross Amounts of Recognized Assets		Gross Amounts Offset in the Consolidated Balance Sheets		Net Presented in the Consolidated Balance Sheets			Financial Instruments				Cash Collateral Received			Non-Cash Collateral Received			Net Assets Exposed
Derivatives	$	138	$	0	$	138		$	0		⁽¹⁾	$	(8	)	$	(31	)	$	99
Reverse repurchase agreements	1,884		0		1,884		⁽²⁾	0				0			(1,884		)	0
Total	$	2,022	$	0	$	2,022		$	0			$	(8	)	$	(1,915	)	$	99

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

⁽²⁾ The balances at December 31, 2012 and September 30, 2013 included $929 million and $1,784 million recorded in cash and cash equivalents, respectively, and $700 million and $100 million recorded in receivable under reverse repurchase agreements, respectively.

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Offsetting of Liabilities
	As of December 31, 2012
							Gross Amounts Not Offset in the Consolidated Balance Sheets, but Have Legal Rights to Offset
Description	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Consolidated Balance Sheets		Net Presented in the Consolidated Balance Sheets		Financial Instruments				Cash Collateral Pledged	Non-Cash Collateral Pledged	Net Liabilities
Derivatives	$	7	$	0	$	7	$	(4	)	^(3)<