META PLATFORMS, INC. You should read the following discussion of our financial condition and results of operations in conjunction with our condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , as filed with theSecurities and Exchange Commission . In addition to our historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in Part II, Item 1A, "Risk Factors." For a discussion of limitations in the measurement of certain of our community metrics, see the section entitled "Limitations of Key Metrics and Other Data" in this Quarterly Report on Form 10-Q. Certain revenue information in the section entitled "-Three and Nine Months EndedSeptember 30, 2020 and 2019-Revenue-Foreign Exchange Impact on Revenue" is presented on a constant currency basis. This information is a non-GAAP financial measure. To calculate revenue on a constant currency basis, we translated revenue for the three and nine months endedSeptember 30, 2020 using the prior year's monthly exchange rates for our settlement or billing currencies other than theU.S. dollar. This non-GAAP financial measure is not intended to be considered in isolation or as a substitute for, or superior to, financial information prepared and presented in accordance with GAAP. This measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We believe this non-GAAP financial measure provides investors with useful supplemental information about the financial performance of our business, enables comparison of financial results between periods where certain items may vary independent of business performance, and allows for greater transparency with respect to key metrics used by management in operating our business. Executive Overview of Third Quarter Results Our key community metrics and financial results for the third quarter of 2020 are as follows: Community growth: •September 2020 , an increase of 12% year-over-year.
•
2020, an increase of 12% year-over-year.
• Family daily active people (DAP) was 2.54 billion on average for September
2020, an increase of 15% year-over-year.
• Family monthly active people (MAP) was 3.21 billion as of September 30,
2020 , an increase of 14% year-over-year.
Financial results:
• Revenue was
was
• Total costs and expenses were
• Income from operations was
• Net income was
• Capital expenditures, including principal payments on finance leases, were
• Effective tax rate was 4%.
• Cash and cash equivalents and marketable securities were
of September 30, 2020 .
• Headcount was 56,653 as of September 30, 2020 , an increase of 32%
year-over-year.
In the third quarter of 2020, we continued to focus on our main revenue growth
priorities: (i) helping marketers use our products to connect with consumers
where they are and (ii) making our ads more relevant and effective.
In response to the COVID-19 pandemic, we have focused on helping people stay
connected, assisting the public health response, and working on the economic
recovery. We have also continued to invest based on the following company
priorities that we believe will further our mission to give people the power to
build community and bring the world closer together: (i) continue making
progress on the major social issues facing the internet and our company,
including privacy, safety, and security; (ii) build new experiences that
meaningfully improve people's lives today and set the stage for even bigger
improvements in the future; (iii) keep building our business by supporting the
millions of businesses that rely on our services to grow and create jobs; and
(iv) communicate more transparently about what we're doing and the role our
services play in the world.
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Our business has been impacted by the COVID-19 pandemic, which has resulted in authorities implementing numerous preventative measures to contain or mitigate the outbreak of the virus, such as travel bans and restrictions, limitations on business activity, quarantines, and shelter-in-place orders. These measures have caused, and are continuing to cause, business slowdowns or shutdowns in affected areas, both regionally and worldwide, which have significantly impacted our business and results of operations. Beginning in the first quarter of 2020, we experienced significant increases in the size and engagement of our active user base across a number of regions as a result of the COVID-19 pandemic. More recently, we have seen user growth and engagement returning to pre-pandemic trends, particularly inthe United States &Canada region. We expect this trend to continue in the future, although we are unable to predict the impact of the pandemic on user growth and engagement with any certainty. At the same time, we experienced a reduction in the demand for advertising, as well as a related decline in the pricing of our ads as a result of the pandemic, particularly in the second quarter of 2020. More recently, we believe the pandemic has contributed to an acceleration in the shift of commerce from offline to online, and we experienced increasing demand for advertising as a result of this acceleration, as well as a partial re-opening of certain business activities in certain regions. However, it is possible that this increased demand may not continue in future periods and may even recede as the effects of the pandemic subside, which could adversely affect our advertising revenue growth given that online commerce is our largest advertising vertical. The impact of the pandemic on the demand for and pricing of our advertising services, as well as on our overall results of operations, remains highly uncertain for the foreseeable future. In addition, we expect that future advertising revenue growth will continue to be adversely affected by limitations on our ad targeting and measurement tools arising from changes to the regulatory environment and third-party mobile operating systems and browsers. We also intend to continue to invest in our business based on our company priorities, and we anticipate that additional investments in our data center capacity, network infrastructure, and office facilities, as well as scaling our headcount to support our growth, will continue to drive expense growth in 2020. 30
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Trends in Our Facebook User Metrics The numbers for our key
and logged-in Facebook user who visited
mobile device, or used our Messenger application (and is also a registered
Facebook user), on a given day. We view DAUs, and DAUs as a percentage of
MAUs, as measures of user engagement on Facebook.
[[Image Removed: dau_q32020.jpg]]
Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region,
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Worldwide DAUs increased 12% to 1.82 billion on average duringSeptember 2020 from 1.62 billion duringSeptember 2019 . Users inIndia ,Indonesia , andthe Philippines represented the top three sources of growth in DAUs duringSeptember 2020 , relative to the same period in 2019. • Monthly Active Users (MAUs). We define a monthly active user as a
registered and logged-in Facebook user who visited
website or a mobile device, or used our Messenger application (and is also
a registered Facebook user), in the last 30 days as of the date of
measurement. MAUs are a measure of the size of our global active user
community on Facebook.
[[Image Removed: mau_q32020.jpg]]
As of September 30, 2020 , we had 2.74 billion MAUs, an increase of 12% from
September 30, 2019 . Users in India , Indonesia , and the Philippines represented
the top three sources of growth in the third quarter of 2020, relative to the
same period in 2019.
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Trends in Our Monetization by Facebook User Geography We calculate our revenue by Facebook user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or consumer hardware devices are shipped. We define ARPU as our total revenue in a given geography during a given quarter, divided by the average of the number of MAUs in the geography at the beginning and end of the quarter. While ARPU includes all sources of revenue, the number of MAUs used in this calculation only includes users ofUnited States &Canada andEurope are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in the third quarter of 2020 inthe United States &Canada region was more than 10 times higher than in theAsia-Pacific region . [[Image Removed: revenue_q32020a01.jpg]] [[Image Removed: adrevenueandotherrevenuea09.jpg]] Note: Our revenue by Facebook user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our
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During the third quarter of 2020, worldwide ARPU was$7.89 , an increase of 9% from the third quarter of 2019. Over this period, ARPU increased by 16% inEurope , 15% inUnited States &Canada , and 13% inAsia-Pacific , and ARPU decreased by 1% in Rest of World. In addition, user growth was more rapid in geographies with relatively lower ARPU, such asAsia-Pacific and Rest of World. We expect that user growth in the future will be primarily concentrated in those regions where ARPU is relatively lower, such that worldwide ARPU may continue to increase at a slower rate relative to ARPU in any geographic region, or potentially decrease even if ARPU increases in each geographic region. 34
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Trends in Our Family Metrics The numbers for our key Family metrics, our DAP, MAP, and average revenue per person (ARPP), do not include users on our other products unless they would otherwise qualify as MAP or DAP, respectively, based on their other activities on our Family products. Trends in the number of people in our community affect our revenue and financial results by influencing the number of ads we are able to show, the value of our ads to marketers, the volume of Payments transactions, as well as our expenses and capital expenditures. Substantially all of our daily and monthly active people (as defined below) access our Family products on mobile devices. • Daily Active People (DAP). We define a daily active person as a registered
and logged-in user of
(collectively, our "Family" of products) who visited at least one of these
Family products through a mobile device application or using a web or
mobile browser on a given day. We do not require people to use a common
identifier or link their accounts to use multiple products in our Family,
and therefore must seek to attribute multiple user accounts within and
across products to individual people. Our calculations of DAP rely uponcomplex techniques, algorithms, and machine learning models that seek to
estimate the underlying number of unique people using one or more of these
products, including by matching user accounts within an individual product
and across multiple products when we believe they are attributable to a
single person, and counting such group of accounts as one person. As these
techniques and models require significant judgment, are developed based on
internal reviews of limited samples of user accounts, and are calibrated
against user survey data, there is necessarily some margin of error in our
estimates. We view DAP, and DAP as a percentage of MAP, as measures of
engagement across our products. For additional information, see the
section entitled "Limitations of Key Metrics and Other Data" in this
Quarterly Report on Form 10-Q.
[[Image Removed: dapq32020worldwide.jpg]]
Note: We report the numbers of DAP and MAP as specific amounts, but these
numbers are estimates of the numbers of unique people using our products and are
subject to statistical variances and errors. While we expect the error margin
for these estimates to vary from period to period, we estimate that such margin
generally will be approximately 4% of our worldwide MAP. At our scale, it is
very difficult to attribute multiple user accounts within and across products to
individual people, and it is possible that the actual numbers of unique people
using our products may vary significantly from our estimates, potentially beyond
our estimated error margins. For additional information, see the section
entitled "Limitations of Key Metrics and Other Data" in this Quarterly Report on
Form 10-Q. In the second quarter of 2020, we updated our Family metrics
calculations to reflect recent data from a periodic WhatsApp user survey and to
incorporate certain methodology improvements, and we estimate such updates
contributed an aggregate of approximately 40 million DAP to our reported
worldwide DAP in June 2020 .
Worldwide DAP increased 15% to 2.54 billion on average during September 2020
from 2.20 billion during September 2019 .
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• Monthly Active People (MAP). We define a monthly active person as a
registered and logged-in user of one or more Family products who visited
at least one of these Family products through a mobile device application
or using a web or mobile browser in the last 30 days as of the date of
measurement. We do not require people to use a common identifier or link
their accounts to use multiple products in our Family, and therefore must
seek to attribute multiple user accounts within and across products toindividual people. Our calculations of MAP rely upon complex techniques,
algorithms, and machine learning models that seek to estimate the
underlying number of unique people using one or more of these products,
including by matching user accounts within an individual product and
across multiple products when we believe they are attributable to a single
person, and counting such group of accounts as one person. As these
techniques and models require significant judgment, are developed based on
internal reviews of limited samples of user accounts, and are calibrated
against user survey data, there is necessarily some margin of error in our
estimates. We view MAP as a measure of the size of our global active
community of people using our products. For additional information, see
the section entitled "Limitations of Key Metrics and Other Data" in this
Quarterly Report on Form 10-Q.
[[Image Removed: map_q32020worldwide.jpg]]
Note: We report the numbers of DAP and MAP as specific amounts, but these
numbers are estimates of the numbers of unique people using our products and are
subject to statistical variances and errors. While we expect the error margin
for these estimates to vary from period to period, we estimate that such margin
generally will be approximately 4% of our worldwide MAP. At our scale, it is
very difficult to attribute multiple user accounts within and across products to
individual people, and it is possible that the actual numbers of unique people
using our products may vary significantly from our estimates, potentially beyond
our estimated error margins. For additional information, see the section
entitled "Limitations of Key Metrics and Other Data" in this Quarterly Report on
Form 10-Q. In the second quarter of 2020, we updated our Family metrics
calculations to reflect recent data from a periodic WhatsApp user survey and to
incorporate certain methodology improvements, and we estimate such updates
contributed an aggregate of approximately 50 million MAP to our reported
worldwide MAP in June 2020 .
As of September 30, 2020 , we had 3.21 billion MAP, an increase of 14% from
2.82 billion as of September 30, 2019 .
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• Average Revenue Per Person (ARPP). We define ARPP as our total revenue
during a given quarter, divided by the average of the number of MAP at the
beginning and end of the quarter. While ARPP includes all sources of
revenue, the number of MAP used in this calculation only includes users of
our Family products as described in the definition of MAP above. The share
of revenue from users who are not also MAP was not material.
[[Image Removed: arpp_q32020worldwide.jpg]]
[[Image Removed: adrevenueandotherrevenuea10.jpg]]
During the third quarter of 2020, worldwide ARPP was
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Components of Results of Operations
Revenue
Advertising. We generate substantially all of our revenue from advertising. Our
advertising revenue is generated by displaying ad products on Facebook,
Instagram, Messenger, and third-party affiliated websites or mobile
applications. Marketers pay for ad products either directly or through their
relationships with advertising agencies or resellers, based on the number of
impressions delivered or the number of actions, such as clicks, taken by users.
We recognize revenue from the display of impression-based ads in the contracted
period in which the impressions are delivered. Impressions are considered
delivered when an ad is displayed to a user. We recognize revenue from the
delivery of action-based ads in the period in which a user takes the action the
marketer contracted for. The number of ads we show is subject to methodological
changes as we continue to evolve our ads business and the structure of our ads
products. We calculate price per ad as total ad revenue divided by the number of
ads delivered, representing the effective price paid per impression by a
marketer regardless of their desired objective such as impression or action. For
advertising revenue arrangements where we are not the principal, we recognize
revenue on a net basis.
Other revenue. Other revenue consists of revenue from the delivery of consumer
hardware devices and net fees we receive from developers using our Payments
infrastructure, as well as revenue from various other sources.
Cost of Revenue and Operating Expenses
Cost of revenue. Our cost of revenue consists primarily of expenses associated
with the delivery and distribution of our products. These include expenses
related to the operation of our data centers and technical infrastructure, such
as facility and server equipment depreciation, salaries, benefits, and
share-based compensation for employees on our operations teams, and energy and
bandwidth costs. Cost of revenue also includes costs associated with partner
arrangements, including traffic acquisition and content acquisition costs,
credit card and other transaction fees related to processing customer
transactions, and cost of consumer hardware devices.
Research and development. Research and development expenses consist primarily of
salaries and benefits, share-based compensation, and facilities-related costs
for employees on our engineering and technical teams who are responsible for
building new products as well as improving existing products.
Marketing and sales. Marketing and sales expenses consist of salaries and
benefits, and share-based compensation for our employees engaged in sales, sales
support, marketing, business development, and customer service functions. Our
marketing and sales expenses also include marketing and promotional expenditures
and professional services such as content reviewers to support our community and
product operations.
General and administrative. General and administrative expenses consist of
legal-related costs; salaries and benefits, and share-based compensation for
certain of our executives as well as our legal, finance, human resources,
corporate communications and policy, and other administrative employees; and
professional services.
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Results of Operations
The following table sets forth our condensed consolidated statements of income
data:
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
(in millions)
Revenue $ 21,470 $ 17,652 $ 57,893 $ 49,615
Costs and expenses:
Cost of revenue 4,194 3,155 11,482 9,279
Research and development 4,763 3,548 13,240 9,722
Marketing and sales 2,683 2,416 8,310 6,850
General and administrative 1,790 1,348 4,965 8,636
Total costs and expenses 13,430 10,467 37,997 34,487
Income from operations 8,040 7,185 19,896 15,128
Interest and other income, net 93 144 229 515
Income before provision for income taxes 8,133 7,329 20,125 15,643
Provision for income taxes 287 1,238 2,198 4,507
Net income $ 7,846 $ 6,091 $ 17,927 $ 11,136 The following table sets forth our condensed consolidated statements of income data (as a percentage of revenue)(1):
Three Months Ended September
30, Nine Months Ended
2020 2019 2020 2019
Revenue 100 % 100 % 100 % 100 %
Costs and expenses:
Cost of revenue 20 18 20 19
Research and development 22 20 23 20
Marketing and sales 12 14 14 14
General and administrative 8 8 9 17
Total costs and expenses 63 59 66 70
Income from operations 37 41 34 30
Interest and other income, net - 1 - 1
Income before provision for income taxes 38 42 35 32
Provision for income taxes 1 7 4 9
Net income 37 % 35 % 31 % 22 %
____________________________________
(1) Percentages have been rounded for presentation purposes and may differ from
unrounded results.
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Share-based compensation expense included in costs and expenses:
Three Months Ended September 30 ,
Nine Months Ended
2020 2019 2020 2019
(in millions)
Cost of revenue $ 116 $ 91 $ 327 $ 287
Research and development 1,297 907 3,557 2,557
Marketing and sales 180 148 516 421
General and administrative 129 103 352 297
Total share-based compensation expense $ 1,722 $ 1,249 $ 4,752
Share-based compensation expense included in costs and expenses (as a percentage of revenue)(1):
Three Months Ended September 30 ,
Nine Months Ended
2020 2019 2020 2019
Cost of revenue 1 % 1 % 1 % 1 %
Research and development 6 5 6 5
Marketing and sales 1 1 1 1
General and administrative 1 1 1 1
Total share-based compensation expense 8 % 7 % 8 % 7 %
____________________________________
(1) Percentages have been rounded for presentation purposes and may differ from
unrounded results.
Three and Nine Months Ended
Three Months Ended September 30 ,
Nine Months Ended
2020 2019 % change 2020 2019 % change
(in millions, except for percentages)
Advertising $ 21,221 $ 17,383 22 % $ 56,981 $ 48,919 16 %
Other revenue 249 269 (7 )% 912 696 31 %
Total revenue $ 21,470
57,893
Revenue in the three and nine months endedSeptember 30, 2020 increased$3.82 billion , or 22%, and$8.28 billion , or 17%, respectively, compared to the same periods in 2019. The increases in both periods were mostly due to an increase in advertising revenue as a result of an increase in the number of ads delivered, partially offset by a decrease in the average price per ad. During the three and nine months endedSeptember 30, 2020 , the number of ads delivered increased by 35% and 38%, respectively, as compared with approximately 37% and 34%, respectively, in the same periods in 2019. The increase in the ads delivered was driven by an increase in the number and frequency of ads displayed across our products and an increase in users. During the three and nine months endedSeptember 30, 2020 , the average price per ad decreased by 9% and 16%, respectively, as compared with decreases of approximately 6% and 5%, respectively, in the same periods in 2019. The decrease in average price per ad during the three months endedSeptember 30, 2020 was caused by an increasing proportion of the number of ads delivered as Stories ads and in geographies that monetize at lower rates. The decrease in average price per ad during the nine months endedSeptember 30, 2020 was primarily driven by a decrease in advertising demand globally due to the COVID-19 pandemic beginning in the first quarter of 2020 and, to a lesser extent, by an increasing proportion of the number of ads delivered as Stories ads and in geographies that monetize at lower rates. In the near-term, we anticipate that future advertising revenue growth will be determined primarily by several factors: the extent to which we continue to see increasing advertising demand in connection with the shift of commerce from offline to 40
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online as a result of the COVID-19 pandemic; the status of the economic recovery from the slowdown caused by the COVID-19 pandemic; and the extent to which changes to the regulatory environment and third-party mobile operating systems and browsers result in limitations on our ad targeting and measurement tools. Foreign Exchange Impact on Revenue The general weakening of theU.S. dollar relative to certain foreign currencies in the three months endedSeptember 30, 2020 compared to the same period in 2019 had a favorable impact on revenue. If we had translated revenue for the three months endedSeptember 30, 2020 using the prior year's monthly exchange rates for our settlement or billing currencies other than theU.S. dollar, our total revenue and advertising revenue would have been$21.36 billion and$21.11 billion , respectively. Using these constant rates, total revenue and advertising revenue would have been$114 million and$109 million lower than actual total revenue and advertising revenue, respectively, for the three months endedSeptember 30, 2020 . Foreign exchange rates had an unfavorable impact on our total revenue and advertising revenue for the nine months endedSeptember 30, 2020 compared to the same period in 2019. If we had translated revenue for the nine months endedSeptember 30, 2020 using the prior year's monthly exchange rates for our settlement or billing currencies other than theU.S. dollar, total revenue and advertising revenue would have been$58.35 billion and$57.44 billion , respectively. Using these constant rates, total revenue and advertising revenue would have been$459 million and$462 million higher than actual total revenue and advertising revenue, respectively, for the nine months endedSeptember 30, 2020 . Cost of revenue Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 % change 2020 2019 % change (in millions, except for percentages) Cost of revenue $ 4,194 $ 3,155 33 %$ 11,482 $ 9,279 24 % Percentage of revenue 20 % 18 % 20 % 19 % Cost of revenue in the three and nine months endedSeptember 30, 2020 increased$1.04 billion , or 33%, and$2.20 billion , or 24%, respectively, compared to the same periods in 2019. The increases in both periods were mostly due to increases in operational expenses related to our data centers and technical infrastructure, higher costs associated with partner arrangements, including traffic acquisition and content acquisition costs, and increases in the cost of consumer hardware devices. Research and development Three Months Ended September 30,
Nine Months Ended
2020 2019 % change 2020 2019 % change
(in millions, except for percentages)
Research and development $ 4,763 $ 3,548 34 % $ 13,240 $ 9,722 36 %
Percentage of revenue 22 % 20 % 23 % 20 %
Research and development expenses in the three and nine months ended
September 30, 2020 increased $1.21 billion , or 34%, and $3.52 billion , or 36%,
respectively, compared to the same periods in 2019. The increases in both
periods were primarily due to increases in payroll and benefits expenses as a
result of a 41% growth in employee headcount from September 30, 2019 to
September 30, 2020 in our engineering and other technical functions, including
in particular functions supporting consumer hardware product development.
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Marketing and sales
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % change 2020 2019 % change
(in millions, except for percentages)
Marketing and sales $ 2,683 $ 2,416 11 % $ 8,310 $ 6,850 21 %
Percentage of revenue 12 % 14 % 14 % 14 %
Marketing and sales expenses in the three and nine months ended September 30,
2020 increased $267 million , or 11%, and $1.46 billion , or 21%, respectively,
compared to the same periods in 2019. The increases were mostly driven by
increases in marketing expenses and payroll and benefits expenses, which were
partially offset by decreases in travel-related expenses due to the COVID-19
pandemic. Our payroll and benefits expenses increased as a result of an 18%
increase in employee headcount from September 30, 2019 to September 30, 2020 in
our marketing and sales functions.
General and administrative
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % change 2020 2019 % change
(in millions, except for percentages)
Legal accrual related
to FTC settlement $ - $ - - $ - $ 5,000 NM
Other general and
administrative 1,790 1,348 33 % 4,965 3,636 37 %
General and
administrative $ 1,790 $ 1,348 33 % $ 4,965 $ 8,636 (43 )%
Percentage of revenue 8 % 8 % 9 % 17 %
Excluding the $5.0 billion FTC settlement accrual recorded during the first six
months of 2019, general and administrative expenses in the three and nine months
ended September 30, 2020 increased $442 million , or 33%, and $1.33 billion , or
37%, compared to the same periods in 2019. The majority of the increases was due
to increases in other legal-related costs and payroll and benefits expenses as a
result of a 26% increase in employee headcount from September 30, 2019 to
September 30, 2020 in our general and administrative functions.
Interest and other income, net
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % change 2020 2019 % change
(in millions, except for percentages)
Interest income, net $ 146 $ 258 (43 )% $ 536 $ 675 (21 )%
Other income
(expense), net (53 ) (114 ) (54 )% (307 ) (160 ) 92 %
Interest and other
income, net $ 93 $ 144 (35 )% $ 229 $ 515 (56 )%
Interest and other income, net in the three months ended September 30, 2020
decreased $51 million , or 35% compared to the same period in 2019. The decrease
was mostly due to a decrease in interest income related to lower interest rates,
which was partially offset by a decrease in other expense from lower foreign
exchange losses as a result of foreign currency transactions and remeasurement,
compared to the same period in 2019.
Interest and other income, net in the first nine months of 2020 decreased
$286 million , or 56% compared to the same period in 2019. The decrease was due
to an increase in other expense, which was mainly due to higher foreign exchange
losses and a decrease in interest income due to lower interest rates, compared
to the same period in 2019.
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Provision for income taxes
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 % change 2020 2019 % change
(in millions, except for percentages)
Provision for income taxes $ 287 $ 1,238 (77 )% $ 2,198 $ 4,507 (51 )%
Effective tax rate 4 % 17 % 11 % 29 %
Our provision for income taxes in the three months ended September 30, 2020
decreased $951 million , or 77%, compared to the same period in 2019, mostly due
to the effects of a tax election to capitalize and amortize certain expenses.
Our provision for income taxes in the nine months ended September 30, 2020
decreased $2.31 billion , or 51%, primarily due to the additional tax expense in
the second quarter of 2019 from the Altera Ninth Circuit Opinion and the effects
of a tax election to capitalize and amortize certain expenses, both discussed
below.
Our effective tax rate in the three months ended September 30, 2020 decreased
compared to the same period in 2019, primarily due to the effects of a tax
election to capitalize and amortize certain expenses. Our effective tax rate in
the nine months ended September 30, 2020 decreased compared to the same period
in 2019, mostly due to the 2019 legal accrual related to the FTC settlement that
was not expected to be tax-deductible, the additional tax expense in the second
quarter of 2019 from the Altera Ninth Circuit Opinion, and the effects of a tax
election to capitalize and amortize certain expenses.
In the third quarter of 2020, as part of finalizing our U.S. income tax return,
we elected to capitalize and amortize certain research and development expenses
for U.S. income tax purposes. As a result, we recorded a one-time income tax
benefit of $913 million , which is comprised of an increase in current income tax
liability of $746 million offset by an increase in deferred income tax assets of
$1.66 billion . The deferred income tax asset amount is greater than the current
income tax liability due to different tax rates applicable for the periods in
which capitalized expenses will be amortized versus the period in which the
increased current tax liability was accrued. We do not believe this election
will materially affect our effective tax rate trend in the future.
On July 27, 2015 , the United States Tax Court issued a decision (Tax Court
Decision) in Altera Corp. v. Commissioner, which concluded that related parties
in a cost sharing arrangement are not required to share expenses related to
share-based compensation. The Tax Court Decision was appealed by the
Commissioner to the Ninth Circuit Court of Appeals (Ninth Circuit). On June 7,
2019 , the Ninth Circuit issued an opinion (Altera Ninth Circuit Opinion) that
reversed the Tax Court Decision. Based on the Altera Ninth Circuit Opinion, we
recorded a cumulative income tax expense of $1.11 billion in the second quarter
of 2019. On July 22, 2019 , the taxpayer requested a rehearing before the full
Ninth Circuit and the request was denied on November 12, 2019 . The taxpayer
requested a hearing before the Supreme Court of the United States and the
request was denied on June 22, 2020 . Since we started to accrue income tax for
stock-based compensation cost-sharing in the second quarter of 2019, the denial
of the request by the Supreme Court did not have a material impact to our
financial results in 2020.
Effective Tax Rate Items. Our effective tax rate in the future will depend upon
the proportion between the following items and income before provision for
income taxes: U.S. tax benefits from foreign derived intangible income, tax
effects from share-based compensation, tax effects of integrating intellectual
property from acquisitions, settlement of tax contingency items, tax effects of
changes in our business, and the effects of changes in tax law.
The accounting for share-based compensation may increase or decrease our
effective tax rate based upon the difference between our share-based
compensation expense and the deductions taken on our tax return which depends
upon the stock price at the time of employee award vesting. If our stock price
remains constant to the October 23, 2020 price, we expect our effective tax rate
for the fourth quarter 2020 will be in the mid-teens and the full year of 2021
will be in the high-teens, although we may see fluctuations in our quarterly
rate depending on our financial results.
Unrecognized Tax Benefits. As of September 30, 2020 , we had net unrecognized tax
benefits of $3.58 billion which were accrued as other liabilities. These
unrecognized tax benefits were predominantly accrued for uncertainties related
to transfer pricing with our foreign subsidiaries, which includes licensing of
intellectual property, providing services and other transactions, as well as for
uncertainties with our research tax credits. The ultimate settlement of the
liabilities will depend upon resolution of tax audits, litigation, or events
that would otherwise change the assessment of such items. Based upon the status
of litigation described below and the current status of tax audits in various
jurisdictions, we do not anticipate a material change to such amounts within the
next 12 months.
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InJuly 2016 , we received a Statutory Notice of Deficiency (Notice) from theIRS related to transfer pricing with our foreign subsidiaries in conjunction with the examination of the 2010 tax year. While the Notice applies only to the 2010 tax year, theIRS stated that it will also apply its position for tax years subsequent to 2010. We do not agree with the position of theIRS and have filed a petition in the Tax Court challenging the Notice. OnJanuary 15, 2020 , theIRS filed its Pretrial Memorandum in the case stating that it planned to assert at trial an adjustment that is higher than the adjustment stated in the Notice. The first sessions of the trial began inFebruary 2020 , and additional sessions are expected to continue in 2021. TheIRS did not provide any information about how it intends to apply the revised adjustment to future years. Based on the information provided, we believe that, if theIRS prevails in its updated position, this could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately$9.0 billion in excess of the amounts in our originally filedU.S. return, plus interest and any penalties asserted. InMarch 2018 , we received a second Notice from theIRS in conjunction with the examination of our 2011 through 2013 tax years. TheIRS applied its position from the 2010 tax year to each of these years and also proposed new adjustments related to other transfer pricing with our foreign subsidiaries and certain tax credits that we claimed. If theIRS prevails in its position for these new adjustments, this could result in an additional federal tax liability of up to approximately$680 million in excess of the amounts in our originally filedU.S. returns, plus interest and any penalties asserted. We do not agree with the positions of theIRS in the second Notice and have filed a petition in the Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740, Income Taxes, that is lower than the potential additional federal tax liability from the positions taken by theIRS in the two Notices and its Pretrial Memorandum. In addition, if theIRS prevails in its positions related to transfer pricing with our foreign subsidiaries, the additional tax that we would owe would be partially offset by a reduction in the tax that we owe under the mandatory transition tax on accumulated foreign earnings from the 2017 Tax Cuts and Jobs Act (Tax Act). As ofSeptember 30, 2020 , we have not resolved these matters and proceedings continue in the Tax Court. We believe that adequate amounts have been reserved in accordance with ASC 740, Income Taxes, for any adjustments to the provision for income taxes or other tax items that may ultimately result from these examinations. The timing of the resolution, settlement, and closure of any audits is highly uncertain, and it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. Given the number of years remaining that are subject to examination in various jurisdictions, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits. If the taxing authorities prevail in the assessment of additional tax due, the assessed tax, interest, and penalties, if any, could have a material adverse effect on our financial position, results of operations, and cash flows. 44
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Liquidity and Capital Resources Our principal sources of liquidity are our cash and cash equivalents, marketable securities, and cash generated from operations. Cash and cash equivalents and marketable securities consist mostly of cash on deposit with banks, investments in money market funds, and investments inU.S. government securities,U.S. government agency securities, and corporate debt securities. Cash and cash equivalents and marketable securities were$55.62 billion as ofSeptember 30, 2020 , an increase of$765 million fromDecember 31, 2019 . The increase was mostly due to$24.71 billion of cash generated from operations, offset by$10.90 billion for capital expenditures, including principal payments on finance leases,$6.30 billion for purchases of equity investments,$4.34 billion for repurchases of our Class A common stock, and$2.44 billion of taxes paid related to net share settlement of employee restricted stock units (RSU) awards. Cash paid for income taxes was$3.12 billion in the nine months endedSeptember 30, 2020 . As ofSeptember 30, 2020 , our federal net operating loss carryforward was$9.99 billion , and we anticipate that none of this amount will be utilized to offset our federal taxable income in 2020. As ofSeptember 30, 2020 , we had$378 million of federal tax credit carryforward, of which none will be available to offset our federal tax liabilities in 2020. InMay 2016 , we entered into a$2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under the facility will be due and payable onMay 20, 2021 . As ofSeptember 30, 2020 , no amounts had been drawn down and we were in compliance with the covenants under this credit facility. Our board of directors has authorized a share repurchase program of our Class A common stock, which does not have an expiration date. As ofDecember 31, 2019 ,$4.90 billion remained available and authorized for repurchases. InJanuary 2020 , an additional$10.0 billion of repurchases was authorized under this program. During the nine months endedSeptember 30, 2020 , we repurchased and subsequently retired 20 million shares of our Class A common stock for an aggregate amount of$4.36 billion . As ofSeptember 30, 2020 ,$10.55 billion remained available and authorized for repurchases. As ofSeptember 30, 2020 ,$6.52 billion of the$55.62 billion in cash and cash equivalents and marketable securities was held by our foreign subsidiaries. The Tax Act imposed a mandatory transition tax on accumulated foreign earnings and eliminatedU.S. taxes on foreign subsidiary distributions. As a result, earnings in foreign jurisdictions are available for distribution to theU.S. without incrementalU.S. taxes. InJuly 2019 , we entered into a settlement and modified consent order to resolve the inquiry of theFTC into our platform and user data practices, which was approved by the federal court and took effect inApril 2020 . We paid the penalty of$5.0 billion inApril 2020 upon the effectiveness of the modified consent order. OnApril 21, 2020 , we entered into a definitive agreement to invest inJio Platforms Limited , a subsidiary of Reliance Industries Limited. The transaction closed onJuly 7, 2020 , and we paid approximately$5.8 billion at the then-current exchange rate. We currently anticipate that our available funds, credit facility, and cash flow from operations will be sufficient to meet our operational cash needs for the foreseeable future. Cash Provided by Operating Activities Cash flow from operating activities during the nine months endedSeptember 30, 2020 consisted mostly of net income adjusted for certain non-cash items, such as$5.0 billion of depreciation and amortization and$4.75 billion of share-based compensation expense, and a cash payment of$5.0 billion for theFTC legal settlement. The decrease in cash flow from operating activities during the nine months endedSeptember 30, 2020 , compared to the same period in 2019, was mostly due to the payment of$5.0 billion for theFTC legal settlement partially offset by an increase in net income. Cash Used in Investing Activities Cash used in investing activities during the nine months endedSeptember 30, 2020 consisted mostly of$10.50 billion of net purchases of property and equipment as we continued to invest in data centers, servers, office buildings, and network infrastructure,$7.69 billion of net purchases, sales and maturities of marketable securities, and$6.30 billion of purchases of equity investments. The increase in cash used in investing activities during the nine months endedSeptember 30, 2020 , compared to the same period in 2019, was mostly due to increases in purchases of equity investments and in net purchases of marketable securities. 45
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We anticipate making capital expenditures of approximately$16 billion in 2020 and approximately$21 billion to$23 billion in 2021. Cash Used in Financing Activities Cash used in financing activities during the nine months endedSeptember 30, 2020 consisted mostly of$4.34 billion for repurchases of our Class A common stock and$2.44 billion of taxes paid related to net share settlement of RSUs. The increase in cash used in financing activities during the nine months endedSeptember 30, 2020 , compared to the same period in 2019, was primarily due to an increase in repurchases of our Class A common stock. Off-Balance Sheet Arrangements As ofSeptember 30, 2020 , we did not have any off-balance sheet arrangements that are reasonably likely to have a material current or future effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources. Contractual Obligations Our principal commitments consist mostly of obligations under operating leases and other contractual commitments. Our obligations under operating leases include among others, certain of our offices, data centers, land, colocations, and equipment. Our other contractual commitments are mostly related to our investments in network infrastructure, consumer hardware, content acquisitions, and data center operations. The following table summarizes our commitments to settle contractual obligations in cash as ofSeptember 30, 2020 (in millions): Payment Due by Period The remainder Total of 2020 2021-2022 2023-2024 Thereafter Operating lease obligations, including imputed interest(1)$ 20,658 $ 235$ 2,842 $ 2,998 $ 14,583 Finance lease obligations, including imputed interest(1) 1,045 140 265 96 544 Transition tax payable 1,565 - - 869 696 Other contractual commitments 7,905 3,023 2,382 404 2,096 Total contractual obligations$ 31,173 $ 3,398 $ 5,489 $ 4,367 $ 17,919
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(1) Includes variable lease payments that were fixed subsequent to lease
commencement or modification.
Additionally, as part of the normal course of the business, we may also enter into multi-year agreements to purchase renewable energy that do not specify a fixed or minimum volume commitment or to purchase certain network components that do not specify a fixed or minimum price commitment. These agreements are generally entered into in order to secure either volume or price. Using projected market prices or expected volume consumption, the total estimated spend is approximately$4.90 billion . The ultimate spend under these agreements may vary and will be based on prevailing market prices or actual volume purchased. Our other liabilities also include$3.58 billion related to net uncertain tax positions as ofSeptember 30, 2020 . Due to uncertainties in the timing of the completion of tax audits, the timing of the resolution of these positions is uncertain and we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months. As a result, this amount is not included in the above contractual obligations table. 46
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Contingencies
We are involved in legal proceedings, claims, and regulatory, tax or government inquiries and investigations. We record a provision for a liability when we believe that it is both probable that a liability has been incurred, and that the amount can be reasonably estimated. If we determine there is a reasonable possibility that we may incur a loss and the loss or range of loss can be estimated, we disclose the possible loss in the accompanying notes to the condensed consolidated financial statements to the extent material. Significant judgment is required to determine both probability and the estimated amount of loss. Such matters are inherently unpredictable and subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to be incorrect, it could have a material impact on our results of operations, financial position, and cash flows. See Note 11 - Commitments and Contingencies and Note 13 - Income Taxes in the notes to the condensed consolidated financial statements included in Part I, Item 1, and "Legal Proceedings" contained in Part II, Item 1 of this Quarterly Report on Form 10-Q for additional information regarding contingencies.
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. In our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 , we disclosed the assumptions and estimates associated with income taxes, loss contingencies, and valuation of long-lived assets including goodwill, intangible assets and their associated estimated useful lives have the greatest potential impact on our consolidated financial statements. There have been no material changes from the fiscal year endedDecember 31, 2019 , except for the assumptions and estimates noted below. During the nine months endedSeptember 30, 2020 , in response to the economic slowdown caused by the COVID-19 pandemic, we now believe that the assumptions and estimates associated with collectibility assessment of revenue and credit losses of accounts receivable may also have a material impact to our consolidated financial statements in future periods, depending on the duration or degree of the impact of the COVID-19 pandemic on the global economy.
Collectibility assessment of revenue
Under Topic 606, we recognize revenue using a five-step model. In step one,
for a revenue contract to exist, it must be probable that substantially all of
the consideration to which we are entitled to will be collected. In performing
such collectibility assessment, we consider various facts and circumstances
including future expectations about our customer's ability and intention to pay.
Collectibility assessment uses a probable
threshold which requires estimation based on several objective and subjective
factors, such as probability of default, customer's intention to pay, payment
history, financial strength, geography, and industry sub-vertical risks.
The collectibility assessment has become increasingly uncertain during the
current economic environment caused by the COVID-19 pandemic, and our actual
experience in the future may differ from our past experiences or current
assessment.
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Credit losses of accounts receivable
OnJanuary 1, 2020 , we adopted Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires the measurement and recognition of expected credit losses for financial assets held at amortized cost that an entity does not expect to collect over the asset's contractual life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions. For accounts receivable measured at amortized cost, we use aging analysis, probability of default methods and incorporate macroeconomic variables that are most relevant to evaluating and estimating the expected credit losses. These macroeconomic variables may vary by geography, customer-type, or industry sub-vertical. The contractual life of our trade accounts receivable is generally short-term; however, we may experience increasing credit loss risks from accounts receivable in future periods depending on the duration or degree of economic slowdown caused by the COVID-19 pandemic, and our actual experience in the future may differ from our past experiences or current assessment.
Valuation of Equity Investments
For our equity securities without readily determinable fair values accounted for
using the measurement alternative, determining whether an equity security issued
by the same issuer is similar to the equity security we hold may require
judgment in (a) assessment of differences in rights and obligations associated
with the instruments such as voting rights, distribution rights and preferences,
and conversion features, and (b) adjustments to the observable price for
differences such as, but not limited to, rights and obligations, control
premium, liquidity, or principal or most advantageous markets. In addition, the
identification of observable transactions will depend on the timely reporting of
these transactions from our investee companies, which may occur in a period
subsequent to when the transactions take place. Therefore, our fair value
adjustment for these observable transactions may occur in a period subsequent to
when the transaction actually occurred. For equity investments, we perform a
qualitative assessment at each reporting date to determine whether there are
triggering events for impairment. The qualitative assessment considers factors
such as, but not limited to, the investee's financial condition and business
outlook; industry and sector performance; regulatory, economic or technological
environment; operational and financing cash flows; and other relevant events and
factors affecting the investee. When indicators of impairment exist, we estimate
the fair value of our equity investments using the market approach and/or the
income approach and recognize impairment loss in net income if the estimated
fair value is less than the carrying value. Estimating fair value requires
judgment and use of estimates such as discount rates, forecast cash flows,
holding period, and market data of comparable companies, among others.
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