Edgar Filing: Facebook Inc

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

____________________________________________

FORM 10-Q

____________________________________________

(Mark One)

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

For the quarterly period ended June 30, 2018

o 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: 001-35551

____________________________________________

FACEBOOK, INC.

(Exact name of registrant as specified in its charter)

____________________________________________



Delaware	20-1665019
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

1601 Willow Road, Menlo Park, California 94025

(Address of principal executive offices and Zip Code)

(650) 543-4800

(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 (Exchange Act) 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 x 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	x	Accelerated filer	¨

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

		Emerging growth company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 x

Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date.



Class	Number of Shares Outstanding
Class A Common Stock $0.000006 par value	2,411,679,559 shares outstanding as of July 23, 2018
Class B Common Stock $0.000006 par value	475,539,105 shares outstanding as of July 23, 2018

FACEBOOK, INC.

TABLE OF CONTENTS



		Page No.

Note About Forward-Looking Statements		3

Limitations of Key Metrics and Other Data		4

PART I—FINANCIAL INFORMATION		5

Item 1.	Financial Statements (unaudited)	5

	Condensed Consolidated Balance Sheets—June 30, 2018 and December 31, 2017	5

	Condensed Consolidated Statements of Income—for the three and six months ended June 30, 2018 and 2017	6

	Condensed Consolidated Statements of Comprehensive Income—for the three and six months ended June 30, 2018 and 2017	7

	Condensed Consolidated Statements of Cash Flows—for the six months ended June 30, 2018 and 2017	8

	Notes to Condensed Consolidated Financial Statements	10

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	37

Item 4.	Controls and Procedures	38

PART II—OTHER INFORMATION		39

Item 1.	Legal Proceedings	39

Item 1A.	Risk Factors	40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	62

Item 5.	Other Information	63

Item 6.	Exhibits	64

SIGNATURES		65

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. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, and our objectives for future operations, are forward-looking statements. The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect," and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Part II, Item 1A, "Risk Factors" in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

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.

Unless expressly indicated or the context requires otherwise, the terms "Facebook," "company," "we," "us," and "our" in this document refer to Facebook, Inc., a Delaware corporation, and, where appropriate, its wholly owned subsidiaries. The term "Facebook" may also refer to our products, regardless of the manner in which they are accessed. For references to accessing Facebook on the "web" or via a "website," such terms refer to accessing Facebook on personal computers. For references to accessing Facebook on "mobile," such term refers to accessing Facebook via a mobile application or via a mobile-optimized version of our website such as m.facebook.com, whether on a mobile phone or tablet.

LIMITATIONS OF KEY METRICS AND OTHER DATA

The numbers for our key metrics, which include our daily active users (DAUs), monthly active users (MAUs), and average revenue per user (ARPU), are calculated using internal company data based on the activity of user accounts. While these numbers are based on what we believe to be reasonable estimates of our user base for the applicable period of measurement, there are inherent challenges in measuring usage of our products across large online and mobile populations around the world. In addition, we are continually seeking to improve our estimates of our user base, and such estimates may change due to improvements or changes in our methodology.

We regularly evaluate these metrics to estimate the number of "duplicate" and "false" accounts among our MAUs. A duplicate account is one that a user maintains in addition to his or her principal account. We divide "false" accounts into two categories: (1) user-misclassified accounts, where users have created personal profiles for a business, organization, or non-human entity such as a pet (such entities are permitted on Facebook using a Page rather than a personal profile under our terms of service); and (2) undesirable accounts, which represent user profiles that we determine are intended to be used for purposes that violate our terms of service, such as spamming. The estimates of duplicate and false accounts are based on an internal review of a limited sample of accounts, and we apply significant judgment in making this determination. For example, to identify duplicate accounts we use data signals such as similar IP addresses or user names, and to identify false accounts we look for names that appear to be fake or other behavior that appears inauthentic to the reviewers. Our estimates may change as our methodologies evolve, including through the application of new data signals or technologies, which may allow us to identify previously undetected duplicate or false accounts and may improve our ability to evaluate a broader population of our users. Duplicate and false accounts are very difficult to measure at our scale, and it is possible that the actual number of duplicate and false accounts may vary significantly from our estimates.

In the fourth quarter of 2017, we estimate that duplicate accounts may have represented approximately 10% of our worldwide MAUs. We believe the percentage of duplicate accounts is meaningfully higher in developing markets such as India, Indonesia, and the Philippines, as compared to more developed markets. In the fourth quarter of 2017, we estimate that false accounts may have represented approximately 3-4% of our worldwide MAUs. Our estimation of false accounts can vary as a result of episodic spikes in the creation of such accounts, which we have seen originate more frequently in specific countries such as Indonesia, Turkey, and Vietnam. From time to time, we may make product changes or take other actions to reduce the number of duplicate or false accounts among our users, which may also reduce our DAU and MAU estimates in a particular period.

Our data limitations may affect our understanding of certain details of our business. For example, while user-provided data indicates a decline in usage among younger users, this age data is unreliable because a disproportionate number of our younger users register with an inaccurate age. Accordingly, our understanding of usage by age group may not be complete.

In addition, our data regarding the geographic location of our users is estimated based on a number of factors, such as the user's IP address and self-disclosed location. These factors may not always accurately reflect the user's actual location. For example, a user may appear to be accessing Facebook from the location of the proxy server that the user connects to rather than from the user's actual location. The methodologies used to measure user metrics may also be susceptible to algorithm or other technical errors. Our estimates for revenue by user location and revenue by user device are also affected by these factors.

We regularly review our processes for calculating these metrics, and from time to time we may discover inaccuracies in our metrics or make adjustments to improve their accuracy, including adjustments that may result in the recalculation of our historical metrics. We believe that any such inaccuracies or adjustments are immaterial unless otherwise stated. We intend to disclose our estimates of the number of duplicate and false accounts among our MAUs on an annual basis. In addition, our DAU and MAU estimates will differ from estimates published by third parties due to differences in methodology.

The numbers of DAUs and MAUs discussed in this Quarterly Report on Form 10-Q, as well as ARPU, do not include Instagram, WhatsApp, or Oculus users unless they would otherwise qualify as such users, respectively, based on their other activities on Facebook. In addition, other user engagement metrics included herein do not include Instagram, WhatsApp, or Oculus unless otherwise specifically stated.

PART I—FINANCIAL INFORMATION


Item 1.	Financial Statements

FACEBOOK, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions, except for number of shares and par value)

(Unaudited)



	June 30, 2018			December 31, 2017
Assets
Current assets:
Cash and cash equivalents	$	11,552		$	8,079
Marketable securities	30,757			33,632
Accounts receivable, net of allowances of $198 and $189 as of June 30, 2018 and December 31, 2017, respectively	5,590			5,832
Prepaid expenses and other current assets	1,934			1,020
Total current assets	49,833			48,563
Property and equipment, net	18,357			13,721
Intangible assets, net	1,573			1,884
Goodwill	18,263			18,221
Other assets	2,265			2,135
Total assets	$	90,291		$	84,524

Liabilities and stockholders' equity
Current liabilities:
Accounts payable	$	419		$	380
Partners payable	440			390
Accrued expenses and other current liabilities	3,720			2,892
Deferred revenue and deposits	91			98
Total current liabilities	4,670			3,760
Other liabilities	6,239			6,417
Total liabilities	10,909			10,177
Commitments and contingencies
Stockholders' equity:
Common stock, $0.000006 par value; 5,000 million Class A shares authorized, 2,413 million and 2,397 million shares issued and outstanding, as of June 30, 2018 and December 31, 2017, respectively; 4,141 million Class B shares authorized, 478 million and 509 million shares issued and outstanding, as of June 30, 2018 and December 31, 2017, respectively.	—			—
Additional paid-in capital	41,832			40,584
Accumulated other comprehensive loss	(687		)	(227		)
Retained earnings	38,237			33,990
Total stockholders' equity	79,382			74,347
Total liabilities and stockholders' equity	$	90,291		$	84,524

See Accompanying Notes to Condensed Consolidated Financial Statements.

FACEBOOK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In millions, except per share amounts)

(Unaudited)



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Revenue	$	13,231	$	9,321	$	25,197	$	17,353
Costs and expenses:
Cost of revenue	2,214		1,237		4,141		2,395
Research and development	2,523		1,919		4,761		3,753
Marketing and sales	1,855		1,124		3,450		2,181
General and administrative	776		640		1,532		1,295
Total costs and expenses	7,368		4,920		13,884		9,624
Income from operations	5,863		4,401		11,313		7,729
Interest and other income, net	5		87		165		168
Income before provision for income taxes	5,868		4,488		11,478		7,897
Provision for income taxes	762		594		1,385		938
Net income	$	5,106	$	3,894	$	10,093	$	6,959
Less: Net income attributable to participating securities	—		4		1		10
Net income attributable to Class A and Class B common stockholders	$	5,106	$	3,890	$	10,092	$	6,949
Earnings per share attributable to Class A and Class B common stockholders:
Basic	$	1.76	$	1.34	$	3.48	$	2.40
Diluted	$	1.74	$	1.32	$	3.43	$	2.36
Weighted average shares used to compute earnings per share attributable to Class A and Class B common stockholders:
Basic	2,895		2,900		2,900		2,895
Diluted	2,930		2,951		2,939		2,950
Share-based compensation expense included in costs and expenses:
Cost of revenue	$	74	$	47	$	130	$	81
Research and development	881		787		1,599		1,457
Marketing and sales	139		120		248		216
General and administrative	92		78		164		145
Total share-based compensation expense	$	1,186	$	1,032	$	2,141	$	1,899

See Accompanying Notes to Condensed Consolidated Financial Statements.

FACEBOOK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In millions)

(Unaudited)



	Three Months Ended June 30,					Six Months Ended June 30,
	2018			2017		2018			2017
Net income	$	5,106		$	3,894	$	10,093		$	6,959
Other comprehensive income (loss):
Change in foreign currency translation adjustment, net of tax	(372		)	246		(278		)	306
Change in unrealized gain/loss on available-for-sale investments and other, net of tax	(21		)	10		(182		)	27
Comprehensive income	$	4,713		$	4,150	$	9,633		$	7,292

See Accompanying Notes to Condensed Consolidated Financial Statements.

FACEBOOK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)



	Six Months Ended June 30,
	2018			2017
Cash flows from operating activities
Net income	$	10,093		$	6,959
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	1,983			1,400
Share-based compensation	2,141			1,899
Deferred income taxes	54			(58		)
Other	18			12
Changes in assets and liabilities:
Accounts receivable	161			223
Prepaid expenses and other current assets	(898		)	(577		)
Other assets	(59		)	82
Accounts payable	50			(38		)
Partners payable	53			(10		)
Accrued expenses and other current liabilities	690			157
Deferred revenue and deposits	(4		)	(4		)
Other liabilities	(124		)	373
Net cash provided by operating activities	14,158			10,418
Cash flows from investing activities
Purchases of property and equipment	(6,272		)	(2,715		)
Purchases of marketable securities	(8,283		)	(14,137		)
Sales of marketable securities	8,612			3,998
Maturities of marketable securities	2,338			1,498
Acquisitions of businesses, net of cash acquired, and purchases of intangible assets	(65		)	(8		)
Other investing activities, net	(1		)	(22		)
Net cash used in investing activities	(3,671		)	(11,386		)
Cash flows from financing activities
Taxes paid related to net share settlement of equity awards	(1,758		)	(1,495		)
Repurchases of Class A common stock	(5,123		)	(378		)
Other financing activities, net	7			12
Net cash used in financing activities	(6,874		)	(1,861		)
Effect of exchange rate changes on cash, cash equivalents, and restricted cash	(149		)	122
Net increase (decrease) in cash, cash equivalents, and restricted cash	3,464			(2,707		)
Cash, cash equivalents, and restricted cash at beginning of year	8,204			9,109
Cash, cash equivalents, and restricted cash at end of the period	$	11,668		$	6,402

Reconciliation of cash, cash equivalents, and restricted cash to the condensed consolidated balance sheets
Cash and cash equivalents	$	11,552		$	6,252
Restricted cash, included in prepaid expenses and other current assets	11			59
Restricted cash, included in other assets	105			91
Total cash, cash equivalents, and restricted cash	$	11,668		$	6,402

See Accompanying Notes to Condensed Consolidated Financial Statements.

FACEBOOK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)



	Six Months Ended June 30,
	2018		2017
Supplemental cash flow data
Cash paid during the period for:
Income taxes, net	$	2,281	$	1,359
Non-cash investing and financing activities:
Net change in prepaids and liabilities related to property and equipment additions	$	231	$	240
Change in unsettled repurchases of Class A common stock	$	6	$	30

See Accompanying Notes to Condensed Consolidated Financial Statements.

FACEBOOK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


Note 1.	Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (GAAP) and applicable rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

The condensed consolidated balance sheet as of December 31, 2017 included herein was derived from the audited financial statements as of that date, but does not include all disclosures including notes required by GAAP.

The condensed consolidated financial statements include the accounts of Facebook, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

The accompanying condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full year ending December 31, 2018.

Use of Estimates

Conformity with GAAP requires the use of estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. 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 information and on various other assumptions that we believe are reasonable under the circumstances. GAAP requires us to make estimates and judgments in several areas, including, but not limited to, those related to revenue recognition, collectability of accounts receivable, commitments and contingencies, fair value of financial instruments, fair value of acquired intangible assets and goodwill, useful lives of intangible assets and property and equipment, leases, and income taxes. These estimates are based on management's knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ materially from those estimates.

Recently Issued Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (ASU 2016-02), which generally requires companies to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. This guidance will be effective for us in the first quarter of 2019 on a modified retrospective basis and early adoption is permitted. We will adopt the new standard effective January 1, 2019. We have selected a lease accounting system, and our implementation of it is substantially complete. Our evaluation of the use of optional practical expedients is pending upon the issuance of the ASU related to comparative reporting at adoption. While we continue to evaluate the effect of adopting this guidance on our consolidated financial statements and related disclosures, we expect our operating leases, as disclosed in Note 8 — Commitments and Contingencies, will be subject to the new standard. We will recognize right-of-use assets and operating lease liabilities on our consolidated balance sheets upon adoption, which will increase our total assets and liabilities.

In February 2018, the FASB issued Accounting Standards Update No. 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (ASU 2018-02), which allows companies to reclassify stranded tax effects resulting from the 2017 Tax Cuts and Jobs Act (the Tax Act), from accumulated other comprehensive income to retained earnings. The new standard is effective for us beginning January 1, 2019, with early adoption permitted. We are currently evaluating the timing of adopting this guidance but do not expect such adoption to have a material impact on our consolidated financial statements and the related disclosures.

Recently Adopted Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in Accounting Standards Codification (ASC) Topic 605, Revenue Recognition (Topic 605). We adopted Topic 606 as of January 1, 2018 using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. See Revenue Recognition below for further details.

In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers Other than Inventory (ASU 2016-16), which requires companies to recognize the income-tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs, rather than when the asset has been sold to an outside party. We adopted the new standard effective January 1, 2018, using the modified retrospective transition approach through a cumulative-effect adjustment to retained earnings as of the effective date, which was not material to our condensed consolidated financial statements.

In November 2016, the FASB issued Accounting Standards Update No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016-18), which requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts shown on the statements of cash flows. We adopted the new standard effective January 1, 2018, using the retrospective transition approach. The reclassified restricted cash balances from investing activities to changes in cash, cash equivalents and restricted cash on the condensed consolidated statements of cash flows were not material for all periods presented.

In January 2017, the FASB issued Accounting Standards Update No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (ASU 2017-01), which revises the definition of a business and provides new guidance in evaluating when a set of transferred assets and activities is a business. We adopted the new standard effective January 1, 2018 on a prospective basis. The new standard did not have a material impact on our condensed consolidated financial statements.

Revenue Recognition

On January 1, 2018, we adopted Topic 606, using the modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts have not been adjusted and continue to be reported in accordance with our historic accounting under Topic 605. The impact of adopting the new revenue standard was not material to our condensed consolidated financial statements and there was no adjustment to beginning retained earnings on January 1, 2018.

Under Topic 606, revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

We determine revenue recognition through the following steps:


•	identification of the contract, or contracts, with a customer;


•	identification of the performance obligations in the contract;


•	determination of the transaction price;


•	allocation of the transaction price to the performance obligations in the contract; and


•	recognition of revenue when, or as, we satisfy a performance obligation.

Revenue disaggregated by revenue source for the three and six months ended June 30, 2018 and 2017, consists of the following (in millions). Revenue excludes sales and usage-based taxes where it has been determined that we are acting as a pass-through agent.



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017⁽¹⁾		2018		2017⁽¹⁾
Advertising	$	13,038	$	9,164	$	24,833	$	17,021
Payments and other fees	193		157		364		332
Total revenue	$	13,231	$	9,321	$	25,197	$	17,353

^{(1) As noted above, prior period amounts have not been adjusted under the modified retrospective method.}

Revenue disaggregated by geography, based on the billing address of our customer (in millions):



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017⁽¹⁾		2018		2017⁽¹⁾
Revenue:
US & Canada⁽²⁾	$	5,982	$	4,359	$	11,424	$	8,149
Europe⁽³⁾	3,307		2,332		6,334		4,300
Asia-Pacific	2,772		1,806		5,247		3,382
Rest of World ⁽³⁾	1,170		824		2,192		1,522
Total revenue	$	13,231	$	9,321	$	25,197	$	17,353

^{(1) As noted above, prior period amounts have not been adjusted under the modified retrospective method.}

^{(2) United States revenue was}^{$5.60 billion}^and^{$4.05 billion}^{for the}^{three months ended}^{June 30, 2018}^and²⁰¹⁷^{, respectively, and}^{$10.69 billion}^and^{$7.57 billion}^{for the}^six^{months ended}^{June 30, 2018}^and²⁰¹⁷^{, respectively.}

^{(3) Europe includes Russia and Turkey, and Rest of World includes Africa, Latin America, and the Middle East.}

Advertising

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, based on the number of impressions delivered or the number of actions, such as clicks, taken by our users.

Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. 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 users. We recognize revenue from the delivery of action-based ads in the period in which a user takes the action the marketer contracted for. For advertising revenue arrangements where we are not the principal, we recognize revenue on a net basis.

We may accept a lower consideration than the amount promised per the contract for certain revenue transactions and certain customers may receive cash-based incentives or credits, which are accounted for as variable consideration when estimating the amount of revenue to recognize. We believe that there will not be significant changes to our estimates of variable consideration.

Payments and Other Fees

Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure.

Other fees revenue, which was not material for all periods presented in our financial statements, consists primarily of revenue from the delivery of virtual reality platform devices, as well as revenue from various other sources.

Revenue is recognized net of applicable sales and other taxes.

Deferred Revenue and Deposits

Deferred revenue consists of billings and payments from marketers in advance of revenue recognition. Deposits relate to unused balances held on behalf of our users. Once this balance is utilized by a user, approximately 70% of this amount would then be payable to the developer and the balance would be recognized as revenue. The decrease in the deferred revenue balance for the six months ended June 30, 2018 was driven by revenue recognized that was included in the deferred revenue balance at the beginning of the period.

Our payment terms vary by the products or services offered. The term between billings and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer.

Deferred revenue and deposits consists of the following (in millions):



	June 30, 2018		December 31, 2017
Deferred revenue	$	62	$	68
Deposits	29		30
Total deferred revenue and deposits	$	91	$	98

Practical Expedients and Exemptions

We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses.

We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.


Note 2.	Earnings per Share

We compute earnings per share (EPS) of Class A and Class B common stock using the two-class method required for participating securities. We consider restricted stock awards to be participating securities because holders of such shares have non-forfeitable dividend rights in the event of our declaration of a dividend for common shares.

Undistributed earnings allocated to participating securities are subtracted from net income in determining net income attributable to common stockholders. Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of our Class A and Class B common stock outstanding, adjusted for outstanding shares that are subject to repurchase.

For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, such as awards under our equity compensation plans and inducement awards under separate non-plan restricted stock unit (RSU) award agreements. In addition, the computation of the diluted EPS of Class A common stock assumes the conversion of our Class B common stock to Class A common stock, while the diluted EPS of Class B common stock does not assume the conversion of those shares to Class A common stock. Diluted EPS attributable to common stockholders is computed by dividing the resulting net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding.

RSUs with anti-dilutive effect were excluded from the EPS calculation and they were not material for the three and six months ended June 30, 2018 and 2017, respectively.

Basic and diluted EPS are the same for each class of common stock because they are entitled to the same liquidation and dividend rights.

The numerators and denominators of the basic and diluted EPS computations for our common stock are calculated as follows (in millions, except per share amounts):



	Three Months Ended June 30,										Six Months Ended June 30,
	2018					2017					2018					2017
	Class A		Class B			Class A		Class B			Class A		Class B			Class A		Class B
Basic EPS:
Numerator
Net income	$	4,246	$	860		$	3,177	$	717		$	8,368	$	1,725		$	5,673	$	1,286
Less: Net income attributable to participating securities	—		—			4		—			1		—			8		2
Net income attributable to common stockholders	$	4,246	$	860		$	3,173	$	717		$	8,367	$	1,725		$	5,665	$	1,284
Denominator
Weighted average shares outstanding	2,407		488			2,368		535			2,405		495			2,363		536
Less: Shares subject to repurchase	—		—			2		1			—		—			3		1
Number of shares used for basic EPS computation	2,407		488			2,366		534			2,405		495			2,360		535
Basic EPS	$	1.76	$	1.76		$	1.34	$	1.34		$	3.48	$	3.48		$	2.40	$	2.40
Diluted EPS:
Numerator
Net income attributable to common stockholders	$	4,246	$	860		$	3,173	$	717		$	8,367	$	1,725		$	5,665	$	1,284
Reallocation of net income attributable to participating securities	—		—			4		—			1		—			10		—
Reallocation of net income as a result of conversion of Class B to Class A common stock	860		—			717		—			1,725		—			1,284		—
Reallocation of net income to Class B common stock	—		(4		)	—		(2		)	—		(9		)	—		(1		)
Net income attributable to common stockholders for diluted EPS	$	5,106	$	856		$	3,894	$	715		$	10,093	$	1,716		$	6,959	$	1,283
Denominator
Number of shares used for basic EPS computation	2,407		488			2,366		534			2,405		495			2,360		535
Conversion of Class B to Class A common stock	488		—			534		—			495		—			535		—
Weighted average effect of dilutive securities:
Employee stock options	2		2			4		4			3		3			4		4
RSUs	33		1			45		3			36		2			47		3
Shares subject to repurchase and other	—		—			2		1			—		—			4		2
Number of shares used for diluted EPS computation	2,930		491			2,951		542			2,939		500			2,950		544
Diluted EPS	$	1.74	$	1.74		$	1.32	$	1.32		$	3.43	$	3.43		$	2.36	$	2.36


Note 3.	Cash and Cash Equivalents, and Marketable Securities

The following table sets forth the cash and cash equivalents, and marketable securities (in millions):



	June 30, 2018		December 31, 2017
Cash and cash equivalents:
Cash	$	2,117	$	2,212
Money market funds	6,676		5,268
U.S. government securities	961		66
U.S. government agency securities	458		25
Certificate of deposits and time deposits	1,340		440
Corporate debt securities	—		68
Total cash and cash equivalents	11,552		8,079
Marketable securities:
U.S. government securities	12,961		12,766
U.S. government agency securities	8,659		10,944
Corporate debt securities	9,137		9,922
Total marketable securities	30,757		33,632
Total cash and cash equivalents, and marketable securities	$	42,309	$	41,711

The gross unrealized gains or losses on our marketable securities as of June 30, 2018 and December 31, 2017 were not significant. In addition, the gross unrealized loss that had been in a continuous loss position for 12 months or longer was not significant as of June 30, 2018 and December 31, 2017. As of June 30, 2018, we considered the decreases in market value on our marketable securities to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired.

The following table classifies our marketable securities by contractual maturities (in millions):



	June 30, 2018
Due in one year	$	7,427
Due in one to five years	23,330
Total	$	30,757


Note 4.	Fair Value Measurement

The following table summarizes our assets measured at fair value and the classification by level of input within the fair value hierarchy (in millions):



			Fair Value Measurement at Reporting Date Using
Description	June 30, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents:
Money market funds	$	6,676	$	6,676	$	—	$	—
U.S. government securities	961		961		—		—
U.S. government agency securities	458		458		—		—
Certificate of deposits and time deposits	1,340		—		1,340		—
Marketable securities:
U.S. government securities	12,961		12,961		—		—
U.S. government agency securities	8,659		8,659		—		—
Corporate debt securities	9,137		—		9,137		—
Total cash equivalents and marketable securities	$	40,192	$	29,715	$	10,477	$	—



			Fair Value Measurement at Reporting Date Using
Description	December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Cash equivalents:
Money market funds	$	5,268	$	5,268	$	—	$	—
U.S. government securities	66		66		—		—
U.S. government agency securities	25		25		—		—
Certificate of deposits and time deposits	440		—		440		—
Corporate debt securities	68		—		68		—
Marketable securities:
U.S. government securities	12,766		12,766		—		—
U.S. government agency securities	10,944		10,944		—		—
Corporate debt securities	9,922		—		9,922		—
Total cash equivalents and marketable securities	$	39,499	$	29,069	$	10,430	$	—

We classify our cash equivalents and marketable securities within Level 1 or Level 2 because we use quoted market prices or alternative pricing sources and models utilizing market observable inputs to determine their fair value.


Note 5.	Property and Equipment

Property and equipment consists of the following (in millions):



	June 30, 2018			December 31, 2017
Land	$	844		$	798
Buildings	5,935			4,909
Leasehold improvements	1,472			959
Network equipment	10,147			7,998
Computer software, office equipment and other	896			681
Construction in progress	4,624			2,992
Total	23,918			18,337
Less: Accumulated depreciation	(5,561		)	(4,616		)
Property and equipment, net	$	18,357		$	13,721

Construction in progress includes costs related to construction of data centers, network equipment infrastructure to support our data centers around the world, and office buildings. No interest was capitalized during the three and six months ended June 30, 2018 and 2017.


Note 6.	Goodwill and Intangible Assets

During the six months ended June 30, 2018, we completed business acquisitions that were not material to our condensed consolidated financial statements, either individually or in the aggregate. Accordingly, pro forma historical results of operations related to these business acquisitions during the six months ended June 30, 2018 have not been presented. We have included the financial results of these business acquisitions in our condensed consolidated financial statements from their respective dates of acquisition.

The changes in the carrying amount of goodwill for the six months ended June 30, 2018 are as follows (in millions):



Balance as of December 31, 2017	$	18,221
Goodwill acquired	47
Effect of currency translation adjustment	(5		)
Balance as of June 30, 2018	$	18,263

Intangible assets consist of the following (in millions):



		June 30, 2018							December 31, 2017
	Weighted-Average Remaining Useful Lives (in years)	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Acquired users	3.3	$	2,056	$	(1,116	)	$	940	$	2,056	$	(971	)	$	1,085
Acquired technology	1.4	988		(796		)	192		972		(711		)	261
Acquired patents	5.4	785		(532		)	253		785		(499		)	286
Trade names	1.8	629		(461		)	168		629		(406		)	223
Other	2.4	162		(142		)	20		162		(133		)	29
Total intangible assets	3.2	$	4,620	$	(3,047	)	$	1,573	$	4,604	$	(2,720	)	$	1,884

Amortization expense of intangible assets was $158 million and $327 million for the three and six months ended June 30, 2018, respectively, and $174 million and $349 million for the three and six months ended June 30, 2017, respectively.

As of June 30, 2018, expected amortization expense for the unamortized acquired intangible assets for the next five years and thereafter is as follows (in millions):



The remainder of 2018	$	311
2019	545
2020	370
2021	266
2022	29
Thereafter	52
Total	$	1,573


Note 7.	Long-term Debt

In May 2016, we entered into a $2.0 billion senior unsecured revolving credit facility, and any amounts outstanding under this facility will be due and payable on May 20, 2021. As of June 30, 2018, no amounts had been drawn down, and we were in compliance with the covenants under this facility.


Note 8.	Commitments and Contingencies

Commitments

Leases

During the six months ended June 30, 2018, we entered into additional non-cancelable operating lease agreements. Our various non-cancelable operating lease agreements, which include among others, certain of our offices, data center, and colocation leases, have original lease periods expiring between 2018 and 2040. Operating lease expense was $138 million and $267 million for the three and six months ended June 30, 2018, respectively, and $81 million and $156 million for the three and six months ended June 30, 2017, respectively.

The following is a schedule, by years, of the future minimum lease payments required under non-cancelable operating leases as of June 30, 2018 (in millions):



	Operating Leases		Financing obligation, building in progress - leased facilities⁽¹⁾
The remainder of 2018	$	265	$	—
2019	634		2
2020	755		14
2021	839		15
2022	827		15
Thereafter	6,438		149
Total minimum lease payments	$	9,758	$	195

(1)

We entered into agreements to lease office buildings that are under construction. As a result of our involvement during these construction periods, we are considered for accounting purposes to be the owner of the construction projects. Financing obligation, building in progress - leased facilities represent the total expected financing and lease obligations associated with these leases and will be settled through monthly lease payments to the landlords when we occupy the office spaces upon completion. This amount includes $121 million that is included in property and equipment, net and other liabilities on our condensed consolidated balance sheets as of June 30, 2018.

Subsequent to June 30, 2018, we entered into an approximately $700 million non-cancelable lease agreement for an office space.

Other contractual commitments

We also have $3.63 billion of non-cancelable contractual commitments as of June 30, 2018, primarily related to network infrastructure and our data center operations. The majority of these commitments are due within a year.

Contingencies

Beginning on March 20, 2018, multiple putative class actions and derivative actions were filed in state and federal courts in the United States and elsewhere against us and certain of our directors and officers alleging violations of securities laws, breach of fiduciary duties, and other causes of action in connection with the misuse of certain data by a developer that shared such data with third parties in violation of our terms and policies, and seeking unspecified damages and injunctive relief. We believe these lawsuits are without merit, and we are vigorously defending them. In addition, the events surrounding this misuse of data became the subject of U.S. Federal Trade Commission and other government inquiries in the United States, Europe, and other jurisdictions. It is reasonably possible that some of these actions or inquiries could subject us to substantial losses, although we are currently unable to estimate the amount of such losses.

In addition, from time to time, we are subject to litigation and other proceedings involving law enforcement and other regulatory agencies, including in particular in Brazil and Europe, in order to ascertain the precise scope of our legal obligations to comply with the requests of those agencies, including our obligation to disclose user information in particular circumstances. A number of such instances have resulted in the assessment of fines and penalties against us. We believe we have multiple legal grounds to satisfy these requests or prevail against associated fines and penalties, and we intend to vigorously defend such fines and penalties. Although we believe that it is reasonably possible that we may incur a loss in some of these cases, we are currently unable to estimate the amount of such losses or a range of possible losses.

We are also party to various other legal proceedings, claims, and regulatory, tax or government inquiries and investigations that arise in the ordinary course of business. With respect to these matters, we evaluate the developments on a regular basis and accrue a liability when we believe a loss is probable and the amount can be reasonably estimated. We believe that the amount or any estimable range of reasonably possible or probable loss will not, either individually or in the aggregate, have a material adverse effect on our business, consolidated financial position, results of operations, or cash flows. However, the outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected.

For information regarding income tax contingencies, see Note 10 — Income Taxes.


Note 9.	Stockholders' Equity

Share Repurchase Program

In November 2016, our board of directors authorized a $6.0 billion share repurchase program of our Class A common stock, which commenced in 2017 and does not have an expiration date. We completed repurchases under this authorization during the three months ended June 30, 2018. In April 2018, the authorization of the repurchase of our Class A common stock was increased by an additional $9.0 billion. During the six months ended June 30, 2018, we repurchased and subsequently retired approximately 29 million shares of our Class A common stock for an aggregate amount of approximately $5.13 billion. As of June 30, 2018, approximately $7.8 billion remained available and authorized for repurchases. The timing and actual number of shares repurchased under this program depend on a variety of factors, including price, general business and market conditions, and other investment opportunities, and shares may be repurchased through open market purchases or privately negotiated transactions, including through the use of trading plans intended to qualify under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended.

Share-based Compensation Plans

We maintain two share-based employee compensation plans: the 2012 Equity Incentive Plan, which was amended and restated in June 2016, and amended in February 2018 (Amended 2012 Plan), and the 2005 Stock Plan (collectively, Stock Plans). Our Amended 2012 Plan serves as the successor to our 2005 Stock Plan and provides for the issuance of incentive and nonstatutory stock options, restricted stock awards, stock appreciation rights, RSUs, performance shares, and stock bonuses to qualified employees, directors and consultants. Outstanding awards under the 2005 Stock Plan continue to be subject to the terms and conditions of the 2005 Stock Plan.

Effective January 1, 2018, there were 67 million shares of our Class A common stock reserved for issuance under our Amended 2012 Plan. The number of shares reserved for issuance under our Amended 2012 Plan increases automatically on January

1 of each of the calendar years during the term of the Amended 2012 Plan, which will continue through and including April 2026 unless terminated earlier by our board of directors or a committee thereof, by a number of shares of Class A common stock equal to the lesser of (i) 2.5% of the total issued and outstanding shares of our Class A common stock as of the immediately preceding December 31st or (ii) a number of shares determined by our board of directors.

The following table summarizes the activities of stock option awards under the Stock Plans for the six months ended June 30, 2018:



	Shares Subject to Options Outstanding
	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value⁽¹⁾
	(in thousands)				(in years)	(in millions)
Balance as of December 31, 2017	3,078		$	10.06
Stock options exercised	(920	)	$	8.50
Balance as of June 30, 2018	2,158		$	10.72	2.0	$	396
Stock options exercisable as of June 30, 2018	2,158		$	10.72	2.0	$	396


(1)	The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock option awards and the official closing price of our Class A common stock of $194.32, as reported on the Nasdaq Global Select Market on June 30, 2018.

The following table summarizes the activities for our unvested RSUs for the six months ended June 30, 2018:



	Unvested RSUs⁽¹⁾
	Number of Shares		Weighted Average Grant Date Fair Value
	(in thousands)
Unvested at December 31, 2017	81,214		$	110.49
Granted	29,176		$	171.99
Vested	(22,519	)	$	97.37
Forfeited	(2,681	)	$	129.54
Unvested at June 30, 2018	85,190		$	134.40


(1)	Unvested shares includes an inducement award issued in connection with the WhatsApp acquisition in 2014 which is subject to the terms, restrictions, and conditions of a separate non-plan RSU award agreement.

The fair value as of the respective vesting dates of RSUs that vested during the three and six months ended June 30, 2018 was $2.17 billion and $4.12 billion, respectively, and $1.51 billion and $3.21 billion during the three and six months ended June 30, 2017, respectively.

As of June 30, 2018, there was $10.25 billion of unrecognized share-based compensation expense, substantially all of which was related to RSUs. This unrecognized compensation expense is expected to be recognized over a weighted-average period of approximately three years based on vesting under the award service conditions. Included in this unrecognized share-based compensation expense are 4.6 million unvested shares as of June 30, 2018, related to a RSU inducement award granted to an employee in connection with the WhatsApp acquisition in 2014. This award is subject to acceleration if the recipient's employment is terminated without "cause" or if the recipient resigns for "good reason".


Note 10.	Income Taxes

Our tax provision for interim periods is determined using an estimated annual effective tax rate, adjusted for discrete items arising in that quarter. In each quarter, we update the estimated annual effective tax rate and make a year-to-date adjustment to the provision. The estimated annual effective tax rate is subject to significant volatility due to several factors, including our ability to accurately predict the proportion of our income (loss) before provision for income taxes in multiple jurisdictions, the effects of acquisitions, and the integration of those acquisitions.

Our 2018 effective tax rate differs from the U.S. statutory rate of 21% primarily due to a portion of our income before provision for income taxes being earned in jurisdictions subject to tax rates lower than 21%, and the recognition of excess tax benefits from share-based compensation.

In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts for the Tax Act during a measurement period not to extend beyond one year of the enactment date. We continue to analyze our provisional amounts, which are still subject to change during the measurement period. We anticipate further guidance on accounting interpretations from the FASB and application of the law from the U.S. Department of the Treasury. During the three and six months ended June 30, 2018, we completed certain items for our remeasurement of deferred tax balances and recorded an immaterial adjustment.

Our gross unrecognized tax benefits were $4.09 billion and $3.87 billion on June 30, 2018 and December 31, 2017, respectively. If the gross unrecognized tax benefits as of June 30, 2018 were realized in a subsequent period, this would result in a tax benefit of $2.65 billion within our provision of income taxes at such time. The amount of interest and penalties accrued as of June 30, 2018 and December 31, 2017 was $275 million and $154 million, respectively. We expect to continue to accrue unrecognized tax benefits for certain recurring tax positions and anticipate that the amount for future quarters accrued will be similar to amounts accrued by quarter in 2017.

On July 24, 2018, the Ninth Circuit Court of Appeals issued an opinion in Altera Corp. v. Commissioner requiring related parties in an intercompany cost-sharing arrangement to share expenses related to share-based compensation. This opinion reversed the prior decision of the United States Tax Court. We are evaluating the opinion as it applies to our facts and circumstances and we currently expect it will increase our effective tax rate for the third quarter.

We are subject to taxation in the United States and various other state and foreign jurisdictions. The material jurisdictions in which we are subject to potential examination include the United States and Ireland. We are under examination by the Internal Revenue Service (IRS) for our 2014 through 2016 tax years and by the Ireland tax authorities for our 2012 through 2015 tax years. Our 2017 tax year remains open to examination by the IRS. Our 2016 and subsequent tax years remain open to examination in Ireland.

In July 2016, we received a Statutory Notice of Deficiency (Notice) from the IRS 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, the IRS states that it will also apply its position for tax years subsequent to 2010, which, if the IRS prevails in its position, could result in an additional federal tax liability of an estimated, aggregate amount of up to approximately $5.0 billion in excess of the amounts in our originally filed U.S. return, plus interest and any penalties asserted. We do not agree with the position of the IRS and have filed a petition in the United States Tax Court challenging the Notice. As of June 30, 2018, we have not resolved this matter, and proceedings continue in the United States Tax Court. In March 2018, we received a second Notice from the IRS in conjunction with the examination of our 2011 through 2013 tax years. The IRS 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 the IRS 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 filed U.S. return, plus interest and any penalties asserted. We do not agree with the positions of the IRS in the second Notice and have filed a petition in the United States Tax Court challenging the second Notice. We have previously accrued an estimated unrecognized tax benefit consistent with the guidance in ASC 740 that is lower than the potential additional federal tax liability from the positions taken by the IRS in the two Notices. In addition, if the IRS 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 Tax Act.

We believe that adequate amounts have been reserved in accordance with ASC 740 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, 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 impact on our financial position, results of operations, and cash flows.


Note 11.	Geographical Information

The following table sets forth property and equipment, net by geographic area (in millions):



	June 30, 2018		December 31, 2017
Property and equipment, net:
United States	$	13,942	$	10,406
Rest of the world ⁽¹⁾	4,415		3,315
Total property and equipment, net	$	18,357	$	13,721


(1)	No individual country, other than disclosed above, exceeded 10% of our total property and equipment, net for any period presented.

For information regarding revenue disaggregated by geography, see Note 1 — Summary of Significant Accounting Policies, Revenue Recognition.


Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations

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 ended December 31, 2017, as filed with the Securities 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 user 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 Six Months Ended June 30, 2018 and 2017—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 six months ended June 30, 2018 using the prior year's monthly exchange rates for our settlement currencies other than the U.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 Second Quarter Results

Our key user metrics and financial results for the second quarter of 2018 are as follows:

User growth:


•	Daily active users (DAUs) were 1.47 billion on average for June 2018, an increase of 11% year-over-year.


•	Monthly active users (MAUs) were 2.23 billion as of June 30, 2018, an increase of 11% year-over-year.

Financial results:


•	Revenue was $13.23 billion, up 42% year-over-year, and ad revenue was $13.04 billion, up 42% year-over-year.


•	Total costs and expenses were $7.37 billion.


•	Income from operations was $5.86 billion.


•	Net income was $5.11 billion with diluted earnings per share of $1.74.


•	Capital expenditures were $3.46 billion.


•	Effective tax rate was 13%.


•	Cash and cash equivalents and marketable securities were $42.31 billion as of June 30, 2018.


•	Headcount was 30,275 as of June 30, 2018, an increase of 47% year-over-year.

In the second quarter of 2018, we continued to focus on our three main revenue growth priorities: (i) helping businesses expand their use of our mobile products, (ii) developing innovative ad products that help businesses get the most of their ad campaigns, and (iii) making our ads more relevant and effective through our targeting capabilities and outcome-based measurement.

We continued to invest, based on our roadmap, in: (i) our most developed ecosystems, Facebook and Instagram, (ii) driving growth and building ecosystems around our products that already have significant user bases, such as Messenger and WhatsApp, as well as continuing to grow new features like Stories, and (iii) long-term technology initiatives, such as connectivity, artificial intelligence, and augmented and virtual reality, that we believe will further our mission to give people the power to build community and bring the world closer together. We intend to continue to invest based on this roadmap and we anticipate that additional investments in the following areas will drive significant year-over-year expense growth in 2018: (i) increased investments in safety and security, marketing, video content, and our long-term technology initiatives, and (ii) scaling our headcount and expanding our data center capacity and office facilities to support our growth. Expense growth exceeded revenue growth in the second quarter of 2018, which we anticipate will continue in 2018 and 2019.

Trends in Our User Metrics

The numbers for our key metrics, our DAUs, MAUs, and average revenue per user (ARPU), do not include Instagram, WhatsApp, or Oculus users unless they would otherwise qualify as such users, respectively, based on their other activities on Facebook. In addition, other user engagement metrics do not include Instagram, WhatsApp, or Oculus unless otherwise specifically stated.

Trends in the number of users 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 users (as defined below) access Facebook on mobile devices.


•	Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our website or a 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.

Note: For purposes of reporting DAUs, MAUs, and ARPU by geographic region, Europe includes all users in Russia and Turkey and Rest of World includes all users in Africa, Latin America, and the Middle East.

Worldwide DAUs increased 11% to 1.47 billion on average during June 2018 from 1.32 billion during June 2017. Users in India, Indonesia, and the Philippines represented key sources of growth in DAUs during June 2018, relative to the same period in 2017.


•	Monthly Active Users (MAUs). We define a monthly active user as a registered Facebook user who logged in and visited Facebook through our 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.

As of June 30, 2018, we had 2.23 billion MAUs, an increase of 11% from June 30, 2017. Users in India, Indonesia, and the Philippines represented key sources of growth in the second quarter of 2018, relative to the same period in 2017.

Trends in Our Monetization by User Geography

We calculate our revenue by user geography based on our estimate of the geography in which ad impressions are delivered, virtual and digital goods are purchased, or virtual reality platform 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 of Facebook and Messenger as described in the definition of MAU above. Revenue from users who are not also Facebook or Messenger MAUs was not material. The geography of our users affects our revenue and financial results because we currently monetize users in different geographies at different average rates. Our revenue and ARPU in regions such as United States & Canada and Europe are relatively higher primarily due to the size and maturity of those online and mobile advertising markets. For example, ARPU in the second quarter of 2018 in the United States & Canada region was more than nine times higher than in the Asia-Pacific region.

Note: Our revenue by user geography in the charts above is geographically apportioned based on our estimation of the geographic location of our users when they perform a revenue-generating activity. This allocation differs from our revenue disaggregated by geography disclosure in our condensed consolidated financial statements where revenue is geographically apportioned based on the location of the customer.

During the second quarter of 2018, worldwide ARPU was $5.97, an increase of 26% from the second quarter of 2017. Over this period, ARPU increased by 39% in Europe, 34% in United States & Canada, 29% in Rest of World, and 23% in Asia-Pacific. In addition, user growth was more rapid in geographies with relatively lower ARPU, such as Asia-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.

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, 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.

Payments and other fees. Payments revenue is comprised of the net fee we receive from developers using our Payments infrastructure. Our other fees revenue, which has not been significant in recent periods, consists primarily of revenue from the delivery of virtual reality platform devices, 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, 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, cost of virtual reality platform device inventory sold, and amortization of intangible assets.

Research and development. Research and development expenses consist primarily of share-based compensation, salaries, and benefits for employees on our engineering and technical teams who are responsible for building new products as well as improving existing products. We expense all of our research and development costs as they are incurred.

Marketing and sales. Our marketing and sales expenses consist of salaries, share-based compensation, and benefits 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, professional services such as content reviewers, as well as amortization of intangible assets.

General and administrative. The majority of our general and administrative expenses consist of salaries, 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. In addition, general and administrative expenses include legal-related costs and professional services.

Results of Operations

The following tables set forth our condensed consolidated statements of income data:



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
	(in millions)				(in millions)
Revenue	$	13,231	$	9,321	$	25,197	$	17,353
Costs and expenses:
Cost of revenue	2,214		1,237		4,141		2,395
Research and development	2,523		1,919		4,761		3,753
Marketing and sales	1,855		1,124		3,450		2,181
General and administrative	776		640		1,532		1,295
Total costs and expenses	7,368		4,920		13,884		9,624
Income from operations	5,863		4,401		11,313		7,729
Interest and other income, net	5		87		165		168
Income before provision for income taxes	5,868		4,488		11,478		7,897
Provision for income taxes	762		594		1,385		938
Net income	$	5,106	$	3,894	$	10,093	$	6,959

Share-based compensation expense included in costs and expenses:



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
	(in millions)				(in millions)
Cost of revenue	$	74	$	47	$	130	$	81
Research and development	881		787		1,599		1,457
Marketing and sales	139		120		248		216
General and administrative	92		78		164		145
Total share-based compensation expense	$	1,186	$	1,032	$	2,141	$	1,899

The following tables set forth our condensed consolidated statements of income data (as a percentage of revenue):



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Revenue	100	%	100	%	100	%	100	%
Costs and expenses:
Cost of revenue	17		13		16		14
Research and development	19		21		19		22
Marketing and sales	14		12		14		13
General and administrative	6		7		6		7
Total costs and expenses	56		53		55		55
Income from operations	44		47		45		45
Interest and other income, net	—		1		1		1
Income before provision for income taxes	44		48		46		46
Provision for income taxes	6		6		5		5
Net income	39	%	42	%	40	%	40	%

Share-based compensation expense included in costs and expenses (as a percentage of revenue):



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Cost of revenue	1	%	1	%	1	%	—	%
Research and development	7		8		6		8
Marketing and sales	1		1		1		1
General and administrative	1		1		1		1
Total share-based compensation expense	9	%	11	%	8	%	11	%

Three and Six Months Ended June 30, 2018 and 2017

Revenue



	Three Months Ended June 30,						Six Months Ended June 30,
	2018		2017		% change		2018		2017		% change
	(in millions, except for percentages)
Advertising	$	13,038	$	9,164	42	%	$	24,833	$	17,021	46	%
Payments and other fees	193		157		23	%	364		332		10	%
Total revenue	$	13,231	$	9,321	42	%	$	25,197	$	17,353	45	%

Revenue in the second quarter and the first six months of 2018 increased $3.91 billion, or 42%, and $7.84 billion, or 45%, respectively, compared to the same periods in 2017. The increase was mostly due to an increase in advertising revenue.

The most important factor driving advertising revenue growth was an increase in revenue from ads on mobile devices. For both the second quarter and the first six months of 2018, we estimate that mobile advertising revenue represented approximately 91% of total advertising revenue, as compared with approximately 87% and 86%, respectively, in the same periods in 2017. The increases in advertising revenue for the second quarter and the first six months of 2018 were due to increases in the average price per ad and the number of ads delivered. During the second quarter and first six months of 2018, the average price per ad increased by 17% and 27%, respectively, as compared with approximately 24% and 19%, respectively, in the same periods in 2017, and the number of ads delivered increased by 21% and 15%, respectively, as compared with approximately 19% and 25%, respectively, in the same periods in 2017.

The increase in average price per ad was driven by an increase in demand for our ad inventory; factors contributing to this include an increase in spend from existing marketers and an increase in the number of marketers actively advertising on our platform as well as the quality, relevance, and performance of those ads. The increase in the ads delivered was driven by an increase in users and their engagement, and an increase in the number and frequency of ads displayed across our products. We anticipate that future advertising revenue growth will be driven by a combination of price and the number of ads displayed.

Foreign Exchange Impact on Revenue

The general weakening of the U.S. dollar relative to certain foreign currencies in the second quarter and the first six months of 2018 compared to the same periods in 2017 had a favorable impact on revenue. If we had translated revenue for the second quarter ended June 30, 2018 using the prior year's monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $12.86 billion and $12.67 billion, respectively. Using these constant rates, revenue and advertising revenue would have been $373 million and $371 million lower than actual revenue and advertising revenue, respectively, for the second quarter of 2018. If we had translated revenue for the six months ended June 30, 2018 using the prior year's monthly exchange rates for our settlement currencies other than the U.S. dollar, our total revenue and advertising revenue would have been $24.29 billion and $23.93 billion, respectively. Using these constant rates, total revenue and advertising revenue would have been $908 million and $906 million lower than actual total revenue and advertising revenue, respectively, for the first six months of 2018.

Cost of revenue



	Three Months Ended June 30,								Six Months Ended June 30,
	2018			2017			% change		2018			2017			% change
	(in millions, except for percentages)
Cost of revenue	$	2,214		$	1,237		79	%	$	4,141		$	2,395		73	%
Percentage of revenue	17		%	13		%			16		%	14		%

Cost of revenue in the second quarter and the first six months of 2018 increased $977 million, or 79%, and $1.75 billion, or 73%, respectively, compared to the same periods in 2017. The increases in both periods were mostly due to increases in operational expenses related to our data centers and technical infrastructure and, to a lesser extent, higher costs associated with partnership agreements, including traffic acquisition and content acquisition costs.

Research and development



	Three Months Ended June 30,								Six Months Ended June 30,
	2018			2017			% change		2018			2017			% change
	(in millions, except for percentages)
Research and development	$	2,523		$	1,919		31	%	$	4,761		$	3,753		27	%
Percentage of revenue	19		%	21		%			19		%	22		%

Research and development expenses in the second quarter and the first six months of 2018 increased $604 million, or 31%, and $1.01 billion, or 27%, respectively, compared to the same periods in 2017. The majority of the increases in both periods were due to increases in payroll and benefits as a result of a 46% growth in employee headcount from June 30, 2017 to June 30, 2018 in engineering and other technical functions. Payroll and benefits expense growths in both periods were less than headcount growth partially due to the lapsing of acquisition-related share-based compensation expense.

Marketing and sales



	Three Months Ended June 30,								Six Months Ended June 30,
	2018			2017			% change		2018			2017			% change
	(in millions, except for percentages)
Marketing and sales	$	1,855		$	1,124		65	%	$	3,450		$	2,181		58	%
Percentage of revenue	14		%	12		%			14		%	13		%

Marketing and sales expenses in the second quarter and the first six months of 2018 increased $731 million, or 65%, and $1.27 billion, or 58%, respectively, compared to the same periods in 2017. The majority of the increases in both periods were driven by marketing, community operations and payroll and benefits expenses. Our payroll and benefits expenses increased as a result of a 37% increase in employee headcount from June 30, 2017 to June 30, 2018 in our marketing and sales functions.

General and administrative



	Three Months Ended June 30,								Six Months Ended June 30,
	2018			2017			% change		2018			2017			% change
	(in millions, except for percentages)
General and administrative	$	776		$	640		21	%	$	1,532		$	1,295		18	%
Percentage of revenue	6		%	7		%			6		%	7		%

General and administrative expenses in the second quarter and the first six months of 2018 increased $136 million, or 21%, and $237 million, or 18%, respectively, compared to the same periods in 2017. The increases in both periods were due to increases in payroll and benefits expenses as a result of a 57% increase in employee headcount from June 30, 2017 to June 30, 2018 in general and administrative functions and increases in legal fees, partially offset by changes in legal settlement costs.

Interest and other income, net



	Three Months Ended June 30,								Six Months Ended June 30,
	2018			2017			% change		2018			2017		% change
	(in millions, except for percentages)
Interest income, net	$	143		$	91		57	%	$	288		$	158	82	%
Other (expense) income, net	(138		)	(4		)	NM		(123		)	10		NM
Interest and other income, net	$	5		$	87		(94	)%	$	165		$	168	(2	)%

Interest and other income, net in the second quarter and the first six months of 2018 decreased $82 million and $3 million, respectively, compared to the same periods in 2017. The decreases in both periods were due to the increases in other expense from foreign exchange impact resulting from the periodic re-measurement of our foreign currency balances, partially offset by the increases in interest income driven by higher invested cash balances and interest rates.

Provision for income taxes



	Three Months Ended June 30,								Six Months Ended June 30,
	2018			2017			% change		2018			2017			% change
	(in millions, except for percentages)
Provision for income taxes	$	762		$	594		28	%	$	1,385		$	938		48	%
Effective tax rate	13		%	13		%			12		%	12		%

Our provision for income taxes in the second quarter and the first six months of 2018 increased $168 million, or 28%, and $447 million or 48%, respectively, compared to the same periods in 2017, mostly due to an increase in income before provision for income taxes.

Our effective tax rate for the second quarter of 2018 was the same as 2017 since the new minimum tax on certain foreign earnings was offset by the decrease in the U.S. statutory tax rate from 35% to 21%, both of which were changes resulting from the enactment of the 2017 Tax Cuts and Jobs Act (the Tax Act).

Effective Tax Rate Items. Our effective tax rate in the future will depend upon the proportion of our income before provision for income taxes earned in the United States and in jurisdictions with a tax rate lower than the U.S. statutory rate, as well as a number of other factors, including excess tax benefits 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 impact of changes in tax law.

The proportion of our income before provision for income taxes earned in jurisdictions with a tax rate lower than the U.S. statutory rate will depend upon the proportion of revenue and costs associated with the respective jurisdictions.

The accounting for share-based compensation will 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.

Integrating intellectual property from acquisitions into our business generally involves intercompany transactions that have the impact of increasing our provision for income taxes. Consequently, our provision for income taxes and our effective tax rate may initially increase in the period of an acquisition and integration. The magnitude of this impact will depend upon the specific type, size, and taxing jurisdictions of the intellectual property as well as the relative contribution to income in subsequent periods.

On July 24, 2018, the Ninth Circuit Court of Appeals issued an opinion in Altera Corp. v. Commissioner (the Altera opinion) requiring related parties in an intercompany cost-sharing arrangement to share expenses related to share-based compensation. This opinion reversed the prior decision of the United States Tax Court. We are evaluating the Altera opinion as it applies to our facts and circumstances and will continue to monitor the potential effects of any future developments in this case and related matters. As a result of the Altera opinion, and excluding any unanticipated events and unexpected effects of the Tax Act, we currently expect our tax rate in the third quarter of 2018 to be between 25% to 30% and our tax rate in 2018 to be in the mid-teens. In addition, since we recognize excess tax benefits on a discrete basis, we anticipate that our effective tax rate will vary from quarter