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Google Inc. (NASDAQ:GOOG)

Investor Update Conference Call

May 31, 2006, 2:00 p.m. EST

Executives

Kim Jabal - IR Director

Eric Schmidt - CEO

Jonathan Rosenberg – SVP, Product Management

George Reyes - CFO

Analysts

Christa Quarles - Thomas Weisel Partners

Imran Khan - JP Morgan

Mark Mahaney - Citigroup

Robert Peck - Bear Stearns

Ben Schachter - UBS

Heath Terry - Credit Suisse

Douglas Anmuth - Lehman Brothers

Jim Friedland - Cowen & Company

Stewart Barry - ThinkEquity

Safa Rashtchy - Piper Jaffray

Youssef Squali - Jefferies & Company

Marianne Wolk - Susquehanna

Anthony Noto - Goldman Sachs

Steve Weinstein - Pacific Crest

Sasa Zorovic - Oppenheimer

Troy Mastin - William Blair & Co

Mark Rowen - Prudential

[Han Tan] for Justin Post – Merrill Lynch

Presentation

Operator

Good day, everyone, and welcome to the Google, Inc. investor conference call. Today's call is being recorded. At this time, I would like to turn the call over to Kim Jabal, Director of Investor Relations. Please go ahead, ma'am.

Kim Jabal

Thank you. Hi, everyone. Thanks so much for joining us today for this discussion with our senior management team. Today's call will be all Q&A. We have here today our CEO, Eric Schmidt; our CFO, George Reyes; and the Senior Vice President of Product Management, Jonathan Rosenberg.

We hope this call will give our investors and analysts more insight into our long-term strategy and how we run the business here at Google. We will not be answering questions regarding our performance this quarter; and as you know, we do not give revenue or earnings guidance.

If you have more than one question, please ask one at a time and get back into the queue for additional questions. After the call, we'd love your feedback on whether or not this format was valuable to you.

Now I would like to remind you that this question-and-answer session will include forward-looking statements about Google, our market and our prospects that are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements.

These risks and uncertainties include a variety of factors, some of which are beyond our control. These forward-looking statements speak as of today, and you should not rely on them as representing our views in the future.

We undertake no obligation to update these forward-looking statements to reflect events or circumstances that occur after this call. Please refer to our SEC filings, including our report on Form 10-K for the quarter ended March 31, 2006 for a more detailed description of the risk factors that may affect our results. Copies of these documents may be obtained from the SEC or by visiting the investor relations section of our Google website.

I would like to turn the call over to the operator and open it up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Christa Quarles - Thomas Weisel Partners.

Christa Quarles - Thomas Weisel Partners

I was wondering if you could update us on your partnership with AOL? Particularly in light of the latest eBay/Yahoo! match up. How is Google better positioned with respect to content and advertising relationships? Also, if you could touch on the IM interoperability? Thanks.

Eric Schmidt

Thank you very much for your question, and thanks, everybody for getting on the call. The AOL deal was signed a little bit more than a month ago. I think that's public knowledge. It's in place today. As part of the deal, we provide search services to AOL and we also have a very, very robust advertising business.

We are extending the advertising business to include some display partnerships, so-called display ads partnerships, which have always been contemplated as part of the extension of our deal. That work is underway, and those products will roll out later this year. So far, everybody is extremely pleased with the deal and it is essentially running at full blast at this time.

Christa Quarles - Thomas Weisel Partners

Can you add on the IM interoperability?

Eric Schmidt

Similar answer. As part of the agreement, we agreed to essentially add a mechanism where AIM could interoperate with Google Talk. Jonathan, do you want to talk a little bit about what Google Talk is?

Jonathan Rosenberg

Sure. I'm not sure I have a specific update on the issues with AOL. Talk is obviously doing very well. It's a simple, small download. We're not putting any ads in it today. We have done a really wonderful job, I think, of integrating it with Gmail. You know, it works. We have overcome most of the initial issues in terms of firewalls and that sort of thing. So it is basically doing very well.

We have partners like Nokia and RIM that are moving pretty quickly to integrate Google Talk in terms of their clients and devices, so it's going well.

Christa Quarles - Thomas Weisel Partners

Thank you.

Operator

Our next question comes from Imran Khan - JP Morgan.

Imran Khan - JP Morgan

Good morning, Eric, George and Jonathan. One of your competitors recently talked about, in terms of the CapEx, that they prefer to mostly rent rather than buying; whereas your CapEx approach is rather more building data centers and real estate.

Can you talk a little bit about what are the benefits that you see building this infrastructure rather than renting, which probably could reduce your CapEx?

Eric Schmidt

Thanks very much. We've looked at this very, very carefully. We believe we get tremendous competitive advantage by essentially building our own infrastructures. It has publicly been described that what we do is purchase PCs and put them in racks and then run our data centers that way.

What we really do, of course, is we are really building what we think of internally as supercomputers. These supercomputers have PC components and are architected in a very specialized way. We are very proud of that.

When you look at our financial performance over the last year, one way to think about that financial performance is that you're getting the benefit of what people talked about a year or two years ago as overinvestment in capital. The numbers are large and I want to assure you that we spend a tremendous amount of time making sure that we’re getting significantly better aggregate performance out of the invested capital that we purchased versus the possibility of renting.

It's simply not possible for us to rent in one form or another, or lease the kind of architectures that we need. We have also said that, in fact, we are constantly limited by the amount of capital that we actually have deployed. We have many more services that we would like to be able to provide to our innovation than we have been able to actually fully deploy.

So not only are we very sensitive to the investment of capital, but we are very, very careful to make sure we are getting full use of it; because we're always essentially out of it.

Imran Khan - JP Morgan

Thank you.

Operator

Our next question comes from Mark Mahaney - Citigroup.

Mark Mahaney - Citigroup

Thank you very much. I wanted to ask a broad question about product development. I wanted to ask it this way. There has been a series of products you have rolled out over the last six to nine months. Could you single out one that has exceeded your expectations, and one that has disappointed your expectations in terms of traction with consumers or with users?

Particularly in the latter example, what you have then done to adjust the product or change the product in order to increase its usage; or whether you have had a situation where you have launched a product and it has not received usage and therefore, you have cut off funding for it and applied those dollars somewhere else. Thank you very much.

Jonathan Rosenberg

Sure Mark. I think probably the biggest success would be the story of Keyhole and the integration which we then did with maps and satellite, which we then used to drive the efforts around local business ads.

So previously we had been able to target ads around a geographical radius around a business. We have really now built out a lot of traffic to Local through the maps and satellite integrations. We're doing a whole lot now more in terms of placing the ads and icons within the context of a map, so that the user can get information about a local business like running a search on Barnes & Noble in New York, where the advertiser can upload their own logo and upload specific information.

I think we have also done a pretty good job of building out some of the Local functionality so that it's a lot more than things like just Yellow Pages. And we are actually mining a lot of content on the web. So if you do a search for something like family-friendly restaurants in San Jose, we can actually give you results that map beyond just specific Yellow Pages examples.

To give you an example maybe of something that hasn't proceeded as expeditiously as we might have otherwise hoped, I guess probably the best example there that I would choose might be some of the offline print efforts. I think that's still in its nascent stages.

What it is going to require is that we really work with a lot of the producers of magazines to come up with formats that actually work for the kind of advertisements that we are placing. So there's not only an issue there of the format, but there's also an issue there of working with the advertisers to produce content that is better suited for the medium. So I think that probably hasn't taken off as fast as we would like.

Eric Schmidt

I can add that we have talked a little bit about the expansion into video and, in particular, video ads and eventually television. My prediction here is that it will be multiple strategies, multiple attempts before we're finding that combination.

People forget, even inside our Company, that the model that is working so very well for us today took a couple of years to get really right. My guess is that for each of these new major media initiatives, we'll have a few cycles of trying to find the right combination of advertiser product, targeting product and business model and partner model that really takes off.

Mark Mahaney - Citigroup

If I could just follow up briefly on the offline print efforts. Is the value proposition, in your minds, is it more towards the publisher or towards the advertiser? Clearly, with search advertising online, there's a very interesting value proposition; much more so to the advertiser in terms of a truly targeted and accountable, measurable advertising solution but much less so in offline. So is the value proposition there to the publisher?

Jonathan Rosenberg

Well, in order for it to work, quite honestly, it has to be both. I think that the value proposition works better for the more esoteric publications. There are two reasons. One is that they don't tend to have as large a sales force, so if you are dealing with a magazine like Home and PC Theater or Home PC Magazine or AudioVisual Theater magazine, they tend to have less resources to build up their own sales force. There, I think it is a big issue for the publisher.

I think it's also an issue for the publisher because if we make the ads really useful, then their publication actually becomes better. So if you can work, again, a form factor where maybe you are not just using 8.5” by 11” space but you're integrating the ads within the context of the magazine a little bit better, then you actually improve the publisher experience. You make the publisher more money and you actually create a magazine or a journal that is more readable.

Obviously the benefit to the advertisers then comes, because the ads are more targeted. On a bang-for-the-buck basis, they are working better.

Mark Mahaney - Citigroup

Thank you very much.

Operator

Our next question comes from Robert Peck - Bear Stearns.

Robert Peck - Bear Stearns

Thanks for having me on the call. My question is around click-through rates and some of the programs you're testing. First of all, on a cleanup note here, a quality score on how the Google AdWords get ranked. Is that tied to the campaign or to the keyword?

Then more recently, we have seen Google playing around with some new ad placements with ads at the bottom and removing the ads at the side as well as adjusting the palettes or the backgrounds of some of the AdSense ads. Can you tell us what the effect of that has been on click-through rates and ROIs as you test that?

Lastly, as part of this, could you talk about the beta test of allowing testers to shop with high-quality merchants?

Eric Schmidt

In terms of the ranking algorithms, we use keyword as the primary ranking algorithm. One way to think about our core businesses is a keyword purchasing business; a keyword targeting business. We now have, of course, products that automatically generate a large number of keywords and the targeting thereof. But fundamentally, the transaction is keyword-based.

We are running a number of tests which have been, again, either discovered or publicized around various forms of display ads; you mentioned bottom ads, those sorts of things. In each case, what we are testing is whether people respond to them or not. We are never satisfied that the current model, which seems relatively simple, is the ideal model. We love the current model, but we question, can we make it even better? So part of our culture is to constantly, constantly test these things.

In most cases we do a small test and then we compare it to a control group that is basically using all the obvious scientific tests. Based on that, we will then do a business review or we will decide whether to make the change in.

The test that you are referring to we have not completed our evaluation on, and they may or may not at some point become a basis of either our generalized advertising product or a specialized advertising product. In some cases, there are things which make more sense for partners than for us, and so we would offer that to partners.

Jonathan Rosenberg

Just following up quickly, I am not sure I fully understood your question with respect to the high-quality merchants. So maybe you can give us some more clarity on that?

There was an article that came out over the weekend which I didn't read fully, but it did seem to have some incorrect interpretations, which Eric alluded to, with respect to the click-through rate and the keyword basis for it. There was a significant discussion around quality-based bidding and this notion of it being campaign-oriented. I can't say that everything in that article was incorrect because I have not read the entire article, but there were specific notions there that were misleading.

Mark Mahaney - Citigroup

So to clarify, it's definitely per keyword, not per campaign?

Jonathan Rosenberg

Yes.

Mark Mahaney - Citigroup

The question I was alluding to on the beta test was that we saw some news that some testers out there are testing shopping from high-quality merchants for products like iPods, music cell phones. People are wondering, is that some sort of version of an eBay Express or an Amazon functionality?

Jonathan Rosenberg

In general, the answer to that question is no. We have been working to automate the advertiser click cycle. In other words, what we want to do is the moment the customer decides to purchase something, we want to make that as fast as we possibly can.

Google does have what is generally known as a payment system that would enable that. But it's not the kind of payment system that eventually results in the kind of product that you're describing. Think of as much more advertiser automation, very much focused on making the advertiser satisfaction much higher. Advertisers will see quicker returns, more click-throughs, better conversions, and then the rest is history.

Mark Mahaney - Citigroup

Thank you so much.

Operator

Our next question comes from Ben Schachter - UBS.

Ben Schachter - UBS

Thank you for holding the call, I appreciate it. I want to ask a multi-part question on the Dell deal. I know you're not going to talk about some of the specific financials, but just wondering if you could answer some of these questions.

The first one would be, in the past, it's been three pieces of software. It's been the toolbar, the Desktop Search tool, and then the co-branded homepage. I wonder if there's anything else to that?

The second part would be, why was there such a long delay between the tests that occurred in late December, I believe, and early January, and the announcement now?

Also, on the co-branded homepage, it appears that the click-through rates would be considerably higher just by virtue of the placement. I was wondering if you can give us an idea of how that works, how you tested that out, and how much higher the click-through rates should be on that co-branded homepage versus a traditional Google.com page.

Two last ones. Would there be any part of this deal in which you would essentially be bartering on the hardware side of things, so you would actually be buying hardware from Dell in exchange for certain placement?

Finally, in Q1 the financial impact we saw from the Dell deal -- which was pretty negligible -- should we take that as how it should be going forward? Or was that more just on a testing basis, do you think it would be more of an impact on both the top line and the bottom line going forward?

Eric Schmidt

Well, lots of good questions about the Dell deal. First, we are ecstatic over the Dell deal. A little bit of the history -- and by the way, there's no hardware barter as part of it, although we purchase a lot of Dell hardware, I should add, because we like them.

We did a six-month test because we wanted to test various components of how people would react from an end-user perspective for an integrated offering. As you said in your question, the primary components are the next version of Google Desktop, the next version of Google Toolbar, and this integrated homepage, which we think is going to solve a whole bunch of end-user problems.

The primary motivation for the Dell deal was, in fact, customer satisfaction. Customers basically want to be able to have an out-of-box experience that solves their information problems. Google, we believe, has some products that can really augment that, can really extend that.

So with respect to the specific financials we are, of course, governed by our confidentiality clause in the contract so I'd rather not go into the specifics.

The time, the roughly six months during which time we did what were in fact a series of trials, was extremely helpful in understanding what worked, what people cared about and ultimately, tens of millions of people are going to have a much more integrated experience because of the discipline that Dell and Google used to get to this outcome.

Obviously, we would like to do more products and more services using this mechanism with Dell as our partnership with them expands.

Mark Mahaney - Citigroup

Could you talk about the accounting of the deal? In the traditional toolbar deals, most of it has been sort of a per-install basis that would run through the sales and marketing line and then also more of a traditional TAC relationship. Is that how we should think of this deal as well?

George Reyes

As Eric suggested, we really are not going to get into the mechanics of the deal.

Mark Mahaney - Citigroup

Well, if I can ask one follow-up -- not on the Dell deal, actually. We recently did a report looking at your job postings. It appears that there are quite a few job postings out there, more than double the same type of openings last year. Is it correct to think that you're going to be hiring considerably more people this year than last year? Is there any acceleration, or is it going to be more or less flattish with last year? Thanks.

Eric Schmidt

I just want to add that I omitted the fact that the agreement includes Google Search in the Internet Explorer side pane. So another opportunity to use Google Search, which again, tested very, very well from the standpoint of end users.

While I admire your data mining capability with respect to our job postings, the job postings do not directly and 100% correlate with the people we are actually hiring. We hire the person, not the job at Google. While we certainly do have reps and we certainly look for these kinds of positions, we really have an approach of hiring the best and the brightest in every field globally. We will modify our practices as we come across those people.

So it turns out that job postings are not a predictor, if you will, of what we're going to do in the future. Think of them as a marketing program to attract people to apply, but then they go through a more private and internal process. Our hiring continues apace. George, do you want to talk about that part?

George Reyes

Yes. If you back historically over the last four quarters here, we have had very solid hiring rates in the mid-teens to somewhat higher. That's something that you should expect. If you're sort of wondering, where are all these heads and all of these resources going? The answer is we have a very thriving, alive, global business.

As an example, I spend a lot of my time trying to figure out what are the best strategies to get finance people on the ground, the right control environment on the ground, and be able to consolidate the business on a timely basis and deliver good management reporting to the exec team here. This is all clearly tied to the levels of hiring that we do in the Company in aggregate.

Mark Mahaney - Citigroup

Thank you.

Operator

Our next question comes from Heath Terry - Credit Suisse.

Heath Terry - Credit Suisse

A bit of a follow-up on the CapEx discussion. Obviously, there has been a lot of spending on real estate build out within your CapEx and I'm sure there's a lot of that planned. Can you talk to us about where you are in that process? What level of capacity do you think you are going to be at once you finish this current planned wave of real estate spending with the Napa located campus and such, assuming that you are probably already over-capacity in your current facilities?

George Reyes

Real estate and Google here in the Bay Area is a constant topic on the exec agenda here. At the rates that we are growing our headcount, we have to keep pace with the rate of growth in hiring. Fundamentally what we have chosen to do is, at least locally here in the Mountainview area is to try and keep everybody contained to the same physical proximity, in general.

As the headcount grows, we're going to continue to add real estate. So this is specifically in the Bay area and this is something that isn't going to go away any time soon. As a matter of fact, we're in the process now, we have acquired some properties which we're going to go out and begin a redevelopment effort to provide more facilities in the Mountainview area.

Heath Terry - Credit Suisse

On the municipal Wi-Fi side of things, can you talk about what you're learning in the municipal Wi-Fi operation that you have going so far in Mountainview that might apply more broadly? Can you also talk to us about what you hope for municipal Wi-Fi as you see it built out both by yourself and then on a more national basis by other companies? What kind of impact do you think that is going to have on your business as a whole? Things that it might enable that wouldn't be there otherwise?

Eric Schmidt

So from the very beginning here at Google, we have understood that customers who move from narrowband to broadband solutions are much heavier users of Google. They are much happier. They use more services. They use more advertising services. They are more likely to purchase advertising products and so forth and so on.

So one of the fundamental strategic goals of the Company for many years has been to encourage the deployment of broadband in all of its different forms. The good news is there are lots of other companies in our industry who see the same thing. But for us it's a very, very clear correlation.

One way to think about our international expansion has been that it has been directly tied to the now international deployment of broadband, which has been proceeding very, very quickly in China and Europe and so forth and so on.

So in that context, you should think of Wi-Fi as another example of getting broadband that is pervasive, inexpensive or free and broadly available as strategic to the Company.

It's not a requirement that Google do all of that. It is a requirement that everybody do it. In other words, if we can serve as a catalyst; if we can come up with some models; if we can show some ways in which people can make money; if we can help people get online and serve as a demonstration, as a prototype, as an experiment with real impact then I think it has a lot of leverage, because a lot of people will watch what we're doing. It's in that context that we did the Mountainview trial and then, of course, now the San Francisco bid which we won, along with our partner EarthLink.

Realistically, these large urban deployments are going to require partners beyond just Google. It's unrealistic to expect that the Google personnel and the priorities we have and so forth, that we could do a big city by ourselves. So lesson one is we're going to do it with partners. Lesson two is that the hardware -- and we work with different partners -- hardware is moving quickly forward. So we're learning which hardware works better.

We do not yet have an answer to the question, which is I think the obvious question, which is what is the limit to an advertiser-supported model? We're in the process of running that experiment. But eventually we should be able to answer the question of how much can advertising be used to help people get online? We see that as a strategic opportunity for the Company. It may ultimately be a very lucrative business; but at a minimum helping people get to more broadband is good for our business overall.

Frankly, this has not been that expensive, because our partners are bearing a lot of the capital cost because of the way their business models work. So that's been a very good deal for us.

Heath Terry - Credit Suisse

Great. Thank you.

Operator

Our next question comes from Douglas Anmuth - Lehman Brothers.

Douglas Anmuth - Lehman Brothers

Thank you. I wanted to ask a question about something that has been a common topic over the last couple years, but I think it's increasingly important now. That's whether it makes sense for Google to build a browser. Given the Company's focus on increasing distribution and the three goals that you identified at your recent Analyst Day of improving the brand, increasing market share, and providing a platform for future products, why doesn't it makes sense to build a browser, particularly one that ties together multiple Google products?

I know that you want to develop products and technology that serve an unfilled need online. A browser is also one that could potentially drive material share gains in search and also be highly strategic in light of IE7 and Vista. Thank you.

Eric Schmidt

We would make the decision based on what end users want, and not based on some strategic calculation that we made about competitors. The industry is obsessed with this browser question. Our observation is that you have a number of fine browsers now, and people have some good choices. We have a very, very active partnership with the Firefox folks. IE7 is coming out and, in response to competition from Firefox, has gotten better. Safari, which is the Apple browser, looks like a very strong offering in the Mac space. So it looks like people have some good browser choices already.

The way Google operates is we would not build a browser for the fun of building a browser and creating another choice. By the way, I omitted Opera and a few others that are also very interesting. We would only do something along the lines you are describing if we thought there was a real end-user benefit.

So far we have seen the end-user benefit has been to augment or expand both Ajax and JavaScript, which is available on all the browsers. We're working very, very closely, as I mentioned, with Firefox. We have a good partnership with Safari and with Opera and a couple of others as well. That seems like a good answer right now for us, strategically.

Douglas Anmuth - Lehman Brothers

Thank you.

Operator

Our next question comes from Jim Friedland - Cowen & Co.

Jim Friedland - Cowen & Co.

The question is on the Local ads or the Local platform. We have seen you test, I think, with Best Buy and a number of other companies, the ability to list inventory when you do a local search. The first part is, I was wondering how extensive is that? Can any Local business list inventory on Google Local today and come up in a search?

Also, do you yet have the platform in place where if I'm a local business, I can come in whether it's through Google Base or just on my Yellow Pages listing to provide more information about my business? Can users search that today? Where are you in terms of that process?

Jonathan Rosenberg

So the first part of the question -- I got the second part of the question, not the first.

Jim Friedland - Cowen & Co.

Okay. The first question is today, Best Buy, for example, I think can list their inventory locally so you can go search to see if you want to buy an iPod. Are you testing that with everybody today, or is it just limited?

Jonathan Rosenberg

Got you. Okay. So certainly, the Best Buy efforts are just getting started. As we really expand Local, and particularly as we move to models with click-to-call, integrating inventory is going to become increasingly important because we really want to be able to offer an ad that is going to give the user a chance to consummate a transaction. Obviously, in order to do that, having knowledge of a physical location nearby where they can actually get it is important.

So we have started that test. I do not believe that it's open to everyone yet. I don't have the numbers in terms of how many people that we have been doing it with.

Your question about Base and Yellow Pages, we are certainly working with a lot of Yellow Page providers. We're also basically working to make the model of submitting information much, much easier.

We have just recently launched the AdWords Starter Edition, and basically what that does is it allows local businesses to much, much more easily pick some keywords in a geographical area and get their campaign started. So in addition to Yellow Pages, that's another way that they can get their information in.

Obviously Base, which you also mentioned, is an additional attempt to give people an opportunity to submit content so that search can be better. Certainly, submitting Local information is one possible type of information.

Jim Friedland - Cowen & Co.

Just as a follow-up to that, if you look back at your experience with the core Google Search business and how long it took to get to a critical mass, how long do you think we are, or how long do you think it will take the Local side of the business, all the things you just talked about, to really get to the point where you have that critical mass of advertisers and information to get to where Google Search is today? Is it two years, five years? Or is it just too early to tell?

Eric Schmidt

Well, I don't think it's too early to tell in the sense that I think Local is becoming an increasingly significant component of our business. I think we will have to see how many of the businesses start to take advantage of products like the AdWords Starter Edition.

One of the things that we've seen there is that the percentage of advertisers, we track the percentage that actually start building a campaign that succeed, and that has significantly increased the percentage that actually make it through and are successful in creating a campaign. So I think there's definitely some real traction there.

I think that what we'll see is that the set of businesses that are already online will start to come on much, much faster. I think that we've already got some traction there, and we will have significant traction throughout this year.

In order to get the set of businesses that don't actually have websites, you then need to move to a model that is something more like Base. I think that that's going to take a lot more time, and I think that the click-to-call initiatives, although promising, or those businesses that are not accustomed to this kind of our ROI-based, carefully measured advertising is also going to take some more time.

Jim Friedland - Cowen & Co.

Great, that is helpful. Thanks.

Operator

Our next question comes from Stewart Barry - ThinkEquity.

Stewart Barry - ThinkEquity

Thank you. As you evaluate your content strategy and perhaps look to extend Google's brands to new verticals, to what degree does your interest in selling branded ad inventory come into play?

Eric Schmidt

With respect to branded ad inventory, we do have some products which do what are called CPM advertising. We do not today offer broad, branding products. There is demand for such products. However, we have not yet invented or come up with an approach that meets the kind of measurable ROI-based advertising that we would really like to put our brand and our name behind.

So it's not so much a question of which verticals we want to be in or so forth. I can tell you that there is demand for branded advertising products from every country and in every market, from every kind of customer. It's a question of whether our system, which is so highly measurable, can really handle that.

This is something that we're working on and I hope over the next year it will have some breakthroughs there. But we don't today have a strong answer there.

Jonathan Rosenberg

We do have a limited answer, in the sense that site targeting and the dollars associated with it are growing presently. Basically, site targeting does let you target specific websites, specifically the ones that have signed up in our AdSense network of content sites. There have been some attempts there to use image and Flash ads.

We have had the most success, interestingly, in the entertainment industry. You may have seen some ads from Sony, Lion's Gate, Fox and others. They have found some very positive ways to build brands around movies before a movie release. There's also a lot of successful work that Fox did with the Fantastic Four in advance of the DVD effort.

We did also add to that demographic site selection so that they can choose ad placements, but it's based on third-party data. A number of the bigger partners, including some of the car companies like Ford and Honda, are using the demographic site selection to basically find sites that meet specific demographic criteria and then placing ads on those sites. So there is some significant progress there.

Stewart Barry - ThinkEquity

Thank you.

Operator

Our next question comes from Safa Rashtchy - Piper Jaffray.

Safa Rashtchy - Piper Jaffray

Good morning, and thank you for providing this forum for us to interact more with you. It's very helpful. I wanted to ask you about Google Base and what kind of traction are you seeing in terms of user adoption? It appears from our research that the listings are increasing significantly, but it is harder to see if there is any user adoption. Is it living up to your expectations?

Broadly, if I can morph it into a broader question, what should our expectations be for Google Base as well as other non-search potential revenue models? When do you think you would be comfortable to give us some measure, even if its qualitative, of how much revenue you are generating from these additional areas, which I believe you're spending close to 30% of research and resources?

Eric Schmidt

Thanks. When we think about Base, we think of it as a way of getting structured data into our index. This is not the same thing as people going to base.Google.com and doing specialized searches. It's really about getting information into the indices that Google cares about, and then using that structured information to then blend those results into the Google experience.

So we don't anticipate Base being a large and separate site with its own user perception, its own branding, its own thing. Rather, it's the next logical step in what we did with Froogle some years earlier, which is to get highly structured information.

You are correct that the quality and the depth of information in Base has been exploding, and the leverage there is that it will eventually be in the Google index as a whole. As we learn how to take that information and, if you will, merge it or index it with other unstructured information, we can offer an even more integrated solution.

So it will be difficult for us to answer a precise question of how much revenue came from that. But you'll see that overall traffic will grow, we hope, and customers will be much happier because we will have a complete solution out of every piece of information they access with Google.

Jonathan Rosenberg

Safa, this is Jonathan. One of the things that you might want to look at, there are a number of examples of some of the general vision as to where Base is going to go as individuals post content to be distributed on Google and our other properties.

One example is to type in recipes on Google.com. Or I think you can even type in something like ‘cheese recipes’. And what does is it triggers refinement boxes, and the refinement boxes basically have different attributes, which is one of the things that we have been talking about in terms of how this will evolve. The attributes in this case would be something like main ingredient and cuisine. If you go ahead and type something like cheese recipe and then refine by Cuisine - American, you're going to get a page of results that shows all sorts of recipes that are very rich in structured content that have been submitted to Google Base.

So that's an example where you can basically see the power of adding these attributes of main ingredient and cuisine and course and having people post them.

Eric Schmidt

Another thing to add is there is an inter-relationship between Google Base and Google Co-op, in that eventually, people will be able to bring what are called naming taxonomies inside of Google Co-op. Those naming taxonomies will integrate with information that's coming in in Base. Through that integration, the overall Google experience will become much more structured, much more refined, and much more precise. It's a real improvement in end-user quality.

Safa Rashtchy - Piper Jaffray

A quick follow-up if I may. Eric, you touched on China. You have a great team on the ground there, obviously. But it seems like it has been difficult to gain market share against Baidu; in fact, Baidu seems to be gaining some ground. Do you think that you may need to rethink the approach in terms of how you can make the search engine experience attractive to the Chinese consumers? Perhaps there is a different set of criteria that has to be applied there as opposed to the other markets?

Eric Schmidt

We have not yet seen a good reason to segregate the Chinese user from worldwide users. So far, all the evidence that we have seen is that the Chinese user is quite similar. I think it's too early to tell how successful any of these new strategies – we announced our Chinese strategy in March. We unveiled the office there. So that's, what? Roughly two months. We have an incredible team that has been assembled in China.

Let’s give them some time to focus on that market, bring out the localized and specialized product part of our initiative is to make sure we have the very best product in each of the markets. Chinese people, so of course the product is in Chinese. There are unique aspects of the Chinese language. We are doing all of that work, and we are doing it as quickly as we can.

I don't see a need to change what we have done, and I think it's probably going to be too early to call that question for many months, not just one month or two months. These things aren't switched. Things don't occur in a month or two, even in China.

Safa Rashtchy - Piper Jaffray

Thank you, and thanks for holding this call.

Operator

Our next question comes from Youssef Squali - Jefferies & Co.

Youssef Squali - Jefferies

Thank you very much. I want to talk about the click-to-play video ad format you have recently launched, which we believe could actually have a substantial impact on the branding opportunity for you guys. Are you planning on offering it for both Search and site targeting? And is it CPC or CPM based?

Jonathan Rosenberg

Right now, it's basically strictly on the AdSense network. Basically, what these are are click-to-play video ads. Unlike some of the annoying videos which you tend to see, they are initiated based on the user actually choosing to initiate the ad. As I said, they are strictly on the site targeted or contextually targeted campaigns. They initially come up as a static image. We're seeing some very, very high click-through rates and some significant success with them so far.

It's a CPM model, which is the same model that we have used for image ads. I think that, unlike some other folks, we are not charging serving fees associated with the ads and the minimum CPMs and the CPCs are the same as for our other ad formats. The big challenge there is just basically figuring out how to get them to work and be successful in the context of the auction as they compete with the traditional ads.

Youssef Squali - Jefferies

Can you tell us how you will decide on whether you serve a text-based ad, banner or video? Just how does that actually work?

Jonathan Rosenberg

It's basically a mathematical calculation. So they are competing against the ads that traditionally run, and the advertiser is setting a CPM in the bidding process. We are making a calculation based on those ads competing with the traditional ads. So it's giving the advertiser an incentive only to put these video ads in places where they actually think that they are going to be successful.

Eric Schmidt

One of the things that we have noticed in video.Google.com is that people actually like to watch the commercials, especially the best ones. So one of the questions that we're experimenting with is how important is it the video ad, in this case, actually be really, really, very good? We will know that pretty quickly.

But there is some possibility that people will actually want to click on these ads. They will find them entertaining, and that will become part of the way in which we sell.

Youssef Squali - Jefferies

Just a clarification. Is it fair to assume that CPMs on this medium are substantially higher than the CPM on the traditional banner ads that you have been serving as part of the site targeting?

Eric Schmidt

Unclear.

Jonathan Rosenberg

Remember, we have never done untargeted banner ads. So our model is always in the auction. So we try different formats to see which ones are most responsive. It's probably the case that no single format will dominate, that different people and different formats, different kinds of customers will want different solutions. And that's fine. Advertisers want some choices, and we're happy to give it to them.

Youssef Squali - Jefferies

Thanks, Eric. Thanks, Jonathan.

Operator

Our next question comes from Justin Post - Merrill Lynch.

[Han Tan] for Justin Post – Merrill Lynch

You have talked a lot about the Company's focus on product innovations. Can you talk about any financial goals that the Company might have? Does the Company have target revenues, operating margins or EPS -- without having to state specific numbers, can you just talk about some key financial objectives for the Company?

George Reyes

Clearly, we care immensely about our financial performance and we rigorously measure it. We try to make sure that we're operating our business processes as tightly as we can. Quite frankly, our goal day in, day out is first of all, to run the Company for the long-term. But, while we are doing that, we are trying to make smart choices and make the best investments that are available to us quarter in, quarter out. If you sort of look back in time and you fast forward to where we are at here, we do this thing quarter in, quarter out; and so far the results have been pretty darn good.

So the business model and the tuning to the business model that drives sustainable, long-term growth in the business is how we really think about the Company.

[Han Tan] for Justin Post – Merrill Lynch

Just as a quick follow-up, can you just talk about possibly some of your other new initiatives in branded, Local, Search and video? When do you think that will be a meaningful part of sales?

Jonathan Rosenberg

I think we already talked about Local, which I think we have indicated already is a pretty significant portion. The branding efforts we also talked to, and we talked about site targeting, and the demographic-based targeting. So I think that that is already making real progress.

In terms of some of the other areas like video, I think that really, if you look at the history of the Company, our success has been based on building great end-user products first and figuring out how to monetize them later. I don't think we yet have figured out the ideal alternatives in terms of how we are actually going to run, create, display the video ads, nor have we fully figured out all of the models with our own Google Video experience. So I think a lot of that new functionality is going to lag behind the two examples that you started with, which were Local and branding.

[Han Tan] for Justin Post – Merrill Lynch

Thank you.

Operator

Our next question comes from Marianne Wolk - Susquehanna.

Marianne Wolk - Susquehanna

Thanks, just a couple of quick questions. In your six months of testing with Dell, were you successful in attracting new users? Or did you mostly find usage increased?

Then I also just wanted to focus a little bit about your new traffic acquisition strategy, if you see any form of new strategic partnerships lately -- Dell, AOL, KDDI? Is that your preferred method going forward to build traffic, or might you also consider M&A going forward?

Eric Schmidt

With respect to Dell, we saw both increases in usage by traditional users or historic users, and we also saw new users. So it was a win-win, in that sense. That's why, as I mentioned, we were so happy.

Could you repeat your second question?

Marianne Wolk - Susquehanna

Yes. I'm just trying to understand your future traffic acquisition strategy. We have seen you recently step up strategic partnerships with Dell, AOL, KDDI. Is that your preferred method of traffic acquisition on a go-forward basis? Should we expect you to sign a lot more of those types of deals, or might you also include M&A as a method to acquire traffic?

Eric Schmidt

M&A as a method to acquire traffic has not historically worked. Again, we would never rule something like that out. But it's unlikely that, in and of itself, we could just buy customers. It typically doesn't work. Usually, those customers are evanescent; they can move from one place to another pretty quickly, not like other businesses, where the customers are kind of stuck. It's a bad business strategy, and it's not consistent with Google's values and business strategy or culture, anyway.

So we much prefer the partnership approach. You listed a number; we have a lot more coming. We like it. There's a lot of reasons to like it. It creates another partner whose incentives are with ours. We work together. They improve their product, we get the benefit. The customer sees a more integrated solution. KDDI is a good example of a mobile phone deal. We have more of those coming.

So there's a lot of reasons to think that the structure of the industry going forward will have a lot of these kinds of deals. We are trying to do the best deals, we think we have the strongest product in the space. So now is a great time to sign those deals.

Of course, the partners always have the opportunity to switch partners if they become dissatisfied with us, and vice versa. So it keeps everybody on their toes as well. So the answer is partnerships.

Marianne Wolk - Susquehanna

Just a quick follow-up on that then. How should we think about the economics of these deals? I know you don't want to give us specific details on any specific deal, but should we think about this as a capital investment much like we saw in AOL? Or should we be thinking about there being upfront expenses that you hope to recoup later? Can you give us some sense of the way that you think about the economics of these deals?

Eric Schmidt

It's sort of a combination of all that, and I will let George talk about the precise way we account for it. We try to think of it as solving an end-user problem and we always want to make sure that we grow our end-user base and we increase our cash flow. So as long as the cash flow outcome is positive, as long as we have more users, we are happy to do whatever financial deal solves whatever problem or opportunity that the partner sees as well.

Businesses run differently, depending on which partner they have so there's no single answer. But usually the customer -- partner, in this case -- wants to participate in what we have talked about as an enormous expansion of online usage. So they see a partnership with Google and Google's brand and Google's services as making their product stronger. They get more demand for their product, we get more demand for our product. That's why, by the way, we like to do these tests, because then we can actually prove that. So we're operating from an accurate spreadsheet as opposed to marketing claims from one side or the other.

Marianne Wolk - Susquehanna

Can we assume that in year one of these deals, you should have positive cash flow? Or are you looking over a longer-term period when you think about that?

Eric Schmidt

So clearly, the Dell deal and the term of the Dell deal spans out over several years. The primary mechanisms in something like a Dell deal, as well as other related deals, would be either through upfront bounties or rev shares. That is the general structure that we have applied over a whole range of these deals.

Marianne Wolk - Susquehanna

Should we expect positive cash flow in year one? Or do you think about that over a multi-year period?

George Reyes

It's a multi-year deal, and it will certainly be cash positive over the course of the transaction.

Marianne Wolk - Susquehanna

Thank you.

Operator

Our next question comes from Anthony Noto - Goldman Sachs.

Anthony Noto - Goldman Sachs

Thank you very much. Eric, I was wondering if you could talk to the strategic importance of the Korean market, given its size and broadband adoption, and your specific initiatives to try to increase your share there?

Eric Schmidt

Korea is a country which has good broadband adoption, where the U.S. companies have not done as well as the Korean companies. There is some evidence that the Korean users have a somewhat more sophisticated and integrated experience online.

There's a much higher penetration of broadband. There's a much higher penetration of gaming. There's some other cultural aspects that they have. One of the leaders there has their own essentially private web of information of user-generated content, for example.

So from a Google prospective we, in addition to having a sales operation and sales partnerships in Korea, we will also be expanding our engineering competency with engineering leadership and localized products. Korea and, from our perspective, China are similar in that they have a strong local competitor who has done well. The market, again, looks to us to be pretty early, and a lot of opportunities for innovation in Korea.

Operator

Our next question comes from Steve Weinstein - Pacific Crest.

Steve Weinstein - Pacific Crest

I just had one more follow-up question on the Dell agreement. As you're looking at the deal, what components of that do you think are particularly unique to this Dell deal that you have not had in other distribution deals?

Alongside that, the numbers being reported for the value placed on this deal are significant. I'm wondering if there's any change in the pricing and distribution deals? How you think that is going to trend over into future deals?

Eric Schmidt

It's better if we don't comment on any of the rumors about pricing and so forth. We have a confidentiality clause in our deal, and we certainly want to respect that.

I think the thing that distinguishes the Dell deal from the others is its comprehensiveness. Most of the other deals, and again, this is also because our products were not as far along, were just around the Toolbar, which, of course, is very successful for us.

This one is much more comprehensive. I mentioned Desktop Search. I mentioned IE integration, I mentioned the Toolbar itself. You should expect other things over time. We would obviously like to do deals such as the Dell deal, if they test out well and if end users like them, with everyone. So there's certainly an intent to replicate this deal to the degree that we're able to, with happy partners.

Steve Weinstein - Pacific Crest

Thank you.

Operator

Our next question comes from Sasa Zorovic - Oppenheimer.

Sasa Zorovic - Oppenheimer

My question would be regarding your efforts here to improve the quality, the targetability of your advertising. Tell us a little bit more about your efforts there beyond just Local. What are some of the next things that you're thinking about, where you're looking at what your competitors are doing and how they are improving, and how you are looking to stay a step ahead, like you have been ahead of them recently?

Jonathan Rosenberg

I think it really revolves around a couple of things: mainly, trying to understand the degree to which there is commercial nature in the query. One of the things that you'll basically see us doing at both ends of that spectrum is trying to give the user better, more clearly targeted ads on the highly commercial queries, and also try to eliminate the ads on the less commercial queries where an ad isn't really appropriate.

So, for example, if you type in "dog parks Mountainview" into Google, it probably isn't appropriate to get an ad. If you type that into Google today, you won't get an ad. You will just get search results for dog parks. But if you try typing that into most of our competitors, you will tend to see a lot of very bad ads, ads that may be relatively inexpensive, but will maybe distract the user or steer to the user toward something that isn't particularly valuable.

So basically, most of the efforts are around this big massive regression that we do on our history of information about user clicks and try to figure out when we have a particularly commercial query, and when we don't. There are a lot of different ways and mechanisms that we work on doing that. There's a lot of statistics around looking at different keywords that may not match other keywords exactly and inferring information about the degree of commercial intent of the query.

So that's mostly what we're doing. You can see, in particular, a lot of the elimination of the less robust or appropriate ads on some of the queries, like the one that I mentioned.

Sasa Zorovic - Oppenheimer

Specifically, how would you look at your behavioral targeting efforts? Could you tell us a little bit more about that?

Jonathan Rosenberg

Yes. So we are certainly making significant progress with personalization. We do think that in general, behavioral targeting has more promise than demographic targeting. We think that in order the most value in terms of a statistical tell with respect to what a user is interested in is, of course, the query that they most recently typed. Because for example, I might type in Barbie dolls. I'm a middle-aged male, but I have a daughter who may well want to purchase Barbie dolls. So serving up those queries is obviously appropriate for me. That's one of the reasons that the demographic set doesn't tend to work as well.

We think that the behavioral efforts are probably more fruitful. We're certainly doing some work there with search personalization where, if you are using the personalized search service, if you run a search on, say, "bass," we will have a sense whether or not you are a fisherman or interested in the musical instrument with the same spelling.

How that is going to apply on the advertising side, I don't think we have yet figured out. But those are the areas and relative promise of the different alternatives in terms of how we see them.

Sasa Zorovic - Oppenheimer

Thank you.

Operator

Our next question comes from Troy Mastin - William Blair & Co.

Troy Mastin - William Blair & Co.

I wanted to ask about the significant investment in some of the competing ads systems out there, given the perspective on what impact that might have on your network members, if you have seen anything recently. I guess IE is a bit more competitive to keep or attract your network partners today. Is there any uptick in the churn there? What might the long-term ramifications be in TAC?

Along these lines, I think Search is generally viewed as a self-funding model. But if your competitors are successful in significantly improving their effectiveness through better monetization, can you give some perspective on what you think might happen to demand within the Google AdWords and AdSense systems? To put that another way, is there risk that budget dollars might get pulled away from Google if your competition significantly improves their monetization?

Eric Schmidt

The short answer to your question is no and no. We have not seen very much change in the structure of partnerships and TAC. They seem quite stable. George actually reports in some quarters it actually goes up in a positive direction for Google, which is not what you would assume from the increasing competitiveness in the market.

One possible explanation for that is that the Google Ad Network and its partners continue to outperform the other competitors. Every quarter, they get better and better. We believe that to be true, and we hope it will be true for a long time. So it looks like the stability of the Ad Network is very strong.

There is a bizarre and curious aspect of competition in the advertising networks that I think many people do not understand, and it's worth explaining. The entrance of new competitors in a market which is untapped stimulates more advertisers and more advertising dollars. The new competitor also then who enters the market, calls on those companies and so forth, then gets those advertisers to spend more money online. They don't just spend it on the new competitor. It's not a zero-sum game.

So to be very precise, Microsoft is entering the market. Microsoft's entering the market undoubtedly will influence some people to enter the market that had not previously been influenced by Yahoo! or Google. Yahoo! and Google will be the beneficiary of more motion of dollars into that. So there's a net positive effect of the increasing competition.

That will be true until the targetability model that we are all pioneering here hits some natural limit. We're not anywhere near that limit. I'm sure there is such a limit. But we are nowhere near it. There's evidence that keyword prices could rise significantly. Budgets are typically under-spent, that people would spend a great deal more money in our advertising model if we had the products and services that could capture and exploit that with the appropriate measures.

So people are very concerned because in traditional industries, the arrival of new competitors is a zero-sum game. But in something as massive as the shift to targeted advertising, which is bigger than the web and bigger than the Internet itself, it's so much of a larger space than the sum of the current online advertising industry, that we just don't see it as a negative. We see it as either neutral or positive, and we get laughed at if we say it's a net positive. But it probably is a net positive on a mathematical basis.

Troy Mastin - William Blair & Co.

So even in the extreme short-term, say, on a monthly or quarterly basis, if your competitor dramatically improves monetization, even if someone is budgeting on, say, a monthly basis, you would not expect to see a negative impact? You think it's self-funding enough of a model that it's a net neutral or positive?

Jonathan Rosenberg

I have the benefit of actually talking to a lot of these advertisers. When you go out and talk to these advertisers, which I would certainly encourage you to do, on a bang-for-the-buck basis, all of them -- almost all of them -- say the same thing, which is, if I could get more inventory that's converting and delivering the ROI that I'm getting today, I would like it.

Basically, what Eric's analysis is saying in a different way is that advertisers in equilibrium on a bang-for-the-buck basis attempt to take their advertising dollars and place them where, on a bang-for-the-buck basis, they are making the most money. And they then kind of go down the spectrum from the highest ROI things to the lowest.

What we are seeing is a big secular shift from offline to online. That's why Eric is saying it's not a zero-sum game, because as advertisers try this medium out, they discover that on a bang-for-the-buck basis, the kind of things that Google and our competitors are doing in this space works so much better than the alternatives that they tend to want as much as they can get.

Obviously, it will continue to help if we can distance ourselves from the competition in terms of the robustness of the monetization mechanisms and the quality of our ads. But even if competitors come in and offer more, as a general rule, the advertisers want more.

Troy Mastin - William Blair & Co.

Thank you.

Operator

Our final question comes from Mark Rowen - Prudential.

Mark Rowen - Prudential

Eric, you have been pretty vocal about Vista and the new version of Internet Explorer that is coming out, and your thoughts that it might put you at some sort of disadvantage.

I wonder if you could give us a big picture perspective on specifically what you don't like about that? The settings and things. What kind of advantages might Microsoft get from that, what sort of disadvantages might it put you at?

Then, in the context of the Dell deal, how much does that alleviate that pressure?

Eric Schmidt

I'm not sure how vocal we have been. Vista is scheduled to ship in 2007, and we'll see how it actually comes out. There's a lot of opportunity for Microsoft to change what they are doing based on customer feedback and other factors.

As they currently reported, there is a default setting in Internet Explorer 7, which, if the default setting is not set, is then set to Microsoft Search. We want to make sure that the use of the power of Windows is done in a correct and legally appropriate way. That's a concern.

With respect to the Dell deal, the Dell deal was really driven by this end-user focus issue and not about the Vista issue. Again, Google's brand and usage and products are very, very strong. So this is a specific point. But certainly, Vista is a product that people have been waiting for, for a long time. We'll see how successful it is in integrating search in the various places that they claim they are going to be doing.

Mark Rowen - Prudential

So assuming that they don't change that, and the default settings for those that are not set, move people to MSN Search instead of Google Search, do you think that that's a big disadvantage for you? Or do you think that it's not such a big deal in the final scheme of things?

Eric Schmidt

Well, it's an example of the increasing competition. We at Google are very, very focused on having the very best search. So hopefully, if that were to occur, people would naturally see that our product is that much better.

Mark Rowen - Prudential

Thanks.

Operator

That concludes today's question-and-answer session. I'll turn the conference back to our speakers for any closing comments.

Kim Jabal

Thanks very much to everyone for joining us and we welcome your feedback on the call. You can send your feedback to us at the investor relations team. Thank you very much.

Operator

That does conclude today's conference. We appreciate your participation. You may disconnect at this time.

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