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Executives

Eric Schmidt - Chief Executive Officer

Patrick Pichette - Chief Financial Officer

Nikesh Arora - President, Global Sales Operations and Business Development

Analysts

Samit Sinha – JMP Securities

Aaron Kessler – Kaufman Bros.

Ross Sandler – RBC Capital Markets

George Askew – Stifel Nicolaus

Scott Davis – JP Morgan

Jim Friedland – Cowen & Company

Heath Terry - FBR

Richard Fetyko – Merriman Curhan Ford

Mary Meeker – Morgan Stanley

William Morrison – Think Equity

James Mitchell - Goldman Sachs

Mark Mahaney – Citigroup

Benjamin Schachter - Broadpoint Am Tech

Justin Post – BAS-ML

Brian Pitz – UBS

Spencer Wang - Credit Suisse

Google Inc. (GOOG) Q4 2009 Earnings Call January 21, 2010 6:00 PM ET

Operator

Good day and welcome everyone to the Google Inc. conference call. This call is being recorded. At this time, I would like to turn the call over to Maria Shim, Senior Manager of Investor Relations. Please go ahead, Ma’am.

Maria Shim

Good afternoon everyone and welcome to Google's fourth quarter and fiscal year 2009 earnings follow up conference call. With us are Patrick Pichette, Chief Financial Officer, and Jonathan Rosenberg, Senior Vice President of Product Management and Nikesh Arora is also going to be joining us for the first half hour so if you have specific sales, geographic vertical questions for him please direct them to him in the first half hour of the call. After we cover a few housekeeping items we will begin taking questions.

This call is being Web cast from our Investor Relations Web site located at investor.google.com. Please refer to our Web site for important information, including our earnings press release and related slide deck. A replay of this call will also be available on our Web site in a few hours. Please note that we routinely post important information on our Investor Relations Web site located at investor.google.com and we encourage you to make use of that resource. As a reminder, the purpose of this follow-up call is to give participants the opportunity to ask more detailed financial and product questions in an efficient and Reg FD-compliant manner.

Let me now quickly cover the safe harbor. Some of the statements we make today may be considered forward-looking and these statements involve a number of risks and uncertainties that could cause actual results to differ materially. Please note that these forward-looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events.

Please refer to our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2008, as well as our earnings press release for a more detailed description of the risk factors that may affect our results. Copies can be obtained from the SEC or by visiting the Investor Relations section of our Web site.

Also, please note that certain financial measures we use on this call, such as operating profit and operating margin, are expressed on a non-GAAP basis and have been adjusted to exclude charges relating to stock-based compensation. We have also adjusted our net cash provided by operating activities to remove capital expenditures, which we refer to as free cash flow. Our GAAP results and GAAP to non-GAAP reconciliation can be found in our earnings press release.

With that, we are ready to take your questions. Operator?

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Samit Sinha – JMP Securities.

Samit Sinha – JMP Securities

I just wanted to get some more details about CPC growth sequentially. Are there any specific circumstances in the past quarter about how emerging markets where query growth has been strong but CPCs have been lower. Can you just quantify that impact? Secondly, on the CPC question itself anything specifically in Europe regarding to where trademark bidding has slowed down or the efficacy of that has slowed down and maybe pulled down CPC with it?

Jonathan Rosenberg

I will let Nikesh comment on any specific issues related to Europe or any dynamics he is seeing there on the trademark issues. The specific issues which we have traditionally talked about a lot, you are looking at average CPC which obviously is a blended number and it is impacted by some of the things you suggested such as the relative growth in maturing markets versus established markets had some anomalous dynamics when you look at this quarter which I would highlight. First and foremost the FX movement. The dollar was weaker in Q4 2009 when you compare to Q4 2008 so that causes the non-US clicks to have higher CPCs when reported in dollar terms. I think the other thing you may not see is there is an important mix effect going on. We made some quality improvements on the AFC network and basically that had the effect of reducing the total clicks in the AFC network relative to what it would have otherwise been.

So we had a higher proportion of clicks coming therefore coming from Google.com and from AFS and that is a mix shift that caused the blended average of CPC the way you are seeing it to otherwise rise. So those are the two things I think are more different in this quarter than in the past. Otherwise I don’t have any more insight.

Operator

The next question comes from the line of Aaron Kessler – Kaufman Bros.

Aaron Kessler – Kaufman Bros.

A question on the local side on mobile and how that ties in. There is a lot of assumption on the mobile side that is really going to head out to local group longer term. Just your view on that and how you are seeing the growth on the local side develop to drive mobile longer-term here?

Patrick Pichette

I think that one element of mobile is local but I would far and away not only pin it to local. There is no doubt we are having some great experiments on local but on mobile what you have is a whole set of searches and a whole set of activities that actually just transcends clearly just a local business. Those searches obviously are going to also fuel it. It is a mosaic of opportunities but local is just one of them. Jonathan maybe you have additional comments?

Jonathan Rosenberg

I think local is hugely important. It is going to be much more important in the not too distant future because as we are seeing more integration and as I mentioned in some of my other remarks people who are shopping offline start online and today people still don’t have access to the inventory information of the local stores. I mentioned that in mobile we are seeing that when phone numbers and coupons are offered people are much more likely to click on the mobile ad. Well imagine if the inventory information is there so they can actually consummate a transaction locally. As that information becomes available local is going to be much, much more powerful.

We already have some examples where advertisers like AT&T are using some of our local products to help people find local stores. I think we are just starting to get there in terms of capabilities that are going to be necessary for local to take off. But I think local is going to matter much more on these devices because obviously they know where they are with GPS.

Aaron Kessler – Kaufman Bros.

I think you filtered out some of your advertisers this quarter. Maybe it was just in essence for content. Maybe you could provide some more details around that?

Patrick Pichette

Sorry could you restate the question?

Aaron Kessler – Kaufman Bros.

I think there were some reports that you may have filtered out some of your advertisers this quarter on the ad sense side. Can you provide any more details about that?

Nikesh Arora

Obviously we are constantly looking at our advertisers to see whether there is an extraordinary [expand] that is happening. We have thrown in those advertisers who repeatedly attempt to scam users. So we went through one of our regular processes of looking at advertisers and seeing which ones of those we though weren’t adding quality or adding sort of value to our users. In those cases we chose to suspend them permanently.

Jonathan Rosenberg

This was happening this quarter with the approach we took to suspend the repeated scam users as opposed to before where all we were doing was disabling certain bad ads.

Aaron Kessler – Kaufman Bros.

Does this have any material impact on the quarter numbers? It sounds like it could have had a slight impact from what I was reading.

Jonathan Rosenberg

No the impact is slight. It is a relatively small number.

Operator

The next question comes from the line of Ross Sandler – RBC Capital Markets.

Ross Sandler – RBC Capital Markets

First on the cyclical nature of paid click growth and then a follow-up from James’ question earlier. So on paid click the growth rate has been decelerating pretty steadily for the last couple of quarters based on some of the mix and some of the natural deceleration you talk about. Do you see any evidence in your data that as the economy recovers in 2010 that paid click could actually reaccelerate? For instance in the fourth quarter you had a reacceleration in the domestic market. Did paid clicks reaccelerate there? What are your thoughts on that? A follow-up from James’ question on the international stuff if we do the math correctly, international growth X currency and X hedging decelerated to around 16% from 19% last quarter. Can you talk about what is driving that deceleration because I think it had accelerated in 3Q.

Patrick Pichette

On the paid clicks the only thing we could tell you because we can’t give you any perspective is obviously as every place there is a recovery and there is robust auctions. There is also seasonality within those auctions. You can have increased CPCs. So that is really the fundamental driver of the CPC growth.

Ross Sandler – RBC Capital Markets

You don’t see consumers clicking on ads, not the CPC but actually the volume of page clicks, you don’t see that incidence increasing when the economy is better?

Patrick Pichette

Yes absolutely. People search more and as they search more not only do they search more but they click more. No doubt about it. If you remember if you go back to a couple of quarters ago we had this conversation where we said because people were more shy of shopping they clicked less. So it was a consumer driven phenomenon that drove our CPC at the time. It was simply that no matter how the auction operated the fact that people clicked less. As the economy recovers and people click more obviously it will have an effect on CPC.

As for the international, Nikesh do you want to cover the international portion?

Nikesh Arora

I think the important thing to note is if you compare and look at last year’s Q4 we had a decline in the US much more sharper than what we saw in the international markets so the comps in the US look much better than they look for international regions. In addition to that many of our new product areas which we staged globally start in the US and make their way across the globe we have had more of them do well in the US than they have done internationally. So purely from that perspective the US is going to look slightly stronger from the rest of our international markets.

Operator

The next question comes from the line of George Askew – Stifel Nicolaus.

George Askew – Stifel Nicolaus

First, has Google since the first of the year finished implementing the caffeine search architecture across all your data centers?

Nikesh Arora

I don’t know that we are finished implementing it. I know…

Jonathan Rosenberg

I believe the answer to that is no. The answer to your question is not yet.

George Askew – Stifel Nicolaus

Obviously display advertising is a huge push for the company. Can you help us please understand how much of your display advertising revenue is from owned and operated properties such as YouTube and how much is powered by tools of Google but does not appear on your websites like Double Click?

Patrick Pichette

We don’t give the mix but clearly it is all of the elements at work.

Nikesh Arora

The best way to think about our business on the display side is we have our business on the display side which corresponds to [inaudible] which is where brand marketers looking for premium advertising slots look to YouTube as a property they want to advertise in competition with other premium inventory that is out there.

If you go to the next level the best way to think about them are network which is our collection of publishers which are all the way from small publishers to certain large publishers who give us access to inventory which we are then able to selectively sell at the network both using conceptual advertising as well as using intraspace advertising and that is of course is a different profile as it relates to the margin and revenues as compared to YouTube.

The third part is where we use both our tools as well as our exchange properties like Ad Exchange and Double Click platforms which is where you can have different buyers and sellers and different people who put inventory and people who have inventory and that is beginning to gain traction now and most of our top ad networks are in that space. Clearly again that is a very different pricing profile and margin profile in the market. So that is the way to think about our three different businesses from a structural perspective.

Clearly from an advertising perspective when we make that pitch we offer the entire gamut of services depending on what campaign objectives they have and what they are trying to achieve.

George Askew – Stifel Nicolaus

Would Google have another owned and operated display ad site?

Nikesh Arora

We are currently experimenting with various properties we have to see what is the best mechanism and the best format of advertising to use.

Operator

The next question comes from the line of Scott Davis – JP Morgan.

Scott Davis – JP Morgan

I think I have a follow-up to Ross’ and James’ question about the rest of the world growth. Given that it decelerated and I understand the products in the US haven’t rolled out there, that would explain why it wouldn’t reaccelerate but it doesn’t explain the deceleration so it sounds like you are saying the primary answer is just the comps which did in fact get a lot more difficult versus the fourth quarter of last year. I was wondering though if there is a third element which has been a number of times on the call it was mentioned large advertisers have come back first. I guess I was wondering if you could give some color on whether the rest of the world make up of advertisers is more small advertisers as compared to large and therefore that lagged a little bit for that reason as well or was it just purely the comps for the first reason that I said?

Nikesh Arora

Thank you for the excellent question. I think there are three elements to what you asked. One clearly is the comp element because as Patrick would say we have had a v-shaped recovery in certain markets we have had sort of a slightly elongated return of markets and some of the markets have been bobbing around. So clearly in the US we have seen a sharper rebound than we have seen elsewhere where they had not as sharp of a decline.

So clearly one is a comp issue. The second issue has also to do with the advertiser mix. Actually the large advertiser phenomenon is over weighted to the US than it is towards the emerging parts of the world so in various emerging parts of Southern Europe or in various parts of Asia, Latin America, the Middle East and the other parts of Europe we are clearly not seeing as much divergence between the large advertisers and small advertisers in those markets. The large advertisers haven’t been as aggressively back as they haven’t as aggressively left in the first place.

The third case is clearly in some of those markets which are nascent what happened is as the economy took a hit or a stuttered earlier they actually reprioritized their spending and some of them may have pulled back from search and it just takes a little bit longer to get them back onto online advertising because in those markets they are not as reliant or as convinced of online advertising but clearly as I said in places like Brazil we will be making huge efforts to get the education up on advertising and we do that around the globe.

Scott Davis – JP Morgan

Do you have an expectation, just to follow-up you are clearly pleased with sales and it is easier for the street including myself to get ahead of ourselves because we can do channel checks and hear about the US and hear about the U.K. and those things accelerated nicely. So it feels like the only thing the bowl is missing is just some condition on when you will see a reacceleration in the rest of the world. Part of it will come just because the comps are getting a lot easier. Do you have a suggestion for what kind of lag you think is involved for those?

Nikesh Arora

Clearly I am not going to try and speculate numbers and try and figure out when these things are going to happen. From a long-term perspective when you think about the US versus these markets clearly some of these markets are further behind in terms of the development where the US is and where certain parts of Europe is. For example, the U.K. is very advanced in the online market. Even if we look at the evolution of some of these markets over the last 3-4 years we have seen a trend. The trend suggests that over time people will start getting more convinced about online advertising as more and more consumers in those markets get online as more and more broadband penetrates those markets. Both dynamics are clearly easy for the street to understand and try and project.

Based on that my long-term conviction is that we are going to see the continued shift towards online advertising both on the search side as well as on the display side as Patrick alluded to in the earlier call where the television market is another huge market where the eyeballs are beginning to shift and advertisers will want to target those audiences and we feel confident the tools we are developing based on our experience in the US markets can be deployed around the world. In the long-term I believe there is clearly growth into those markets. I can’t project which we are going to show it in.

Patrick Pichette

I think just as a general comment on the overall total revenue and then the difference between all these markets and geographies, as we said on the previous call we are really pleased with the trajectory of the company and the reason for it is you can see how a quick rebound in the economy in the US, not a strong rebound but a quick rebound actually you can see the leverage model of the Google model so in that sense I think we take a lot of comfort for the long-term.

Operator

The next question comes from the line of Jim Friedland – Cowen & Company.

Jim Friedland – Cowen & Company

On G&A if I look at Q4 versus Q3 it actually moved up decently. Last year it was flattish but then you were really working on the costs. Was there anything one-time in nature or unique about that increase or was it seasonal or is this just getting back to sort of a more traditional pattern?

Patrick Pichette

I think on G&A the two big areas we talked about one of them was actually ramping up our marketing as we discussed on the previous call. We also had a few expenses more than would be ordinary on the legal side and so those would be the kind of two big bumps in the quarter. Nevertheless, very much under our control. If you think about it if there is one thing we have proven this year at Google is our ability to actually really control our expenses and dial where we think we are going to get a great payback and a great return. That is exactly what you have seen in Q4 where when Eric talked about let’s push back the investments let’s go back into making sure we run the business the way we want to run it. Obviously when you have areas like marketing broadly defined that is the first place you can actually turn on the dial to get a real impact back. That is why we moved that way.

Jim Friedland – Cowen & Company

On marketing, with the Nexus One we have seen some ads around the Google network but we haven’t seen any more traditional advertising given that it is sort of a meaningful product launch and you are trying to change an industry. Why haven’t we seen a push in that area or are you just telling us that you are going to use sort of the traditional way that Google has gotten out there?

Patrick Pichette

Nikesh will probably have more details on this. Because we launched the product and it is really a new model we are trying to launch with the online store, all we wanted to do and we had so much advertising anyway and marketing around the product itself. We didn’t deem it necessary to actually push it in the same way that other, more traditional channels would have done.

Nikesh Arora

I think Patrick said it and I think we alluded to this in the earlier call that as Eric said this is a new way for selling mobile phones. Clearly the first target group we can go after are the people that like Google, who are the Google aficionados, people who are online, and since we are trying to come up with a model for selling something online it is perfectly logical for us to do online marketing for that and as this evolves and as we test it we can explore other ways going forward.

Operator

The next question comes from the line of Heath Terry – FBR.

Heath Terry - FBR

Eric touched on this a little bit on the call but can you give us an idea on where you are seeing the most traction in your display efforts? As you look at the Double Click ad network what are its competitive advantages and what does the development path look like there?

Patrick Pichette

In terms of display I think that Nikesh in the way that he portrayed it a few minutes ago there is really…Let me just give the high level answer and then Nikesh can add color commentary. There is a simplification of the process with Double Click and the Double Click platforms for both the publisher and the advertisers, the simplification of all that has made a huge difference and we can see it in the numbers of people signing up for it. Obviously on the performance and the markets two other big thrusts that actually are good trajectories. Maybe Nikesh you would want to give a bit more in the display itself?

Nikesh Arora

I think that it is very important to think about the evolution of the display market. In the early days of display we have been selling sites and as we look at it there has been a huge explosion of the sites. There are millions and millions of websites that you can actually decide to target ads and target display ads. Now the challenge that it creates is on two ends. One is it creates a challenge in consistency which is where products like Double Click which creates some degree of consistency are served and how they are put across the board and products like Ad Exchange begin to help. Because effectively you are trying to create a consistent way of serving ads in the market.

The second part also is sort of the inefficiency of the selling side. It is very hard for an advertiser to go to aggregate multiple sites and try to buy them individually. So it really helps to have an exchange. They can aggregate tremendous amounts of inventory. If you do both of those things then we can layer on top of that both contextual and intraspace advertising. So that is the way to think about it. We are slowing shifting the display behavior to look and mimic what advertisers are currently used to buying. They have been used to buying audiences on an aggregated, large scale. The way we are able to put together the Google Content Network, the Ad Exchange and the Double Click platforms we are trying to replicate the ability to buy large audiences. As that begins to happen and as they are [rebuilding target] more and more you clearly expect it becomes more relevant or them and therefore the prices will react accordingly to the that [inaudible] of the advertisers.

Jonathan Rosenberg

I would summarize the competitive advantage as we are making it easy to buy, sell and serve display ads. One of the things I think is particularly exciting which Eric was asked about on the call earlier was this shifting budget dynamic. One of the dynamics that has been very positive that we have seen is that with products like display ad builder we are actually bringing a lot of new advertisers to display. They can much more easily create display ads now. They can do it directly from the ad works interface. It turns out they are new advertisers to display and they are not fundamentally decreasing their budgets in search so we are winning on both sides.

Operator

The next question comes from the line of Richard Fetyko – Merriman Curhan Ford.

Richard Fetyko – Merriman Curhan Ford

In the past you have talked about changes in ad coverage or density of coverage. I was wondering if you can characterize the changes in the last few quarters if there has been any. Secondly on the mobile strategy I am just wondering if the success you had with the adoption of the Android operating system for the mobile devices what role do you see that playing in your mobile strategy? Does that lead to a certain level of certain opportunity for monetization over time?

Patrick Pichette

Let me answer the mobile first and then I will let Jonathan answer the first question on coverage. The whole mobile strategy is built on building and accelerating an ecosystem. Obviously we have our own mobile teams that have developed these cool aspects. People who know Vic and all of the really cool applications that he conceives with navigations and all the rest, but it is above the ecosystem that there are three things; It really promotes innovation. It has a lower cost of innovation because by being open source you enable everybody to jump in and do it and then as a consequence you keep it open source.

The benefit to us really is twofold. The benefit is users get better applications faster at market spreads faster everywhere. So think of the spread of high end devices faster and at a lower cost sooner which drives all these applications and so users get a benefit. Then as a consequence of that as we have talked before consumers that have Android devices we know from our own research they use it 30 times more than what a typical handset would be. In consequence they do a lot more searching and there is a lot more advertising opportunities. So pushing that ecosystem is so critical because that is where the world is going. If you think in terms of NPV as the image I always use, what is the value of accelerating that? It is huge for the users but it is also huge for us.

That is why we are pushing it with the three dimensions of mobile, Android and now with the Nexus handsets to kind of set the standards at a higher level. So that is the mindset in which we operate. We benefit nicely from it and so does the user. Now for the ad coverage, Jonathan?

Jonathan Rosenberg

As you know we really don’t break down the components of the RPM equation specifically to cover CPC or click through rates. We have told you in the past on a couple of occasions where there has been a situation where we noticed a dynamic that caused us to make a change which we mentioned a few quarters ago in the past. Right now I think we are pretty happy with where coverage is. We have mostly been focused on improving the quality of the ads themselves and we have talked to you a bit in the past about the tradeoffs we make there in terms of how we decide to take improvements with respect to quality and coverage.

I think the main change you can probably see is the new formats we have been launching which we talked about which basically offer a better experience within our ads rather than new ads that were not otherwise showing today. There is not a lot to say in terms of fundamental changes in coverage.

Operator

The next question comes from the line of Mary Meeker – Morgan Stanley.

Mary Meeker – Morgan Stanley

You on the call were obviously very enthusiastic about the growth and monetization opportunities in YouTube, Mobile, Double Click and enterprise. That said desktop is still the vast majority of you revenue. You are the ones that are getting the inbound phone calls about people getting more interested in these categories and to Scott Davis’ question the stock market is not responding that well to your earnings announcement but at the same time you were really enthusiastic about 2010 per your tone and your commentary. Could you give us a sense of when these new initiatives start to add 100 basis points here and there or a couple hundred million of incremental revenue to the business? If not quantitatively just philosophically about when they start to move the needle because that would drive an acceleration in revenue for the company.

Patrick Pichette

Let me start by saying the following; One, display as Eric said is already a pretty significant business for us. In the sense when he talked about it is the next billion dollar business and when you take all of the elements that Nikesh has talked about if you think about YouTube and you think of all of the elements that are within it at some point in the future this will add up to something that we are excited about and two, that moves the needle. You could argue in many areas within this we have already started moving the needle.

Then on the other ones, as you said they are nowhere near where the core business is but the trajectory and growth rates we see in the adoption rates and the adoption rate on users gives us…that is why we feel so comfortable when we talk about 2010 and beyond and building this business for the long-term. We see a lot of positive trajectories and we have to celebrate that because two years ago we couldn’t have said that maybe about mobile and we couldn’t have said that about enterprise but two years later when we stand at the end of 2009 we look at the great programs from Jonathan’s comment of putting a few arrows in the right places and then just putting more wood around them, we are very pleased about the trajectories that these have.

Mary Meeker – Morgan Stanley

Is there any stuff around it you can provide us?

Nikesh Arora

If you just think about our business in the various ways we just talked about and I want to sort of underline that search is not by any means exhausted the scenario where we continue to make progress and we continue to see interest. I would say we are seeing more and more large advertisers coming in and that is not just a function of the economy. It is also a function of them having developed their e-commerce capabilities and worked really hard on having online strategies. So as they come forth and build their online strategies across multiple verticals we are beginning to see a resurgence and return of those guys into the online space.

Having said that, in addition to from a direct marketing and direct response perspective the next leg which we are beginning to see a surge is that people are beginning to see the offline impact of people searching online. So even if you have a business where you are not selling something on the web it is very clear to most businesses whether they are in pharmaceuticals, consumer goods, autos that most people or 78% of the people will research something online which is a significant value to them or a significant importance whether it is a drug or a car, before they will go make that purchase or before they will make [inaudible]. Clearly that sort of research is being funded by us and various agencies out there and that is continuing to drive that cycle and whilst it is driving that in some of the more mature markets clearly those effects are still making their way into the emerging markets and maturing markets in Europe.

So I just want to underline there is tremendous runway and surge still from where we stand. As Patrick said about display, again you have seen the shift from people buying sites to where people are buying audiences and people are getting more and more intraspace which that is how traditional advertisers are used to buying. They are buying frequency, they are buying advertisers, they are often not buying sites because sites over emphasize brand association as opposed to interest targeting. I think that trend is going to continue.

If you think about the YouTube space and the online video space I think we have seen that sort of becoming a relevant part of the media mix as far as online advertising is concerned but if you just take structurally in the industry we are beginning to see the emergence of professional content on the web slowly both from broadcasters or from creators as well as people who provide online video. As that trend continues as that puts more and more inventory in the online web we are going to see more and more people get excited about advertising video to the audiences which I think is going to be another big leg for the whole industry not just for us.

And if you continue that story Jonathan talked about with mobile, again as we see the emergence of smart phones and devices such as the Nexus One continue successes of various devices from various manufacturers around the world we are again going to see the search traffic begin to move in that direction. So clearly all those things are in the right direction. Of course as Eric alluded to earlier on the enterprise side, we are seeing this big shift to cloud computing. We are beginning to see large customers and even parts of the government, the City of L.A., start to make inroads into those customer segments and clearly other people will watch those customers and gain strength from those that start to convert.

Across the board I am very positive about the potential prospects of each of those business lines. Again, as Patrick and Jonathan said we can’t actually comment on when these things will materialize in the quarter but again we remain convinced this is a good market. Does that give you some flavor?

Operator

The next question comes from the line of William Morrison – Think Equity.

William Morrison – Think Equity

A couple of quick modeling questions, how should we be thinking about tax rate in 2010 and then on CapEx before the recession you were kind of consistently spending somewhere in the low teens as a percent of revenue CapEx and that came way down last year. I am curious if we should be expecting CapEx to ramp back up to 10+ percent of revenue or any commentary around CapEx?

Patrick Pichette

The usual suspects continue to be OI&E, CapEx and tax rate. This quarter is no different than the prior quarter. So just to give a bit of color quickly on each, the tax rate has been quite stable through the year and so the big issue we focus on the tax rate because it gets affected by mix and a few other things. The real fundamental issue is legislation for us in this quarter or next quarter so I think that there is nothing in our tax rate that is affecting it more in the long-term than any of these big legislations. That is why we are focused on them. I think it is really important for the US economy and for US companies that are participating internationally to get this right because there are so many jobs in the US associated with it. That is on the tax side.

On CapEx sometimes people say too often but it is true. I am really pleased with our CapEx numbers. I think that we are ramping back up. We are ramping back up at a much lower level than what it has been historically but we are ramping back up and every opportunity we have to make sure we meet capacity or we meet CapEx, we will fund everything fully. We have been really fortunate in 2009 that we have had a couple of good breaks in terms of capacity utilization, a bunch of chip sets that worked in our favor in terms of performance as we discussed before and all this. We just dropped right to the bottom line. That is fantastic to us and to our shareholders and we will continue to monitor that very closely. What you should take away is we are going to continue that level of discipline.

If you allow me to close on OI&E again big variability quarter-over-quarter so everybody who has their crystal ball on both the variability of FX as well as just variability in general between FX and it drove so much of our FAS 133 that you see the big swing this quarter hit once again but in the other direction. It was also, you will remember I said in the previous call we had taken so much accelerated write offs on our previous hedges portfolio that we had so much of it written off that at some point you get some benefit in the short-term. So that is what has happened.

Then also people should know we have started moving off as we discussed in previous quarters we have been so focused during the crisis of late 2008 and early 2009 of cash preservation to make sure we do not put at risk the cash we had accumulated. Over the last couple of quarters we have begun to transition to a more balanced portfolio so you also see the kind of proper ramp up in yields there as well. These are the big ticket items that usually fluctuate or you have questions on the P&L. So I am glad you asked the question.

Operator

The next question comes from the line of James Mitchell - Goldman Sachs.

James Mitchell - Goldman Sachs

I believe you mentioned on the fourth quarter 2008 results call that the quarter was “one of our strongest quality improvement” whereas on the call just now you mentioned that the quality launches are more modest in terms of impact on monetization. Is it fair to infer that fourth quarter 2008 revenue benefited more from quality initiatives versus fourth quarter 2009 revenue?

Patrick Pichette

That is a pretty hard question to fully parse without my actually going back and digging into the data. It is consistently the case that we freeze quality improvements after Thanksgiving so I would have to actually look at what the exact improvements were and when they occurred intra-quarter comparing Q4 this quarter and Q4 last quarter and without actually having that in front of me it is pretty hard to say.

Operator

The next question comes from the line of Mark Mahaney – Citigroup.

Mark Mahaney – Citigroup

There was a recent deal with Twitter in terms of live feed. Jonathan you mentioned your own anecdotal uses of it. Can you make any broad comments about what kind of impact you think that has had on overall usage? Have you found any levels of greater engagement because of the inclusion of real time Twitter results in your overall search results? Anything in terms of click through rates, length of time or number of searches or anything like that?

Jonathan Rosenberg

I am not sure I have any great data to offer you there. The sets of things that we are now incorporating into the real-time search are Tweets, blogs, news, we certainly see those dynamics when you have something that is very interesting like an earthquake. So the feature we think is certainly performing well and it is giving people better quality results much more expeditiously than they previously had but what the overall impact is across search and each of the other metrics I think it is still too early to say.

Patrick Pichette

It is worth saying again if you go back in the last 6-9 months the thing that continues to amaze me on the search side is how people almost take it for granted that search works. When you look at the last 6-9 months real time search introduction which was really done in the second half of this year the complete overhaul of the caffeine so from a speed perspective and tying it all back again to the mobile it is amazing the kind of searches you can do right now, just typing a few words that even six months ago you wouldn’t have dreamed of doing. So from that perspective I think it was really important to us to get real time search up and running because there are a lot of types of information that people want on an actual basis because it just happened and having these feeds provides so much value. I think that there is no doubt they are having an impact.

The issue is we haven’t asked the economics team that actually can run these models to give me a sample and then run the experiment and so it is a good question to ask but there is no doubt that it has clearly improved the experience.

Mark Mahaney – Citigroup

On China is there a solution here whereby you can stay committed to China in the future and not censor search results? Is there some sort of work around on that?

Patrick Pichette

The team is working on this. I think it is really important that we stick to Eric’s comments earlier this afternoon. I just refer you back to his comments.

Operator

The next question comes from the line of Benjamin Schachter - Broadpoint Am Tech.

Benjamin Schachter - Broadpoint Am Tech

A couple of housekeeping modeling questions and then Jonathan one for you. On the housekeeping front can you give us specifics on how you are accounting for Nexus One products being sold? Are you taking inventory, how do they go through the P&L and then also on gross margin it is obviously trending up significantly from lower CapEx is there anything that is going to offset that any time soon? Jonathan if you could, CPA product ads, I know it is still the early stages here but how widespread are they? Where are we in the rollout of that product and your general thoughts on the product?

Patrick Pichette

Let me start with the specific Nexus One. On Nexus One we have partnerships as you know with TMobile with that specific handset right now. Actually we book them to other revenue so the revenue comes as other revenue and we recognize the full $529 per device up front. And that is tied into the licensing in other revenue. That is regardless if it is an unlocked phone or a TMobile phone.

In terms of the gross margin the cost obviously goes through other costs. On the gross margin I think the thing that you have noticed properly over the last few quarters not only did CapEx run well but because CapEx ran well also our data center expenses as we continue to push for efficiencies we got some benefit out of that as well. Again, can’t push forward to give you any details on the future but you should take comfort that we are actually really managing these efficiencies quite well right now.

One last point that you talked about on the Nexus on the inventory side it is really immaterial to us. I mean it is inconsequential. We don’t have a big exposure either on either inventory and clearly not on margin. I will turn it over to Jonathan.

Jonathan Rosenberg

The product ads I think are still occurring on a relatively small portion of the queries. I was trying to come up with an example here and it took me a couple of tries. Jogging strollers if you type into Google will show you one. I think it is a small portion of the queries. There is certainly a lot of interest from the advertisers. We started by focusing on the larger retailers and it was just a relatively small number of them. But it is a great ad experience for users because you see the pictures. You see the prices. It gives you a lot more information to help them decide which product to buy. I am very excited about the form but I think right now it is still in pretty nascent stages in terms of the number of participants and the degree to which it shows itself in the results.

Operator

The next question comes from the line of Justin Post – BAS-ML.

Justin Post – BAS-ML

I just wanted to talk about the CapEx efficiencies. You have really been able to pull back your CapEx budget and just going forward do you think you can still see a lot of efficiencies or do you think you just need a ramp up as you see growth reaccelerating? What is your view on that?

Patrick Pichette

It is a tough answer to give for the following reasons and I don’t want to be evasive here but here the real issue is because Google as you know does its own data centers and most of its equipment is built and designed by ourselves, all you need by pushing hard on the limits of this equipment and working really hard to make sure we get good performance. You get a couple of good breaks and as you see in the last 12 months we got a really nice break from a CapEx perspective. In the future we are obviously pushing the team for utilization and design to make sure we get as many of those as possible.

What is the beta on that? It is pretty high but every time you get one you get a lot of value and you have at least some evidence we are pretty good at it. So there lay the tension because I am not just assembling stuff that is off the shelf from regular products and I can give you the exact forecast and life goes on, it is much more difficult to actually answer your question. Having said that there is no doubt as you can see in the last 12 months the level of commitment that we have in making sure we are going to be capital efficient and on the flip side of that if we ever needed to actually ramp up our CapEx for any reason we are ready to pounce as well. So that is the balance we are trying to strike.

Operator

The next question comes from the line of Brian Pitz – UBS.

Brian Pitz – UBS

Quickly regarding China, I know what you have said so far, but help us think about for a second if you in fact made the decision to leave this market do you think you would still operate your ad sense and/or apps businesses which are pretty much unrelated to censorship in the region?

Patrick Pichette

Again, I am going to ask everybody to be patient over the coming weeks as we are working through the resolution of this issue. I think Eric was quite eloquent in what he tried to communicate. The blog post was very clear as to the objectives we have and Eric was quite eloquent in trying to, so I would circle back to his answers. In a way, work with us as we have over the coming weeks and as you can imagine we are working really hard at this and as soon as we have more information we will let you know.

Operator

The next question comes from the line of Spencer Wang - Credit Suisse.

Spencer Wang - Credit Suisse

If we look at the international markets I was wondering as you wrap up 2009 and 2010 which geographies do you think you have the most opportunity to gain incremental share in search?

Patrick Pichette

In search the answer is yes. You would expect to have in every area with the kind of product rollout we have and focus we have I wouldn’t say we are favoring one market versus another to actually push. There are just clearly the world is really divided into three separate markets as Nikesh always pointed out right. The very mature markets are the US and the U.K. Then you have the next tier of kind of somewhat mature markets but a lot of headroom is the big European countries, Japan and all of the kind of industrialized nations of that nature. Then you have all of these other emerging economies which are on a very difference CPC but very promising. We have a balanced set of approaches for each of them because they are just so different in terms of where they are and that is why even the marketing is different for each of them because of the different circumstances. Our objective is to continue to actually increase our share of search by having the right total global products but also pushing localization with languages and everything you hear from us.

Mary or someone else talked about how we feel optimistic about 2010. I think that we have had, we are very optimistic for the reason we see great trajectories from our 2009. I think Eric said it very well. 2009 was a real year of testing. We tend to forget how fast 12 months has passed. The roller coaster we went through over Q1, Q2, Q3 and Q4 of this year we are delighted to see the recovery in terms of our growth rate, performance of the business and the innovation we drove through 2009. From that perspective that is why the company feels confident about not only 2010 but its long-term prospects in all these areas.

With that I would like to thank everybody for your great questions and I look forward to seeing you at the end of Q1. Have a happy New Year.

Operator

This concludes today’s conference. We thank you for your participation.

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Source: Google Inc. Q4 2009 Q&A Earnings Call Transcript
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