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Executives

Krista Bessinger - Investor Relations

Eric E. Schmidt - Chairman of the Executive Committee, Chief Executive Officer, Director

George Reyes - Chief Financial Officer, Senior Vice President

Lawrence Page - President - Products, Director

Sergey Brin - President - Technology, Director

Omid Kordestani - Senior Vice President - Global Sales & Business Development

Jonathan Rosenberg - Senior Vice President, Product Management

Analysts

Imran Khan - J.P. Morgan

Anthony Noto - Goldman Sachs

Benjamin Schachter - UBS

Robert Peck - Bear Stearns

Christa Sober Quarles - Thomas Weisel Partners

Mark Mahaney - Citigroup

Douglas Anmuth - Lehman Brothers

Justin Post - Merrill Lynch

Brian Pitz - Bank of America

Jeffrey Lindsay - Sanford Bernstein

Youssef Squali - Jefferies & Co.

Heath Terry - Credit Suisse

James Friedland - Cowen and Co.

Sandeep Aggarwal - Oppenheimer & Co.

Mark May - Needham & Company

Jason Helfstein - CIBC World Markets

Google Inc. (GOOG) Q3 2007 Earnings Call October 18, 2007 4:30 PM ET

Operator

Good day and welcome, everyone, to the Google Inc. Conference call. Today’s call is being recorded. At this time, I would like to turn the call over to Ms. Krista Bessinger. Please go ahead.

Krista Bessinger

Good afternoon, everyone and welcome to today’s third quarter 2007 earnings conference call. With me today are: Eric Schmidt, Chief Executive Officer; George Reyes, Chief Financial Officer; Larry Page, Founder and President of Products; Sergey Brin, Founder and President of Technology; Jonathan Rosenberg, Senior Vice President of Product Management; and Omid Kordestani, Senior Vice President of Global Sales and Operations.

Eric, George, Larry, and Sergey will provide some thoughts on the quarter and then Jonathan and Omid will join us for Q&A.

This call is being webcast from our investor relations website and our press release, issued a few minutes ago, is now also posted on our website, as well as the slides that accompany today’s prepared remarks.

Please note that a replay of this call will be available on our investor relations website in just a few hours.

Now, let me quickly cover the Safe Harbor statement. Some of the statements we make today may be considered forward-looking, including statements regarding our investments, seasonality, traffic acquisition costs, increase in the cost of sales, plans to continue to invest in personalization, international growth, growth in headcount, and our expected level of capital expenditures.

These statements involve a number of risk 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 quarterly report on Form 10-Q, for the quarter ended June 30, 2007, as well as our earnings release posted a few minutes ago for a more detailed description of the risk factors that may affect our results.

Copies of these documents can be obtained from the SEC or by visiting the investor relations section of our website. Also, please note that certain financial measures we will use on this call, such as EPS, net income, operating margin, and operating income, are expressed on a non-GAAP basis and have been adjusted to exclude charges relating to stock-based compensation. We’ve also adjusted our net cash provided by operating activities to remove capital expenditures, which we refer to as free cash flow.

We report our GAAP results as well as provide a GAAP to non-GAAP reconciliation in our earnings press release.

With that, it is my pleasure to turn the call over to Eric.

Eric E. Schmidt

Thank you very much, Krista and thank you all again for joining us. We are very pleased with such strong results in what is seasonally one of our weaker quarters.

When we look at it, revenue growth of course very healthy, both in google.com and also in our AdSense businesses. And the seasonal weakness in traffic was milder than we expected on google.com, which was a very pleasant surprise from our perspective. It is obvious to us that the search quality investments that we are making are paying off, particularly internationally, as we do better and better in almost every country.

Along with that, of course, we are working on expanding our breadth of ads offering with all sorts of new types of ads -- gadget ads, video ads, others coming -- and each of these initiatives gives advertisers new and interesting ways to build relationships with their customers.

So by building these deeper ad solutions, we really can deliver more value, especially in markets and industries where they’ve not really had these kinds of tools before. These are highly measurable and ROI driven campaigns and Sergey is going to talk a little bit more about this in terms of the steps we are taking in ads.

Looking at it as search, ads, and apps, on the apps side, we are now seeing a massive transition to web-based cloud computing at a consumer and enterprise level. We talked about this for a while and we now see not only the progress but also the future products, both from Google and from the other folks in the industry to make this really happen.

In our case, of course, we launched the presentation product as well as closing Postini, which is central to our enterprise push.

We are really on the cusp of a world where everyone can create, share, collaborate and find their content in the cloud anytime and anywhere.

Before I turn it over to George for all I think the good news, let me say something about George. George announced his retirement. I’ve had the privilege of working with him from almost 20 years. I’m going to embarrass him now. And everything that I can think of financially that’s happened at Google has really had George in the middle, whether it’s going public, building the infrastructure of a multi-billion corporation, our large cash position, the secondaries, the financing, very, very good investor relationships, the openness that we are now seeking, the financial discipline that exists in the company and also amazingly, our ability to deal with Section 404 and Sarbanes-Oxley -- all driven not just by George but people he brought into the company.

With that, George, and hopefully an even better introduction to come -- go ahead, George.

George Reyes

Thanks, Erik and good afternoon, everyone. We had a very strong quarter across the board, with continued impressive growth in our business. Gross revenue increased 57% over last year to $4.2 billion. Our Google.com performance was strong at $2.7 billion, representing year-over-year revenue growth of 68% and a 10% increase over last quarter.

As was the case in Q2, Google.com traffic was stronger than expected, reflecting a milder, seasonal affect than we’ve experienced historically. Consistent with past summers, we also saw strong growth in monetization, supported in part by healthy pipeline quality improvements.

We are particularly pleased with our AdSense performance, which grew 8% over the second quarter and 40% over last year to $1.5 billion. Both the AdSense for content and AdSense for search businesses were strong as we experienced continued increases in traffic and improved our ability to monetize our newer partner relationships.

Let’s now take a look at aggregate paid clicks growth. Aggregate paid clicks include clicks related to ads served on Google properties, as well as ads served on our partner sites. Aggregate paid clicks grew approximately 45% over Q3 of last year, and increased approximately 5% over Q2.

Let me now discuss our international performance. International revenue grew to just over $2 billion, or 48% of revenue. The U.K. reported revenues of $661 million, and 10% sequential growth, led by the strength in the finance vertical. The region consisting of Belgium, The Netherlands, and Luxembourg also experienced notable growth in Q3.

The travel vertical was a contributor of growth across France, Italy, Spain and Portugal, and helped drive monetization growth.

And in Asia and Latin America, where we are still building our presence and investing heavily, we continued to experience strong growth rates in countries such as Brazil, China, and Korea.

Let’s now turn to operating expenses. Traffic acquisition costs were $1.2 billion and 29% of total advertising revenue, down from 30% in Q2. AdSense TAC was $1.1 billion, while TAC related to distribution partners and others who direct traffic to our website totaled $105 million in the quarter.

As we have discussed previously, as we grow our AdSense partner network and embark upon new initiatives, we may see pressure on TAC rates going forward.

Turning to other costs of revenue, other costs of revenue increased $29 million over the prior quarter, primarily as a result of increases in costs related to our data centers, including depreciation, equipment, operations, content acquisition costs, data licensing fees, and amortization.

We anticipate that our cost of sales will continue to increase going forward.

Let’s now turn to operating expenses. Operating expenses in Q3 other than cost of revenue included approximately $200 million of stock-based compensation and totaled $1.3 billion.

Expenses related to payroll and facilities increased $34 million to $659 million. During the quarter, we added 2,130 employees, the majority in engineering and sales and marketing. At the end of the quarter, we had a full-time employee base of 15,916.

Consistent with previous years, a large portion of our starts in the third quarter were related to university hires. Approximately 1,000 employees had accepted offers earlier in the year but started in Q3, after the end of the academic year.

Included also are approximately 300 employees from the Postini acquisition which closed in September. As we have previously discussed, we are continuing to take a careful look at how we can more efficiently allocate resources across functions and globally.

Let’s now turn to non-GAAP operating profit, which excludes stock-based compensation. This was $1.5 billion with non-GAAP operating margins of 36%, up from 35% in Q2. As we have stated previously, margins may decline as we continue to make investments in our business.

Now, turning to cash, operating cash flow was $1.6 billion and CapEx for the quarter declined to $553 million. The majority of our CapEx was again related to IT infrastructure investments, including data center, construction, production of servers, and networking equipment. We intend to make similar investments going forward as we continue to build a global infrastructure and resources necessary to serve and improve our product for our users and our advertisers.

Lastly, free cash flow, a non-GAAP measure which we define as cash flow from operations less CapEx, increased to $1.1 billion.

Now, we will turn it over to Larry for more comments on the quarter.

Lawrence Page

Thank you, George. I am really excited to talk to you a little bit about search and our improving search quality this quarter. We had a lot of improvements we made to search quality for users and markets outside of North America and I am very excited about that. It’s a big part of our traffic and we launched several dozen search quality improvements in specific particular international markets and we are especially happy with the results that we had in Russia, Thailand, Japan and Arabic speaking markets.

In mobile search, our search traffic there increased both domestically and internationally and the mobile apps traffic is growing well, particularly in maps. YouTube also launched their public site to stream select YouTube content to mobile devices, of course, sporting the [inaudible] edition, which we launched last quarter.

Mobile ads are really doing well, especially in Japan where we had strong revenue growth and we also launched mobile ads in Korea.

Let me tell you a little bit about our user experience worldwide, and especially about personalization and some new features. iGoogle, which has just been growing tremendously, expanded up to 43 domains now. We’re really excited about that.

We also made it easier for users to set up their homepage on iGoogle, and that increased retention and usage. I love looking at some of these -- the weather, even though in California isn’t such an issue for us, still good to know what’s happening, and I can very easily get that on my homepage now.

The number of available gadgets are increasing significantly and the developer ecosystem there is really growing.

Now in book search, we really increased funding of relevant book results a lot this quarter, and we think that has a significant effect on improving quality. Our book search index is also huge now. It’s over a million books. You think about trying to stack those up on your desk, it would take quite a bit of space.

We also added several new partners there with a total of 27 partners now involved in that product, and we introduced a number of new features.

Now, let me switch gears and talk to you a little bit about maps and Earth, our geographic products. In maps, we really opened up an [outlook API] that makes maps a development platform and it makes it easy for people to put their own functionality into maps.

For example, you can get real estate listings just when you are looking at maps, or real time updates to gas prices or ski and snow reports right on your Google maps provided by third parties.

In street view, which is a feature that lets you see a view of a particular street or house or business, we added five cities in Q3 and six more just in the last week, so we are very excited about that. There’s a total of now 15 major cities where you can see street level views of almost anywhere in the city.

In Earth, last week we actually launched a YouTube video layer on Earth. You can go to different areas and see videos users have posted about that area, and I looked at a few from Brazil that are very interesting. And companies like the Hidden Bay Lodge in Ontario posted a fishing video about going fishing there, so we are very excited about too.

So I will turn it over to Sergey now to talk to us about progress in ads and apps.

Sergey Brin

Thanks, Larry. I am really excited to tell you today what we’ve done over the past quarter in ads and apps. As you all know for advertising, our real philosophy is to create win-win between advertisers and customers by presenting users with really relevant information which is interesting to them that’s likely cause a transaction to commence, we are really helping out both.

But it is also important that it is not just what we say, but we can actually prove it, and so measurements of our return on investment and the ability to optimize the investment is really important for advertisers.

We have a lot of tools now available for advertisers to do that but I want to highlight a couple of new ones and a couple of updates for this quarter.

In beta testing right now, we have the conversion optimizer and this lets advertisers adopt an ROI driven financial model even more easily than just going straight with a kind of a cost-per-click type bidding. Basically, clients specify, advertisers specify how much they want to pay for a customer and then we automatically optimize for them in each auction how much they ought to be bidding in order to accomplish that goal.

We’ve also launched a new release of our website optimizer, and this is where advertisers can run and create these AB kind of split experiments. You know, they can change their website layouts, they can rearrange their content, and this is very important because there is tremendous variance, even once you get a user on your website how likely are they to really understand what they are seeing, how likely or how easy is it for them to use, and ultimately what percentage of those users do actually perform a transaction? And this was a really great way to optimize that, to make a really big difference in the business.

Next I want to talk about some new app formats that I am quite excited about. And this does not mean that really flashy, in-your-face stuff. For example, we’ve launched our gadget ads and this is a global beta that we are running now. And for gadget ads, you can actually put functionality into the advertisement so it is more than just something to look at and click but something you can really interact with.

We have a Nissan gadget ad running right now that lets you punch in your zip code, you get local traffic. It’s fun for users, it helps Nissan build brand. We also have gadgets that are actually really function to what the company does. For example, if you are trying to book a flight or what not, you can punch where you are flying from and to directly into the ad. Anyway, we really are excited about these.

Of course, you’ve probably heard about our in-video ads, as well as the AdSense video units. So basically, instead of trying to do something, say a pre-rollout for video where you would have to watch a commercial before watching the video, that would really not make sense, especially the kinds of several minute type videos we typically show on properties such as YouTube. It would be very distracting.

Instead, we have a really nice ad that shows up in the bottom 20% of the video that just overlays for a few seconds after the video starts playing and in fact, the initial user response rates have -- well, the user responses and feedback have been positive and we’ve had better click-through rates than we anticipated. So I’m very optimistic about this ad format and this is the kind of thing that we have to do when we develop new ad programs. You have to experiment with different kinds of things until you can actually find formats that really work for users and for advertisers.

The AdSense video units of course are -- the YouTube videos can be embedded on sites in the AdSense network, and this certainly provides more distribution for the videos. They allow us to have contextually targeted ads in the video player and this creates this three-way revenue share, which is really a win-win-win between the publisher, the video’s producer, and Google.

I also want to, just while on the subject of video ads, just mention TV ads, which we of course have been running now for a while. We’ve really been getting a lot of interest and bookings from advertisers. And the remarkable thing about television is, it’s surprising, but in fact of the offline advertising, it’s the one that’s closest to Internet level accountability and we feel we can bring much greater ROI type accountability to television advertising, much as we’ve done online.

Let me take a moment to talk about apps and what we’ve been doing there. We’ve been growing. We’ve been seeing a lot of adoption of certain apps for your domain, apps for your university. The University of Phoenix, which is up to about 250,000 accounts now, students, faculty, employees and so forth; Northwestern is now offering it to all students, that’s on the educational front.

For companies, we have a partnership now with Capgemini, which integrates Google apps into their suite of offerings and then Capgemini provides the systems integration support. And we are really excited about working with third parties like this because there are just so many great companies in the enterprise space that really know how to work with the customers and can plug our technologies in where it makes the most sense.

We also closed the Postini acquisition and not only did we close it, but we already have deployed some of the Postini functionality on Google apps for domain and this was just an automatic upgrade for our apps customers.

Now, in the apps suite, we now have rounded it out a bit. For example, we launched Presentations, so you can create a presentation, you can import one, edit them and share them, and what this basically means now, for my usage, whenever I get e-mails or I need to work with somebody on something, I don’t really have to leave the web browser. And for Presentations, it’s great because you want to collaborate on a presentation. If there’s something you’re presenting, you want to get ready ahead of time. You can also, as you are even watching a presentation, you can make comments on it and what not. You can even just go to the URL of the presentation as you are being presented to and page through it forward or backward without having to have received a large attachment or having a big printout or something like that.

It is really convenient and I think has the potential to change how people really work together.

Now, these apps support a total of 27 languages now. We added six more this quarter, so it is a very international product and we are getting adoption worldwide.

An important piece that we are working on has to do with offline functionality because of course, you don’t want to just have access to these things when you are on -- if you want it in an airplane, you want it somewhere where you just don’t have Internet or your Internet connection goes down or is flaky. And the Google Gears was launched in Q2 to address that. Our reader, as you all know, is our first geared application, as we call it, and the fact that it is very nice. I encourage all of you to try this product. It is very fast. It obviously downloads all the items, so they are pre-fetched. They show up quickly.

But you can expect more and more of Google's applications to show up in geared versions so that you can work untethered.

Anyhow, I’m very excited about the progress we’ve made on both fronts. Thanks for your time and now back to Eric.

Eric E. Schmidt

Thanks a lot, Sergey and looking back at the quarter, it is obvious to us that our model continues to work very well. It is a systematic approach that we have to innovation and the way in which the company is executing speaks for itself.

The strategy of search, ads, and apps seems to resonate perfectly with this worldwide transition, if you will, to the use of the Internet on many, many difference devices, so all very exciting from a Google perspective and again, thank you for listening so long to us.

Why don’t we go ahead and get your questions and see what people think? Krista.

Krista Bessinger

Operator, we would like to go ahead and poll for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Imran Khan from J.P. Morgan.

Imran Khan - J.P. Morgan

Thank you for taking my questions. Two questions; number one, if I look at your network revenue, Google network website revenue, that improved significantly in Q3 after being roughly flat in Q2. I was trying to better understand what is driving that growth.

Secondly, you have been working with MySpace for a while and to get a better sense of what you have learned, how monetizable these social networking sites are out there and as these social networking sites engagements are growing so quickly, are you concerned that that could be a point of entry on the web?

Eric E. Schmidt

Thank you very much for your question. When we look at the network revenue, a lot of the benefit we think is simply coming from greater traffic to our partners and then also strong monetization gains and the way our ad networks work.

Omid, can you give us some color on how the partners view this?

Omid Kordestani

Sure, Eric. We look at basically both seasonality of the partners and their distribution strategy. Some of our partners benefited last quarter from having greater distribution of their services through their own efforts of syndicating their search and advertising or using our services, and we have been ramping up partnerships in the UGC space and we’ve seen nice growth in that space from partners, like MySpace.

I’ll let Sergey maybe add to the monetization angle here.

Sergey Brin

We’ve been very pleased with our partnership with MySpace. We’ve been pleased with the advertising performance. It has been a lot of work and innovation, actually. I know you might not see it from kind of a the user interface point of view that you see, but we are developing really new technologies and I think these social networks are going to require a different kind of targeting technologies, difference concepts of advertising.

We’ve already made big strides. It’s obviously a challenge because there is so much inventory, people can be distracted by very many different things and it is very personal, so there are a lot of things that make it hard.

But our technology, our targeting, all those things are actually coming along very well and we are really happy. We view it as a great opportunity. I mean, it is just so much more inventory that if done correctly can create that kind of win-win I was talking about between advertisers and users.

Operator

We’ll go next to Anthony Noto from Goldman Sachs.

Anthony Noto - Goldman Sachs

Thank you very much. You talked on the call about iGoogle and the positive feedback you’ve gotten from user metrics and I was wondering if you could comment a little bit about improving that product even further. It’s a great application to allow me to more efficiently use Google. I don’t have to enter in searches for all the information I want to have on a daily basis.

And there’s two things I think that could make it a lot better, and the real root of my question is, is there a technology limitation to doing the following two things, or a legal limitation -- the first is other, pulling in other applications that are popular on in the Internet, specifically those that have been written to Facebook and others. Second, you’ve also talked about advertising being a form of content and in many of the verticals that I have on iGoogle in my account, such as movies, would really benefit from display advertising as an additional form of information. So is there a technology and/or legal or other considerations that have limited you putting display ads on a the page or pulling in other applications? Thank you.

Eric E. Schmidt

Thanks very much, Anthony, for your good product suggestions. There are some legal limits as to what we could do. We obviously have to get permission of the partner and content in so forth and so on. There is no intrinsic reason why the vision that you painted can’t occur and in fact, part of our developer strategy is to get people to build what we call iGoogle Gadgets, and we encourage the site that you name and others to make them available.

We need to work with them. We obviously can’t do it without their permission.

Jonathon, do you want to talk a little bit about the display ads?

Jonathan Rosenberg

In particular with respect to gadgets, Anthony, we are certainly going to be offering a lot more functionality through the gadgets. The current focus with them really is the user experience. We’ve done some things with themes which we think have been a pretty big success, but really what we are trying to do is figure out how to integrate much of what we are doing with iGoogle and also the concept of these gadget ads, which Sergey mentioned.

What is so powerful there is that the gadget ads just don’t serve up your simple brand impression. What they do is they get people to engage with the brand and then we can actually empirically measure the level of engagement, which is much more powerful than the things people have traditionally done with display.

One of the things that I would suggest you do, Sergey mentioned one of the gadget ads, the Nissan ad, I think if you type into Google either Honda gadget ad campaign or the Six Flags gadget ad campaign, you’ll get some examples of some campaigns that have leveraged this technology to really deliver.

Eric E. Schmidt

Our next question.

Operator

We’ll go next to Benjamin Schachter from UBS.

Benjamin Schachter - UBS

If I’m reading the TAC rates right, it looks like the partner TAC went down pretty meaningfully, and then the TAC associated with Google.com went up as a percentage of revenue. I’m wondering if you could comment on those trends.

Also, you mentioned in the prepared comments about the level of accountability on TV ads. At a high level, can you talk about the learnings that you are getting from targeting ads on the search side, how those will work with both video and display, possibly offline and on? Thanks.

Eric E. Schmidt

Jonathon, do you want to talk about TV ads first?

Jonathan Rosenberg

Sure. I think TV ads could actually really be underappreciated for the reason that you mentioned, in terms of our offline efforts. This is really one of the few places where you can bring the same type of Internet level accountability to offline advertising, so with search advertising, obviously our customers see real-time how their ads performed.

The same thing is really true with the feedback mechanism that we get with set-top boxes. We are bringing the same level of granularity to the offline TV format. The trials that we have right now are with EchoStar and Astound Cable.

And what we are able to do there is we are able to show the advertisers when their spot is playing and look at the viewing levels of users actually during the course of the spot, so we are very excited about how that is playing out and we think it bodes very, very well for our progress in TV.

Eric E. Schmidt

Why don’t we talk about TAC rates? George, do you want to start that?

George Reyes

So our AdSense TAC went down slightly, but on the other hand, Google.com TAC went up, and primarily driven by the partner mix.

Eric E. Schmidt

Our next question.

Operator

We’ll go next to Robert Peck from Bear Stearns.

Robert Peck - Bear Stearns

I had a question on future use of capital here, and as I think of any large expenditures going forward -- first of all, I was wondering if maybe you could comment on Google's desire to maybe put a large investment in Facebook or a large social network? And then I was wondering if maybe Larry could talk about the importance of 700-megahertz going forward. I mean, it doesn’t look like [inaudible] will probably codify what Google wants for the 700-megahertz, so does it come to a point where Google has no choice to not only put a token bid in but to also sort of bid to win, whether it be with a consortium or what not?

Eric E. Schmidt

On the question about specific investments, as you know, I can’t really comment on any specific investments. I want to assure you all that the cash isn’t -- it’s not burning a hole in our pockets. We don’t feel some great need to spend it right now for any particular reason. We would do an investment that is capitaled if we thought it was incredibly strategic. Many of the partners we’ve been able to work with, we’ve not needed to do such an investment. They are happy partnering with us simply because of our technology and our ability to monetize.

Larry, do you want to comment about 700-megahertz?

Lawrence Page

Sure. I think we’ve been actually quite happy with the openness provisions that have been put into the 700-megahertz auction, so I disagree with your assertion there.

I think we have many, many different options available to us as a company, in terms of spectrum and connectivity for people in wireless and so forth, so I don’t think we feel like there’s any desperate need for us to have to bid to win or anything like that. And again, the money is not burning a hole in our pockets.

Eric E. Schmidt

Next question.

Operator

We’ll go next to Christa Sober Quarles from Thomas Weisel.

Christa Sober Quarles - Thomas Weisel Partners

First question is just around in the mobile side, we’re starting to see sort of a convergence among hardware, software and services, you know, a la Nokia’s bid for NAVTEQ. I was just wondering, do you feel comfortable with your current position on just having applications and the ubiquity that you can achieve in the distribution of those applications?

Secondly, I was just wondering if you could give us an update on when you think DoubleClick might get some clarification on when that might close. I guess the EU decision begins next week, but just an update there would be great. Thanks.

Eric E. Schmidt

On the DoubleClick side, we are following all of the appropriate steps that are needed to get worldwide approval and we are certainly optimistic. It would be I think premature for me to suggest any particular timing. I can tell you we have a pretty close working relationship with all the people who I think in my view responsibly are checking on does this make sense and so forth. But we believe it will ultimately result in a very good outcome for us.

On the mobile side, we have talked at some length about our mobile application strategy. We are very happy with it. Mobile applications, there’s some evidence that we are becoming the leading mobile applications provider, at least in certain segments, and the mobile story is a very strong one for Google. It is also a great one for the world.

You see over and over again one company after another announcing a new interesting mobile platform. We want to make sure that Google and its technology is a part of each and every one of those platforms.

Next question.

Operator

We’ll go next to Mark Mahaney from Citigroup.

Mark Mahaney - Citigroup

First, congratulations to George for a job extremely well done. Just to keep going on mobile, what I’m trying to figure out is how much of the future investment requirements success for Google in mobile could entail? And the setup here is you’ve obviously achieved a leading position as a PC search service without the need to develop a Google PC or a PC operating system or an Internet access service with all the infrastructure requirements that that would entail.

Is there any reason that your success in the mobile Internet world would require any similar type developments -- a Google phone, a mobile phone operating system, or a wireless access infrastructure with all of the requirements that that would entail?

Lawrence Page

I don’t think again that there’s a requirement to do any things like that. I think Google, obviously we’ve grown a lot since we entered the search business and the opportunities that are available to us are different, and there are opportunities for us available in those kinds of spaces. And we would also love to get even greater numbers of people and wider access to our applications that we provide.

So I think that it is more of an opportunity for us then a cost. We have tremendous usage of our current mobile applications and we have deals with very, very many different wireless carriers and so on, and many other types of carriers. I think those things will all continue.

Eric E. Schmidt

Next question.

Operator

We’ll go next to Douglas Anmuth from Lehman Brothers.

Douglas Anmuth - Lehman Brothers

It looks like you added more than 2100 net headcount adds in the quarter, which is significantly more than you added in Q2, despite being more focused on headcount. So even ex Postini, it looks like it is more than 1800. So can you give us some color on the timing of your hires during 3Q and also how we should think about this in relation to margins going forward? Thank you.

Eric E. Schmidt

Obviously can’t talk about margins going forward. What we said last quarter, as you know, is that this is an area where we needed to spend some more time and focus more on what is the appropriate rate. And the good news is we have done that. The numbers that you are seeing are essentially an overhang and they are an overhang from hiring that had been agreed to many, many months earlier. June, of course, is a major college hiring, university hiring, professor hiring kind of a cycle, so I don’t know that that will be repeated.

The important thing here is that we did in fact correct and I think going forward, you should be comfortable that we are paying a lot of attention to the headcount.

Douglas Anmuth - Lehman Brothers

Thank you.

Operator

We’ll go next to Justin Post from Merrill Lynch.

Justin Post - Merrill Lynch

Thank you. The gap between your revenue growth, 57%, and your sponsored click growth, has been maintained around 12%. Could you talk about the drivers there, where you are in your monetization cycle? Do you have a pretty good pipeline of things coming forward?

And do you think things like YouTube and AdSense for content could actually grow that gap as we look out to next year?

Jonathan Rosenberg

I can maybe cover some of the monetization issues. We are certainly very happy with the product upside that we achieved this quarter. It was really -- it really came out of over 20 quality and UI improvements that we launched.

There were two very big things that we’ve talked about publicly. The first was the reserve base promotion, and actually we only launched that in late August, so it only had part of the quarter to manifest itself in terms of improvements, and that was basically the change to the formula which determines which ads are shown above the search results, so that was certainly significant.

We’ve also been doing some things like previous query based ad targeting, which is pretty significant. We’re looking at the previous query to try to figure out what to do on the next query. So we’re pretty confident that we’ve got many, many more ad quality improvements like these.

We’re also launching them internationally pretty expeditiously, so from that standpoint we think there is a very healthy pipeline in ads improvements.

Eric E. Schmidt

Next question.

Operator

We’ll go next to Brian Pitz from Bank of America.

Brian Pitz - Bank of America

Your CPC growth rate accelerated from 7% last quarter to 8% this quarter. Can you provide any commentary on this, including is this driven by your recent algorithm change?

Secondly, with respect to your ability to monetize significantly better than competitors, is there the possibility for TAC rates to continue to come down, especially with respect to the upcoming renewal of Ask.com? Thanks.

Eric E. Schmidt

Jonathan and Omid.

Jonathan Rosenberg

I’ll let Omid handle the Ask.com comment. Basically you are talking about a 1% difference. CPC, as we’ve talked about in the past, is largely driven by mix, so I think if you looked at the monetization improvements that I mentioned, that is certainly a component of it but a large part of it is also a mix issue. Summer does tend to be modestly higher from a CPC perspective. One of the things that we see is that there is a lot less academic traffic, which Google has disproportionate to most of the other players in the market.

So with less non-monetizable traffic and modestly more monetizable traffic, that is a mix that actually does play a role.

Omid Kordestani

We are going to I think enter a period where you will see a lot of these fluctuations so it will be hard to predict. One is driven by partner renewals, like the ones you mentioned where we obviously focus on preserving our relationships with as many of our partners as possible, including Ask.

But the other thing that is going in parallel with that obviously is increasing the quality of our network and our partners are also actively involved with distribution strategy of their services, like we are.

I think the mix of those effects is really hard to predict. We are trying to improve the quality overall, which will I think actually eliminate some growth in terms of distribution in the network. That’s unhealthy, in our opinion, for the network.

On the other hand, the renewal and improvements in monetization really drive up the monetization [efforts]. So that makes it hard to predict at this point.

Jonathan Rosenberg

The one other thing I would add is that all of the ads quality efforts are very, very focused on eliminating a lot of the bad ads, and in particular, it’s a lot of the very bad ads which are low CPC, so one of the things you will see is that as we improve ad quality, reducing coverage which in general is what we’re doing, you will see the CPC increase because those lousy ads are generally the nickel or thereabouts types of ads.

Brian Pitz - Bank of America

Thank you.

Eric E. Schmidt

Our next question.

Operator

We’ll go next to Jeffrey Lindsay from Sanford Bernstein.

Jeffrey Lindsay - Sanford Bernstein

We would like to ask a little bit more about the 2100 new hires, or the 1800 after Postini. We noticed that a high proportion came in sales. Could you possibly give us an indication of the geographic split for these new hires, overseas versus domestic? And then, could you give us an indication for the rationale for the expansion of the sales force? And given that a lot of your sales are automated, wouldn’t expansion of the sales force be taking your cost structure in the wrong direction?

Omid Kordestani

A couple of important factors in that, some of them you mentioned. First, we have been very focused in having the proper level of presence in every country that makes sense for us to have, both our partnership teams as well as advertising sales teams that directly work with customers.

As you can imagine, in some of the emerging markets, for example, both in Asia and in Europe, we’ve had actually early success with advertisers working directly with our system through our online channel. However, you reach a point where local education are helping the efforts on monetization with the clients. It requires the presence and what our focus has been is to really push our field sales forces, our direct sales forces, to really spend their time on the named accounts and also represent the full suite of products that we have.

So one of the things we are trying to avoid is having multiple sales forces for the different products and services we have. For example, the YouTube activity; one of the great efforts we have done, both in North America and other regions, is to actually train the sales force and combine effort so that our customers receive one voice and one representation from the company covering the majority of the products.

At the same time, what we are doing is paying a lot of attention to cost per revenue dollar metrics and sales force productivity and putting the right customers in the right channels and mapping that with our sales organization where again, we balance the direct sales force that is in the field versus the operations team and sales efforts that go on in our big operation centers in Dublin and in Argentina, in local countries in Asia and in India, which we have a major presence in.

Eric E. Schmidt

Next question.

Operator

We’ll go next to Youssef Squali from Jefferies.

Youssef Squali - Jefferies & Co.

Thank you very much. Can you talk about monetization on the video side and YouTube in particular? You’ve started syndicating that content across the ad network. When do you turn up the monetization dial on that? Is it an ’08 event? What’s preventing you from doing it now?

And secondly, I guess for Sergey, is it fair to assume that you’ve decided to go with ad overlays over a pre-roll and potentially post-rolls? Thanks.

Sergey Brin

Let me just take both of those. We’re certainly progressing on monetization for YouTube and what not, but that’s not the number one priority for that property right now. We continue to grow the traffic and improve the user experience. We continue to really improve the publisher experience and also, we are working on things like the fingerprinting, which we announced recently, which we have just really fantastic technology for.

On the advertising UI, we are very pleased with the overlay but I don’t think we are ever going to say this is it from now on. We are going to continue to test a variety of different formats.

When we started in UIs for advertising on search, were by the way the little text ads, we were considered really crazy. I mean, it took a long time to really perfect that to get advertisers to really understand it, learn it, and ramp the monetization. Here also I think we are in for a long-term investment.

Youssef Squali - Jefferies & Co.

Thanks.

Eric E. Schmidt

Next question.

Operator

We’ll go next to Heath Terry from Credit Suisse.

Heath Terry - Credit Suisse

Thank you. As you start broadening out your advertising formats with your television relationships, YouTube, to what degree are your search advertisers starting to manage these mediums from a single point of contact for you? And how far along are the more traditional branded advertisers in beginning to look at their Internet and traditional forms of advertising alongside of each other when they are trying to evaluate the effectiveness of that advertising?

Omid Kordestani

We are actually spending a lot of time -- that’s a very good question -- in terms of how we should focus on the core business and help all advertisers, including the major Fortune companies and companies across the world, really take advantage of search. That’s a proven model for us. We really understand a lot about it and that is something we -- the sales force spends the majority of their time doing at this point.

In these other areas, as Sergey mentioned, for example, we are really prioritizing in the case of YouTube the user experience but at the same time, we are having great demand and interest in advertisers trying these new formats and working with us. So in the case of radio, TV, print, all of these are new initiatives. We are seeing a lot of interest. We are spending time on it and really trying to balance not losing focus on the core business that we really understand well and clearly works with the advertisers, as well as getting interesting trials going, trying different formats.

So I think we are very confident in terms of the future of these formats, and especially the video, which is a great area of focus for us, as well as TV. I would say those two areas, you will see a lot of progress from us in the coming quarters and search will continue to remain a very, very strong focus.

Eric E. Schmidt

Next question.

Operator

We’ll go next to James Friedland from Cowen and Co.

James Friedland - Cowen and Co.

Thanks. I didn’t hear any comments on the call about Google Checkout, and now that we are heading into the holiday season, I just wanted to see if we could get some commentary on what you are seeing in terms of adoption, especially in the U.K. where you just launched.

Secondly, CapEx, while we expect it to continue to grow quickly, has gone down sequentially and I was just wondering if you can comment on how it has been trending in the core search business in terms of ROIC. On that incremental dollar spend, are you getting better returns on your search CapEx today than you were say 12 months ago? Thanks.

Sergey Brin

On Google Checkout, Google Checkout is continuing to grow. We are very excited about it. I personally use it all the time. We’ve been adding a number of great merchants. Most recently, we added B&H, which happens to be my favorite camera equipment store. But we are adding many others as well.

We are excited going into Q4 because we have -- it’s a fairly young product and this time, we get to develop it further into the holiday season, so we are really excited about that one.

On your other question, I am going to turn it over to --

Jonathan Rosenberg

This is Jonathan. I caught the checkout part of the question. Maybe we can follow-up and get the second half. I just wanted to mention Sergey’s shopping experiences are too limited. We’ve got a big chunk of top 500 merchants. In Q3, we launched PetSmart, Drugstore.com, Shoebuy.com, and the NHL Store.

I think the real story that is important there is that many of the advertisers that we are working with, such as Jockey, are reporting much, much higher click-through rates. They achieved as much as 60% higher with Checkout and they decreased the cost-per-click by over 31% with Google AdWords and Google Checkout. So we are seeing much more significant volumes in terms of some of these advertisers and the performance with the advertisers.

I’m not sure I got the other half of your question.

James Friedland - Cowen and Co.

The other half was on the returns on invested capital on search CapEx, because CapEx has been trending down a little bit. It’s still expected to grow quickly but for that dollar spend on search CapEx a year ago versus today, are you seeing improved returns on your business?

Eric E. Schmidt

That’s a good question. We don’t actually use that metric in the way you phrase it. What we are really trying to do is to invest the capital of our shareholders as wisely as possible. As you know, we have built large and very powerful data centers that are largely custom designed. Those data centers do more than just search; they do advertising, they host apps, they do Google Earth and maps and so forth and so on.

We are quite comfortable that that investment, which we monitor incredibly closely because it is, you know, millions of dollars involved, really does translate into superior financial returns.

One way to think about this is that a year ago, people would ask us about capital, why we were spending on this money on capital, and we’d say we’ll get it. We’ll get it back in scale and in systems and so forth. And you are seeing the benefit of the investment a year ago. Hopefully you’ll see the same investment return in the year for what we are doing today.

James Friedland - Cowen and Co.

Thank you.

Eric E. Schmidt

Thank you. Next question.

Operator

We’ll go next to Sandeep Aggarwal from Oppenheimer & Co.

Sandeep Aggarwal - Oppenheimer & Co.

Thank you. Two questions and one, sorry, again, asking a question on mobile search, but I wanted to know if you can share what kind of mix are you seeing in terms of a search query initiated by [mobile] versus PC, and if there is basically a trend you can share versus last year?

Secondly, you have completed one quarter with universal search. If you can make any comment in terms of what kind of improvement the end user has seen and what kind of benefits advertisers have realized? Thank you.

Eric E. Schmidt

On the mobile search side, our mobile searches are increasing rapidly compared to a year ago. They are growing more quickly than non-mobile searches. They are still a very small percentage of total searches, which is of great frustration to us and we are working very, very hard with some mobile operators to get Google Search to be as standard as possible on every phone -- very quick and very responsive. Because we think the people using phones really want to use Google to solve interesting information problems.

Jonathan, do you want to handle the second question?

Jonathan Rosenberg

The second question specifically on universal search, I think as you know we launched at the Searchology event back in around the middle of May. We are very pleased with the increases in traffic which we saw this summer, relative to the traditional seasonality. I am not sure that I can statistically attribute the causality to universal search but certainly what we are seeing is very, very favorable feedback from users. We are seeing good click-through rates particularly, as Larry mentioned, with the better integration of pieces from different data sets like book search. So as we add more books into the index and make it blend better, we certainly see higher click-throughs.

So in terms of revealed user activity, what we are seeing is very strong. Whether or not that is actually what drove growth is unclear. I think it is certainly a component.

Eric E. Schmidt

Our next question.

Operator

We’ll go next to Mark May from Needham & Company.

Mark May - Needham & Company

Thanks for taking my question. It is increasingly clear that in order to succeed long-term in the online marketing services space, that it’s best to have a broad set of ad format capabilities. The question is can you provide us with some data points that illustrate Google's current position in what I think is the largest of those, or one of the largest, which is brand or display ads? And what are you doing to better your position there?

Omid Kordestani

I think at this point it is still early for us to be able to really put any markers. What we are very busy with is just engaging the customers, training the sales force, trying these new formats, understanding which ones work best.

It is clear that the engagement model is of great interest, things like the gadget ads that we mentioned. The accountability and the measurements, the kinds of things we are doing in TV that we discussed earlier -- all of those is very meaningful to the advertiser and there is great interest from them to participate in these trials we are doing and these tests we are doing.

I think we should be in a position to share more information with you in 2008 as we get more of these services out of beta, as well as sign up more partners, more inventory and get the advertisers to have more spending in these.

I think you’ll, as I mentioned earlier, I think you will see that primarily happen initially in both TV and the video space for us.

Krista Bessinger

I think we have time for just one more question, please.

Operator

We’ll go next to Jason Helfstein from CIBC World Markets.

Jason Helfstein - CIBC World Markets

Thanks. Two questions, one quick one and then fairly longer; are there any market share numbers or growth rates you can provide for China and India?

And then my second question relates to the consolidation we are seeing of network guys by AOL and Yahoo!. It seems to us that that’s kind of a play on behavioral marketing. Do you have any concerns if they are not careful, it might trigger privacy concerns for the industry and legislation or something we obviously don’t want to happen? And are there any discussions that are going on perhaps at the industry or IAB level, so everyone is careful in that regard? Thanks.

Eric E. Schmidt

On the growth rates in China and India, we are starting from a relatively smaller base in a number of other countries, and so the growth rates are quite significant. We would expect that to continue until they get to some reasonably stable growth pattern. Both markets are growing quickly. Both markets are under-penetrated in the Internet as a whole.

In China, as you know, we have a local competitor who has majority share. In India, it appears as though we have majority share. But in both cases, it’s essentially an open field for all the players.

On the question of consolidation and some of the privacy concerns, this is something that we spend a lot of time on and we are very concerned that the actions of the industry as a whole, people who are concerned about what happens on the Internet could somehow affect us or really hurt consumers.

From a Google perspective, we had done a number of things to that respect. We have announced a whole bunch of policies around cookies and log retention, which are innovative in the industry. As best we can tell, we have the most aggressive privacy policy of any of the key players in the industry today.

But we are also working very hard with government relations teams all around the world to try to get people to understand what it really means to have people using the Internet all day and the various conflicts that are inherent there.

From a Google perspective, our ultimate success is based on the happiness, satisfaction and excitement of end users. I can tell you that an end user is not going to come to Google if they don’t trust us. To the ultimate check, if you will, on a company like Google, is the fact that we are a consumer company, primarily, and the consumers are free to choose and if they believe that Google is a poor quality company with respect to their privacy, they are not going to use Google. They are going to use somebody else.

So it is very much a fundamental part of our business strategy not only to promote privacy but also to encourage everyone to take it very seriously.

With that, it looks like we’ve run out of time. I wanted to make sure that everybody knew that we are having our financial analyst meeting next week and we are looking forward to all of you who can attend in person coming, and of course, you’re invited. And those of you who cannot attend in person, of course there will be a full webcast and everything will be available online, as you would expect.

So with that, thank very much, Krista. Thank you, everyone, for joining us.

Krista Bessinger

Thank you all for joining.

Operator

And this concludes today’s conference. We thank you for your participation. You may now disconnect.

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Source: Google Q3 2007 Earnings Call Transcript
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