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. Please go ahead, ma'am.

Good afternoon, everyone, and welcome Google's second quarter 2009 earnings follow up conference call. With us are Patrick Pichette, Chief Financial Officer, and Jonathan Rosenberg, Senior Vice President of Product Management. After we cover a few housekeeping items we'll open the call immediately to your questions. Please limit yourself to one question and one follow on. Also, this call is being webcast from our Investor Relations website located at Investor.Google.com. Please refer to our website for important information, including our earnings press release and related slide deck. A replay of this call will also be available on our website in a few hours. Please note that we routinely post important information on our Investor Relations website 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 website. 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 share-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?

Thank you. (Operator Instructions) Your first question comes from William Morrison - ThinkEquity Partners.

I have a follow up question on the Exchange. And, Jonathan, I think in the call you said that it's now essentially integrated with AdWords and AdSense. And I'm just curious, do you think the bigger opportunity in the Exchange is on the double-click network of publishers or Google content network? That's question number one. And question number two is, as I'm sure you're aware, Congress is once again looking at regulating behavioral advertising and it seems like at least the initial take is they're pushing for opt-in on third-party cookies, opt-out on first party. I'm just curious, I believe you guys have stated that you support that kind of environment and I'm curious what kind of impact that would have on the Exchange business and behavioral targeting you're doing in the Contact Google Network? Thanks.

I guess it's a little early for me to handicap the overall opportunity. You know, today we're happy with the progress on the ad exchange. We've integrated the existing double-click exchange with the AdWords and AdSense advertisers and it's all on the Google infrastructure at this point. Overall, I mean, the idea there is about creating the biggest pool we can of liquidity so advertisers will find opportunities where they can't today and be able to monetize inventory the most efficiently. I don't think I can give you any better insight into what the relative sizes might be. On the cookie side, we're already allowing users to edit preferences in the Manager in terms of opting in and opting out. I think that's a pretty positive sign because it means that you control the ads to a degree. But I don't really have a sense and I can't really speculate on what's going to happen based on different potential legislation that we haven't yet seen on how it's going to impact the market overall. I think people are very interested in the interest-based advertising efforts and I think probably a larger fraction of the opportunity is just in creating this open platform for both advertisers and publishers to buy and sell inventory. So I think that's probably relatively more important than just the modest incremental improvement in targeting that you might get from one particular component of the targeting.

Your next question comes from Marianne Wolk - Susquehanna Financial Group.

You highlighted the strengths in the AdSense for content business this quarter. Can you talk about whether you're seeing a net increase in overall spending when advertisers use AFC or is this a more economical source of conversions for them and reduces net spending?

I don't know if it reduces net spending, but it is a good, I mean, obviously there is, as Nikesh mentioned earlier on the call, there is a mix, if you think of the display space, there's clearly a mix between the branding side and then the performance side. And people are in these times really focusing on the performance side. And in consequence it really helped in that part of the business. I don't know, Jonathan, if you have more comment to give on it, but that's basically what we see.

Yes, the only other observation I have is I've certainly seen with some advertisers they're finding that display is really a great complement to search. And an advertisers starts a new display campaign on the content network and then they actually see some improvement in their search ads getting more effective. So I think that there's a positive dynamic between the two, but we're not really seeing a shift from search. We're seeing the substantive advertisers who are tapped out on search and still have budget to spend looking for incremental conversion and being aware of the fact that on an ROI basis they can get that from the content network and grow their total sales.

Overall, you think this is an incremental source of revenue?

Yes.

Your next question comes from Ross Sandler - RBC Capital Markets.

First, on the partner sites versus Google sites, so partner sites revenue growth outpaced Google websites' growth on a quarter-over-quarter basis for the first time I think, ever, even with the 44 million quarter-over-quarter FX boost. So can you provide us with a little color on what's driving mix shift? Is it the display stuff you were just referring to?

There's nothing really fundamental. In terms of percentages, if you look at how the mix is changing, it's not changing in any fundamental way. So this quarter, I mean, in fact, you know, Google properties have really delivered most of the growth in terms of revenue. So the AdSense network continues to grow, but in fact it grew at a slower pace, right 3.5% versus 2%. So I'm not exactly sure if I understand your question.

The only other big component that you might consider there maybe if you look at it relative to a year or so ago is the component that's coming from display.

Right, on a sequential basis I think was what I was - I think Google sites were down about 1% and the partner sites up 3%. That was what I was referring to, Patrick, I guess.

Yes, on a quarterly basis, but on a quarterly basis. I mean, really it's very difficult for 90 days to make a trend. I know it sounds like - and given these numbers in terms of total revenue, I mean, that's how you have to think about it.

Okay, but there weren't any like real significant partner wins that may have kind of been a one-time incremental boost in the second quarter?

No, not at all.

Okay. And then on the FX hedging issue, so you had a greater FX hit if we look year-over-year, the 497 versus last quarter 429, but your hedging revenue was $124 million this quarter versus the $154 million last quarter. So is that difference explained by some of the one-time gains that you had on the hedging side in 1Q and is this $124 million that you had in 2Q kind of the right, stable run rate to think about going forward?

No. Again, FX is a complicated matter for two reasons. One is we started building our FX program last year roughly at this time. And at that time we had nothing for the GDP, for example, right? We actually only started setting up GDP hedges at the end of the third quarter, so kind of September/October timeframe. So if you think of the ladders of hedges that we've started building last year, they come at different times and then therefore they impact through this year in different magnitude. So be careful of using this quarter and the numbers you see as what should be the steady state for a certainly set of exposures. Second is where the currency was last year, depending on where you were Q1, Q2, or Q3, again, on a delta year-over-year basis gives very different sets of numbers. So you have to think of the puzzle in terms of those two factors. Unfortunately, you don't have all of this information to build, but that's how the mechanics really work from our FX desk. So that's why you end up with, you know, this quarter the delta between where the rates are today for Q2 versus the Q2 of last year give you these kind of sets of magnitudes. So that's the simplest way I can explain it. And I know it's frustrating. I acknowledge that. Let me acknowledge it, that it is a complex set of issues and so it's very tough to get a sense of.

Your next question comes from Sameet Sinha - JMP Securities.

So you'd mentioned that CPCs in part have been impacted because of the increase in query volumes in countries like - low CPC countries like Brazil and China. If you were to think about if macro conditions were to improve in higher CPC geographies, do you think the momentum would be big enough to overcome the declining CPCs of Brazil and China or do you think declining CPCs we should start to expect as a secular trend from here on just because query growth from those markets would probably be higher than some of the more developed countries?

Well, I think you're painting the puzzle the right way, which is international mix has a real affect on our CPC and it has it in two ways - which country it comes from, whether it be, you know, Germany versus India, the growth rates between these different countries, and then obviously there's all the currency issues and the FX issues that play into it as well. So, I mean, what we talked about, you know, it was down year-over-year and up quarter-over-quarter as a good illustration of what the combination of all these things do, right? And then you have seasonality on top of it. So these are the pieces at work. Jonathan, I don't know if you have additional comment?

Well, I mean, international growth will be a significant component in terms of what the blended average CPC will move towards. You know, we certainly expect growth in those developed markets as the economy rebounds, but the relative difference between the monetization in the U.S., Canada, Australia, Western European countries is quite significant relative to some of the more nascent markets. So as you add incremental clicks from those developing markets, that brings the blended average, everything else being constant, down.

In terms of tax rate, Patrick, what tax rate should we be using for 2009?

I can tell you that at the end of the second quarter 20% was a good one because that's where - I can't give you any forward - and, again, I think that the comment I made on the call was an important one, right? There are really two sets of kind of big dynamics in our tax rates. Obviously, remember, all of the mix between our international versus U.S. mix of revenues is a big component that will actually swing the tax rate. And then second is how the hedging program rolls out. And depending on the types of gains that we may have on hedging and the way that this flows through also has a significant impact on our tax rate. So if you remember in Q4, for example, where we had very large gains on FX, it drew a lot of tax implications. So these are the two big-ticket items that you have to consider as to the modeling.

Your next question comes from Trip Chowdhry - Global Equities Research.

First, regarding the new initiatives you have with app exchange and other product initiatives, it seems like we don’t have a business model sporting those initiatives. Do you think it will be still ad-supported or license-supported? And if you think it's more license-supported, how can investors feel confident that Google can execute on business models which are other than pure ad-driven?

The ad exchange itself is actually - it has a business model today. And so it's driven by the volume of ads that are flowing through the exchange. And it's the same thing -

Well, I mean, [inaudible].

I think that Eric addressed that question when we talked about enterprise and apps earlier. And I think that there are certainly opportunities for other licensing models and other models in terms of garnering revenue, but I think that we're confident that with a lot of the functionality we're delivering to people, where they're running search both across their internal information and across their external information what we're doing is creating a better environment on the web, creating a better environment online, creating more applications for developers to produce, and the more people spend time on the web, the more they search, the better they can search over their own internal information, the more they run searches online. So I think we're pretty confident that in the long run from a strategic perspective that's positive for us.

And a follow up on that. I was investigating and trying to understand your developer programs and that stuff. It seems like, you know, between the competition, between Microsoft and Google, the race being played out, it is less of a competition more of a war of accretion. And why I say that is you're giving up a lot of OS and a lot of software for free and even before the industry matures. And [inaudible] immediately gets collapsed, in which I don't see any person as the winner. So who do you think - you create products where you grow the industry in terms of revenues rather than collapse the industry from Day 1? And obviously we have different points here regarding Android; even though Google claims it's very successful, I have a data point saying it hasn't been successful. And, again, the prime reason is it just couldn't gather the revenue mattresses for your developers. Developers are not making money on Android and they're making a lot of money on iPhone and that's the reason why one is successful. My next question is: How do you think about growing the industry rather than collapsing the industry from Day 1?

Okay, well I'm not sure I completely understand your premise about growing the industry versus collapsing it. I mean, the broad story from a developer perspective is we're trying to make the web the place to build, to deploy and experience what are becoming increasingly rich and exciting applications. And we're doing that in a few areas. We're making the browser more powerful with Chrome. We're trying to make connectivity pervasive and accessible and usable for developers. I disagree with some of the comments about the degree to which the Android market is robust; we've got a lot of applications that we're seeing there and a lot of users using them. And we're also trying to provide Google-level services to every developer, which is App Engine, and we're very optimistic that that's going to make for a much more exciting and richer web.

Your next question comes from Benjamin Schachter - Broadpoint Am Tech.

A few housekeeping questions: One, bonus accruals didn't come at all, I don't think, and that was sort of the issue last quarter, so I was wondering if you could talk about those turned in and how we should think about those. And then if we could dig a little bit deeper into G&A and if you could just remind us what were the big issues in Q1? I think you were sort of implying that there was nothing special about where the run rate was in Q2, so maybe we should think about that going forward. And then finally on the tax rate, my understanding previously it's always been the tax rate you put in the quarter is sort of what you expect is your best guess for the year, and so we should all sort of think about that as your best guess for the year. Is that correct?

So let's start with the last one. In theory you're right that when we take tax provisions, you know, you can't just look backwards; you have to also kind of think through the full fiscal year. But, again, if you think of all the moving parts within it, it's a bit like OI&E with Sprint and the team in Treasury, right? They try to give you a number that reflects what they thinks going to happen, but then the currency takes off and then the world changes. So just a word of caution on that one. In the case of G&A, you're right that we have not had - you'll remember in Q1 we talked about kind of three items that really impacted our G&A or that we had noted, anyway - the legal settlements, which were kind of one-time in a few areas; then there was the restructuring of our sales and marketing group and then finally there was some bad debt. So these were the three that specifically we had documented and mentioned. We didn't have anything of any significance this quarter, so that's the essence of some of the delta. In the case of the bonus, you'll remember it was really a big issue between Q4, a year end issue, and starting the year. I mean, there's nothing special to report on the bonus accrual for this quarter.

Well, were the bonus accruals similar to what they were in Q1?

We wouldn't comment on that. I mean, all I can tell you - let me tell you this way: We have our plan that's been approved with the Board, and that plan basically has a set of kind of indicators within it and we're tracking according to these indicators.

And then one other thing. You sort of very subtly were mentioning YouTube might be doing a bit better than it has in the past. The preroll issue is the first time you've sort of really embraced that on a public call. Do you think that's going to be the key modernization effort going forward or is it still kind of you're testing out new methods? Or are you kind of set on preroll in terms of how you're pushing your sales force?

Let's give two answers on it. Let me give you the general answer and then I'll let Jonathan jump in on the details. I think that it is true that we are pleased with YouTube's trajectory. And in part the reason why we're communicating it to the Street is there's been so much press over the last quarter with all of these documentations of, you know, massive cost and no business models and all of the kind of negative press that we've read a lot about. And we just wanted to kind of reaffirm to the Street that this is a very credible business model and it's one that's got trajectory. So in that sense it's just to kind of tell everybody that we're on progress on the plan that we had made for it. I'll turn to Jonathan on the monetization pieces.

Yes, sure, Ben. There really isn't a simple answer there because there's sort of four main user activities on the site if you think about it broadly, right? They enter on the home page, they search for videos to watch, they watch videos, and they upload videos and engage with the community with comments, recommendations and that sort of thing. And the different types of modes really get different advertising models. And that's part of why I think it's taken us time to kind of triangulate towards what works, and I think some of the things that we have now are still in pretty nascent stages. If you look at the home page it's basically big brand display ads. You know, search can be good for promoting videos, kind of similar to maybe what AdWords does for Google. But if you look at where the big inventory is, the massive users are in more the watch pages. So that's what we're sort of trying to figure out. You know, is it overlays that are going to work? Is it the in-stream stuff? I think we're still testing all of these things and the answer's going to be different for the different areas on the site that the user's on.

But I think on the call you indicated much more - just being more open to the prerolls, and that seemed to be new to me. Were you not trying to indicate anything in particular there?

I would not say that our overall optimism that we expressed with respect to YouTube is primarily a function of one specific format. We've actually been testing prerolls, I think, for quite awhile. So if you interpreted that one single comment to prerolls to imply the broad conclusion with respect to optimism on YouTube, I think that's probably a mistake.

Your next question comes from James Mitchell - Goldman Sachs.

If I was smarter this question would be simpler, so I kind of apologize in advance if it's confusing. But if I look back at the last year or so, it seems like [inaudible] growth sailed right through the financial crisis, where as price-per-click access [inaudible] dropped very sharply. And then this most recent quarter, [inaudible] growth slowed a little bit to up 15% year-on-year, while price-per-click seems to be stabilizing quarter-on-quarter. So when I think those trends, is it better to infer that [inaudible] just grow structurally over time but face the law of large numbers, while price-per-click is very sensitive to the economic cycle, or is it better to infer that Google's monetization initiatives tend to boost [inaudible] in some quarters and boost price-per-click in other quarters?

Well, maybe you're smarter than I am because I'm not sure I understand the entire question, but I think what you said is generally true. I think that in any give quarter the economic situation can impact the number of leads that are likely to convert. It can impact the number of commercial queries. I do think what Nikesh said is true, which is that advertisers don't constrain by their budgets; they manage to bids.

I think the model, if you think of - go back and take a look at the relationship between click growth and then CPC, right? Click growth is driven by so many factors, so you have the growth of the Internet itself, then you have the seasonality within it, and then you have - there's so many factors that will drive the click growth. And then obviously, you know, if people are in recessionary environments, shopping even more for the better bargain, then they click even more because they move around a bit. So it is a complex hypothesis that you are tabling and to kind of say here, I've figured out the four dots that make it work, I mean, I don't think any of us around the table that live in this world would make it a simple puzzle.

The one thing I think we could say for sure is queries are less sensitive to the economy. There's more comparison shopping when the economy is not strong and potentially a little bit less buying. So you could still have high-paid - the paid clicks can be high even when the economy is bad and I think the CPCs would adjust if the users aren't converting and drop if that's consistent with the hypothesis that you're trying to articulate.

The comparison shopping could have helped paid [inaudible] growth in the fourth quarter and first quarter while the weaker conversion sort of hurt PPC and now conditions have normalized a little bit. I mean, maybe it just is an extrapolation question. You mentioned there were 12 improvements to ad quality in the quarter and they had a bigger impact than usual on revenue. Would that impact be felt more on the paid [inaudible] or more on the PPC?

It would impact both, yes.

Your next question comes from Mark Mahaney - Citigroup.

One question just on mobile. There's been some data points that - I think in the founders' letter about a third of queries in Japan coming off of mobile devices; that's obviously a very unique market. You don't quality unique, but that obviously is a very unique market. Any other markets where you think search queries are material - 5% - as a percentage of total queries and any thoughts on are there any particular reasons why Western Europe and the U.S. and other markets over time wouldn't reach levels that may be half of what you'd see in Japan's, call it over a two to three year period?

So are you specifically asking questions with respect to mobile search volume increasing in Japan?

Just mobile search, yes, please.

Well, I mean, mobile search volume has increased quite a bit in the U.S., I think, as we mentioned, and that's largely a function of availability of phones with good browsers. And I think data plans are also an important dynamic. You know, generally I think mobile search volume is pretty high in Indonesia and in the Middle East, but we're starting to see mobile growth increase pretty well overall. You certainly see more interest in mobile search where the landline infrastructure is relatively poor, but I don't have any more specific thoughts beyond that.

Eric said in the previous call and I think that the adoption of these high-end devices, which are getting more and more ubiquitous - the G phones, the Android platform, the iPhone - I mean, they really do drive a lot of living on the web because the web is so much more accessible and therefore a lot more searches as well. So there's a fundamental trend that's happening there as well that's clearly is more than just Japan. I mean, there's a whole ecosystem that's building right now.

And one quick follow on; it has to do with paid search results. What's the latest thinking on the inclusion of broader formats within paid search results, i.e., allowing advertisers to respond to intentions with more than just text but to include display ads or video links or whatever in the paid search results, to apply universal search, that you've applied to organic search, to paid search results?

Yes, well I think Nikesh mentioned the video plus box. We're also working on much better ways of offering valuable information in ads with functionality like the product one box, where we're doing similar efforts. We're also I think going to make significant progress and we have made some progress in experimenting with local where it's easier to or we're getting better at determining where a user is and thereby being able to give them the appropriate local information. So I think that there's a lot of opportunity. And if you look over the course of the last year, I think that the search results have in many ways, with universal search, been outpacing the innovations on the ad side and we're really going to move forward with the experiments on things like products and video and local. We've, of course, got to do that in ways that are good for the user, but we think we're making progress there. I think we've made more progress on the search side.

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

If I take the domestic business, which was sequentially down, and I take out some revenues from YouTube - so you talked a lot about how well YouTube did - I can very easily get to year-on-year decline in U.S. search business. So I'm trying to understand what this really means. I mean, why wouldn't that imply maybe the beginning of maturation of search? I know it's somewhat unbelievable, but what's the counterargument there?

That the U.S. search business is not declining.

So that means YouTube -

Well, of course, I mean, it's not all static, right? We're going to continue to deliver to these advertisers much better ways to manage their bids, much better ways to optimize their campaign and manage their budgets. We actually didn't talk about it on the call, but we've rolled out a new advertiser interface for AdWords to a very large fraction of our advertisers. The previous question just asked about the opportunities to improve the quality of ads, and if you look at it today, the click-through rate on ads is still low relative to the search results. So I think there's lots and lots of opportunity there and there's still many verticals where we don't do a particularly good job with the searches. So I think there's lots of headroom in terms of monetization for search overall.

You know, that's helpful. I'm just looking at the domestic revenues last year versus this year and the delta is really only about $40 - $45 million, so the point there, if, just for the sake of argument, is YouTube was zero last year - which, obviously, it wasn’t - and if it's [$50] million this year - which, arguably, if it is or not - then your domestic revenues in search would be declining year-on-year. But your point is they're not. Okay, so I'll take that.

But there's also - I think there's another flaw in that logic, because YouTube is not U.S. only.

The majority of it is U.S., though.

It also wasn't zero last year.

Right, okay. Fair enough. And then if I look at growth in the network, it was up 2% versus negative 3% in Q1, right? So how much of that was driven by YouTube versus AdSense for content? In other words, is AdSense per search up as well year-on-year or is AdSense for content just growing faster because looking at AOL, traffic for AOL for ads for MySpace, the numbers don't just look too impressive to imply that AdSense for search would be that much higher.

Yes, there's no doubt that AFC is up relative to AFS within that period, but also in general display as well has been up because Q1, if you'll remember, the comments we had made is on the display side there was some pullback in Q1 versus Q4 and now coming back into Q2.

Your next question comes from Christa Quarles - Thomas Weisel Partners.

You guys talked a little bit about the mobile advertising market being basically not a separate biddable marketplace. I was wondering if you could just give us rough sizes in percentages of advertisers who've opted out to the mobile piece, you know, more or less than half? So that's the first question. And then the second question is: Do you guys have any data around your developer community yet, you know, which are the most popular products that people - or that developers tend to be working, size of developer, community, you know, how many people went to the developer conference. So question two. And then the third question is just I found myself opening my wallet to Google last weekend to pay for storage because I'd been bumping up against my limits. I was wondering if you guys have actually said how many people pay for Google storage?

I think that we had 3,500 people at the developer conference sign up. Somebody can check on that and tell me what the -

Yes, but it included people like me.

I think it was 3,500 developers. We can specifically check on that. I believe on the mobile side that's generally a separately biddable marketplace.

I thought it was an opt-in. I mean, I think Eric's comment on the call was specifically that it's roughly the same CDC because it's embedded in the same PC marketplace but over time - I thought as of right now you basically have your queries basically for the PC and you have to opt out so as not to be included in the mobile results. Is that not -

Mobile is sort of tricky because there's the smart phones, which are more conventional browsers, and that's tied to the traditional experience, but then there's a separate set of mobile-only campaigns that you can also run.

Okay. I guess I'm talking about the smart phone side and those. I guess, you know, the question is manifesting out of the fact that I've talked to some mobile competitors who are sort of frustrated that you guys are embedding that and they were saying, you know, that the ad's quality may not be as good or whatever. So I guess what I'm trying to get a sense of from you is what percentage of advertisers have chosen to opt out of those mobile because they either don't feel like the quality's there or they're just not ready to measure it?

That I don't know. I know the default - I think the default is that you show on both but we give advertisers control and they can opt out, they can do just smart phone only capabilities.

Right. But you don't have any -

I think the number's pretty small, but I don't actually have it with me.

Small that has opted out?

Yes.

Okay. And then paying for storage?

I don't think we've ever disclosed that.

Yes, it's not a significant - paid storage is not a significant portion of our revenue.

Your next question comes from Sandeep Aggarwal - Collins Stewart LLC.

Jonathan, it has been nearly six or seven weeks since Bing launched. Just a couple of questions to the extent you are willing to comment. What is your overall take on Bing? Are you seeing any changes of behavior by a typical Google user in terms of propensity to search at Google? And also, in terms of [inaudible] or blending search along with some [inaudible] of [inaudible] suggest travel, shopping, can really work here?

I think we said on the call that we think it's relatively early to call. We certainly haven't seen a large shift in share. I do think that there are opportunities to do a much better job with vertically oriented searches. And the question was asked on the call earlier - we talked about some verticals; I think I mentioned finance on the call earlier, where there's certainly an opportunity to do a much better job with ads. And certainly I think there's an opportunity to do a better job in shopping and in travel and in many verticals in time.

And, Patrick, if I may ask one question on the headcount, there was a 378 headcount reduction sequentially. What was [inaudible] you know, maybe job elimination was [inaudible] accretion.

All right, let me give you the context on this again; I think it's important. We had announced at the end of Q1 a number of rationalizations in the sales and marketing program. And we continue to have a lot of job openings and we're hiring. So in the second quarter what you see is just a manifestation of, you know, if you can't hire fast enough in the job openings that you have, just for whatever reason, over the last 90 days, you end up in this position where you haven't started kind of catching up, if you wish. So it's just a timing issue. So the company continues to hire; it continues to have many recs open in many departments. And then some positions were eliminated in sales and marketing, as was discussed. So that's the net result of it, right? So if you go to the Google site for job posting, you'll see a lot of job postings today.

Your next question comes from Doug Anmuth - Barclays Capital.

Two questions, I think pretty straightforward, the first one on cash flow. You net income was higher Q-to-Q, but your free cash flow was lower, so can you clarify what's going on in working capital and then also in income taxes? And then secondly, on TAC, it came in somewhat higher than we expected, at least, so I'm curious how much you're benefiting at this point from the Dell deal coming off? Are you still paying residuals there and are we likely to see sort of greater benefits from that going forward?

So on the cash flow, I'll give you the most simple answer, which is in Q2 you have two tax payments, for the federal and the California state, and they occur April 15th and I think June 15th. So just those are not in Q1 and then you've got a big hit in Q2. And it's a big amount of money, like hundreds and hundreds and hundreds of millions - I think it's like $800 million or $900 million, in that range, right? So it's like a ton of money. So that will obviously impact, by far outweigh everything else, on the free cash flow calculation. Everything else actually is in pretty good shape. On the TAC side, I think there's, again, if you look at our TAC and it's been progressing, as I said on the previous call, you've just got moving pieces, but you wouldn't have kind of - there's no significant event that would have actually moved it in one way or another. You just have this effect between the Google and the non-Google and then you have the affect of the mix within the AdSense network between the smaller and the larger guys. And then that moves all the time and that's what you see in the reflection. I mean, obviously, so what we have seen in Q2 is, you know, a higher percentage of the smaller partners and slightly higher on the Google, and that's what you end up with.

And just going back real quick on that TAC hit, as I look back at other second quarters, I mean, I assume that timing would be the same, but I don't see sort of a similar affect there in previous years.

Yes, but I wouldn't worry about two years ago what happened in Q2 for TAC. I mean, two years ago to two years ago you would have had a very different mix of deals with very different payouts.

I was referring to income taxes, actually.

Oh, sorry.

TAC, taxes - close.

T-A-X.

T-A-X, yes.

Okay, yes. I thought it was TAC. Did everybody get TAC? Oh, sorry about that. On taxes, no, I mean, well, I'd have to go back. Every year we pay a lot, right?

All right. We'll take it offline.

Okay, we'll have the IR people come back to you on the details.

Your next question comes from Jeetil Patel - Deutsche Bank Securities.

On the TAC, it's obviously been moving down, as Doug alluded to as well, but I'm curious, are you able to basically take down TAC on the search side, on the CPC front, and maybe reallocate it to more the lead gen side of the business in terms of CPA and CPM inside the network there? And second, as you look at your kind of display category developing, are you seeing the interest in YouTube develop among pure display-oriented advertisers or lead gen-oriented advertisers? And then lastly, Germany, last quarter I think you pointed out as a fairly strong market for you, I guess. Can you give us a sense of where Germany is and is that close to cracking the 10% mark in terms of contribution?

I just need to understand better your first question.

Yes. TAC's been moving down. Is there the possibility that you could take some of your TAC dollars that you pay out on a CPC basis, whether it be search or CSEs or others, and bring down those TAC payments and reallocate them to more of the display side of the business in terms of inside your AdSense for content network on a CPM basis?

I mean, the different deals have just different characteristics and you can't just shift them; they're with each of the partners and they appear in the AdSense network; I mean, there's a certain structure. And then if you do a deal for Chrome or for Toolbars, you just have a completely different set of structures for those deals. So, I mean, we continue to manage each of these sets of partners and each of these streams of TAC with their own set of economics and, you know, every time we get a good deal we do it. And the mix is just a product of all that, no more, no less. We don't think okay, we'll reduce the dial on one to increase the dial on the other. Everything that makes sense we do.

I guess on the questions with respect to YouTube, I tried to address some of that in I think it was Ben's question. And, again, the type of advertiser really depends on which of the activities it is, right? There's the home page, there's searching for videos to watch, there's the watch pages. So it depends which activity you're talking about. The traditional Google advertisers are generally direct-response focused. The brand display advertisers - the people taking over the home page banners - are more display oriented. And I think you're starting to see some TV advertisers come online, but I don't think I can give you too much color on exactly to what degree that's playing in the equation. And what's the question - there was also, I think, a question about Germany?

Yes, Germany. I think you highlighted it as a strong market last quarter, I guess. Can you just provide an update or commentary of how that progressed in Q2?

I mean, it did well, but I wouldn't give any more information than that. You'll remember last quarter in Q1 there was a lot of macroeconomic events that people were asking about, you know, how is Europe doing given the meltdown of the economy in UK, and how was the rest of Continental, so we just used it as an illustration rather than a set of data points with a lot facts around it.

Your next question comes from Steve Weinstein - Pacific Crest Securities.

Can you just help explain all the volatility in the interest and other income line, how we can get our hands around that, because it's swinging enough that it's affecting the numbers.

Yes. OI&E will continue to be a real challenge. It's a real challenge for us as well, right, because there's been so much volatility in FX in the last little while when you think of the last three, four quarters. I mean, it is difficult to predict where FX is going. In fact, we were discussing as a team that some companies kind of right now stay at the margin level, right, and then after that they say it's really tough to give guidance anywhere below. Obviously, we don't give guidance, but the point is in general there's really two big drivers that affect it for us. One is obviously on the investment side we've been very conservative in the last year to make sure that we protect the capital of Google and by doing so obviously our yields have gone down quite dramatically to protect that. So all of our investment in our marketable securities that have been sovereign backed and that we've talked about, I mean, it has a pretty big impact in terms of trajectory. On the flip side of that, our hedging costs, you know, as volatility continues to be really high, the hedging costs, you know, we've benefited from it, but sometimes you just get the timings of the FAS 133 that hit you. And even though you're doing fine on your hedges per se, right, you end up at the end of a quarter and because of where the FX rates stand at the point and then you marked-to-market your options, you end up with having from an accounting point of view bringing a lot of these expenses back into a current quarter. It can have a big effect, right? These swings can be quite significant. So I sympathize with you because it in fact is really difficult to get some good semblance of where this thing's going on a quarter-to-quarter basis. I mean, I can tell you on the flip side of that is we manage this very responsibly, obviously, as you can see in the results of our FX program and then our investment program. We have to think through in the coming quarters as to how do we, given the economy stabilizing and the banking systems are stabilizing, right, how do we re-think our investment portfolio to kind of take advantage of kind of the stabilized environment.

Since I actually got a factual answer to one of the questions that was asked earlier over e-mail I said I would just share it. I answered Christa and said that there were 3,500 developers or I might have said attendees at the developer conference. There were 3,500 attendees, but 2,196 developers, so Christa must have been there with a lot of her friends. But the factual answer to your question is just under 2,200 developers.

So, Steve, I hope that answers your question and the big pieces at work.

Your next question comes from Ross Sandler - RBC Capital Markets.

Just a couple follow ups, first on the CapEx. So, Patrick, you've said in the past - you've kind of thrown off the hypothetical example that up until, call it middle of last year, you guys were managing the CapEx program to always kind of stay ahead of capacity. So if you thought you needed 20 data centers in a given year, you'd invest in 22 or 23. How do we think about where we are today in terms of capacity utilization of all of Google's infrastructure and when does kind of a maintenance CapEx have to start kicking in? And then a follow up question on just the relative growth rates for U.S. versus Western Europe. Do you think those two markets through the second quarter are now moving closer in tandem, Western Europe starting to slow down a little bit later than the U.S. in terms of kind of where we've come from in the last four quarters? Do you think that we're not kind of at parity in terms of the deceleration in those markets? And then the last question is: When you talk about putting the content network on Ad Ex, the next version of the Exchange, how does Google think about sacrificing potentially more favorable web share deals with publishers that are on the content network today with potentially a lower rev share if they put their inventory on the exchange? I think the exchanges are closer to a 5% to 10% type rev share. How do you think about that dynamic when you start plugging in all the inventory from the content network?

Let me start with the CapEx question. On CapEx, it has been every quarter - I've been here now for four quarters and every quarter everybody asks, Patrick, it's going down again, so is it bottoming out? And we've had a great benefit in the last two to three quarters of not only higher utilization rates but Moore's Law's been at work for us on top of that, and we have had really good planning of our capacity. So the combination of all these things has given us quite a boost in terms of managing our CapEx and that's just shown in the results. You'll remember, also, that I said we have a number of areas where we need to invest and we are making these investments. And I mentioned, you'll remember, one place which is in Scandinavia which the only time you could work on it is in the summer. So even if we had all our plans to start in March, the place was a deep freeze at the time and now they're kind of working hard at it. So we continue to invest. And they're lumpy and they're big and when you get a next generation of servers ready then you do a big overhaul and then at that point you get a lot of capital in. And that's just the nature of the business. So we're, one, very pleased with the way that the team has worked really hard to get this better utilization and better planning of the capacity, so they're smarter about it. So we got the benefits over the last three/four quarters and we're continuing to invest and we'll do so in the future. So that's on the CapEx side.

I don't think there's an easy answer on the Ad Exchange question. I mean, the idea is basically to create an open platform so advertisers and publishers can buy and sell inventory. I think there are going to be different optimization insights and different margins which are justified by different targeting technologies that different players bring to the table, but I think that what we're hoping to do is reduce a lot of the fragmentation that exists in the whole buying experience and if overall you can get more budget and more advertisers and more publishers flowing through there, in the end the economics are going to work across both sides.

The last question you asked, which is U.S. versus Western Europe, we're really pleased with the growth in Western Europe. Obviously, in both of these markets the economy has had a lot of short-term affects that you can't discount; it's been true for the U.K. And also the FX has had a huge affect, as you can see through our results. So in both cases we're really pleased with the growth rates that we have and I don't think that I would correlate one with the other right now; I think they have their own sets of momentums and dynamics. We'll take one last question. Unfortunately, we're running out of time. So we'll take one last question, please.

Your final question comes from Colin Gillis - Brigantine.

I know every customer is important, but when we talk about slimming down the sales and marketing efforts could you give me a sense as to what is that customer base that needs an awful lot of direct handholding? Is it 1,000 customers? Is it 5,000 customers?

I don't think there's an easy answer to that question. I mean, basically the way we manage the sales and the support experience is on a bang for the buck basis we're providing support to the customers from whom we're going to garner the largest amount of revenue. I think that if you are able to support larger numbers of customers you'd be able to make incremental revenue, so I think there are many, many thousands of customers that could use utilization efforts from our support organization; there's only a subset that we're actually able to support at the level that we would like to. But on a bang-for-the-buck basis, we're prioritizing at the top of that funnel. The key there is really focus, I mean, what we're really trying to do there is create automated tools that make scaling these efforts easier and make it easier for customers to optimize on their own. Of course, we also partner with agencies who I think do a lot of the heavy lifting there for us and play an important component to the equation.

Absolutely. So just trying to get some sense, directionally would you say you're focusing in more on the larger customers at the top of the funnel?

Yes. Certainly, we allocate our sales time. I mean, the salespeople allocate their time on the basis of, you know, on a bang-for-the-buck basis where the money is for the most part.

The direct sales force focuses essentially on these very large national accounts who are very large advertisers, whether they are agencies or they are big customers, and that's where they focus essentially their attention. And then we have a second category that, you know, you get some phone support, and then the third category that you just - sort of on the web. And so the reason why we do this, coming back to the original question, when we did the rationalization we grew so fast and then we made a number of acquisitions, and then you end up in a position when you kind of start adding all the bodies and you say okay, who's talking to whom, you end up with duplications in some places. And that's neither good nor bad; it was just the way it was and we set let's do a bit of rationalization. But we continue to, you know, we have all the headcount that we need in order to focus on the big accounts that we want to bid. We're not constrained in that sense, if you wish, right? And that's why we just did the cleanup in Q1.

Okay, with that, Maria, we can close the call. Is that okay?

Yes. Thank you everyone for your time. We'll talk to you next quarter.

Thank you, everybody.

And this concludes today's conference. We thank you for your participation.