Alphabet Inc - Class C (GOOG) — Q4 2018 Earnings Call Transcript

… fourth quarter 2018 earnings conference call. With us today are Ruth Porat and Sundar Pichai. Now I'll quickly cover the Safe Harbor. Some of the statements that we make today regarding our business performance and operations and our expected level of capital expenditures may be considered forward looking and such statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our most recent Form 10-K filed with the SEC. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations Website located at abc.xyz/investor. And now I'll turn the call over to Ruth.

Thank you, Ellen. We had a strong 2018, with total revenues of $136.8 billion, up 23% over 2017, reflecting the benefit of our ongoing investments to deliver exceptional experiences for users and compelling returns for our advertisers, partners and enterprise customers. For the fourth quarter, revenues of $39.3 billion were up 22% year-on-year and up 23% in constant currency, as we continued to benefit from ongoing strength in mobile search with important contributions from YouTube, Cloud, and Desktop Search. For today's call, I will begin with a review of results for the quarter on a consolidated basis for Alphabet, focusing on year-over-year changes. I will then review results for Google followed by Other Bets, and will conclude with our outlook. Sundar will then discuss business and product highlights after which we will take your questions. Let me start with a summary of Alphabet's consolidated financial performance for the quarter: our total revenues of $39.3 billion reflect a negative currency impact year-over-year of $724 million or $600 million after the impact of our hedging program. Turning to Alphabet revenues by geography, you can see that our performance was strong again in all regions: U.S. revenues were $18.7 billion, up 21% year-over-year. EMEA revenues were $12.4 billion, up 20% year-over-year in both reported and constant currency terms with a slight headwind primarily from the euro. APAC revenues were $6.1 billion, up 29% versus last year and up 32% in constant currency, reflecting weakness of the Australian dollar. Other Americas revenues were $2.2 billion, up 16% year-over-year and up 26% in constant currency, reflecting weakening of the Brazilian real and the Argentine peso. On a consolidated basis, total cost of revenues including TAC, which I'll discuss in the Google segment results, was $17.9 billion, up 26% year-on-year. Other cost of revenues on a consolidated basis was $10.5 billion, up 34% year-over-year, primarily driven by Google-related expenses. The key drivers were: first, content acquisition costs, primarily for YouTube, mostly for our advertising-supported content in what is a seasonally strong quarter for YouTube, but also for our newer subscription businesses, YouTube Premium and YouTube TV which have higher CAC as a percentage of revenues. Second, costs associated with our data centers and other operations, including depreciation and, third, hardware-related costs for our made by Google and Nest family of products. Operating expenses were $13.2 billion, up 27% year-over-year. The biggest increase was in R&D expenses, with the larger driver being headcount growth, followed by the accrual of compensation expenses to reflect increases in the valuation of equity in certain Other Bets. Growth in Sales and marketing expenses reflects increases in sales and marketing headcount primarily for Cloud and Ads, followed by advertising investments mainly in Search and the Assistant. The growth in G&A expenses reflects mostly increases in headcount. Stock-based compensation totaled $2.3 billion. Headcount at the end of the quarter was 98,771, up 4,399 from last quarter. Consistent with prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount increases were in Cloud for both technical and sales roles. Operating income was $8.2 billion, up 7% versus last year for an operating margin of 21%. Other income and expense was $1.9 billion, which includes $1.3 billion of unrealized gain related to a non-marketable debt security investment. We provide more detail on these line items within OI&E in our earnings press release. Our effective tax rate was 11.2% for the fourth quarter, reflecting a discrete benefit due to the reversal of an accrual made as a result of updated guidance associated with the U.S. Tax Act. Net income was $8.9 billion and earnings per diluted share were $12.77. Turning now to CapEx and operating cash flow. Cash CapEx for the quarter was $7.1 billion, which I'll discuss in the Google segment results. Operating cash flow was $13 billion with free cash flow of $5.9 billion. We ended the quarter with cash and marketable securities of approximately $109 billion. Let me now turn to our segment financial results. Starting with the Google segment. Revenues were $39.1 billion, up 22% year-over-year. In terms of the revenue detail, Google Sites revenues were $27 billion in the quarter, up 22% year-over-year. In terms of dollar growth, results were led again by mobile search, with a strong contribution from YouTube followed by desktop search. Network revenues were $5.6 billion, up 12% year-on-year reflecting the ongoing momentum of AdMob and Google Ad Manager. Other revenues for Google were $6.5 billion, up 31% year-over-year fueled by Cloud, Hardware, and Play. We continue to provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses. Total traffic acquisition costs were $7.4 billion or 23% of total advertising revenues and up 15% year-over-year. Total TAC as a percentage of total advertising revenues was down year-over-year, primarily reflecting a favorable revenue mix shift from network to sites. The increase in the sites' TAC rate year-over-year was driven by the ongoing shift to mobile, which carries higher TAC, followed by changes in partner agreements offset by the seasonally higher proportion of YouTube advertising revenues in the fourth quarter. In Q4, the network TAC rate declined year-over-year, primarily due to our revenue mix shift within our programmatic business. Google stock-based compensation totaled $2.1 billion for the quarter, up 22% year-over-year. Operating income was $9.7 billion, up 13% versus last year and the operating margin was 24.8%. Accrued CapEx for the quarter was $6.8 billion, reflecting investments in office facilities, data centers, and servers. Let me now turn to and talk about Other Bets. I'll cover results for the full-year 2018 because it remains most instructive to look at the financials for Other Bets over a longer-term horizon, as we've discussed on prior calls. Results for the quarter are in our earnings release. For the full-year 2018, Other Bets revenues were $595 million, up 25% versus 2017 primarily generated by Fiber and Verily. Operating loss for Other Bets was $3.4 billion for the full-year 2018 versus an operating loss of $2.7 billion in 2017. Other Bets accrued CapEx was $181 million, down from $493 million in 2017, primarily reflecting investments in Fiber. Key recent accomplishments include: in December, Waymo launched Waymo One, which enables participants to use its app to hail and pay for rides. Also, Verily recently announced a $1 billion investment round led by Silver Lake as it advances on plans that are complementary and additive to its current life sciences portfolio. That investment of course, was in addition to the $800 million it raised from Temasek previously. Let me close with some observations on our priorities and longer-term outlook. First, with respect to revenues. Our 23% revenue growth in 2018 was powered in particular by the ongoing benefit of innovation in our Sites business. With eight products, with more than 1 billion users each and more people coming online every day, we remain excited by the opportunities to continue to create valuable experiences for users around the globe. In particular, we see significant ongoing potential to apply our machine learning capabilities across our businesses. In our advertising business, machine learning has enabled innovation in advertisers' ability to match consumer intent more effectively for improved ROI. It has also enhanced the ability of smaller businesses to benefit from advertising on our platforms. Machine learning is also driving differentiation for newer Google businesses, like Cloud and Hardware, as well as central to a number of Other Bets, most notably Waymo and Verily. Looking ahead, a couple of things to note. First, as we’ve said many times, we continuously work to enhance the user and advertiser experience. Because we make changes with a focus on the best interest of users and advertisers over the long term, the timing of the introduction of new experiences, particularly in search advertising can vary which can result in an impact on quarterly year-on-year growth. Second, during 2018, the FX tailwinds in the first half of the year turned to headwinds in the third and fourth quarters, in line with the strengthening of the U.S. dollar. Based on the continuing strengthening of the U.S. dollar, we expect a headwind to reported versus fixed FX results in the first quarter, in contrast to the favorable impact of FX in the first quarter of 2018. Turning to investments and profitability. In terms of gross margin, the biggest component within cost of revenues remains our traffic acquisition costs, reflecting our strong revenue growth in mobile search and the fact that mobile search carries higher TAC than our desktop business. As we've discussed on prior calls, while the pace of year-on-year growth in Sites TAC as a percentage of sites revenues slowed after the first quarter of 2018, we do expect the Sites TAC rate to continue to increase year-over-year, reflecting ongoing strength in mobile search. Within OpEx, we remain focused on prioritization in order to optimize resources for longer-term growth in sizable markets. You'll see us continue to support our priority areas with increased headcount, which will remain concentrated in R&D. Although we expect the growth rate to moderate in 2019. In 2018, we also saw continued progress on our goal to nurture new businesses outside of Google, our Other Bets with a model of independence. While I've said previously that there is no monolithic approach to how the Other Bets execute against opportunities, a shared principle is aligning employee interests with the long-term value creation by these companies. Since inception, this has been an important part of our approach at Google with stock grants comprising a meaningful component of overall compensation across our employee days. We are increasingly following that approach in the Other Bets with compensation programs that align employee and company interests. You’ve seen the impact of some of those programs in the fourth quarter as we accrued compensation expenses to reflect increases in the valuation of equity in certain Other Bets. While these expenses will recur, the timing relaxation events is unpredictable and can vary between debts which can affect quarterly comparisons. Finally, on capital allocation. Our primary use continues to be to support organic growth in our businesses, followed by retaining flexibility for acquisitions. After taking these needs into account, our Board has authorized the repurchase of up to an additional $12.5 billion of our Class C capital stock. With respect to CapEx, we continue to invest in both compute requirements and for office facilities. Although we expect the CapEx growth rate in 2019 to moderate quite significantly. In conclusion, 2018 was another great year, with tremendous ongoing opportunity ahead of us. I will now turn the call over to Sundar.

Thanks, Ruth. Last year, we set out to bring the benefits of AI to everyone through our products. And I'm proud of the tremendous progress we made toward that goal. From smart compose and Gmail to the new Google news experience, to call screening on the Pixel and improving the overall safety of our products. AI is helping people get things done every day. Beyond our products, AI is also helping us drive our mission forward at a scale we couldn’t have imagined just a few years ago. Google AI Lead, Jeff Dean recapped the results of our efforts in a great post on our AI blog, using AI to better detect the spread of breast cancer, or providing flood victims with real-time information in a crisis. I encourage everyone to check it out. We also launched the Google AI impact challenge to help nonprofits find ways to use AI to solve social and environmental problems. In addition to our progress in AI, we saw great traction across newer areas, like the Google Assistant, hardware, and Cloud. Our core areas such as Search, Maps, new use cases, YouTube, computing, and advertising platforms continue their strong momentum. Everything we do at Google is united by the mission of making information accessible and useful for everyone. Providing accurate and trusted information at the scale the internet has reached is an extremely complex challenge, and one that is constantly getting harder. But we’ve 20 years of experience in these information challenges, and it's what we strive to do better than anyone else. As we do this, we feel a deep sense of responsibility to do the right thing and are continuing to build privacy and security into the core of our products, keeping users' data safe and secure with the industry's best security systems and giving people better and clearer controls. You will see us continue to do a lot more here in 2019. Today I will start by sharing some of the new ways that we are working towards our mission. Then I will give an update on our video and advertising platforms, followed by the latest on our hardware and cloud efforts. And I will close with a few thoughts on our investments around the world. First, advancing our mission of making information accessible and useful. The Google Assistant is a great example of how we help people throughout the day, and we demonstrated that at CES last month with lots of exciting new partners and features. From the Lenovo Smart Clock that wakes you up in the morning to real-time navigation that helps during your commute. To a built-in interpreter that translates conversations across dozens of languages on Google Home. And speaking of languages, over the past year, the Google Assistant expanded from eight languages and 14 countries to nearly 30 languages and 80 countries. In that time, the number of active users quadrupled. As we had more partners, devices, and capabilities, the Google Assistant will only get better and more helpful. There's a lot of great progress in other areas too. Last month, we announced the launch of activity cards in search. Now when you search for a topic that you’ve previously explored, you can quickly see variations of it and pick up where you left off. Thanks to our strengths in AI and Search, Google Lens uses your smartphone camera to help identify more than 1 billion products. So if you see an item that you like, Lens can show you similar designs, along with useful information like product reviews. We continue to see great momentum across our computing platforms, Android and Chrome. In Q4, we announced that Android was officially supporting affordable phones, with partners like Samsung introducing their first portable devices this year. We see continued traction with manufacturer adoption of Android Auto. We recently announced new media and messaging features to significantly simplify and improve the car dashboard experience. And building on the speed, simplicity, and security of Chrome OS, partners like Asus and HP introduced a slew of great consumer and enterprise Chromebooks last month at CES. Now let me provide an update on our video and advertising platforms, starting with YouTube. We are seeing great traction in some of our newer experiences on YouTube. YouTube Music and YouTube Premium are now available in nearly 30 countries, up from five countries at the start of 2018. Last month, YouTube TV announced that it expanded nationwide to cover 98% of U.S. households, with the rest to follow shortly. YouTube continues to invest in its thriving community of creators and build great features for its nearly 2 billion monthly logged-in users. For instance, in Q4, they expanded access to tools like stories and community polls that strengthen the connections between fans and creators. One of our newest tools, Premieres, is a breakout hit. Ariana Grande's premiere of her official music video for Thank U, Next in November holds the record for the biggest music video debut in YouTube history, earning over 55 million views in its first day. We are driving revenue to the YouTube creator community from established channels to newly emerging ones. The number of YouTube channels with more than 1 million subscribers nearly doubled in the last year, and the number of creators earning five or six figures grew by more than 40% year-over-year. A big priority for YouTube in 2019 is to continue our work to quickly find and remove content that violates YouTube's content guidelines. It's an important challenge and with advanced machine learning and investments in human reviewers, we are making continued progress. Now I'll touch on some of the recent highlights of our advertising business, which continue to go from strength to strength. Recently, Warner Brothers embedded the first full-length film with an ad on YouTube and reached a record number of people, over 17 million users in a single day. Viewers who watched the trailer for LEGO Movie 2 on Black Friday were served the franchise's original film for free within the ad. So it's a great example of how advertisers continue to delight users on YouTube. Performance advertisers love TrueView for action, YouTube's direct response offering. Since the product launch in March 2018, over 30% of the advertisers who use TrueView for action were new to buying in-video ads on YouTube. In Q4, we also announced a global strategic ad tech relationship with The Walt Disney Company across their entire portfolio of brands and properties. With Google Ad Manager as its core platform, Disney will be able to serve across its digital property seamlessly on the web and mobile apps through connected TVs and even during live events. Our shopping tools were also front and center during the holidays, helping retailers reach people during the busy holiday shopping season. In fact, the number of shopping daily active users on Google.com during the holidays doubled compared to last year, thanks in part to new features like product list modules that showcase the most popular products across the web. Small retailers are also benefiting from automated bidding solutions like smart shopping campaigns, which now has more than 20,000 live merchants. Impressive progress since launching in April. Now on to our growing hardware efforts. During the holiday season, our newest lineup of Made by Google devices topped many best of 2018 lists. The response from shoppers was equally positive. It was another record year for our Google Home family of devices, with millions sold this holiday season. They’re helping people easily get things done around the house. For example, people used Google Home devices to cook over 16 million recipes this holiday season, 1 million on Christmas Day alone. Our newest smart displays were particularly popular. One out of every seven Google Home devices activated during the holiday season was a Google Home Hub. In Q4, we launched significant advances in computational photography in our Pixel 3 with features such as Night Sight for low-light photos. We’ve also expanded availability to four more countries: Japan, France, Ireland, and Taiwan. And finally, our growing cloud business. I want to thank Diane Greene for her leadership over the last three years. Google Cloud is a fast-growing multi-billion-dollar business that supports major global 5,000 companies in every important vertical with a robust enterprise organization. This was not the case just three years ago. What Diane and her team accomplished is phenomenal. Now Diane's work is done and she has handed the reins to Thomas Kurian, and I’m thrilled to have him here as our new Cloud leader. Google Cloud closed out the strong year with momentum across the business. Last year, we more than doubled both the number of Google Cloud platform deals over $1 million as well as the number of multi-year contracts signed. We also ended the year with another milestone, passing 5 million paying customers for our cloud collaboration and productivity solution G Suite. Our focus on helping customers digitally transform their businesses is paying off. We continue to see strong growth in all our major geographies and industries this quarter. In financial services, we signed agreements with two of the top financial institutions in the U.S. to help them transition their business to Google Cloud with our highly secured solutions. In retail, brands like Bed Bath & Beyond, DSW, and Ulta Beauty are using our cloud to manage data and provide more personalized experiences to consumers. In Media and Entertainment, The Telegraph and the U.K. is going all in with Google Cloud because of our data and machine learning expertise. To support our global growth, in Q4, we launched our 18th Google Cloud region and announced plans for a new region in Jakarta. So as you can see, we are investing in the many incredible opportunities across our business. We would also invest in communities around the world and right here at home. I was recently in Europe, opening our new office in Berlin, which will help us more than double the number of Googlers who work there. Across Europe, we've invested more than €4.3 billion in five data centers since 2007. In Q4, we announced a new data center coming in Denmark. In all, it's estimated that these data centers have generated more than €5.4 billion in GDP over the last decade. Of course, the amount generated by our creators, publishers, and app developer partners across the region is orders of magnitude larger. We also continue our substantial investments throughout the U.S. Last year, we made significant investments in new and expanded office space. In Q4, we opened the doors to our new office in Detroit and announced that we will be investing over $1 billion in capital improvements to establish a new campus in New York City, which will begin to open in 2020. We are also continuing to invest in data center construction and expansion. There are important long-term investments that lay the groundwork for our future computing needs, primarily to exude machine learning across our businesses but also to support the opportunities we see in Cloud, Search, Ads, and YouTube. More than 20 years in, there is still tremendous opportunity for Google to help people save time, learn new things, grow their businesses, and build stronger communities. I want to thank every Googler around the world for making 2018 a great year for users and our business. With that, I'll hand it back over to Ruth.

Thank you, Sundar. And we will now take your questions.

Thank you so much for taking the question. Two, if I could. On YouTube, you never have a number of brands in the marketplace between YouTube Premium, TV, and YouTube Music. How are you thinking about positioning those brands against a global opportunity, especially in mobile to consume media on a global scale and how you’re positioning those brands for the opportunity? And then, Ruth, I wanted to come back to comment on revenue versus expenses with respect to YouTube. It sounds like you called out YouTube as strong in the quarter on the revenue side, but is depressed on the expense side. Was that because of licensed content for things like Music and YouTube TV, or what is ad splits? How should we think about what the drivers were there and how they’re now permanent versus seasonal in Q4? Thank you so much.

Thank you, Eric. Regarding the YouTube question, our main focus is the primary YouTube product, which continues to scale effectively worldwide. We are experiencing ongoing engagement, and it is performing well. We are dedicated to ensuring a premium experience on YouTube by providing content that people want, with YouTube Music being a significant aspect of that as well. Therefore, we are investing in both. YouTube TV, which is only available in the U.S., is an exciting and unique product that holds long-term value for us as it integrates our advertising products and allows us to serve it via TV. We are clearly investing in areas where we identify opportunities. We also ensure that our investments lead to growth by closely monitoring metrics, engagement, and revenue growth, and we see significant potential here.

In terms of revenue, this is an overall investment in YouTube. We are continuing to benefit from the shift in how users consume content, which is reflected in strong revenue growth. Brand advertising remains the largest segment of our business and is growing rapidly. We are particularly excited about the significant growth in direct response formats, including TrueView for action and app promotions, which are providing great value for both users and advertisers, driving growth across various regions and channels. Regarding expenses, the main factor in the fourth quarter was the rise in content acquisition costs related to YouTube growth, encompassing both ad-supported content and the seasonally strong quarter. Additionally, our newer subscription businesses have higher TAC as a percentage of revenue, and we are excited about the growth in this area.

Thank you for taking my questions. I have one for Ruth and one for Sundar. Ruth, I've noticed that the segment operating losses for Other Bets were higher in both the fourth quarter and for the entire year of '18 compared to '17. Can we assume that investments in Waymo are contributing to this, or could you share more details? Were there other Other Bets besides Waymo that saw significant changes in investment? That would be helpful. And for Sundar, could you share any updates on how well the Cloud is performing? Have there been any milestones? You mentioned investments in headcount growth in technical and sales roles, and with the new leadership from Thomas Kurian, what initiatives could help accelerate growth in that business? Thank you.

So in terms of the investment levels in Other Bets, the major point is that we are investing across Other Bets consistent with what we think is required looking out at the opportunity set for each one. We go through a regular process with weekly business reviews and quarterly board reviews and try and calibrate the appropriate pace of investment. In terms of the increase this quarter, as I indicated in opening comments, we accrued some comp expenses for a number of bets and that was really to reflect increases in the valuation of equity in certain Other Bets.

On Cloud, one of the things that was evident towards the end of last year is now our ability to win in a very large customer global 5,000 companies with multi-year contracts. And so that's definitely something we want to focus on. I think Diane and Thomas have been working closely on a transition with a lot of continuity, and you'll continue to see us. It's very clear to us that our product offerings are ready and differentiated, and so we want to invest and scale our go-to-market both in terms of direct sales and our channel partnerships. Maybe you will see us focus more on areas where we’re clearly seeing returns, be it the geographic regions we care about, the six main verticals where most of the momentum is. And within product offerings, the five major areas where we’ve clearly defined products with differentiated features too. But I’m excited at the traction we are seeing; we are getting large wins, and I look forward to executing here.

Thank you.

Great. Thanks for taking the questions. I just wanted to ask to, first, can you think about the strong Google Sites growth 23%, that’s actually neutral. Can you just help us understand some of the mobile search innovations that you think are really driving things here beyond some of these underlying secular strength, with the particular focus perhaps on the retail channel, and just how you’re thinking about the opportunity there? And then, second, Ruth, just wanted to go back to your comment on OpEx. Just wanted to clarify, were you saying that headcount growth, specifically you think will moderate in '19 or are you talking about overall OpEx spending? Thank you.

Doug, on the first one, obviously we have thousands of engineers working on continually launching search improvements. I think for me a lot of this has been the clear hard work that's gone into making sure search on mobile works really, really well, removing friction where we can, constantly working to get the answers a bit quicker and faster, and making them more relevant. So to me, it's more a set of a continual innovation mentality that we’ve had there for a long time, and that’s really working at scale.

And then the specific comment I think you’re referencing is I was pointing to headcount growth. We are continuing to hire to support growth opportunities, particularly hiring engineers and product managers in Google and continuing to support growth in Cloud, and what I was just trying to draw out was we will continue to hire, but the year-on-year growth rate will moderate there.

Okay. Thank you, both.

Great. Thank you. Yes, I had a follow-up on to Anthony's questions on Cloud. It doesn’t seem like you want to share an update on the revenue run rate. But I was wondering if maybe you can share with us what you’re seeing in terms of year-over-year growth rate, and in particular are they growing faster than what the competitors disclosed in their public results? Because maybe they will help think about the pace of growth in your Cloud business. And then, secondarily, I was just wondering if you can give us a sense of the types of workloads, if there's any commonality to the types of workloads, you might be running work frequently than not. Thank you.

So, in terms of growth, Cloud does continue to deliver sizable revenue growth driven by GCP and GCP does remain one of the fastest-growing businesses across Alphabet. As Sundar said, we doubled the number of GCP contracts greater than $1 million. We are also seeing a really nice uptick in the number of deals that are greater than $100 million and really pleased with the success and penetration there. At this point, not updating further.

Heather, there are a couple of specific examples that highlight our strengths in data management and analytics. For instance, in retail and with companies like The Telegraph, these aspects are crucial. Our application platforms enable customers to deploy cloud-native applications, which has set us apart for clients like Unity and Ubisoft. Additionally, our Multi-Cloud capability allows services to operate across multiple cloud environments, which is vital for global multinational firms like HSBC. We see a diverse range of opportunities and are concentrating on infrastructure as an application platform, data management, and smart analytics, in addition to G Suite for productivity and collaboration. These are the main areas where we are focusing our investments in both product development and market strategy, and we are experiencing significant traction in these sectors.

Thanks for taking my questions. I have two. Just the first one to go back to YouTube in a very strong quarter. It sounds like on branded advertising and now some of these new direct response ads. I was curious, Sundar, as you think about with an innovation focus, what do you see as being one or two of the biggest opportunities to further improve the quality or the efficacy of the ad product you provide for advertisers on YouTube from here? And then Waymo, got a couple of milestones. But the last 3 to 6 months, maybe talk us through how you see the next one or two big factors that you're really focused on ensuring that Waymo becomes what it could be?

On YouTube, I still think we are in the early days of making sure YouTube is a better platform for direct response and TrueView for action is still early. We see great traction, but I think there's a lot more to do, and I think we had a set of features which we launched last year to make sure it works better. But I think there's a lot more to do. In the long run, I think for me, YouTube is a place where we see users not only come for entertainment; they come to find information, to learn about things, to discover, to research, and so being able to match that intent over time in a way that we can bring the right value for our users and advertisers, I think there's a long run opportunity. And we're taking all the right foundational steps to realize it.

And in terms of Waymo, as you know well, we are intently focused on safety first and ensuring a great user experience, and that's why we're expanding methodically. We are pleased that we’ve continued to broaden out our service in the Phoenix area and we're focused on expanding both the number of riders and the geographic reach around Phoenix. In addition, we're having conversations with a number of other interested cities, and we are continuing to explore applying our technology for logistics and deliveries and for personal use vehicles and for last-mile solutions for cities, so continuing to execute as we’ve described previously.

Thanks. I have two questions. First, Ruth, could you give us more details about the R&D expense increase? Is there anything unusual there? Could you also comment on the pace of that? Then, Sundar, regarding hardware, it's been a long-term effort that appears to be accelerating. We are working on a series of new products and want to ensure we understand them fully. Can you discuss the strategic and possibly synergistic effects you are observing from hardware on Google's and Alphabet's overall business? Do you think it’s still early, and could you illustrate how significant these synergies might be? Thank you very much.

So starting with R&D, the main driver is our ongoing investment in engineers, in particular, in Google, and then as I said, the sizable increase in accrued compensation for Other Bets. To just build that out a bit more and give you a bit more color, in certain Other Bets, employees are compensated through equity-based programs. And that's because we believe that this alignment of interest is valuable. We do assess valuation on an ongoing basis. And at a minimum, we do a formal valuation assessment once every 12 months or when there is a significant event. What you're seeing in the fourth quarter is the impact of higher valuation in certain Other Bets. And as we've talked about previously, a goal with the Alphabet structure is to enable us to build new businesses that would make a positive impact and create long-term value. And it's still early days; we're very excited about the opportunities we see. So what you're seeing is the impact here of valuation. The way we approach it is very consistent with the way startups are typically valued, and that includes technical progress and a range of other items.

And Mark, on hardware, we are dedicated to providing the optimal Google experience by integrating AI, software, and hardware. While there is significant synergistic value, our current focus is on utilizing hardware to enhance our core products within the computing ecosystem, resulting in a considerable leveraged effect. As we continue to scale our hardware initiatives thoughtfully, I believe we will provide an impressive experience. For example, the Google Home Hub demonstrates a seamless interaction across Search, Assistant, YouTube, and Photos, offering a glimpse of what the future holds. Therefore, we are committed to investing in this vision.

Okay. Sundar, picking up on the AI for everyone theme that you’ve been highlighting at I/O and other venues, are conversations with advertisers indicating that products like smart bidding are becoming increasingly popular as a tool in their bidding strategies? How has the adoption been among small and medium-sized businesses, particularly local advertisers? Do you believe you can target that market without a sales force? Additionally, as we discuss two companies transitioning to the Cloud, there is more emphasis on data collection, managing data lakes, and analyzing that data for better decision-making. From your perspective leading Google, do you think the current technology available is advanced enough to meet all the demands of running the company while you gather data from across the internet? Thanks.

I think two questions. On your first question around using machine learning to help serve advertisers better and be able to reach newer advertisers, SMBs and local advertisers, I definitely think you highlight an exciting opportunity. Whenever we’ve done work like last year or the last couple of years through universal app campaigns, smart shopping campaigns last year, responsive search ads, those are all great examples of where we brought machine learning. And with that, we made process much easier for advertisers of all sizes and we see an impact. I think it's a natural extension for us to continue working in that direction, and that will help us reach SMBs and local advertisers better over time. So I do think that's a good opportunity. And on the second part of your question, I want to make sure I understand it. If you’re asking about how we invest in our security as a company, I think it's the foundation of how we do everything for the past 20 years. We realize a deep responsibility that comes with being the stewards of users' data. So everything we design is designed with privacy and security in mind. It's where some of our core investments go, be it securing our data centers, literally the practices we have across the company, the quality and talent in our security teams, and over time using AI itself to do all this well. So it's a core part of what we do and we take it very, very seriously.

Thank you.

Hi. Good afternoon, everyone. Sundar, in your review of some of the shopping products during the fourth quarter, you didn't mention shopping actions. And there were reports there that Walmart decided to leave the program recently, and I think there have been some public comments on social media from Googlers confirming that. So I would just love to hear a little bit more about that. But maybe more broadly the traction of shopping actions and, in particular, the price per sale metric that you rolled out with it during the holiday season. And then, Ruth, just a quick one for you, if we could return to your prepared remarks, there were a couple of sort of things to keep in mind that you’re highlighting. One was FX going from a tailwind to a headwind, but just before that you were talking about how new experiences can rollout over time to users. And I just wanted to clarify, were you referencing an experience that’s rolling out currently, or just generally that that is a best practice in general for Google? Thanks.

On shopping, we launched shopping actions around March of last year and have seen strong traction since then. There’s been roughly a sevenfold increase in merchants participating in the program since its launch. In Q4, we announced new partnerships with Best Buy, Nike, and Sephora, for example. Walmart remains one of our key partners and continues to collaborate with us across various businesses, including Google Ads. We are actively working on closer collaboration with them in shopping. They are an important partner who is still experimenting, and we will support them in multiple ways. Overall, I’m excited about our shopping initiatives and you can expect us to focus more on that in 2019. We notice that users frequently turn to Google during significant shopping moments, and we want to enhance the experience to align better with their needs.

And then on the second question, we've talked about this on prior calls. We've often talked about the fact that we have been and remain committed to long-term revenue growth through innovation. And the point I was trying to underscore is the timing and scale of the impact. It's inherently difficult to predict. And so it can be inconsistent from quarter-to-quarter. The main point is we remain very excited about the opportunities for users and advertisers, in particular, building off of Sundar's comment as we apply machine learning to solutions.

Great. Thank you, both.

Great. Thank you. Two quick ones for me. First on Project Stream and YouTube TV. Just wondering how important it will be to invest in original content as well as how you might view the rollout of 5G as catalyzing consumer adoption of these services? And then on the Discover feed, I know that’s still pretty new, but curious if you have any color on usage and engagement to date? And if there's any way you expect to monetize that feed in the near future? Thank you.

On Project Stream, delivering gaming with real-time and low latency requirements is a significant computing advancement for us. We believe it will enhance the new computing platforms we're developing. As 5G is introduced, we anticipate that services like this will create a positive cycle. We're enthusiastic about the feedback on our Project Stream experience, which has been very positive. We're planning to build on that and will be doing more in 2019. Regarding Discover, our success is measured by engagement and satisfaction levels, which have been impressive. We provide the best experience on our products, such as the Pixel, and aim to expand our reach to more users. We have a strong product that complements the search experience, and we look forward to bringing the best of both to our users as we expand in 2019.

Thank you.

Great. Thank you. A couple of questions. First, it looks like Google core margins were down about 3 points and what was an easier comp. So just wondering if you can give us any thoughts on how the core advertising business is doing in there? We know there's a lot of investment in Cloud and hardware and YouTube TV, but just would like to get an update on the health of the advertising business margins. And any thoughts on if you ever do segment disclosure? And then the second question is just on the Cloud strategy. There's been a pretty big leadership change. Just wondering if there's any new strategies or new things you will be doing this year with the Cloud related to the management change? And look forward to the Cloud Conference in April. Thank you.

Thanks. In terms of Google margins, the main point is that we see significant opportunities across Google, prompting us to invest for long-term revenue and earnings growth. We've emphasized the importance of machine learning, which plays a crucial role in additional investments, especially in capital expenditures for technical infrastructure supporting both existing and new businesses. This is reflected in our margins. We're also aware that capital expenditures translate into depreciation, which is why I mention this. The ads business, including Search and Ads, is thriving, and beyond machine learning, we're investing to improve the user and advertiser experience across Mobile, Desktop, and YouTube. For instance, a key focus in 2018 was to expand content availability for what we refer to as next billion-user markets, which are critical for us. We are enthusiastic about growth and the chance to deliver experiences in these markets. Additionally, we're investing in more visual ways to access information, like through photos and videos. We are also heavily investing in our newer businesses within Google, particularly Cloud and Hardware, as Sundar has already indicated. Hence, the impact on our margins reflects the product mix we discussed; a significant part of that is the ongoing strength in YouTube. On the operational expenses side, we are investing in engineering talent for Google, along with an increased headcount in sales and marketing to support not only Ads but especially Cloud.

In response to the second question regarding Cloud, I previously addressed Anthony and Heather's inquiry. To provide additional insight, it appears that the transition in leadership was well-planned, with Diane and Thomas collaborating on the 2019 strategy. A major focus will be on global 5000 companies, and we are experiencing success with large, multi-year contracts worth millions. Our efforts will concentrate on expanding sales and distribution channels to meet customer demand, which will be crucial in 2019. We will maintain a strong emphasis on the 15 countries, six industries, and five key solution areas that we believe will make the most significant impact, directing most of our resources towards these initiatives throughout the year.

Thank you.

Great. Two questions. First, there's a lot of discussion right now about alternatives to Google Play and Apple's App Store for distribution. And some of the large developers are starting to come up with these workarounds around the App Store fees. So, I guess, just philosophically, how do you think about the 30%? Do you think that’s the right long-term rate for Google Play? And then, Ruth, coming back to the headcount and CapEx growth moderating comments, so you have expenses growing well in excess of revenue for some time in the core Google segment, and 2018 was the lowest operating income growth since you started disclosing the segments. So are you just flagging this as a change of direction? Is this a material change or is this just a small amount of moderation in 2019? Thank you.

On Google Play, we operate at a large scale; numerous developers depend on it to securely and efficiently deliver their games to billions of Android users globally. We invest significantly in our infrastructure to ensure that their overall experience remains safe and leads to strong engagement for the developers. There is a value exchange in this model, which has become the industry standard. We intend to continue on this trajectory while adapting to market developments.

So the reason I started by laying out, I think, in response to the question on margins where we're investing and how we look at is, we are very focused on investing to support long-term revenue and earnings growth. We are very mindful of the CapEx impacts on free cash flow and earnings growth. So we're trying to get it right; over-investing, under-investing neither of those works for long-term value creation, but we are very mindful of the pace here and trying to lay out work with more specificity, how we are looking at the opportunity set and making trade-offs where we can.

Thank you.

Thanks everyone for joining us today. We look forward to speaking with you again on our first quarter 2019 call. Thank you and have a good evening.