GOOG | Q1 2017

Operator: Good day, ladies and gentlemen, and welcome to the Alphabet first quarter 2017 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session, and instructions will follow at that time. I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead.

Ellen West: Thank you. Good afternoon, everyone, and welcome to Alphabet's first quarter 2017 earnings conference call. With us today are Ruth Porat and Sundar Pichai. While you were waiting, you were listening to the infectious song "Diggy," by Spencer Ludwig. Spencer is a new, exciting artist on Warner Bros. Records who is touring Europe this month. You have heard his trumpet stylings when he performed with Capital Cities on "Safe and Sound." Be sure to check out his official "Diggy" video on his YouTube channel. Now I'll quickly cover the Safe Harbor. Some of the statements that we make today may be considered forward-looking, including statements regarding our future investments, our long-term growth and innovation, the expected performance of our businesses, and our expected level of capital expenditures. These 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 Form 10-K for 2016, filed with the SEC. Any forward-looking statements that we make are based on assumption as of today, and we undertake no obligation to update them. 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. As you know, we distribute our earnings release through our Investor Relations website located at abc.xyz/investor. This call is also being webcast from our IR website, where a replay of the call will be available later today. And now I'll turn the call over to Ruth.

Ruth Porat: Thank you, Ellen. Our revenues of $24.8 billion in the first quarter demonstrate our broad-based strength globally, with revenues up 22% year on year. In constant currency, our consolidated revenues grew 24% versus 1Q 2016. Growth in advertising revenues was again driven by mobile search, with ongoing strength in YouTube and programmatic. We also had substantial growth in other revenues from Play, hardware, and Cloud. Our outline for today's call is, first, I'll review the quarter on a consolidated basis for Alphabet. Given the obvious seasonality in Q4, I will focus on year-over-year changes in our results. As a reminder, I will review our results on a GAAP basis, which includes stock-based compensation for operating income, net income, and earnings per share. Second, I will review results for Google and then Other Bets. Finally, I will conclude with our outlook. Sundar will then discuss our business and product highlights for the quarter, after which we will take questions. Let me start with a summary of Alphabet's consolidated financial performance for the quarter. Total revenues were $24.8 billion, up 22% year over year. We realized a negative currency impact on our revenues year over year of $304 million or $87 million after the benefit of our hedging program. Holding currency constant to the prior period, our total revenues grew 24% year over year. Turning to Alphabet revenues by geography, as you can see in our press release, we've enhanced the geographic split to give you more insight into our businesses around the world. We are now reporting our revenues in four regions

Sundar Pichai: Thanks, Ruth. It's been a terrific start to the year. This quarter was notable for the fantastic momentum across our products. Advances for the Google Assistant, the launch of YouTube TV, and lots of new features launched at our Google Cloud Next event. In the next few weeks, there's much more to come. We'll host our annual developer conference, Google I/O; our advertising event, Google Marketing Next; and our YouTube upfront, Brandcast. I hope you'll join us. Today I'll discuss three things. First, how our continued investments in machine learning are fueling innovation across Google, and particularly how it's helping drive our core mission of providing access to information for everyone. Second, progress in three of our biggest bets

Ruth Porat: Thank you, Sundar, and we will now take your questions.

Operator: Thank you. And our first question comes from Douglas Anmuth of JPMorgan. Your line is now open.

Douglas T. Anmuth: Thanks for taking the question. I had two. First, just, you talked about Cloud as a huge strategic priority. Could you just talk more about the go-to-market strategy for GCP and how you plan on building up the reseller channel there going forward? And then secondly, Sundar, on Waymo, I was curious on some of your thoughts. I know it's early, but on the timing for Waymo to become commercially viable. And then what are the key guideposts and requirements along the way? Thank you.

Sundar Pichai: On the Cloud stuff, talking about go-to-market, as Ruth said in Q1, our largest growth in head count and CapEx was in Cloud. So we are thrilled with the progress we have made there since Diane arrived, building our world-class sales, marketing, and engineering teams. The heavy lifting, I would say, is around how we meet enterprises in the market. We have reorganized so we have one face to the customer. So it's not just sales reps. We've been thoughtful about how we have built out the entire go-to-market organization. So we created two new areas that customers can now take advantage of. One is the office of the CTO, which helps customers solve difficult technical problems. And the second is our Advanced Solutions Lab, where customers can get help from machine learning experts. And on top of that, now we have a phenomenal support team that helps keeps customers' applications up and running. So I think what we have done – our approach is one Google. When a customer sings up for Google Cloud, they get more than GCP and G Suite. They have access to the ads and analytics teams, YouTube teams, and resources within our organization. So I think it's coming along quite well.

Ruth Porat: And then on your question on Waymo, we view Waymo as a great example of a graduate from X that's addressing a sizable problem and builds off of tremendous technology here. We started with safety; we remain a leader in safety. And we continue to view that as the foundation for success. And at this point we're exploring many options enabling ridesharing, personal-use vehicles, logistics, and deliveries, and we also see opportunities to work with cities to address public transportation. So the announcements that we made this week are a continuation of the progress the team has made. We do have a strong relationship with Fiat Chrysler, increased our car order, given the opportunity. They have been our primary partner to date, but to note we're in active discussions with others around the globe. And then I think, importantly, the trial in the Phoenix area is something that's been in the works for some time, and we do look forward for that trial. So it's still in the early days, and we're excited about the upside from Waymo.

Douglas T. Anmuth: Great. Thank you both.

Operator: Thank you. And our next question comes from Heather Bellini of Goldman Sachs. Your line is now open.

Heather Bellini: Great. Thank you. I also wanted to ask a question about Cloud as a follow-up. I was just wondering, Sundar, if you could share with us what's the feedback been since Next from your Cloud customers? And could you share with us how qualitatively – something so we can gauge just kind of whether this business is starting to see an inflection in growth or not? Is there anything you could give us qualitatively about how the pipeline is building in this area? And I guess just what I'm interested in is also the types of conversations you're having with customers now versus maybe six years ago. I'm sorry – six months ago. Sorry about that. Thank you.

Sundar Pichai: Time flies fast. Next was – having done Google I/O many, many times, I was surprised to see the scale and growth of Next from even last year to this year. We had five many times as people. I think everyone really appreciated seeing large customers, very sophisticated customers, like HSBC, eBay, Colgate-Palmolive, et cetera, discussing use of Google Cloud, GCP. Along with Diane, I did follow-up lunches with a set of people, and so the feedback has been very positive. People sense our commitment to the area. They understand the pace at which we are investing. They see that we are committed to machine learning and AI at a deep level. They appreciate how we are open-sourcing things. Facetalk was extraordinarily well-received. They are noticing the acquisitions we are making, Kaggle and AppBridge are a couple of acquisitions which happened around that time. So all that, all those details, I think clearly made an impact. I just spoke about the go-to-market progress, and I think that's beginning to get traction as well. In general, I think there is a very strong recognition that we are have pivoted to being a deep enterprise company, and our conversations are very strategic. We are engaging at the highest levels within companies. And so, overall, I can see qualitative lead and momentum there. When we are in the middle of deals, we find we are very competitive, and there are areas where customers perceive us as best-in-class already. So it's been exciting to see.

Heather Bellini: Thank you.

Operator: Thank you. And our next question comes from Eric Sheridan of UBS. Your line is now open.

Eric J. Sheridan: Thanks for taking the question. Sundar, you mentioned Google Assistant in your remarks. Wanted to know, what have you seen in terms of consumer adoption of Google Assistant, whether at the Pixel level or the Google Home level? What does it give you in terms of sense of how people want to interact with the Assistant? What it might do in terms of putting artificial intelligence capabilities down to the consumer level and improve consumer experiences over the next couple years? Thanks so much for the color.

Sundar Pichai: Good question, Eric. Pixel is a good example, because I think it's the place where we do the leading work here. And how we presented Google Assistant and the Pixel – well-received, both qualitatively in terms of consumer feedback we get, quantitatively in terms of how we see people using voice, how we see people interacting with overall Google Assistant and Search better. So we find that when we drive the Assistant experience well, it works overall in helping people engage with Google at a broader level. It's always surprising to us – we always said, even with Search, every single day we see so many new types of queries. When you bring the assistant into the mix, you start getting even more different tips of queries, and queries are more casual, more conversational. And so over time I think it starts breaking down the barriers to computing people have, and that's what makes it very, very exciting. Now, artificial intelligence will help us push all that further. Just to give an example, we will make text to speech much, much better over time. Yesterday, we announced our Neural Machine Translation is launching in nine new languages. So all that starts accruing to the Assistant, and I think we'll overall improve the customer experience pretty dramatically. We'll talk about all this a lot more at Google I/O, so stay tuned.

Operator: Thank you. And our next question comes from Mark Mahaney of RBC. Your line is now open.

Mark Mahaney: Great, thanks. Two questions, please. One on YouTube and one on Google Maps. Sundar or Ruth, there was some press about some of the pushback or some of the controversy around content and advertising and monetization of that. Are those technical problems that can be solved over time? Or is just the magnitude or the volume of content in trying to keep bad content off the site, however that's defined, and keep it from being monetized, is that an ongoing technology challenge or did you already find a solution? Then did you see any material impact to advertisers' budget interest with YouTube? And then if you could also comment briefly on Google Maps. This is one of those massive properties that you've owned that's highly used by almost everybody, and I think the monetization to date has been really de minimis. Is there anything that's changed for you in terms of your thought about the ability to monetize Google Maps over time? Thank you.

Sundar Pichai: On advertising and monetization in YouTube, we talked a bit about it. We have taken it pretty seriously, and we are taking significant steps. And obviously as part of doing that, we have brought new technical solutions into place. Machine learning is a great example of it. It helps us enforce – as we improve our policies, it helps us enforce it better. And we are in early days, so as machine learning gets better, I think we'll be able to do all of this even better and create that virtuous cycle. Overall, I'm pretty confident at the rate at which we have made progress. And we're going to continue investing a lot here. It is super important to us that this ecosystem works well. It matters for advertisers. It matters for content creators. And so we take that responsibility very seriously. I would say advertisers have clearly noticed all the improvements we have made. Our conversations with them are very, very positive, and so I'm pretty optimistic about how we'll continue to make progress here. On Google Maps, your question is – it's a good question. I get surprised at, for a property which we had launched many, many years ago, even now it's showing strong growth, especially in emerging markets. Maps is an integral part of your mobile phone. And users get more interested in the real world around them with AR and so on, I think Maps will continue to play a bigger role. We take a long-term view. It's already impacting monetization very significantly for us with local search. So today, when you use Google, a lot of the information we are able to do is because of Google Maps. But I'm sure you've noticed changes within Google Maps over the past few months. If you open Google Maps, you're traveling or you're out on a Friday evening, we start surfacing a lot more interesting information about what you can do, places to eat, and so on. So those are beginning to get good feedback from users, and I think that gives us an opportunity to add value there over time as well.

Mark Mahaney: Thank you, Sundar.

Operator: Thank you. And our next question comes from Peter Stabler of Wells Fargo Securities. Your line is now open.

Peter C. Stabler: Good afternoon. Thanks for taking the question. Wanted to follow up on Mark's question on the local opportunity. Assuming that you agree it's a large one, what kind of steps are you taking to educate the smaller businesses out there on the opportunities you have? You've mentioned increasing take-up of local inventory ads. We understand that. But more generally, a go-to-market strategy on how you reach the millions of SMBs out there in terms of educating them on the growing opportunities on a local basis. Thanks so much.

Sundar Pichai: It's a great question. And I think there's a lot of opportunity for us. Today we have many touch points. Obviously people – we reach out to SMBs, they want to get listed in Search and in Maps. AdWords Express has been a big part of how they want to advertise on our platforms. We obviously provide things like Google Apps to SMBs. So we have a lot of touch points, and internally we are beginning to do a much better job of reaching out and having a more thoughtful go-to-market approach. I think there's a lot more work there, but the rate at which we are seeing advertisers – small, medium businesses – on our platform has been growing very, very strongly as well. So indications are that it's already currently working at scale. We have millions and millions of SMBs on our platform, and the number continues to grow very well. But you'll see us invest a lot more here in the years ahead.

Peter C. Stabler: Thank you, Sundar.

Operator: Thank you. And our next question comes from Brian Nowak of Morgan Stanley. Your line is now open.

Brian Nowak: Thanks for taking my question. Could you talk a little bit more about the retail search category? Any high-level commentary on consumer search-query trends in retail, either an area of strength or otherwise? And then you talked about the real-time local-inventory integration, but, Sundar, I'd be curious if you could talk about any opportunities or areas of innovation in the retail search space that you see to really continue to improve users' retail-search experience. Thanks for the color.

Sundar Pichai: I think obviously when we see what users are looking for in mobile, how shopping is evolving, it's an area we're continuously working on. I've been happy to see the evolution in our shopping experiences. Retail overall also happens to be an amazing category for us from a Google Cloud standpoint, so in some ways we are developing deeper partnerships with retailers around the world. And so as we start doing that, and I think as we get a better understanding of their inventory and the data, how we can translate all of that into our core experience is a bit of the work ahead. I think that's what excites us about the longer term. Shorter term, I think it's a space we continue to invest in. We are actually seeing strong trends in that category.

Brian Nowak: Great, thanks.

Operator: Thank you. And our next question comes from Dan Salmon of BMO Capital Markets. Your line is now open.

Daniel Salmon: Hey. Good afternoon, everyone. I've got two questions on YouTube for Sundar. First, this morning on the earnings call, WPP's CEO, Sir Martin Sorrell, noted that the company is being very responsive, I think were his words, to some of the recent concerns that we'd talked about earlier in the Q&A. We've also seen some official policy changes, things like that. I'd be interested, Sundar, to hear a little bit more about some of the softer outreach that you may be doing, thinking of Philipp Schindler's team, maybe the agency relations team, and how your people are reaching out and connecting with their clients, especially as you go into Brandcast? And then the second follow-up on YouTube was, I'd be interested to hear your updated thoughts on the role of the YouTube Spaces. I think Ruth's prepared comments on CapEx mentioned some investments in production equipment. I don't know if that is related to that or something related to Cloud, but it does seem that the Spaces remain an important part of YouTube and continue to grow. And I'd love to hear an updated view on them. Thank you.

Sundar Pichai: On the first part, (43

Ruth Porat: Yeah, Exactly. In the CapEx, when I talked about production equipment, we were talking about machines, and that was the primary driver here. We're investing more machines given both our growing requirements and the higher cost of the new generation of machines and accelerators. So that will be more expensive in the short term, and we are continuing to build our inventory. But it does increase performance, and we believe reduce total cost of ownership in the longer term, so just to clarify that on CapEx.

Daniel Salmon: Okay, great. Thank you both for the color.

Operator: Thank you. And our next question comes from Ross Sandler of Barclays. Your line is now open.

Ross Sandler: Great. I'm not sure if this is for Sundar or Ruth, but a question about regulatory. You guys recently reached an agreement in Russia around the Android bundling issue, where you're going to provide options for other browsers and search engines and app stores when a new Android phone is activated. So I was just wondering if this is the right way to think about these kinds of disputes in other areas of the world, where you may be under some regulatory pressure around Android bundles, or if that was kind of a one-off, isolated agreement. Thank you.

Sundar Pichai: I think – without getting into specifics, I think when we deal with regulatory issues, I mean, the concerns vary differently depending on local laws and what the concerns are. I think in the case of Russia, I think there were some specific issues. And I'm glad we were able to work together with the regulatory agencies there, with our partners there, to come to a good solution. I'm not sure that's the right template. But as much as we are very committed to making sure we work with all the right agencies in all the countries we operate in, and I'm confident we'll get to a good place.

Operator: Thank you. And our next question comes from Justin Post of Merrill Lynch. Your line is now open.

Justin Post: Great. Thank you. Sundar, ahead of this advertising conference I was thinking about Search innovation. And over the last four years, you've had an acceleration with PLAs, a really acceleration with the third ad link. And I'm just wondering, maybe you could talk about what excites you. Or do you think there's still a lot to go on Search monetization or coverage? And then from Ruth, obviously so many areas you can invest in. You could cut price on Cloud. You could really ramp up engineers in the core or Cloud. Just a lot you can do. And just how does the management team think about balancing profitability versus driving market share and long-term growth? Thank you.

Sundar Pichai: On Search, I continue to get surprised by the kind of things users reach out to us for and how that keeps evolving and changing. And with the Assistant now, too, just exposes a whole new surface area. And so I think there's a lot of innovation ahead. In terms of monetization, I think about it – it still looks like there is a lot of – for example, if you just look at retail, 90% of retail is still offline. So there are many, many secular trends like that, which we look at and we see a huge opportunity to help connect users to the information they are looking for. So, structurally, I do think we still have lots of both innovation and growth ahead for the long term, and that's how we think about it. Maybe to Ruth on the second part?

Ruth Porat: Yeah, and really actually building on that, to answer the second part of your question. When we look at the ongoing momentum that you've seen here in Sites revenue, it really does go to innovation. No one change tends to drive results, it's really the combined benefit of all that we're doing across the franchise, continuing to invest in the business and the benefits that we see there. And that's the way we look at it, is we have tremendous opportunity continuing in mobile search and in YouTube across the business there. And as we're looking at these newer opportunities, all that we're doing in Cloud, in hardware, YouTube subscription businesses, we analyze each one of those individually, working very closely with the leaders and the milestones that are established there. We do very much across the business have an operating principle that too many resources and too few can lead to suboptimal decisions and execution. And so what we're looking at over a multiyear period is the pace of innovation that's appropriate, given the sizable opportunity. But the key point – and I've said it on so many different calls – is that we remain focused on long-term value creation. And we're excited about the growth opportunities, not just within Google but across Alphabet with all that we're doing in Other Bets. And so we're looking at these, again, individually, over a multiyear period, looking at milestones, and appropriately calibrating the pace of investment that is logical. And at the same time, we continue to have a focus on enhancing efficiencies where we can. But overall, as I keep saying, our main priority remains revenue and profit dollar growth.

Operator: Thank you.

Justin Post: Thank you.

Operator: Our next question comes from Michael Nathanson of MoffettNathanson. Your line is now open.

Michael B. Nathanson: Thanks. I have two for Sundar. The first is, now that you've launched YouTube TV, I wonder if you'd tell us about the advertising opportunity there. And then what are you going to do, given all the assets, to maximize an inventory for marketers? And then secondly, I wonder, with that focus on brand safety you hear now from agencies and the bigger marketers, what's going to be the long-term impact, do you think, to YouTube programmatic from a more focused view on finding the right places to advertise?

Sundar Pichai: On your first question about YouTube TV, we're just getting started. I think the product is really intended for the YouTube generation. It's really great to see a take on how to consume TV, which is mobile first for that generation. And I think – I've been using the product and enjoying it. And I think that gives – as (50

Michael B. Nathanson: Okay, thank you.

Operator: Thank you. And our next question comes from Anthony DiClemente of Nomura. Your line is now open.

Anthony DiClemente: Thanks for taking my questions. I have one for Ruth and one for Sundar. Ruth, Sites TAC as a percentage of revenue grew sequentially and year over year. I totally understand that mobile search is contributing meaningfully to the profit dollars, but as we look at the Sites TAC as a percentage, is there a quarter or is there a point in time looking forward where that sort of elevated TAC growth rate will anniversary or fall back into line with Sites revenue growth as a growth rate? Is there anything you can do to proactively manage that TAC growth? And then for Sundar, on YouTube, as the competition out there for video content really intensifies, to what extent is YouTube providing more favorable economics to its content creators in order to ensure that YouTube remains the leading platform and, importantly, in a lot of cases, an exclusive platform for your most popular channels? Thank you.

Ruth Porat: So on Sites TAC, as we've often discussed, and as you said in your question, there are a number of factors that affect Sites TAC as a percentage of Sites revenue, and the primary driver has been the strong growth in mobile and the fact that more mobile searches are subject to TAC. The other factors include the mix of paid versus organic, as well as changes in partner, mix, or agreement terms. And when we look year over year, the primary driver of the increase is – very much to your question – the strength in mobile search. And we do expect Sites TAC to increase as a percentage of revenues. But, again, our focus continues to be on growing profit dollars. And I think the main point is we're very pleased to have a very strong business in a rapidly growing area. And that's benefiting our profit dollars even as the TAC percentage increases.

Sundar Pichai: And on YouTube, when I look at it from a content creator standpoint, I think there are a lot of factors which are working well. So, for example, when we recently invested in original shows, we find that like over half the time people spend watching originals is on their mobile phones. We find that creators who are featured in originals experience a significant boost in YouTube subscribers and watch time on their main channels as well, often from new fans. So all of this shows us that the enthusiasm which is there for the platform, how creators can do unique things which are different from what they can do on other platforms. And I think that's what gives us the differentiation here. And in these areas, we are just getting started, and so there's a lot more to come. And I think that will help us provide better economics for them, better engagement for them, and I think positions us well.

Anthony DiClemente: Thank you both.

Operator: Thank you. And your next question comes from Ben Schachter of Macquarie. Your line is now open. Benjamin Schachter - Macquarie Capital (USA), Inc. Sundar, when we think about virtual reality and augmented reality, from your point of view, what are the key steps that are needed to see more mass market appeal and usage? And could you help quantify the amount of investment that you are willing to place in this area before you expect to see a payoff? Thanks.

Sundar Pichai: So I think obviously you're seeing we are very happy with the progress we have seen with Daydream. Just like we built Android, we are good at building platforms and ecosystems, and I think we are taking the right first steps with VR there as well. When I broadly look at VR and AR, I think all of us clearly understand the potential, and technically we are making the breakthroughs that are needed. And all of it needs to converge, from a hardware, software, services standpoint, to a stage where it has mass-market appeal. And I think that is still some ways away. The thing which gives me excitement is all these changes start happening with a set of early adopters and moves mainstream, and so we're engaging at that level with the early adopters. And that's where Daydream is working well. We are learning how to write great content on top of VR. YouTube, Google Earth VR, Tilt Brush – these are all great examples. So underlying technology wise, be it all the kinds of sensors and tracking you need to do, the machine learning and AI you need, things like voice recognition, everything – it's just a computing evolution, so everything we are investing today in machine learning and AI, as well as what we're doing in our computing platforms, transitions well. So I think we're already well-positioned to play this, and so I think we'll thoughtfully approach it. And we'll approach it more holistically.

Operator: Thank you. And our final question comes from the line of Colin Sebastian of Robert Baird. Your line is now open.

Colin Alan Sebastian: Thank you. I guess just as a follow-up to the question on voice interfaces and personal assistant, something that Larry also called out in his founder's letter. It appears there are more tests around monetization, including transactions and integration with Shopping Express. I wonder if there's a view internally now as to how best to make that transition in a voice-first world towards monetization, towards voice and less tech spend and video-centric? Thank you.

Sundar Pichai: We are very focused, actually, on the consumer experience now, and it's a good question. And we've always had these questions, be it the early days of Search or when YouTube was first built out. How do I see (58

Colin Alan Sebastian: Thank you.

Operator: Thank you. And that concludes our question and answer session for today. I'd like to turn the conference back over to Ellen West for closing remarks.

Ellen West: Thanks, everyone, for joining us today. We look forward to speaking with you again on our second quarter 2017 call. Thank you, and good day.

Operator: Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.