Alphabet - Earnings Call - Q3 2015
October 22, 2015
Transcript
Sundar Pichai (CEO)
Good day, ladies and gentlemen, and welcome to the Alphabet Inc. Third Quarter 2015 Earnings Conference 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. If anyone should require operator assistance, please press star then zero on your touch-tone telephone. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Ellen West, Vice President, Investor Relations. Please go ahead.
Ellen West (VP of Investor Relations)
Thank you. Good afternoon, everyone, and welcome to Alphabet's Conference Call on Google's Third Quarter 2015 Earnings. With us today are Ruth Porat and Sundar Pichai. As you know, we distribute our earnings release through our Investor Relations website located at investor.google.com. Please refer to our IR website for our earnings releases, as well as the supplementary slides that accompany the call. This call is also being webcast from investor.google.com. A replay of the call will be available on our website later today. Now, let me quickly cover the safe harbor. Some of the statements that we make today may be considered forward-looking, including statements regarding Alphabet's 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 2014 filed with the SEC. Any forward-looking statements that we make are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. 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. The press release and an accompanying investor presentation are available on our website at investor.google.com. And now, I'll turn the call over to Ruth.
Ruth Porat (President and CFO)
Thanks, Ellen. We turned in a strong performance in the third quarter, notwithstanding continued meaningful currency headwinds. The key highlight this quarter was the substantial growth of our mobile search revenue, complemented by ongoing strong contributions from YouTube and our programmatic business. I will first give you a summary of the quarter, followed by specific financial details, and conclude with comments regarding our upcoming move to segment reporting. Sundar will then review the business and product highlights of the quarter, after which we will take your questions. Beginning with a summary of our financial performance, total revenue was $18.7 billion, up 13% year-over-year and up 5% sequentially. As a result of the ongoing strengthening of the U.S. dollar, we realized a negative currency impact on our revenues of $1.6 billion, or $1.3 billion, after the benefit of our hedging program.
Holding currency constant to prior periods, our total revenue grew 21% year-over-year and 7% sequentially. On a GAAP basis, operating profit was $4.7 billion, and the operating margin was 25%. On a non-GAAP basis, operating profit was $6.1 billion, and the operating margin was 33%. GAAP operating income was up 26% versus last year, and GAAP net income from continuing operations was up 36% year-over-year. As a reminder, the year-on-year increases reflect a non-cash impairment charge of $378 million in the third quarter of 2014. Non-GAAP operating income was up 15% year-over-year, and non-GAAP net income was up 19% year-over-year. GAAP earnings per diluted share were $5.73. Non-GAAP earnings per diluted share were $7.35. As detailed in the earnings slides on our IR website, stock-based compensation totaled $1.4 billion, up 14% year-over-year, and up 27% sequentially.
With respect to stock-based compensation, the increase reflects the fact that our annual equity refresh grants were made in the third quarter, as well as headcount growth. Headcount increased 16% versus last year and 5% versus 2Q15. Sequential growth reflects typical seasonality, with new grads starting, the vast majority of whom are engineers and product managers. Let me now turn to key elements of our financial statements, starting with our primary revenue sources. Google Sites revenue was $13.1 billion, up 16% year-over-year and up 6% sequentially, notwithstanding currency headwinds. Year-on-year and quarter-on-quarter growth reflects substantial strength in mobile search due to ongoing improvement in ad formats and delivery to better address how consumers use their mobile devices. YouTube revenue continues to grow at a significant rate, with growth driven primarily by video advertising across TrueView and Google Preferred.
Network revenue was $3.7 billion, up 4% year-on-year and up 2% sequentially, continuing to reflect the significant growth of programmatic, offset by the traditional network businesses. Other revenue was $1.9 billion, up 11% year-over-year and up 11% sequentially. Given the geographic mix of our Play business, FX also had an impact on other revenue. Year-over-year growth was driven by Google for Work, including Cloud, as well as continued strong growth in Play. Both were offset by the absence of revenues included in 3Q14 from a licensing agreement and lower hardware sales as we reached the end-of-life cycles for certain Chromecast and Nexus devices. Next, let me discuss revenues by geography, which will highlight the impact currency headwinds continue to have on our non-U.S. business. U.S. revenue was up 19% year-over-year to $8.8 billion, and up 9% versus Q2.
U.K. revenue was up 10% year-over-year to $1.8 billion, and up 7% sequentially. In fixed FX terms, the U.K. grew 18% year-over-year and 7% quarter over quarter. Rest of world revenue was up 7% versus last year to $8.1 billion and up 2% versus Q2. In fixed FX terms, revenues were up 23% year-over-year and up 5% sequentially. The acceleration in U.S. and U.K. growth, in particular, reflects the growth in mobile search. Finally, on monetization, as a reminder, these metrics similarly are affected by currency movements. Aggregate paid clicks grew 23% year-over-year and 6% sequentially. Aggregate CPCs were down 11% year-over-year and 1% sequentially. In terms of the drivers, within Google Sites, paid clicks were up 35% year-over-year and up 7% sequentially. Google Sites CPCs were down 16% year-over-year and down 2% sequentially.
The movement in Google Sites paid clicks and CPCs primarily reflects the continued growth in YouTube TrueView. Network paid clicks were down 5% year-over-year and flat sequentially, reflecting the impact of our ongoing policy changes designed to reduce lower quality inventory on AdSense for Search, consistent with our focus on improving the user experience. Network CPCs were down 4% year-over-year and up 1% sequentially. Let me now turn to expenses. Total traffic acquisition costs were $3.6 billion, or 21% of total advertising revenue, essentially flat as a percentage of revenue sequentially and down slightly year-over-year. As a reminder, the Sites TAC line includes the TAC that we paid to search distribution partners for distributing Google search as distinct from their own branded search.
Non-GAAP other cost of revenues was $3.2 billion in Q3, up 16% year-over-year, primarily driven by costs associated with operating our data centers, including depreciation, as well as content acquisition costs primarily for YouTube and Play. Non-GAAP operating expenses were $5.7 billion, or 31% of revenue, up 14% year-over-year and up 7% versus Q2. The increase in operating expense versus comparable periods was primarily driven by R&D expense. A breakout of individual operating expense lines is available on our earnings slides. Other income and expense was $183 million. The effective tax rate was 19% for the third quarter. Turning now to CapEx and operating cash flow. CapEx for the quarter was $2.4 billion, reflecting investments in production equipment, data center construction, and facilities. Operating cash flow was $6 billion, with free cash flow of $3.6 billion.
Finally, turning to cash, we ended the quarter with a cash balance of approximately $73 billion, of which approximately $42 billion, or 58%, is held overseas. As we announced today, our board has authorized us to commence a repurchase of our Class C capital stock of up to $5.099 billion. This decision is consistent with our overall capital management framework and complements a disciplined capital allocation program. Our primary uses of capital will, of course, remain CapEx and M&A across the breadth of our businesses. So now, let me conclude. Starting in the fourth quarter with our move to segment reporting, we intend to provide additional detail for Google on the one hand and all the other Alphabet businesses on the other hand. We refer to those other Alphabet businesses as Other Bets.
We expect Other Bets to include, among others, Access and Energy, Nest, Life Sciences, our investment arms, and X, which is where driverless cars and certain other incubation efforts reside. Specifically, we intend to disclose for both Google and Other Bets revenues, profitability, and CapEx. By doing this, we expect that you will be better able to understand how we manage the businesses, including the pace and allocation of our investments. As Larry said in his CEO letter announcing Alphabet, we are focused on rigorously managing capital allocation and working to make sure each business is executing well. With that preface, let me turn to four key themes. First, in terms of revenues, our strong revenue growth in Q3 reflects the ongoing momentum in Google, with acceleration in mobile search complemented by the strength of YouTube and programmatic.
The Other Bets are earlier stage businesses, which we believe have significant longer-term revenue potential. In the near term, the focus there is on optimizing our investments. Second, with respect to profitability, we remain focused on managing expenses within our control while investing to support the growth areas we have in Google and Other Bets. Segment reporting, by definition, provides greater insight into the profit dynamics within Alphabet. Third, as to CapEx, the vast majority to date, of course, has been to support Google, where we continue to invest given our exciting opportunities globally. At the same time, CapEx and Other Bets is expected to increase through next year as we continue to execute on the growth agenda there, in particular in Access and Energy, which contains our fiber business, among other efforts.
Fourth, our growing cash balance remains a powerful tool, giving us the flexibility to invest in the breadth of opportunities we have within Google and Other Bets, as well as to selectively pursue compelling new bets. I will now turn the call over to Sundar, who will go into more detail regarding our business trends and products.
Sundar Pichai (CEO)
Thanks, Ruth. I'm glad to be here with you all today to talk about the areas we have focused on now and in the future at Google. There is a real sense of energy and focus throughout the company, and we are seeing momentum across our businesses. Products like Search, Android, Maps, Chrome, and YouTube each have over a billion users already, and Google Play crossed that milestone this quarter as well. But what's most exciting is that we are just beginning to scratch the surface. We know that computing transforms people's lives. We have gone from the PC revolution to the internet revolution to the mobile revolution. And 10 years from now, everything will be different again in ways no one can predict.
Our vision is for Google to remain a place of incredible creativity and innovation that uses our unique technical expertise to tackle big problems and create that future. We do this arm in arm with our partners around the world. Today, I want to touch on three key areas that are important for us. First, making information accessible and useful. Then, how we are building computing platforms used by billions of people. And lastly, how we are driving growth in our core advertising business, as well as new emerging businesses. Let's start with the first area. Google's core mission has always been to organize the world's information and make it universally accessible and useful. Search continues to be at the center of this, with people turning to Search on mobile every day to find quick answers. In fact, Search traffic on mobile phones has now surpassed desktop traffic worldwide.
We are also seeing strong mobile momentum in many emerging markets like India, which is the number two country for mobile search queries behind the U.S. This is the result of our laser focus on helping users quickly find the right information. People just want to be able to find the information they are looking for on mobile without having to worry about whether it lives on the mobile web or within apps. Mobile app usage, as well as web usage, is accelerating significantly. We have now indexed more than 100 billion deep links within third-party apps. So if you're looking for information that lives within an app, we'll surface it as a result and even give you an install link if you don't already have it. The teams have made great progress, and 40% of searches now return app index results in the top five results.
These investments have gone well, and you'll continue to see us push in this area. We also continue to improve the Google app. For instance, app developers can now build conversational voice experiences that work within the Google app. So if you ask Google to play NPR, NPR will respond by asking if you want to pick up where you left off or catch up on the latest news. It's also very important that we help to make the mobile web better and faster for users, both through our own products and by partnering with others. Working with over 30 publication and technology partners, we recently announced an open-source initiative called Accelerated Mobile Pages to make it easy for publishers and content creators to build super fast web pages for their content. This will help make the mobile web a better, more enjoyable experience for users.
I also want to point out that our investments in machine learning and artificial intelligence are a priority for us. Machine learning has long powered things like voice search, translation, and much more. And our machine learning is hard at work in mobile services like Now on Tap, which quickly assists you by providing additional useful information for whatever you're doing, right in the moment, anywhere on your phone. If you're an Android user that runs Marshmallow, try it out by long pressing the home button when you're in an app. It's very cool. Another example is the Google Photos app, which leverages powerful machine learning technology to help people discover, organize, and share their photos. It's a great product that people love.
In fact, in just a few months since we launched it at Google I/O, Photos is now used by over 100 million users who have collectively uploaded more than 50 billion photos and videos. Now, I want to talk about how we are building computing platforms that are used by billions of people. We'll continue to invest in large open ecosystems that we build with partners to reach great scale. Android is a prime example of this, and we are seeing exciting momentum on our platform. There are more than 1.4 billion 30-day active Android users around the world, and we are beginning to roll out Android Marshmallow, which is our best-performing release yet. Working with partners Huawei and LG, we announced the newest devices joining our Nexus family, the Nexus 6P and Nexus 5X.
They're beautiful and powerful devices that show off the latest and greatest that Android has to offer, and they've gotten tremendous reviews so far. We also announced the Pixel C, which is the first Android tablet built end-to-end by Google that brings together the benefits of a full-size keyboard with the portability of a tablet. We are also creating platforms for newer areas of computing, such as Android Wear, which now works with iOS as well. Android Auto, the Internet of Things platform that we unveiled at I/O, Brillo, and of course, Chrome. Chrome also powers Chromecast, and our recent Chromecast update gave it a refreshed look and faster performance. We also introduced Chromecast Audio, which lets you stream your favorite music from your phone to any set of speakers.
To date, we have sold over 20 million Chromecast devices and have seen over 1.5 billion taps of the cast button since we launched. We're also seeing great momentum in our ads business. Our value proposition to marketers of all sizes is simple. Google can help you show the right ads to the right people at the right moment. As you've heard on these calls before, we are seeing a major shift in consumer behavior towards micro moments. These are moments of high intent when consumers are looking to find, buy, or do something. They happen throughout the day, most often on mobile devices. The single biggest theme throughout our advertising business is to help small businesses, large marketers, agencies, and content creators to take advantage of this mobile opportunity. In search advertising, there's a huge amount going on.
Advertisers like Dunkin' Donuts and Airbnb are turning to mobile search to capitalize on these key moments, reach customers, and create engaging local experiences. We also recently made Search Ads and Google Play available to all developers, letting app developers find new customers for their app at a great price where it matters. Many smart developers are already taking advantage of this. At Ad Week, we introduced Customer Match, which lets marketers reach their existing customers with customized search ads on Google.com, as well as ads on YouTube and Gmail. Of course, these are really valuable for reaching key customers at moments of high intent on mobile devices. With the holiday season coming up, we are investing in providing great shopping experiences on mobile.
We are also helping marketers understand how Search Ads are driving in-store sales with products like Store Visits, which uses our unique mobile location capabilities and is easy for any business to implement. Moving to YouTube, every day people watch hundreds of millions of hours on YouTube. You know from the last quarterly call about the amazing momentum that YouTube has in mobile, and it's largely coming from the YouTube app. The growth in mobile watch time also extends to videos featuring product reviews and information. People turn to YouTube when they want to research, buy, or fix a product. For example, mobile watch time for apparel videos has doubled this year, and videos about toys have also doubled. We see the same growth in advertising on the platform too.
We continue to invest in building ways for marketers to reach consumers effectively, like our recently announced Shopping ads for YouTube, which lets people shop directly from a video, turning any relevant video into your digital storefront. In programmatic video and display, the strong momentum continues. The number of advertisers using our programmatic solutions has nearly doubled in the last year and a half and now includes over 80% of Ad Age's top 100 advertisers. Additionally, both mobile and video impressions served on DoubleClick Bid Manager have grown more than 3.5x since last year. This is an area that's on fire for us right now, and you'll see us continue to invest in creating the best programmatic solutions for advertisers and agencies. Before I close, I want to touch on a few of our emerging businesses where we see enormous opportunities. First, digital content.
Google Play continues to be a thriving hub for our digital content business, now with over a billion users. And just yesterday, I was really pleased that we announced YouTube Red, our YouTube subscription service for just $9.99 a month. It enables you to see videos on YouTube without ads, watch them offline, or keep playing videos when you lock your screen or start using another application. Additionally, our Google for Work business is seeing tremendous growth. In the third quarter, we crossed one million paying active customers using Google Drive at work. Cloud is also a growing area where we see great opportunity, and we are building a fantastic service that we'll keep investing in.
Our momentum in the education space continues as well, with more than 50 million Google Apps for Education users worldwide and over 10 million teachers and students using Google Classroom since it launched a year ago. There are also 30,000 new Chromebooks activated in schools in the US every school day. That's more than all other devices combined. So to wrap up, we have tremendous new opportunities in our new and existing businesses. We are really excited by the products and platforms that we are building for people everywhere in the world, and we are passionate about the transformative power of computing to improve people's lives in the years ahead. Thank you to everyone for your keen interest in our business, and thank you to all of the Googlers around the world for another great quarter. And with that, I'll hand it back to Ruth.
Ruth Porat (President and CFO)
Thank you, Sundar. We will now take your questions.
Operator (participant)
Thank you. Ladies and gentlemen, if you have a question at this time, please press star, then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Mark Mahaney from RBC Capital Markets. Your line is now open. Please go ahead.
Mark Mahaney (Managing Director)
Great. Thanks. Two questions. Could you talk about the sustainability of the mobile search revenue growth that you see there? Is that just really being driven by finally the gapping up of kind of mobile search pricing versus desktop pricing, or is there something else going on? Then, Ruth, I was just trying to figure out how you came up with that your repurchase number, and I've been Googling that number a couple of times.
I can see it's 26 to the E18 of the square root of that. But outside of that, how did you come up with that particular amount of share buyback? Why not more? Why not less? Thanks.
Ruth Porat (President and CFO)
Thanks, Mark. So starting on the sustainability of mobile revenue growth, as I said in my opening comments, revenue growth really reflects continued improvement in ad formats and delivery. And that's on top of what's a really strong industry-wide global growth in mobile usage, as you know well. And then we regularly adjust the way we present ads. So we expanded ad space in some queries with particularly high commercial intent to display more relevant mobile-friendly ads. And our view is just as we saw consumer behavior change on desktop, we're seeing the same on mobile. And as Sundar said, we continue to believe we're in very early innings here.
And then in terms of sizing, so this is the way we approached it. If I take you back to the capital framework that I laid out last quarter, it's defined primarily by CapEx and M&A, but also includes working capital and a buffer, as well as the potential return of capital. We remain focused on solving the biggest problems and solving them at scale, and that presents sizable potential revenue opportunities. It was a key catalyst for creating Alphabet. But these opportunities also require investment. So the focus of our team is on prioritizing these opportunities over a multi-year period. We look out kind of as we're modeling it out a number of years. Then working with the board, we reviewed our outlook.
We reviewed the opportunity set, and we concluded that layering in this action at this time complements what we view as a very disciplined budgeting process while still, very importantly, providing ample capacity to pursue the growth agenda. And then applying this framework, once we had come up with a size that we believe fits and consistent with the way we do things around here, we decided to come up with some fun math similar to the way we approach sizing the IPO. It sounds like you've backed right into what that was. We do view it as the right action at the right time, and it really is anchored in the framework.
Mark Mahaney (Managing Director)
Thanks, Ruth.
Ruth Porat (President and CFO)
Thanks, Mark.
Operator (participant)
Thank you. And our next question comes from Ross Seymore from Deutsche Bank. Your line is now open. Please go ahead.
Ross Seymore (Managing Director)
Thanks. I had one for Ruth and one for Sundar. Ruth, so back to the mobile search question. The bear case on Google has been the company's ability or lack thereof to port the search business model from PC over to mobile. And you called out mobile search as the key driver of acceleration in both the U.S. and the U.K. So can you just give us a little bit more color around the volume trends that you're seeing between desktop and mobile as you cross that 50% threshold that you talked about last quarter? And then Sundar on the platform side, it seems like every few years new companies crop up as the next big Android OEM. Looks like it's Huawei now. It's been other companies in the past. How do you plan on getting Android to a point where all these OEMs can build successful businesses on the back of it?
And any update on when Google plans to roll out the Play Store in China would be helpful. Thank you.
Ruth Porat (President and CFO)
So starting with mobile and our outlook there, clearly, as I said, mobile search revenue was up significantly, and it was an important catalyst in the quarter. But the very important thing to note, as we discussed also last quarter, is the desktop remains a solid contributor. And so we continue to have healthy growth there. And when we look, if you step back overall sites revenue, we're firing on all cylinders. Really strong growth in mobile. Desktop's healthy and continuing to grow. And then you layer on top of it YouTube and some of the color that Sundar added there. But that's really a continuation of what we talked about last quarter as well.
Sundar Pichai (CEO)
And on the platform side, look, we continue to see tremendous momentum overall on Android. In just over a year, we've gone from 1 billion to 1.4 billion users. So obviously, that translates into huge opportunities for OEMs, and that's what we are seeing. Especially, there are whole new markets opening up. There's a next billion users coming online in emerging markets. And businesses, I mean, enterprises, a whole opportunity for OEMs as well. So I think there's a lot of room ahead.
Operator (participant)
Thank you. And our next question comes from Carlos Kirjner from Bernstein. Your line is now open. Please go ahead.
Carlos Kirjner (Managing Director and Senior Analyst)
Thank you. I have two questions, one for Sundar and one for Ruth. Sundar, in two parts, if you take a three-year view, what are the three main milestones you think you need to reach to be successful as Google CEO? And what do you think would be the externally observable consequences of achieving these milestones?
Ruth, in the last call, you talked about the 70-20-10 framework. Can you help us understand what the 70-20-10 applies to? Is it related to operating expenses, our expenses and costs in the P&L, CapEx, R&D, management time? Is it an explicit constraint in the budgeting process, or am I trying to read too much into something that's just a conceptual framework and a broad guideline? Thank you.
Sundar Pichai (CEO)
Thanks, Carlos. In terms of how I think about it, I think we are fortunate to have an incredibly broad mission statement. Organizing the world's information turns out to be something that has a lot of room ahead. We are still in early days.
Especially with mobile, I think you have a computing platform that's going to reach. It's already reached half the world's population or on its way to reach the entirety of the human population in about five to 10 years. So I want to stay focused on that, both from an information standpoint and a computing standpoint. I think of them as two sides of the same coin and making sure we are building the right user experience for that.
Ruth Porat (President and CFO)
And then on 70-20-10, it's intended to be instructive, and it's intended to mirror the founders' vision and really capture how we devote our resources, which for us means how do we apply effort.
And for me, one of the many very important statements from the founders that explains this framework is when they said in the letter some years ago and repeated since, incrementalism in technology leads to irrelevance, and thus innovation is critical. And so this mantra is really about pushing people to look at newer areas, invest in newer areas, look for things that are adjacent, the 20%, and even the unrelated big bets, the 10%. It's not intended to be a specific guide to financial modeling. I think with our move to segment reporting, we look forward to giving you more information next quarter, which should be helpful there, but directionally, to talk about philosophically how we think about our approach to the business.
Carlos Kirjner (Managing Director and Senior Analyst)
Thank you.
Ruth Porat (President and CFO)
Thank you.
Operator (participant)
Thank you. And our next question comes from Heather Bellini from Goldman Sachs. Your line is now open. Please go ahead.
Heather Bellini (Partner, Managing Director)
Great. Thank you very much. This question is for Ruth. I was just wondering, given you're likely in the midst of 2016 business planning right now, can you share with us the way in which you're approaching budgeting versus maybe how it was done last year? And are there any specifics you can share with us in terms of how you're thinking about it? Thank you.
Ruth Porat (President and CFO)
Well, I guess a couple of things. There's been a very strong foundation here on budgeting and the approach and setting an envelope and working very closely with business leaders on what that envelope should be. And we are in the midst of it. And as I said last quarter, but to emphasize, our priority remains revenue growth, and that doesn't give us a pass on a rigorous approach to expense growth. And that's where we're focused.
So I think really what was very encouraging for me is there's a framework, a very strong approach to financial planning and analysis, and really building on that to make sure we have reasonable but tight envelopes so that we can have the right conversations collectively, collaboratively with our business leaders to assess how we can look at optimizing all of our resources. And that's what it really comes down to. It's looking at how to manage the rate of growth of expenses while still supporting our growth initiatives. And we'll be going into more of that as we go through our segment reporting in the fourth quarter.
Heather Bellini (Partner, Managing Director)
Thank you.
Operator (participant)
Thank you. And our next question comes from Brian Nowak from Morgan Stanley. Your line is now open. Please go ahead.
Brian Nowak (Managing Director)
Thanks for taking my questions. I have one on YouTube. I guess, could you just talk to some of the qualitative drivers that are really bringing more advertising dollars onto YouTube? And then I think last quarter you'd mentioned top 100 advertisers spend was up 60% year-on-year on YouTube. I wonder if you could update us on that. And the second one on search, it sounds like mobile is accelerating. Where are you now in the mobile versus desktop monetization gap? And Sundar, how do you think about that long term? Do you see mobile being higher, reaching equilibrium? How do you see that trending?
Sundar Pichai (CEO)
On the YouTube one, look, I mean, the shift to video is a profound medium shift, and especially in the context of mobile. And obviously, users are following that. You're seeing it in YouTube as well as elsewhere in mobile. And so advertisers are being increasingly conscious. They're being very, very responsive.
And so we are seeing great traction there, and we'll continue to see that. They are moving more of their traditional budgets to YouTube, and that's where we are getting traction. On mobile search, to me, increasingly we see we already announced that over 50% of our searches are on mobile. Mobile gives us very unique opportunities in terms of better understanding users. And over time, as we use things like machine learning, I think we can make great strides. So my long-term view on this is it is as compelling or, in fact, even better than desktop, but it'll take us time to get there, and we're going to be focused till we get there.
Brian Nowak (Managing Director)
Thanks.
Operator (participant)
Thank you. And our next question comes from Eric Sheridan from UBS. Your line is now open. Please go ahead.
Eric Sheridan (Managing Director, Equity Research)
Thanks for taking the question. Maybe a big picture question with respect to media distribution, media consumption, and monetizing that usage across all the platforms that you distribute media. I'm sort of curious about the various business models you've now put in front of consumers: subscription versus advertising versus pay-per-unit like on Google Play, how you think about the pros and cons of some of those distribution models, and how you think about the need to maybe source content yourself for media distribution. Thanks.
Sundar Pichai (CEO)
Thanks. To me, we want to stay focused on the user experience, and we want to follow what users want, right? So if you take something like YouTube, we expect most users to consume YouTube the way it has been, and advertising has been a strong part of providing that content for free to those users, and it's growing very, very well.
But we also see a need for certain users in certain scenarios, be it music or gaming or for premium content, to experience it in a different way. And we want to make sure we do that. So we don't have a prescriptive opinion on this as much as we will provide the right user experience and follow where it goes. And that applies to Google Play as well.
Operator (participant)
Thank you. And our next question comes from Justin Post from Bank of America Merrill Lynch. Your line is now open. Please go ahead.
Justin Post (Managing Director and Senior Equity Research Analyst)
Thank you. Two things. Ruth, it really does seem like there's been a change in the management philosophy this year as far as kind of expense discipline and to Q2. Also have seen the disclosures, and now you get the buyback announcement.
Can you talk about the change there, if there has been one, and how you think about that? And then the second thing, we're pretty focused on the cloud over here. Google, we don't have a number. It's in your other revenues. But Amazon's probably $8 billion plus run rate, Microsoft over $1.5 billion. Just wondering if you can give us any thoughts on your cloud strategy and how you're thinking about using those really strong data center assets. Thank you.
Ruth Porat (President and CFO)
So I guess I would say a couple of things on expenses and expense management. And clearly, a lot of the foundation here was laid some time ago. I think after a period of big expense buildup, there was an appreciation that we needed to manage the cadence of spend. And that's what we're doing. And collectively, we're locked arm in arm to make sure that there's resource prioritization.
I think that's an important part of it. We have an extraordinary set of opportunities, not just within Google, but across the Alphabet businesses. And we need to ensure that prioritization is a key part of all that we do. I would note that when you're looking at some of the expenses, operating expenses as an example, when we look forward to the fourth quarter, in particular, given the hardware launches that we've done here with the Nexus, Chromecast, and Pixel launches, consistent with prior device launches, we would expect higher sales and marketing. And I realize I'm getting a little more specific than your question, but I think it's very important to note that there are also certain patterns to some of these. Similarly, with CapEx, CapEx has been a bit more muted here. And I indicated last quarter that we're in a bit of a digestion period.
But when you look forward to 2016, we do see accelerated investment given the nature of the businesses that we're building up here. So I want to also just make sure we keep things in perspective. And I think it's been an extraordinary experience joining this team. I think that with the move to Alphabet, it gives us the opportunity to then provide some greater insight into the extraordinary operating performance within Google and breakout so you can see the investments that we're doing. And we're working very tightly as a senior team here as we make that next step into this new environment in Alphabet.
Sundar Pichai (CEO)
On the cloud side, on the cloud side, as you observed, I mean, it's an exceptional opportunity. I think it just reflects as a secular shift. Every business in the world is going to run on cloud eventually.
And so we view it as an amazing opportunity. We are uniquely qualified to do so. As you pointed out, we have tremendous experiences in running large-scale cloud services. And it's been only in the past two years in earnest we've been taking those assets and serving customers outside. For me, what's exciting is as I look at new customer adoption, we are seeing tremendous momentum. We are very competitive in each of those situations. And we are investing a lot and playing for the long term.
Operator (participant)
Thank you. And our next question comes from Douglas Anmuth from JPMorgan. Your line is now open. Please go ahead.
Douglas Anmuth (Managing Director and Head of US Internet Equity Research)
Great. Thanks for taking the question. Sundar, I wanted to ask about mobile. You talked about it being greater than 50% of queries and wanted to ask if you have a view on when that will pass 50% of clicks. And then also your thoughts on what happens to desktop pricing and demand as that happens. How do you think about the tail on the desktop business as mobile just continues to take share? Thanks.
Sundar Pichai (CEO)
The interesting thing we are seeing is when we talk about mobile, mobile as a computing paradigm is eventually going to blend with what we think of as desktop today as well. So overall, it's a shift in a computing paradigm. So it's not just form factors. And so over time, we see all of this is together. What matters to us is as people evolve, their computing paradigm search transitions to that world, and we are the best source to provide that information. So along that line, I expect all the metrics to follow the trend. And so we only see all the right indicators.
And so I think we're positioned for the long-term well. So I can't comment too much on the specifics beyond that.
Douglas Anmuth (Managing Director and Head of US Internet Equity Research)
Thank you.
Operator (participant)
Thank you. And our next question comes from Ken Sena from Evercore. Your line is now open. Please go ahead.
Ken Sena (Senior Managing Director, Global Head of Internet Research Coverage)
Thank you. I just have an ad format question, maybe just to follow up on Eric's. We noticed that there was an additional ad slot added on mobile. And can you just maybe talk through the decisioning on that? And if so, is there anything we should interpret as far as the other ad formats that have been used too? Thank you.
Ruth Porat (President and CFO)
Well, big picture, what we're doing is looking at ways to use the mobile screen space to be as useful as possible for users. So this quarter, we had some important changes, and we're always focused on innovation. And we're growing in a growing market.
But as we've said, we're looking at how consumer behavior is changing. And just as it did on desktop, we're seeing the same on mobile. And the notion of trying to make sure we're being as useful as possible for users is a key driver here, and we'll continue to innovate.
Ken Sena (Senior Managing Director, Global Head of Internet Research Coverage)
And maybe just as one follow up, can you say anything then maybe in terms of the success or the efficiency that you're seeing in terms of the text-based mobile ads versus more of the other structured data ones around product listing ads or hotel price ads and so forth?
Ruth Porat (President and CFO)
Yeah, there's probably not much to add there.
Ken Sena (Senior Managing Director, Global Head of Internet Research Coverage)
Okay. Thank you.
Ruth Porat (President and CFO)
Thank you.
Operator (participant)
Thank you. And our next question comes from Anthony DiClemente from Nomura. Your line is now open. Please go ahead.
Anthony DiClemente (Managing Director, Internet and Media Research)
Thanks a lot. I have two, one for Sundar and one for Ruth. Sundar, is ad blocking something that has the potential to have an impact on the business either in the fourth quarter or longer term? And then, Ruth, in terms of M&A, just wondering if the buyback might indicate that the company is becoming a bit more selective around large acquisitions than it's been in prior periods of the company's life cycle. Thanks.
Sundar Pichai (CEO)
Thanks, Anthony. On the ad blocker stuff, it's not a new phenomenon. I think it's important to understand that ads today fund almost all the services which people use, including products like Google Search, Google Maps, many, many third-party products. For publishers, it represents the majority of their revenues. And I think users are okay with the contract, and we need to make sure it works well. It's also clear that there are areas where the ad experience is getting in the way. It affects performance.
And so we as an industry need to collectively do all that better. And so we are going to work hard to do that. And so we want to make sure we transition areas like the mobile web to have better ad experiences. But overall, I think we are used to this. We have seen this for a while. Overwhelmingly, the model works well, and we expect that to continue.
Ruth Porat (President and CFO)
And then in terms of your M&A question, and I talked about how did we think of sizing the return. I started with what's really most core to us, which is continuing to focus on the biggest problems and solving them at scale and ensuring that we're investing in those. And as I said, that's primarily defined by, obviously, the opportunity, but how do we support the growth? That's about capital expenditure and about M&A.
And those are really the anchor pillars in our capital framework. And then beyond that, there's working capital and a buffer and then the potential return of capital. We've talked about the fact that we have six products that have over a billion users. Three of those were through acquisitions: YouTube, Android, and Maps. That is not lost on us. And then you layer on top of that DoubleClick. That was also through acquisition. So we have viewed acquisition, and at the time, it wasn't clear, I'd say to everybody, that those would end up being the incredibly powerful businesses, effective businesses for users that they are today. And so it remains a part of what we consider. The bar is high, but I certainly wouldn't want you to read anything into it beyond what it is. It fits right within our framework.
And as I said, we view it as the right action at the right time.
Anthony DiClemente (Managing Director, Internet and Media Research)
Understood. Thank you.
Operator (participant)
Thank you. And our next question comes from Paul Vogel from Barclays. Your line is now open. Please go ahead.
Paul Vogel (Managing Director)
Great. Thanks. Two questions, please. First, just when we think about search and deep linking, can you just sort of quantify a little bit how important deep linking has been to either clicks or ROI or improvements in CPC on mobile? And then the second question, just as we think about the more transparency going forward in Q4, how should we think about businesses that currently are in the Other Bets line that may continue to grow? And what would be considered to move something from Other Bets into core Google? Thank you.
Sundar Pichai (CEO)
On the deep linking, I would view it as we're beginning to scratch the surface in terms of how we get information within apps. What's been exciting to us is all early indications show that when we provide these deep links, users respond to them the same way they've done with links to websites, and the model is working well. The second thing, maybe we can.
Ruth Porat (President and CFO)
Yeah, interesting in the way you've framed the question. So within Other Bets, we have a pretty broad array of challenges, opportunities that are being tackled, as you know well, from Life Sciences to driverless cars to what we're doing in Access and Energy. And those we're funding. We've got a very rigorous disciplined approach to looking at the metrics against which they're performing and growing. But you used a term, "When do they move into Google?" And I wouldn't assume that that's the plan.
What we're really looking at is how do we continue to broaden the nature of issues that we're able to address. What we want with Alphabet is to be an extraordinary magnet, the best magnet for entrepreneurs, and to be an accelerant for their development and to give them the kind of environment where we can continue to thrive and therefore build great businesses that generate tremendous returns as well for our stakeholders on top of solving big problems. But that doesn't necessarily mean, in fact, we're very much thinking they will continue to grow and be independent entities. So it's a broader view of what is Alphabet.
Paul Vogel (Managing Director)
Got it. So just to be clear, it's not about that they're sort of newer or smaller or growing. It's just that they're a separate business that will grow on their own separate from the core Google?
Ruth Porat (President and CFO)
Our view is that we are seeding them, and they are growing, and we're not predetermining what ends up happening. They're big opportunities, and we're excited to be in a position where we can address them in a way that is an incredible magnet for great entrepreneurs.
Paul Vogel (Managing Director)
Thank you.
Ruth Porat (President and CFO)
Thank you.
Operator (participant)
Thank you. And our next question comes from Stephen Ju from Credit Suisse. Your line is now open. Please go ahead.
Stephen Ju (Managing Director)
Okay. Thanks. Sundar, so I think it was on a conference call about three years ago when Larry articulated a vision of a simple and consistent consumer experience from Google and the same for your advertising customers as well. So as this is your first conference call with investors, where do you think you are on that initiative today?
Are you still on the same path, or do you plan to take that in a different direction in your new role? And Ruth, despite the high growth of YouTube and Play, presumably, are your cost of goods sold where the content costs for these two businesses live? It's not growing as rapidly. So will you give some color on where you might be driving the leverage? Thanks.
Sundar Pichai (CEO)
On the first one, I think the vision that Larry articulated is a very compelling vision, and it's still valid. To me, the way I think about it is mobile is a good forcing function in some ways. It's a good constraint for us to focus and deliver against that vision. So what I'm doing is internally, all our objectives are primarily focused on mobile.
And how, within the context of mobile, we get to a better, simpler, and a consistent experience for consumers and advertisers. And so that framework is how we are thinking about it. And I think we are making solid progress.
Ruth Porat (President and CFO)
And then if you're focusing on the other cost of revenue line, the year-over-year and quarter-over-quarter growth was driven by ongoing data center operations, including depreciation that's in there as well, as well as content acquisition costs, as you said, primarily YouTube and Play. One thing to note as we look forward to the fourth quarter with the launch of Nexus, Chromecast, and Pixel; it's worth noting that we do book the hardware costs in this line.
Stephen Ju (Managing Director)
Thank you.
Ruth Porat (President and CFO)
Thanks.
Operator (participant)
Thank you. And our next question comes from Mark May from Citi. Your line is now open. Please go ahead.
Thanks. I had two questions that are kind of interrelated around mobile apps. When you talk about the strength in mobile search, are you including also searches that are done on some of your mobile apps, like a search done on the Maps app or on the mobile YouTube app? And then kind of somewhat related, I guess, is you have, I think, it's six apps that have over a billion users globally, but some of these you're not really monetizing today or very nascent stages. Can you talk about kind of your efforts maybe to monetize some of these large and actively used apps and maybe identify one or two where you're, I guess this is for Sundar, where you're particularly sort of excited about the opportunities? Thanks.
Sundar Pichai (CEO)
Thanks, Mark. On the first one, I mean, we are specifically talking about the mobile search experience on Google.com or the Google app, but we are seeing the same traction within Maps or YouTube. We are seeing mobile usage dramatically grow, and in that context, people are searching as well. It's across the board we are seeing strength. In terms of our apps which have scaled, and obviously, we take a very long-term view, and several of those apps today already play a huge role. For example, take Google Maps. It already plays a huge important role in making mobile search better, and so these are interrelated. YouTube is obviously a big opportunity. Google Play is one, and even things like Gmail are playing a critical role in Google for Work and how we are driving big business opportunities as well.
And by the way, because we are scaling all these apps over a billion users, we are building the infrastructure, which is what will power our Cloud Platform externally as well. So in many ways, these are all working for us.
Operator (participant)
Thank you. And our next question comes from Colin Sebastian from Robert W. Baird. Your line is now open. Please go ahead.
Great. Thanks. I want to ask about two areas of the business mentioned on the call. One is machine learning, and it's just coming up a lot more frequently as a topic. And I wonder if you could mention more specifically the vision that you have for some of the core applications and how machine learning can make them more useful.
And then just as a follow-up to the question on the Google Cloud and specifically the infrastructure as a service layer, I wonder there if your strategy is more focused on price or if there are other ways that you can differentiate the service from the competition. Thank you.
Sundar Pichai (CEO)
Machine learning is a core transformative way by which we are rethinking everything we are doing. We've been investing in this area for a while. We believe we are state-of-the-art here. And the progress, particularly in the last two years, has been pretty dramatic. And so we are thoughtfully applying it across all our products, be it Search, be it Ads, be it YouTube and Play, etc. And we are in early days, but you will see us in a systematic manner think about how we can apply machine learning to all these areas.
On cloud, I think the right way to think about it over time for a company or for a developer to build stuff on cloud, they need not just basic things like compute and storage. They need a whole set of services on top of it. So there is a lot in the stack. And so I think the way we will differentiate over time is because we have built large services on top of our infrastructure. We understand all the layers which you need to build great applications. So you will see us increasingly provide value-added services on top of compute and storage. And that's the way I think we'll play this.
Operator (participant)
Thank you. And that's all the time we have for questions. I would now like to turn the call back to Ellen West for any closing remarks.
Ellen West (VP of Investor Relations)
Great. Thanks, everyone, for joining us today. We look forward to speaking with you again on our fourth quarter call. Thank you and have a good evening.
Operator (participant)
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.