Alphabet Inc - Class C (GOOG) — Q2 2019 Earnings Call Transcript

Thank you. Good afternoon everyone and welcome to Alphabet's second quarter 2019 earnings conference call. With us today are Sundar Pichai and Ruth Porat.

Thanks Ellen. Q2 was an exciting quarter at Google. We made several big announcements at I/O, YouTube's Brandcast, and Google Marketing Live. They're all part of our broader vision to build a more helpful Google for everyone. When we say everyone, we mean users, developers, creators, partners, advertisers, and all the customers of our growing cloud business and the communities we call Home. From the beginning, Google's mission has been to organize the world's information and make it universally accessible and useful. Over the years, we have evolved from a company that helps people find answers to a company that helps you get things done. Today, I'll share how we are approaching this work. Building a more helpful Google starts with advancing our core information mission. In Q2, we have made a number of improvements to our founding product, Search. We redesigned our mobile search page and brought our popular full coverage feature to search to better organize news results. We are also integrating augmented reality into Search. So, if you're searching for new shoes online, you can view the shoes in 3D or even superimpose them onto your wardrobe to see if they match. Thanks to advancements in AI, we are making significant improvements to the Google Assistant. The next-generation Assistant can process requests up to 10 times faster, making it easier to multitask, compose emails, and even work offline. With features like Duplex on the web, that system will soon be able to help users book rental cars and buy movie tickets. If you are searching for the fastest way home, Google Maps will now tell you when your bus is delayed or how packed your next train will be. We have rolled this out to people in 200 cities worldwide.

Thank you, Sundar. In the second quarter, total revenues of $38.9 billion were up 19% year-on-year and up 22% in constant currency. Once again, our results were driven by ongoing strength in mobile search, in particular, as well as YouTube and Cloud. 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 we'll conclude with our outlook. We will then take your questions. Let me start with a summary of Alphabet's consolidated financial performance for the quarter. Our total revenues of $38.9 billion reflect an acceleration in both reported and constant currency revenue growth across all regions compared with the first quarter. Details of our results by geographic region are available in our earnings press release. Turning to profitability. On a consolidated basis, total cost of revenues, including TAC, which I will discuss in the Google segment, was $17.3 billion, up 25% year-on-year. Other cost of revenues on a consolidated basis was $10.1 billion, up 35% year-over-year, primarily driven by Google-related expenses.

Thanks for taking the question. I really appreciate all the additional commentary and disclosure in the remarks. I think investors will find that really helpful. Sundar maybe could you, one bigger picture question. A lot of innovation on the product side in the early part of this year. Now those products are going to start getting rolled out in the back part of this year and into 2020. Can you give us a little bit of additional color on what some of the key investments you're making, some of the key themes you're trying to drive in terms of pushing the organization to collaborate on product launches and leveraging the strength within Google? And then the second part of the question would be, as you lower friction for consumers on the product side, what are you hearing from advertisers on the monetization side about how those products might resonate on the monetization piece? Thank you so much.

Thanks Eric. In terms of the key investments, we have been focused on our investments in AI. So that continues to be a foundational investment we are making across the board, including getting a lot of our engineers trained on AI techniques, etc. It's an important area we are focused on. And making sure, digging deeper to push our products to be more helpful is the main theme by which we are evaluating everything we do. Beyond that, the focus on cloud has been a big part of it, continuing to scale up YouTube including being focused on content responsibility. These are all some of the key things we are doing. And of course, deep focus on Search and Assistant being a core part of everything we do. In terms of the work we are doing on consumers and the impact it has on monetization, I do think they go hand-in-hand. As we are making the experience better for customers, including on products like Discover, it allows us to get information to them more seamlessly when they need it. I think they all tend to have a commercial aspect at the right intent when users are interested in it. Taking a long-term view, I think it will resonate on the monetization side as well.

And just building on that question and the impact from some of the announcements that you've seen from us. To just comment a bit on the impact from Google Marketing Live that Sundar referenced at the outset. What’s notable here is that every year at GML, we announce new changes to products and features. Most ad product launches are introduced in phases as advertisers initially experiment with new formats. As a result, the new products announced at GML typically are adopted over time. I wanted to add in here, while we're excited about the new ads products we announced at GML last quarter, we don't view this year's slate of launches differently from introductions made in previous years.

Great. Thanks for taking the question. I was just hoping Ruth, you could just talk a bit more about the accelerating growth that you saw in 2Q relative to the slowdown that we saw in 1Q. It seems in the previous quarter it skewed more to the Google Search side than YouTube. I was just hoping you could provide a little more clarity on how the product changes that you've talked about in the past played out across 1Q and 2Q. Then Sundar, regarding user privacy and control over data, that was certainly a key theme across the multiple events in 2Q. Can you just talk about how you balance those initiatives as you're rolling out products going forward? Thanks.

Starting first with the strength in sites revenue. The growth we talked about this quarter reflects the same underlying trends that we discussed previously. It is the benefit from applying machine learning to both the user and advertiser experience. I am echoing a lot of what we said in prior quarters where we remain very positive about the opportunity set. We introduced product changes only after extensive testing, which means there can be some variability in quarterly growth rates. We're very positive about the opportunity set. Overall, as it relates to both Search and YouTube strength, I would just like to add that YouTube revenue growth was strong in the first quarter, and in the second quarter, YouTube was again the second largest contributor of revenue growth. We are really pleased with the ongoing momentum that we're seeing here.

On user privacy and control, it's always been a big focus for us in some of the things we recently announced. Initiatives are underway, for example, like federated learning for almost three years. I think you will continue to see us focus on this. It’s one of the most important areas we are working on. But with AI, we are excited that we can give better experiences for users with less data over time. Those are the kinds of directions we are pushing. We are also working hard to simplify user understanding of how their data is used and giving them better controls, making it easier for them to manage, ensuring more users actually exercise those controls. Those are all our goals and we’ll continue focusing on that as we move forward.

Thank you both.

Thank you. Ruth, regarding the $8 billion annual run rate for Cloud, could you clarify whether this includes both GCP and G Suite? Additionally, is this figure comparable to the $1 billion mentioned by Sundar in the fourth quarter of 2017? Also, do you have any comments about the distribution between GCP and traditional G Suite? Thank you.

Yes. So, it does include the entire business that Thomas Kurian is leading. Our Cloud business includes both GCP and G Suite, and it is on an apples-to-apples basis. It continues to be the business of the cloud. We're not breaking out the components of cloud as I tried to indicate in opening comments; I'm pleased with the performance of both GCP and G Suite. Growth in GCP was led by strong customer demand for our compute and data analytics products, and G Suite continues to deliver strong growth, benefiting from both new pricing and expansion. Overall, GCP remains one of the fastest-growing businesses in Alphabet and we're really pleased with how the team is executing.

Thank you.

Great. Thank you very much. I'll just echo people's comments about the new disclosure. That's much appreciated. Thank you. I wanted to ask, Sundar, how you've seen your go-to-market and partnership strategies change under Thomas? It does seem that Google has become the more friendly cloud company, if you will, when it comes to partnering with other software companies. I'm wondering if there are any tangible benefits you can point to because of this, whether it's in win rates, partner momentum, or anything else that you can call out. I also wanted to ask about the acquisition of Looker recently. How are you thinking about organic versus inorganic product development, and has the thought process there changed with Thomas now running the business? Thank you.

Thanks, Heather. I appreciate it. Definitely go-to-market, Thomas has been heavily focused on it, mainly with the realization that we are very competitive when we are engaged with customers. So, we are investing heavily in sales, service, partner, and operational teams. As I mentioned in my opening comments, we are looking to triple the size of our sales force over the next few years, and we are doing it aggressively in major markets around the world. Some specifics, we did launch our new partner program, Partner Advantage. The ASAP relationship has been super important to us. We have really focused on that, helping many customers adopt our solutions. Home Depot and Cardinal Health are some examples of that. A big part of it has been really expanding our customer-facing bench with several new senior executive hires in addition to our new Global Head of Sales. Recently, we added a 25-year customer experience veteran to build out our customer support. You will see that focus on serving customers. We have done it in our other areas. We are used to building ecosystems. If you look at an ecosystem like Android, this is what we do. So, that's going to be a focus for us. In terms of inorganic versus organic, we are clearly focused on the areas where we are differentiated. Data management and analytics is a key area for us. As part of that, we looked at gaps we have that would help us complete the solution offering for customers. That's what drove the Looker acquisition. We will be customer-focused and where we see gaps, we'll look at doing it in-house or consider attractive opportunities outside on a case-by-case basis.

Thank you.

Can I try two questions, please? Ruth, just any color on that $25 billion share repurchase authorization, why $25 billion, not $20, not $30? Any color there. Then, when you think about the ad business, we've seen this nice acceleration in Q2, but that's kind of back to norm. There's still this question about what happened in Q1. Was there something in Q1 that you needed to correct in Q2? Is it just the normal rhythms of the search in YouTube and advertising businesses? I find Q1 still a little bit of a question mark. Q2 seems like very much the norm with the last several years. Any color on what could have transpired in Q1 that required some correction in Q2? Thanks.

I'll answer them in reverse order. I tried to comment on that last quarter and reiterated again this quarter. We are pleased with the ongoing momentum in the business. The key point that I'll reiterate is that as much as there is a lot of innovation happening in the business and we've talked about it, we introduce product changes only after extensive testing, which can lead to variability in quarterly growth rates. We're pleased with the strength of the business. The team is extremely focused on delivering for users and advertisers. We have introduced over 100 enhancements to the user interface every quarter, and no one change drives results. There can be timing variability, and we believe it's crucial to stay focused on the right things for the long term and the quality we can deliver. On the capital return, we are maintaining the same capital allocation framework we've discussed before. The primary focus is on investing for long-term growth, and the primary use of capital is to support that growth. The second use is to support acquisitions and investments, as we've been discussing. Given our outlook on cash, we deemed it appropriate to step in again. We've increased our program four times since we began the program in 2015, and we're pleased to announce another increase today of $25 billion, viewing the repurchase program as an effective use of capital.

Okay. Thanks, Ruth.

Thanks for taking the questions. I have two. The first one, Ruth, your comments on YouTube were really helpful in being the second largest driver this quarter and last quarter. I guess with that as a backdrop with the overall acceleration, can you give us a couple of examples of what types of products or advertiser segments or regions resonate particularly well on YouTube this quarter versus last quarter? And then a question for Sundar or Ruth, this has been recent announcement in press about children safety on YouTube. For advertisers and parents on the call, what steps have you taken to ensure that YouTube is safe for kids? What are the biggest areas you're focused on to make sure it stays that way? Thanks.

In terms of YouTube growth, just maybe to add a bit more there given your question, I noted previously that YouTube revenue growth was strong in the first quarter and again strong here in the second quarter. To clarify, the changes in early 2018 regarding sites click and CPC growth were not related to policy enforcement actions at YouTube; they had a negligible impact on YouTube revenues. I wanted to make that clear. The revenue growth was strong last quarter. The click and CPC growth are unrelated to actions on policy enforcement. Our ongoing efforts to protect the YouTube ecosystem remain focused on the right steps regardless of their impact on revenues. An important point is that the removal of content violating our policies has virtually no impact on YouTube revenues. So, consistent growth here. In response to your earlier question about where the growth is, we continue to see substantial growth in direct response. Brand advertising still represents the largest part of the business and is growing at a strong pace.

Regarding your important question about kids' safety, as part of our content responsibility work, it's one of the most critical areas we focus on. We have put significant effort into developing YouTube Kids as a safe product for children and are continuously evolving it, adding more curated content to ensure its safety for kids and giving parents peace of mind. We also ensure that our content responsibility work applies to family-oriented content on the main YouTube app. All our efforts, whether it’s removing harmful content or promoting authoritative high-quality content, are consistently applied across the platform. Rewarding trusted creators is a significant way we help ensure quality content for children.

Great. Thanks.

Good afternoon everyone. Thanks for taking the question. Maybe that’s for Ruth, but Sundar feel free to jump in. The first question here is based on a couple of comments you reminded us in your prepared remarks about YouTube, which was the inclusion of Originals and YouTube TV in the Google Preferred inventory. You’ve given us a little color on direct response growth at YouTube over the last while. Can we assume that those two additions provided a boost to the brand advertising side of the business, as that's more inventory available for that high-quality brand orientation that TV advertisers are looking for? Then, coming back to Google Marketing Live, notwithstanding your comments, Ruth, that it takes some time for products to be adopted, are there maybe one or two announcements there that you would highlight as being potentially particularly material over the longer term? Thank you.

On the first regarding YouTube for brand, I would say it's more secular across the platform promoting higher-quality content. Our work on brand safety and content responsibility adds up to this effort, with creators generating better content. I think all have played a part, and it's more crosscutting. On the second question regarding Gmail, I would highlight discovery ads and gallery ads, as both are pushing us towards mobile-first visually-rich immersive ad formats, which offer great user experiences. I'm excited about changes like that. I think they hold potential and there is advertiser excitement. However, as Ruth mentioned, it's early days, and as we roll them out now, it will take time to play out.

Great. Thanks, Sundar.

Thank you. Ruth, earlier you mentioned the importance of machine learning for driving growth in the quarter, and I'm sure in many recent quarters. I believe many have a hard time understanding exactly what that means. I was hoping you might provide a couple of specific examples of how the company is leveraging machine learning to drive growth and improvements for both users and advertisers. Secondly, for Ruth, in terms of the sites TAC, I know there are a lot of variables involved in changes in sites TAC. How do you see that trending over the next year or two?

For us, machine learning plays a critical role across both the consumer user experience and the ad side. We are generally using machine learning to simplify processes for advertisers and make campaigns easier while providing better insights. For example, processing complex datasets and providing sophisticated real-time insights makes a difference. Also, on the front end for marketers, helping them find the right creator for each moment and managing bidding in real-time is vital. So, throughout the consumer journey, machine learning is making things more efficient, easier to use, and driving productivity.

In terms of the TAC rate, as we've discussed previously, growth in mobile does put upward pressure on the sites TAC rate, which was the primary driver of the year-on-year increase in the second quarter. We do expect the underlying trend to continue given the ongoing growth in mobile.

Thanks. A couple for me as well. First off, as you embrace more commerce and payments on the platform broadly, along with the new ad formats you've talked about, can you discuss the role take rates might play in future initiatives and revenue growth? Secondly, regarding Assistant and Duplex, could you characterize the importance of near-term Search innovation in terms of the momentum you're seeing? Additionally, how might this impact platform monetization in the long term? Thank you.

On the first question, that's a good question. There's a lot of discovery that happens across Google's properties, including Search and YouTube. Anything we can do to improve the user's experience when they are interested in transacting will play a big role. More work is underway to improve payments and sign-ins. All these improvements will drive long-term growth, especially for commercial clicks. In terms of Assistant and Duplex, for us Assistant is where we clearly see value in pushing our goal of being more helpful to users, helping them accomplish significant tasks in the real world. If we get that right, like with Search, there are various objectives users want to accomplish that have commercial intent. That's a value-creation opportunity as well. We are dedicated to making the user experience better, and we are investing to achieve this.

Thank you.

Great. Thank you. Sundar, there's been a lot of regulatory news lately, especially from the DOJ. Just wondering how you think about a more intense regulatory environment. We’re getting a lot of questions on this, and I’m curious to know if you think this will affect Google operations. Ruth, definitely nice acceleration across the board. Of course, Europe accelerated as well. When you think about the GDPR implementation last year and you're lapping that, is that helping Europe at all? Or was there really no impact from GDPR? Thank you.

On the regulatory question, we understand that there will be scrutiny. We will engage constructively. It's not new to us; we have participated in these processes before. Today, we operate under many regulations, including privacy, competition, and copyright laws. Even in the U.S., we have previously engaged in these processes. To the extent we need to answer questions, we will do so constructively. If there are concerns, we'll address those as well. I think, ultimately, it’s important that we stay focused on building helpful products for users; that's the value we provide.

Regarding GDPR, we implemented it late in the second quarter of 2018. It’s a critical area, and we’re focused on making sure we get it right. The overall impact of regulation on consumers and businesses is still playing out, and we're committed to ensuring we do what's best for users while complying with the law, regardless of any potential revenue impact.

Thank you.

Hey guys. If I can squeeze two in real quick. Ruth, the Google segment operating profit was up 16%. That's the highest growth rate in about two years. So, how should we think about the cadence of that concerning your comments about headcount growth and the Looker acquisition looking forward? Sundar, at I/O you mentioned the active Android installed base is now over 2.5 billion. That's up about 10% year-on-year, much of it coming from emerging markets. How do we think about the growth rates you can sustain in mobile search revenue relative to that 10% growth rate in active Android?

Thanks for that. Our overall long-term investment thesis is unchanged. We are focused on investing to support the ongoing growth we see across Google, particularly in Search, while also building new businesses, especially in Cloud. Across all of Alphabet, we continue to benefit from machine learning, which impacts both OpEx and CapEx. Given the opportunities we see with the application of machine learning across the business, we are continuing to invest. When considering the pace of investing, we look at three facets: first, investing at an appropriate pace to support long-term earnings growth; second, optimizing investments within each product area; and finally, investing to support operational excellence. But the main point is that we are excited about the long-term opportunity and continuing to invest. This is why, in my opening remarks, I wanted to highlight our ongoing investments and across the business the increases in headcount and the reasons for them, with the anticipation of benefits from these investments, also recognizing that spending in sales and marketing will be more back-half weighted.

On the mobile question, we are certainly investing in Android with a focus on the next billion users and continuously improving the mobile experience. There is still a lot of information overload from a user standpoint, so being helpful to users in navigating through it, whether in Search, Assistant, Maps, or YouTube, is our focus. The next billion users represent a significant opportunity, and we are committed to lowering barriers so that more people can benefit from being online and participating in the digital economy.

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