Alphabet Inc - Class C (GOOG) — Q3 2019 Earnings Call Transcript

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

Thank you, Ellen, and good afternoon. Q3 was another great quarter at Google with strong revenue growth driven by mobile search, YouTube, and Cloud. We celebrated Google's 21st birthday this quarter. While our mission to organize the world's information and make it universally accessible and useful hasn't changed, we've evolved from a company that helps people find answers to a company that helps you get things done. Since the beginning, we've always invested in tackling deep computer science problems that can have a significant impact on society. The chance to be part of these fundamental engineering challenges is why so many people want to work at Google. In just the last week we have announced two significant advances. First, powered by our long-term investment in AI, we dramatically improved our understanding of the questions people ask Google Search. It's the biggest leap forward for search in the past five years. It’s all possible because of a new type of neural network-based technique for natural language processing called BERT, which recognizes subtle patterns in language and provides more relevant results. Second, we recently announced a major quantum computing milestone. I was extraordinarily proud to visit our team in Santa Barbara. To demonstrate supremacy, Google's 53-qubit quantum machine Sycamore successfully performed a test computation in just 200 seconds that would have taken the most powerful supercomputers much longer to accomplish. It's the Hello, World! moment we’ve been waiting for and represents a distinct milestone in our effort to harness the principles of quantum mechanics to solve computational problems. Turning from quantum to the quarter. Today, I'll talk about the momentum we saw across the business in the last three months. First, Cloud. We saw customer momentum across multiple areas under Thomas’ leadership. In September, we announced a landmark partnership with Mayo Clinic. Using Google Cloud to secure and store data and understand insights at scale, Mayo Clinic will partner with us in many ways. Together, we'll work to transform patient and clinician experiences, identify new methods of diagnosing diseases, conduct clinical research, and find new models for delivering patient care.

Thank you, Sundar. In the third quarter, total revenues of $40.5 billion were up 20% year-on-year and up 22% in constant currency. Once again, our results were driven by ongoing strength in mobile search, YouTube, and Cloud. I will begin with the review of 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 conclude with our outlook. Sundar and I will then take your questions. Details of Alphabet’s consolidated revenues by geographic region are available in our earnings press release. Regarding our key expense lines, on a consolidated basis, total cost of revenues, including TAC, which I will discuss in the Google segment, was $17.6 billion, up 23% year-on-year. Other cost of revenues on a consolidated basis was $10.1 billion, up 31% year-over-year, primarily driven by Google-related expenses. The biggest contributor again this quarter was costs associated with our data centers and other operations including depreciation, followed by content acquisition costs, primarily for YouTube and mostly for our advertising-supported content, but also for our newer subscription businesses, YouTube Premium and YouTube TV which have higher CAC as a percentage of their revenues. This line also includes the impact of hardware costs, primarily associated with our mid-tier Pixel 3a smartphones. Operating expenses were $13.8 billion, with headcount growth being the largest driver of year-on-year growth for both R&D and sales and marketing, which is reflected in both compensation and facilities expenses. With respect to R&D, the growth was again driven by the addition of engineering talent consistent with our focus on product innovation. The increase in G&A year-over-year was primarily due to a $554 million charge from our previously announced legal settlements in France. Stock-based compensation totaled $2.6 billion. Headcount was up 6,450 from the second quarter. And consistent with prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizable headcount increases were again in cloud for both technical and sales roles. Operating income was $9.2 billion, up 6% year-on-year for an operating margin up 23%. Other income and expense was a loss of $549 million, which primarily reflects the impact of unrealized losses and marketable equity securities. As of September 30, the unrealized equity gain in the combined portfolio of marketable and nonmarkable securities was $5.8 billion. We provide more detail on the line items within OI&E in our earnings press release. Net income was $7.1 billion and earnings per diluted share were $10.12.

Thanks for taking the questions. Maybe two, if I can. First, Sundar, big picture question. It feels like the concept of ambient computing was sort of prevalent at the Made by Google event recently. It started with sort of a bit of a shift in theme, what I could tell at Google I/O earlier this year. Can you just talk about what some of the key investments you want to make to capitalize on that opportunity into long-term? How you think Google and maybe broader Alphabet is positioned to capitalize on that? How it might show up at the product services layer? So, I guess, maybe a three-part question, more of a bigger picture nature.

Thanks, Eric. We are very excited by the vision of ambient computing and evolving that. I think it's a continuity in the sense that over time computing should be more intuitive to users and computing should adapt to users, not the other way around. And the foundations of all of this is all the work we have done with our computing platforms to date and the successful consumer services and developer platforms we have built. And I think that's the most of the investments there. The phones will continue to be at the center of ambient computing for the future. So, that's another important piece where we are already invested. I think, as we expand beyond and that's what the Made by Google family is focused on, products in your home with our Nest family of products, and wearables which we do with Wear OS and so on. So, supporting that ecosystem, whether you're at home or on the go or at work, and making sure it works. Our investments in AI across the company, I think, will end up playing a key role, AI, and Assistant. I think they'll be at the center of making sure we can anticipate what users want and serve them better.

Sundar, you talked about the new neural network techniques talking about the biggest breakthrough in Search in years. Could you just help us understand if that’s impacting kind of the advertising and monetization side of the business yet or how that can play out going forward?

Anytime I can address it, let me explain that BERT, which is the technique we've implemented, is now being used in Search. When we better understand queries, we enhance user satisfaction, improve search quality, and increase user engagement. This is a significant advancement in our ongoing efforts to enhance the search experience and quality. It will aid us with specific types of queries. While we already handle many queries effectively, this helps us grasp subtleties and comprehend human context more thoroughly. I would describe this as a major enhancement that boosts search quality and fosters a positive cycle of higher engagement. Often, we apply the same techniques on the app side, and eventually, we will also implement machine learning techniques there.

I just wanted to follow up on a couple of the comments you made about Cloud, Sundar. I was wondering if you could just give us some color on the size of your GCP backlog. And maybe even if you just talk about the trajectory, and how that's changed over the course of the last year? And then, you mentioned the strength and the uptake of BigQuery, I'm just trying to think through how we should think of the margin, level of a service like this versus the traditional compute offerings where you've seen strength to date. And just wondering if we start to see some positive mix shifts benefits, as some of these premium products start to ramp more aggressively? Thank you.

Thanks, Heather. Overall, I know, we gave some visibility into our cloud business and we'll continue to do that periodically. And the momentum has been great. Obviously, ever since Thomas has come in, he has continued to invest across the board. He’s definitely focused a lot on scaling up our sales partner and operational teams. And it's playing out well. In this business, it's important for you to be in as many deal situations as possible and get those wins, which accrues over time. And so, we are definitely seeing the momentum. Analytics is a huge area of strength for us. And it's an area where Thomas has a lot of expertise as well. And BigQuery is such a strong product, so it's a natural area where we are seeing strength. And my sense is, if I look at the TAM, the percentage of TAM for which we were eligible compared to two years ago to last year to now, that number is shifting aggressively due to either completing our product feature set or completing some of the certifications we need. And so, I think there are several strong forward-looking indicators and look forward to sharing more at the right time.

Can you provide more details about Google Maps? Earlier this year, it seemed like it was moving towards better integration into the purchase path, making it easier for small businesses to access well-qualified leads. Could you discuss the speed at which monetization or advertising opportunities will be available to small businesses? Thank you.

Local is a crucial focus for us, and we are committed to enhancing the experience that links merchants, advertisers, and users. Our primary initiative in this area has been Google My Business. Currently, millions of businesses can reach and engage users through Search and Maps. Specifically, in GML, we announced plans to expand local campaigns, which I assume is what you're referencing. It’s still early in this process, and overall, we aim to simplify how advertisers, especially small and medium businesses, can connect with users across our various platforms, such as Search, YouTube, Discover, and Maps. This is our vision moving forward. Small and medium businesses are a significant area of focus, and Maps presents a substantial long-term opportunity for us.

And just to add on there, given you referenced back to GML, and I think we talked about this last quarter as well. Our view is that the products that were introduced to GML this year, like in previous years, they're rolled out in phases, they're adopted over time. And so, we don't view the potential impact from this year's slate differently than the impact from products that were launched at previous events, and so just to kind of keep that in perspective.

I wanted to ask another one about new product you guys announced earlier this year at GML. And that was really Google Shopping and moving that across some of the new different properties like YouTube and Image Search and Discover. Can you give us a sense for where you are in that migration, kind of over what timeframe should we be thinking about that? And then, maybe just elaborate a bit on the long-term vision of moving shopping functionality into properties like YouTube and how you think that experience will evolve? Thanks.

In general, I think it’s a paid opportunity for us. We see tons of what I would call commercial user journeys across Google. Obviously, Search is an important area, Image Search, YouTube, and Maps are all great surfaces by which users come with varying degrees of commercial interest, looking to discover and at times transact as well. So, we’ve started thinking much more holistically about what are those experiences and how can we make it better. That involves helping improve the Discovery experience, but when people are interested in it, being able to make it easier to transact. So, the equivalent of being signed in and being able to pay when you want and then of course, the fulfillment and logistics. So, we're thinking through the end-to-end experience across all our surfaces and are investing. But I see the user interest, and it’s an area that I think we have significant opportunities ahead.

We’re still in the early stages of testing, but we’re excited about the long-term impact.

Thanks for taking my questions. I have two. Ruth, I think you mentioned the Desktop Search might have been one of the contributors of growth. Can you just talk to us a little bit about what types of products or verticals you’re still seeing growth? I know desktop search is really impressive, given how long has this been around. And then, Sundar, with all the exciting changes going on with search becoming more relevant, et cetera. Can you just talk about some of the KPIs that you monitor or what you're seeing when it comes to query volumes, click-through rate, overall response time, what are you seeing that sort of gives you confidence that you’ll continue to get more and more relevant results for your users? Thanks.

So, in terms of desktop, I described it as a solid contributor to revenue growth. And what we see is that desktop does remain an important form factor for certain more complex tasks. So, things like planning vacations or assessing insurance options, what we see is users continue to go back to desktop, notwithstanding the growing utility of mobile. And I think one of the things that we’ve been very focused on is that innovations that benefit mobile also enhance the desktop experience for users and advertisers.

We have developed extensive metrics to measure and track search quality, allowing us to gauge user satisfaction with their search experiences. As we delve deeper into this work, we recognize that users often conduct searches in sessions, making it essential to understand their satisfaction, engagement, and whether they find what they're looking for. This includes a focus on specific areas such as shopping and commerce, where we aim to improve the user experience. Health is another area where our dedicated Google Health team is working to enhance the overall search experience. This is a thorough initiative, and we are continually seeking to expand and deepen our efforts.

I have two. Sundar, there's clearly a lot of innovation happening at Google. But, I'm wondering how do you think about the increase in scrutiny and oversight possibly impacting your ability to explore new services or new markets over time, and ultimately to remain competitive? And second, Sundar or Ruth, we don't often ask about the display network, but just wondering, given all the concerns around privacy, ad blocking and the like, how do you view this business strategically, as part of the overall ecosystem?

On the first part, we consistently want to work and build products that benefit users and support the ecosystem. And so, our products and services benefit consumers, small and medium businesses, advertisers, and overall, they help reduce prices and expand choice. And so, that's our underlying approach, which helps us engage and explain to regulators and we’ll continue to do that. I think there are also many new areas of opportunities available for us, and in many of these areas we are a new entrant and we create competition. And sometimes the competitive pressures can lead to concerns from others. And so, that's part of what's going on as well. But the other area is, in addition to developed markets, we are investing deeply in our next billion users. So, markets like APAC continue to be a long-term opportunity for us as well.

Ruth, just, if you rewind the clock a little bit, when we entered this year, you had called out how some product changes may cause year-over-year growth rates to fluctuate from time to time. And we haven't heard that in a couple of quarters. So, as we look out towards like 2020 and beyond, do you feel like a lot of the product queue is in a good place, as far as Search and YouTube are concerned, and that these product changes might be a little bit more subtle going forward, or could we return to having more meaningful impact in the future, just any color there? And then, on the third quarter, the Asia region, the growth rate was solid but a tad lower than the prior trend. So, anything notable to call out on APAC?

So, in terms of the first question, I think, as Sundar and I talked about, we're pleased with the strength of the business that you've seen here again in the third quarter. And as we said, since the IPO, we don't manage the business to maximize quarterly results and we'll always do the right thing for the long term. We're very focused on investing for the long term. And I tried to make it clear in opening comments that as a result, quarterly growth can vary and has varied. And I think to your question, our view is that quarterly growth around the rates you've seen since the beginning of the year, for us underscores the strength and the vibrancy actually in our business. And that's particularly true at our size, in the last 12 months we've generated over $150 billion in total revenues. That's about $25 billion of growth in the last year. And we are continuing to invest in long-term opportunities. But I would make the point that we do keep a lens to the long-term. In terms of your question about geographies, when we look at the performance on a fixed FX basis around the globe, we're pleased with the performance again in the third quarter. You aptly point out, year-on-year growth in APAC in the third quarter was a bit lower than the second quarter. That primarily reflected slower growth in the network business, and that was in part due to policy changes. It also reflected the fact that the launch of the Pixel 3a was in the second quarter, which boosted the year-on-year growth rate in the second quarter. But I think also implicit in your question, at 26% year-on-year growth on a fixed FX basis, running at about now $7 billion in quarterly revenues, we’re really pleased with all what the team is doing and the year-on-year growth rate.

Sundar, could you provide us with an update on the Discover feed? It's a new product that we have previously highlighted, and I know many users are finding it increasingly useful. In the past, you shared some updates regarding monthly active users or daily active users. Any new information on that would be appreciated, as well as any insights into the overall usage, which has been promoted to users more recently. Additionally, Ruth, Sundar discussed your investments in renewable energy earlier, and in line with the focus of this earnings call, could you explain how that might be contributing to efficiencies within the company and its overall operating costs? Thank you.

Discover is a product we are very excited about. It complements Search, as our mission is to assist users seeking information. Discover allows us to proactively understand what might be helpful or relevant to users and deliver that information. We are focused on ensuring the product quality is high and that users find it useful when they engage with it. We are making progress, as our investments in machine learning are enabling us to anticipate user needs and provide information proactively. Over time, I see this as a significant area for us. It integrates well with our search and knowledge initiatives. For instance, if a user starts a query in Search—perhaps planning a trip or researching a topic—we can continue that interaction journey in Discover, creating a positive feedback loop. Our goal is to assist users in a meaningful and continuous way, and the synergy between Search and Discover facilitates that.

We're proud of our sustainability efforts, which we consider a crucial aspect of our business and financial impact. Sustainability is integrated into every part of our operations, from our technical infrastructure to product development, facility management, and AI initiatives. About a year ago, we mentioned our use of machine learning to enhance energy efficiency in our data centers, which resulted in reduced energy consumption, benefiting both sustainability and operational efficiency. We also recently announced equal investments in renewable energy to ensure that we offset 100% of our electricity usage with renewables. We believe this commitment will spur additional investments in renewable energy, despite a modest short-term cost increase. Overall, we are proud of the comprehensive efforts we are making to support sustainability.

So, Sundar, I was wondering if you can put the quantum computing investment into some sort of perspective. Compute needs for Google have to be exponentially higher versus when you first launched. So, we’re wondering if this helps you get your arms around that ever-increasing compute need. And further, I think you’ll find that investors are as impatient as you guys are for progress. So, can you talk about what kind of products or services this will help you create that you other couldn’t even think about doing before? Thanks.

I’m incredibly proud of the work that the team did and excited about the advancement in the whole industry. I think, in general, obviously, we’ve relied on advances in computing to be able to do what we do. And when we look ahead, we definitely see being able to drive the pace of change here fastest is an important need for us as well as a source of competitive advantage. As Moore’s Law effects have diminished, I think we are looking at a variety of approaches to make sure we can continue doing what we need to. And in that this is an important tool in the arsenal. While quantum will take many years to really start making a difference, we want to be at the cutting edge of driving it. I don’t think over time for sure, cloud itself, we do see a lot of interest from cloud customers, particularly in cutting-edge verticals about quantum computing. And so, that's an area where I think we’ll participate as a business, and more importantly applying it across other verticals we are in, be it health, as an example, I think we will be where we will deliver value in the long run.

And as much as we're extremely excited about the long-term implications for quantum computing, part of your question there about our near-term computing requirements. Given our outlook in particular across Google, we do expect to see ongoing demand for compute investments to support our growth, particularly for machine learning, Cloud, Search, and YouTube. And the primary driver of the CapEx does continue to be our expectations for compute requirements, so investments in technical infrastructure, as we've talked about today.

Thanks. I need a Google headset. Sundar, just on investments in GCP, you're in a really unique situation, having built infrastructure and productivity applications. Can you just walk through how you prioritize the two big buckets? There's a lot of different ways you can go in GCP. And just want to follow up with Ruth. You alluded to some G Suite pricing changes. And I know there were some prices that were changed earlier in the year. And I was just curious if you were referring to that price change or earlier in the year or if there was something new?

I mean, you're right. I mean, these are two big buckets and we treat them that way. Obviously, we've talked a lot about GCP, but G Suite continues to be very differentiated. And we just announced a new leader Javier Soltero coming in with lots of experience to turbo-charge this area as well. And in general, there are many G Suite customers now with whom we are having GCP conversations and vice versa. So, I think in general, given we have a big go-to-market effort, the breadth you have allows us to have more conversations and engage through many different paths into the organization. So, it's very synergistic as well.

And in terms of the G Suite pricing, I was referencing the pricing that we announced back in April. It's all outlined in a blog post. Our view was it was the right time to increase prices, given the ongoing functionality and tools that are included within G Suite. And as I said, what we're seeing here is in addition to the benefit from the price change. We also continue to have nice seat growth.

I think I’ll ask on YouTube, could you talk a little bit about your high level OTT viewing strategy? Obviously, subscriptions are growing. Maybe give us an update on how your YouTube subscription product is doing versus expectations? And then, on the paid click growth, it decelerated 18%, anything to call out there, especially related to YouTube, any change to coverage going on or anything we should know about? Thank you.

We are very enthusiastic about our subscription offerings. We are satisfied with our progress so far with YouTube Music and YouTube Premium, which have been launched in 71 countries since the beginning of 2018. We're definitely ramping up our efforts and seeing significant growth. YouTube TV is also performing well; we've recently announced that PBS will join YouTube TV in July, and last month we shared that YouTube TV is now available on select Amazon Fire TV devices. User satisfaction with the product is high, and we are committed to expanding our services, enhancing the quality of our offerings, and raising awareness about them. Overall, our main focus is to engage users with premium features on YouTube, and although our efforts are still in the early stages, we are seeing promising results.

And then, you asked about click growth and the trend there, the biggest driver affecting the click trends continues to be the growth of YouTube engagement ads. As in the first and second quarter, the rate of YouTube click growth decelerated in the third quarter. That does continue to reflect the changes that we made in early 2018 to really improve the user and advertiser experience. And as we've talked about on prior calls, those changes in 2018 weren't related to policy enforcement actions that YouTube had, which had a negligible impact on YouTube revenues. So, not a read-through.

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