Alphabet Inc - Class C (GOOG) — Q2 2020 Earnings Call Transcript

Thank you. Good afternoon, everyone, and welcome to Alphabet's second quarter 2020 earnings conference call. With us today are Sundar Pichai and Ruth Porat. Now I'll quickly cover the safe harbor.

Thank you, Jim, and thank you, everyone, for joining in. It's certainly been a busy week, and I'm glad to be here. I hope everyone is staying safe and well. All of us at Google continue to send our deepest gratitude to everyone on the front lines of the pandemic all around the world. I also want to personally thank all our employees who continue to work so hard to make sure our products and services are available for everyone right now. People looking for important health information, hard-hit businesses working to inform customers about opening hours or delivery options, or teachers connecting to their students. The macroeconomic environment caused by the pandemic created headwinds for our business. Our revenue declined on a reported basis and is flat year-over-year on a fixed FX basis. Like other companies, this quarter, we saw the early signs of stabilization as users return to commercial activity online. This is true across most of our advertising verticals and geographies. Of course, the economic climate remains fragile. One thing I'd like to call out is our continuing journey to invest in and grow new businesses. We delivered strong growth in our non-ads revenues, particularly from Cloud, Google Play, and YouTube subscriptions. This, in turn, is helping our partners, developers, and creators earn revenue and deliver valuable services to people. We are focused on the steps to build long-term value with these opportunities. Today, I'll review the quarter by walking through the four key areas for 2020 that you heard me mention over the last several quarters: creating the most helpful products for everyone; providing the most trusted experiences for our users; executing at scale; and creating sustainable value.

Thanks, Sundar. We are cautiously encouraged by our results for the second quarter, although mindful of the fragile global economic environment. Our advertising revenues gradually improved through the quarter, and our non-advertising revenue lines maintained their strong performance, particularly Google Cloud and Play. I will begin with a 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 outlook. Sundar and I will then take your questions. Starting with consolidated Alphabet results, our total revenues in the second quarter were $38.3 billion, down 2% year-on-year and flat in constant currency. Year-on-year declines in our advertising revenues from Search and Network were offset by growth in Google Other and Google Cloud revenues. Details of Alphabet's consolidated revenues by geographic region are available in our earnings press release. Across each region, we saw a gradual improvement in revenues in the quarter, with some differences reflecting product mix. In terms of the foreign exchange impact, exchange rate movements resulted in approximately a 2% headwind to reported revenues.

Maybe two, if I can, for Sundar. One, on the commerce initiatives, a lot of announcements from the company in the quarter, moving towards sort of commission-free and amplifying both the advertising and e-commerce efforts. I want to understand some of the moves you're making strategically and how you think that positions you broadly against, obviously, an e-commerce landscape that's seeing a lot of pulled forward penetration given the current environment. And second on YouTube, obviously, a fairly volatile brand advertising environment and TV advertising remains in flux. What are the opportunities both in the U.S. and globally to go after sort of TV ad budgets under the YouTube umbrella?

On Shopping, I spoke a little bit in my remarks, but I'm really excited about the potential there. The team has been executing very well. Overall, users come to Google a lot to find the products they are looking for, but we see an opportunity to invest and make the experience better. Sometimes the journeys may fail because they don't find what they're looking for. So we want to make sure it's comprehensive. Next, when people find what they like, we want to make it simple for them to transact. And so working on that end-to-end experience has been a big focus. And obviously, making sure for merchants, really making sure we are open for business for merchants, and we are giving value to them has been the focus. The early indications are that users are responding positively, both in terms of user engagement and, more importantly, giving value back to merchants for their investment there. So in some ways, it's a return to our first principles. We want to ensure that Google is the best place for merchants to connect with users. And so I'm excited about it, and you'll continue to see us focus in this area. The second was on YouTube brand. Obviously, YouTube has been doing well in terms of engagement and watch time. And so we see a long-term opportunity there. We've had strength in direct response as well through this quarter. But on brand, which was your question, we are obviously investing not just in YouTube's main product, but YouTube TV as well. And so areas where we can offer a bundle, advertisers are interested in streaming, and so bringing that bundle together, especially to advertisers and upfronts through YouTube Select is a big opportunity as well. So we are focused on that.

I have two. Just first, Ruth, curious if you can just talk about the cost structure a little bit more. We know you'll continue to invest to drive growth over the long term. Just curious how you're thinking about it as the top line starts to recover more hopefully over coming quarters. And then secondly, I know you said that search trends were flat to last year by the end of June. Just curious if there's anything you could add in terms of what you've seen more recently over the last month as well.

Thanks for this, Doug. So in terms of cost structure, as we talked about last quarter, we have been focused on taking steps to enhance efficiency in the near term. And that being said, as Sundar and I both noted, what you're seeing is the fact that we do remain focused on investing for the long term. So sort of breaking that down in cost of revenues, while TAC and content acquisition costs are obviously tied to revenues, there is a sizable percentage of other cost of revenues that are not directly correlated with revenue growth, as I noted in opening comments, and we are very focused on the user experience and the overall ecosystem. So we are investing to make sure that we're supporting our products so they remain reliable in all environments. And then in OpEx, much of our operating expense is generally less variable and not necessarily correlating to revenues in the near term. So in terms of a couple of the items, although we do continue to expect the year-on-year headcount growth rate to decelerate, as I noted, we are hiring aggressively in priority areas like Cloud. And so we're taking near-term steps to enhance efficiency but still investing for the long term. So we're trying to make sure that we're getting those tradeoffs right. And as I noted, we do expect the year-on-year headcount growth rate in 2020 to be down somewhat from the 20% year-on-year rate last year, and that's even adjusting for two items that put upward pressure on headcount growth. The first, we're moving certain customer support roles from third-party vendors to Google's in-house operation center. That is actually OpEx neutral but does increase reported spend. And then second, the pending acquisition of Fitbit. So we're trying to navigate it appropriately. In terms of your second question, in terms of search trends and what we saw throughout the quarter, I would say that following a rough end to the first quarter, ads revenue gradually improved in the quarter, not only in Search, but YouTube and Network. And so for Search, we ended March at a mid-teens percentage decline in year-on-year revenues. And then as we progressed through the second quarter, we saw a gradual return in user search activity to more commercial topics, and then that was followed by an increase in spending by advertisers. So that resulted in a gradual improvement in year-on-year Search revenue trends in the second quarter. We ended basically flat to last year by the end of June, and you know to carry it forward, although we're pleased that ads revenue gradually improved throughout the quarter. As I said, we do believe it's premature to say we are out of the woods given the fragile nature of the macro environment. And as you're aware, ad spend does tend to be correlated with macroeconomic performance. And so the macro backdrop will continue to be a key signal to monitor. But to your question, based on our estimates from the end of June through last quarter, there has been a modest improvement in July.

I have two questions about Google Cloud. First, Sundar, could you discuss the change in the pace of customers migrating workloads to the cloud due to COVID? Second, can you elaborate on the upsides and downsides regarding those who have accelerated their migration to the cloud? How has this affected the impacted industries or companies that may be experiencing lower utilization of cloud capacity? It would be helpful to hear about the factors influencing growth as well.

Thanks, Heather. From my perspective, we have been investing in Google Cloud to expand, particularly in our engineering and go-to-market efforts, as well as on the investment side with data centers and cloud regions. It has been encouraging to see that as we scale up, we are executing more effectively. Last quarter, I was involved in numerous discussions, and we welcomed many large customers to our cloud platform, including significant deals with telecom and banking companies, like Deutsche Bank. Overall, the momentum feels strong, and there seems to be a growing interest in digital transformation among companies that are planning for the long term. I sense that we're almost there with our execution as we continue to scale up. Regarding your second question about the various factors at play, while it's true that the impact varies across different sectors, I don't have any significant highlights to share today.

I have two. The first one, Sundar, we try to always figure out changes in consumer behavior. I guess as you have sort of been studying what people have been doing through shelter-in-place and from the way things are changing from a consumer perspective, talk to us about areas you're most focused on, investing in and driving your teams to create new products to really help consumers with their changing habits. And then the second one, Ruth, I know as we sort of we look ahead with potentially a larger percentage of the workforce, work remote or work from home, without looking for quantification, maybe just talk to us about some puts and takes to areas where you could see either efficiency or higher potential costs from a larger percentage of the workforce being remote over the long term.

Yes. Regarding the first point, the shift to online is substantial. We observe that people are engaging more and exploring new interests. Their preferences have definitely expanded. For instance, I am examining different types of user journeys to ensure they become richer and more effective. For example, with Google, as users seek more health-related information, we are considering how to enhance that experience for the future and are investing in it. I mentioned Shopping earlier, which has been a key focus for us, along with education in general. We are also exploring the potential of G Suite for small and medium businesses as well as larger companies and the investments we are making in collaboration tools, which I find very exciting. Underneath all of this, even if it wasn't explicitly stated, we are concentrating on our AI teams and ensuring they receive the necessary investments to advance our next-generation TPUs and improve our models and algorithms. I am genuinely interested in expanding our capabilities, and that excites me for the long term.

And then in terms of your question about work-from-home, I think it's a great point because it obviously feeds so much into a lot of the product work that we're doing in Cloud through G Suite, et cetera. So that's where I would actually start, but I appreciate what you're asking is how are we looking at our own cost base. And we called that out last quarter, in particular, with respect to CapEx, and you can sort of see it here this quarter. The main change in CapEx has really been we slowed the pace on the office facilities front. And what we're looking at is really how to reimagine what the workplace will look like. We continue to be very much focused on the fact that place and space are important. We believe in collaboration. Serendipity is key to innovation. So we do view space in the office as important and are very focused on what does that mean over the long term. We've actually opened quite a number of our offices, in fact, in 40 countries and do hope to reopen in many more. But your question to what does it mean for overall cost structure, we're looking at that with the place you see it now is in our CapEx, and the way we've been looking at it and our indication that we do expect 2020 will be lower CapEx on the facility side as a result.

I was just curious if you could just comment in terms of some of the near-term business trends and anything that's changed as you've gone through the month of July versus what you saw in June?

Sure. I already commented on that with respect to Search, but to broaden it a bit more, and again, this is based on estimates from the end of June through last week. So for YouTube, we ended March with a year-on-year growth rate in the high single digits, and that's reflecting a substantial headwind from brand. The headwind from brand moderated modestly at the end of the second quarter, and then we saw a further improvement in July. Direct response has been consistently strong. For Network, revenues improved toward the end of the second quarter, and we have seen a further slight improvement in July. Obviously, three weeks are not a quarter, but that's based on the estimates here from the end of June. And then as Sundar and I both said, when you look at, for example, Cloud, it has maintained its strength consistently. And I'd say that with a business that's growing at this pace, it's really much more about a secular trend to the move to cloud. So really nothing to comment on there.

Great. Sundar, I don't know how much you can comment on the regulatory environment, but it's obviously top of mind with the hearing yesterday. Maybe just characterize it for Google right now. And are you seeing any progress with the regulatory environment? And then secondly, we saw the YouTube TV price increase, a pretty interesting business model. But longer term, do you see that as really strategically important for the YouTube brand? Or do you think you can have a really profitable business on that?

On the regulatory front, we have been under scrutiny for some time, which we recognize is appropriate given our size. We have engaged constructively across various jurisdictions, and I am confident in our approach, our focus on users, and the evidence in nearly all the areas we operate. We expand choice and generally lower prices, all while maintaining a very fast pace of innovation, creating a dynamic and competitive environment. That said, we will adhere to the rules, and we are prepared to adapt where necessary. As a company, being flexible in response to scrutiny is crucial, and we are committed to navigating this challenge. Regarding YouTube TV, it’s a good question. As I mentioned earlier, people are interested in streaming. As YouTube TV scales, I anticipate more opportunities will arise. We are still in the early stages of developing the product, but we have recently added several new channels and ensured its functionality. In the U.S., the TV market is significant to the advertising market as well. Therefore, if we invest and scale here, the synergies with YouTube should become increasingly meaningful over time. I am excited about the traction the product is gaining, though it is still too early to fully assess its potential.

This one is for Sundar. I was hoping you might be able to expand on the earlier comment you made about the AI strategy. I'm particularly wondering if there've been things over the past five months since the pandemic began, that you thought an expansion of a very high strategy or an evolution of the past strategy might be able to solve for whether that relates to commercialization or monetization or really anything across the business. Just really, really curious.

I am very pleased with the significant progress we are making in our AI research and development. It's crucial for us to remain at the forefront as a company, and I believe we are leading the way. I am particularly excited about how rapidly our engineering and R&D teams, both at Google and DeepMind, are advancing. We are achieving good results in areas such as language understanding, and you might have noticed substantial improvements with BERT and Search last year. However, developing BERT took several years, and I see even more advancements coming in the future. One area where I think we have yet to fully capitalize on our potential is Cloud. We recognize the opportunities there, but companies are still contemplating workload migrations. The long-term potential of using AI to create genuine business solutions across various industries is significant, and we are still in the early stages. We need to better connect our internal resources and provide comprehensive solutions to our users. We have made progress in certain product areas, but I believe there is a larger opportunity ahead.

Great. I just had two questions. First, on YouTube subscription. So can you talk about the size of that area of the business relative to that $15 billion? We had it at about 15% of total YouTube revenue. And then how is the faster growth in that area relative to advertising impacting your long-term profitability goals at YouTube? And then the second question is on Search. So it sounds like the flat exit run rate year-on-year is pretty encouraging. If we strip out travel, I'm guessing it's well above that. So how would you characterize the query growth versus just the ad auction dynamics outside of travel across the other categories? Are we back to pre-COVID levels in those areas?

We have not detailed the specifics of YouTube subscription revenues, which fall under Other revenues rather than advertising revenues. Overall, we see a significant opportunity here, which we previously highlighted during the subscription product launch. The response was based on user feedback, emphasizing that music plays a vital role in the YouTube experience and contributes significantly to watch time. Users expressed a desire for choice, with many seeking a premium ad-free YouTube experience, including options to download songs and videos. This demand was a major driving force behind our initiatives. Additionally, YouTube Premium creates extra revenue streams for music labels and publishers. For instance, in 2019, YouTube contributed over $3 billion to the music industry. We've significantly expanded our geographic reach from five countries at the start of 2018 to 94 countries today. Earlier this year, we announced that YouTube Premium had over 20 million paid subscribers, reflecting a growth of more than 60% compared to the previous year. Our subscriber growth continues to be fueled by the objective of providing users with more choices.

I guess maybe a follow-up to the earlier question on commerce. Beyond the marketplace functionality and some of the free year promotional transactions, I wonder how some of the other initiatives are going to play a role. And things I'm thinking specifically are, were you focused before on Google Checkout and Maps and some of the assistant functionality, how those may play a changing role in commerce on the Google platform.

Yes. Great question. I think the bar is to have that super simple experience, which is delightful and that you have peace of mind and satisfaction in terms of getting the product and being able to return it and so on. So the end-to-end funnel matters a lot. And part of the reason why through the changes, a couple of things we have done. As you saw, we changed and we removed the commission for merchants to be on the platform. And part of it is by removing that, they can take that and invest in, be it shipping, be it delivery, be it the customer experience. And so that matters, matters I think in the overall experience. And from our standpoint, the Buy on Google experience is something which deeply investing in. Obviously, our integrations with PayPal, our investments are underlying it to make sure for a lot of users that it's as close to a one-click experience as possible is a big part of the investment as well.

I want to ask a broad question about Google's position in online retail. This is important because Google has been central to commerce for the last 20 years, particularly through search and YouTube. With the pandemic creating a significant shift in online retail demand, we've seen impressive results from companies like Amazon and Shopify. However, I’m not sure that we see the same in Google's outcomes. Can you discuss how Google is positioned during this rapid increase in online retail demand over the past few years? Are there adjustments you need to make to your products and services to enhance your positioning?

As a company, we derive our strength from the wide range of categories we serve our users. This includes not just products but also services and diverse areas like travel. Our diversification means that while we have certain strengths during a pandemic, there are also areas where we face challenges. This is what is evident in our performance. In e-commerce, it's clear that direct providers are experiencing significant growth, particularly in essential categories like groceries, which we do not directly engage with. However, our long-term focus on shopping, led by our new leadership team, aims to enhance our platform and ensure that Google remains a critical destination for users in their shopping journeys. I believe this presents a growth opportunity linked to our investments, not just through Search but also in Shopping initiatives, YouTube, and supporting retailers on the cloud side. We view this as a significant opportunity for collaboration with Google.

Thanks, everyone, for joining us today. We know you all have a busy evening. We look forward to speaking with you again on our third quarter 2020 call. Thank you, and have a good evening.