Alphabet Inc - Class C (GOOG) — Q3 2020 Earnings Call Transcript

Thank you. Good afternoon, everyone, and welcome to Alphabet's third quarter 2020 earnings conference call. With us today are Sundar Pichai and Ruth Porat. Now I'll quickly cover the safe harbor. Some of the statements that we make today regarding our business, operations and financial performance, including the effect of the COVID-19 pandemic on those areas, may be considered forward-looking. And such 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 most recent Form 10-K filed with the SEC and in our Form 10-Q for the quarter ended September 30, 2020 expected to be filed with the SEC later today.

Thank you, Jim, and good afternoon, everyone. Thanks for joining us today. This quarter, our performance was consistent with the broader online environment. It's also a testament to the investment we've made to improve search and deliver a highly relevant experience that people turn to for help in moments big and small. We saw an improvement in advertiser spend across all geographies and most verticals, with the world accelerating its transition to online and digital services. In Q3, we also saw strength in Google Cloud, Play and YouTube subscriptions. This is the third quarter we are reporting earnings during the COVID-19 pandemic. Access to information has never been more important. This year, including this quarter, showed how valuable Google's founding Product Search has been to people. And importantly, our products and investments are making a real difference as businesses work and get back on their feet. Whether it's finding the latest information on COVID-19 cases in their area, which local businesses are open, or what online courses will help them prepare for new jobs, people continue to turn to Google search. You can now find useful information about offerings like no contact delivery or curbside pickup for 2 million businesses on search and maps. And we have used Google's Duplex AI Technology to make calls to businesses and confirm things like temporary closures. This has enabled us to make 3 million updates to business information globally. We know that people's expectations for instant perfect search results are high. That's why we continue to invest deeply in AI and other technologies to ensure the most helpful search experience possible. Two weeks ago, we announced a number of search improvements, including our biggest advancement in our spelling systems in over a decade, a new approach to identifying key moments in videos, and one of people's favorites, hum to search which will identify a song based on the humming. We also announced a huge breakthrough in natural language understanding that we introduced last year. Now we improve results for almost every English search query. We are also investing in improving the shopping experience in search to help people find the best products and prices available from a wide range of merchants. We recently added easy to see price comparisons to help consumers know if they're getting a good deal.

Thank you, Sundar. We are very pleased by our results in the third quarter, which reflect both broad-based increases in advertiser spending in search and YouTube, as well as ongoing strength in our non-advertising revenue lines, in particular Google Cloud and Play. Starting with consolidated Alphabet results, our total revenues in the quarter were $46.2 billion, up 14% year-on-year and up 15% in constant currency. Our total cost of revenues was $21.1 billion, up 20% year-on-year, primarily driven by other cost of revenues, which was $13 billion and up 29% year-over-year. The biggest factors here again this quarter were costs associated with our data centers and other operations including depreciation, and then content acquisition costs primarily driven by costs for YouTube's advertising-supported content, followed by costs for subscription service content. Operating expenses were $13.8 billion, up 1% year-on-year, reflecting both the impact of actions taken earlier in the year as a result of COVID as well as lapping a $554 million legal settlement in the third quarter of 2019. In terms of the three component parts, first, the deceleration in R&D growth was due primarily to slower headcount. Second, the year-on-year decline in sales and marketing expenses reflects the planned reduction in advertising and promotional spend that we implemented towards the end of the first quarter. Third, G&A growth reflects the lapping of the settlement. All three categories benefited from lower G&A expenses due to COVID.

Question maybe I could ask to Sundar on the high level. You called out some of the innovation you're aiming for over the medium to long-term with respect to search, can you take a step back and maybe give us your sense of how search is going to evolve from a product it is today where there's a lot of input by the user to sort of the push dynamic with the Discover feed and Discover ads that could drive both engagement and monetization across your platform? And the second part of the question was, it seems like you're taking a little bit of a different tactic with your hardware strategy this year, they're a little bit less of it. And it was more on the mid to low-end price range of hardware, how does hardware and broadly time the assistant into the hardware strategy fit broadly similar into your view for where search is going to the medium to long-term? Thanks so much.

Thank you, Eric, for your questions. You're correct that with mobile and ambient computing today, accessing information across different devices is crucial. It's important to have relevant information readily available. I view this as a comprehensive user journey, and search will continue to evolve. Discover and YouTube play significant roles in ensuring users receive pertinent information. For us, it’s essential to meet users' information needs, which also presents monetization opportunities. This is why platforms like Discover and our approach on YouTube are crucial to us. Regarding our hardware, I'm thrilled about our deeper investments in this area, which will yield results over the coming years. Our previous products, like the Pixel 4a and Pixel 5, have demonstrated a clear value, and we plan to build on that. We are carefully considering which form factors are essential, with the perspective that search and the assistant must be integral as well. Thus, our hardware strategy is designed to strategically enhance both the Android ecosystem and ensure information is easily accessible. I'm excited about our future plans, and next year you'll see us making more significant investments that will come into play.

Thanks for taking the question. Ruth, we appreciate the incremental color on 3Q and 4Q expenses, which was hoping that you could help us understand the cost structure a little bit more, kind of as we're coming out of this and just know whether you're anticipating any more notable changes, just coming out of the pandemic kind of around the sustainability of the margin improvements that you saw in this quarter. Thanks.

Thanks for that, Doug. So as I said, as a result of COVID, we did make tactical adjustments to slow the pace of spending in certain categories. And that started late in the first quarter. And in part, that's what you see here, plus the impact from the improvements in revenue performance. And we do remain focused on optimizing efficiency where we can, we've said that on many prior calls, but as we've also discussed with you on prior calls, as both Sundar and I noted, today, we are committed to making the right investments to support long-term profitable growth. And I think what's exciting in this environment, there appears to be an acceleration in digital transformation that underscores the importance of the products and services that we provide, and the longer-term opportunities. So we will continue to invest to best position us for the long-term opportunity. An obvious example is cloud, we do intend to maintain a high level of investment, given the opportunity we see that includes the ongoing increases in our go-to-market organization, our engineering organization, as well as the investments to support the necessary CapEx. So hopefully that gives you a bit more color there.

Great, thank you very much for taking the question. Sundar, I have a question for you. Just Thomas has been the Head of Google Cloud now for around two years, if I remember correctly, I'm just wondering, what do you see as the biggest changes he's put into place that has allowed the business to start gaining what appears to be materially more share? And as you look ahead to 2021, and what's going on with digital transformation, what would you say is top strategic priorities would be? Thank you.

Thanks, Heather. A couple of things stand out for me, I think it's been a very consistent focus strategy. So the focus on the five major geographies, the four customer segments in the six priority industries, healthcare, retail, financial services, media, entertainment, manufacturing and public sector, that focus and going deeper, and scaling our go-to-market, both in terms of our people, our partner setting, that's been key. The second thing I would say is some of the key differentiators are playing out particularly as we have taken them deeper as unique industry solutions. So going deeper and having solutions and in some of those cases where we are now pricing based on value. I think that kind of deeper play, something I'm very excited about, definitely has strengthened just based on our underlying technology. So we do have differentiation in areas like data analytics, AI, et cetera. So that's been, that's been huge as well. But I'm pleased with the execution obviously, in this there is a time lag between when you hire the sales and when we train and when you enable them to be more productive. And that's the investment Ruth has been talking about. And I can see it ramping, and they can see the results come into play. So credit towards that focus and execution and so looking forward to the next.

Thanks for taking my question. Sundar, I wanted to ask one about ecommerce specifically, you know, it seems to become increasingly competitive within the ecommerce funnel. So maybe talk to us about one, what types of consumer behavior changes? Are you seeing within ecommerce search on the platform? And then, in your mind, what are the key priorities of investment, you need to really execute on to ensure you stay at the top of the funnel within ecommerce? Thanks.

I appreciate the standard, and first, I'm excited about the announcements and progress we've made in recent months. We're highly focused on user experience and want to ensure that consumers have access to comprehensive, high-quality inventory and offerings on our platform. Our free shopping listings, launched in the U.S., are now available in 48 countries worldwide. We've also removed commission fees for the buy on Google Checkout option and opened the platform to PayPal and Shopify for integration, which enhances our comprehensiveness and quality. Regarding funnel and behavior, it's interesting to see how search captures intent at the moment, and the breadth of search has proven to be a significant asset. As users adapt, advertisers do too, allowing us to observe this dynamic in real time. Additionally, YouTube serves as an important platform for e-commerce. Advertisers are engaging with YouTube at the mid-funnel level, even when immediate intent isn't present, helping to create demand and interest. Overall, e-commerce is thriving across our platform, and we are committed to ensuring that the entire user experience remains positive.

Good afternoon. Ruth, you called brand advertisers coming back to YouTube, I'm just curious if you could give us a sense of where you're seeing that strength in kind of where you at relative to pre-COVID levels, with those advertisers?

So overall, we're pleased at the degree to which advertisers really have reactivated their budgets, this in the third quarter, they are reacting in part to, I think, evidence that consumers are showing strong demand across nearly all verticals, it's everything from home and garden to computer to work from home. And so very helpful there. And then YouTube's strong watch time growth enables advertisers to reach an audience that they can't reach on TV, as we've often talked about. And so they're increasingly looking to us to help them reach people who are going to YouTube to learn new topics and engage with fresh entertaining content, great, great, unique content. So it's, it's been an opportunity, we're pleased to see our performance in the third quarter.

Great, thank you so much, maybe one for Sundar and one for Ruth. Sundar, thanks for the update on the DOJ. As you think about all the regulators all over the world, is there. Is there any hope of coming to a middle ground here? How are you thinking about how far apart you guys are in different regions? And then maybe for Ruth, on the YouTube opportunity, if you assume about 2 billion users, you're on a run rate of maybe $10 per user. I just wondering how you how you're thinking about the monetization? Are you still very early and if you can give us any help on what the margins might look like? Thank you.

Ruth, please proceed.

We are pleased with the ongoing momentum in YouTube's revenue. As we've mentioned previously, in our ad-supported business, we distribute a significant portion of revenues to our content creators. We also cover all infrastructure and networking costs related to storing and serving videos, as well as running YouTube. This includes marketing and support for content creators, which we believe adds immense value to the ecosystem, ensuring positive experiences for both users and creators. We have discussed our investments in content protection and moderation, which are essential to our operations. We continue to enhance the experience for both creators and users as a result of these efforts. On the subscription side, as Sundar highlighted, both YouTube Music Premium and YouTube TV have higher content acquisition costs relative to revenues compared to YouTube ads, and we are still in the early stages of expanding our subscriber base.

Justin, regarding regulatory matters, we have faced scrutiny before and it has become a broader issue across our sector, which is not unexpected. We will engage positively where we can, and as demonstrated in previous situations, when we are confident about the advantages we provide to our users, we will present our case in response to feedback or decisions, remaining adaptable as needed. While there is a lot happening in legislation and regulation, progress on these issues can foster certainty, clarity, and even opportunities. This is our approach, and we are committed to a long-term perspective. Ultimately, our focus is on maintaining a relentless commitment to our users and developing exceptional products, which will be where we direct most of our efforts.

Thanks two questions, please. It sounds like you're going to provide more disclosure on Google Cloud in the fourth quarter, will that also be on the profitability of Google Cloud or could you address the question of whether Google Cloud has reached a point of scale where it's no longer dilutive to overall margins, and then briefly, two new revenue opportunities, or growing revenue opportunities over the year Google Maps and the Discover tab, any update or any new data points that suggest a monetization opportunity with those two assets? Thank you.

Thank you for that, Mark. When we break out our Cloud segment, we will report these results in the fourth quarter, along with the full-year results for 2018, 2019, and 2020. We will provide not only the revenue breakdown data that we expanded earlier this year but will also include operating income for each segment, which we believe is the most relevant information. Both Sundar and I have emphasized our aggressive investments in Cloud due to the opportunities we see. We are very encouraged by the rapid pace of customer acquisitions and the strong revenue growth in both GCP and Workspace, despite being late to the game compared to our peers. We plan to maintain a high level of investment to position ourselves effectively. I discussed some of the efforts from our go-to-market team, the engineering team, and our capital expenditures. We consider this a multi-year journey, as we believe we are still in the early stages.

On Maps and Discover, I previously mentioned the importance of taking a more holistic approach. For instance, as developers, we're focused on promoting apps through universal app campaigns, which can effectively reach a wide audience. Recently, we expanded smart campaigns to 150 countries, really benefiting small businesses. A small business owner can set up their first campaign and create their first ad in just 15 minutes using their mobile device. It's crucial for us to ensure that the most relevant information is delivered while thinking holistically about these platforms. This approach allows us to engage users both when they are actively seeking information and when they want information presented to them. Overall, I find the opportunities ahead very exciting.

Great. Thanks, and good afternoon, everyone. Sundar, in your response to the DOJ's lawsuit compared to your search partnerships to how brand might pay a supermarket to be at the end of the row or at high level. We've also heard Philip Schindler talk about your addressable market being potentially twice as large as commonly viewed and maybe that includes things like those payments inside supermarkets. So my question is two parts. Firstly, is it fair to tie those two types of comments together and assume that they're related to each other? And then second, could you maybe talk about how that might matter to your bigger picture thinking about the advertising and ecommerce opportunity for Google? And in particular, the competitive environment you face?

At a broad level, our mission is to provide information in a competitive environment where users have many options, especially on mobile. The key is ensuring that Google remains a relevant source for that information. When people are looking to purchase products or considering various competitors in travel or hotel bookings, it's crucial for us to compete holistically. This means delivering relevant information to capture users' attention, which presents both challenges and opportunities. Regarding the specifics of the DOJ case, we are confident in our approach, focusing on creating the best user experience. We want Google to be accessible on all platforms and to partner with other companies in this effort. We will continue to evaluate the situation and provide updates as we progress.

Thanks, I have a couple here as well. Maybe just a follow-up on the shopping question. Specifically on YouTube, if you could expand on the role that shopping and shopping ads are now playing in the growth strategy there. And on Google workspace, it seemed like this is a unique opportunity, with work from home to really drive adoption and monetization of the services, including meet as well as bundling with cloud services, so I wonder if you could provide a little more detail on the levels of usage and engagement you're seeing with those applications? And how you plan to monetize those going forward. Thank you.

Great, on shopping and YouTube, definitely say, we are on the earlier part of the journey. But we have seen strength in YouTube for direct response and on a few other categories. And I think the experiences we see there, I think can directly carry over to commerce. And as we build out the experience, so I see that as an opportunity. I earlier also mentioned what searches currently capturing the intent at that given time, YouTube, advertisers can take a longer-term view create brand awareness, create interest, and so on. So that also offers opportunity. So we today in many, many categories have creators with very compelling content. And I've always felt things work well if you match user interest and it's very relevant to users. And so I think commerce, there is a lot of commercial activity on YouTube organically. And so I see it as a long-term opportunity. On Google workspace, I'm very excited that we both have strong growth, I mentioned meet metrics earlier, that we saw a peak of 235 million daily meeting participants in Q3 and more than 7.5 billion daily video call minutes. Definitely significant growth and meet as well as our other products like docs drive and chat. But Google workspace also now creates the unified experience and I think we are definitely seeing a lot of interest. And demand there, I do think COVID is really accelerating the future of work. And many of the trends there are, you know, will last through time, and I think gives all of us a chance to reimagine this, what would we imagined? What does collaboration and productivity at scale including people working remotely look like? And we plan to be at the forefront of that, and I'm excited for the opportunity there.

Hi, just two questions. If we look at search, your growth rates in January and February compared to today, so pre-COVID versus today, I guess how many categories are above the growth rate? Is travel the only large category at this stage that's running below your pre-COVID growth rates in search? And then the second question is on the topic of the Apple search agreement, so as you guys said in your blog post, based on other agreements, where you're seeing things change hands, you didn't really lose a lot of query volume after the change. So what do you think the recapture rate of queries on the toolbar would be if that deal were to change hands? Is this really a COVID situation or is it something that we should be able to manage through? Thanks a lot.

So in terms of your first question, as we've often said, we have a very diverse business globally, and that's across sectors, customer size, geographies. And with respect to sectors, we saw broad-based improvement across virtually all, basically what you see in the broader economy, and we don't break out more than that, but it was quite broad-based. In terms of your second question, Sundar, do you want to take that?

On search, as I said, you know, for a long time, we work hard to make sure users can conveniently access us. Most of our partners choose us because they are the best search provider; users find us having the highest search quality. And so there's organic demand for it. And we believe in investing in our experience across all our platforms. And so we are definitely committed to making sure we can serve our users everywhere and we are really focused on it.

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