Alphabet Inc - Class C (GOOG) — Q4 2020 Earnings Call Transcript

Thank you. Good afternoon, everyone, and welcome to Alphabet's Fourth Quarter 2020 Earnings Conference Call. With us today are Sundar Pichai, Philipp Schindler, 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-Q filed with the SEC. Additional information will also be set forth in our upcoming Form 10-K filing for the year ended December 31, 2020.

Thank you, Jim, and good afternoon, everyone. 2020 was a year unlike any other. We are proud that people continue to choose Google's products to stay informed, connected, and comforted during uncertain times. Being helpful to people in moments big and small is the foundation of everything we do. The past year also accelerated the shift to cloud and the adoption of online services. This has profound implications for all companies and consumers, and we are pleased that so many trust us to help them make this transition. In particular, Google's products and support have been a lifeline for millions of small and medium businesses hit hard by the pandemic. Today, I'll review some of the important work we have done this quarter across Google and Alphabet with a particular focus on our growing cloud business, which we are breaking out as a separate segment for the first time. Then I'll welcome to the call Google's Chief Business Officer, Philipp Schindler, who many of you know from investor conferences and events. Philipp will speak about partnerships, business, and advertising trends in the Google Services segment. We have heard that you’d appreciate more texture and detail there. Then Ruth will go through the quarter in more detail. First, some highlights at Google. Since the pandemic began, our teams have built new features and products to help people and businesses. Now we are helping with the complex challenge of getting vaccines to billions of people around the world. Vaccination locations have started to roll out in Google Search and Maps. Google Cloud's Intelligent Vaccine Impact platform is helping authorities improve vaccine distribution and forecasting. We are providing substantial new ad grants to the CDC, the World Health Organization, and others to promote vaccine education. We're also making direct grants to organizations addressing racial and geographic disparities in vaccination access, plus opening up Google's facilities as vaccination clinics as needed. Elsewhere, in Maps, we added a new community feed in the Explore tab, and now you can track takeout and delivery orders when you book or order from Google Maps. At YouTube, we are building products to help creators benefit from two important trends: live video and short-form video. More than 0.5 million channels livestreamed on YouTube for the first time in 2020, from artists performing in their living rooms to churches moving their services online. And videos in our new Shorts player are receiving 3.5 billion daily views. We are looking forward to expanding Shorts to more countries this year.

Thanks, Sundar, and good afternoon, everyone. It's great to be joining you today. We're pleased with Google Services revenue of $52.9 billion in the fourth quarter, which continued the significant rebound from the negative impact of COVID earlier in the year. Two trends drove the strong results across Search, YouTube, and network advertising. Consumers continued to move more of their activity online, and advertisers responded to the shift in consumer behavior by reactivating spend that they had paused earlier in the crisis.

Thank you, Philipp. We are very pleased with our exceptional fourth quarter performance after an unprecedented year. For 2020, total Alphabet revenues were $183 billion, up 13% year-on-year or up 14% in constant currency. With our new segment disclosures this quarter, I'll start with quarterly results at the Alphabet level, followed by segment results and conclude with our outlook. My focus will be on year-on-year comparisons for the fourth quarter, unless I state otherwise. For the fourth quarter, our consolidated revenues were $56.9 billion, up 23%, which reflects broad-based increases in advertiser spending in Search and YouTube within Google Services, as well as ongoing strength in Google Cloud. Our total cost of revenues was $26.1 billion, up 24%, primarily driven by other cost of revenues, which was $15.6 billion and up 25%. The biggest factors here were: first, content acquisition costs, primarily driven by costs for YouTube's advertising-supported content, followed by costs for subscription content; and second, costs associated with data centers and other operations, including depreciation. Operating expenses were $15.2 billion, down 4%. The year-on-year decline reflects the lapping of valuation-based compensation charges in certain Other Bets in the fourth quarter of 2019, primarily in R&D, as well as the impact of actions taken earlier in the year as a result of COVID. Each of the three components of OpEx also reflects our decision to slow headcount growth beginning late in the first quarter. Headcount was up 3,180 from the third quarter. Again, the majority of new hires were engineers and product managers, with continued aggressive investment in cloud for both technical and sales roles. Operating income was $15.7 billion, up 69%, and our operating margin in the quarter was 28%. Other income and expense was $3 billion, which primarily reflects unrealized gains in the value of investments in equity securities. Net income was $15.2 billion. Operating cash flow was $22.7 billion, with free cash flow of $17.2 billion in the quarter and $43 billion for the full year 2020. We ended the fourth quarter with $137 billion in cash and marketable securities. Let me now turn to our segment financial results, starting with our Google Services segment. Total Google Services revenues were $52.9 billion, up 22%. Each component of our advertising revenues reflects the return of advertiser spend in response to the continued movement of consumer activity online that Philipp spoke about, including Google Search and other advertising revenues of $31.9 billion in the quarter, up 17%; YouTube advertising revenues of $6.9 billion, up 46%, driven by a rebound not only in brand advertising but also ongoing strength in direct response; network advertising revenues of $7.4 billion, up 23%. Other revenues were $6.7 billion, up 27%, primarily driven by growth in YouTube non-advertising and Play revenues. Within Play, app revenues in the fourth quarter continued to benefit from elevated levels of engagement, reflecting increases in active buyers and spend per buyer due to COVID. However, we did experience a deceleration in growth from the levels we saw in the third quarter. Google Services operating income was $19.1 billion, up 41%, and the operating margin was 36%. Turning to the Google Cloud segment, including GCP and Google Workspace. Revenues were $3.8 billion for the fourth quarter, up 47%. GCP's revenue growth rate was again meaningfully above Cloud overall. Strong growth in Google Workspace revenues was driven by growth in both seats and average revenue per seat. Google Cloud had an operating loss of $1.2 billion, essentially flat versus last year. As to our Other Bets, for the full year 2020, revenues were $657 million, primarily generated by Fiber and Verily, and reflect that most of our Other Bets are pre-revenue. The operating loss was $4.5 billion for the full year 2020 versus an operating loss of $4.8 billion in 2019. Let me end with our outlook for each segment and our investments more broadly. For Google Services, we're encouraged by the increase in consumer online activity and the return of advertiser spend as reflected in our Q4 results. Looking forward to 2021, year-over-year quarterly comparisons will be affected meaningfully by the impact of COVID last year with easier comps in the first half, especially in Q2, and then lapping stronger performance in the second half. With respect to other revenues, with the closing of the Fitbit acquisition earlier this month, we will be reporting its revenues within Google Other. In terms of investment levels within Google Services, late in the first quarter of 2020, as a result of COVID, we made what we described as tactical adjustments to slow the pace of spend in certain categories. Given the ongoing uncertainty in the external environment, we maintained the discipline through the rest of 2020. Looking forward, we do expect the pace of investment to increase to support the extraordinary opportunities we see given the usefulness of our products and services in this environment. The investment pace will ramp up over the course of the year. As for Google Cloud, we've obviously been investing aggressively given the substantial market opportunity we see. Under Thomas Kurian's leadership, we further accelerated investment to strengthen the position of the business. For example, we are on track to meet our near-term goal of tripling the size of the Cloud Direct sales force and have greatly expanded the partner channel. We've also substantially improved our product offering while rationalizing our approach to focus on our six key industry verticals. And we've invested in expanding our network of locations for compute capacity to support Cloud, ending 2020 serving customers in 24 regions and 73 zones. We're encouraged by the momentum in the growth of revenue and customer wins. We more than doubled revenues over the last two years from $5.8 billion in 2018 to $13.1 billion in 2020. Our backlog, which is nearly all attributable to Cloud, nearly tripled from 2019 to 2020. Although increases in backlog do not directly correlate to revenue trends, the growth in backlog demonstrates the success Google Cloud is having with large enterprises, which are signing meaningful long-term commitment agreements. Looking forward, we will continue to focus on revenue growth driven by ongoing investment in products and the go-to-market organization. Cloud's operating loss reflects that we have meaningfully built out our organization ahead of revenues, as we've discussed in prior quarters, with respect to the substantial investments in our go-to-market organization as well as engineering and technical infrastructure. Operating loss and operating margin will benefit from increased scale over time. In addition, we are focused on delivering on efficiency efforts across the board to contribute incrementally to profitability over time. Finally, as you can see from the historical data provided in the press release, Cloud's operating loss was higher in the first quarter relative to other quarters, and then the operating loss improves thereafter. We expect similar seasonality in 2021. In terms of Other Bets, we continue to invest with a focus on the long-term value creation opportunity. On headcount, we plan to reaccelerate the pace of hiring in Google Services, in line with our opportunities. Our headcount growth will also reflect the addition of Fitbit and our ongoing transition of certain customer support roles from third-party vendors to Google's in-house operation centers. We also plan to continue to prioritize investment in both sales and technical roles for Google Cloud. Turning to CapEx. At the consolidated level, the year-on-year results this quarter again reflect the slower pace throughout 2020 of investment in office facilities. Within technical infrastructure, servers continue to be the largest driver of investment in the fourth quarter, followed by data centers. Looking ahead, we expect a return to a more normalized pace of ground-up construction and fit-out of office facilities, which translates into a sizable increase in CapEx in 2021. Servers will continue to be the largest driver of spend on technical infrastructure. Finally, a housekeeping point. As noted in our earnings press release, we have adjusted the estimated useful lives of servers and certain network equipment starting in 2021. We expect these changes will favorably impact our 2021 operating results by approximately $2.1 billion for assets as of year-end 2020. We look forward to the year ahead. I hope everyone stays safe. Thank you. And now Sundar, Philipp, and I will take your questions.

I hope everyone is safe and well on the team out there as well. Maybe I'll try first on Cloud. I don't know if it's better to Sundar or to Ruth, but can you just conceptually help us understand how to think about the opportunity versus Cloud and how it factors back into which you want to invest against the opportunity or, possibly, maybe even accelerate the opportunity by looking at inorganic paths to growing scale vis-à-vis competition in the space? And then maybe for Philipp if I can. YouTube continues to evolve as a platform. There's now subscription offerings. You highlighted the strength you're seeing in DR. Could you talk a little bit about the path for monetization in the coming years and how we should think about the opportunity against a large-scale audience and engagement you see at YouTube broadly?

On Cloud, obviously, we see how early customers are in the shift. We see the large TAM ahead and, definitely, the market dynamics. And our momentum, in the context of the market, is what is the framework in which we are thinking about the scale of investments and the pace of investments. Obviously, it's an area in which the longer you are in, the cohorts add up and so contributes more and the economies of scale start working as well. But we are definitely investing ahead to making sure we are able to serve the customers globally across all the offerings they are interested in, and that's how we are thinking about it. Ruth, I'm not sure you want to add more.

I think that's the main point, just given the sheer scale of the opportunity and our position, investing to really position ourselves well across industries and geographies. And the key elements of it, I tried to call out in the opening comments: investing in product, go to market, data centers. And you can see it in the results. I think you're going to continue to see us building there, and that's what we're talking about building ahead. We are keenly focused on delivering for both customers and shareholders and that, of course, includes an intense focus on the path to profitability.

Yes. Regarding YouTube, our Direct Response business was hardly noticeable three years ago, but it has now become one of our largest and fastest-growing advertising offerings. With TrueView for action, we are simplifying the process for advertisers to connect with audiences through video campaigns. Notably, 60% of TrueView for action customers are new to the platform, and we've more than doubled the number of active advertisers using this feature in the first half of 2020. We're harnessing the strong commercial behavior on YouTube, where 70% of viewers report purchasing a brand after seeing it on the platform. For example, L'Oréal and MasterClass have utilized TrueView for action effectively, with MasterClass experiencing a 140% increase in clicks and a 70% increase in course sign-ups. YouTube continues to excel for brand advertisers, having recovered from the pandemic's initial impact in our brand business during Q3 and Q4. The platform allows advertisers to connect with younger audiences, reaching more 18- to 49-year-olds than all linear TV networks combined. Watch time is on the rise, and advertiser effectiveness continues to improve. Additionally, music is a highly popular sector on YouTube, contributing significantly to the overall experience. Users have expressed a desire for a premium YouTube experience, which includes features like song and video downloads. YouTube Premium generates extra revenue for music labels and publishers, with over $3 billion paid to the music industry in 2019. We currently have over 30 million paid subscribers for music and premium services and operate in over 95 countries, offering members numerous additional benefits.

Ruth and Sundar, I just wanted to follow up on Eric's question a bit. Anything else you can add just in terms of the significant inflection that you saw on Google Cloud backlog there? And I guess, in particular, curious what you're seeing in terms of benefit and success as you're leveraging Alphabet more broadly like in the Ford deal. And then how do you think about Google Cloud margins structurally kind of long-term relative to peers? Any color there would be helpful.

I'll start by discussing customers who are pursuing digital transformation. Depending on their industry, they are certainly looking for a wider range of solutions that Google and Alphabet can offer. This is evident in healthcare through our initiatives in Google Health and Verily, which all contribute positively. Ford exemplifies a long-term approach, not solely for Cloud but for Android, which powers their vehicles. These are significant transformations that span the entire company. We are effectively leveraging our global business operations, managed by Philipp, while closely collaborating with Thomas' teams, creating substantial synergies. Regarding your second question about the broader aspects, I previously mentioned our long-term deals, which, over time, as we add more groups, enhance our margin structure. The scale of our product offerings, the variety of areas, and the numerous regions we operate in require substantial investment. Consequently, there is a fixed cost structure involved, and we are proactively investing. However, as we expand our business, we anticipate favorable trends.

You mentioned that you saw increased brand spending in the quarter. Many investors are curious about sustainability and what trends you are observing as you move into the start of this year. Could you share insights on how your clients are behaving as they transition out of the holiday season?

I'll take that. The financial results clearly reflected an increase in advertiser activity, partly due to unlocking budgets that had been paused earlier in the year and an increase in consumer online activity. Retail was the largest contributor to the year-on-year growth of the ads business, but tech, media and entertainment, as well as consumer packaged goods, also played significant roles. In Search, we observed ongoing improvement in advertiser spending overall. For YouTube, Direct Response maintained a very high growth level, and the acceleration in overall YouTube revenue growth indicates a rise in brand advertising across all sectors, alongside the continued strength in Direct Response. Similarly, in the network segment, the increase in advertiser spending was evident, driven by growth in AdMob and Ad Manager. We were pleased with the performance in Q4, marking a strong end to a tough year. Looking ahead to 2021, we noted that the first half will have easier year-on-year comparisons as we anniversary the pandemic's effects. Overall, it was a strong quarter, and we're optimistic about the current level of activity.

Great. I appreciate the level of detail on the drivers behind the acceleration in Search and YouTube. I was wondering if you could go a bit further and disaggregate or give, even just qualitatively, the drivers behind that acceleration between pre-pandemic advertisers returning to prior spending levels versus new advertisers or new advertiser spend being allocated to the platform.

The main point is that we observed a slowdown, as Philipp mentioned, and we've discussed on previous calls. Initially, there is a step-back, but then users start to reengage, activity increases, and advertising effectiveness improves, leading to a resurgence in advertising. I talked about this trend last year and noted its resemblance to what we saw during the previous financial crisis. We are seeing a broad-based reengagement, which is encouraging across various industries. Additionally, as Philipp highlighted, there has been a significant opportunity to support small and medium businesses as they adapt to the new digital landscape, which has been crucial as well.

I have two for Philipp. Philipp, first one, I appreciate all the color on retail and commerce, the merchant community growing so strong in the last year. I'd be curious to hear about your discussions now with merchants and sort of what the largest friction points that they're looking for you to solve and sort of continue to help them as the world reopens, kind of the merchant discussions. And then secondly, a question on one of the earlier products on Discover feed, I'd love to hear about sort of early learnings on Discover feed and how you think about hurdles you need to overcome to monetize that.

Thank you for the question. At a high level, our goal is to create a healthier e-commerce ecosystem. When users come to Google for shopping, we want to help them discover the best products at the best prices from a wide range of merchants, ensuring our results are comprehensive and relevant. Last year, we made notable advancements in Google Shopping, aligning with our core principles: free listings, no commissions, and valuable feedback that helps reduce barriers for online retail. This has made Google a great platform for stores to connect with customers, whether through free listings, ads, or facilitating direct purchases on Google. Additionally, shopping ads will remain an effective tool for retailers to showcase their products. Overall, we're fostering an open ecosystem that benefits various businesses, from national chains and online marketplaces to small local stores, while providing retailers with more options that have been positively received, including opening our platform to third-party providers like PayPal and Shopify. We've also begun integrating YouTube and experimenting with features that allow users to learn more about products in videos across select channels. Overall, this has been very well received. On the Discover side, we've seen significant growth in discovery, which includes both Discover and discovery ads, since its launch three years ago. Users appreciate how we're presenting relevant information and stunning visuals through what we term the Coriolis feed experience. Some of these experiences are commercial. We made discovery ads generally available around six months ago, reaching nearly 3 billion people globally across Discover, YouTube, and Gmail. Advertisers value our ability to meet performance objectives by aligning their premium creatives with user intent on what we refer to as Coriolis surfaces.

Maybe for Sundar or Philipp, a follow-up on YouTube. Just given the strength of those services ads and subscriptions during the pandemic, I wonder if part of what we're seeing is more of an acceleration from TV ad budgets from linear spending to more of YouTube spending, I mean given also the momentum we've seen in over-the-top over the last nine months or so. And then given some of the changing industry dynamics around privacy, including what you've already announced around browser cookies, wondering what plans might be as well for Android and how we should think about potential impact on ad revenues broadly as a result of privacy changes.

We've noticed that brands are increasingly reallocating their budgets to YouTube to enhance their linear TV advertising as audiences fragment further. With traditional TV ratings on the decline, advertisers are shifting to streaming platforms like YouTube to engage viewers who no longer watch traditional television. Connected TVs represent our fastest-growing screen segment. In the U.S., more than 100 million people watch YouTube and YouTube TV on TV screens monthly. YouTube enables advertisers to reach general audiences that are difficult to access through other means. It reaches more individuals aged 18 to 49 than all linear TV networks combined, presenting a significant opportunity for YouTube to facilitate connections between brands and agencies with this demographic. We are deeply invested in this area. For instance, in the latter half of last year, we introduced YouTube Masthead for TV screens to help advertisers generate awareness with large audiences in a single moment, with brands like Uber taking advantage of it. We also launched Brand Lift for YouTube on TV screens to aid advertisers in making informed choices regarding ad performance and to optimize streaming campaigns in real time. Last year, we enabled advertisers to purchase placement among the most popular content on YouTube and YouTube TV on TV screens in what we refer to as a single lineup. Regarding the strategy with third-party cookies, we recognize that online data usage expectations are evolving, and people are seeking enhanced privacy. We take our obligation to user privacy and our support for partners in the web ecosystem very seriously. In 2019, we announced The Privacy Sandbox, an initiative aimed at developing new technologies to replace third-party cookies with privacy-preserving mechanisms for the web, and we are making significant strides. We have shared a comprehensive proposal with the industry for experimentation and feedback, including our Federated Learning of Cohorts API, which we believe offers a viable replacement for third-party cookies. We are committed to Privacy Sandbox as the optimal way forward and are dedicated to collaborating with the advertising community on privacy-preserving open standard mechanisms to sustain a healthy, ad-supported web.

Philipp, I wanted to follow up on Colin's question. Can you explain the framework and discuss the long-term opportunities, particularly in streaming video? Are you satisfied with the progress of YouTube TV so far? Will you expand into other countries? How does this compare to the opportunities with connected TVs and devices like Google TV or Chromecast? Additionally, do advertisers perceive added value in this type of inventory? Does it attract new advertisers offering YouTube TV or connected TV inventory compared to traditional YouTube advertising?

One of the things that has worked well for Google over the years is reaching users where they are, which has always been our approach. We've made significant investments across platforms, devices, and countries. The same applies to the YouTube experience; we aim to bring it to the most convenient screens for users. This is evident in our investments in Google TV, Chromecast, and YouTube TV as a whole. We are taking a long-term approach, focusing on the user experience and ensuring everything works seamlessly. While smartphones are central to YouTube, TV is also an important format, and users will gradually use it across multiple screens. This is the experience we are prioritizing, and we understand that when we provide this experience, there will be commercial value captured over time that aligns with advertisers' needs, but we maintain a long-term perspective.

Yes. And I talked about the connected TV part already. Maybe briefly just on YouTube TV, YouTube TV continues to gain momentum. Our advertising efforts on YouTube TV itself are still very, very early. But we think there is an opportunity to apply some of our targeting and measurement capabilities to really provide a better user and advertiser experience over time. And yes, we heard from customers, they have a very strong interest in advertising and streaming environments. I mentioned how we combine it in the single lineups. So that's an interesting path going forward.

So Sundar, I believe you've recently mentioned that AI and quantum computing are on a journey that will unfold over the next 10 to 20 years, revealing new use cases. You've previously highlighted some ways AI is supporting your current products in the market. Looking ahead, what new applications do you foresee emerging? Also, Philipp, I recall a few years back at an investor conference, you expressed the aim of onboarding and assisting small and medium-sized businesses, particularly since they previously had limited advertising options. Google and online platforms represent a significant opportunity to help them expand. Where do you think you currently stand in developing user-friendly tools for those who lack agency representation so they can engage with the various customers they should be targeting across all your services?

Thank you, Stephen. I'll address the AI portion first. Our goal has always been to lay a strong foundation in technological advancements, which is a core strength of ours. We invest heavily throughout the company and are among the largest R&D investors globally. AI is a significant focus for us. I'm genuinely enthusiastic about the progress we've made in understanding various modalities, including text, images, voice, and vision. I believe we are at a pivotal moment, and we are committed to developing better models and enhancing our understanding in a more comprehensive manner. When we achieve this, it will benefit all of our products. You witnessed an example of this when we introduced Bird in Search, which marked a major quality enhancement. You'll see this integration in Google Search, YouTube, Android, as well as in our Alphabet ventures, including self-driving cars and robotics. Our perspective remains clear: we aim to lead advancements in state-of-the-art technology.

Yes. So first, let me recognize, I mean it has obviously been a very, very challenging environment for SMBs. Many weren't online. Many lost line of sight to demand overnight due to COVID. So around this time last year, as soon as we saw the scale of the impact, we really accelerated product that give our customers, and especially our SMB customers, signals to help them actually navigate and pivot. And as I noted earlier, as more consumers moved online and advertisers obviously responded by reactivating spend, we also saw our advertiser base grow, particularly the number of smaller advertisers or SMBs, and we're helping them see shift in supply and demand not just across sectors but actually within sectors. For example, travel continues to get hit hard, hit pretty hard. And after the initial lockdown last year, searches for vacation homes and near-me rentals saw huge spikes, and that continues to fluctuate. On the other hand, if we look at retail, demand isn't disappearing. It's shifting in many cases. We're seeing increases in searches for things like gym equipment, crafts, patio heaters, and so on, anything related to outdoor activity and so on. We're obviously thinking about how to help SMBs on products like Maps. Like, over the last five years, we've made more than 1,000 improvements to business profiles, making it a lot easier for merchants to connect with customers and especially now into the crisis. In 2020, we added new features to, for example, provide COVID updates, service changes, and new attributes like takeout, delivery, curbside pickup, now all easily available for consumers on Maps to connect them to their favorite SMBs, so a really incredible investment, frankly, from our side, and I think it's very well received.

Thanks, everyone, for joining us today. We look forward to speaking with you again on our first quarter 2021 call. Thank you, and have a good evening.