Alphabet Inc - Class A (GOOGL) — Q2 2019 Earnings Call Transcript

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

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

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

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

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

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

Thank you.

Great. Thanks for taking the question. I was just hoping Ruth, you could talk a bit more about the accelerating growth you saw in Q2 relative to the slowdown in Q1. It seems certainly in the previous quarter to skew more to the Google Search side than YouTube. Could you provide a little more clarity on how the product changes you talked about in the past played out across Q1 and Q2? And then Sundar, regarding user privacy and control over data, that was a key theme across multiple events in Q2. Can you talk about how you balance those initiatives as you're rolling out products going forward?

Starting first with the strength in sites revenue, the strength we discussed this quarter reflects the same underlying trends that we discussed previously. I want to highlight that part of it involves the benefit from applying machine learning to both the user and advertiser experience. I'm echoing much of what we've shared in prior quarters. We remain very positive about the opportunity set. We introduced product changes only after extensive testing, which means there can be some variability in quarterly growth rates as you've seen, but we are very positive about the opportunity set. Overall, as it relates to both Search and YouTube strength, I would add that YouTube's revenue growth was strong in the first quarter, and in the second quarter, YouTube was again the second largest contributor of revenue growth. We are pleased with the ongoing momentum we are seeing here.

Regarding user privacy and control, it's always been a big focus for us, and some of the things we recently announced are initiatives underway, like federated learning, which has been important to us for almost three years. Going forward, you'll continue to see us focus on this area, as it is one of the most important things we are working on. With AI, we are excited that we can provide better experiences for users with less data over time. These are the types of directions we are pushing. We are also aware of our responsibility to simplify user understanding of how their data is used, give them better controls, and make it easier for them to manage those controls. These are all our goals, and we'll continue focusing on that as we move forward.

Thank you both.

Okay. Thank you. So, Ruth, in regards to the Cloud $8 billion annual run rate commentary, does this include GCP as well as G Suite? Further, is this apples-to-apples to the $1 billion that Sundar talked about during the fourth quarter of 2017? Any other comments regarding the mix between GCP versus the more traditional G Suite?

Yes. It does include the entire business that Thomas Kurian is leading. Our Cloud business includes both GCP and G Suite. It is on an apples-to-apples basis. It continues to be part of the cloud business, but we're not breaking out the components within cloud. I'm pleased with the performance of both GCP and G Suite. GCP growth was driven by strong customer demand for our compute and data analytics products and G Suite continues to deliver strong growth, benefiting from both new pricing and growth overall. GCP remains one of the fastest growing businesses in Alphabet, and we're pleased with how the team is executing.

Thank you.

Great. Thank you very much. I wanted to ask, Sundar, how you've seen your go-to-market and partnership strategies change under Thomas. It seems that Google has become a more friendly cloud company when partnering with other software companies. Are there any tangible benefits you can point to, such as win rates or partner momentum? Also, you recently acquired Looker. How are you thinking about organic versus inorganic product development? Has the thought process changed with Thomas running the business now?

Thanks, Heather. Definitely, in terms of go-to-market, Thomas has been heavily focused, mainly with the understanding that we are very competitive when we are present in different banks. We're focusing on how we can scale up and build a customer-facing organization. We are investing heavily in sales, service, partner and operational teams. We're looking to triple the size of our sales force over the next few years aggressively in major markets worldwide. For specifics, we launched our new partner program, Partner Advantage. The ASAP relationship has been significant for us. We've focused on helping many customers choose us; Home Depot and Cardinal Health are just a couple of examples. A significant part of it has been expanding our customer-facing team and making several senior executive hires in addition to our new Global Head of Sales. We are committed to serving customers. We have done it in areas like Android and building ecosystems. As for organic versus inorganic development, we are focused on areas where we are differentiated. Data and business analytics is key for us. We assess our gaps and how we can complete our solution offering. That's what led to the Looker acquisition. So we'll approach this on a case-by-case basis based on customer needs.

Thank you.

Can I try two questions, please? Ruth, just any color on that $25 billion share repurchase authorization—why $25, not $20 or $30? And then, regarding the ad business, we've seen this nice acceleration in Q2, which seems to revert back to norm. There's still some questions about what happened in Q1, what you needed to correct in Q2? Was it just the normal cycles in search, YouTube and advertising businesses? Q1 still seems a little bit of a question mark, while Q2 appears to be back to the trend of the last several years. Any color on what transpired in Q1 that needed addressing in Q2?

I'll answer in reverse order. We are pleased with the ongoing momentum in the business. The key point I'll reiterate is that while there is a lot of innovation happening and we have talked about that, we only introduce product changes after extensive testing. There can be variability in quarterly growth rates, as you've seen, but we are pleased with the strength of the business. The team is highly focused on ensuring we deliver for users and advertisers. We've introduced over 100 enhancements to the user set every quarter, and the timing variability is common. We want to ensure we stay focused on the right things for the long term and the quality we can deliver. Regarding capital return, our capital allocation framework remains unchanged. We focus on investing for long-term growth primarily and then support acquisitions and investments as we’ve discussed. Given our outlook on cash, we saw it appropriate to step in and increase our repurchase program. We've increased four times since inception in 2015, and we're pleased to announce another increase today as we view this as an effective use of capital.

Okay. Thanks, Ruth.

Thanks for taking the questions. I have two. First, Ruth, your remarks on YouTube were riveting regarding being the second largest driver this quarter and last quarter. If we take that as context for the overall acceleration, could you provide examples of what types of products, advertiser segments, or regions resonated particularly well on YouTube this quarter versus last? Lastly, for Sundar or Ruth, there’s been recent announcements regarding children's safety on YouTube. For advertisers and parents on the call, what steps have you taken to ensure YouTube is safe for kids? What are the biggest areas of focus?

Regarding YouTube growth, to address your point, I noted earlier that YouTube revenue growth was strong in both the first quarter and again in the second quarter. To clarify, the changes in early 2018 that I referenced regarding sites click and CPC growth were unrelated to policy enforcement actions at YouTube, having had negligible impact on YouTube revenues. Just to be clear, revenue growth was robust last quarter. The click and CPC growth are independent of policy enforcement actions regarding our ongoing efforts to protect the YouTube ecosystem. We remain focused on taking the right steps aligned with our goals, regardless of revenue implications. It's important to note that the removal of content that violates our policies has virtually no effect on YouTube revenues. In terms of where the growth is, I want to reiterate that we see substantial growth in direct response advertising. Brand advertising is still the largest part of the business and is growing at a strong rate.

On your important question about kids' safety as part of our content responsibility work, it's a key area we focus on. We've put significant effort into developing YouTube Kids, a product we will continue to evolve, adding curated content to ensure it's safe for kids and to give parents peace of mind. We also ensure that our content responsibility initiatives apply to family-oriented content on the main YouTube app. All our efforts, including removing harmful content and highlighting authoritative, high-quality content, apply across the board, and we're committed to rewarding trusted creators to ensure they produce content beneficial for children while still meeting our goals.

Great. Thanks.

Good afternoon everyone. Thanks for taking the question. This one may be for Ruth, but Sundar feel free to jump in. Based on a few comments you made about YouTube, particularly the inclusion of Originals and YouTube TV in the Google Preferred inventory, can we assume that those two additions provided a boost to the brand advertising side of the business as there's more high-quality inventory for brand advertisers to seek? Additionally, regarding Google Marketing Live, notwithstanding your comments Ruth about the adoption time for new products, are there one or two announcements that you would highlight as potentially significant over the longer term?

Regarding YouTube for brands, I would say it's a more cross-sectional improvement across the platform promoting higher-quality content, our work on brand safety, content responsibility, and creators generating superior content all have contributed. I would say it’s a more holistic improvement. For Gmail, we're particularly excited about the introduction of discovery ads and gallery ads; both are pushing us towards mobile-first visually-rich immersive ad formats, which also provide a fantastic user experience. There's excitement among advertisers, but as Ruth mentioned, it's still early days as we roll these out and allows things to unfold.

Great. Thanks, Sundar.

Thank you. First, Sundar, earlier Ruth had mentioned the significance of machine learning for driving growth in the quarter, and I imagine in many recent quarters. Many have difficulty grasping exactly what that means. Could you provide a few specific examples of how the company is employing machine learning recently to drive growth and improvements for both users and advertisers? Secondly for Ruth, regarding the sites TAC, I know there are many variables impacting the changes in sites TAC. But when you assess the trends, how do you see that developing over the next year or two?

For us, machine learning plays a critical role across the consumer user experience and ads. We're using machine learning to simplify things for advertisers, making campaigns easier while providing better insights through processing complex datasets and delivering sophisticated real-time insights. Also, from the marketer's standpoint, we help them find the right creator for every moment and manage bidding in real time. Essentially, machine learning enhances efficiency and ease of use across the consumer journey, driving productivity.

In terms of the TAC rate, as discussed previously, mobile growth applies upward pressure on sites TAC rate; this was the primary driver of the year-on-year increase in the second quarter. We expect this underlying trend to continue with the ongoing growth in mobile.

Thanks.

Thanks. A couple for me as well. First, as you embrace more commerce and payments on the platform with new ad formats discussed, can you also talk about what role take rates might play concerning future initiatives and revenue growth? Secondly, regarding Assistant and Duplex, in terms of near-term search innovation, could you characterize how crucial that is for the momentum you're seeing? Longer-term, how might this affect platform monetization?

On the first question, there is a lot of discovery that occurs across Google's properties, including Search and YouTube. Anything we can do to enhance users' experiences during transactions will play a substantial role going forward. We're working hard to improve payments, sign-in processes, and overall transactional experiences, which should enhance user engagement and lead to better commercial outcomes over the long term. As for Assistant and Duplex, we're focused on pushing our goal of being more helpful, assisting users in completing tasks that matter in the real world. If we succeed, we'll create value for users as many of these tasks entail commercial intent.

Thank you.

Great. Thank you. Sundar, there's been a lot of regulatory news lately, especially from the DOJ. How do you view a more intense regulatory environment? We’re getting a lot of questions and wondering if this could significantly affect Google operations. Ruth, nice acceleration across the board, especially in Europe. With GDPR implementation last year, are you seeing any benefits from lapping that period or was there really no impact from it?

Regarding the regulatory question, we recognize there will be scrutiny. We will engage constructively, and it's not new to us. We have participated in these processes before. We operate under significant amounts of regulation today, including privacy, competition, copyright, intellectual property, and more. In the U.S., we will respond constructively to any questions posed and address any concerns raised. However, it’s crucial that we remain focused on building helpful products for users as this is the value we provide.

As for GDPR, we implemented it late in the second quarter of 2018. Ensuring compliance is critical, and while the overall impact of such regulations is still unfolding, we are committed to ensuring we do what is best for users and comply with the law, rather than being driven by potential revenue outcomes.

Thank you.

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

Thanks for that. In terms of our long-term investment thesis, it's unchanged. We're primarily focused on investing to support ongoing growth across Google, notably in Search, while also investing in building new businesses, particularly in Cloud. Overall, we benefit across all of Alphabet from machine learning, impacting both OpEx and CapEx. As we assess investing pace, we consider three aspects: first, the pace requisite to support long-term earnings growth; second, optimizing investments within each product area; and third, maintaining operational excellence. However, the key focus is our excitement regarding long-term opportunities and our commitment to invest, which is why I highlighted ongoing investments, headcount increases, and their respective benefits—particularly noting that our sales and marketing is back half-weighted.

On the mobile question, we are definitely investing in Android, focusing on the next billion users and the evolution of the mobile experience. Users still experience information overload, so being helpful to them and helping them navigate—be it Search, Assistant, Maps, or YouTube—is a priority. With the next billion users, there's immense headroom for growth, and we're committed to lowering barriers for online participation in the digital economy; it remains a primary focus for us.

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