Alphabet Inc - Class A (GOOGL) — 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-ad 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 am 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. So working on that end-to-end experience has been a big focus. And obviously, making sure for merchants, we are open for business for merchants, and we are providing value to them has been the focus. Early indications are that users are responding positively, both in terms of user engagement and more importantly, providing 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. I am excited about it, and you will 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. We see long-term opportunities 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 the YouTube main product, but YouTube TV as well. Areas where we can offer a bundle, advertisers are interested in streaming, and bringing that bundle together, especially to advertisers and upfronts through YouTube Select, is a big opportunity as well. We are focused on that.

I have two. Just first, Ruth, curious if you can 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 the 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 the cost structure, as we talked about last quarter, we have been focused on taking steps to enhance efficiency in the near term. That being said, as Sundar and I both noted, we do remain focused on investing for the long term. 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. In OpEx, much of our operating expense is generally less variable and not necessarily correlating to revenues in the near term. In terms of a couple of the items, although we continue to expect the year-on-year headcount growth rate to decelerate, as I noted, we are hiring aggressively in priority areas like Cloud. We are taking near-term steps to enhance efficiency while still investing for the long term. We are trying to make sure that we're getting those tradeoffs right. 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 are 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. The second, the pending acquisition of Fitbit. We are trying to navigate it appropriately. In terms of your second question, regarding search trends and what we saw throughout the quarter, I would say that following a rough end to the first quarter, ad revenue gradually improved in the quarter, not only in Search, but YouTube and Network. For Search, we ended March at a mid-teens percentage decline in year-on-year revenues. As we progressed through the second quarter, we saw a gradual return in user search activity to more commercial topics, followed by an increase in spending by advertisers. This 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 to carry it forward, although we are pleased that ad revenue gradually improved throughout the quarter. We believe it's premature to say we are out of the woods given the fragile nature of the macro environment. As you are aware, ad spend does tend to be correlated with macroeconomic performance. The macro backdrop will continue to be a key signal to monitor. Based on our estimates from the end of June through last quarter, there has been a modest improvement in July.

I would like to ask two questions regarding Google Cloud. Firstly, Sundar, could you provide insights on how you've observed the pace of customers migrating their workloads to the cloud in light of COVID? Secondly, can you discuss the factors at play here? Microsoft mentioned something similar about their Azure business last week. For those customers who have expedited their migration to the cloud, how much has that counterbalanced the challenges faced by industries or companies you serve that are currently experiencing lower utilization of cloud capacity than usual? It would be helpful if you could also address the growth factors involved.

Thanks, Heather. Overall, from my vantage point, with Google Cloud, we've been investing to scale up, especially on the people side, on engineering, go-to-market, and then obviously on our investment side with data centers, cloud regions, and so on. It has been good to see as we are scaling up, we are executing more effectively. I have been personally involved in many, many conversations last quarter. We had many large customers come onto cloud, with big telco deals and banking deals, such as Deutsche Bank, as an example. Overall, I felt the momentum was strong. Generally, it felt like things were continuing well through the course. There is more secular interest in digital transformation. Companies are keenly thinking long-term and planning for us. Overall, I feel at the moment, almost there. I feel our execution, as we are scaling up, is working well. I won't know whether there's anything significant worth highlighting. Obviously, you are right to point out that it doesn't affect everyone the same, but nothing significant for me to highlight here 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 how 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. Then the second one, Ruth, I know as we look ahead with potentially a larger percentage of the workforce working remote or from home, without looking for quantification, maybe just talk to us about some puts and takes in terms of areas where you could see either efficiency or higher potential costs from a larger percentage of the workforce being remote over the long term.

On the first one, the shift to online is profound. We see people engaging a lot, doing newer things than they did before. People's interests are broadening across the board. For me, I'm focused on different types of user journeys and making sure each of them is getting deeper and better. For example, within Google, as people have started coming for more health-related information, how is that experience working? How are we thinking about that for the long term and investing in it? I obviously spoke about Shopping earlier, which has been a big focus for us. Education, in general. We are considering small, medium businesses and bigger companies thinking through collaboration, where G Suites' potential is; the investments we are undertaking, all of that is very exciting to me. Cutting underneath all that, although we didn't talk about it, we are really focused on our AI teams doing the investments they need, evolving our next-generation TPUs and the teams building better models and better algorithms. I am really interested and focused on our ability to do more things in the future.

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, etc. That's where I would actually start. I appreciate what you're asking is how we are looking at our own cost base. We called that out last quarter, particularly with respect to CapEx, and you can see that here this quarter. The main change in CapEx has really been that we slowed the pace on the office facilities front. We are looking to reimagine what the workplace will look like. We continue to be very focused on the fact that place and space are important. We believe in collaboration. Serendipity is key to innovation. We view space in the office as important and are very focused on what it means over the long term. We have opened quite a number of our offices, in fact in 40 countries, and we hope to reopen in many more. But regarding the cost structure, we are looking at that in the context of CapEx, and we expect 2020 will show lower CapEx on the facilities side as a result.

I was just curious if you could comment on 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. For YouTube, we ended March with a year-over-year growth rate in the high single digits, reflecting a substantial headwind from brand. The headwind from brand moderated modestly at the end of the second quarter, and 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 is not a quarter, but that's based on the estimates here from the end of June. Beyond that, as Sundar and I both said, when you look at Cloud, it has maintained its strength consistently. With a business growing at this pace, it is 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. Are you seeing any progress with the regulatory environment? 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've obviously been operating under scrutiny for quite a while, and we realize, at our scale, that's appropriate. We've engaged constructively across jurisdictions. From my standpoint, I'm confident in the approach we take, with our focus on users, and in the evidence in almost all areas we operate in. We expand choice and generally lower prices. There is overall a very fast pace of innovation, which makes it dynamic and competitive. Having said that, we will obviously operate based on the rules. To the extent there are areas where we need to adapt, we will. As a company, I think it's important to be flexible around those things. The scrutiny is going to be here for a while, and we are committed to working through it. On the second question around YouTube TV, yes, there is an interesting opportunity there. I spoke earlier about how people are interested in streaming. As YouTube TV gains more scale, I think we will see more opportunities there. We are still in the early stages of building out the product. Recently, we've added several new channels and are ensuring it works well. In the U.S., the TV market represents a significant part of the advertising market as well. If we can invest here and scale up, I think the synergies with YouTube will become more meaningful over time. I am excited about the traction the product is getting, but it is still too early.

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 have 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, monetization, or anything else across the business. Just really curious.

First of all, across the board, the progress is steep. I am very happy with the pace at which our R&D on AI is progressing. For me, it's important that we are state-of-the-art as a company, and we lead the way. I am excited about the pace at which our engineering and R&D teams are working, both across Google and DeepMind. Specifically, we are making good progress in areas like language understanding. You saw some improvements last year, significant improvements with BERT and Search. BERT took us a few years to get there, but I see more advancements in the future. An area where I think we are still under-tapped vis-à-vis potential is definitely Cloud. We see potential there. Companies are thinking about migrating workloads, but the longer-run opportunity of using AI to truly provide business solutions for various industries feels like there is a lot of potential, and we are still very early in that journey. For us, it's about connecting the dots internally and bringing these solutions to our users. We have achieved some success in certain product areas, but I see a bigger opportunity in the future.

I have two questions. First, regarding YouTube subscriptions, can you discuss the significance of this segment of the business in relation to the $15 billion? We estimated it accounts for about 15% of total YouTube revenue. How is the rapid growth in this area compared to advertising influencing your long-term profitability objectives for YouTube? The second question pertains to Search. The flat year-on-year exit run rate seems positive. If we exclude travel, I assume it's significantly higher. How would you describe the query growth compared to the ad auction dynamics outside of travel in other categories? Are we back to pre-COVID levels in those areas?

In terms of the first question, we haven't broken out the specifics within the YouTube subscription revenues. YouTube subscriptions are classified in Other revenues, not in advertising revenues. As we think about the opportunity, our view is that when we launched the subscription product, it was really responsive to what we were hearing from users. Users wanted choice; some wanted a premium YouTube experience with ad-free viewing and the ability to download songs and videos. That was really the impetus. Additionally, YouTube Premium provides extra revenue streams for music labels and publishers. For example, in 2019, YouTube paid the music industry over $3 billion. We've made a meaningful increase in our geographic presence, growing from five countries at the start of 2018 to 94 countries today. Earlier this year, we announced that YouTube Premium had more than 20 million paid subscribers, up over 60% compared to the previous year. Our subscriber numbers have continued to grow, driven by the goal of giving users choice.

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. Specifically, were you focused before on Google Checkout and Maps and some of the assistant functionality? How might those play a changing role in commerce on the Google platform?

Great question. I think the bar is to have a super simple experience, which is delightful, providing users peace of mind and satisfaction in terms of getting products and being able to return them. The end-to-end funnel matters a lot. Part of the reason for the changes we have made is that we removed the commission for merchants to be on the platform. By removing that, they can invest in shipping, delivery, or customer experience. From our perspective, the 'Buy on Google' experience is something we are deeply investing in. Our integrations with PayPal, our underlying investments, are intended to make it as close to a one-click experience as possible, which is a big part of our investment as well.

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.