Alphabet Inc - Class A (GOOGL) — 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 to 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 humming. We also announced that we had 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 with 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 cost 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 of the price range of hardware. How does hardware and broadly tie the assistant into the hardware strategy fit broadly similar into your view for where search is going in the medium to long term? Thanks so much.

Thanks, Eric. Good questions. On search, you're right, today, particularly with mobile and ambient computing, that is you having access to computing across other form factors. I think information both you go looking for and there are times when it's important that you have relevant information at your fingertips. So I do think about it as a holistic user journey. And obviously, in search will continue to evolve. Discover has been very good in terms of Discover and YouTube both play a role in ensuring people are getting relevant information. And, I think for us, it's important holistically that we're meeting users' information needs and out of which, the monetization opportunity also works as well. This is why, whether it be Discover or how we pick up on YouTube, all of that matters for us. On your second question regarding our hardware, I'm excited about the deeper investments we are making in hardware, which some of it may take years to come together. I'm excited about the terrific roadmap ahead. I think we have definitely shown that Pixel 4a and Pixel 5 have a clear value proposition, and we'll build on that. You know our portfolio, and we are thoughtfully considering what the important form factors are, which matter and we do think about it with the view of how search and assistant will be important as well. So in many ways, hardware is there to strategically benefit how we guide the Android ecosystem, and to ensure information is right there at users' fingertips. And so those are both strategic views we take into it as well. But I'm excited about the roadmap ahead, and next year you will see us lean more into some of our deeper investments that will come into play.

Thanks for taking the question. Ruth, we appreciate the incremental color on Q3 and Q4 expenses. I was hoping that you could help us understand the cost structure a little bit more, coming out of this, and just to know whether you're anticipating any more notable changes just coming out of the pandemic 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 stated 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 is that 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 have 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 are your top strategic priorities?

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 and our partner ecosystem has 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 in some of those cases where we are now pricing based on value. I think that kind of deeper play is something I'm very excited about and definitely strengthened just based on our underlying technology. So we do have differentiation in areas like data analytics, AI, etc. So that's been huge as well. But I'm pleased with the execution. Obviously, there is a time lag between when you hire the sales team, when we train them, 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're seeing the results come into play. So credit towards that focus and execution, and I look forward to the next few quarters.

Thanks for taking my question. Sundar, I wanted to ask one about e-commerce specifically. It seems to become increasingly competitive within the e-commerce funnel. So could you talk to us about one, what types of consumer behavior changes you're seeing within e-commerce 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 e-commerce? Thanks.

Thank you for the question. I'm really excited about the announcements and progress we've made in the past few months. We are focused on providing a great user experience, ensuring that consumers have access to comprehensive, high-quality inventory and offerings on our platform. Our free shopping listings, which we launched in the U.S., are now available in 48 countries. We have also removed commission fees for the buy on Google Checkout option and opened the platform for integration with PayPal and Shopify, enhancing our comprehensiveness and quality. What's interesting about user behavior is that search captures immediate intent, and our broad search capabilities have been a significant advantage. As users adapt, so do advertisers, allowing us to observe these dynamics in real time. YouTube is also a crucial platform for e-commerce; I see advertisers engaging at the mid-funnel level, even if the intent is not immediate, to generate demand and interest. E-commerce operates across our entire platform, presenting a great opportunity, and we are committed to ensuring that the user experience remains strong.

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 and where you stand relative to pre-COVID levels with those advertisers?

So overall, we're pleased with the degree to which advertisers have really reactivated their budgets in the third quarter. They reacted in part to evidence that consumers are showing strong demand across nearly all verticals. It's everything from home and garden to computing for work from home needs. And so it's been very helpful there. Also, YouTube's strong watch time growth enables advertisers to reach audiences 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, unique content. So it's been an opportunity, and 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 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 wonder how you think about the monetization? Are you still very early, and can you give us any help on what the margins might look like? Thank you.

Ruth, would you like to proceed?

So look, in terms of YouTube, as I said, we are pleased with the ongoing momentum that you see in the revenue line. I think, as we've talked about quite frequently, in our ad-supported business within YouTube, we do pay out a majority of revenues to all of our content creators. We cover all the infrastructure and networking costs, which includes storing, serving video, or otherwise operating YouTube. And that includes marketing to support content creators. There's quite a bit more that we think is invaluable for creators in the overall ecosystem to make sure we're creating not only great experiences for users and creators, but really the right overall ecosystem. We've talked about that in the context of how we invest, protecting content, and content moderation investments we view as critical. So we're continuing to support that, as we see the experience that both creators and users have as differentiated as a result. And then on the subscription side, we're continuing to build it out. As Sundar noted in his opening comments, both YouTube Music Premium and YouTube TV have higher content acquisition costs as a percentage of revenues than YouTube ads, and we are still early there, continuing to build out that subscriber base.

Justin, regarding regulatory matters, scrutiny is something we are accustomed to. In many ways, it's become an issue across the entire sector, which isn't surprising. We plan to engage constructively whenever we can, and as demonstrated in previous cases, we are confident in the benefits we provide to our users. We'll present our case and be adaptable to any feedback or rulings. This approach is part of our strategy. While there's a lot happening on the legislative and regulatory front, resolving some of these issues can also lead to certainty, clarity, and new opportunities. We are committed to taking a long-term perspective on these matters. Ultimately, what we can control is our relentless focus on our users and our commitment to building exceptional products, which will remain our primary focus.

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, could you address two new revenue opportunities or growing revenue opportunities over the year, specifically Google Maps and the Discover tab? Any update or any new data points that suggest a monetization opportunity with those two assets? Thank you.

So thanks for that, Mark. And when we break out Cloud, we will be reporting that in the fourth quarter results, but we'll be providing full year results for 2018, 2019, and 2020. We'll be providing not just the revenue disaggregation data that we expanded earlier this year, but we will also be adding operating income for each of our segments, which we think is the most relevant data. The point that both Sundar and I have underscored is that we are investing aggressively in cloud, given the opportunity that we see. And frankly, considering the fact that we were later relative to peers, we're very encouraged by the pace of customer wins and the very strong revenue growth in both GCP and workspace. We intend to maintain a high level of investment to best position ourselves. I went through some of those items; the go-to-market team, the engineering team, and CapEx. We describe this as a multiyear path because we believe we're still early in this journey.

On Maps and Discover, I think I spoke a little bit earlier about thinking through it more holistically. An example where we've worked well is you know, as developers, we're looking to promote apps that are universal app campaigns. You could really reach across, and it's a good model to think about. Recently, for example, to serve small and medium businesses, we expanded smart campaigns to 150 countries. For a small business owner, you can set up your first campaign and create your first ad in 15 minutes from your mobile device. So for me, thinking about these surfaces give us a chance to engage users in the way they want us to, sometimes when they come looking for it and sometimes when they proactively want information given to them. So that's the overall view, and I think the opportunity is very exciting ahead.

Great, thanks, and good afternoon, everyone. Sundar, in your response to the DOJ's lawsuit, you compared your search partnerships to how brands might pay a supermarket to be at the end of the aisle or at a 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 secondly, could you maybe talk about how that might matter to your bigger picture thinking about the advertising and e-commerce opportunity for Google, and in particular, the competitive environment you face?

Yes, Dan, at a high level, stepping back from it all, our mission is to provide information. The competitive environment we face, particularly with mobile, is about how users are looking for information. There are so many choices they have. And so the question is, making sure Google is a relevant way to get that information. You can imagine, when people are looking to buy products, or the competitors that exist, travel, booking hotels, or any category you take. For us, that's why I talk about holistically competing and making sure we can provide relevant information. It is both the competition we face for mindshare, and that's the opportunity we have ahead. In terms of the specifics of the DOJ case, we are confident in our approach. We've always built Google for everyone, so we want it to be available on all platforms and be convenient for users to access our services. We partner with other companies in doing so. We're looking forward to making our case, but it's early days. We're still reviewing and understanding it all, and I'm sure we'll have more updates as time goes by.

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.

On shopping and YouTube, I would say we are on the earlier part of the journey. But we have seen strength in YouTube for direct response and in a few other categories. I believe the experiences we see there can directly carryover to commerce. As we build out the experience, so I see that as an opportunity. I earlier also mentioned that what search is currently capturing is the intent at that given time. YouTube advertisers can take a longer-term view to create brand awareness and generate interest, and so on. This also offers opportunity. In many categories, we have creators with very compelling content. I believe things work well when you match user interest, and it's very relevant to users. Therefore, I see commerce as a long-term opportunity. On Google Workspace, I'm very excited that we are seeing strong growth. I mentioned earlier that we saw a peak of 235 million daily meeting participants in Q3 and more than 7.5 billion daily video call minutes. We are seeing significant growth in Meet, as well as in our other products like Docs, Drive, and Chat. Google Workspace creates the unified experience, and I think we are definitely seeing a lot of interest and demand. COVID is really accelerating the future of work. Many of these trends will last through time, which gives us a chance to reimagine what collaboration and productivity at scale looks like, including working remotely. We plan to be at the forefront of that, and I'm excited about the opportunity.

Hi, just two questions. If we look at search, your growth rates in January and February compared to today, pre-COVID versus today, how many categories are above the pre-COVID growth rate? Is travel the only large category that's currently running below your pre-COVID growth rates in search? And then the second question is on the topic of the Apple search agreement. As you guys said in your blog post, based on other agreements, where you're seeing changes, you didn't really lose a lot of query volume after the change. 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 can it be managed through? Thanks a lot.

In terms of your first question, as we've often said, we have a very diverse business globally, and that's across sectors, customer sizes, and geographies. With respect to sectors, we saw broad-based improvement across virtually all. Basically, you see what's reflected in the broader economy. We don't break out more than that, but it was quite broad-based.

On search, as I said for a long time, we work hard to make sure users can conveniently access us. Most of our partners choose us because we are the best search provider, and users find us having the highest search quality. There is organic demand for it. We believe in investing in our experience across all platforms, and we are definitely committed to making sure we can serve our users everywhere.

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.