Alphabet Inc - Class A (GOOGL) — Q1 2021 Earnings Call Transcript

Thank you. Good afternoon, everyone, and welcome to Alphabet’s first quarter 2021 earnings conference call. With us today are Sundar Pichai; Philipp Schindler; and Ruth Porat.

Thank you, Jim, and good afternoon, everyone. After a hard year, people in some parts of the world are beginning to rebuild their lives, businesses, and communities. But recovery is far from uniform across the globe as the tragic scenes in countries like India and Brazil remind us. We are continuing to help support public health officials in their vital and urgent work. Our focus is on providing authoritative information. We are helping over 100 government agencies and non-profits worldwide distribute critical information and billions of PSAs about COVID-19 and vaccines, and Google Cloud technologies powering a virtual agent to help make vaccination appointments over the phone, supporting 28 languages and dialects for those with limited internet access. We are focused on doing our part to help. In some parts of the world, the economy began to rebound, which created a rising tide in the first quarter that benefited a number of sectors, including existing and emerging companies and partners. For example, data suggests that investment in startups is at an all-time high. Our product releases are returning to a regular cadence. I am particularly excited that our developer event Google IO is back this year, all virtual and free for everyone on May 18th through 20th. We will have significant product updates and announcements, and I invite you all to tune in. Today, I will briefly mention a few highlights from the past quarter and go a bit deeper on Cloud. Then Philipp will discuss advertising and partnership developments. Finally, Ruth will cover the quarterly results. Quickly turning to product highlights of the quarter. Our knowledge and information services like Search and Maps remain at the heart of our mission to provide helpful and accurate information during important moments.

Thanks, Sundar, and good afternoon, everyone. It’s great to be joining you again today. We are pleased with strong growth in Google Services revenues in the first quarter. Year-on-year performance reflects elevated consumer online activity, broad-based strength in advertiser spend, and lapping of the initial impact of the pandemic on advertising revenues that began in March last year. In the first quarter in Search, we saw sustained strength across most categories led by retail. We also saw strong performance in tech and CPG. In YouTube, we had phenomenal growth driven by Direct Response, followed by continued strength in brand. We have seen great momentum in TrueView for action ads, with a number of advertisers using the format doubling over the past year. In Network, exceptional growth was driven by AdMob and Ad Manager, with particular strength in app campaigns. Google Other revenues were driven by growth in Google Play and YouTube’s non-advertising revenues, followed by hardware. I would now like to take a few minutes to dive deeper into the trends we are seeing in our business. As Sundar touched on earlier, the pandemic is evolving in different ways across the world. Some countries are in advanced stages of reopening, while others are facing reacceleration of cases, and there’s everything in between. It’s never been more important to help businesses navigate the pandemic as circumstances change. On travel, we are starting to see a renewed interest from users as they turn to Google to plan their next trip, even before they are ready to book. Every travel partner is looking to understand where demand is going, and we are helping them find these opportunities through insights and automation.

Thank you, Philipp. Our very strong financial results in the first quarter reflect both lapping the impact of COVID on our business beginning in March 2020, as well as the benefit of excellent underlying operating performance. My focus will be on year-over-year comparisons for the first quarter unless I state otherwise. I will start with results at the Alphabet level, followed by segment results and conclude with our outlook. For the first quarter, our consolidated revenues were $55.3 billion, up 34%, or up 32% in constant currency, reflecting elevated consumer activity online and broad-based increases in advertiser spending within Google Services, as well as ongoing strength in Google Cloud. Our total cost of revenues was $24.1 billion, up 27%, primarily driven by other cost of revenues, which was $14.4 billion, up 25%, followed by TAC, which was $9.7 billion, up 30%. Within Other cost of revenues, the biggest factors are, first, content acquisition costs, primarily driven by costs for YouTube’s advertising-supported content, followed by costs for subscription content. Second, costs associated with data centers and other operations, offset partially by a reduction in depreciation expense due to changes to estimated useful lives of servers in certain network equipment. Operating expenses were $14.8 billion, up 4%. In terms of the three component parts of OpEx. First, the increase in R&D expenses was driven primarily by headcount growth. Second, sales and marketing expenses were essentially flat, reflecting headcount growth, which was offset by lower spend on ads and promotions, as well as on travel and entertainment. Finally, the decline in G&A reflects the benefit of lapping unusually high allowances for credit losses recorded in the first quarter of 2020 due to the impact of COVID, offset by charges relating to certain legal matters. Headcount was up 4,694 from the fourth quarter, including more than 1,800 Fitbit employees who joined us in Q1. Again, the majority of new hires were engineers and product managers. Operating income was $16.4 billion, up 106%, and our operating margin in the quarter was 30%. Other income and expense was $4.8 billion, which primarily reflects unrealized gains in the value of investments in equity securities. Net income was $17.9 billion. Operating cash flow was $19.3 billion, with free cash flow of $13.3 billion in the quarter and $50.7 billion for the trailing 12 months. We ended the first quarter with $135 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 $51.2 billion, up 34%, consisting of Google Search and other advertising revenues of $31.9 billion in the quarter, up 30%, with strength across most categories led by retail. YouTube advertising revenues of $6 billion, up 49%, driven by exceptional performance in Direct Response and ongoing strength in brand advertising. Network advertising revenues of $6.8 billion, up 30%, driven by AdMob and Ad Manager. Other revenues were $6.5 billion, up 46%, primarily driven by growth in Play and YouTube non-advertising revenues, followed by hardware, which benefited from the addition of Fitbit revenues. Google Services operating income was $19.5 billion, up 69%, and the operating margin was 38%. Turning to the Google Cloud segment, including GCP and Google Workspace, revenues were $4 billion for the first quarter, up 46%. GCP’s revenue growth 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 billion. As to our Other Bets, in the first quarter, revenues were $198 million. The operating loss was $1.1 billion. Let me end with our outlook for each segment and our investments more broadly. For Google Services, for the remainder of 2021, year-over-year comparisons will be affected meaningfully by the impact of COVID last year, with a greater benefit in Q2 from an easier comp relative to what you saw in Q1 and then beginning to lap stronger performance in the second half of the year. In the first quarter, we continue to benefit from elevated consumer online activity and broad-based strength in advertiser spend. It is too early to say how durable this consumer behavior will be as economies recover and restrictions on mobility are lifted.

Thanks. On Search, great question. I still think we are in very early stages. A recent example, which I was proud of, was when the ship was stuck in the Suez Canal and then it got out. If you ask the question to Google, I think, very soon after that we had the right answer. It seems obvious to do, except we need to provide the right answers and without giving wrong answers or misinformation for many other things. So to do that is where all our underlying investments go, and that’s how we think about it over the long-term. BERT last year, I think, was a great example of it. It was one of our biggest quality improvements and that was based on the transformer breakthrough from our Google AI team, which laid the foundation for it. So we are continuing to invest in that way in the deep technology as the web is scaling up. There’s more information than ever before. So that’s a big part of what we are doing. Beyond that, there is a lot of opportunity to improve the user experience. You have seen our efforts around shopping. That’s one aspect of how we are working hard to improve the experience there.

Yes. On the YouTube side, let me start with our Direct Response business. Growth was truly exceptional this quarter. Direct Response was practically non-existent on YouTube a few years ago, and it’s now a large and fast-growing business, and we are just getting started in my view. People already, as you know, go to YouTube to decide what they want to buy, and we want to make it easier for them to buy and make the discovery process overall a lot easier. And for creators, we launched new shoppable capabilities. So viewers can actually make purchases from their favorite creators directly on YouTube. Just as an example, as part of our Brand Connect program, Calvin Klein tested these and drove over, I think it was, a 200% lift in brand search and sold out multiple products. For merchants, they can now bring their product feeds directly into their video campaigns, and I think we are still scratching the surface on what’s possible really with commercial intent on YouTube. There is, of course, the opportunity to be a major platform for brands. Historical approaches to reaching audiences through, let’s just say, linear TV don’t really work anymore. Advertisers are using YouTube now to reach the audience they can’t find anywhere else. And remember, more 18- to 49-year-olds are actually watching YouTube than all linear TV combined, and brands are also seeing more incremental reach on YouTube compared to TV. So we are starting to see advertisers buy a mix of awareness and more action-oriented formats. They are driving reach and results across the funnel from awareness to consideration to action. So we see a lot of really interesting opportunities here.

Thanks for the question. So in terms of Cloud and overall performance, I think the main point I would say is, I wouldn’t extrapolate generally from quarter-to-quarter, given we are still in the early stages of building the business. We do intend to continue to invest meaningfully in Cloud given the opportunity. And so, as you said, there were a couple of things that benefited margins in the quarter, both the depreciation expense item, but also lapping the unusually high allowance for credit losses that were recorded back in the first quarter. So, the main takeaway is we are continuing to invest. We will invest aggressively in products and go-to-market, as we have talked about quite consistently over time. Operating losses and operating margin will benefit from increased scale over time. At this point, we do remain focused on investing to build the organization for long-term performance.

And Doug on Waymo, John is stepping down as our CEO, and he has been planning for this transition, with Dmitri and Tekedra working closely with him. We will continue our investments there. I am excited that the fully autonomous experience of Waymo One is available in Phoenix, and we are also accelerating the development of our next-generation Waymo Driver to deploy it in San Francisco. Last quarter, Waymo began limited rider testing in San Francisco. We are focused on making the necessary technical progress to operationalize this, and we will continue executing towards that.

So, overall, what we indicated is the strong results reflect, in part, lapping the impact that we saw starting late in Q1 of last year, and then a pickup in a number of areas. The main thing we would want to leave you with is that we are seeing, in part, an acceleration in the shift to digital, but it’s too early to forecast the extent to which these changes in consumer behavior and advertising spend will endure.

Look, it’s been a year since we brought Bill onboard, pivoting our Shopping strategy to better support retailers and consumers, trying to really build an open retail ecosystem, and we are pleased with the progress we are making. Free listings and zero commissions have actually lowered various online retail. Shopping ads continue to be a powerful way for retailers to promote their products, and the combination of free and paid is a meaningful one. We had a set of new partnerships with Shopify and PayPal that are giving retailers a lot more choice. We will continue to simplify the end-to-end user and merchant experience. In particular, we are trying to streamline and working hard to streamline the back-end experience for merchants, especially for hybrid retailers. Overall, we want to make it much, much easier for retailers to get started on Google and have their information appear across surfaces.

Colin, thanks. Obviously, as we are thinking about AI, it all starts with foundational R&D we do. I think we are one of the largest R&D investors in AI in the world. We are looking ahead and doing that, and we are doing it across all the foundational areas, taking many diverse approaches. As we make breakthroughs, I earlier spoke about transformers and how that translated as BERT to improve search quality. Similarly, we are committed to taking the AI improvements and bringing it through our GCP offerings to our enterprise customers as well. It’s an approach we are deeply committed to, and we are thinking at all layers of the stack. This is why you see us work hard on TPUs and I think about the tool chain for developers on top of all that. Looking at the progress ahead, I think, there’s a lot more progress coming down the pipe, and I am pretty excited that GCP will be differentiated over time as our competitive advantage.

So, I can take this. A lot of the new advertisers that you are referring to are obviously SMBs, and there is no doubt that this has been a challenging year for SMBs. The pandemic has disrupted how many of them connect with their customers. But frankly, the pandemic has also been a catalyst for key consumer trends, creating a lot of new opportunities for small businesses. Consumers are spending more time online. They are buying more online. They were willing to try new brands and eager to support local businesses, SMBs. Searches for 'support local businesses' are up significantly since last year, and we have been focused really on helping SMBs with simpler tools, so they can embrace digital a lot faster. That’s where we have really invested over the year, making everything simpler.

In terms of CapEx, I think I will address two parts. You asked about office facilities, but we are continuing to invest in our technical infrastructure, as you saw again this quarter, and we will continue to do so to support growth we are seeing in Cloud, in Search, in Ads, and machine learning, with no change there. We value bringing people together in the office and are looking at a hybrid work-from-home/work-from-office model. As we look forward at developing our real estate footprint for offices, first, we are growing our headcount, so we are looking at less density per employee. Even with a hybrid work environment, we will continue to need space and are continuing to build out our campuses and office facilities.

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