Alphabet Inc - Class A (GOOGL) — Q4 2022 Earnings Call Transcript

Thank you. Good afternoon, everyone, and welcome to Alphabet's Fourth Quarter 2022 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 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 Forms 10-K and 10-Q filed with the SEC, including our upcoming Form 10-K filing for the year ended December 31, 2022. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of non-GAAP to GAAP measures is included in today's earnings press release, which is distributed and available to the public through our Investor Relations website located at abc.xyz/investor. Our comments will be on year-over-year comparisons unless we state otherwise. And now I'll turn the call over to Sundar.

Thank you, Jim, and good afternoon, everyone. It's clear that after a period of significant acceleration in digital spending during the pandemic, the macroeconomic climate has become more challenging. We continue to have an extraordinary business and provide immensely valuable services for people and our partners. For example, during the World Cup final on December 18, Google Search saw its highest query per second volume of all time. And beyond our advertising business, we have strong momentum in Cloud, YouTube subscriptions, and hardware. However, our revenues this quarter were impacted by pullbacks in advertiser spend and the impact of foreign exchange. I'll focus on two major things today in a bit more detail, and then I'll give a shorter-than-usual quarterly snapshot from across our business. First, how we unlock the incredible opportunities AI enables for consumers, our partners, and for our business; and second, how we focus our investments and make necessary decisions as a company to get there. First, the AI opportunity ahead. AI is the most profound technology we are working on today. Our talented researchers, infrastructure, and technology make us extremely well positioned as AI reaches an inflection point. More than six years ago, I first spoke about Google being an AI-first company. Since then, we have been a leader in developing AI. In fact, our Transformer research project and our field-defining paper in 2017, as well as our path-breaking work in diffusion models, are now the basis of many of the generative AI applications you're starting to see today. Translating these kinds of technical leaps into products that help billions of people is what our company has always strived to achieve. Everyone working on the various projects underway is excited. We'll pursue this work boldly but with a deep sense of responsibility, with our AI principles and the highest standards of information integrity at the core of all our work. We have been preparing for this moment since early last year, and you're going to see a lot from us in the coming few months across three big areas of opportunity. First, large models; we published extensively about LaMDA and PaLM, the industry's largest, most sophisticated model plus extensive work at DeepMind. In the coming weeks and months, we'll make these language models available, starting with LaMDA so that people can engage directly with them. This will help us continue to get feedback, test, and safely improve them. These models are particularly amazing for composing, constructing, and summarizing. They will become even more useful for people as they provide up-to-date, more factual information. And in Search, language models like BERT and MUM have improved searches for four years now, enabling significant ranking improvements and multimodal search like Google Lens. Very soon, people will be able to interact directly with our newest, most powerful language models as a companion to Search in experimental and innovative ways. Stay tuned. Second, we'll provide new tools and APIs for developers, creators, and partners. This will empower them to innovate and build their own applications and discover new possibilities with AI on top of our language, multimodal, and other AI models. Third, our AI is a powerful enabler for businesses and organizations of all sizes, and we have much more to come here. There's a few flavors of this. Google Cloud is making our technological leadership in AI available to customers via our Cloud AI platform, including infrastructure and tools for developers and data scientists like Vertex AI. We also offer specific AI solutions for sectors like manufacturing, life sciences, and retail and will continue to roll out more. Workspace users benefit from AI-powered features like Smart Canvas for collaboration and Smart Compose for creation. And we are working to bring large language models to Gmail and Docs. We'll also make available other helpful generative capabilities, from coding to design and more. And for our advertising partners, Philipp will discuss in detail how AI is powering dramatic campaign improvements and value-adding features for them. Overall, I see this as an important journey to reengineer the company's cost base in a durable way. There are several dimensions already underway, including prioritization of our product investments across Google and Other Bets. It also includes a careful focus on our hiring needs, reflecting these priorities, as well as efficiencies in our technical infrastructure and productivity improvements from our AI tools. Let me give a few quick updates from across the business this quarter. Just this week, we started bringing revenue sharing to YouTube Shorts, which is now averaging over 50 billion daily views, up from the 30 billion I announced on the Q1 2022 call. This will reward creators and help improve the Shorts experience for everyone. Our subscription business continues to grow, with YouTube Music and Premium surpassing 80 million subscribers, including trialers. Together with YouTube Primetime channel subscriptions and YouTube TV, we have good momentum here. YouTube's NFL Sunday Ticket will accelerate that by helping to drive subscriptions, bring new viewers to YouTube's paid and ad-supported experiences, and create new opportunities for creators. Turning to hardware. Many outlets and reviewers named Pixel 7 Pro the phone of the year. Features like Magic Eraser and Photo Unblur are incredible and help differentiate Pixel from others. 2022's Pixel 6A, 7, and 7 Pro are the best-selling generation of phones we have ever launched, and we gained share in every market we operate in this year. Next, Google Cloud. We see continued momentum with Q4 revenue growing 32%. Our differentiated products and focused go-to-market strategy continue to drive customer momentum, beginning with real-time data analytics and AI. Customers are increasingly choosing BigQuery because we unify data lakes, data warehouses, and advanced AI/ML into one system and now analyze over 110 terabytes of data per second. Customers like Kroger can analyze data in multiple clouds without moving data in most cases, and MSCI processes unstructured and structured data at scale. Our reliability advantages and open edge cloud powered the mission-critical 5G network of Telefonica Germany. As I mentioned, our suite of AI/ML solutions across verticals are a key differentiator. We helped Wells Fargo automate the customer service experience for mobile users and helped improve the quality of patient care. In 2022, Mandiant, which we are now integrating, helped over 1,800 customers prepare for or recover from the most critical cybersecurity incidents. To close, we are all standing on the cusp of an era of amazing opportunities. We are going to be bold, responsible, and focused as we move into it. A healthy disregard for the impossible has been core to our company culture from the very beginning. When I look around Google today, I see that same spirit and energy driving our efforts. I'm excited for what's next. Over to you, Philipp.

Thanks, Sundar. Hello, everyone. It's good to be with you all. I'll start today with our Google Services performance in the fourth quarter and then dive deeper into our priority areas. Google Services revenues of $68 billion were down 2% year-on-year, negatively affected by sizable foreign exchange headwind. In Google advertising, Search and Other revenues were down 2% year-over-year, and YouTube Ads and Network had high single-digit revenue declines. Google Other revenues were up 8% year-over-year, with strong growth in YouTube, non-advertising and hardware revenues, offset by a decrease in Play revenues. I'll highlight two other factors that affected our Ads business in Q4. In Search and Other, revenues grew moderately year-over-year, excluding the impact of FX, reflecting an increase in retail and travel, offset partially by a decline in finance. At the same time, we saw further pullback in spend by some advertisers in Search in Q4 versus Q3. In YouTube and Network, the year-over-year revenue declines were due to a broadening of pullbacks in advertiser spend in the fourth quarter. I'll now zoom out to share more broadly where we're investing and see clear opportunities for long-term growth. First, Google AI. It's important to recognize that our advertising business has obviously benefited over the past decade from the transition to mobile. More recently, we had outsized growth in advertising revenues during the pandemic, with 2022 advertising revenues $90 billion higher than in 2019. Going forward, we are focused on growing revenues on top of this higher base through AI-driven innovation. Sundar highlighted the incredible opportunities underway with AI and the transformative impact it will have on businesses. Already, breakthroughs in everything from natural language understanding to generative AI are fueling our ability to deliver results that drive meaningful performance for advertisers and are useful to users. Take Smart Bidding, which uses AI to predict future ad conversions and their value, helping businesses stay agile and responsive to rapid shifts in demand. In 2022, AI advances boosted bidding performance, allowing us to move advertiser outcomes down the funnel to drive better ROI and use budgets more efficiently. Google AI also underlies our creative products like tech suggestions in Google ads and creative optimization and responsive search ads. We're excited to start testing our automatically created assets beta, which uses AI to generate headlines and descriptions for search created seamlessly once advertisers opt in. But we're not stopping here, and these examples aren't exhaustive. AI has been foundational to our ads business for the last decade, and we'll continue to bring cutting-edge advances to our products to help businesses and users. Number two, retail. Our foundation for delivering value over the long term includes three pillars. First, we are on a multiyear mission to make Google a core part of shopping journeys for consumers and a valuable place for merchants to connect with users. This means constantly improving our consumer experiences, starting with a more visual, immersive, browsable search. Second, we're empowering more merchants to participate in our free listings and ad experiences. In 2022, we saw an uptick in merchants, particularly SMBs, and product inventory coming onto Google. Adding more value for merchants remains a top priority. Third, to drive retail performance further, we focus on great ads products, from automation and insights to bidding tools and omnichannel solutions to AI-powered campaigns like PMax. We're helping retailers hit their goals and connect with customers no matter where or when they shop. Two quick insights on PMax, which we upgraded the majority of advertisers to from Smart Shopping Campaigns last year. First, advertisers on average see a 12% uplift from SSC to PMax. Second, it was a success story during the holidays and Cyber 5. Its ability to scale and adapt to changing traffic over a volatile peak retail season drove strong results for many retailers, particularly mid-market advertisers. Moving on to YouTube. Despite ongoing revenue headwinds in Q4, we're confident in YouTube's long-term trajectory. Here's how we think about our strategy. It all starts with a creator ecosystem. Creators are the lifeblood of YouTube. In 2022, more people created content on YouTube than ever before, long-form, short-form, audio, podcast, music, live streams. What sets YouTube apart is we give creators more ways to create content and connect with fans and more ways to earn money than any other platform. More creators mean more content, more viewers, which leads to more opportunities for advertisers. The creator ecosystem and our multi-format strategy will continue to drive YouTube's long-term growth. We're focused on ramping Shorts, accelerating engagement on large screens, investing in our subscription offerings, and a long-term effort to make YouTube more shoppable. First, Shorts. Viewership is growing rapidly, as Sundar said, with 50 billion-plus daily views. We're also still pleased with our continuing progress in early monetization. On the creator side, it's been impressive to see the innovative ways creators are using Shorts to introduce their content and extend existing channels. We're focused on providing creators with the best content creation and monetization tools. And ultimately, our goal is to make YouTube the best place for Shorts and creators. On that note, a big thank you to our partners and customers for their ongoing collaboration and trust, and to Googlers for their energy, focus, and dedication to helping our users, customers, and partners succeed, especially through these tougher times. Ruth, over to you.

Thank you, Philipp. For the full year 2022, Alphabet delivered revenues of $283 billion, up 10% versus 2021 and up 14% on a constant currency basis, adding $37 billion to revenues, excluding the impact of foreign exchange. I will briefly cover the main points of our fourth quarter results and then turn to our outlook to give you more context for Sundar's comments on how we're focused on investing for growth as well as on reengineering our cost base for long-term success. For the fourth quarter, our consolidated revenues were $76 billion, up 1% or up 7% in constant currency. Search remained the largest contributor to revenue growth on a constant currency basis. Our total cost of revenues was $35.3 billion, up 7%. Operating expenses were $22.5 billion, up 10%, reflecting an increase in R&D expenses. Operating income was $18.2 billion, down 17% versus last year, and our operating margin was 24%. Net income was $13.6 billion. We delivered free cash flow of $16 billion in the fourth quarter and $60 billion in 2022. We ended the year with $114 billion in cash and marketable securities. Turning to our segment results, starting with Google Services. Revenues were $67.8 billion, down 2%. Google Search and other advertising revenues of $42.6 billion in the quarter were down 2%. YouTube advertising revenues of $8 billion were down 8%. Other revenues were $8.8 billion, up 8%, reflecting several factors: first, significant subscriber growth in YouTube Music Premium and YouTube TV; second, strong growth in hardware revenues, primarily from the Pixel family. Offsetting growth in these two areas was a year-on-year decline in Play revenues, reflecting a particularly large foreign exchange headwind in APAC. Google Services operating income was $21.1 billion, down 19%. Turning to the Google Cloud segment. Revenues were $7.3 billion for the quarter, up 32%. Revenue growth in GCP was again greater than Google Cloud, reflecting strength in both infrastructure and platform services. Google Cloud had an operating loss of $480 million. Turning to our outlook for the business, in 2022, our year-on-year revenue growth was affected by several challenges: tough comps from the recovery in 2021, foreign exchange headwinds grew throughout the year, and a more challenging economic climate continues to impact many of our customers. We remain very optimistic about the longer-term prospects for mobile apps and gaming. In hardware, we continue to make sizable investments particularly to support innovation across our Pixel family while working to drive greater focus and cost efficiencies across the portfolio. Thank you.

I have two. The first one around AI and the cost of AI. I appreciate all the color about all the AI tools that are to come. I guess, first question is, how should we think about the potential impact on CapEx, and the higher compute intensity of these AI tools potentially impacting margins over the next couple of years? And then the second one, Ruth, I really appreciate the conversation about long-term efforts underway to improve efficiency. How should we think about potential impacts of those efforts in '23 and '24?

Thanks for the question. Starting on your question about AI and CapEx. As I think Sundar and Philipp both noted, AI is already incorporated in many of our products, products like Performance Max and Smart Bidding, and Cloud, as Sundar said. It is more compute-intensive but also opens up many more services and products for our users, for creators, and for advertisers. That being said, we're very focused on further optimizing the cost of compute, and that's across all elements: data center, servers, and our supply chain. So we're continuing to invest with a keen lens on the return on that capital. Regarding overall efficiency opportunities, we have a very keen focus on the three areas that I noted, and one of the key elements of it is using AI and automation to improve productivity and efficiency of our technical infrastructure. These work streams that we have in flight take longer to implement, execute, and continue to provide added upside as we go through time, which is why I indicated you would see more of an impact in 2024 than in 2023. But we're continuing to work through them.

I have two. For Sundar and Philipp, you both mentioned the NFL in your remarks and the opportunities it opens up. Can you comment and help us define what do you see as that longer-term opportunity? And then just, Philipp, you've said in the past about scaling monetization on YouTube Shorts. What are the sticky factors? What's taking time to really bring advertisers on? And what are some of the things you've seen in terms that you've solved to make this a more quickly monetizable product?

Yes. Thank you so much for the question. We think there are a lot of great opportunities to differentiate the user and creator experience with our unique capabilities. It means that every YouTube viewer who is interested in the NFL can now have one-click access to the full offering of Sunday Ticket as a add-on package on YouTube TV subscription and as a stand-alone offering on Primetime Channels. This will be the first time that Sunday Ticket is actually available a la carte for fans. On YouTube TV, we're building the ability for subscribers to watch multiple screens at once. And on YouTube CTV, we'll be adding new features specific to the Sunday Ticket experience like comments, chats, polls, and so on. On the creator side, imagine all the innovative ways they can create with exclusive NFL content, behind-the-scenes event access, and so on. Closing the gap between Shorts and long-form content is a big priority for us, as is, of course, continuing to build a great creator and user experience, which we're paying a lot of attention to. As on Shorts are now available, it gives you a bit of a sign for the progress. We brought revenue sharing to Shorts via our YouTube Partner Program. Ultimately, our goal is to make YouTube the best place for Shorts and creators.

One for Sundar and one for Ruth. For Sundar, can you just talk more about how you can bring the AI products to market with the principles and integrity that you talked about, and how you can do that without sacrificing quality or trust? And then, Ruth, can you help us quantify how you're thinking about these efforts?

Thanks, Doug. On the AI side, it is a really exciting time. I think we've been investing for a while, and it's clear that the market is ready. Consumers are interested in trying out new experiences. I feel comfortable with the investments we have made in making sure we develop AI responsibly. We'll be careful. We'll be launching more lab products in certain cases, beta features in certain cases, and just slowly scaling up from there. We see this as a chance to rethink, reimagine, and drive Search to solve more use cases for our users as well. So again, early days, you will see us be bold, put things out, get feedback, and iterate and make things better.

On your second question regarding Other Bets investment levels, our goal for Other Bets is to use our deep technology investments to drive innovation with the potential for value creation. At the same time, we focus on the pace of investment and financial returns. We're analyzing opportunities for monetization and commercialization. There is no monolithic approach across the portfolio, but we ensure that investment supports products and services within Google or for Alphabet broadly. DeepMind's research is core to our future across the product areas in the Alphabet portfolio. This reporting change reflects the strategic focus in DeepMind, which is why I indicated that beginning Q1, DeepMind financials will be reported within our corporate cost segment.

Just digging into Search kind of low single-digit growth excluding FX. Can you talk about the pressures there, volume versus pricing or CPCs? What's really driving the slowdown? Just think about that. And then any signs that we're near a bottom? Any stabilization in growth rates you can talk about or how your outlook is for '23 on that?

Overall, as we've indicated, we remain very excited about all that we're doing in Search, and so that's why you've heard so many comments about the application of AI and what that means for the ongoing opportunity. You had a number of different questions in there. I think one was on volumes. In the 10-K that we'll be filing shortly, you'll see that for the full year 2022, CPCs were down 1% versus last year. Clicks were up 10% in 2022, reflecting several factors, including increased engagement primarily on mobile devices and improvements in ad formats. But overall, we're really excited about what we see ahead. We're not going to predict the global environment, but we're very focused on what we can control. The innovation to help advertisers overall and our cost reengineering will drive long-term sustainable value creation.

Just a question on the hardware business. Pixel's doing quite well, but it seems like there have been issues around other areas with this inventory write-down. So could you just talk about the strategic importance of having the wide range of hardware products that you have in that segment as it relates to your overall AI initiatives?

Thanks, Ross. First of all, I'm very pleased with how Pixel has performed through a challenging macro environment. Our computing portfolio is incredibly important. It allows us to invest and drive innovation forward. You have to put it all together as a product and ship it. The ecosystem helps guide the overall usage. So we are very thoughtful about how we are approaching this area, and we continue to focus on improving all of this in a durable way.

I'll just ask one question on, Ruth, you mentioned a couple of times getting Google Cloud to profitability. Can you just talk through how that gets done? You had almost 40% growth in Google Cloud. The operating loss level stayed about the same from '21 to '22, so the growth is there. What are the factors that need to be solved in order to get nice profitability out of that segment?

With Google Cloud, we've been investing ahead of our revenues, given the growth and the opportunity overall. There have been meaningful investments to ensure that we're equipped to support customers across segments around the globe. While we remain focused on the path to profitability, every element is relevant here for Cloud as well, everything from our efficiency with our technical infrastructure to our efforts that are driving these financial outcomes. We're closing the gap to profitability but still working through the investments for growth.

Ruth, can you give us a sense of what you're seeing in Q1? Is this year a little more seasonal than historic? Are you observing any different patterns just over one month into the year? Can you give us any color in terms of how you're framing this quarter?

As you know well, we don't provide exit run rates. What we try to do is give you context within which we're approaching the overall business and the priorities that we have as we're looking at revenue upside and growth levers as well as how to reengineer our expense base to deliver attractive returns. So not really much to add to the comments that you've heard today; we're continuing to execute across each of the elements discussed.

Thanks, everyone, for joining us today. We look forward to speaking with you again on our first quarter 2023 call. Thank you, and have a good evening.