Alphabet : Q4 2018 Earnings Call Transcript

2/7/2019

[DRAFT] 2018_Q4_Earnings_Transcript - Google Docs

This transcript is provided for the convenience of investors only, for a full recording please see theQ4 2018 Earnings Call webcast.

Alphabet Q4 2018 Earnings Call February 4, 2019

Candice (Operator):Good day ladies and gentlemen, and welcome to the Alphabet fourth quarter 2018 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. If anyone should require operator assistance, please press star and then zero on your touch-tone telephone. I'd now like to turn the conference over to Ellen West, Head of Investor Relations. Please go ahead.

Ellen West, VP Investor Relations:Thank you. Good afternoon, everyone, and welcome to Alphabet's fourth-quarter 2018 earnings conference call. With us today are Ruth Porat and Sundar Pichai.Now I'll quickly cover the Safe Harbor. Some of the statements that we make today regarding our business performance and operations, and our expected level of capital expenditures 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. During this call, we will present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-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. And now, I'll turn the call over to Ruth.

Ruth Porat, CFO Alphabet and Google:Thank you, Ellen. We had a strong 2018 with total revenues of $136.8 billion, up 23% over 2017, reflecting the benefit of our ongoing investments to deliver exceptional experiences for users and compelling returns for our advertisers, partners and enterprise customers. For the fourth quarter, revenues of $39.3 billion were up 22% year-on-year and up 23% in constant currency, as we continued to benefit from ongoing strength in mobile search, with important contributions from YouTube, Cloud, and Desktop Search.

For today's call, 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 will conclude with our outlook. Sundar will then discuss business and product highlights, after which we will take your questions.

Let me start with a summary of Alphabet's consolidated financial performance for the quarter. Our total revenues of $39.3 billion reflect a negative currency impact year-over-year of $724 million, or $600 million after the impact of our hedging program. Turning to Alphabet revenues by geography, you can see that our performance was strong again in all regions.

US revenues were $18.7 billion, up 21% year-over-year. EMEA revenues were $12.4 billion, up 20% year-over-year in both reported and constant currency terms with a slight headwind, primarily from the Euro. APAC revenues were $6.1 billion, up 29% versus last year, and up 32% in constant currency, reflecting weakness of the Australian dollar. Other Americas revenues were $2.2 billion, up 16% year-over-year, and up 26% in constant currency reflecting

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weakening of the Brazilian Real and the Argentine Peso.

On a consolidated basis, total cost of revenues, including TAC, which I will discuss in the Google segment results, was $17.9 billion, up 26% year-on-year. Other Cost of Revenues on a consolidated basis was $10.5 billion, up 34% year-over-year, primarily driven by Google-related expenses. The key drivers were: first, content acquisition costs -- primarily for YouTube, mostly for our advertising-supported content in what is a seasonally strong quarter for YouTube, but also for our newer subscription businesses, YouTube Premium and YouTube TV, which have higher CAC as a percentage of revenues. Second, costs associated with our data centers and other operations, including depreciation; and third, hardware-related costs for our Made by Google and Nest family of products.

Operating expenses were $13.2 billion, up 27% year-over-year. The biggest increase was in R&D expenses, with the larger driver being headcount growth, followed by the accrual of compensation expenses to reflect increases in the valuation of equity in certain Other Bets. Growth in Sales & Marketing expenses reflect increases in sales and marketing headcount, primarily for Cloud and Ads, followed by advertising investments mainly in Search and the Assistant. The growth in G&A expenses reflects mostly increases in headcount. Stock-based compensation totalled $2.3 billion. Headcount at the end of the quarter was 98,771, up 4,399 from last quarter. Consistent with prior quarters, the majority of new hires were engineers and product managers. In terms of product areas, the most sizeable headcount increases were in Cloud for both technical and sales roles.

Operating income was $8.2 billion, up 7% versus last year, for an operating margin of 21%. Other Income & Expense was $1.9 billion, which includes $1.3 billion of unrealized gain related to a non-marketable debt security investment. We provide more detail on these line items within OI&E in our earnings press release. Our effective tax rate was 11.2% for the fourth quarter, reflecting a discrete benefit due to the reversal of an accrual made as a result of updated guidance associated with the U.S. Tax Act. Net income was $8.9 billion and earnings per diluted share were $12.77.

Turning now to Capex and Operating Cash Flow. Cash Capex for the quarter was $7.1 billion, which I will discuss in the Google segment results. Operating Cash Flow was $13.0 billion with Free Cash Flow of $5.9 billion. We ended the quarter with Cash & Marketable Securities of approximately $109 billion.

Let me now turn to our segment financial results.

Starting with the Google segment: Revenues were $39.1 billion, up 22% year-over-year. In terms of the revenue detail, Google Sites revenues were $27.0 billion in the quarter, up 22% year-over-year. In terms of dollar growth, results were led again by mobile search, with a strong contribution from YouTube, followed by desktop search.Network revenues were $5.6 billion, up 12% year-on-year, reflecting the ongoing momentum of AdMob and Google Ad Manager. Other revenues for Google were $6.5 billion, up 31% year-over-year, fueled by Cloud, Hardware and Play.We continue to provide monetization metrics in our earnings press release to give you a sense of the price and volume dynamics of our advertising businesses.

Total traffic acquisition costs were $7.4 billion, or 23% of total advertising revenues, and up 15%

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year-over-year. Total TAC as a percentage of Total Advertising Revenues was down year-over-year, primarily reflecting a favorable revenue mix shift from Network to Sites. The increase in the Sites TAC rate year-over-year was driven by the ongoing shift to mobile which carries higher TAC, followed by changes in partner agreements, offset by the seasonally higher proportion of YouTube advertising revenues in the fourth quarter. In Q4, the Network TAC rate declined year-on-year, primarily due to a revenue mix shift within our programmatic business.

Google stock-based compensation totalled $2.1 billion for the quarter, up 22% year-over-year. Operating income was $9.7 billion, up 13% versus last year, and the operating margin was 24.8%. Accrued Capex for the quarter was $6.8 billion, reflecting investments in office facilities, data centers and servers.

Let me now turn to and talk about Other Bets. I'll cover results for the full year 2018 because it remains most instructive to look at the financials for Other Bets over a longer term horizon, as we have discussed on prior calls. Results for the quarter are in our earnings release. For the full year 2018, Other Bets revenues were $595 million, up 25% vs. 2017, primarily generated by Fiber and Verily. Operating loss for Other Bets was $3.4 billion for the full year 2018, versus an operating loss of $2.7 billion in 2017. Other Bets Accrued Capex was $181 million, down from $493 million in 2017, primarily reflecting investments in Fiber.

Key recent accomplishments include: In December, Waymo launched "Waymo One," which enables participants to use its app to hail and pay for rides. Also Verily recently announced a $1 billion investment round, led by Silver Lake, as it advances on plans that are complementary and additive to its current life sciences portfolio. That investment of course was in addition to the $800 million it raised from Temasek previously.

Let me close with some observations on our priorities and longer-term outlook. First, with respect to Revenues. Our 23% Revenue growth in 2018 was powered in particular by the ongoing benefit of innovation in our Sites business. With eight products with more than one billion users each, and more people coming online every day, we remain excited by the opportunities to continue to create valuable experiences for users around the globe. In particular, we see significant ongoing potential to apply our machine learning capabilities across our businesses. In our advertising business, machine learning has enabled innovation in advertisers' ability to match consumer intent and to bid more effectively for improved ROI. It has also enhanced the ability of smaller businesses to benefit from advertising on our platforms. Machine learning is also driving differentiation for newer Google businesses like Cloud and Hardware, as well as central to a number of Other Bets, most notably Waymo and Verily.

Looking ahead, a couple of things to note: first, as we've said many times, we continuously work to enhance the user and advertiser experience. Because we make changes with a focus on the best interest of users and advertisers over the long-term, the timing of the introduction of new experiences, particularly in search advertising, can vary, which can result in an impact on quarterly year-on-year growth. Second, during 2018, the FX tailwinds in the first half of the year turned to headwinds in the third and fourth quarters, in line with the strengthening of the US dollar. Based on the continuing strengthening of the US dollar, we expect a headwind to reported versus fixed FX results in the first quarter, in contrast to the favorable impact of FX in the first quarter of 2018.

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Turning to investments and profitability. In terms of gross margin, the biggest component within Cost of Revenues remains our Traffic Acquisition Costs, reflecting our strong revenue growth in mobile search and the fact that mobile search carries higher TAC than our desktop business. As we've discussed on prior calls, while the pace of year-on-year growth in Sites TAC as a percentage of Sites Revenues slowed after the first quarter of 2018,we do expect the Sites TAC rate to continue to increase year-on-year, reflecting ongoing strength in mobile search.

Within Opex, we remain focused on prioritization in order to optimize resources for longer-term growth in sizable markets.You'll see us continue to support our priority areas with increased headcount, which will remain concentrated in R&D, although we expect the growth rate to moderate in 2019. In 2018, we also saw continued progress on our goal to nurture new businesses outside of Google -- our Other Bets -- with a model of independence.

While I've said previously that there is no monolithic approach to how the Other Bets execute against opportunities, a shared principle is aligning employee interests with the long-term value creation by these companies. Since inception, this has been an important part of our approach at Google, with stock grants comprising a meaningful component of overall compensation across our employee base. We're increasingly following that approach in the Other Bets, with compensation programs that align employee and company interests. You've seen the impact of some of those programs in the fourth quarter as we accrued compensation expenses to reflect increases in the valuation of equity in certain Other Bets. While these expenses will recur, the timing of valuation events is unpredictable and can vary between Bets, which can affect quarterly comparisons.

Finally, on capital allocation our primary use continues to be to support organic growth in our businesses, followed by retaining flexibility for acquisitions. After taking these needs into account, our Board has authorized the repurchase of up to an additional $12.5 billion of our Class C Capital Stock.With respect to Capex, we continue to invest in both compute requirements and for office facilities, although we expect the capex growth rate in 2019 to moderate quite significantly.

In conclusion, 2018 was another great year, with tremendous ongoing opportunity ahead of us. I will now turn the call over to Sundar.

Sundar Pichai, CEO Google:Thanks, Ruth. Last year, we set out to bring the benefits of AI to everyone through our products, and I'm proud of the tremendous progress we made towards that goal. From Smart Compose in Gmail, to the new Google News experience, to Call Screening on the Pixel, and improving the overall safety of our products, AI is helping people get things done every day.

Beyond our products, AI is also helping us drive our mission forward at a scale we couldn't have imagined just a few years ago. Google AI lead Jeff Dean recapped the results of our efforts in a great post on our AI blog -- like using AI to better detect the spread of breast cancer or providing flood victims with real-time information in a crisis. I encourage everyone to check it out.

We also launched the Google AI Impact Challenge to help nonprofits find ways to use AI to solve social and environmental problems. In addition to our progress in AI, we saw great

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traction across newer areas like the Google Assistant, Hardware and Cloud. And our core areas such as Search, Maps, News, YouTube and our computing and advertising platforms continued their strong momentum.

Everything we do at Google is united by the mission of making information accessible and useful for everyone. Providing accurate and trusted information at the scale the Internet has reached is an extremely complex challenge. And one that is constantly getting harder.

But we have twenty years of experience in these information challenges and it's what we strive to do better than anyone else. As we do this, we feel a deep sense of responsibility to do the right thing and are continuing to build privacy and security into the core of our products, keeping users' data safe and secure with the industry's best security systems, and giving people better and clearer controls. You will see us continue to do a lot more here in 2019.

Today, I'll start by sharing some of the new ways that we're working toward our mission. Then, I'll give an update on our video and advertising platforms, followed by the latest on our Hardware and Cloud efforts. And I'll close with a few thoughts on our investments around the world.

First, advancing our mission of making information accessible and useful. The Google Assistant is a great example of how we help people throughout their day, and we demonstrated that at CES last month with lots of exciting new partners and features.

From the Lenovo smart clock that wakes you up in the morning…to real-time navigation that helps during your commute…to a built-in interpreter that translates conversations across dozens of languages on Google Home.

And speaking of languages, over the last year, the Google Assistant expanded from 8 languages and 14 countries to nearly 30 languages and 80 countries. In that time, the number of active users has quadrupled. As we add more partners, devices and capabilities, the Google Assistant will only get better and more helpful.

There's a lot of great progress in other areas too. Last month, we announced the launch of activity cards in Search. Now, when you search for a topic that you've previously explored, you can quickly see where you've already been and pick up where you left off. Thanks to our strengths in AI and Search, Google Lens uses your smartphone camera to help identify more than one billion products. So if you see an item that you like, Lens can show you similar designs, along with useful information like product reviews.

We continued to see great momentum across our computing platforms, Android and Chrome. In Q4, we announced that Android will officially support foldable phones, with partners like Samsung introducing their first foldable devices this year. We see continued traction with manufacturer adoption of Android Auto. We recently announced new media and messaging features to significantly simplify and improve the car dashboard experience. And building on the speed, simplicity and security of ChromeOS, partners like ASUS and HP introduced a slew of great new consumer and enterprise Chromebooks last month at CES.

Now, let me provide an update on our video and advertising platforms, starting with YouTube. We're seeing great traction in some of our newer experiences on YouTube. YouTube Music and

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