Meta Platforms, Inc.

Good afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the Facebook third quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during that time, please press star, then the number one on your telephone keypad. This call will be recorded. Thank you very much. Ms. Deborah Crawford, Facebook's Vice President of Investor Relations, you may begin.

Thank you. Good afternoon, and welcome to Facebook's third quarter 2020 earnings conference call. Joining me today to discuss our results are Mark Zuckerberg, CEO, Sheryl Sandberg, COO, and Dave Wehner, CFO. Before we get started, I would like to take this opportunity to remind you that our remarks today will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially in today's press release and in our quarterly report on Form 10-Q filed with the SEC. Any forward-looking statements that we make on this call are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. During this call, we may present both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in today's earnings press release. The press release and an accompanying investor presentation are available on our website at investor.fb.com. And now I'd like to turn the call over to Mark.

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Thanks, everyone, for joining us today. I hope you're all staying safe and doing well. We had another strong quarter as people and businesses continue to rely on our services to stay connected and create economic opportunity, especially during these tough times. Now, 2.5 billion people around the world use one or more of our apps each day. More than 200 million businesses use our free tools, and there are more than 10 million active advertisers across our services. Most of these are small businesses, which otherwise would have had a much harder time moving online and reaching customers during this pandemic, and that's something that I'm really proud of. And before I cover other topics, the election is, of course, top of mind for everyone right now, so I want to start there. I've discussed our efforts many times on previous calls, but I want to take a few minutes to reiterate how far we have come since 2016. Four years ago, our security teams were looking for traditional threats like hacking, But what we ended up seeing was something new, coordinated interference campaigns using fake accounts that tried to spread misinformation and discord. And since then, we've built the most advanced systems in the world to find and remove these threats. And it shows in the numbers. In the years since, we've taken down more than 100 networks, including from Russia, Iran, and China. And we block millions of potentially abusive accounts every day. No other company has systems nearly as advanced. We've also taken industry-leading steps to make ads transparent so people know who's trying to gain their support. Anyone who wants to run a political or social issue ad has to go through our authorization process first. In between March and September, we rejected ads 2.2 million times before they could run for trying to target the U.S. without authorization. We also built the ads library. where you can see any ad that is running on Facebook or Instagram, even if it's not targeted to you. For political and social issue ads, you can see who paid for the ad and what audience the ad reached, making political advertising on Facebook more transparent than any other medium. We're very focused on voter suppression, working closely with experts in the space, including civil rights leaders, and I'm grateful for their guidance here. Our policies prohibit misrepresentations of when and how to vote and content meant to intimidate people into not showing up to polling places like claiming that ICE will be there. And we recently expanded these policies to include implicit misrepresentations, like, for example, claims that you will get COVID by voting in person. From March through mid-October, we removed more than 135,000 pieces of content in the U.S. for breaking these rules. Now, these are all changes we've made in the last four years, and they've helped us protect the integrity of more than 200 different elections around the world, including in the EU, India, and Indonesia. And they've been important for stopping abuse ahead of next week's vote in the U.S. But 2020 has also brought new challenges. COVID raises questions about how people will vote safely, which will lead to higher levels of voting by mail. And I'm worried that with our nation so divided and election results potentially taking days or weeks to be finalized, there is a risk of civil unrest across the country. And given this, companies like ours need to go well beyond what we've done before. That's why we've taken additional steps to help people register to vote however they're comfortable, to clear up confusion about how this election will work, and reduce the chance of uncertainty and unrest. It would take too long for me to cover everything we've done in detail, but I'd like to mention a few things. First, we ran the largest voting information campaign in American history. We estimate that we've helped 4.4 million people register, exceeding the goal that we set for ourselves this summer. We also estimate that in September, we helped 100,000 people sign up to be poll workers, and South Carolina saw 20% of their total sign-ups to date over a single weekend that we ran that recruitment drive. We're also taking a number of additional precautionary steps. As of this Tuesday, we've blocked new political and social issue ads from running the week ahead of Election Day and after the election. We're doing this because while I generally believe that the best antidote to bad speech is more speech, In the final days of an election, there may simply not be enough time to contest new claims. If any candidate or campaign tries to declare victory before the final results are called, we'll put a notification at the top of people's Facebook and Instagram feeds, letting them know the results aren't final yet, and we'll put an informational label on candidates' posts saying the same. We're also attaching an informational label to content that seeks to delegitimize the outcome of the election or any particular voting method. And when there is a projected winner, we'll send people notifications letting them know, and we'll show them in the Voting Information Center we've been displaying at the top of our apps. Finally, we've made a number of important content moderation decisions in recent weeks, including banning QAnon and Holocaust denial content. as well as rejecting ads that discourage vaccines. And to be clear, this is not a shift in our underlying philosophy or strong support of free expression. Instead, it is a reflection of the increased risk of violence and unrest and an increased risk of harm associated with vaccine misinformation as we near an approved COVID vaccine.

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Even the strongest free expression advocates don't think you should be able to yell fire in a crowded theater because they recognize that your actions or speech should not be able to put people in imminent risk of physical harm. And our policies here try to balance free expression and safety as well, and that's what we're doing. Now, while next week will certainly be a test for Facebook, our systems have been tested in many elections over the last few years. Election integrity is and will be an ongoing challenge, and I am proud of the work that we have done here. I also know that our work doesn't stop after November 3rd, so we will keep anticipating new threats, evolving our approach, and fighting to protect the integrity of the democratic process and the right of people to make their voices heard around the world. Now, with that all said, I want to spend the rest of our time talking about our product work. We're making significant investments in hiring to develop a range of new products across the spectrum, from messaging to reels to our commerce efforts to our longer-term AR and VR platform work through Facebook Reality Labs. Dave will share more on the scope of those investments in just a few minutes. But while we face intense competition in every area of what we do, I'm proud of the product that we keep delivering for our community. Now, first on messaging, Private messaging continues to be one of the fastest-growing forms of communication, now with roughly 100 billion messages exchanged every day on WhatsApp alone. But these conversations are still often fragmented across different apps, and people tell us that they want to be able to use the app that they like best to reach everyone who they want to message. And to address this, we've been working on a long-term infrastructure project to let people message across apps, and we've now started rolling out an update to Instagram that brings the best features from Messenger and creates a better messaging experience across both apps, and early feedback has been positive so far. This quarter, we also expanded Reels, a new way to create and discover short, entertaining videos. People have always come to Instagram to express themselves and be entertained, and the community has been telling us that they want a way to make and watch short-form videos for a while now. The early results make me quite optimistic here, I also want to say I've been impressed by the AR effect that have been built by more than 400,000 creators on our AR platform. There's obviously a lot of competition in this space as well, but I think that we're going to bring something new and higher quality that delivers value for creators and people who want to watch this content. This quarter, we also took major steps forward in building the next computing platform. We launched Quest 2, our most advanced virtual reality headset, right in time for the holidays. It delivers a real sense of presence, like you're right there with another person or in another place. And we've worked to make it accessible to more people. It's lighter, faster, has a sharper screen, and a new price point of just $300. Pre-orders have outpaced the original Quest pre-orders by more than 5x and have surpassed our expectations. We are also laying the foundation for AR glasses, which will be the holy grail of delivering a sense of presence while not taking you away from the physical world. One day, you're going to be able to sit down for dinner with your parents, even if they're on the other side of the country, or look up directions without having to take out your phone and take yourself out of the moment. We're working on the building blocks for true consumer AR glasses. And in the meantime, we are partnering with Luxottica, the maker of Ray-Ban and Oakley, to build our first smart glasses, which will launch sometime next year. Supporting small businesses also continues to be a major focus for us, and it's important, more important now than ever. Cheryl is going to cover this in more detail shortly, but I want to call out a few new products that we've shipped. The Facebook Shop tab gives people a dedicated place to shop and find product. The Facebook Small Business Suite lets businesses easily manage their presence across our apps. And Paid Online Events lets businesses, creators, and educators make money by live streaming classes, talks, and other events. In WhatsApp, we just announced how we're going to make it easier for people to buy products directly within a chat. and integrating WhatsApp business features with Facebook Shops, so that way when a small business sets up a shop, they can now establish or will be able to establish a commercial presence across Facebook, Instagram, and WhatsApp all at the same time. We continue to see how personalized advertising is helping small businesses find customers, grow their businesses, and create jobs. I continue to believe that we need new regulation that allows for personalized and relevant ads while protecting people's data and privacy. And I worry that some proposals, especially in the EU, and actions planned by platform companies like Apple, could have a meaningful negative effect on small businesses and economic recovery in 2021 and beyond. This is one of the policy questions that we're going to need to continue showing up and engaging on for the future of the Internet. There are very different visions of that future held in different parts of the world. Some are motivated by different values and others by strategic advantage. We're going to have to stand up strongly for our vision of an Internet where every individual can have access to free services and every small business can have access to the same kinds of tools to grow and create jobs that the big companies have. I am grateful to everyone at Facebook and all of our partners who are working to make this vision a reality. I'm proud of all the new products and experiences we've been able to deliver this year. And as always, thank you for being on this journey with us. Now I will hand it over to Cheryl.

Thanks, Mark, and hi, everyone. I join Mark in thanking all of you for joining us today. This was a strong quarter for us as more businesses shifted online to reach customers, tell their stories, and sell virtually. Our total ad revenue for Q3 was $21.2 billion, which is a 22% year-over-year increase. Our largest verticals were e-commerce, retail, and CPG, and we continue to see broad growth across sectors such as advertisers continue to optimize for measurable objectives like sales and website visits. The digital transformation has been underway for years, but the pandemic has accelerated it dramatically. As Mark said, we now have more than 200 million businesses using our free tools across our platform every month to create virtual storefronts and communicate with customers. We also now have more than 10 million active advertisers across our services every month, the vast majority of which are small and medium-sized businesses. These businesses rely on personalized advertising to reach potential customers and grow. According to the US Census Bureau, before the pandemic, e-commerce share of U.S. retail sales was steadily increasing by an average of one percentage point a year for the past four years. This share leapt by four percentage points in Q2 alone. That's four years of change in less than 100 days. That doesn't mean we will continue to see sustained acceleration. This may simply be future growth being pulled forward. But it is increasingly clear that the economic recovery will be driven by businesses finding customers and selling online. As the number of businesses going digital accelerates during the pandemic, we have accelerated our efforts to support them. On the product side, our teams have been working around the clock to build new tools that make operating online simple and efficient. This quarter, we released Facebook Business Suite, a new interface for businesses to manage their pages and profiles across our apps, helping them save time and stay up to date with customers. We also expanded Facebook and Instagram shops Instagram checkout, and launched the Facebook Shop tab, so businesses can showcase their products and consumers can discover brands and buy things they love. And with more and more businesses using live streaming when they can't host events in person, we introduced paid online events to help them generate revenue. On WhatsApp, there are now more than 40 million people viewing a business catalog every month, So we created a new shopping button to make it even easier for people to discover a catalog and find something they'd like to buy. Soon, you'll also be able to click a WhatsApp icon on a Facebook shop to chat directly with the business. As well as improving our products, we are also helping business owners learn the skills they need to thrive online. Our business resource hub provides training to small businesses on everything from getting set up online to engaging with customers. and has been visited tens of millions of times since its launch just in March. As the needs of our community evolve, our training changes too. We launched a new partnership with Coursera to train job seekers in skills like social marketing that are becoming ever more critical in a digital economy. We have also built on the success of our summer of support training program, which reached more than 17 million people, by launching a new three-month season of support to help businesses make the most of the holidays. This includes our Buy Black Friday initiative to support black-owned businesses in their communities. While we continue to invest in helping businesses, we are equally focused on keeping our platform safe. Last month, we took an important step by agreeing, along with YouTube and Twitter, to a common set of definitions of hate speech and other harmful content. This was done in partnership with the World Federation of Advertisers and a global alliance for responsible media. There's more work to do, but we're headed in the right direction as we continue to develop industry-wide standards. I want to acknowledge that despite these strong results, we face significant headwinds, which Dave will talk about more. There is an important debate taking place about the way companies use data, including for online advertising. We welcome this debate and have been advocating for new rules for the Internet in a range of areas. from privacy and harmful content to election integrity and data portability. While we face greater scrutiny than ever before, we are also experiencing more demand from businesses for both our free and paid tools, especially our personalized ad products. As this debate continues, it is important that we don't lose sight of the hugely important role personalized ads play for small businesses. Small businesses can't afford the broad mass marketing campaigns that big brands can. A good example is Glamnetic, a beauty brand specializing in magnetic eyelashes, which started in a one-bedroom apartment in Los Angeles a little more than a year ago. Co-founders Ann and Kevin post photos and videos on Instagram and Facebook and use personalized ads to reach people they think might like their products, including women between 18 to 50 who are interested in beauty and cosmetics. They also advertise to people who have visited their website made possible by personalized ads technology. which helped them identify customer hotspots to focus on, like California, New York, Texas, Ohio, and several southern states. They saw a nine times increase in revenue in Q3 versus 2019 and doubled their revenue month over month. While so many businesses are struggling this year, this has helped them to grow from five employees to 35. There are countless stories like Ann and Kevin's among the over 10 million advertisers on our platform. For many small and medium sized businesses, personalized advertising, which uses data safely and in a privacy protected way, is the secret ingredient that makes their success possible. These businesses have the potential to be the driving force of the economic recovery in the months and years ahead, as long as they can continue to rely on the data driven tools they use day in and day out. We're living in a time of deep uncertainty. The next few months or quarters will continue to be precarious for so many businesses. Whatever happens, we will remain focused on keeping people connected and supporting businesses as they make the transition online. I want to close by saying how grateful I am to our partners, big and small, old and new, around the world, and to our incredible teams who are working hard every day to make a real and very positive difference in people's lives. Now here's Dave.

Thanks, Cheryl, and good afternoon, everyone. Let's start with our community metrics. In September, we estimate that approximately 2.5 billion people used at least one of our services on a daily basis, and that approximately 3.2 billion people used at least one of our services on a monthly basis. Facebook daily active users reached 1.82 billion, up 12%, or 197 million compared to last year. DAUs represented approximately 66% of the 2.74 billion monthly active users in September. MAUs grew by 291 million, or 12% compared to last year. Turning to the financials, all comparisons are on a year-over-year basis unless otherwise noted. Q3 total revenue was $21.5 billion, up 22% or 21% on a constant currency basis. We benefited from a currency tailwind and had foreign exchange rates remained constant with Q3 of last year, total revenue would have been $114 million lower. Q3 ad revenue is $21.2 billion, up 22% or 21% on a constant currency basis. The acceleration in advertising revenue growth from Q2 to Q3 was largely driven by strong advertiser demand, resulting from the accelerated shift from offline to online commerce that we saw in connection with the pandemic. We are seeing particular strength among small and medium-sized businesses. We are proud of the role that our services are playing in helping people stay connected and businesses reach consumers during these challenging and uncertain times. On a user geography basis, year-over-year ad revenue growth rates improved in all regions compared to Q2. Asia Pacific and Europe were strongest and grew 30% and 25% respectively. Both regions benefited from currency tailwinds. U.S. and Canada grew 20%. The rest of the world grew 12% and was impacted by foreign currency headwinds. In Q3, the total number of ad impressions served across our services increased 35%, and the average price per ad decreased 9%. Impression growth was driven by both Facebook and Instagram. The decline in average price per ad was primarily driven by the ongoing mixed shift towards geographies and stories ads, which monetize at lower rates. Although year-over-year pricing trends improved from the second quarter due to broad improvements in advertiser demand coupled with slower impression growth. Other revenue was $249 million, down 7%, primarily due to the timing of a new product launch as we transitioned to Quest 2, which we began selling in the fourth quarter. Turning now to expenses. Q3 total expenses were $13.4 billion, up 28% compared to last year. In terms of the specific line items, cost of revenue increased 33%, driven primarily by infrastructure-related investments, including both depreciation and operational expenditures. R&D increased 34%, driven primarily by hiring and investments in our innovation efforts, notably Facebook Reality Labs, as well as core product. Marketing and sales increased 11%, a slower growth rate than prior quarters due to a slowdown in consumer marketing and hiring. Lastly, G&A expenses increased 33%, driven primarily by higher legal-related expenses. We added over 4,100 net new hires in Q3, primarily in technical functions. We ended the quarter with over 56,600 full-time employees, up 32% compared to last year. We continue to be pleased with our ability to recruit, onboard, and retain talent in this environment. Operating income was $8 billion, representing a 37% operating margin. Our tax rate was 4%, which reflects a one-time benefit related to a tax election to capitalize certain R&D expenses for tax purposes. Net income was $7.8 billion, or $2.71 per share. The one-time tax benefit resulted in EPS being 31 cents higher.

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Capital expenditures were $3.9 billion, driven by investments in data centers, servers, office buildings, and network infrastructure. In Q3, we announced that our 17th data center will be in Gallatin, Tennessee, and will be 100% supported by renewable energy. Facebook recognizes the urgency of addressing climate change, and we are committed to help tackle this global crisis. That is why in Q3, we set a new goal to reach net zero carbon emissions for our value chain in 2030. This is in addition to our current plans for our global operations to achieve net zero carbon emissions and be 100% supported by renewable energy by the end of 2020 and beyond. Free cash flow was $5.9 billion. We repurchased $1.7 billion of our Class A common stock, completed the $5.8 billion investment in Geo Platforms Limited, and ended the quarter with $55.6 billion in cash and marketable securities. Turning now to the outlook. As expected, in Q3, we saw Facebook DAUs and MAUs in the US and Canada decline slightly from Q2 levels, which were elevated due to the impact of the pandemic. In Q4, we expect this trend to continue and that the number of DAUs and MAUs in the U.S. and Canada will be flat or slightly down compared to Q3. Turning now to revenue. We expect our Q4 year-over-year ad revenue growth rate to be higher than our reported Q3 rate, driven by continued strong advertiser demand during the holiday season. Additionally, Oculus Quest 2 orders have been strong, which should benefit other revenue. Looking ahead to 2021, we continue to face a significant amount of uncertainty. We believe the pandemic has contributed to an acceleration in the shift of commerce from offline to online, and we experienced increasing demand for advertising as a result of this acceleration. Considering that online commerce is our largest ad vertical, a change in this trend could serve as a headwind to our 2021 ad revenue growth. In addition, we expect more significant targeting and measurement headwinds in 2021. This includes headwinds from platform changes, notably on iOS 14, as well as those from the evolving regulatory landscape. There is also continuing uncertainty around the viability of transatlantic data transfers in light of recent European regulatory development. And like other companies in our industry, we are closely monitoring the potential impact on our European operations as these developments progress. Turning now to expenses. We expect 2020 total expenses to be in the range of 53 to $54 billion, narrowed from our prior range of 52 to $55 billion. We anticipate that our full year 2021 total expenses will be in the range of 68 to $73 billion, driven by continued investments in product development and technical talent, as well as a return to more normal levels of spend in areas like office operations and travel. However, these are preliminary estimates as we have not yet finalized our 2021 budget. We expect 2020 capital expenditures to be approximately $16 billion, unchanged from our prior outlook. For 2021, we anticipate capital expenditures be in the range of $21 to $23 billion, driven by investments in data centers, servers, network infrastructure, and office facilities. Our outlook includes spend that was delayed from 2020 due to the impact of the pandemic on our construction efforts. Turning now to tax. We expect our Q4 2020 effective tax rate to be in the mid-teens and our full year 2021 tax rate to be in the high teens. In summary, we are proud of the role that our services are playing in keeping people and businesses connected through these difficult times. At the same time, we are continuing to invest aggressively in new products and experiences to better serve our global community. With that, Mike, let's open up the call for questions.

We will now open the lines for a question and answer session. To ask a question, press star followed by the number one on your touchtone phone. Please pick up your handset before asking your question to ensure clarity. If you are streaming today's call, please mute your computer speakers. Your first question comes from the line of Brian Noah from Morgan Stanley.

Thanks for taking my question. I have two, one for Mark, one for Dave. Mark, there's a lot of different types of consumer behavior on the platform from messaging, posting videos, stories, shopping, et cetera. I'd be curious as you sort of look at the way in which people are using the products now versus the start of the year pre-COVID, what's changed the most that surprised you and how does that sort of impact your product priorities as you continue to make sure you're delivering value for your advertisers over the next couple of years? And then Dave, I wanted to ask one about the initial 21 OpEx guide. And you mentioned sort of R&D and technical talent. Are there any specific projects or initiatives where you sort of look at and you say these areas really need to invest maturely harder in next year than you may have this year? Thanks.

Sure. Thanks for the question. In terms of what behaviors we really saw with COVID, it was an increase in, well, first of all, there was an increase in almost everything across the board, which I think was somewhat temporary and is now returning to baseline levels of growth, which is partially what we're seeing. But in terms of some of the more permanent trends, I think more people are doing kind of synchronous forms of connection. So voice calling and video calling, I think we're seeing. continued to be elevated in a lot of areas. We're seeing a stronger need for community. That's been a theme that we've seen for a while, but I think especially with COVID and people feeling a little more isolated, that has grown, the need to do that online. We're really going to double down and invest in that area to help even more than we are today, building out the infrastructure for communities as a foundation going forward. People have more time where they want entertainment, so we're seeing video and gaming and things like that grow as well, and that seems to have been sustained. That's on top of all the commerce trends, where I don't think we know exactly which way This will turn, as Dave and Cheryl both said, whether this is a sort of a one-time shift towards a dramatic increase in the amount of commerce that's happening online versus a continued trend that we will see. But certainly we haven't seen any decline or return to baseline off of the quite elevated levels of online commerce behavior that we see both from consumers and small businesses.

Hey, Brian, I'll take that second question. As Mark outlined in his prepared remarks, we're making significant investments in hiring across a wide range of new products. I'd probably talk about big investments that we're making in our longer-term AR, VR work through Facebook Reality Labs, as well as continued investments in areas like messaging, commerce, and reels. The other thing that I would mention on the 2021 total expense guide is that we expect to have higher expenses from office operations and travel once we have seen larger parts of the workforce return to the office. We estimate that in 2020, we saved approximately $1.5 billion on those expenses. and you know in 2021 we would be kind of working off a higher employee count which is ultimately what drives those expenses so we we'd expect to see a you know a snapback of some of those savings your next question comes from the line of eric sheridan from ubs thanks so much uh maybe i'll try two as i also uh first maybe following up on

Brian's question, the way Dave answered it, but turning it back to Mark. Mark, we'd love to understand your philosophy around what you think the company needs to either invest in or sort of solve for the unlock on augmented reality of the long term. It's sort of a broad-based consumer and enterprise platform to be that sort of next wave of computing that you've talked about in the past. What do you see as sort of the three to five-year roadblocks you're investing against and key unlocks you're looking for in the business. And maybe Cheryl, if I could just ask you, you know, probably the number one question we get from investors is about all the innovation you guys are doing on the commerce side, whether it be Facebook shops or transformation of Instagram around shopping at checkout. Given the way you framed your statements around the shift in commerce in real time, as we continue through this COVID period. How are those sort of platforms positioned to capitalize very short-term, Q3 into Q4, and how are you thinking about the ability for those shifts to be there for advertisers and commerce participants in 21 and beyond? Thanks.

Sure. Well, I can take the first one in terms of some of the milestones for the next computing platform. I think that there are There are a few things that I'm really looking for. So there's virtual reality, there's augmented reality, and then there's the whole kind of operating system of sort of spatial computing in 3D around that. And there are pieces that need to come together on each of those. VR, we are the most advanced in. The big milestone that I'm focused on here is we want to get to 10 million active units in our VR systems because we think at that point, that's when it will become the ecosystem will really be able to be self-sustaining and accelerate where independent developers will be able to start. It'll really economically make sense for independent developers to prioritize the Oculus platform above alternative gaming platforms because the install base will be sufficiently large that they will get good returns. Right now we're funding a lot of the content development ourselves, but we hope that at some point in the next few years we'll reach that. And we feel like we have line of sight to that. Part of building out AR is going to be a little bit harder in that VR, you know, people do it, they do at home. It's meant to be pretty immersive. Obviously, you want the headset to be as small and comfortable as possible, but fundamentally, it's not the type of thing that you're going to be wearing down the street that you need to really have a very kind of stylish or socially acceptable form factor just yet. Whereas I do think to have viable augmented reality consumer glasses, you need to clear a number of technological hurdles to make it so that all of that technology fits in what would be kind of a normal, you know, maybe thick-rimmed consumer glasses form factor. So these are – there are a number of fundamental technological advances that still need to be made there, which is why I think that that product is still a few years out, but it's one that we're very excited about. The work that we're doing on VR and AR will share some of kind of the operating system and ecosystem around them of 3D development and spatial development. And that's also shared across, you know, some of the AR effects and things that we're seeing people use in Reels and the camera and Instagram and Facebook and Messenger. And that work, I think, is going quite well, where there are hundreds of thousands of creators and developers and people building for that. But all those pieces basically need to come together for the ecosystem to work. And I've been very impressed and excited by the progress that our teams have made on this. I think that the new Quest 2 product is extraordinary. I love using it, and I'm really proud of the work that we've done there.

So I'll talk about commerce. We've been focused on making commerce more convenient, more accessible, secure across our apps for people and businesses. We always were at the top of the funnel for discovery and for connecting people to many businesses and products around the world. And we saw, even before the pandemic, an opportunity to keep moving people down that funnel. What happened with coronavirus is we just massively accelerated, this shift massively accelerated And we really doubled down on shipping commerce products so that we could help, you know, the now 10 million small businesses who advertise but the hundreds of millions who really rely on our free tools so that they would be able to pivot online. And so, you know, Mark mentioned shops in his remarks. We launched this very quickly in Q2 and we're seeing, you know, it's early but we're really pleased with the progress. We've just announced expansion to WhatsApp. We're building for Facebook. We're building for Instagram. And I think what we see is that acceleration really works, and it's good because we can provide these tools to small businesses, but it also accelerates our ad revenue. And I'll share an example. There's an indigenous brand called Sisters Sage. They make handcrafts and wellness products like soaps, and they were founded by sisters. And before coronavirus, They were selling at local farmers markets and mall kiosks. So that obviously just went away overnight. They pivoted to Facebook and Shopify, were able to put themselves online and then used our targeted ads and have had a nine times return on ad sales and have increased their sales, you know, by two and two over two and a half times during this. And so what we see is that when we help provide the commerce tools, It can help the small businesses that rely on us, and it can also drive our ad revenue.

Your next question comes from the line of Justin Post from Bank of America.

Great. Thank you. Mark, on prior calls, you mentioned that eventually margins have to kind of – I mean, expense growth kind of has to match revenue growth. So interesting, the midpoint of your range, 32% expense growth. Does that show some optimism on revenues, or are you investing in some products that could pay off with some revenues down the road? And just thinking about the progress with messaging – You have a deal with Didi in Brazil and opening up with other platforms. Is that something you're excited about over the next couple of years of starting to really show some revenues? Thank you.

So, Justin, why don't I take the first part of that, which is on the expense growth guidance. And there – We're not giving guidance on revenue growth, and there's not implied guidance on revenue growth. So at the midpoint, you've got that right. It's sort of in the low 30s on an expense growth basis. That's fairly consistent with where our headcount growth is right now, and that really reflects the opportunities we see to invest. We've been successful with hiring and retaining talent. We've got a lot of priorities, given everything we have, you know, seen from COVID and the shift to online with commerce, with messaging, and also the big investments that we're making for the long term in Facebook Reality Labs. So, you know, I think it's clear that we would expect there to be, you know, a margin decline next year based on that guidance, but we're not giving specific revenue guidance at this time. And then, Mark, do you want to cover the messaging?

Sure. I think the short answer is Yes, I think the goal is to build out a commerce platform around messaging with all of the tools, starting with Facebook Shops, which we've already announced, will be coming to WhatsApp and Messenger. So any small business will be able to set up a shop and have that kind of automatically establish a presence in those services too. We're building out a number of tools around business messaging so that way people can follow up and complete transactions and get support. Through messaging and then payments so that people can complete transactions too. One of the early monetization products that is working quite well are these click-to-messaging ads. So that way, you know, someone can get, you know, a business can run ads in Facebook or Instagram. And the destination for that ad can take the person to a thread, a chat thread, either in Messenger or WhatsApp to kind of further build out the relationship with the consumer or complete a transaction. And that's growing quite well. And I'm quite excited about that. But overall, this is a big priority is building out all these commerce tools, both so that small businesses and all kinds of businesses can do this kind of commerce in Facebook and Instagram, but also within messaging, like you say.

Your next question comes from the line of Brent Mill from Jefferies.

Thank you. If you could just maybe talk a little bit about the real engagement and what you're seeing so far. I know it's early, but any observations there? Thank you.

I'm happy to jump in here. You know, I'm quite excited about the progress here. It's still quite early. We've expanded Reels into more than 50 countries. We've launched a number of new features. The results are encouraging. There's a lot more work to do here as well. And I don't have any specific numbers to share here, Dave. I assume you don't have any specific numbers that you would share either.

Yeah, that's right. I think we're encouraged by the initial results, but it's still early.

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And your next question comes from the line of Heather Bellini from Goldman Sachs.

Great. Thank you. I have two questions, Mark. I know you've been asked a lot about AR VR on this call, but I was wondering if you could share with us, how do you think about the advances you're making on that front, helping to drive differentiation from an e-commerce perspective and how much of a competitive differentiator can your work be here as commerce obviously continues to accelerate online. And then I just had a quick one for Dave about, Any update on the percentage of revenue from the top 100 advertisers? I could have missed that. Thank you.

Yeah, I mean, I think your question on augmented reality is a really good one because it hits on the fact that we mostly talk about it as a long-term new kind of platform. But in the next couple of years, I also think that there will be opportunities to build these kind of features into our mobile apps um in an increasing way to to kind of help people express themselves like they're doing in reels and stories um in our cameras um we have as you probably know rolled out a number of augmented reality um commerce tools and ad formats right so the type of things like for um cosmetics people can try on lipstick or um or sunglasses to see what they would look like on them um you know we we think we can get to the type to the place where you know for more kind of items that you might buy to put in your house um we'll be able to uh for a lot more of that stuff be able to visualize what it would look like in your living room um you know just through your camera and an augmented reality tool um try on clothes different things like that over time so There is a lot of this work that I think will help out by building new innovative experiences in our mobile apps. And all of that is also contributing to building up this longer-term development platform around 3D and spatial computing that will be very foundational to all of the VR and AR work longer term as well.

And Heather, it's Dave. We don't have an update on the top 100 advertiser statistic, but I would say that we continue to see you know, strong growth from our small and medium-sized advertisers in the quarter, you know, continued strength with our direct response to advertisers. So, you know, we're really pleased with the broad base of advertisers that we saw in the quarter and helping those advertisers connect with consumers, you know, in this challenging climate. So, really pleased with what we're seeing on that front.

Your next question comes from the line of Doug Amuth from JP Morgan.

Thanks for taking the questions. One for Mark and then one for Cheryl or Dave. Mark, you touched on interoperability briefly. I was hoping you could talk about your rollout efforts thus far and how we should think about the key benefits and milestones there. And then Cheryl or Dave, would you still expect IDFA to have the same degree of impact on your business as you did three months ago whenever it is actually rolled out? Or is it possible that the delay has benefited you with more time to work around and leverage other data sets and therefore minimize the impact? Thanks.

I can speak about Interop. You know, it's been a long-term infrastructure project that we've been working on to make it so that people can send messages between the apps. We've started rolling out interoperability between Messenger and Instagram messaging, and that's live in a lot of countries around the world now, including in the U.S. The initial feedback I think has been quite positive as it brought a number of features to Instagram that we previously had only had in Messenger. The big benefit, the way that I think about this, is that in a lot of countries around the world, there is a primary messaging app that most people use. In the U.S., that doesn't quite exist in the same way. iMessage is certainly the leading messaging app, but of course people on Android can't use it, and and there's still a quite large portion of the population is on Android. So the messaging experience in the U.S. is very fragmented compared to what you would experience if you were in India or China or Brazil or a lot of countries in Europe, which I think just makes it confusing. It means that people have to have all these different apps to reach people that they're not sure where to reach people. It makes it a little bit harder to build out the business ecosystem because now businesses have to work across all these different places. So our goal is to make it so that people can just choose the one of our apps that they prefer using the most for messaging and can reach all the people who they want to reach across all of our different apps from whichever of the apps is their favorite. And, of course, they can continue using multiple if they want. This is going to be a choice that people have. But I think it should simplify things and make it so that these three different networks that we've had between Messenger, Instagram, and WhatsApp can start to function a little bit more like one connected interoperable system. And that's the vision. There's more work to happen here. We, of course, want to bring in WhatsApp to that interoperability as well. There are more features we want to add even to the Messenger, Instagram interoperability. But it's good to see this starting to roll out after what has been a a pretty large engineering and infrastructure project.

And Doug, on, you know, IDFA and I guess iOS 14 more broadly, you know, obviously Apple did delay the implementation of certain elements of their iOS 14 launch as it relates to some of the privacy initiatives. So I think that impact won't be felt in Q4. where prior we would expect to have seen that in Q4. So I think it's mainly a delay in the impact rather than it's a change in the impact. So we're going to experience that in 2021. Specifically, as it relates to IDFA, it's going to have a disproportionate impact on app installs and thus our audience network. And so that's obviously a big challenge for you know, app developers who are, you know, looking to grow their business in, you know, in what is a difficult time. So, you know, we think that challenge will remain when that implementation happens. But, you know, in terms also of, you know, whether there's, you know, work that we can do to mitigate that impact that businesses reach out to us all the time on, you know, how they can continue to run effective ads. in the face of these platform changes. You know, we're looking at various options, but our best view is that there's a, you know, there are going to be significant headwinds next year as a result of these changes, you know, specifically on iOS 14.

Your next question comes from the line of Michael Nathanson from Moffat Nathanson.

Thanks. I have one for Mark and one for Cheryl. Mark, I want to take you back to Section 230 and yesterday for a second. It seems like you're the most comfortable CEO about making changes to the law. I wonder what are the changes that you would propose? Does that PACT Act proposal in June resemble where we need to go? And what do you think the costs of these changes would be for Facebook? And then for Cheryl, we talked about the acceleration of more businesses embracing Facebook due to this crisis. Can you talk a bit about what verticals maybe had been lagging within their moves to Facebook and Instagram and maybe how this crisis has accelerated certain verticals to spend more than they had before?

I can talk about the first one. So at this point, we have the benefit of seeing how different countries have adopted different types of regulation and getting to understand how that either makes the problem is more effective for dealing with them or in some cases makes it harder and actually creates worse results. So the approaches that I think seem to have worked best by looking at what France and a few other countries have done is basically one which focuses on creating a transparent process where companies have to report how they're doing moderation, reporting on how much harmful content of different categories is visible, the portion of the content on the service, and what percent of it our content moderation systems can get to before people need to report it to us. And I think a system like that, that basically requires companies to meet certain thresholds or show improvement basically aligns incentives in the right way to encourage companies to minimize the amount of that harmful content that people are seeing. You know, but there are plenty of examples where there are other regulatory regimes that I think point towards, that are counterproductive, right, or basically require companies to do things that aren't quite getting at the most important aspect of the problem. And it was one example, you know, in some countries, there are rules saying you have to get to certain content within a short period of time. And And that, I think, is good on its face, but I think the reality is that a piece of content that's going to not be seen by many people, maybe it's not as urgent to deal with, is one that is going to be problematic but is going to be seen by a lot of people. You really want to get to that sooner. So treating all content equally compared to just looking at the prevalence of how much bad stuff people are seeing I think it's going to be less effective overall. So it's hard for me to speak to the cost to Facebook or other companies specifically because this is pretty nuanced stuff, and a lot of it will depend on specific language or details of how this lands. But I do think at this point there are enough examples in other countries that you can kind of get a sense of what helps create a more healthy ecosystem and what doesn't.

So on verticals, Our growth is very broad-based, and it's especially important for small to medium-sized businesses. You know, these businesses have faced huge challenges in the pandemic, and they've needed to become digital often for the first time. So the free tools we provide to get themselves online, online presence, mobile presence, have been more and more important, and personalized ads are more and more important. You know, the use of data, which we can do in a very privacy-protective way, to let them buy the audiences they want are increasingly important. You know, big companies can afford to buy broad-based ad campaigns that hit countries or hold geographies. Small companies can't. So survival and the economic growth and the increasing ability to stay afloat and hire has really been driven across the board by SMBs. Now some verticals have, you know, experienced more of this. Certainly e-commerce is the leading example. But there are a lot of other businesses that have also lend themselves to online. Education is growing nicely, retail. There are others like travel and auto that have lagged during this but are starting to rebound as well. I also, while we're talking about verticals, want to take the opportunity to say that I think there is a bit of a misunderstanding about the size of political ads on our services. Combined political ads and government spending altogether was still low single-digit percentages of ad revenue in the U.S. and globally, and it's not a top-ten vertical in the U.S. or globally as well.

Your next question comes from the line of Mark Mahaney from RBC.

A question for Cheryl. Cheryl, you talked about an acceleration in ad revenue associated with I guess the build-out of social commerce. Could you double-click on that a little bit more and explain that? And is it just that as the inventory becomes more transactionable, it's more valuable, and therefore marketers are willing to bid more for it? Just explain that link between the growth in commerce activity on the network and the acceleration in ad revenue. Thank you.

I think the acceleration I was talking about is really an acceleration to businesses moving online. There were just a lot of businesses that before the pandemic were, you know, consistently offline businesses. They sold locally. They advertised locally. You walked into their store and bought. And this was already changing, right? Businesses were already going online. But we just have seen a massive acceleration in businesses doing things online, whether it's finding customers, letting you know they're open, selling, curbside pickup, You know, when people couldn't walk into stores all over the world, they had to reach customers a different way. That acceleration has really powered our business. That's why there are 200 million small businesses or businesses using our free tools because a lot of these businesses had to get online for the very first time. That's why we have 10 million advertisers because once you have an online presence, once you're doing things to reach customers online and even delivering products not in person, you see that you see that acceleration and so it is that overall acceleration onto online commerce some of our e-commerce tools that's really um i think increase the number of small businesses all over the world that are using our free tools and are advertising with us operator we're going to take one last question only two things are forever love and liberty mutual customizing your car insurance so you only pay for what you need

Your last question comes from the line of Yusef Squali from Truist Securities.

Great, thank you very much. One question for Mark and one for Dave. Mark, online gaming is an emerging opportunity for you. I was wondering how you see your position today, just as you compete with very entrenched players like Twitch and YouTube, What do you need to do to win longer term? And is VR and AR and the work you're doing potentially a competitive advantage over time? And then, Dave, just given the amount of cash you guys have on the balance sheet, I think you just added $5.9 billion in free cash flow this past quarter. Would a change in the administration and prospects for maybe higher capital gains and dividend taxes change your way on how to manage or how you guys are managing your capital allocation and returned short term. Thank you.

I can talk about gaming. So this is an area that I'm very excited about. I think it's a big growth area and one that I enjoy a lot personally. So we're doing a number of things here. And I think you're right that the longer term virtual and augmented reality projects do help here both in the near term and the long term. It's also just a very exciting area of gaming. But most people are using gaming through our services through the Facebook gaming initiative that we have. You know, people stream games. Using our live tools, people want to be able to build community. I think our features and our just kind of social focus as a company means that we are better able to serve game streamers who want to build out a community across our service. That part is going quite well and is growing quickly. You know, we just launched our cloud initiative, which plugs into both the Facebook gaming work that we're doing and the ads work that we do around helping game companies get new customers. It's sort of not a completely different approach. It sort of plugs into the core things that we do. So you're basically seeing gaming combine with video, and the community's work that we're doing in order to just kind of grow all of those at once. Over the longer term, I think the VR piece will obviously come into that as well. Some of the cloud gaming stuff that we're doing will of course be useful for VR as well, and we're building a big community around that on Oculus. But this I do think will be a very exciting growth opportunity and ability to offer a lot of innovation over the coming years.

Yeah, thanks, Yusuf.

So on our capital allocation, you know, our focus is in investing in growth and continuing to make sure that we make the investments to drive the long-term growth of the business. That includes investing in our core product as well as investing in some of our longer-term initiatives like Facebook Reality Labs. You know, this past quarter, we made an important strategic investment in Geo Platforms, so that was a significant outlay of capital. You know, we continue to have an active share repurchase program. authorized by the board. And we'll certainly factor in any changes in the tax landscape, but I wouldn't expect that to necessarily lead to a shift in our fundamental approach.

Great. Thank you for joining us today. We appreciate your time, and we look forward to speaking with you again.

Ladies and gentlemen, this concludes today's conference call. Thank you for joining us. You may now disconnect your lines.