Baidu, Inc. (NASDAQ:BIDU) Q1 2023 Earnings Call Transcript May 16, 2023

Baidu, Inc. misses on earnings expectations. Reported EPS is $1.38 EPS, expectations were $1.79.

Operator: Hello and thank you for standing by for Baidu’s First Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After managements prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the meeting over to your host for today’s conference, Juan Lin, Baidu’s Director of Investor Relations. Please go ahead.

Juan Lin: Hello, everyone. Welcome to Baidu’s first quarter 2023 earnings conference call. Baidu’s earnings release was distributed earlier today, and you can find a copy on our website, as well as on newswire services. On the call today, we have Robin Li, our Co-founder and CEO; Rong Luo, our CFO; Dou Shen, our EVP in-charge of Baidu AI Cloud Group, ACG; and Zhenyu Li, our SVP in-charge of Baidu Intelligent Driving. After our prepared remarks, we will hold a Q&A session. Please note that the discussion today will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations.

For detailed discussions of these risks and uncertainties, please refer to our latest annual report and other documents filed with our SEC and Hong Kong Stock Exchange. Baidu does not undertake any obligation to update any forward-looking statements, except as required under applicable law. Our earnings press release and this call include discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures and is available on our IR website at ir.baidu.com. As a reminder, this conference [is being recorded] [ph]. In addition, a webcast of this conference call will be available on Baidu’s IR website. I will now turn the call over to our CEO, Robin.

Robin Li: Hello, everyone. 2023 is off to a good start with our business performing well across the board and driving strong growth. In Q1, Baidu Core’s revenue growth reaccelerated year-on-year and supported an improvement in our operating margin. Our online marketing business has seen a positive impact from China’s overall economic improvement. After the Chinese New Year, there was a quick recovery, which was especially beneficial for many of our advertisers in offline sectors such as travel, healthcare, bin services, and local services. Moreover, we’ve been working hard to enhance user experience for Baidu apps and this has led to good user metrics and increased online marketing revenue for the first quarter compared to the previous year.

Our AI Cloud achieved profitability on a non-GAAP operating level this quarter. Starting in Q2 last year, we have focused on building sustainable growth for our cloud business by phasing out low quality projects and business. At the same time, we have been building standardized AI solutions for key used cases and replicating them from one project to another. This approach has led to an increase in AI Cloud margins over the past few quarters and we have seen profitability on the non-GAAP operating level this quarter. Today, all eyes are keenly focused on the transformative impact of generative AI. For today’s call, I will first provide an update on this topic and then walk you through our operational highlights in AI Cloud, Intelligent Driving, and mobile ecosystem.

Generative AI represents a tremendous opportunity for us. It can be compared to the introduction of the Internet and smartphones. To capture this opportunity, we leveraged our technology capabilities and our extensive experience in search, knowledge graph, and dialogue. We were able to quickly deploy early bots in mid-March, which became the first GPT model owned and operated by a public company. This launch demonstrated our significant investments and achievements in AI over the past 10 years and it will also highlights our position as the operator of China’s largest search engine. With our search engine, we have gathered a vast amount of data, facts, and knowledge for natural language understanding, which has been critical in training our models.

Baidu has established a robust range of AI capabilities powered by its four-layered AI architecture, which encompasses cloud infrastructure, the PaddlePaddle deep-learning framework, large language models, Ernie, and AI applications. We have this distinctive advantage that helps us optimize in higher process and reduce costs for model training and inference. One of our significant advantages is owning PaddlePaddle, which is the leading deep-learning framework in China. We have developed the PaddlePaddle in a way that aligns with ERNIE Bot. And this creates a strong synergy between these systems. Let me give you an example. Training and running large language models require a lot of data, which can be complex and overwhelming. And demand significant computing resources.

To tackle this challenge, we use our proprietary full stack AI architecture. We are continuously looking for new techniques to make our four layers work seamlessly, which helps us achieve better performance and quicker throughput. Specifically, we have improved compatibility between PaddlePaddle, the large language model, and the Cloud Infrastructure. As a result, since launching ERNIE Bot in March, we normalized – our normalized queries per second have increased almost 10x, indicating significant efficiency gains. Baidu is rapidly integrating ERNIE Bot into all of our businesses for testing. The goal is to leverage its capabilities to enhance reviewed and create both our enterprise and consumer facing products and services, thereby revolutionizing [our business.] [ph] We are also working on building an ecosystem around ERNIE Bot to promote the adoption of generative AI in a wider range of used cases.

This strategy should enable us to gain market share across all sectors and achieve sustainable long-term growth. As more people use ERNIE Bot, more products integrate ERNIE Bot in seamless ways, we will be able to gather large scale human feedback and iterate the model rapidly and tailored to real life market need. On the enterprise facing [fin] [ph] side, generative AI is expanding the total addressable market of the cloud industry. This is because the cloud service providers can use generative AI to add or enhance capabilities to their current offerings, develop new solutions and applications to address unfulfilled market demand and drive productivity and efficiency. As a result, since we introduced ERNIE Bot, we have observed more and more enterprises from various industries started their model training on our Cloud.

Our powerful foundation models and our unique full stack AI capabilities differentiate us from our competitors, which gives us an edge in the market. In March, sales lead increased by more than 400% year-over-year, which is a significant achievement for us. We believe that our AI Cloud will continue to gain market share over time. I’ll provide some examples of how ERNIE Bot is helping our customers to gain efficiency. In the financial services industry, we have partnered with a prominent domestic insurance company to help them enhance their digital experiences for employees and clients. To achieve this, we will utilize our AI capabilities, including PaddlePaddle and Ernie on their private cloud. Additionally, we will create customized tools and technologies to assist them in training and refining models on ERNIE Bot with their unique data.

And we will continuously improve the system over time. These models will power various applications, including helping financial advisors, analyze large amount of research reports and public information. We believe that this project has the potential to establish a new industry standard for innovation and efficiency in China’s financial services sector. In the software industry, we are collaborating with some productivity software developers to test the integration of ERNIE Bot into their applications with the goal of automating certain workloads and expanding the capabilities of their end users. Additionally, we are partnering with some ERP companies who are exploring the use of ERNIE Bot to assist their programmers in writing code. In the education industry, we opened ERNIE Bot to a leading online education company via model as a service, helping them fine tune their own model on Baidu AI Cloud.

One of the features we’re working on together is an enhanced sophisticated AI tutor enabling them to better serve their students. We’ve observed that industry is experiencing a surge in demand after the pandemic are interested in using ERNIE Bot to improve their business operations more efficiently. Online travel companies are a good example of this trend. As some of the biggest players are testing the use of ERNIE Bot to assist their customer service teams in managing customer queries, suggesting trips, and directing customers to relevant information. The feedback so far has been positive and customers are also beginning to switch their IT expenditures to our cloud. On consumer facing businesses, we are utilizing ERNIE Bot to enhance our product for the users.

We’re currently beta testing an upgraded version of Baidu search, which is powered by ERNIE Bot. This version provides natural conversational interactions for a more seamless search experience. We are also testing the integration of ERNIE Bot is Baidu Wenku, our online document sharing platform to enable ERNIE Bot to work alongside users and assist with searching, summarizing, and generating content using natural language. Additionally, we are incorporating ERNIE Bot into other consumer facing products such as Baidu Map, Baidu keyboard, Baidu Post, and Xiaodu. Furthermore, we are testing a standalone application for ERNIE Bot. So far, we have been encouraged by the positive user feedback at the current testing stage and look forward to bringing these experiences to more users in the coming months.

In the new era, AI chatbots will become a traffic gateway for people to seek information and content. Therefore, we should continue to gain user traffic and mind share, which will drive monetization over time. We’re also working to build an ecosystem around ERNIE Bot with our partners to fuel innovation and drive growth. On the regulatory front, as a leader in AI and an advocate for AI ethics, Baidu continues to promote the responsible use of AI. To comply with regulatory requirements, any new technology product or service must undergo government review and approval before large scale deployment. We have applied for review and approval of ERNIE Bot and will roll it out at a large scale to our customers and users once we get the green light.

Baidu has been operating search in China for more than 20 years and has extensive experience with Chinese culture and regulatory environment, which we believe will help us navigate the regulatory landscape. In early April, the cyber space administration of China released a new draft regulation for comments on generative AI, which explicitly endorses the development of self-designed [AI algorithms] [ph] and deep learning frameworks. We believe that regulators active engagement in generative AI in the early stage will raise the bar to entry and we are well-positioned for that. Overall, we are thrilled about the prospects that lie ahead with Ernie Bot, and we will continue to invest in it to unlock the tremendous potential that we envision. Now, let’s have a look on the first quarter operational highlights.

In Q1, revenues from AI Cloud increased 8% year-on-year, which is an improvement from the 4% year-over-year growth in the fourth quarter last year. We’re pleased to report that AI Cloud achieved profitability on the non-GAAP operating profit level during the quarter. The margin improvement [unrolled] [ph] two points of progress. One is our ability to optimize operations and drive sustainable and healthy revenue growth. Two is our efforts to standardize our AI solutions and applications and efficiently replicate them across different customers and sectors. Since Q2 of last year, we have phased out low margin businesses and projects for AI Cloud leading to a healthier business product portfolio and cost structure. At the same time, we continue to standardize AI solutions for key used cases for replication.

In the water industry, for example, last year, we replicated AI solutions we developed for predicting water usage and controlling water pressure from Changzhou water company to Quanzhou Water company. And in Q1, we deployed the majority of our earlier standardized dissolutions to the Lintao County Water Company in Gansu Province. This example demonstrated the scalability and margin expansion of our standardized approach in creating AI Solutions for traditional industries. As I mentioned earlier, generative AI is creating a host of opportunities for the Cloud industry and expanding the Cloud market significantly. Therefore, we will continue to invest and actively explore ways to grow our cloud services. Moving into intelligent driving. We continue to make solid progress.

In Q1, the number of rides provided to the public on [open road] [ph] increased over threefold, compared to the same period last year and reaching nearly 660,000. Thanks to the remarkable growth in rides and our strong track record of safe operation, we have received more permits from government to offer fully driverless ride hailing services in China. On March 17, Apollo Go was allowed to provide fully driverless ride-hailing services in Yizhuang region of Beijing,. As of today, we are providing the services in three cities, Beijing, Wuhan, and Chongqing. We are prioritizing fleet expansion and passenger adoption in regions where we can provide driverless commercial operation. Meaning it’s fully driverless and we can charge. Our efforts are yielding good results.

In Wuhan, where we first received the permit to provide such services on public growth last August, we now have more than 135 travel lease vehicles and more than one-third of the paid ride Apollo Go provided were in fully driverless vehicles. We are confident that the number of rides provided by 40 driverless vehicles will continue to increase leading to cost optimization and creating a profitable business model. We firmly believe the demand for autonomous driving services will continue to grow at a rapid pace and we will further dedicate our technology and operational capabilities to better provide safe and reliable services to the public. Moving to mobile ecosystem. I’m pleased to report that online marketing revenues returned to positive year-over-year growth in Q1, resulting in an increase in operating margin.

One contributing factor to this growth was the overall improvement in China’s economic recovery and commercial environment as a result of China’s reopening. As I mentioned earlier, many offline related verticals, travel, healthcare, business services, and local services have substantially increased. We are at spending on our platform. Some of these verticals have already rebounded to above pre-pandemic levels, indicating [solid finds] [ph] of recovery. Our own initiatives aimed at improving the product experience such as incorporating short videos and product listing information within the Baidu app, also plays a significant role in the revenue increase. Additionally, revenues from retail and e-commerce continued to grow, mainly driven by merchant, direct spending on our platform.

The quarterly GMV facilitated by Baidu Search, grew by 55% year-over-year in Q1, demonstrating our continuous traction in the e-commerce sector. Our users and traffic continued to grow in the quarter. The Baidu app MAU increased by 4% year-over-year in March and feed distributed through Baidu app and mobile search queries maintaining steady growth. This reflects the high value that users placed on Baidu Search as their primary source of information. During the quarter, we continued to focus on enhancing user experience and customer satisfaction. On the user side, Baidu app has a wonderful flow on the [Explore page] [ph], which is particularly attractive to young female, enabling an infinite browsing experience and catering to their diverse needs.

We expanded our immersive video feature to more and more used cases on Baidu app, including incorporating it into search results. Additionally, we continuously improve our one-shop search result through AI to provide better search experience. These efforts have helped to increase user engagement and expand our user base. On the advertiser side, since launching our AIGC capabilities late last year, we’ve been working with advertisers to create more effective ads. By allowing advertisers to specify their requirements, our platform generates customized options for them to choose from. For instance, a local travel agency turn to our AIGC capabilities to create ads. Our AI generated ads outperformed those created by the advertiser. Delivering an average of about 20% higher sales leads.

In Q1, advertisers adopting AIGC increased their ad spending year-over-year and quarter-over-quarter on our platform, demonstrating the effectiveness of our technology in driving business results. Earlier this year, we began using our AIGC capabilities to help advertisers respond to customer inquiries on our platform. By harnessing the power of AI, our advertisers can provide professional and timely answers to their customer inquiries, which in turn drives an increase in sales lead. For instance, a B2B advertiser witnessed a monthly increase of over 100% in sales leads in March after using our AIGC technology. We are expanding the service to increasing number of advertisers helping them better serve their customers and drive improved business results.

These efforts have resulted in improved ROI for advertisers on our platform. Looking ahead, we remain committed to assisting our advertisers in reaching and converting their target audience by leveraging our cutting edge generated AI technology. With that, let me turn the call over to Rong to go through the financial results.

Rong Luo: Thank you, Robin. Now let me walk you through the details of our first quarter financial results. Total revenue was RMB31.1 billion, increasing 10% year-over-year, Revenue from Baidu Core was RMB23 billion, increasing 8% year-over-year. Baidu Core’s online marketing revenue was RMB16.6 billion, increasing 6% year-over-year. Baidu Core’s non-online marketing revenue was RMB6.4 billion, up 11% year-over-year. In Q1, AI Cloud increased by 8% year-over-year to RMB4.2 billion. Revenue for iQIYI was RMB8.3 billion, increasing 15% year-over-year. Cost of revenue was RMB15.2 billion, decreasing 3% year-over-year. Baidu cost of revenue was [RMB9.4 billion] [ph], decreasing 4% year-over-year. Operating expenses were RMB11 billion, increasing 7% year-over-year, primarily due to an increase in China spending and promotional market expenses.

Baidu Core’s operating expenses were RMB9.5 billion, increasing 5% year-over-year. Baidu Core’s SG&A expenses were RMB4.5 billion, increasing 16% year-over-year. SG&A accounting for 20% of Baidu Core revenue in the quarter, compared to 18%, the same period last year. Baidu Core R&D expenses were RMB5 billion, decreasing 3% year-over-year, R&D accounting for 22% of Baidu Core revenues in the quarter and decreased from 24% in the same period last year. Operating income was RMB5 billion. Baidu Core’s operating income was RMB4.1 billion and Baidu Core’s operating margin was 18%, and non-GAAP operating income was RMB6.4 billion. Non-GAAP Baidu Core’s operating income was RMB5.4 billion, and non-GAAP Baidu Core operating margin was 23%. Total other income, net was RMB2.6 billion, which mainly including a fair value gain of under RMB1.5 billion from long-term investments.

In the first quarter last year, we recognized a fair value loss of RMB3 billion. A significant portion of the long-term investments include, but not limited to, investments in equity securities of public and private companies and private equity funds. This is subject to quarterly fair value adjustment, which may contribute to net income volatility in future periods. Income tax expenses was RMB1.2 billion, increasing 205% year-over-year, primarily due to an increase in profit before tax. Our net income attributable to Baidu was RMB5.8 billion, and diluted earnings per ADS were RMB15.92. Net income attributable to Baidu Core was RMB5.5 billion. Non-GAAP net income attributable to Baidu was under RMB5.7 billion. Non-GAAP diluted earnings per ADS was RMB16.1, and non-GAAP net income attributable to Baidu Core was RMB5.3 billion, and non-GAAP net margin for Baidu Core was 23%.

As of March 31, 2023, cash, cash equivalents, restricted cash and short-term investments were RMB194 billion, and cash, cash equivalents, restricted cash and short investments, excluding IT, were RMB188.8 billion. Free cash flow was RMB4.5 billion. And free cash flow, excluding IT, was RMB3.5 billion. Baidu Core had approximately 36,000 employees as of March 31, 2023. On [separate] [ph] notes in the quarter, [iQIYI] [ph] generated about RMB1 billion in non-GAAP operating income and above RMB1 billion in free cash flow. With that, operator, let’s now open the call to questions.

Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from Alex Yao with J.P. Morgan. Please go ahead.

Operator: Thank you. Our next question comes from Alicia Yap with Citigroup. Please go ahead.

Operator: Thank you. Our next question comes from Gary Yu with Morgan Stanley. Please go ahead.

Operator: Thank you. Our next question comes from Lincoln Kong with Goldman Sachs. Please go ahead.

Operator: Thank you. Our next question comes from Miranda Zhuang with Bank of America Securities. Please go ahead.

Operator: Thank you. Our next question comes from Kenneth Fong with Credit Suisse. Please go ahead.

Operator: Thank you. Our next question is from Wei Xiong with UBS. Please go ahead.

Operator: Thank you. Ladies and gentlemen, that concludes our conference for today. Thank you for participating. You may all disconnect your lines.