Baidu, Inc. (NASDAQ:BIDU) Q4 2022 Earnings Call Transcript

Baidu, Inc. (NASDAQ:BIDU) Q4 2022 Earnings Call Transcript February 22, 2023

Operator: Hello and thank you for standing by for Baidu’s Fourth Quarter and 2022 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.

Juan Lin: Hello, everyone, and welcome to Baidu’s fourth quarter and fiscal year 2022 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 US 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 updated annual report and other documents filed with the 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. 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. In Q4 2022, Baidu core revenues were impacted by a challenging environment caused by a rapid increase in COVID-19 cases and its impact on the broader economy. However, we managed to improve our operating profit and margin year-over-year in the quarter. Beyond that, Baidu demonstrated its value as a trusted platform for users seeking accurate and authoritative information during critical moments like the peak time of COVID-19 pandemic. As restrictions in China were relaxed and many people get infected, people were most keen to monitor the progress of the epidemic in their local areas. We quickly mobilized our resources and launched COVID-19 indices based on Baidu search queries, providing real-time updates and forecasts for better transparency.

Also we partnered with reputable hospitals and medical experts to offer guidance and advice for public health. In Q4, health related search queries grew about 40% year-over-year, reaching a record-breaking high. And today, we are on the threshold of exciting, new developments in our industry. For this call, I will focus on three major themes. And then I’ll provide quarterly reviews across our business lines. And finally, I’ll talk about our outlook for 2023. Regarding the major themes. First, although our first — our fourth quarter results were impacted by COVID-19, we are optimistic about our path to reaccelerate revenue growth in the coming quarters. So far in Q1, we have already seen a recovery of our online marketing revenue from the Cloud, in particular from verticals in healthcare, travel, business services and lifestyle.

Assuming no significant new disruptions, we expect this recovery trend to continue and boost our online marketing revenue through increased demand and take advantage of pent-up consumption in China. We also anticipate resuming cloud project implementation as business operations return to normal, signing new contracts and accelerating AI cloud revenue growth. Second, we are riding high on the wave of AI, as our earlier investments make us well positioned to benefit. Now that the industry is about to experience significant growth and monetization. Over the past many years, we have doubled down on AI, recognizing its potential to drive market expansion and increase enterprise value. Today, AI has become a cornerstone of many of our products and services.

For example, in search the early family of large models have been instrumental in delivering improved search results since March of 2019. These models enable improved ranking and multi-modal search capabilities. In cloud, we leverage our AI expertise to offer industry-specific AI solutions and applications for traditional industries such as transportation, manufacturing, energy and utilities. Our intelligent driving business built on the backbone of Baidu’s computer vision and other machine learning algorithms is another testament to our commitment to this field. Recently, with users reading about ChatGPT, large language models using generated AI have created a megatrend that will revolutionize many businesses. And Baidu is well-positioned to capitalize on the imminent inflection point in AI, thanks to our extensive talent pool, well-developed infrastructure, a diverse array of businesses and leading technology.

We are also excited about the upcoming launch of Ernie Bot, our new conversational AI bot powered by our latest in-house large language models. We plan to fully integrate Ernie Bot across all of our operations. For our consumer-facing products, we plan to embed Ernie Bot into Baidu Search, first. We believe this will reshape information generation and presentation and create a new entry point for the next-generation Internet, helping us attract more users and gain market share in a profitable manner. In the future, we will also integrate Ernie Bot into Xiaodu, which will allow Xiaodu to significantly upgrade all the smart devices and services. We believe AIGC will also provide notable potential for iQIYI on content generation and user acquisition.

For our 2B businesses, we plan to make this technologies widely available to our customers, developers and ecosystem partners to help boost productivity across industries. By opening the platform to generated large language model to the public, we expect more and more business owners and entrepreneurs to build their own models and applications on our AI cloud. For intelligent driving, we plan to integrate Ernie Bot into our auto solutions, further enhancing user experience. We also believe generative pre-trained transformers will play an important role in driving the expansion of our operations. Clearly, we can benefit from the new AI inflection point, as we have timely prepared our overall business for this new megatrend. Turning to my third theme.

We will continue to focus on the long-term sustainable development of our company. As you all know, 2022 was an incredibly challenging year. However, we have used the time wisely to lay a strong foundation for €“ by building a more efficient organization through cost optimization, organizational adjustments and management reshuffles. As a result, in the second half of 2022, Baidu Core’s non-GAAP operating margin and profit both improved year-over-year. We believe a more streamlined operation will help us to achieve sustainable growth. Now let’s review the fourth quarter operating highlights. AI cloud recorded 4% year-over-year growth in Q4. Revenue growth decelerated from the prior quarters due to the impact of COVID-19 operate at the end of the quarter.

Nevertheless, the margins of AI cloud in Q4 improved year-over-year. Two major factors were at play. First, we continued to scale back low-margin business for both at and cloud solution projects. And second, we continued to standardize our AI solutions and applications for specific use cases in traditional industries. For example, our quality inspection and strong inspection solutions have been adopted by many leading companies in traditional industries like chemical fiber, electric power and renewable energy. We have seen margin improvement as we replicate our AI solutions and applications, which tackle industry-specific challenges. By working with the industry leader, we are enhancing our knowledge of industry-specific challenges and standardizing AI cloud solutions and applications for scale.

As an example, thermal power, which is mainly coal fired, make up majority of the power supply in China, generating around 5.9 trillion kilowatt hour in 2022, according to National Bureau of Statistics of China. Recently, we developed an AI solution for a leading coal-fired power plant in Shanxi province to improve the efficiency of power generation through method such as automated cooling system. According to our internal estimates, this solution resulted in almost a 5-gram of coal consumption per kilowatt hour, well above our customer’s expectation of 1-gram reduction. This also means a 12.5-gram reduction in carbon dioxide emissions per kilowatt hour. We aim to create more similar projects to gain scale. Turning to Intelligent Driving. We continued to make significant progress in the fourth quarter, further reinforcing our belief in our strategy and business model.

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Apollo Go remained the largest autonomous ride-hailing service provider in the world, measured by the number of rides completed. In Q4, Apollo Go provided 561,000 rides to the public on open roads. That’s up 162% year-over-year. By the end of January, the cumulative number of rides exceeded 2 million. This demonstrates users’ increasing acceptance of Apollo Go autonomous ride-hailing service. As we scale up our operations, we are able to continuously improve our technologies and refine our services. These accomplishments also build our safety record and bolster both users’ and regulators’ trust and including the development of the fully driverless ride-hailing market. In 2022, we made some notable breakthroughs in fully driverless operations on public roads.

Since last August, we have begun to offer fully driverless ride-hailing services in Wuhan and Chongqing. In late December, we were granted permission to test drive vehicles with no safety operators in the car on public roads in the Yizhuang region of Beijing, a critical step before the capital city allows fully driverless ride-hailing operation. As I stated in the past, labor cost is a major cost component in ride-hailing operations. Removing safety operators from vehicles can significantly reduce this cost. In Q4, fully driverless rides provided to the public, increasing very fast, helping us to expand our operations and reduce cost per mile. In 2022, we also unveiled RT6, aiming to bring the cost of robotaxis to the price range of mass market EVs for the first time in China.

This initiative will allow us to further reduce our costs in the future. Baidu Apollo’s auto solutions made a breakthrough engagement with a multinational automaker. It intends to cooperate with us on AVP functionality for one of their popular car models in China. Moving into mobile ecosystem. Our traffic remained strong. Both total mobile search queries and feeds distributed through Baidu App continued to experience double-digit year-over-year growth in the quarter. In December, MAUs for the Baidu App increased 4.2% year-over-year. Despite revenue declining in Q4, our mobile ecosystem continued to generate high operating profit, operating margins and substantial cash flow, thanks to increased efficiency. Encouragingly, we have seen a recovery in our online marketing revenues after the Chinese New Year holiday.

On another positive note, retail and e-commerce remained an outperforming vertical, with more than 20% year-over-year growth, accounting for over 10% of the total advertising revenue. Users not only come to Baidu to search for information and knowledge but also increasingly come to us to search for services and merchandise, driving up growth in merchandise search queries and transactions on Baidu. Quarterly GMV facilitated by Baidu Search grown by 84% year-over-year in Q4. Short videos contributed to year-over-year increase in feed revenue in Q4 despite macro challenges. Apart from feed, we believe short videos also benefit search in both user experience and monetization. And the growing prevalence of short videos within Baidu mobile ecosystem should drive long-term online marketing revenue growth.

We continue to help content creators to generate content through AI, enriching our mobile ecosystem, in particular producing short videos. As we move forward into 2023, our priorities are clear and focused. First, we are committed to revenue growth, as we have seen a clear pathway for a successful business recovery. Second, we are poised to take advantage of the huge potential of AI to drive business growth. We aim to integrate generative AI into most of our products and services and make our cutting-edge large language models available to both consumers and businesses. Third, we will maintain healthy growth while also strengthening our foundation. Our mobile ecosystem should continue to generate strong margins and cash flow. We aim to continue expanding margins for AI cloud and outgrowing our Internet peers.

We also will continue to make strategic and prudent investments in intelligent driving to capture the long-term market opportunity. With that, let me turn the call over to Rong to go through financial results.

Rong Luo: Thank you, Robin. Now let me walk you through the details of our fourth quarter and full year 2022 financial results. We closed the year 2022 with solid financial results. Baidu Core’s total revenue was RMB 25.7 billion, decreasing 1% year-over-year. In 2022, Baidu Core generated RMB 95.4 billion or US$13.8 billion in revenue, basically flat from last year. Now online marketing business continued to grow very fast and reached 30% of Baidu Core revenue in the fourth quarter, up from 26% a year ago, demonstrating by cloud and other AI-powered businesses have fueled our business model and will continue to do so in mid or long-term. For the full year 2022, our online marketing business accounting for 27% of Baidu Core revenues, up from 22% in 2021.

Within the non-online marketing business, revenue from Baidu AI Cloud increased by 4% year-over-year to RMB 5.1 billion in Q4 on an apples-to-apple comparison and were up by 23% year-over-year to RMB 17.7 billion in 2022 on an apple-to-apple comparison. Xiaodu is another revenue contributors to the non-online marketing business. Xiaodu continued to achieve solid revenue growth in both Q4 and the year 2022. Baidu Core online marketing revenue decreased by 6% year-over-year and 4% sequentially in Q4 due to the weak demand from advertisers in the challenging macro environment caused by COVID. Baidu Core online marketing revenue was down by 6% year-over-year in the year 2022. iQIYI revenue was RMB 7.6 billion in Q4, increasing 3% year-over-year.

iQIYI revenue was RMB 29 billion in the year 2022, decreasing 5% year-over-year. Cost of revenue was RMB 16.9 billion in Q4, decreasing 2% year-over-year primarily due to the reduction in content costs, cost of goods sold and other costs related to new AI business, partially offset by the increase in traffic acquisition costs. Cost of revenue was RMB 63.9 billion in 2022, decreasing 1% year-over-year primarily due to an increase in traffic acquisition costs, bandwidth costs, cost of goods sold and other costs related to new AI business, offset by the decrease in content costs. Operating expenses were RMB 11.5 billion in Q4, a decrease of 17%, 1-7, year-over-year, which was primarily due to a reduction in staff-related expenses. Operating expenses were RMB 43.8 billion in 2022, decreasing by 12% year-over-year, which is primarily due to a reduction in channel spending, promotional marketing and personnel-related expenses.

Non-GAAP operating income was RMB 6.5 billion in Q4 and non-GAAP operating margin was 20%. Non-GAAP operating income was RMB 23.2 billion in 2022, and non-GAAP operating margin was 19%, 1-9, in 2022. For Baidu Core, non-GAAP operating income was RMB 5.5 billion and operating margin was 21% in Q4. Non-GAAP operating income was RMB 20.9 billion and non-GAAP Baidu Core operating margin was 22% in the year 2022. Regarding the non-operating items, in Q4, total other income net was RMB 1.8 billion, mainly resulting from fair value gain of RMB 1.6 billion from long-term investments. Income tax expenses was RMB 1.3 billion. In 2022, total other loss net was RMB 5.8 billion, mainly resulting from a fair value loss of RMB 3.9 billion and an impairment loss of RMB 3 billion from long-term investments.

Income tax expenses was RMB 2.6 billion. In Q4, net income attributable to Baidu was RMB 5 billion, and diluted earnings per ADS was RMB 13.59. Net income attributable to Baidu Core was RMB 4.8 billion, and net margin for Baidu Core was 19%, 1-9. Non-GAAP net income attributable to Baidu was RMB 5.4 billion. Non-GAAP diluted earnings per ADS was RMB 15.25. Non-GAAP net income attributable to Baidu Core was RMB 4.9 billion. And non-GAAP net margin for Baidu Core was 19%, 1-9. In year 2022, net income attributable to Baidu was RMB 7.6 billion, and diluted earnings per ADS was RMB19.85. Net income attributable to Baidu Core was RMB7.6 billion, and net margin for Baidu Core was 8%. Non-GAAP net income attributable to Baidu was RMB20.7 billion and non-GAAP diluted earnings per ADS amounting for RMB58.93.

Non-GAAP net income attributable to Baidu Core was RMB19.9 billion, and non-GAAP net margin for Baidu Core was 21%. Cash and short-term investments for Baidu Core as of December 31, 2022, were RMB177.4 billion or US$25.7 billion. Free cash flow for Baidu Core excluding iQIYI was RMB18.1 billion, or US$2.6 billion in 2022. Baidu Core had approximately 36,300 employees as of December 31, 2022. On a separate note, we are excited about iQIYI’s continuous efforts to improve operating efficiency. In the quarter, iQIYI once again generated positive non-GAAP operating profit and free cash flow. On the user side, iQIYI’s average daily number of total subscribing members increased to 111.6 million in Q4, a net addition of 10.6 million from the previous quarter.

iQIYI maintained its largest market share for the drama category in terms of effective video reels, according to Enlighten Data. In addition, in the past 12 months, iQIYI raised around US$1.3 billion. Post these fund raisings, Baidu continue to hold controlling voting power in iQIYI and consolidated iQIYI’s financial results. Operator, with that, let’s now open the call to questions. Operator, please.

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Q&A Session

Operator: Sure. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes Alex Yao from JPMorgan. Please ask your question.

Alex Yao: Thank you management for taking my question. Congrats on a strong quarter. I have a couple of questions for the online advertising business. Can you share with us the trends you are seeing in February, post the Chinese New Year holidays? From a industry perspective, what are the stronger-recovery industry? And what are the relatively weaker-recovery industry? And particularly, I’m interested in the off-line verticals such as travel, local services, franchising and health care. Can you comment on your revenue exposure to these off-line verticals? And how are they recovering since the Chinese New Year holiday? And then secondly, can you share with us your preliminary thoughts on the advertising recovery trend in the coming months?

Particularly, I think second quarter will be a little bit special, because of consumption has already been normalized. And you are comping against a low-base on year-over-year basis. How should we think about the advertising growth trend in the next couple of months, particularly second quarter? Thank you.

Robin Li: Hi Alex, this is Robin. Our ad business is highly correlated with Core. As you know, when we entered the first quarter, the number of COVID infections had passed its peak. And it’s now on a downward trend. People’s daily lives are gradually back-to-normal and the operations of many companies are recovering as well. As the economy continues to recover, our ad revenue is gradually improving from the cost. When we look into our ad verticals, we have seen substantial improvements in our largest verticals, including health care, travel, lifestyle and franchises. These are all pretty much offline businesses. And online businesses, — especially, online games is relatively weaker. And regarding to the recovery by region, I think the COVID infection number has passed its peak, in all of China.

The regions passing the peak earlier, started to recover earlier. And the — post-Chinese New Year holiday, Tier 2 and Tier 3 cities recovered faster than Tier 1 cities. That’s because a lot of people took longer breaks from their families before going back to Tier 1 cities for work. And again, the magnitude of the recovery correlates heavily with the recovery of our top verticals. As we look beyond the first quarter and into the latter part of 2023, we’re confident that our ad business will benefit from China’s reopening and macro recovery. And with that, we look forward to demand recovery from advertisers, which should provide significant boost to our ad revenue. I also want to highlight that advertisers prefer to spend on performance-based ads, rather than pure brand promotions during the process of economic and business recovery.

And search has proven to be the most effective form of performance-based advertising, because users have a clear intent when using search. Search ads connect the users’ intentions with the most relevant product and service offerings. That’s why we expect to gain more marketing dollars from our advertisers. Over the long-term, we will continue to benefit from the sustained growth of China’s macro economy improvement. Also, e-commerce and short videos will continue to drive long-term growth of our ad business. Overall, we believe our ad revenue should outgrow China’s GDP in the long run. Beyond that, we are very excited about the opportunities around generative AI. We believe, by incorporating Ernie Bot, Baidu App and particularly Baidu Search, we will have an enhanced user experience.

The new features powered by Ernie Bot should help us to attract new users and drive user engagement and also drive advertiser interest in Baidu too, so this will power our long-term revenue growth. Thank you.

Juan Lin: Operator, next question, please.

Operator: Thank you. Your next question comes from Alicia Yap from Citigroup. Please ask your question.

Alicia Yap: Hi. Yes, thank you. Good evening, Robin, Rong Luo and management team. Thanks for taking my question. My questions is related to ChatGPT. So there’s been a lot of expectation on Baidu progress in ChatGPT and also the AI-generated content. Can management share with us what could be the new opportunities that you are seeing in this field? And how is Baidu positioned in this trend? Any color that management can share would be appreciated.

Robin Li : Thank you for your questions, Alicia. We are obviously excited about ChatGPT and AIGC. It represents a megatrend that could change a lot of things. We are working on Ernie Bot, a new version of conversational AI bot that uses our latest technology in large language models. We will embed Ernie Bot into Baidu Search, first; and we’ll open it to the public in March. Baidu is the leader in China’s technology innovation. Remember, we launched Ernie in March 2019 and have scaled it up with well over 100 billion parameters. It is trained by serving billions of user search requests and other applications every day, so in terms of MLP capabilities, Ernie is considered as the state-of-the-art Chinese language model. And it is not only about language, but also about understanding Chinese culture.

Ernie 3.0 is already a very localized AI foundation model for China market, which means the generative large language model we are working on right now will be more suitable in Chinese language and to the China market than models developed overseas. In addition, our deep learning framework PaddlePaddle, on which Ernie is based, has gained strong momentum. Millions of developers use Paddle for their AI works. This is — there is a strong synergy between the framework layer and the model layer. AI pre-training, as you know, is very expensive. We believe our full-stack AI capabilities will allow us to build the most efficient large language model and support all kinds of applications, from search to content generation or — and in vertical areas that could improve productivity significantly.

For Baidu Search, I just mentioned that we are working on — we’re working hard on a revolutionary version of Baidu Search built upon Ernie Bot that incorporates generative AI into our search algorithm as well as content creation. And we are adding interactive features too. Users will soon be able to interact directly with the new generative large language model. It would be complementary or even upgrading the traditional search experience and attract more users. ChatGPT types of features could potentially become a new traffic entry point for Internet users and therefore, expand the market size of search. Meanwhile, it will also help our advertisers, our content creators and merchants, et cetera. With our strong AI capabilities, we should be able to keep iterating and upgrading the model.

Search is just one example. There are — many other applications, we believe, will also benefit from it. And for AI Cloud. Our AI Cloud provides full-stack offerings of four layers from the cloud infrastructure layer, to deep learning open-source framework layer and to the large foundation model layer and ultimately to application. So these are the four layers. And by opening the generative large language model to the public, a.k.a. model as a service, we should help many business owners and entrepreneurs build their own models and applications on our cloud; bring about significant positive change and improvement in a number of areas, including increased efficiency, better decision-making and improved customer experiences. So to recap, Baidu’s strong AI capabilities build our moat in large language models and AI foundation models.

In addition to expand the market size for search, we are able to help many, many industries to build their own models, develop their own applications and significantly improve their productivity. We believe it will be a game changer for cloud computing. AI is transforming many industries in a big way and we are super excited about what’s to come. We are building an AI ecosystem around Ernie Bot. As of today, a number of organizations have already decided to integrate Ernie Bot into their products and services. And remember, this is just the beginning of the journey. Thank you.

Alicia Yap: Thank you, Robin.