Baidu: Advertising is restrained by macro uncertainty, cost reduction and efficiency enhancement pave the way for cloud and smart driving (2Q22 earnings call transcript)

The following are notes from Baidu's 2Q22 conference call, and the interpretation of financial reports can be reviewed in 《Baidu: Will the Future Depend on Cloud Rather than Advertising?》

Management report

1. Revenue from Intelligent Cloud increased by 31% YoY, with growth rate exceeding that of its peers. It accounts for 18% of Baidu's core business revenue in Q2, up 4% YoY. Both its YoY and QoQ operating profit have improved. As travel restrictions are gradually lifted, the Intelligent Cloud development will be helped. Its differentiation advantage lies in its AI capability and its profound understanding of specific industry pain points, helping customers accelerate transformation.

2. The revenue of Apollo Autopilot's Baidu ACE Intelligent Transportation increased by 40%, winning new projects on highways and city roads. It has been adopted by 51 cities, up from 20 cities a year ago and 41 cities a quarter ago, with total contract amount exceeding RMB 20 million.

"Luo Bu Kuaipao" completed 287,000 orders, up 500% YoY and 50% QoQ, with a total cumulative order volume of 1 million on July 20th. Its market share in Beijing Yizhuang District is 10%, with over 100 cars called per day, and more than 20 orders per car per day on average.

Launched in July in Chengdu and currently operating in 7 cities charging fees. Large-scale operation greatly increases the amount of daily operation data, identifying previously invisible problems upon testing, further improving the level of autopilot technology.

Two achievements: Launched fully- unmanned commercial operation(L4 technology) in Chongqing and Wuhan to the public on public roads, becoming the first company in China to provide fully unmanned automatic driving services on open roads. Apollo RT6, the sixth-generation mass-produced unmanned vehicle, is planned to be launched in July, with a target mass production cost of only RMB 250,000 and put into operation on a certain scale in 2024. RT6 takes passengers as the core and has a detachable steering wheel to unlock more space inside the car, helping to reduce operating costs (labor costs and unmanned driving vehicle costs), and making Apollo cars the alternative of choice for millions of people.

Many automakers have cooperated with Baidu, and internal forecasts show that orders and pinpoint orders for automobile solutions (ADS and DuerOS for Auto) have increased to RMB 10.3 billion.

1. Advertising revenue decreased by 10% YoY, but benefited from the improvement of operational efficiency, and Baidu mobile ecosystem continues to generate strong cash flow. Since early June, control measures have been gradually lifted, and signs of recovery have emerged: Advertising revenue in June and July narrowed its YoY decline and retail customers' advertising revenue during 618 shopping festival has recovered YoY growth.

2. In June, Baidu App's MAU increased by 8% YoY to reach 628 million; Q2 search and published content grew by double digits YoY; DAU84% is locked-in users, up 10% YoY; quarterly GMV promoted Baidu search and LotSmart to increase by 127% YoY; GMV of 618 Shopping Festival increased by 260% YoY; 130,000 industry experts have registered for instant reply services, up 190% daily YoY, up from about 100,000 in March.

3. In 2022 Q2, 85% of the content on Feed will be short videos, and the number of short video distributions on Feed will grow by double digits YoY. AI tools will be provided for creators, and AI will help understand user needs, optimize ads, and increase customer conversion rates.

4. [Future plans]

(1) Apollo has been developed as a powerful new growth engine for core business, and its unique AI capabilities lead the industry. RT6 costs are very low, and it will continue to consolidate its position as the world's largest autonomous driving transportation service provider.

(2) Focus on reducing costs and increasing efficiency to continuously generate strong cash flow for mobile ecosystem business, and then help long-term investment in intelligent cloud and intelligent driving.

(3) Continue to focus on key industries, use AI innovation to achieve cross-industry replication, reduce operational losses, and achieve profitability. At the same time, continue to focus on high-quality and sustainable revenue growth, and strive to maintain a leading position in the industry.

Analyst Q&A

Q: Advertising revenue recovery situation and future prospects in different vertical areas

A: Retail, tourism, service, medical health, and other industries were greatly impacted and have gradually recovered since June.

There is still uncertainty in the macro environment in the second half of the year, and it is difficult to predict the COVID-19 pandemic. For example, in the tourism destination of Sanya, the impact of the epidemic is quite severe, so the development of our advertising business in the future is closely related to the macro environment (economic development and epidemic). Search and GDP are highly correlated with the performance of small and medium-sized enterprises, and we believe that when the macro environment improves, advertising revenue will be restored.

The next step will focus on leveraging the value of e-commerce and short videos in the mobile ecosystem, and there will be more and more short video content in search results to enhance the user experience. Integrating the two with search and Feed will improve the user experience, promote transactions, and help advertising revenue.

Q: What are the underlying driving factors and strategies for the development of Intelligent Cloud, and when will the balance of cloud business profitability be achieved?

A: "Cloud computing + AI" can help enterprise users improve efficiency to serve the public and promote traditional industries such as energy and government departments to digitize further. We will further analyze demand to seize opportunities.

Focus on high-quality and sustainable growth overall, maintain a growth rate higher than our peers, AI cloud is a very important business, and its revenue in the second quarter accounted for 18% of our core business. We will shrink the loss rate of the business sector in the future, and we can see healthy growth space for AI cloud, and we will continue to develop software and solutions.

Our differentiation is in cloud + AI. Our AI capabilities are stronger than traditional cloud vendors, and our cloud capabilities are stronger than AI companies. Currently, Chinese enterprises and public sectors are still in the early stages of digitalization, and they hope to use AI technology to improve work efficiency and competitiveness. For example, our revenue in the manufacturing, utilities, and energy industries has doubled.

In AI cloud, the gross profit margin is positive, and the operating profit margin increased in the second quarter, reducing some low-income projects. Among them:

(1) Personal cloud has a relatively small revenue contribution, but generates more profit and has slower revenue growth than the overall.

(2) Enterprise cloud has a positive gross profit margin, and the operating profit margin has increased YoY and QoQ. It will continue to narrow losses in the future. Baidu ACE is considering further deployment on open roads, such as highways, and is currently doing replicable sample projects. The ACE gross margin is relatively healthy because there are many AI and software components, and the expected time of breakeven is earlier than that of enterprise cloud.

Q: Reasons for the cost reduction of RT6

A: 1. Nine years of research and experience have accumulated rich industry knowledge and passenger demands. RT6 focuses on passenger-centered, values safety performance and passenger experience, and removes the steering wheel and connected parts, which can greatly reduce costs.

60% of BOM cost is related to L4 technology and autonomous driving.

1. Leveraging third-party manufacturers to produce RT6 can reduce BOM costs after scaling.

2. China's smart EV industry is developing rapidly, and the supply chain is mature, and the prices of intelligent components have fallen sharply. For example, LiDAR laser radar used to cost thousands of dollars, but now only costs $1,000.

Q: China's regulatory status on autonomous driving, how can Baidu better meet regulatory requirements?

A: 1. Keep in close communication with regulatory authorities.

1. Collect more data on deployed projects to further analyze various issues and optimize L4 technology; provide operating experience for regulatory authorities in terms of standards and policy-making.

2. Consider more edge cases on open roads.

3. Launching fully autonomous operations in Chongqing and Wuhan can collect more data and guide deployment in other cities. In Beijing Yizhuang, it has obtained about 10% of the taxi share. ACE has been promoted to 51 cities.

Q: Cooperation between autonomous driving and vehicle manufacturers

A: Autonomous driving has three ways of cooperation: making cars, sharing autonomous vehicles, and cooperating with vehicle manufacturers.

Currently cooperating with BYD and Dongfeng, more and more vehicle manufacturers will be absorbed as partners in the future, applying in-car entertainment solutions, especially AI technology. More and more customers are adopting intelligent driving solutions, such as ASD (autonomous driving platform), ANP (navigational assisted driving), AVP (autonomous valet parking), etc. ACE's cooperation amount exceeds RMB 10 million, and these projects provide experience in deployment in different cities and also improve attractiveness to vehicle manufacturers.

Q: 2022H2 performance guidance

A: Maintain the profitability of Baidu's core advertising; AI cloud and intelligent driving have grown rapidly in the past few quarters, and large investments are necessary. In the future, these investments will bring opportunities to improve operating conditions. Continue to focus on sustainable revenue growth, and continue to improve our operating profit margin in the future.

Q: The positioning of Jidu and RT6

A: 1. Jidu is an example of cooperation with vehicle manufacturers, while Luobaokuai and RT6 are shared unmanned taxis.

1. Jidu is a car brand for consumers, introducing L4 technology, achieving highly automated end-to-end driving, providing intelligent parking solutions, and installing more intelligent cabins (such as controlling vehicles while enjoying entertainment). 3. Starting from 2023, gradually deliver the first vehicle model ROBO-01, and release the second vehicle model by the end of the year. The second vehicle model will be open for reservation in 2023, and delivery will begin in 2024.

Q: Cash usage plan

A: 1. The company's long-term development momentum is good, and there is sufficient balance of cash equivalents and short-term investments. Therefore, the company will continue to repurchase its shares. Currently, USD 2.9 billion has been used for repurchase, and the remaining plan approved in 2020 has USD 1.6 billion.

1. Continue investing in AI Cloud and Apollo.

Q: Expectations for Sino-US audit negotiations and dual primary listings in the United States and Hong Kong

A: 1. There has been phased progress in Sino-US negotiations, and the two governments are actively seeking regulatory measures for Chinese concept stocks listed in the United States. The company will prudently comply with the laws of both countries.

1. After secondary listing in Hong Kong, some shareholders will convert ADRs into common stock in Hong Kong.

2. Being included in the Hang Seng Index is beneficial for increasing the liquidity of Hong Kong stocks.

3. The company's long-term focus is to focus on its fundamental business and realize long-term value for its shareholders.

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