Baidu, Inc.
Q4 2016 Earnings Call Transcript

Published: 24 Feb 2017

[Operator:]

Hello, and thank you for standing by for Baidu's Fourth Quarter and Full-Year 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's 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, Linda Sun, Baidu's Senior Manager of Investor Relations.

[Linda Sun:]

Hello, everyone, and welcome to Baidu's fourth quarter and full-year 2016 earnings conference call. Baidu's earnings release was distributed today, and you can find a copy on our website as well as on Newswire services. Today, you will hear from Robin Li, Baidu's Chief Executive Officer; Jennifer Li, Baidu's Chief Financial Officer; and Qi Lu, Baidu's Chief Operating Officer. After their prepared remarks, Robin and Jennifer will answer your questions. Before we continue, 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. Potential risks and uncertainties include, but are not limited to those outlined in our public filings with the SEC; including our Annual Report on Form 20-F. 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 also be available on Baidu's IR website. I will now turn the call over to Baidu's CEO, Robin Li.

[Robin Yanhong Li:]

Hello, everybody, and thank you for joining today's call. 2016 was a busy year, in which we experienced both significant breakthroughs and challenges as Baidu transitioned into the newest and most exciting stage of our journey so far. In 2016, we began to see glimpses of AI revolutionizing the Internet and traditional industries. The PC era and the rise of mobile over the past four or five years are in our rear view mirror. We are now living and breathing the era of artificial intelligence. We believe that AI is the new electricity, which will transform industry after industry, (3

[Qi Lu:]

Thank you very much, Robin, and hello to everyone. It is a real honor to be joining my first Baidu earnings call as Group President and COO. As a leader in China's Internet industry for over a decade, Baidu has built up an incredibly strong set of reinforcing assets in terms of technology, data, talents and insights. This is a very exciting time, as China plus AI is an enormous opportunity for growth, which Baidu is very well-positioned to lead. We have a great journey ahead of us, and I have already been very energized by the amazing work that's going on here. I look forward to speaking with you more in the months ahead on many of the initiatives, especially in AI, that are underway. Back to you, Robin.

[Robin Yanhong Li:]

Thank you, Qi. To conclude, AI represents a revolution in how humans and businesses interact with, and benefit from, technology. China plus AI will be a tremendous field of opportunity that Baidu is well-positioned to lead as a result of our long track record of investment and innovation. Looking ahead, we will continue to apply our expanding portfolio of AI-based technologies to an ever-widening range of applications, while we strengthen Baidu's role as an essential distributor of dynamic content on the Chinese Internet, from news and images to video, data and connected services. With that, I will now turn the call over to Jennifer for an update on financials.

[Jennifer Xinzhe Li:]

Thank you, Robin. Hello, everyone. 2016 was a challenging year and a busy year, with proactive implementation of stringent customer requirements and compliance with the new advertising law impacting our revenue. These efforts are necessary, and will help us build a better user experience and a healthier, more robust platform. We largely completed our cleanup initiative in the fourth quarter, and believe that the most significant revenue impact is behind us. Revenue in the fourth quarter resets our revenue base, and we look forward to 2017 as a time of gradual recovery and growth. Over the past year, we have carefully reviewed our strategy and business portfolio. As Robin mentioned, the mobile transition is behind us, and we're at the cusp of an AI revolution. Baidu's strategic focus, organization, and resources have shifted increasingly towards AI, and we are excited to execute our vision in this new era. Given the strategic shift to capture the opportunities in the new AI era, we do not believe metrics such as mobile search MAU, mobile maps MAU, GMV and Wallet user numbers are indicative of our business performance. As such, this will be the last quarter that we will report that set of operating metrics. We always seeks to be open and transparent, and we'll continue to update the investment community on the most important metrics to track our progress. In 2017, we'll continue to invest to build our content and service ecosystem and execute our plan to capture the AI opportunity in China. Content continues to be an important investment area, as we continue to support ITE's growth and build out (21

[Operator:]

Thank you. Our first question comes from the line of Eddie Leung from Merrill Lynch. Please go ahead.

[Eddie Leung:]

Good morning. Thank you for taking my questions, and many congratulations in bringing Qi to the team as well. I have a question on News Feed. I think Robin mentioned that so far, you have been seeing some complementary results between Search and News Feed. Could you share more color with us on how your marketing clients are looking at these two applications, how they are allocating their budgets between Search and News Feed? Should we also see a bit of cannibalizations to some clients as well? Thanks.

[Robin Yanhong Li:]

Eddie, this is Robin. I think, when we see that News Feed is complementary to Search and will bring incremental traffic and revenue to Baidu, it really means that many of our marketing clients, especially when I mentioned large clients in the industry of auto and real estate, they were not able to find enough number of (33

[Operator:]

Thank you. Our next question comes from the line of Chi Tsang from HSBC. Please go ahead.

[Chi Tsang:]

Good morning, good evening. Thank you so much for taking my question. I also want to congratulate you on hiring Dr. Qi Lu, as well as ending 2016 and putting it behind us. I was wondering – I wanted to ask you a little bit about strategy and also about core search. In particular, I was wondering if you could give us a little bit more detail on some of the strategic imperatives you may put in place over the next few years, and what that game plan might be? And relatedly, I'm wondering if you can give us your current thinking on the importance of O2O? And then on core search, you're guiding to about 6% revenue growth in the first quarter. I'm wondering what that might indicate for Search revenue? And also, if you can give us some color on just the pace of the recovery of the core Search business this year, that would be very helpful. Thank you very much.

[Robin Yanhong Li:]

Chi, I'll give you a big picture on the core business and new opportunities, and I'll let Jennifer address the Q1 growth guidance. I think we have entered the era of artificial intelligence, and fortunately, we invested in this area for the past five to six years. Actually, both the existing, the core business of Baidu and the new opportunities we are addressing, are powered by AI today, especially for Search. Five, ten years ago, when you think about search technology, it was very different. It's basically statistics-based technology. Today, search is almost all about machine learning, natural language understanding. So it's all about search. And the people will be able to express their interest or queries in a much more natural way. And we support voice as well as image as queries, and we're seeing increasing number of people using this kind of new form of queries to find what they need. These are all AI-based technologies. And News Feed again is also pretty much an AI, essentially it's the technology that matches user interest with relevant content. So we find we can leverage our strengths in AI technology to come up with much better products for our users. O2O, again, we reduced the sub fees as well as marketing cost for Nuomi and Baidu Deliveries. But we think this is an integral part of our core business. People come to Baidu Search for all kinds of things, including information, content and services, and Nuomi provides the perfect content for services. And we are fine-tuning the Nuomi content as well as services, and make them more friendly to the Mobile Baidu users, and make more opportunities for Nuomi merchants to show up in the Mobile Baidu platform. So going forward, we think we will be able to see solid growth in both our core products, which now includes Search, News Feed, O2O, and also new initiatives in terms of cloud, financial services, autonomous driving, and a few other AI-related new initiatives.

[Jennifer Xinzhe Li:]

And Chi, as you recall, last year was a busy year. Lots of the activity, particularly in related to addressing the customer base happened in the middle of the second quarter. So as we look at 2017, I think thinking about 2016 was a – not a very normal year, maybe looking and thinking about the revenues pattern from a sequential quarter-over-quarter perspective would be more meaningful. And that – I think it's more perhaps an easier way to think about the revenue growth. As I mentioned earlier, Q4 largely resets our revenue base particularly for Search business. Much of the cleanup activities, the higher requirement for our customers are put in place. And the revenue impact that – as a result is largely behind us. So as we are going into Q1 and for the rest of the year, I think, the Search – we have been carrying out this business for years and it does have its quarterly pattern. And thinking it in that way as a normal pattern, maybe that's a helpful way to think about the business this year. And this year, as we are looking towards gradually recovering and we'll drive growth in the Search business, of course, other than the Search, we have the Feed product that is complementary to the core Search business. So that's perhaps, is helpful as you think about the 2017 revenue growth.

[Operator:]

Thank you. Our next question comes from the line of Alan Hellawell from Deutsche Bank. Please go ahead.

[Alan Hellawell:]

Thank you very much. And, yeah, I just want to join the chorus to congratulations of the (41

[Jennifer Xinzhe Li:]

Hi, Alan. Yes, as I indicated earlier, content investment will continue to be a important investment area for us going into 2017. For ITE, over the past two years, we have invested strategically and very successfully in ITE's content. And as you can see, ITE's subscription user base is growing and that nicely complements its advertising revenue business model. So I think going into 2017, we'll continue to execute on that strategy. ITE has demonstrated, over the years, a high core competency in quality content selection. And going into 2017, more of the efforts will be spent in self-produced content, and that will help further strengthen and expand our subscription user base. From a margin perspective for ITE, over the past two years, their margin is actually improving, and we expect that it will be the trend going forward. So ITE is on a solid path, and I think the investment is very warranted, and they have demonstrated good returns for those kind of content investment. Included in 2017 content, as you mentioned, you've correctly pointed out, that we also invest in content for our Feed business. The Feed business product from a margin profile perspective is different from Search. Related at this early stage part of the investment for Feed is content related and also we will be aggressive in rolling out user adoptions, mechanisms for Feed to be more penetrated into the user base. So early stage monetization maybe ramping up, but at the same time, we're investing in distribution channels in sales and marketing as well as content for Feed. Over time, as we mentioned earlier, this is also a integral part of our Search service and that offers a bigger product selections for our advertiser customers, and also very importantly, offers more ad inventory if our users adoption is good. So early stage for Feed, but it does carry a slightly different margin profile, but overall, it's a complementary and enhancive to our Search service.

[Operator:]

Thank you. Our next question comes from the line of Alicia Yap from Citigroup. Please go ahead.

[Alicia Yap:]

Thank you. Good morning, Robin, Jennifer, and Qi. Thanks for taking my questions. So my questions also related to News Feed. Wanted to get a sense, does the 1Q guidance that you provided include any expectations from the News Feed ad contributions? And what is management expectation and target regarding how fast and how big the News Feed could achieve in 2017? And also given your comment on shifting to AI and all this content platform, and Jennifer you just mentioned about some spending. Just roughly, could you get a sense of how much the investment spend that we should expect related to this News Feed ads initiative? Thank you.

[Jennifer Xinzhe Li:]

Alicia, thank you for the question. For Q1, specifically, there is a – News Feed is a product that we launched for a few quarters now and early stage in monetization. So, for Q1 guidance, we do have a small part that is contributing from Feed. It will roll over the years over the quarters into 2017 as we're growing the user base, users time on it, the advertiser pool, and we expect News Feed to add more contributions to our overall revenue contribution. For investment related to News Feed, I mentioned earlier, content is one specifically related to building out the ecosystem and provide a rich content and good user experience as our users use the product and engage with our service. For News Feed investment, I also mentioned about sales and marketing related expenses. So, this is more for user adoption. The investment in AI particularly are more in the technology side and that has to do mainly with R&D expenses. And therefore, as I mentioned earlier, we'll continue to invest in R&D steadily and – that is more gradual, its competency build up, its talent, so – but that's not different from the way that we have been approaching R&D investment over the years.

[Operator:]

Thank you. Our next question comes from the line of Alex Yao from JPMorgan. Please go ahead.

[Alex Yao:]

Hi, good morning, everyone. Thank you for taking my questions. I have a question on the core Search business. The mobile search MAU this quarter, the growth rates slow down to 2% on a year-over-year basis. As you guys mentioned in the past that Search is a traffic-bound business, now that the mobile search traffic is slowing down and PC most likely is declining, how should we think about Search growth outlook for the next two to three years? Thank you.

[Robin Yanhong Li:]

Yeah. I think the MAU for mobile search have to slow down because we basically penetrated almost all the Internet users here in China. And Internet penetration rate when that's (48

[Operator:]

Thank you. Our next question comes from the line of Juan Lin from 86Research. Please go ahead.

[Juan Lin:]

Hi. Good morning, Robin, Jennifer, Dr. Qi Lu, and Linda. Thank you my questions. Actually I have one follow-up question on News Feed, I am wondering if you could share with us some metrics in terms of News Feed advertising? What is the current pricing policy fixed rate (49

[Robin Yanhong Li:]

Yeah, I think we allow users to create designated creative work for News Feed advertisement. Therefore, the advertisers have the power to name their own price. If they don't do that, I mean, when they show the same creative for both Search and News Feed, we will typically apply a smart discount to the cost-per-click on the News Feed. So, on average, the click price for News Feed is meaningfully lower than that of Search. We are thinking about probably half of the Search related click price. Right now the ad load on our News Feed is relatively low and user experience has been very good with our Search-related customers at those creative dedicated for News Feed.

[Operator:]

All right. Thank you. Our next question comes from the line of Piyush Mubayi from Goldman Sachs. Please go ahead.

[Piyush Mubayi:]

Thank you for taking my question. Jennifer, you talked about MAU and GMV being less relevant for gauging success of business. What would be the relevant metrics you'd look at going forward? And could you give us a sense of which ones are the ones that you would share with us going forward? And a question for Robin, Robin you made them push into software and hardware AI applications including the acquisition of Raven Technology and the establishment of few business units. How do you see this evolve, and could we talk about the shape and size of this opportunity? Thank you.

[Jennifer Xinzhe Li:]

Yes, with regards to the operating metrics as we mentioned earlier, the mobile transition is pretty much behind us. And our services are very much penetrated into the current Internet population in China. And also related to Nuomi services, it helps provide a service related content for our Search ecosystem and GMV won't be a meaningful target or objective for us. And so, we will always seek to be transparent and open with our business performance and provide relevant indicative metrics to give you insights into our business. We will – as we develop and focus on the ecosystem for Search, the service of the Feed product, information such as you know what we commented on how many parties are registered with (53

[Robin Yanhong Li:]

Yeah, on the hardware-software integration, I think this is one of the most important characteristic of AI era. With this kind integration, lot of innovations become possible, and the user experience is significantly improved based on that. That's why we are investing in both hardware and software for AI-related technologies. That its true for the mobile platform, but it's also true for the home environment as well as auto environment. For example, when you're at home, we mentioned we have collaborated with (55

[Operator:]

Thank you. Our next question comes from the line of Natalie Wu from CICC. Please go ahead.

[Natalie Wu:]

Hi, good morning, management. Thanks for taking my questions. So I've got question regarding your Transaction and related service. I think that the GMV declined sequentially by RMB 1.3 billion, but you also mentioned that your Transaction Service reduced operating margin by 21.8% versus 23.8% last quarter. So, just wondering, why is it that the related losses expanded while GMV scale contracted? And also, what's the management guidance for the margin for this year? Any color would be helpful. Thank you.

[Jennifer Xinzhe Li:]

For Q4, I think the margin impact from Transaction Services is also have to do with the overall base business. As you recall, our Search service – our service is sequentially a slight decrease. Normally in Q4 we would have increased, but because of all the activities going on, we didn't grow our revenue in Q4 per se. So I think that sets the base, and the component for Transaction Services, even if it stays similar with our continued investment in R&D and all that, that would translate into a bigger impact. At the same time, just looking at the Transaction Services, within it, we have reduced the spending for Nuomi-related promotional expenses. But at the same time, we see good traction on the Takeout Delivery service, that continues to do well. And also included in Transaction Service is Financial Services, and we're growing that business very nicely too. And so, I think our strategy is quite clear, and components of the Transaction Services, different elements are performing differently. And I think, as we go into 2017, it is quite clear. I think it's not the whole package that you're focused on GMV and Nuomi can help Search ecosystem on the service content side, and both Takeout Delivery service and FSG, Financial Services, can also take advantage of the AI technology and enable business growth, and also good user experience.

[Operator:]

Thank you. Our next question comes from the line of Evan Zhou from Credit Suisse. Please go ahead.

[Evan Zhou:]

Hi. Good morning, Robin, Dr. Lu, Jennifer, and thanks for taking my question. The question is regarding our paid subscription business on ITE. So you've been actually sharing with the – some updated paid subscribers numbers, I remember by 2Q last year, we have reached the target of roughly 20 million, which is the leader across the sectors. I was wondering if you can provide an update on that. And also, regarding the comments about the cost structure possibility for ITE, I think – are we looking into the possibility that ITE can be close to breakeven in the next year or two? And also, a quick follow-up on the content spend guidance comments you have just now regarding the similar level of increase, is it related to the – referring to the percentage terms increase year-over-year, or about absolute amount of incremental cost run rate hike? Thank you.

[Robin Yanhong Li:]

On the ITE membership question, number of subscribers continue to grow at a very rapid rate. And we believe we are solidly number one in terms of subscription revenue, and will continue to go very fast.

[Jennifer Xinzhe Li:]

Yeah. I think, on your other comment, specifically for content cost for 2017, what we were trying to provide you some color is, it will increase at the same rate, very similar rate compared to last year. So over the past two years, steadily, content cost have been following similar increase in investment levels. ITE, as we mentioned, ITE is doing well in its business, both on the user front as well as revenue front, and we are the market leader. So, I think the business has demonstrated a two-engine – two-powered engine revenue source. And I think in near term, we'll continue to invest in content and differentiate ITE as a service, and it's tracking very well.

[Operator:]

Thank you. Our next question from the line of Ella Ji from China Renaissance. Please go ahead.

[Ella Ji:]

Thank you for taking my questions. I have a question for Dr. Lu Qi. So I just wonder after you have joined the company for several weeks, what do you think would be your to do list for 2017. Is there any specific strategy that you can share with us? And then, as an ordinary user as we use Baidu product, what should we expect to see differently going forward? Thank you.

[Qi Lu:]

First of all, thank you very much for your question. It seems I've been here only for few weeks. I would say, I've been able to spend lot of time with Robin thinking about our overall company's long-term strategy, particularly in the context of AI and China. And the focus is to land the opportunity in concrete user experience and concrete economic opportunities. And that will take some time to unfold and evolve, as I mentioned a little bit earlier. I look forward to the opportunity of – in coming months speaking to many of you about those ongoing initiatives. And I have full confidence over time, they will generate real user values and economic opportunities for company. And that's perhaps what I'm able to say at the time for now, but I do very much appreciate your question.

[Operator:]

Thank you. Our next question comes from the line of Wendy Huang from Macquarie. Please go ahead.

[Wendy Huang:]

Thank you. So, I have three housekeeping questions. The first, can you give us update about the Search revenue breakdown between the mobile and PC? And also how has the pricing gap between the two actually evolved over time in terms of CPM? And secondly, the number of advertisers seem to be the lowest point in the past 10 quarters. I assume that was partly due to the seasonality, partly due to the lingering impact from the medical adscene advertising law. So, going forward, how should we expect the number of advertisers to churn in Q1, and when should we expect the advertiser base to normalize? Lastly on the ITE, you recently did a CD, but I notice Baidu only contributed US$300 million out of US$1.5 billion. So, previously, Baidu hold about 80% in ITE, so what would be the Baidu holding after this? Thank you.

[Jennifer Xinzhe Li:]

Yeah, Wendy, I think we reported on the mobile revenue contribution for our total revenue. So, for the fourth quarter, it stands at 65% and continue to grow. And obviously, we're living in the mobile age and it's undoubtedly, mobile is contributing more and we do see monetization power on the mobile front growing at a much faster pace compared to PC, and it's close to be – we expect that to exceed PC's monetization capability, not very soon. On the customer front, yes, I mean, I think you understand last year we went through the whole review of our customer base, have much higher and stringent requirements for our customers. And for particularly, the ICT license and the bank account validation for enterprises, basically we block out individuals who do business, search engine marketing business on our platforms. So having raised the bar is no doubt that some of the customers may not meet that requirement. But we know it's good for our user experience, it's good for the business long-term, and that's what we'd do. At the same time, we know the addressable market for the customers that we can service is vast and we are innovative on the product side. So not only Search with Feed products, there is much more inventories for advertisers and that can serve both brand players as well as the smaller players. So we expect our customer pool to be able to grow. We will continue to have the high requirement for our customers and gradually build up our customer base, assuring that we have high quality advertisers with us. For ITE, yes, Baidu will continue to strongly support ITE, and ITE is a very important content provider for our Search ecosystem. With this transaction, Baidu continues to have a majority ownership of ITE.

[Operator:]

All right. Thank you. Our last question comes from the line of Thomas Chong from BOCI. Please go ahead.

[Thomas Chong:]

Hi, Robin, Jennifer, Dr. Lu, thanks for taking my questions. I have got quick question about the (1

[Jennifer Xinzhe Li:]

Yes. We have steadily invested in talent and R&D capabilities is really a key differentiating and competitive advantage Baidu has over the years. And we have steadily investing in R&D talent. As I mentioned earlier, particularly in the AI age, with many of the AI-enabled services that we are working on, we will continue to invest in R&D. But I think from a overall head count perspective, if you look at last year, the head count overall has not materially changed. Obviously, with more mature business, we look to the business to produce (1

[Operator:]

Thank you. Ladies and gentlemen, we are now approaching the end of the conference call. Thank you for your participation. This end today's conference. You may now disconnect. Good day.