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Edited Transcript of BIDU earnings conference call or presentation 28-Apr-17 12:00am GMT

Thomson Reuters StreetEvents

Q1 2017 Baidu Inc Earnings Call

Beijing May 3, 2017 (Thomson StreetEvents) -- Edited Transcript of Baidu Inc earnings conference call or presentation Friday, April 28, 2017 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Qi Lu

Baidu, Inc. - Vice Chairman, Group President and COO

* Sharon Ng

Baidu, Inc. - Director of IR

* Jennifer Li

Baidu, Inc. - CFO

* Robin Li

Baidu, Inc. - Co-Founder, Chairman and CEO

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Conference Call Participants

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* Alan Hellawell

Deutsche Bank AG, Research Division - MD and Head of Asian Telecommunications, Media and Technology Equity Research

* Alex Yao

JP Morgan Chase & Co, Research Division - Analyst

* Alicia Yap

Citigroup Inc, Research Division - MD and Head of Pan-Asia Internet Research

* Chi Tsang

HSBC, Research Division - Head of Internet Research of Asia Pacific

* Eddie Leung

BofA Merrill Lynch, Research Division - MD in Equity Research and Analyst

* Evan Zhou

Credit Suisse AG, Research Division - Research Analyst

* H. Chen

Morgan Stanley, Research Division - Equity Analyst

* Juan Lin

86Research Limited - Research Analyst

* Karen Chan

Jefferies LLC, Research Division - Equity Analyst

* Ming Xu

UBS Investment Bank, Research Division - Director and Research Analyst

* Piyush Mubayi

Goldman Sachs Group Inc., Research Division - MD

* Natalie Wu

China International Capital Corporation Limited, Research Division - Analyst

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Presentation

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Operator [1]

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Hello, and thank you for standing by for Baidu's First Quarter 2017 Earnings Conference Call. (Operator Instructions) 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, Sharon Ng, Baidu's Director of Investor Relations.

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Sharon Ng, Baidu, Inc. - Director of IR [2]

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Hello, everyone, and welcome to Baidu's First Quarter 2017 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.

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, Jennifer and Qi 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 statement, 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.

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Robin Li, Baidu, Inc. - Co-Founder, Chairman and CEO [3]

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Hello, everybody, and thank you for joining today's call.

Earlier today, we announced that Jennifer will become CEO of Baidu Capital, an investment firm. Jennifer will transition away from her responsibilities as CFO following the appointment of her successor. Jennifer has played an instrumental role in Baidu's growth over the 9 years she has been our CFO. And as CEO of Baidu Capital, she will continue to be part of the Baidu family and contribute to building Baidu's ecosystem, which is crucial in bringing AI to real-world applications. Jennifer's extensive experience in the areas of finance, capital markets, technology, auto, financial services and consumer industries will help bridge technology with various traditional industries, and I look forward to working with Jennifer in her new capacity.

Now turning to the quarter. I will begin with a few brief comments and then Qi will provide a business review and Jennifer will present the financials.

2017 is shaping up to be a transformational year for Baidu as we complete our strategic evolution to China's largest AI-centric technology company.

We believe that a great technological revolution comparable to the Industrial Revolution is taking shape, representing a once-in-a-generation opportunity that will create new commercial frontiers and transform a wide range of industries such as auto, healthcare, education, financial services and industrial automation. In the AI-enabled era, the scenarios for human-machine interaction will be much broader than what we've seen before. And as natural language understanding and image recognition power new information gateways, with the new paradigm for human-machine interaction will have significant implications for how people conduct their daily lives. I'm confident that Baidu's advantages in technology, specifically advanced AI research, well position us to be the industry leader for the long term.

Search is one of the first applications of AI, where search works to understand humans. As the leading search engine in China, we have been fortunate to amass vast amounts of rich, valuable data in a market with over 700 million Internet users who speak the same language, have the same culture and abide by the same laws. Moreover, we live in an age where we can finally match this data with powerful, efficient computing infrastructure and a deep bench of talent to make real progress in AI.

We believe Baidu's opportunity to apply AI to real-world consumer and enterprise applications in China is enormous. We envision a world where machines continue to learn about humans. In the not too distant future, using natural voice input or images to interact with machines will be mainstream, alleviating humans of the burden of mundane tasks. We imagine a world where your face is your identity, and you only need to show your face to pay at the supermarket or to go through airport security. Cars will drive us, freeing up our time and attention.

As machines become more like hyper-efficient real-time assistants for people, the mode of user interaction is evolving correspondingly. Just as the mouse and keyboard were the gateways in the PC era and touch is the gateway for mobile, voice recognition through Conversational DuerOS will be the gateway in the China + AI era.

While our investment in AI is a long-term proposition with dividends that will be paid over the medium to long-term, we are already seeing the powerful benefits of AI in our existing online advertising platform and in the more personalized, more image-enhanced and more predictive search experience. Beyond the existing PC and mobile channels, AI will expand the scenarios and use cases for search - in the home, car and work - and lower the friction for search - through voice recognition, image recognition and user personalization. Our strategy is clear, and we are working hard on multiple fronts.

I'll now turn the call over to Qi to go through our business progress.

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [4]

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Thank you, Robin.

To build on Robin's key points, operationally, here at Baidu, we very much focus on building and applying AI technologies as the foundation of what we do, and the primary driver of product innovation and business growth.

Over the past 3 months, I have spent the majority of my time working with our product and business teams to map out our strategy and ways to drive high-performance execution. Our focus is twofold - to enhance and expand our existing core business platform; and to lead the commercialization of AI technology across a number of AI-enabled new business initiatives, such as our AI cloud, financial services, DuerOS and autonomous driving. For our new business initiatives, we have gone through a rigorous and disciplined process to evaluate and select the most promising new business opportunities to pursue. Our criteria includes category life cycle, market penetration, Baidu's competitive position, differentiated value propositions and our ability to execute. We will be shedding more light on the process and the progress of these new business initiatives and sharing operating metrics, as appropriate, as we move forward.

On our core business front, we're off to a good start, driving improvements in both traditional core search as well as in our newsfeed products. Search is and will continue to be, a fundamental user need, especially as we digitize more and more world's information and our daily lives. We see much more room for innovation to deliver a better user experience with richer information and user interactions as we expand search into more and more scenarios. For example, we are making great strides in enriching our search results, especially with video. In fact, now over 25% of mobile queries have rich video content as part of the search results, representing a material increase over last year. We are also making our search experience on mobile devices more natural and easy to navigate using touch. The experience is much more engaging, like that of our mobile native apps as compared to the traditional browser-based experience. This is achieved through intelligent filtering and presentation technologies based on our AI capabilities in content and user intent understanding, especially in more advanced areas such as classification and object recognition in images and videos.

With the twin engines of search and newsfeed, we have broadened our core product experience by complementing the explicit, intent-driven pull experience of the traditional search, with the implicit user understanding-driven push experience of newsfeed. While we are pleased with the rapid user adoption of our newsfeed product, with daily active users reaching 83 million this month and the overall volume of content distribution and user time spent reaching a new weekly high, we'll stay laser-focused on improving the user experience and building out our content platform. Especially, the number of content creators on our Baijiahao content platform has surpassed 450,000, more than doubling over last quarter, becoming an increasingly important part of the Baidu overall information ecosystem.

And speaking of ecosystem, Maps, Nuomi and the Local Express continue to play a vital role in connecting users with local content and services and helping local businesses connect users through our search, feed and advertising products. Operationally, in Q1, we consolidated Nuomi into our core business. Going forward, our focus for Nuomi will be building more and better content of our local services and the monetization through advertising, through Local Express instead of the transaction business.

All of these improvements to our core products and ecosystem are reflected in the growing engagement of our users, with the ratio of mobile search daily active users to monthly active users showing a clear upward trend.

On the commercial product front, we added upgrades to our search ad platform, making click-to-connect ad formats available across search, Union and the newsfeed. This has yielded a notable lift in monetization. We are also actively developing and applying AI technologies across a number of key areas such as ad targeting, creative and landing page optimization, which will contribute to increasing monetization capabilities over time.

While monetization is still at an early stage for newsfeed, customer feedback has been very positive. They view newsfeed traffic as incremental to their campaigns. Late last year, we also launched a dedicated newsfeed ad platform to complement newsfeed bidding within our search ad platform and customer campaigns through this dedicated channel is ramping up at a rapid rate.

Now turning to AI-enabled and new business initiatives, we are making good strides across the board. And here are few specific areas to call out. DuerOS is our next-generation conversational AI platform. By design, it provides powerful capabilities to enable the use of voice in natural language to interact with any digital experience on any device for any scenario. This is because for the first time in our history, AI technology enables natural language to serve as a general purpose user interface. While it is still early, this platform will have enormous potential relative to the traditional platforms because it can run everywhere, and it enable users to interact naturally and easily. We believe we're the clear market leader in China. And DuerOS has already gained great momentum in building out its ecosystem. For example, we have secured broad partnership to power conversational AI services for Xiaomi andVivo smartphones, Lenovo smart TV, Haier and Midea smart appliances, Harman smart speakers and many others across a rapidly growing number of devices.

Home and cars are two high-value scenarios to anchor the DuerOS platform at this early phase. Here we have made important investments in our Raven Tech acquisition as well as our Internet of Vehicles business unit, both of which will help further establish the DuerOS platform and strengthen our market leadership position. At the same time, both in their own right will have significant business opportunities that we will grow into.

In Q1, we consolidated our L4 and L3 and Internet of Vehicles Business Unit into the new IDG, Intelligent Driving Group. This will enable us to build out a common technology platform, shared services and a consistent solutions for all our partners. At the Shanghai Auto Fair last week, we announced Project Apollo, an open, complete and reliable autonomous driving technology platform that we plan to launch in July. This is a historical opportunity to apply our AI technology strength to create an open innovation ecosystem that will empower all parties in the auto industry to accelerate the pace of innovation, enable more win/win partnerships, and create greater business opportunities in this vast and rapidly growing market. The response from the industry and our partners has been very positive thus far. It is a big step forward.

Our AI-cloud business, named as ABC, or AI, Big Data and Cloud, has been gaining traction with our customers who appreciate our AI value-added approach. Baidu Cloud builds upon foundational cloud solutions of computing, storage and CDN. We differentiate by providing AI technology-enabled solutions such as big data, deep learning, video, IoT and more. Customers across media, financial services, healthcare and other verticals have expressed very positive feedback. This month, at the Baidu Cloud ABC Summit, together with NVIDIA, we announced the establishment of the Baidu Deep Learning Platform which will greatly help our customers and partners to enhance their capability in deep learning and AI.

Our Financial Services business continues to grow as our AI and big data capabilities serve as key differentiators that can intelligently target and match users with the right products, identify and prevent fraud and appropriately assess credit risk through our continuously increasing proprietary data and modeling capabilities.

iQiyi, which celebrated its seventh anniversary this month, continued its sector leadership with ongoing improvements in revenue and paid subscriber numbers. In March, according to iResearch, iQiyi's mobile app maintained its top ranking with 129 million daily active users, 490 million monthly active users and 342 billion minutes of monthly user time. We will continue to work closely with iQiyi to support its growth as part of the overall Baidu ecosystem.

Baidu Deliveries, with its first-rate service quality and clear technology advantage made strong progress in the quarter, seeing healthy revenue growth year-over-year. In March, during the International Women's Week, Baidu Deliveries ran a highly successful special joint promotion with Yum China's KFC and Pizza Hut brands.

In conclusion, we are very pleased with our progress in Q1, and we are more confident and energized about using AI to elevate our core products and business, and to create long-term values through our next-generation AI-enabled new business initiatives.

With that, I'll turn it over to Jennifer to go through the financials.

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Jennifer Li, Baidu, Inc. - CFO [5]

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Thank you, Qi. Hello, everyone.

In the first quarter, we bought back about $200 million of our own stock. We are very confident in Baidu's long-term outlook. And this decision is consistent with our overall capital allocation framework.

We had a solid first quarter, with the business performing to our expectations. As we're moving from mobile-first to AI-first, we worked to align our business operations by folding Nuomi into our core business. Nuomi will play a role to serve as part of the core business's content and service ecosystem.

We'll continue to scale back spend for Nuomi and shift Nuomi from a take-rate transaction-based business model to an advertising-based business model which leverages our core business. We do not expect Nuomi to be a significant contributor to margin drag going forward. Other components in Transaction Services such as Maps, Financial Services and Baidu Deliveries, are also part of our core business's content and service ecosystem, with Financial Services and Baidu Deliveries very much leveraging our AI capabilities. Baidu Deliveries continues to show improving operational efficiency and a visible path to sustainability and profitability. Consistent with our strategic and operational focus to build our core business and invest in AI, we intend to realign our segment reporting and fold Transaction Services into our core business. Starting next quarter, we'll report Baidu Core as a whole and Transaction Services will no longer be a separate segment.

As Robin and Qi have shared, and as we have been communicating to you in the past few quarters, AI is the core of our strategy and is both the foundation of our existing platform and driver of vast opportunities going forward. We are continuously leveraging our existing technology capabilities and devoting resources to our AI-enabled initiatives of enterprise cloud, financial services, DuerOS and autonomous driving. The majority of these investments are on the R&D front which we expect to bear fruit in the medium to longer-term. This year, we expect incremental R&D expenses over 2016 to be all related to AI. Incremental R&D spend this year is largely related to AI R&D headcount.

As a reminder, as disclosed in our form 20-F, we disposed of our mobile gaming business for RMB 1.2 billion, a transaction which is expected to close mid-May. After mid-May, we will no longer recognize revenue for the mobile gaming business. The mobile gaming business contributed close to 3% of total revenue in 2016.

Now moving to the financials. All monetary amounts are in RMB, unless otherwise stated.

For the first quarter, total revenues were RMB 16.9 billion, representing a 6.8% increase from the corresponding period in 2016.

During the first quarter, Baidu had approximately 451,000 active online marketing customers, representing a 23% decrease from the corresponding period in 2016 and flat compared to the previous quarter. Revenue per online marketing customer for the first quarter was RMB 32,200, a 27% increase from the corresponding period in 2016, and a 9% decrease compared to the prior quarter.

Traffic acquisition cost as a component of cost of revenues in Q1 was RMB 2.2 billion, representing a 12.9% of total revenues compared to 14.1% in the corresponding period in 2016, and 14.5% in the fourth quarter of 2016.

Bandwidth costs as a component of cost of revenue in Q1 were RMB 1.3 billion, representing 7.9% of total revenues compared to 6.9% in the corresponding period in 2016.

Depreciation costs as a component of cost of revenues in Q1 were RMB 823 million, representing 4.9% of total revenues compared to 4.5% in Q1 of 2016.

Operational costs as a component of cost of revenues in Q1 were RMB 959 million, representing 5.7% of total revenue compared to 6.9% in Q1 last year.

Content costs as a component of cost of revenues in Q1 were RMB 2.6 billion, representing 15.6% of total revenue compared to 8.7% in the corresponding period in 2016. This increase was mainly due to iQiyi's increased content costs.

SG&A expenses in Q1 were RMB 2.8 billion, representing a decrease of 29% from the corresponding period in 2016. The year-over-year decrease was primarily due to a decrease in promotional spending for transaction services.

R&D expenses in Q1 were RMB 2.8 billion, a 35% increase over the corresponding period in 2016. The increase was mainly due to the growth of R&D personnel-related expenses.

Share-based compensation expenses, which were allocated to related operating costs and expense line items, increased in aggregate to RMB 631 million in Q1 from RMB 309 million in the corresponding period in 2016. This year-over-year increase was a result of increased share grants to employees.

Operating profit for Q1 was RMB 2 billion, representing a 9.3% decrease from the corresponding period in 2016. Non-GAAP operating profit was RMB 2.6 billion, a 4.6% increase over the corresponding period in 2016.

Income tax expense was RMB 405 million for the first quarter. The effective tax rate for the first quarter was 18.6% compared to 25.4% in Q1 2016. The decrease in the effective tax rate reflected our operating losses narrowed for some loss-generating entities in the group.

Net income attributable to Baidu for Q1 was RMB 1.8 billion, a 10.6% decrease from the corresponding period in 2016. Basic and diluted earnings per ADS for the first quarter amounted to RMB 4.65 and RMB 4.63, respectively.

Non-GAAP net income attributable to Baidu for Q1 was RMB 2.4 billion, a 1.3% increase year-on-year. Non-GAAP diluted earnings per ADS for Q1 was RMB 6.85.

As of Q1, the company had cash, cash equivalents and short-term investments of RMB 90.7 billion. Net operating cash inflow and capital expenditures for the first quarter were RMB 4.7 billion and RMB 1.2 billion, respectively.

Total headcount on a consolidated basis, including invested entities, was about 43,400 as of the end of first quarter of 2017. This represents a decrease of 5.5% as compared to the end of last quarter.

Now let me provide you with our top line guidance for the second quarter of 2017. We currently expect total revenues for the second quarter to be between RMB 20.47 billion and RMB 20.98 billion, representing an annual increase of 12.1% to 14.9% and a sequential increase of 21.2% to 24.2%. Please note, this forecast reflects Baidu's current and preliminary view and is subject to change.

I will now open the call to questions. Operator, please go ahead.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Eddie Leung from Merrill Lynch.

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Eddie Leung, BofA Merrill Lynch, Research Division - MD in Equity Research and Analyst [2]

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First of all, my best wishes to Jennifer for your next role. And then for my questions, I'm wondering if you could share more color with us on the different components of your revenue guidance for the second quarter and especially any color on the contribution of subscription and the newer business, mobile newsfeed, will be helpful.

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Jennifer Li, Baidu, Inc. - CFO [3]

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Eddie. Thank you for your kind words. With regards to Q2 revenue, if you look at our business, essentially, it's the core business as well as iQiyi that are the main revenue contributors. Within the core business, there is search, we're also putting a lot of effort in the feed. The feed product, as Qi mentioned earlier, from a user adoption perspective, it's progressing very well. We're in the early stage of monetizing the product, so we're not driving aggressively on the monetization front. For our core business, it continues to be very search-centric, and we are very excited to extend the services we can offer to our users and advertisers, and we expect a solid progress in that regard, and we should expect the search business to expand over the next few quarters. For the iQiyi business, as you would have seen from our 20-F, last year iQiyi had a very solid growth and contribution to our overall business. iQiyi is an integral part of the overall Baidu ecosystem, and they continue to deliver very strong top line growth driven by the business model of subscription user base. So if you look at Q1, sequentially, you'll continue to observe other revenue line continues to grow quarter-on-quarter and a big part of that is iQiyi's subscription user business. iQiyi's revenue growth is built on a solid ground. The 2 engines - advertising as well as subscription fees, continue to grow very well. We're still on the path of recovery from last year's incident, and search is ramping up very nicely.

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Operator [4]

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Your next question comes from the line of Chi Tsang from HSBC.

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Chi Tsang, HSBC, Research Division - Head of Internet Research of Asia Pacific [5]

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Congratulations, Jennifer, on this next opportunity. I wanted to ask you about core search. In particular, I was wondering if you can touch on traffic as well as demand. On the traffic front, what are you guys seeing in terms of growth in traffic and maybe growth in paid clicks year-to-date? And I'm wondering if you expect paid clicks to grow faster this year than last year. And then, in terms of demand, given the rebasing of your customer base and as well as the higher standards, what type of customer growth do you expect this year?

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Jennifer Li, Baidu, Inc. - CFO [6]

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I'm going to take the first part on Chi's question, and Qi and Robin can feel free to add. The traffic as overall continues to be very solid. Mobile continues to be growing nicely and a bigger proportion of the overall traffic. As you know, we mentioned earlier, the feed product, also, we're busy developing that and seeing good progress on that. So from our product service perspective, we have a nice search traffic as well as user engagement that a user has more time and interesting topics that they can view on the Baidu platform. For us to build in more of these inventories and create more of the user product, it provides a bigger advertising pool and inventory for our advertisers. So I think going into 2017, later in the quarter, we should continue to expect that the paid clicks will power the growth of monetization. From a -- what was the other question?

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Robin Li, Baidu, Inc. - Co-Founder, Chairman and CEO [7]

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Just on customer.

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Jennifer Li, Baidu, Inc. - CFO [8]

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Oh, customer. Customer-wise, seasonally Q1 was a low quarter. And I think, for the remainder of the year, as we have richer product for our advertisers and as our sales force refocus their efforts to develop the market, we should expect the customer base to grow as well.

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [9]

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Yes. Let me just add to what Jennifer described. With regard to search traffic, as we mentioned earlier, we view search as a fundamental human need, user need. And as we digitize more and more information, digitize more and more daily activities, the search overall demand will increase, that's number one. Number two, in its current form, users express their intent through keywords, query inputs, landing on a set of information that will see its natural pace of growth. As you have seen, our industry in China has been expanding so far. However, what I will emphasize is that there is through AI technology innovations, we believe we can, over time, expand our search traffic by additional user experiences. For example, you can search based on voice, you can search based on images, and more and more content will be available for search. So our focus is tapping into the current trend of user traffic growth for sure, at the same time, focusing on building better experience, more search capabilities, expanding into more search scenarios over time to expand search traffic. On the paid clicks side, again, the pattern will be similar. The focus would be using AI technologies to understand the user intent better and enable that to expose to advertisers, to our business customers, so that advertisers will have, over time, richer opportunities to place their campaigns as part of the product so that we have more opportunities to tap into the ongoing growing demand of advertising needs. So netted out, there's existing forms that's growing at its current pace, and then we're also focusing on tapping into future user traffic and the future of pay-to-click growth opportunities through AI, through technological-based enablement.

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Operator [10]

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Your next question comes from the line of Alicia Yap from Citigroup.

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Alicia Yap, Citigroup Inc, Research Division - MD and Head of Pan-Asia Internet Research [11]

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My question is related to margins. So your comments of the operating margin, including Baidu Core versus the Transaction Services, where Transaction Services is 16.8 point reduction. Does that mean, in Q1, the margin under transaction service only includes the Baidu Takeout Delivery and the Maps, but the Nuomi expenses is now part of the Baidu Core? And then how should we be thinking about the overall core margins in the future, with newsfeed becoming a more meaningful part of the contributions? And then related to that, I wanted to ask about the content cost on the iQiyi front. Is all the RMB 2.6 billion in Q1, all related to iQiyi? Is there anything on that's related to the newsfeed content? And then with iQiyi recent licensing deal with Netflix, does the content cost guidance of doubling year-over-year this year still hold true? Or should we expect even more than double in the content cost?

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Jennifer Li, Baidu, Inc. - CFO [12]

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Thank you, Alicia. So a few questions. First of all, the margin drag that we reported on transaction services was reported on the same concept and definition, consistent with the prior quarters. This is to give you an idea, and you can clearly see that we are reducing the investment on this front, and we're shifting from mobile to AI. And so for your specific comment, Nuomi was included in this number and included in the transaction services, as a reminder, also has financial services Baidu Delivery, Maps and Nuomi, and so these are the main components. As I mentioned earlier, we'll continue to reduce spend on Nuomi, and the other elements within the old transaction services sector have to do with core search for AI-related initiatives. So it doesn't really make sense for transaction services to stand as a separate sector. But for your information, it's more to give you an indication for this quarter that we are reducing spend on this front. For newsfeed, as mentioned before, newsfeed carries a different margin profile. And we're in the early stage of developing its business model from an advertising perspective. Currently, we're focusing on driving the user experience, user adoption, so investment related to feed has to do with the ecosystem build-up, content acquisition, R&D effort and some infrastructure-related, bandwidth and depreciation related to servers because we're building the user traffic on the front. We haven't really focused on the advertising effort, but as Qi mentioned earlier, the business model is pretty apparent and the customers are quite open and accepting to this advertising model. So over time, we will ramp up the advertising and monetization capability. But at this point, it's at a very early stage. With regards to the content cost for Q1, yes, predominantly, a big majority of the Q1 content expense was iQiyi related. And as we mentioned earlier, our expectation is, this year, there will be a very important content investment mainly for iQiyi and also partly related to our feed product. The overall guidance we provided earlier that the content cost will likely go up the same percentage as before, that estimate still holds.

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Operator [13]

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Your next question comes from the line of Alan Hellawell from Deutsche Bank.

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Alan Hellawell, Deutsche Bank AG, Research Division - MD and Head of Asian Telecommunications, Media and Technology Equity Research [14]

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Great. I just wanted to join the chorus in thanking Jennifer for setting a high watermark in the industry as a CFO and also wish her the very best in her new role. A question around the interplay between demand for our search and newsfeed product. I can see key accounts scratching up new incremental budget to buy newsfeed ad. But I wonder if it is more cannibalistic to our budget-limited SMEs that generally prefer the more focused sales generation aspects of buying a keyword to the more impression-based aspect of newsfeed ads. And then just a quickie, a disclosure-related question. By folding in transaction services to core search, are we no longer going to segregate out margin drag from transaction services and maybe even iQiyi?

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [15]

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Let me first answer the first part of the question on the demand side. The evidence so far has been showing an overall healthy growth and a specific evidence of qualities that we have enabled our customers to place their campaign budget in 2 ways. One is through the search campaign, they can indicate how much to go to the feeds. And there's also a separate interface that they can explicitly say this budget will be out on the feed side. There's a clear upward trend, a very rapid growth for customers explicitly placing more campaign budget on the feed side while maintaining their search campaign budget. And that's a clear sign of healthy overall growth, for our advertising needs, for our combined search and feed product, that's number one. Number two, over time, it will become more apparent that feeds, in many ways, enable brand advertising to have a meaningful play in our ad platforms. This is, again, very early. We are more focused on getting user experience to be truly, truly compelling and grow our user base and time spent. But from a campaign demand perspective, our combined search and feeds will enable more overall growth not just from the traditional performance-based advertising but into brand-awareness-based advertising as well.

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Jennifer Li, Baidu, Inc. - CFO [16]

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And Alan, to your second question, yes, we're folding transaction services into core. However, we will continue to separately identify iQiyi as a separate segment and report separately its margin impact on a quarterly basis.

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Operator [17]

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Your next question comes from the line of Alex Yao from JPMorgan.

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Alex Yao, JP Morgan Chase & Co, Research Division - Analyst [18]

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I have a question on the Apollo Project you guys announced recently. Does that make your autonomous car research project an open-source type of project which will potentially impact your monetization capability? If it's not, can you help us understand your future project for monetizing the autonomous car driving initiative?

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [19]

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Thank you for the question. Actually, a terrific question. As a matter of fact, I can tell you my goal for Project Apollo is to expand our monetization opportunities ahead, a real plausible task towards future economic value creation for Baidu. Specifically, let me give you the thumbnail of what Apollo is and I'll comment on the growth business opportunities. First of all, as I described, it's an open, complete and a reliable platform. So we'll open code, we'll open software, and we'll also open capabilities that's through APIs. And we are also providing core services as the overall part of the platform. The overarching design is any player in the auto industry, with Apollo, you can put together a complete vehicle using off-the-shelf hardware components and be able to run with different intelligent driving scenarios and all the way up until 2020 towards fully autonomous driving. So that's the overarching vision by design, it's an open-innovation ecosystem. The key here is design point of that ecosystem because the epic innovation center for the auto industry will be in data, in algorithms, in rapid pace of innovations towards intelligent driving. And Apollo is designed in that way. And I can tell you my personal experience, the Hadoop ecosystem, the code base come from Yahoo! teams. And I personally witnessed through, if you pick the right design points for the industry, you can tap into the vast growth, and I emphasize vast growth as win-win with all partners and yet, at the same time, enable Baidu to tap into the economic opportunities. Now without going into the specifics, what I can point to is there are known ways of monetizing open ecosystem. Whether it's services, packaging software, components, solutions, all these options are available to Baidu to tap into, that's number one. Number two, the response from auto partners, from industries has been overwhelmingly positive. And our confidence of our ability to tap into the new rapid growth through the Apollo ecosystem and our ability to monetize is increased substantially going forward. So it's a terrific question. By design, we want to enable a healthy ecosystem but let's all make money in our way and grow the whole pie together.

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Operator [20]

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Your next question comes from the line of Juan Lin from 86Research.

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Juan Lin, 86Research Limited - Research Analyst [21]

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Congratulations, Jennifer, on your new role. I have a question on the mobile gaming business. You mentioned that revenue contribution of mobile gaming businesses is around 3% of total revenue. I'm wondering what is the contribution to our profit. And after disconnecting this business, are you going to monetize the mobile game-related traffic, which was previously directed to the mobile gaming business? Do you think that disconnecting this business will eventually lead to a more efficient usage of your traffic in terms of monetization?

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Jennifer Li, Baidu, Inc. - CFO [22]

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Mobile game, yes, as I said earlier, it contributed close to 3% of revenue last year. The gaming business, as you can see, is relatively small in our overall picture, and it doesn't generate the kind of margin as we do for our main business. So this transaction is actually a very good transaction for both us and the parties involved and also, it brings some good level of gains for us. For us, the mobile games sector is always a very attractive sector for our advertising business. And we do expected that, even in the past, with mobile game operations, we have game advertising income. And going forward, we will continue to develop this market and grow the mobile game advertiser base.

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Operator [23]

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The next question comes from the line of Natalie Wu from CICC.

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Natalie Wu, China International Capital Corporation Limited, Research Division - Analyst [24]

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Firstly, I want to extend my best regards to Jennifer on her new role. And my question is regarding the margin of the core business, excluding transaction services and iQiyi, which seemed to decline quite a lot in the first quarter despite savings from traffic acquisition cost. So just wondering if this is mainly due to the AI-related investment? Or are there any other factors behind that? And how should we look at the trend going forward? And also just a little bit of clarification on the mobile game. So the deconsolidation of mobile game business will be in mid-May, right, so that is to say your current guidance is reflecting half quarter's deconsolidation for game-related revenue?

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Jennifer Li, Baidu, Inc. - CFO [25]

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Thank you for the question. For Q1, I think a couple of factors to think about as you look at the margin for core. Mainly for core, a couple of things are going about. One is we're still recovering from our search service from the last year's incident. It has not been fully recovered. We're on a good path, it's ramping up, it's performing as expected. The other thing is the investment related to feed. As I mentioned earlier, early stage in terms of monetization, but we're very focused on building feed as a very solid and good complementary product to our search service. Related to that, our bandwidth, depreciation, R&D, content cost and also channel distribution investment to have Mobile Baidu be more prominent among the user base, so that's the other factor going into Q1. And the third element, as you mentioned, AI investment, you will have seen R&D expense increase year-on-year. As I mentioned earlier, the incremental spend would all be related to AI initiatives. AI initiatives are an integral part of our core service and builds upon the core technology capabilities and infrastructure capabilities, so that's what's driving the Q1 margin performance. For your second question with regards to mobile games, yes, you're correct. So basically, as I mentioned earlier, mobile game contributed to Q1 overall financial performance. It will only have about half of that in the Q2 period.

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [26]

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So Jennifer, what I would just add to emphasize the AI investment part, the place that I would like to emphasize is we'll be very disciplined and systematically optimize our resource allocations to make sure that our engineering investments and R&D investment is truly tapped into the substantial growth opportunities ahead of us. And we are growing through a lot of work across the different teams to make sure that our resource allocation, utilization is fully optimized towards 2 fundamental focus. One is elevating our current core business. We see a lot of growth opportunities ahead and, at the same time, accelerating the commercialization of our AI-enabled business. So being disciplined and being very systematic in optimization is very important to us.

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Operator [27]

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Your next question comes from the line of Piyush Mubayi from Goldman Sachs.

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Piyush Mubayi, Goldman Sachs Group Inc., Research Division - MD [28]

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First, Jennifer, congratulations on your new role. We wish you the best in your future endeavors. My question is directed to Qi at this point. We recognize that Baidu is strongly positioned in AI R&D. And as the business model evolves in the medium term, could you give us a glimpse into the range of operating metrics that become relevant so we can better understand and appreciate the new world we're getting into? And very specifically, as we go into a face, voice and image recognition-based world that AI would bring about versus the current search monetization model in place, how do you think that's going to change?

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [29]

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Well, thank you for the questions. So let me first comment on your first question with regard to operating metrics. First, myself, my teams are very, very focused on accelerating the commercialization of our AI-enabled new businesses. And because the core AI technology is about to efficiently extract knowledge from data and our focus is first of all, establish very, very compelling user scenarios, and users and usage are an important part of the metrics. And the second is the data and integration rate. How we can integrate based on the data that we have in our systems. And third is a rapidly explored business models and monetization capabilities. And adding up together, we are developing our overall operating frameworks and operating dashboards. These are the type of things, Jennifer, myself, and our teams collectively look at every week, every month, and we're focusing on driving a disciplined and accelerated pace of execution on commercializing the AI-enabled new business initiatives. As I mentioned in my prepared speech earlier, as we move forward, where appropriate, we will shed more light with the investor community about those operating metrics because it will take time to evolve. But what I can show you is our teams are staying very, very focused to be very disciplined and rigorous in accelerating our pace forward. With regard to your question about modality change. On the consumer side, our current view is that will not fundamentally affect the economic patterns because even if you use voice instead of using keyboard, you still express your intent. And once we understand user intent and we understand the content that a user is trying to seek to access, we will be able to place, match that in a good way and existing models of advertising or other forms will be equally applicable in that scenario. So at this stage, we do not see a fundamental shift, even though modality may change, the economic opportunities in front of us will be equally compelling as we have seen up to this point.

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Operator [30]

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The next question comes from the line of Karen Chan from Jefferies.

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Karen Chan, Jefferies LLC, Research Division - Equity Analyst [31]

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Congratulations to Jennifer on your new role. My first question is related to core margin. So is it negatively impacted partly by the initial ramp-up of mobile newsfeed ad? So how should we think about a normalized margin level once the mobile newsfeed ad reaches certain scalability? And my second question is regarding our monetization time line of DuerOS with the AI-enabled home device partnership recently secured, wondering if management can share any color on that.

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Jennifer Li, Baidu, Inc. - CFO [32]

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Thanks, Karen. I'll take the first part, and Qi can help address the second. As I mentioned earlier, currently, the margins doesn't reflect a true picture, I think. We mentioned earlier, feed is a product that's going to carry a different margin profile. But overall, I think just purely focusing on margin is just one angle. It's more important to think about the overall service and the revenue opportunities that we can generate because of the product of search. Core search continues to be a very fundamental need, and that business model is beautiful and scalable and high margin. For feed to complement the search service, we give our advertisers a much bigger advertising inventory. And the advertisers, big or small, can have more budget allocated with us. So for us to think about feed, because it is a push kind of product, it's different from search. The overall is the mix, it's more beautiful and more integrated and richer service that we provide, I think it's important to look at the bigger market value we can potentially tap.

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [33]

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Let me comment on the second part of the question with regard to DuerOS monetization and its time line. And here's how we think about DuerOS, its position in the industry, and I will shed light on how we think about monetization. First of all, DuerOS is the AI generation user experience platform, very similar to iOS and Android. iOS and Android is design ready for fingers, the device sitting in everybody's pocket. DuerOS, the fundamental interaction is a natural language and voice-based, and it's everywhere, it's on every device in every scenario. So it's a platform in that regard. Second, DuerOS is also a new entry point because as you use DuerOS more and more in your home, in your car, say "play the next song for me, order pizza," that becomes a new entry. So it plays dual roles as an experienced platform and a new form of entry. On the entry side, the monetization is very natural. This is very similar to today's information gateway like search. And the time line would be the amount of scale that we can grow into, and there'll be natural opportunities that we can tap into. The second is about the platforms. Traditionally, there are several dimensional platform economics. If you look at iOS and Android, there is ways to run an app store type of models, you can get economic value. There's VIG for the applications that builds on top of our platforms, and at the same time, DuerOS also strategically bring additional demand to our ABC cloud so we can also indirectly monetize through that vehicles. So having said all of that, our focus right now is really grow the ecosystem. We are doing a good job. Our team is really racing ahead. Every day, every week, we're signing up new partners. So our focus is on scale. But as I said, we see ourselves as a clear leader in China and opportunities over time would be tremendous.

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Operator [34]

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Your next question comes from the line of Grace Chen from Morgan Stanley.

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H. Chen, Morgan Stanley, Research Division - Equity Analyst [35]

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My question is about the search business. From the Q2 sales guidance, we can see that the search sales should be recovering on both a Q-o-Q and year-over-year basis. Can you help us understand what are the key drivers for sales recovery in terms of market segments? And also can you comment on the competitive landscape in the advertising business in general, for example, from like social and e-commerce peers? And also, on the margin for search business, as we've just discussed we can see that margin have been contracting in the past 2 quarters for a couple of reasons. But with the sales recovery and margins recovery, so can you give us a guidance about the reasonable margin level of the search business?

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Jennifer Li, Baidu, Inc. - CFO [36]

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For us, as you noted correctly, the business is recovering and rebuilding. The factors that we look at, many other factors have a lot of potentials, specifically education, real estate, local services, even retail continues to be very strong. I mentioned earlier also sectors like games could have a lot of possibilities, too. So as we look forward, search continues to have a lot of verticals that we can further develop and service our customers better and with complementary feed product to service even bigger customer pool. I think for us to look at the overall business performance is our focus to run a highly efficient business. We have always steered our resources towards strategically important areas. As we identify AI as our key strategic focus, a lot of the efforts are focusing on the R&D side, in particular related to talent. So as I mentioned, if you look at the margin performance for the year, I have given a pretty clear indication in terms of how you look at our overall business. Basically, this year, I think for us we talk about content, that's related to iQiyi and our overall ecosystem buildup. I talked about R&D that's related to talent specifically for AI. And I think these are the main items, and the rest of it is to focus on execution. No specific margin guidance, but I hope the information we provided is helpful for you to construct your margin picture.

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [37]

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With regard to competition, what I will emphasize is, first, we are clearly the market leaders, particularly in search market share on mobile, and that's number one. Number two, our focus is innovation. Our focus are expanding the search scenarios, particularly expand search capabilities so that search experience is fundamentally natural to our mobile device and tapping to the rich capabilities such as camera and speech so that, over time, we will be more compelling. And last I will say is search at its core is a scaling business. There's a fundamental scaling impact. As market leaders, we want to fully leverage that, so that our technological capabilities, with the new AI at the core, will understand users better than any others and understand content better than any others. So over time, we are confident that we will be able to maintain a strong market leadership position.

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Robin Li, Baidu, Inc. - Co-Founder, Chairman and CEO [38]

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So let me just add on the search revenue side. I think the search business has been a very traffic-bound business. Advertisers or customers, they always want to buy more traffic, and the performance is unmatched by any other type of media online or offline. So our focus has been and will continue to be on growing the search traffic so we would not worry about the other type of advertisement from other type of media.

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Operator [39]

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The next question comes from the line of Ming Xu from UBS.

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Ming Xu, UBS Investment Bank, Research Division - Director and Research Analyst [40]

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So I have 2 questions. The first one is on the newsfeed side. So if you name one key area to improve on the user experience for newsfeed, so I'm wondering what is that? Whether it's a recommendation algorithm or targeting or content or some others. Could you help us understand? And my second question is on CPC. I think from the 20-F, we know that last year, the number of paid clicks actually ramped up more quickly than revenue growth, indicating that the CPC is actually down. So you just mentioned that this year the paid clicks will continue to grow. So could you also comment on the CPC trend?

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Qi Lu, Baidu, Inc. - Vice Chairman, Group President and COO [41]

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Let me first talk about the feed side, a good question. The one thing for us to focus is the quality of the matching algorithms because the search product fundamentally is about deeply understanding the user, the user's interest, the information he needs. On the other hand, understand the content. But its core is about matching them together. So the areas for us to focus on or the top priority areas is the quality of the matching algorithm so that we can sustainably improve overall user satisfaction and grow the base of that product.

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Jennifer Li, Baidu, Inc. - CFO [42]

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And on your second question, yes, if you recall, last year, we took effort to have a higher standard for our customers. And as a result, a lot of the customers are removed or are unable to do business with us. For search, it is a bidding business model. When you have less, like a smaller advertiser pool, the bidding will not be as intense. So that, in itself, can affect the CPC. However, looking at the paid click trend, you will notice that for this kind of phenomenon to occur, our advertisers are actually having better ROIs for the business and it continues to speak to a high-performance nature of paid search, and it's just a matter of transition now that we're going through, CPC was a result of that. That is not something that I feel we should be worried about.

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Operator [43]

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Our next question comes from the line of Evan Zhou from Credit Suisse.

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Evan Zhou, Credit Suisse AG, Research Division - Research Analyst [44]

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Just lastly, I wanted to ask an update about Baidu Financial Services. Wondering whether this business has become more visible or a higher contribution portion within the other revenue being recognized for the quarter. And how's is the kind of profitability improvement within this segment for our business? Because we have also seen across industry the overall growth and profitability into in the past few months. So I wanted to get a reaction on that.

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Jennifer Li, Baidu, Inc. - CFO [45]

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For our Financial Services business, it does generate financing income, and that would flow through other revenue. It's still in its early stage. And having us building the fundamental capability like leveraging data and algorithm to have better modeling for credit risk underwriting would be the focus. So as you would see that we positioned our Financial Services business as a fin-tech business and we do originations and wealth management to help train our models, and so that we can really get better handling of the much richer data that we have and the technology capabilities. So Financial Services itself as our effort is progressing very well. And I think it's on the path of getting stronger fundamental capability in helping in using the technology and a different angle to look at the Financial Services business.

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Operator [46]

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