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Edited Transcript of BIDU earnings conference call or presentation 20-Aug-19 1:15am GMT

Q2 2019 Baidu Inc Earnings Call

Beijing Aug 21, 2019 (Thomson StreetEvents) -- Edited Transcript of Baidu Inc earnings conference call or presentation Tuesday, August 20, 2019 at 1:15:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Herman Yu

Baidu, Inc. - CFO

* Dou Shen

Baidu, Inc. - SVP

* Sharon Ng

Baidu, Inc. - Director of IR

* Robin Li

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

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Conference Call Participants

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* Alicia Yap

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

* Eddie Leung

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

* James Lee

Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Internet Sector Analyst

* Jin-Kyu Yoon

New Street Research LLP - Analyst

* Piyush Mubayi

Goldman Sachs Group Inc., Research Division - MD

* Tianxiao Hou

T.H. Capital, LLC - Founder, CEO & Senior Analyst

* Xiaoguang Zhao

Barclays Bank PLC, Research Division - VP

* Yue 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 Second Quarter 2019 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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Thank you, operator. Hello, everyone, and welcome to Baidu's Second Quarter 2019 Earnings Conference Call. Baidu's earnings release was distributed earlier today and you can find a copy on our website as well as on newswire services.

On the call today, we have Robin Li, our Chief Executive Officer; Herman Yu, our Chief Financial Officer; and Dou Shen, our Senior Vice President in charge of Baidu's Mobile Ecosystem Group, our Search and Feed Business. After our prepared remarks, we will hold a Q&A session.

Please note that the discussion today will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities and 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 the call include discussions of certain unaudited non-GAAP financial measures. We have made minor adjustments to our non-GAAP measures and retroactively apply these changes for comparison purposes. Our press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measure and is available on our IR website at ir.baidu.com.

As a reminder, this conference is recorded. In addition, a webcast of this conference call will be available on the Baidu IR website.

I will now turn the call over to our CEO, Robin.

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

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Hello, everybody, and thank you for joining our call today.

Baidu's second quarter revenues reached CNY 26.3 billion, above our guidance midpoint of CNY 25.8 billion, which can be attributed to Baidu Core performing better than our original expectation. Baidu's Q2 revenues grew 9% sequentially and Baidu Core revenues grew 12% quarter-over-quarter in spite of the impact from industry-specific policies, self-directed health care initiatives and slowing macro environment.

In the midst of significant influx of ad inventory into the market, we are seeing an upward trend for Baidu's revenue on a sequential basis. Our monetization foundation is strengthening the strong traffic growth such as Baidu App DAU, in-app search queries and feed time spent and strong growth of content and services on Baidu's platform. As our mobile ecosystem expands, we are able to better understand user behavior as users navigating the landing pages on Baidu's platform. Over time, this deepening user insight will allow us to further improve Baidu's user experience and ad conversion for our marketing customers.

On today's call, I will share recent developments on our search and feed business and highlight the progress that we have made on our AI business. In early July, we held our annual AI developer conference, Baidu Create, in Beijing, which drew approximately 7,000 developers and partners from around the world and was concurrently broadcasted from the Internet. We released the Baidu Brain version 5.0, which includes industrial applications of Baidu AI technologies. Baidu Brain is the common AI engine that powers all of our businesses, from search and feed to DuerOS, Apollo, Cloud and iQIYI. Developers can access the AI capabilities of Baidu Brain through Baidu AI Open Platform, which saw developer accounts reaching 1.3 million in June, up 37% in the first half of this year. Enabling a large developer community is important in the world of AI computing as our Baidu Cloud ecosystem and capabilities. At Baidu Create, we also expanded our strategic alliance with top industry players, including Geely Auto, Huawei and Intel.

Let's begin our operational review with MEG, our Mobile Ecosystem Group. In June, average DAUs on Baidu App continued to see robust growth, reaching 188 million, up 27% year-over-year, contributed by the synergy generated when search is combined with feed. Search and feed provide Baidu 2 strong traffic engines. Baidu's Search is an indispensable means by which people find more objective and reliable information, and our feed is powered by Baidu's AI algorithms formulated with Baidu's unmatched intent-driven user insight.

Our relentless focus to strengthen Baidu's mobile ecosystem, by enabling newsfeed and short videos searchable through Baijiahao accounts, and information and services found in third-party apps searchable through Baidu Smart Mini Program, is driving more usage scenarios for Baidu App. In June, user time spent on feed grew 33% year-over-year and in-app search queries grew over 20% year-over-year. In addition to Baidu App, total time spent on our feed and short video apps together grew robustly, up 67% year-over-year in June.

Baidu is the premier go-to destination in China to find knowledge-based content and longtail information. To supplement information on third-party sites, we have spent years developing an extensive knowledge-based content ecosystem such as Baidu Encyclopedia, Baidu PostBar and Baidu Knows to make useful, sought-after knowledge readily accessible.

As we focus on strengthening Baidu's mobile ecosystem, Chinese users are becoming more dependent on Baidu for knowledge content. For example, in June, daily time spent per user on Baidu Knows in Baidu App grew 55% sequentially, daily video views of Baidu Encyclopedia grew 80% year-over-year and membership and services revenue for Baidu Wenku grew 61% year-over-year. Baidu's mobile ecosystem is drawing newsfeed and short video content creators to Baijiahao accounts, which saw publisher accounts reaching 2.2 million in June, up 83% year-over-year.

App developers are also making their services and information available through Baidu Smart Mini Program, which saw MAUs accelerate to 217 million in June, up 49% sequentially, and the number of Smart Mini Programs increased more than sixfold in the last 3 months.

Baidu Smart Mini Program offers our users richer content and services selection and provides traffic to app developers without requiring users to download their apps. This native app-like model improves user experience and will ultimately improve app conversion and expand the monetization potential of Baidu's marketing services platform.

Baidu Smart Mini Program is attracting well-known apps such as Weibo, Meituan and JD as well as services with lower frequency usage. On the latter, for example, the Shanghai Auto Show is held every 2 years in China. This past April, the event host created a mini program on Baidu and WeChat and leveraged other online sites to promote their events. In 1 month's time, the Shanghai Auto Show attracted 3 million users to its Baidu Smart Mini Program, which offered indoor event navigation, ticket purchase and electronic event pass. In the end, Baidu was Shanghai Auto Show's largest third-party channel for ticket sales.

Whereas other mini programs allow users to search the titles of mini programs, Baidu Smart Mini Program allow our users to search the massive content within those mini programs to locate the most relevant information and services. Similarly, our top 1 capabilities, which recently satisfied 51% of the queries, allow users to search the massive content on the Internet and satisfy user's intent with Baidu's first recommendation. From the developer's point of view, Baidu Smart Mini Program helped service providers attract higher quality users with Baidu's intent-focused user base.

Consistent with Baidu's search and feed philosophy, we offer an open ecosystem that embraces and promotes a wide array of Smart Mini Program developers, which provides more options to our users. For example, long-form video apps who have joined Baidu Smart Mini Program include Youku, iQIYI, PPTV and China Mobile's MIGU video as well as traditional media such as Guangdong Satellite TV.

Baidu managed page is another area that we are strengthening our mobile content ecosystem and is one of the options by which we are enabling industry-specific merchants to more effectively reach and engage with users. In lieu of HTML5 sites, industry-specific merchants can provide their information on Baidu managed page, which is open and freely accessible by other traffic sources. Since the merchant content resides on Baidu's platform, we are better equipped to ensure greater reliability and trustworthiness on the information offered by the merchants.

Structured data for health care industry is a form of managed page. In March, we required our health care marketing services customers to switch over from their H5 page to Baidu managed page for the landing pages of their mobile ads, and in July, we expanded the requirement to health care PC ads. Baidu Managed Page for the health care industry allows us to monitor the health care provider's information and communication with users, while enabling our managed page platform to continuously add new functionality, for example, live chat and call features with the health care provider, incognito caller ID to protect user information and consumer protection program for added consumer comfort. We are seeing significant improvement in user experience with managed page, and search queries on health care are growing faster than before. The increase in traffic, improvement in health care content quality and added functionality are generating meaningful lifts in customer leads for health care providers on managed page.

While our self-directed health care initiative has dragged down our recent revenue growth and optic-wise make it that much more difficult to implement in the current macro environment as the lower-quality health care providers are going elsewhere, we believe improving user experience, better management of health care information and lead conversion for our health care customers will generate greater value for Baidu over time.

Aside from health care, we are adopting managed page for home services such as moving companies and home repair. And in July, we began to offer attorneys, which as a collective body, has fragmented online presence, an easy way to promote their businesses in a card format in Baidu's search results. From the card search result, users can access an attorney's educational background, legal credentials and legal cases handled as well as social features such as user commentaries and ratings.

Managed page gives us the opportunity to build industry-specific solutions to empower SMEs and allow them to better leverage web traffic and engage with users without having to maintain an IT department and keep pace with Internet infrastructure and technologies. SMEs can simply run a business using Baidu's managed page, and we will continue to add tools, services and features to Baidu's platform over time to improve their user engagement and lead conversion. Extending managed page into new industries should further expand Baidu's revenue growth opportunity.

Looking forward, we are excited about MEG's market position and monetization opportunities, with traffic growing robustly, our mobile content ecosystem expanding and different monetization plans in the works, including the recent launch of Baidu CRM in July, especially when we step out of the weak macro environment.

Moving to DuerOS. In the second quarter, DuerOS voice assistant continues to gain momentum through the use of Baidu's leading technologies in speech, natural language processing and search. DuerOS installed base surpassed 400 million, up 4.5 fold year-over-year, and monthly voice queries surpassed 3.6 billion, up 7.5 fold year-over-year in June.

DuerOS first-party smart devices is experiencing strong sales momentum. Market research firms Canalys and Strategy Analytics ranked Xiaodu Smart Speaker #1 in shipment in China for the first quarter, which is quite an incredible achievement considering Baidu launched Xiaodu smart devices only last year, and compared to our peers who have online distribution and hardware management strategic advantages.

Xiaodu Smart Display, with average selling price of approximately USD 50 per unit, is becoming a sweet spot for us as it penetrates not only first and second tier cities, but also lower tier cities in China, becoming an important computing device for affordable Internet connectivity. Average time spent of a Smart Display has reached about 2 hours a day and sales volume of Smart Speaker in China is forecasted to reach over 35 million units this year, similar to the expected decline in smartphone unit sales in China, making AI-powered smart speakers an indispensable Internet channel for content and service providers, especially with mobile internet user and time spent slowing in China.

The rise of smart speakers seems to mirror the rise of smartphones a decade ago, when smartphones took over feature phones with the advent of iOS and Android app stores. This shift was spurred by the change in input modality and the superior user experience of mobile apps.

Far-field conversational AI is making it easier for users to interact with smart speakers. Xiaodu stands out from the competition with leading speech recognition and natural language processing capabilities. For example, recently added full-duplex continued conversation feature enables continuous dialogue with Xiaodu smart devices without wake words, while Xiaodu intelligently distinguishes between the voice queries directed at Xiaodu versus dialogues directed at human. In July, we announced the development of Baidu Honghu, an energy-efficient AI chipset to power voice interaction in homes and autos, to further improve Xiaodu's conversational AI capabilities while driving down unit economics.

We are gradually seeing time spent on skills surpassing time spent on music and videos on smart speakers. This is quite exciting, with the number of skills in DuerOS skills store doubling sequentially to over 2,400 and DuerOS developer community growing to above 33,000. Seven car models were recently released with DuerOS-powered infotainment and 30 car models are in the pipeline, scheduled to be released with DuerOS preinstalled.

Turning to Apollo. We are excited that Apollo continues to be the leading autonomous driving solution in China with over 155 leading OEM, Tier 1 supplier, key component and other partners. In June, Apollo's test fleet of over 300 vehicles accumulated more than 2 million test kilometers across 13 cities. As of July, Baidu has received almost half of the 204 autonomous driving pilot licenses granted in China and Baidu became the only company in China to receive T4 licenses, the highest level of autonomous driving test license issued by Beijing Municipal Commission of Transport, which permit autonomous vehicles to operate in complex driving conditions, including urban roads, tunnels, school zones and other scenarios.

Also in July, First Automotive Works announced commercial production of level 4 autonomous passenger vehicles to support Apollo-powered robotaxi pilot program, which is scheduled to be deployed in Changsha, the capital city of Hunan province, along Baidu's V2X solutions later this year.

Turning to Baidu Cloud. We continue to see momentum of our cloud business with revenues reaching RMB 1.6 billion in second quarter, up 92% year-over-year. Baidu Cloud leverages AI capabilities of Baidu Brain to enable enterprises a better way to do business.

For example, Baidu Cloud worked with a hardware manufacturer to integrate Baidu AI capabilities into their screening solution that helps smartphone component OEMs automate the quality assurance process, achieving faster throughput while reducing overhead costs. Baidu AI-powered hardware and software integrated solution can take a snapshot of a finished smartphone component from 18 angles simultaneously and determine whether the component satisfies the designated QA criteria of the OEM's customer. Unlike human screening, Baidu AI-powered QA screening allows the OEM customer to access the data of screening results for added comfort of quality compliance. We are excited about the opportunities of Baidu's computer vision capabilities to help Baidu Cloud enterprise customers in sectors like consumer electronics, metal, auto to improve their business.

Turning to iQIYI. iQIYI continues to see solid subscriber growth with membership reaching 100.5 million in June, that's up 50% year-over-year, which provides a strong foundation for iQIYI to offer blockbuster original entertainment content. Long-form video content from iQIYI enrich Baidu's search and feed offerings and improve Baidu's user experience.

With that, let me turn the call over to Herman to go through our financial highlights.

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Herman Yu, Baidu, Inc. - CFO [4]

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Thanks, Robin. Hello, everyone. Welcome to Baidu's second quarter 2019 call. All monetary amounts that we'll be discussing or used are in CNY unless stated otherwise.

Let's now turn to Baidu's second quarter 2019 financial highlights. Total revenues reached CNY 26.3 billion, up 6% year-over-year, excluding spin-off revenues, and up 9% quarter-over-quarter. Revenue from Baidu Core was CNY 19.5 billion, up 3% year-over-year, excluding spin-off revenues, and up 12% quarter-over-quarter.

Let me give you more color on Baidu Core revenues. Baidu's marketing services revenue is well diversified, with the top 12 industry sectors making up about 2/3 of Baidu Core revenues. Half of the top 12 sectors saw year-over-year sales declines, including health care, online gaming, financial services and auto logistics. Excluding these poor performing sectors, Baidu Core revenues would have grown in the mid-teens year-over-year in the second quarter. Although the increase in ad inventory in the market has impacted the overall growth rate of our marketing services, it's fair to say that a bigger part of our revenue slowdown can be attributed to industry-specific policies, self-directed health care initiatives and the softening of macroeconomic conditions. Additionally, revenue derived from Baidu's union partners contributed to a 3% drag on Baidu Core's year-over-year revenue growth, which is in sync with our goal to optimize profit on past revenues versus bidding for incremental revenue at negative margins.

Total marketing services customers in the second quarter was approximately 330,000, down 4% year-over-year and up 5% quarter-over-quarter. Please note that this customer number excludes Nuomi customers and other calculation policy adjustments that we have made internally such as excluding customers with minimal daily spending.

Our new AI businesses continue to see fast growth, particularly Baidu Cloud, which generated CNY 1.6 billion revenues in Q2, up 92% year-over-year.

iQIYI revenue reached CNY 7.1 billion, up 15% year-over-year; membership revenue continue to see strong growth, up 38% year-over-year; while iQIYI's ad business was down 16% year-over-year, mainly due to slowing macro, delay of top content launches and slower-than-expected recovery of feed advertising.

Turning to cost of sales. Excluding stock compensation and intangible asset amortization, cost of sales was CNY 15.9 billion, up 33% year-over-year. Content, bandwidth and other costs of revenues increased to support Baidu's traffic growth, greater video consumption and new AI businesses, including bandwidth and depreciation expenses for Baidu Cloud and cost of goods sold related to Xiaodu Smart Speakers. TAC increased 27% year-over-year as a result of higher TAC revenue share and expansion into offline connected screens and other areas.

SG&A expenses, excluding stock compensation, were CNY 4.7 billion, up 13% year-over-year, primarily due to the increase in channel and promotional marketing, mainly for Baidu's family of apps. On a sequential basis, SG&A expenses were down 14% as we scaled back on marketing spending that did not meet our stringent ROI criteria. This has hampered the sequential growth of our apps, including Haokan short video and Quanmin flash video. We plan to continue to manage our marketing dollars with a strong, disciplined ROI approach.

R&D expenses, excluding stock compensation, were CNY 3.7 billion, up 13% year-over-year, primarily due to increased personnel-related expenses, and up 5% on a sequential basis.

Non-GAAP operating income was CNY 2 billion and non-GAAP operating margin was 7% compared to 2% last quarter. Non-GAAP operating income for Baidu Core was CNY 3.5 billion or USD 508 million, down 55% year-over-year and up 65% quarter-over-quarter. On a non-GAAP basis, total expenditure for Baidu Core were approximately CNY 700 million increase sequentially, less than the CNY 1 billion that we had planned at the beginning of the year.

Since our last earnings call, we have been reviewing our businesses for operational efficiency and have made significant progress in implementing spending discipline, while making investments in future revenue growth and our 3-year plan. Non-GAAP operating margin for Baidu Core was 18% in the second quarter compared to 12% last quarter. We expect Baidu Core's incremental revenue growth to have higher margins and non-GAAP operating margin to rise above 20% in the third quarter. As an Internet platform, a big part of Baidu Core's cost structure is fixed such as the approximately 2,000 scientists and engineers of Baidu's AI lab and our large server network and other infrastructure equipment. Thus, sequential growth of our revenues will likely bring about higher margins.

Total other income was CNY 1.2 billion, which included equity method income of CNY 429 million compared to equity method losses of CNY 860 million last quarter.

Income tax expense was CNY 416 million and effective tax rate was 28% compared to 18% in Q2 last year, primarily due to the lower pretax income generated from Baidu Core and to iQIYI not being able to recognize tax benefit from its losses in the current period.

Non-GAAP net income attributable to Baidu was CNY 3.6 billion and non-GAAP net margin was 14%. Non-GAAP net income attributable to Baidu Core was CNY 4.7 billion or USD 690 million, down 46% year-over-year and up 160% quarter-over-quarter. Non-GAAP net margin for Baidu Core was 24% compared to 10% last quarter.

Adjusted EBITDA was CNY 3.4 billion or USD 489 million. Adjusted EBITDA margin was 13%. Adjusted EBITDA for Baidu Core was CNY 4.8 billion or USD 694 million. Adjusted EBITDA margin for Baidu Core reached 24% in the second quarter compared to 19% last quarter.

As of June 30, 2019, cash and short-term investments was CNY 137.3 billion or USD 20 billion. Excluding iQIYI, cash and short-term investments for Baidu Core was CNY 120.9 billion or USD 17.6 billion.

Free cash flow was CNY 5.6 billion and free cash flow for Baidu Core was CNY 4.9 billion or USD 710 million. Total employees of Baidu Core was approximately 29,900.

Turning to third quarter guidance. We expect total revenues to be between CNY 26.9 billion and CNY 28.5 billion, representing a decrease of 5% to an increase of 1% year-over-year, or a decrease of 1% to 5% increase year-over-year, excluding spin-off revenues of CNY 1 billion for the third quarter of 2019. In this it also means it's an increase of 2% to 8% on a quarter-over-quarter basis. Excluding spin-off revenues, our guidance assumes Baidu Core will grow between negative 3% to positive 3% year-over-year and between 2% to 9% quarter-over-quarter. These forecasts are our current and preliminary view and are subject to change.

Before I turn the call over to the operator, let me summarize Baidu's second quarter. We have made solid progress with our search and feed business. Traffic growth remains robust for Baidu App DAUs, with double-digit growth in in-app searches and continuous robust growth on feed time spent. User experience is significantly upgraded with content and service providers offering native app-like experience on Baidu's mobile platform. Our emphasis on improving search and feed monetization is in progress. We witnessed double-digit sequential revenue growth in the second quarter and expect further sequential growth into the third quarter. Our focus to diversify away from TAC traffic and grow search revenues through in-app search and feed is proving to be a dominant search model as in-app services allow us to gain more user insight across vast domain of knowledge, content and services, and continuously improve on user engagement for both Baidu and our marketing services customers. We are making meaningful strides in the area of voice assistant, cloud and smart transportation, which will be critical revenue drivers as we look out 1 to 3 years. On the content management side, we will be diligent on reining in our expenditures with disciplined ROI implementation, while balancing the needs for near-term and long-term revenue growth. iQIYI is weathering the challenging macro environment with strong membership growth and the diversification of its revenue stream.

Operator, with that let's now open the call to questions.

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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 Gregory Zhao from Barclays.

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Xiaoguang Zhao, Barclays Bank PLC, Research Division - VP [2]

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So if we exclude iQIYI, so we can say Baidu's SG&A and also the content cost growth had some substantial slowdown during the quarter. And so it's a very big contrast to your investment during the Chinese New Year around Q1. So I just wanted to understand your marketing and the promotional strategy for your product portfolio like the short video and also Baidu App and also the content cost to trend in the rest of the year.

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Herman Yu, Baidu, Inc. - CFO [3]

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Thanks, Greg, for the question. As we mentioned on the prepared remarks, our SG&A, mainly marketing expenses, are very ROI-driven. So when we are spending the channel costs and other marketing programs, we're looking at the lifetime value that we can get from our users. So when the economy is good and we think that we can generate more revenues compared to the cost that we have accumulated, then we'll spend more money. Because we're transitioning from a TAC model to an in-app services model, TAC you get revenue in the quarter that we expense, but in the channel cost and in the marketing program in-app services, which we're expensing in that one quarter, then we might be deriving revenue from the user and in the quarters after that, there's a lag. But even with that, we are very disciplined in calculating ROI. So you see us spending more on Q1 when we see higher ROI. With the current macro conditions and some of the issues that we talked about in the prepared remarks, the ROI has come down. And as a result, we've been very diligent in screening out the marketing costs that has a low ROI. And we'll be looking at that continuously very closely as we move forward for the remainder of the year.

With regards to our content costs, I think it's been growing on a year-over-year basis, but recognize that Baidu Core, the content cost is not that significant. For example, in the second quarter, we talked about maybe CNY 0.5 billion per quarter. So although the increase is significant on a percentage basis, but the total cost is 0.5 billion. So we're increasing even if the base is pretty very small. I don't think it's that significant compared to our overall expenditures.

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Operator [4]

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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 [5]

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My question is related to the Mini Programs. So with increasing applications and services tapping into Baidu Mini Program ecosystem, and I think management also commented on some positive developments on the progress and traction earlier. So how should we think about the tractions of this Mini Program to translate into the monetization upside over time? And then any update on upcoming rollout of the CRM initiative?

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Robin Li, Baidu, Inc. - Co-Founder, Chairman & CEO [6]

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Alicia, I'll have Shen Dou answer your questions.

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Dou Shen, Baidu, Inc. - SVP [7]

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Okay. Thanks for your question, actually. As you say, the Mini Program has attracted much attention from the developers. We have seen the benefit of the Smart Mini Programs already, but for the users, the better Smart Mini Programs offer them richer content in service selection. And then for developers, the Smart Mini Programs use our AI-powered algorithms to screen the massive content of the Smart Mini Programs and recommend the relevant content and service to the users based on their proactive search for information and service.

So this Smart Mini Program already helped the developers to acquire users, and in turn, to enhance better user experience on the Baidu's platform. So actually, as you may already have seen, Baidu Smart Mini Program has attracted some well-known apps like Weibo, Meituan, JD as well as services with lower frequency of usage like the Shanghai Auto Show.

So that' said, we also have our customers from different industry sectors. They have tried the Smart Mini Programs as their landing page for their campaigns. So we see pretty significant ROI lift for those who tried this Smart Mini Programs. So actually, the Smart Mini Programs also offered our customers and the developers much more options to engage the users in their service. So with that, the ROI would be further improved. So that is how we're going to see how Mini Programs is going to help first to strengthen our monetization capabilities, actually.

As to CRM, actually it's just a start. And because we guided that most of our customers, they have the leads generated from Baidu's platform, so combined with the CRM, we have more ways to help the customers to engage with their users better and to explore the leads in a better way to improve the effectiveness and also clearly to improve the ROI. So that's why we are using the CRM to help the campaigns on our platforms first, and then in the next level, we're going to provide more valuable features to the customers to further explore the utilities of the CRM.

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Herman Yu, Baidu, Inc. - CFO [8]

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Let me add a point, Alicia. For the Smart Mini Programs, I think from a service provider, there's a couple of points that are key for them. First is as the number of smartphones in China sales is declining, we saw that last year, we saw that first half of this year, it cost more and more to actually leverage our App Stores in order to have installation of their apps. The economics of Smart Mini Programs is much better than App Stores because app stores, you have to spend the channel cost and you're not sure if you're going to get ROI, whereas Mini Programs, because we're in the business of search, these are natural results to be in search.

So rather than shifting this and directing the traffic over to your apps, you have to, first, pay-per-channel app. Secondly, there's usually more steps, for example, to convert a sale from our Mini Programs to -- within an app versus if you're a native on Baidu's platform directly to that buy page on the Mini Program. So I think first of all, you're able to see that result right away. You don't need users to download the app. And secondly, I think the case that Dou have explained would help drive up conversion. So obviously, with better conversion, marketing customers are usually focused on better conversion, looking at ROI.

So with better conversion, you'll have, we believe, over time, more people developing Smart Mini Programs so that when they have their search results, they have better conversion. I think from a user perspective, you will probably have users over time relying more and more on search within Baidu because of that native app experience directly with the Mini Programs.

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Operator [9]

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Your next question comes from the line of Tian Hou from T.H. Capital.

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Tianxiao Hou, T.H. Capital, LLC - Founder, CEO & Senior Analyst [10]

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Robin, Herman, Sharon, the question is related to Baidu's efforts in content building. So as you guys are aggressively developing feed business, you guys also need to build a very healthy content. So in addition to your Baijiahao, Haokan video, Baidu App, recently, we saw from the news you acquired some stakes in Zhihu. And also, I think yesterday, you put money in Guokr. So I wondered for Guokr, in which way they helped you in the content ecosystem building. And also in the going forward, what are some other content area you see you need to continue to build up? And so is there any other potential content investment on the horizon? So that's the question.

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Dou Shen, Baidu, Inc. - SVP [11]

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This is Dou, actually. Let me answer your question first. For sure, content is extremely important to our whole business, as we've already shown you in the past. So for Baijiahao, we see the creators on Baijiahao grow significantly over year-over-year, reaching like 2.2 million creators already. So that is still not enough for us because users come to Baidu for not only information but also services. That's why we just discussed how we are strengthening the Smart Mini Programs to provide further information and service, which we see significant growth as well.

In addition to both Baijiahao and Smart Mini Programs, we're also working with even wider collaborators to provide valuable information. As we have noted, so we invested in Zhihu. We've got Zhihu providing additional information, complementary information to Baidu's Zhidao. And we see our users' interest out of the search queries, they have strong interest in Zhihu's content. So that's why we invested in those. So along with that, we are trying to look for more and more content which can better satisfy our users' interest.

So in short, to sum up, so we will keep looking for better content. And as we know, the content is extremely important for the whole business today. So we are developing our own platforms to generate content. We are looking for partners to get more useful information and service as well.

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Robin Li, Baidu, Inc. - Co-Founder, Chairman & CEO [12]

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Tian, let me just add a few comments. I think our content strategy is pretty much to adopt the overall user experience to the new mobile ecosystem, meaning that we will make or strike a partnership or investment if that deal can help us to improve the user experience. But the content may be available on the open web or on the PC Internet, but if we can have a deal that enhances the mobile user experience with that kind of content, we will do it. Or if that kind of content is not available on the open web or not available on the PC Internet, if we can acquire that content, we will also do it. So basically, the content strategy is to either make the experiences better or make something that was not available to become available to our Internet users.

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Dou Shen, Baidu, Inc. - SVP [13]

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Okay. I will just add one more thing on that. So as Robin just mentioned, we are looking for better user experience. Actually, when we switched Baidu Knows to the Smart Mini Program in our platform, we see significant user spend time growth, actually. So for Zhihu, now is most of the content are presented in the form of H5. With this deal, we're going to convert all of the Zhihu content in Baidu's platform to Smart Mini Programs, and this will be another good example to show how we are going to improve the user experience through the Smart Mini Programs, actually.

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Herman Yu, Baidu, Inc. - CFO [14]

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And just to add, Tian, you asked which areas will we be interested in. When you look at our content, Baidu as a whole, there's really 3 categories of content. We're looking at a content that's knowledge-based, in this case, Zhihu. In case of Baidu Knows, that would be it. So we're looking at example the vast amount of services and information that are in apps today and making that basically having a native app experience. So service is very important. And clearly, we're looking at industry verticals where right now, if it's fragmented on the Internet, if we can concentrate it within Baidu's content platform so that they have better conversions so that they can build user engagement and have better user experiences. So 3 areas: knowledge, services and industries vertical information.

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Operator [15]

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Your next question comes from the line of Eddie Leung from Bank of America Merrill Lynch.

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Eddie Leung, BofA Merrill Lynch, Research Division - MD in Equity Research and Analyst [16]

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Could you share with us your thoughts on the recent news of potential new entrants? So are you going to see any difference this time? And then just a quick follow-up on Herman's comments on some of the advertising industries. Given the recent weakness in some of the verticals, could you remind us what the top, for example, 3 or 5 verticals we have right now?

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Robin Li, Baidu, Inc. - Co-Founder, Chairman & CEO [17]

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Dou will answer your first question, and Herman will answer the second.

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Dou Shen, Baidu, Inc. - SVP [18]

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Okay. For the new players in the market, I think it's not new, actually. So search business is a pretty profitable business, as we all know. So we have players who are trying to enter into this business in the past decades. So actually, search has a very high entry barrier actually because user come to a search engine with a very specific information need. We need to locate that information out of hundreds billions of web pages to get an information located.

So this is quite different from other business like feed because for feed, we usually just show general interest and then the engines to match the user's general interest. So it's not easy to tell right or wrong. But for search, it's the user usually has a very strict demand and strict criteria to judge the performance. So that said, we see for us, I know we have actually the only one successful twin engine model with both search and feed so far in the world. So in our experience, we see it is relatively easy to switch from search to feed because we can generalize the users' interest of their queries but not the other way.

So we're not surprised to see new players in this market, and we have seen this many times. So that said, we are happy to see new players. But with the Baijiahao and Smart Mini Programs, we are strengthening our mobile ecosystem, and we see we're providing better user experience to the users, so that's pretty much what I can offer at this time.

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Herman Yu, Baidu, Inc. - CFO [19]

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Yes. And Eddie, with regards to our top industry, we have health care as you guys know is our top. In addition to that, the other industries are much smaller. So the top 12 industries are 2/3, and the remaining industries are all less than 10% of Baidu Core's revenue, and those would include e-commerce, online games and education.

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Operator [20]

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Your next question comes from the line of James Lee from Mizuho Securities.

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James Lee, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Internet Sector Analyst [21]

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Two, if I may. First -- and maybe, Robin, you can talk about -- you sound pretty excited about the prospect of Duer operating system, the voice search going into next year. And maybe can you help us understand the road map in terms of commercial road map going to 2020 and maybe help us understand what verticals that you weren't able to monetize on text search now you're able to monetize in voice and also what verticals that you could optimize potentially with voice search over the text search.

And also second question on Herman. On 4Q, on revenue growth, is that going to be similar to your guidance in 3Q? And also in operating expenses, you're stepping up about CNY 400 million and change in total expenses in 3Q. Should we expect very similar trend into 4Q as well?

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Robin Li, Baidu, Inc. - Co-Founder, Chairman & CEO [22]

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Yes. On DuerOS, it's a whole new ecosystem. It fully leverages Baidu's investment in search and in AI technologies for the past many, many years. And we are offering a better and better user experience. It does lower the barrier to entry significantly. I talked about it during the prepared remarks that we are entering lower cities with more affordable device system. And we are also able to access people at very young age or very old age because it's just a lot easier to use, and we see strong momentum continue to go into the current quarter and maybe in the coming years.

Talking about the potential business model, because right now, it's in very early stage, we have not really seriously tried to monetize the product, but we see huge potential in many fronts. For example, in education, it's very natural for kids to learn things through this kind of new devices. Games, can offer a very different experience in mobile games because for mobile, you have to hold your handset. But for the Smart Display, your hands are free and we have cameras to capture users' behaviors intelligently.

So there are many, many possible business models, including the app model, including the subscription model for all kinds of content and services. And this is a whole new era for entertainment, for education and for the smart life for many, many people who may not spend a lot of time with mobile phones.

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Herman Yu, Baidu, Inc. - CFO [23]

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And James, the question you asked about revenue and expenses. We typically do not give guidance out of 2 quarters. And with the current macro situation, it's hard to predict what's going to happen in 2 quarters. But I would use a reference. For example, if you look at last year, Q3 to Q4 has very minimal sequential growth. So if the economy keeps pace and so forth, we will probably have similar trends. But I can't commit at this point given that we don't have as much visibility in the current macro situation.

And so when we set our expenditures for the second half, we're cognizant of the current of revenue situation and the economic conditions. So from an expenditure perspective, in terms of total expenditure for Baidu Core, cost of sales plus operating expenses, we're going to try to keep pace with our total expenditures for Q2. So we should not see too significant increase from the second quarter level. And mind you that this would adjust if, for example, our revenue, for example, improves significantly and so forth. So that's current thinking right now.

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Operator [24]

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

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Yue Wu, China International Capital Corporation Limited, Research Division - Analyst [25]

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I have a question regarding your CRM open platform. How should we understand the related financial impact in near term and longer term? And what kind of incentives are you going to provide to attract developers to your platform? And also, if I may, I'm still curious about the Smart Mini Programs. Just wondering what kind of sectors are the most frequent users for your Smart Mini Programs initiative. Do you observe the change of ad budget on your platform of those frequent Smart Mini Program users? And I would appreciate it if management can elaborate more on the difference you have observed among different sectors for the Smart Mini Program users.

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Robin Li, Baidu, Inc. - Co-Founder, Chairman & CEO [26]

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Natalie, on the financial impact of CRM, we are currently trying to do an integrated solution for our online marketing customers. They already spent a lot of money to try to acquire potential customers for their products and services, and we help them to better manage this process and achieve better conversion. We think, longer term, the CRM offering will be able to provide independent product value, and we will be able to charge a significant amount of money for this kind of offering. But to begin with, we'd like to help our advertisers and customers to think in a more holistic way. They acquire traffic from the Baidu channel, and we help them to better manage the traffic or better manage the users, and then help them to improve the overall efficiency of the whole marketing funnel. That's the difference between our CRM and the independent CRM products.

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Dou Shen, Baidu, Inc. - SVP [27]

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For the Smart Mini Programs, let me add a few new things. So actually the user come to Baidu not only for information but also for service. So with Smart Mini Programs, we provide both information and service to the users. So that's saying we are seeing growth for Smart Mini Programs in quite a few different verticals, including travel, real estate, education and other stuff. So say for Weibo and Xiaohongshu, right, so in general, we think they provide information to users. And for this type of Smart Mini Programs, we see each of them has like a few million users, daily active users actually in Baidu's platform for their Smart Mini Programs. Also, the Smart Mini Program is very valuable to developers with long tail information and service, because users come to Baidu yearly looking for some long tail information and service. So this is very helpful for them to locate new users, because new users come here proactively to identify or locate some information. So for those type of business, they also get players for the Smart Mini Programs. So for your question about marketing customers, we do see more and more customers adopting Smart Mini Programs as their landing page. So we see examples from travel like Ctrip, from real estate, from education like Xueersi. So all those customers, we do see their performance, budget performance are getting better through different traffic. So these are just some examples to see, and we are expanding the coverage of the landing pages through Smart Mini Programs. So down the road, maybe you can see more good examples, to share more information with you.

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Operator [28]

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Your next question comes from the line of Jin Yoon from New Street Research.

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Jin-Kyu Yoon, New Street Research LLP - Analyst [29]

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Just on the Mini Programs again. I just wanted to kind of go back into kind of the health care vertical, just kind of where we are on kind of bringing everyone up to speed. And at the same time, you were also talking about moving more of the other verticals into the Mini Program, just kind of just on the traction of that. That's kind of my first question. And my second question is -- well, we'll stop there and then I'll follow up with the second question.

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Dou Shen, Baidu, Inc. - SVP [30]

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Okay. Thanks for the question. So actually, as we mentioned in the remarks, right, so Smart Mini Programs and managed pages are 2 forms we are using for the landing pages. So for the marketing customers, they do not have to specifically use Smart Mini Programs, but they can use it in a lighter version, managed pages. For the health care vertical industry, so as Robin has already mentioned, all the marketing customers, they have switched from HTML5 to managed pages. So in this way, we cannot only guarantee the quality of the content and the information correctness for the landing page. We can also help the marketing customers to engage in a better way with their users.

So you can treat Smart Mini Programs as another way or a relatively heavier way with even stronger capabilities to strengthen the engagement. So that's why for all the services which you need relatively complicated interactions to fulfill users' need, right, so those for type of business, Smart Mini Programs are a better way to do this.

Down the road, to guarantee the quality of the landing page, so the correctness of the information, we will strongly recommend the marketing customers to use either managed pages or Smart Mini Program. But in the meanwhile, since we see most of the cases, if not all, are using Smart Mini Programs or managed pages, the customers already see the lift in their ROI. So we bet, they are going to switch even by themselves. I think that's what I can offer now. Is that okay?

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Jin-Kyu Yoon, New Street Research LLP - Analyst [31]

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Great. If I could follow up -- go ahead.

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Dou Shen, Baidu, Inc. - SVP [32]

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Yes. In terms of sector in relation to health care, we also mentioned moving companies, home repair, attorneys. They are all using managed pages with this.

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Jin-Kyu Yoon, New Street Research LLP - Analyst [33]

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Got it. If I can just -- one just follow-up. I remember just the last time you guys had a health care cleanup like in 2015, there was a little bit of a drop-off in terms of the number of advertisers not being able to qualify. You said in this time around that a lot of the, I guess, marketers have moved over. Have you seen any kind of the overall TAM or actually the number of advertisers being able to drop off this time as well? Are you seeing that some of these advertisers are not able to qualify? And is that anything material?

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Robin Li, Baidu, Inc. - Co-Founder, Chairman & CEO [34]

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Jin, your question is, are we seeing the number of health care marketing services customers drop off?

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Jin-Kyu Yoon, New Street Research LLP - Analyst [35]

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Yes, that's right, being not able to qualify or not able to make the transition because I think that happened a little bit in 2015, correct?

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Herman Yu, Baidu, Inc. - CFO [36]

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Yes. So when you look at the number of customers from the health care sector, we saw them started to drop off at the beginning of the year, and we've seen that consistently into Q2. And as Robin mentioned earlier, because once they use the managed pages, we're able to screen the content using our AI. We're installing, for example, live call capabilities and messaging capabilities. So we use our AI to also screen the communication with users to make sure that they're providing content and information that was more secure and more trustworthy. So as a result of that, it's a filtering system for the lower-quality health care providers. So those are probably going to go elsewhere, probably going to drive revenues for other people. For us, we're basically turning away the lower-quality customers in health care.

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Operator [37]

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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 [38]

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Thank you for the additional color on traffic growth rates in the second quarter. I wonder if you could just take us through what you think are the drivers of the acceleration in that number from the first quarter. And could we expect that to potentially continue at least based on the July and August data that you're seeing currently? And my second question is -- I know you talked about the medical vertical quite a bit, but can I ask what the number would have been or the growth rate would have been for the core, if you excluded the medical vertical? And also on medical, could you talk about what percentage of traffic is on your landing pages and what the initial feedback is?

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Robin Li, Baidu, Inc. - Co-Founder, Chairman & CEO [39]

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Dou, can you answer the traffic question, the growth rate?

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Dou Shen, Baidu, Inc. - SVP [40]

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Sure. Actually, I think we have touched this question previously. The user acquisition efficiency is getting higher and higher, actually. So as Herman just mentioned, we are spending the marketing budget in a smart way to consider more about the ROI. That's why nowadays, when we look at the new users we acquired, their lifetime spend on Baidu is growing pretty significantly, actually. Because of the content quality and also the service provided by Smart Mini Programs, we can see even stickier engagement between the users and our service.

And all that together, that's why we can explain the traffic is growing relatively significant. But for sure, summer is also a good time for traffic in general. So that's another reason we see the growth. But in general, with the better content, as we just mentioned, from Baijiahao, Smart Mini Programs and also the strong collaboration with partners to provide better content and service, we can see the engagement between users and platforms is being strengthened.

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Herman Yu, Baidu, Inc. - CFO [41]

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Okay. With regard to the questions on the numbers, a few verticals that helped us grow sequentially are retail and e-commerce or education. Travel did very well, too, and then service-related industries. So these are some of the highlights for the second quarter. And then with regards to health care revenues, we're seeing double-digit declines in health care revenues. So when you look at the second quarter, as a percentage of total Baidu Core revenues, we're talking about less than 1/7 of our revenue. So that has declined pretty significantly when you look at it from last year. But I think for the long term, it's better for us because we're now having a better way to ensure better quality of the content, both looking at the landing page and also monitoring the kind of communication between the merchants with the users.

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Operator [42]

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We are now approaching the end of the conference call. Thank you for your participation in today's conference. You may now disconnect. Good day.