百度 (BIDU) 2017 Q3 法說會逐字稿

Hello, and thank you for standing by for Baidu's Third 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 will now like to turn the meeting over to your host for today's conference, Sharon Ng, Baidu's Director of Investor Relations.

Hello, everyone, and welcome to Baidu's Third 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; Qi Lu, Baidu's Chief Operating Officer; and Herman Yu, Baidu's Chief Financial Officer.

After their prepared remarks, Robin, Qi and Herman will answer your questions.

Before we continue, please note that the discussion today 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 obligations 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 measure 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 made available on Baidu's IR website.

I will now turn the call over to Baidu's CEO, Robin Li.

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

We delivered solid financial results and made meaningful progress this quarter on Baidu's strategic pillars, strengthening our mobile foundation and leading in AI.

On strengthening our mobile foundation, Baidu's core business continue to build momentum from our twin-engine: mobile search and feed.

In mobile search, Baidu is making good progress in product innovation that enables native access to rich content, such as video and content within top mobile apps.

Our strategy to leverage Baidu's leading AI technology to improve the algorithmic recommendation of our feeds is showing measurable results in improving user experience.

In September, the DAU over MAU of our flagship app, Mobile Baidu, increased by 2 percentage points year-over-year.

Daily user time spent on Mobile Baidu grew 15% sequentially in the third quarter, the fastest among apps in China with DAUs over 100 million, according to QuestMobile.

We will continue to work on increasing the user scale and improving the user stickiness of Mobile Baidu by leveraging Baidu's leading AI technology, coupled with user experience data, based on the large array of Baidu apps that they use.

This strategy will allow us to continuously improve user experience on Mobile Baidu, which ultimately is the key to growing market share.

The natural result of our feed increasing user scale and user time spent is better monetization.

For the third quarter, feed revenue on an annualized basis exceeded USD 1 billion.

This is an impressive milestone as our feed product was officially launched about a year ago.

Turning to Baidu's second strategic pillar, leading in AI.

We are making measurable progress across our initiatives on Apollo, DuerOS, ABC Cloud and FSG.

In September, we launched Apollo 1.5, an upgrade of Baidu's open source autonomous driving platform and created a multi-billion-dollar fund to support the growth of Apollo's ecosystem.

Last week, we announced a major milestone forming strategic cooperation with 2 leading automotive companies in China, BAIC Group and King Long, which will help make Apollo an industry standard.

On DuerOS, Baidu's voice-assist operating system for smart devices, we are growing industry partners and increasing adoption through the expansion of DuerOS capabilities.

For example, in the third quarter, we launched DuerOS Intelligent Device Platform and DuerOS Bot Platform for third-party developers and launched our DuerOS global partner plan.

ABC Cloud released new products and is expanding its industry solutions to enterprise customers across more sectors.

Cloud is a key component of our voice-assist and autonomous driving OS strategy, and we are leveraging this foundation to extend cloud services to targeted industries, as well as internally, to companies such as iQiyi.

FSG is making impressive progress leveraging Baidu AI and big data to assess credit risks and customize financial product based on our user profile.

At Baidu, we serve hundreds of millions of Chinese users every day through an array of over 20 products and apps.

We place a high priority on continuously improving user experience and the trustworthiness of information and services found on our platform.

At the end of September, we introduced a screening system to limit the distribution of fake news through search results.

This system utilizes probably China's largest centralized database to combat fake news, employing Baidu AI and the network support of over 600 organizations to identify and verify false information and rumors.

In addition, as a follow up to the additional customer verification requirements that we added last year to improve ad quality, we're taking proactive steps to better gather, verify and rank information from the healthcare and medical industry based on source credibility, quality and relevance.

We are enlisting the participation of the healthcare community including top health and medical organizations and industry experts to work with Baidu toward a long-term solution for better health information.

On November 16, we will be holding our 12th annual Baidu World event in Beijing.

We look forward to showcasing Baidu's AI products and hope to see many of you there.

And last but not least, I'd like to extend a warm welcome to Herman Yu, who joined us a little over a month ago, as Baidu's new CFO.

I trust many of you know Herman from his last 10 years as CFO, first at SINA, then at Weibo.

Herman joins Baidu at an opportune time as we are transforming into an AI-first company by strengthening our mobile foundation while developing technology platforms for 2 potentially huge markets, voice-assist smart devices and autonomous driving.

Together with the hiring of Qi, our COO, at the beginning of the year, and the reorganization of management over the last year, we believe these changes are increasing the depth and breadth of Baidu's leadership and allowing us to be more focused on what we do best as a technology company.

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

Thank you, Robin.

On our core business front, we remain focused on improving the user experience through product innovation for search, feed, Mobile Baidu and iQiyi.

On search, AI is the underlying technology foundation that enables us to systematically drive product innovation in a number of areas.

A big priority for us is to improve user experience so that the overall search experience is much more mobile-native.

For example, our Top-1 initiative enables a faster and more immediate "one and done" search experience.

It intelligently optimizes the top search result and has gained strong traction.

In Q3.

Top-1 results has grown to cover over 20% of search page views.

By applying intelligent filtering and advanced presentation technologies, the percentage of search landing pages that provide a good mobile-native experience has now exceeded 90%, which was 40% at the beginning of 2017.

At the same time, we continue to expand search's coverage of richer content, especially video, and the percentage of video content within search result pages continue to grow.

Through deep link and sharelink, Baidu search now can access high-quality content embedded within top apps.

AI also enabled voice and image as search input modalities and we're all making sustainable progress in providing our users with a more natural and overall more compelling search experience.

On feed, AI technology plays an even more potent role in product and user experience our content ecosystem.

First, we continue to strengthen the core foundation of feed, which is a very high-scale personalized information recommendation.

Our core algorithms are iterating and improving at a rapid pace, leveraging Baidu's strengths in AI algorithmic capabilities and Baidu's data assets such as search data.

As a result, core product metrics, such as click-through rates and user satisfactions, continued a healthy pace of improvement.

At the same time, we significantly enriched the content in our feed product.

Video and short videos consumption on the Baidu platform has grown very rapidly, as well as other key areas such as user-generated content, question and answers, new verticals such as Sports, and the highly engaging content areas such as animation and the literature.

Baijiahao is the publishing platform of our Content Ecosystem, and we've made strides in enabling more quality publishers and better content productions on our platform over the past quarter.

The ratio of clicked-on content to displayed headlines has grown at a very healthy upward trend, doubling from 1 year ago.

Overall, the user base and the usage of feed product continue to grow at a strong pace.

Mobile Baidu is flagship product for strengthening our mobile foundation, and has the strong twin engine of search and the feed to propel its growth.

We'continue to make good progress across a number of areas, such as the synergies between search and the feed; the speed and the richness of the user interactions, such as voice output, content social sharing, the mobile bandwidth discount offerings.

We believe Mobile Baidu has the foundation and what it takes to build out the industry's leading mobile information content container and the corresponding ecosystem over time.

We will share more about our product vision and the future plans about Mobile Baidu at the upcoming Baidu World Conference.

On the customer front, with our twin engine of search and feed, we are able to deliver a more comprehensive, richer and a diversified offering to fulfill customer needs.

For example, we helped Chrysler Jeep with a unified campaign to expand their presence in China across search, Brandzone and a feed.

The campaign was highly successful, exceeding the expectations for lead scale and ROI.

With Baidu's robust ad platform and technology and data capabilities, we were able to provide Chrysler Jeep with targeted high-quality leads that resulted in better conversion rates compared with leads from other app platforms.

We continue to use AI and the big data to systematically drive improvements on our advertising platform across a number of areas.

For example, this past quarter, we launched Dynamic Ads in feed, which tightly integrates consumer shopping data with our feed ads.

Dynamic Ads in feed complement our Dynamic Ads in search.

Dynamic Ads show user products that are most relevant to them based on past actions, such as browsing or adding products in a checkout basket.

Customers share their data with us, which dramatically improves the relevance and the level of targeting, resulting in a step-function increase in ROI and higher ad spend with Baidu.

We're working closely with a select number of customers in e-commerce and travel verticals, including JD and Ctrip.

JD has been a long-standing customer using Dynamic Ads across search and feed.

Since the adoption of Dynamic Ads in feed in early July, JD saw ROI from Dynamic Ads in feed more than doubled, and JD meaningfully increased overall ad spend with Baidu.

We plan to rollout Dynamic Ads to even more customers such as those in the auto, travel and the real estate sectors.

Turning now to iQiyi.

iQiyi has continued to ride the secular growth of video and entertainment.

In Q3, iQiyi again showcased its industry leadership with The Rap of China, China's first rap reality show.

The Rap of China was self-produced by iQiyi and have garnered over 2.7 billion views in the first season.

Over the years, iQiyi has invested to grow its library of self-produced content and has established itself as an IP platform with premium content.

This strategy has differentiated iQiyi from its peers and underpins iQiyi's leadership and growth.

In August, according to iResearch, iQiyi's PC and mobile app daily active users reached 78 million and 160 million, respectively, again, reaching new highs.

Monthly time spent in August grew strongly with users spending 461 billion minutes on the mobile app, 29.5% higher than August last year.

In addition, we're leveraging the operating synergy between Baidu and iQiyi through content integration and data cooperation.

For example, iQiyi is an exclusive content partner for Baidu feed.

iQiyi's video feed uses Baidu's platform and back-end technologies.

Next, I'll talk about our progress on our AI-enabled new businesses.

On Apollo and our autonomous vehicle business, we made strong progress in Q3.

Last month, we released Apollo 1.5, which opens up a number of important services such as HD map and a simulation engine, which will be key to drive developer productivity.

Also, a number of key capabilities such as map engine perception, planning and control and LIDAR reference implementation.

Apollo 1.5 has been very positively received by our partners and developers.

Overall, in Q3, the number of Apollo ecosystem partners has grown from 54 to 74 with more OEMs, component and solution providers as well as start-ups joining the Apollo ecosystem.

We reached strategic agreements with OEMs such as BAIC Group, King Long, one of China's largest bus manufacturers, and Chery and Jiang-Huai for commercial L 3 productions in 2018 for buses and 2019 for cars as well as L 4 production by 2021.

This month, we began a strategic collaboration with Shouqi, one of China's leading car hailing platforms and we will work with Shouqii to integrate Apollo technology and DuerOS across their fleet.

We have also begun putting Apollo Fund's capital to work and have made investments in areas including hardware, software and transportation services.

On DuerOS, our conversational on AI platform.

We continue to improve our technology and the platform, and strengthen our leadership position in this important emerging ecosystem because voice and natural language interface will become the future universal gateway to the digital world.

According to IDC, 27% of homes and 51% of cars will be voice-powered by 2020.

In Q3, we launched our DuerOS Intelligent Device Platform and DuerOS Bot Platform for third-party developers and our DuerOS global partner plan.

We continue to expand the DuerOS market footprint to power more third-party devices including select models of TCL and Lenovo televisions, Vivo and Xiaomi smartphones, Guo'an television set-top boxes, and the connected car dashboard in select models of the First Automotive Works, Hyundai, Chery cars, and many more.

On ABC, our AI and big data-powered cloud business.

We held our 2017 ABC Summit last month and launched a number of new products such as the ABC-Stack, which integrates a broad suite of 60 AI technologies and 9 open source big data technologies and powerful infrastructure services.

Another key offering is the ABC all-in-one hardware, which can be deployed in either hybrid or private cloud, enabling our enterprise customers to implement end-to-end applications with one-stop service.

We continue to expand vertical solutions across manufacturing, media marketing, financial services, energy and logistics, and secure key customers such as Shanghai Pudong Development Bank.

On FSG, our AI-enabled financial services business, we continue to have healthy growth in our core offering of wealth management and consumer credit.

At the same time, we are making strides in building out a broad suite of Fin-tech capabilities and a comprehensive Fin-tech platform, with over 300 financial institutions sharing data and plugged into our platform.

Since last quarter, we have put in motion a plan to provide the FSG business with an operating structure that allows FSG to operate more independently, enable stronger long-term growth.

At this point, we do not have a specific time table and structure to share.

Overall, we're pleased with our operating focus and the business progress.

We look forward to continuing our momentum and sharing our progress with you as we continue to move forward.

With that, I will turn the call over to Herman to go through the financials.

Thanks, Qi.

Hello, everyone.

It's a great pleasure to join Baidu and participate on my first earnings call.

Baidu is an enviable tech company.

Its search business delivers an operating margin of approximately 50% and then invest another 30% or so of its revenues back to strengthen its mobile and lead in AI.

In the third quarter, Baidu shed its delivery business as part of a year-long strategy to free up company resources and management attention to focus on AI and projects that have strong synergy.

In addition to investing in mobile, in areas such as Mobile Baidu and iQiyi, we're also putting significant efforts to develop AI-based platforms in the voice-assist autonomous driving markets.

Like the rest of the world, smartphone sales in China over the last few years have been flattish, and we are seeing heavy investments moving towards smart devices for homes and autonomous driving.

These trends present a unique opportunity for Baidu to offer operating systems for smart devices and autonomous driving vehicles.

On a global scale, our peers in the voice-assist autonomous driving spaces are formidable.

However, Baidu has been developing AI technologies for the last 5 to 6 years, including voice assist in Chinese.

Over the past year, we have been very focused on developing a strong network of partnerships with local companies in areas such as home electronics and auto manufacturers to adopt our technologies.

We believe this is what it takes for an AI platform player to be successful in China.

A big part of Baidu's investments today is in the new market opportunities presented by AI that will not have material revenues in the near future.

We believe our investments to become a platform player for smart devices and autonomous driving will bear a significant return in the future, as this strategy plays to Baidu's core strength.

Thus we must exercise due care to avoid assigning a negative value to Baidu's enviable AI investments based on simple P/E multiple or deviation thereof.

Let's now turn to our financials.

All monetary amounts are in renminbi, unless stated otherwise.

For the third quarter, Baidu's total revenues reached [CNY 23.5 billion], (corrected by company after the call) representing a 29% increase from the same period last year.

Online marketing services revenue were [CNY 21.1 billion], (corrected by company after the call) representing an increase of 22% year-over-year.

Online marketing customers reached approximately 486,000 this quarter, down 7% year-over-year and up 3% quarter-over-quarter, as our business steadily recovers.

Revenue per online marketing customer was CNY 40,900, showing a healthy increase of 31% year-over-year and 9% quarter-over-quarter.

Two key drivers of our online marketing services revenue growth were feed and iQiyi, which we are quite excited about.

From ad offering stand point, Qi talked about the power of Baidu's Dynamic Ads, leveraging customer data to increase ad efficiency and effectiveness.

In addition, we experimented with AI ads.

For example, Mercedes-Benz ran an ad using Baidu's facial recognition technologies to help potential customers select the most suitable Mercedes car model.

Baidu's other AI ad formats include using [augmented] (corrected by company after the call) reality in the campaign where a mobile user can take a selfie, insert him or herself in the ad.

The rich user experience that these AI brand ads create will generate new opportunities for Baidu to grow our display ads, especially as we venture into the feed business.

This is another example that Baidu's focus on AI is creating synergy across our platforms from mobile to voice-assist to autonomous driving: 3 platforms weaved together through Baidu's leading AI.

Turning to other service revenue.

Other services revenue was $3.4 billion, up 92% year-over-year, primarily driven by FSG and iQiyi membership.

Let me quickly go over Q3 cost of revenue components.

Traffic acquisition costs were CNY 2.5 billion, decreasing 5% year-over-year and representing 10.5% of our total revenues compared to 14.2% in the corresponding period last year.

Bandwidth costs were CNY 1.4 billion, increasing 16% year-over-year, representing 6.1% of total revenues compared to 6.8% last year.

Depreciation costs were CNY 852 million, increasing 6% year-over-year, representing 3.6% of total revenues compared to 4.4% last year.

Operational costs were CNY 1.4 billion, increasing 19% year-over-year, representing 5.9% of total revenues compared to 6.3% last year.

Content costs were [CNY 3.9 billion], (corrected by company after the call) increasing 76% year-over-year, representing 16.6% of total revenues compared to 12.1% last year.

The year-over-year increase in content costs were mainly due to iQiyi's acquiring more hot series content.

Turning to Q3 operating expenses.

SG&A expenses were CNY 3.7 billion, increasing 4% year-over-year.

R&D expenses were CNY 3.2 billion, increasing 24% year-over-year.

The increase in R&D expenses were primarily due to the growth of R&D personnel costs.

Share-based compensation, which were allocated to related operating and expense line items, were CNY 841 million compared to CNY 418 million last year.

The year-over-year increase was mainly due to additional share grants to retain talents and stay competitive in the high-tech industry.

Operating profit was CNY 4.7 billion, representing a 69% increase from the corresponding period in 2016.

Non-GAAP operating profit reached CNY 5.5 billion, increasing 73% year-over-year.

Other income net was CNY 4.2 billion, which mainly consisted of investment gain recognized as a result of the disposal of Baidu Deliveries.

Income tax expense was [CNY 1.1 billion] (corrected by company after the call) for the third quarter.

The effective tax rate for the third quarter was 12% compared to 25% in the same period last year.

The decrease in the effective tax rate was primarily due to a nontaxable investment gain arising from the disposal of Baidu Deliveries.

Net income attributable to Baidu for the third quarter was CNY 7.9 billion, increasing 156% year-over-year.

Diluted earnings per ADS was CNY 24.

Non-GAAP net income attributable to Baidu was CNY 9.1 billion, increasing 163% year-over-year.

Non-GAAP diluted EPS was CNY 26.

Adjusted EBITDA reached CNY 6.8 billion, increasing 62% year-over-year.

As of September 30, the company had cash, cash equivalents and short-term investments of CNY 108.1 billion.

Net operating cash flow and capital expenditures for the third quarter were CNY 9.7 billion and CNY 1.3 billion, respectively.

Total headcount at the end of the third quarter was approximately 39,800, representing a decrease of 6% from the end of last quarter.

Turning to fourth quarter 2017 guidance.

We currently expect total revenues for the fourth quarter to be between CNY 22.23 billion and CNY 23.41 billion, representing a year-over-year growth rate of 22% to 29%.

Based on our Q3 revenue run rate, Baidu Deliveries will have generated approximately CNY 400 million in revenues.

As mentioned above, we disposed of Baidu Deliveries in August and will no longer have such revenue stream going forward.

Excluding disposed businesses, such as mobile games and Baidu Deliveries, we expect our revenue to grow between 28% to 34%.

Also built into our fourth quarter guidance is the assumption that iQiyi's revenues will drop roughly CNY 700 million sequentially, primarily as a result of limited hot series being featured in China in the recent period.

Over the past month, television stations in China have been broadcasting programs, featuring the 19th party congressional meetings and related contents in China.

To show our respect, iQiyi adopted a self-restriction to not show hot series during this time.

iQiyi has been a robust driver of Baidu's revenue growth historically.

Year-to-date, it has been consistently growing over 50% year-over-year each quarter.

We expect to -- this to slow down to less than 40% in the fourth quarter.

Thus, excluding revenues from iQiyi and disposed businesses, we're expecting Baidu revenues in the fourth quarter to grow between 25% to 34% year-over-year, and this compares to 26% year-over-year in the third quarter.

In other words, we continue to see healthy growth for our core business.

This reflects our current and preliminary view and is subject to change.

I will now open the call to questions.

(Operator Instructions) Our first question today comes from the line of Chi Tsang from HSBC.

I wanted to ask you about Mobile Baidu, and I guess, my first question is maybe housekeeping question.

Do you guys disclose how many DAUs you have for news feed currently?

And secondly, I was wondering if you can sort of give us a little bit more commentary about engagement.

And I'm wondering sort of how many times people are opening up the Mobile Baidu app per day.

And then sort of related to that, the #1 news app in China has about 70 to 80 minutes of use per day.

I'm wondering if that is a figure that you think Mobile Baidu can reach at some point in the future.

So let me take first cut, and Robin and Herman, feel free to chat.

For Mobile Baidu, as we talked in the past, we view -- this is the flagship product for the mobile-era information content containers.

And Baidu is in a unique position to drive sustained improvement of growth on user base, DAU and user engagements, such as time spent.

The reason, the fundamental reason is, we have the twin engine of feeds and search.

Because feed through the fundamental power of AI technology and more data we'll be able to understand the user's interest, user's needs in increasing degree.

The product will really know you and provide services that are timely and of high value to you.

And at the same time, we always know for our industry in the last almost 20 years, search is the fundamental needs for users.

We always have information, content, service, knowledge needs to access through search.

So by harnessing the synergy between these 2 fundamental trends, and Baidu's fundamental strengths, we believe we will be able to drive sustained improvements of our products through better more content in our ecosystem, overall better experience, richer modality, and most importantly, the twin engine of personalized recommendation and search.

Baidu is in a unique position more than any other players in China market to sustainably drive a high-paced improvement on user base growth and engagement.

Yes, this is Robin.

Let me add that we basically view Mobile Baidu as one product, including the search feature and the feed feature.

And feed is highly, highly personalized.

We distribute feed content based on a lot of understanding about our users, especially user queries that represents their true interests.

So we basically view feed and search as 2 major features of this one product, and we are able to provide a much more personalized information distribution channel for our users.

And we believe this still has a lot of potential to go.

Our recommendation will continue to evolve on almost a daily basis.

Users who use our feed product will be able to see progress going forward.

Constantly, I think there are still allow us room for improvement on this front.

Our next question today comes from the line of Alicia Yap from Citigroup.

Congratulations to Herman on your new role.

So my question is related to the traffic acquisition cost versus the SG&A spend.

So it seems like the TAC continued to decline on a year-over-year basis.

So could we assume that this is mainly driven by overall slower growth in the search-specific traffic from the union members while the organic Mobile Baidu app's traffic improving as the user engagement in news feed is leading to more organic search traffic in return?

And then it seems that the step-up in SG&A this quarter is mainly related to more aggressive promotions in Mobile Baidu installations.

So any color as to how we should think about the SG&A line for the fourth quarter as well as the TAC for the fourth quarter and some color into the 2018.

Okay, great, Alicia.

So 2 items.

First, on the TAC, I think the fact that you mentioned it's correct.

Part of the reason is the fact that part of our TAC is also coming from Mobile Baidu, and that we're seeing big growth with overall Mobile Baidu.

Secondly, on the SG&A, within the SG&A expense this quarter, we had bad debt allowances for Baidu Deliveries and also for Nuomi that amounted to over CNY 522 million.

So that was part of the reason for the increase.

So when you back that out, actually, looking at marketing expenses is not as significant.

Our next question today comes from the line of Gregory Zhao from Barclays.

Congratulations to Herman on the new role.

I have 2 very quick questions.

The first one is about our core search revenue.

If we compare our segment revenue growth trend with our Q4 total revenue growth guidance, our news feed is very strong, iQiyi is very strong.

So if we backfill just to get the search revenue growth, the search revenue for Q4 looks a little bit soft.

Do we have any special reason behind?

That's my first question.

The second question is about our news feed product.

In terms of revenue, the news feed is growing very fast and, based on Robin's disclosures, is catching up with our competitors such as Weibo and Jinri Toutiao.

In terms of our content generation capability and the user engagement, so Weibo's social features and Jinri Toutiao's strategy such as video, I think they have some special selling point, right?

Compared to the Weibo, compared to Jinri Toutiao, what's our position into the market and what's our strategy to compete with such kind of competitors?

Herman will answer your first question, and Qi will answer the second one.

Yes, Gregory.

So on your question of search, whether it's soft in the fourth quarter, as I mentioned earlier, the guidance that we're giving when you're looking at Baidu core business, that excludes our spin-off business and iQiyi, we're actually seeing the range that we give you, most of it is above Q3.

So I don't actually see that.

I think your point is, can we break out the difference between feed and search?

And as Robin mentioned earlier, when we look at, for example, the traffic in Mobile Baidu, we actually don't see a user and try break out the time they're spending on search versus on feed.

We see it as just one product.

And as long as the user is getting good experience in that product and we're generating revenue, whether it's in search or whether it's in the feed, we see that as kind of one container, and how do you optimize the time spent and also monetization for that one app?

So I wouldn't break that out separately.

The way I would just see it is that a lot of apps including Mobile Baidu where you have the different experiences in one.

And when we, for example, do marketing, so far we look at it as how much can we get from this particular app versus how much can we get it from different functionality of that particular app?

Yes.

So let me answer the second question and also add to what Herman just said.

We fundamentally view Mobile Baidu, the combination of search and feed, as one unified product.

And we have what it takes to build the mobile-era leading containers and the starting point for our users.

With regard to competition specifically against, you mentioned the Jinri Toutiao and Weibo, there are several fronts we believe Baidu has strong strengths in our capability to compete extremely well and grow our business at a very, very rapid pace.

First is the fundamental strengths of algorithm and data.

If we look across our competitors, Baidu has the strongest AI algorithmic capability and data because our search data encompass so much user signals about the user interests and user needs.

That's number one.

Number two, on growing the richness of content offering, you mentioned videos.

Our video products not only videos displayed within search, within feeds, and also, we have separate video apps, they're all growing at a very, very rapid pace.

You will see us investing more and growing more innovations in enriching the content in our offerings and search front is monetization.

Our ad platform has fundamental strengths.

We have vast scales of customer base.

We have rich algorithmic capabilities and data sets, leveraging from our search advertising synergies.

So you've combine all of these 3 key factors, we have very high confidence that our products will compete extremely well and will grow very strongly going forward.

And Greg, let me add another point, just to hone in on the point of looking at Mobile Baidu search and feed together.

So as you know, one thing in trying to get app adoption is channel cost, right?

So because we have 2 functionalities, when we look at channel cost, we look at it very closely on the ROI, we can get a bang for our bucks.

So that means that you're looking at the lifetime value of that user once you acquire versus the cost.

And because we have 2 functionalities, we look at the functionalities together and what we can get from the users as we're acquiring those.

And you can see our peers who basically is reinforcing our strategy by now, trying to add search.

The thing is it takes many, many years to actually build that quality, but it just shows that our business model works, that you're probably going to be able to get more monetization if you have feed and if you have a very good search engine.

Yes, I'll add to that in terms of on content generation, we view the whole Baidu platform as a one-content ecosystem, which includes the search content in web format.

There's the iQiyi video, which is mostly in the long forms of videos, but we can cut that into shorter clips and distribute it through our feed product.

We also have Tieba, Zhidao, Baike.

We have lots of lots of content-generation tools and apps, and we continue to integrate all of this kind of content into the Mobile Baidu platform.

And Mobile Baidu, both in terms of search and feed has unmatched distribution capabilities for content.

Therefore, we will be able to build a stronger and stronger content ecosystem.

Our next question today comes from the line of Alex Yao from JPMorgan.

Congratulations to Herman's new role.

Wish you all the best in the new role.

I'd like to follow up with the 4Q revenue guidance.

I think, Herman, you mentioned the core search could be growing at 26% on year-over-year basis for 4Q.

And then, if my math is correct, that still suggest that the core search is going to decline somewhere between 2% to 4% Q-o-Q from 3Q to 4Q?

And then Qi also mentioned that AI has improved click-through rates which supposedly should improve the RPM.

Does it mean we are seeing some weakness in the traffic for the core search?

Yes, Alex, thanks.

Actually, with the math I'm looking at is converse to what you've just said.

When you look at our sequential growth from Q3 to Q4, taking out iQiyi, taking out the businesses that we have spun-off, actually, if you look at the midpoint, we're talking about maybe a sequential growth of 2%.

So it's up 2%.

And this is very consistent with, for example, past year.

When you look at 2015, using the same math, taking out businesses that we have spun off, sequentially, you're also looking at around 2%.

So I'm looking at this number pretty consistently.

Because it's an up quarter, I think that when you put in the calculation, you might get a different result.

Our next question today comes from the line of Thomas Chong from Credit Suisse.

Congratulations, Herman, on the new role.

I have a couple of quick questions regarding the cloud and the financial services.

On cloud, how should we envision the business scale over the next couple of years, and how we think we can outpace our peers in terms of customers and revenue?

And my second question is about the financial services.

Can management provide some more guidance about the timing for profitability, the business breakdown, et cetera, that will be great.

Or if not, can we actually rank different business in descending order under the Other Revenue?

So let me take both questions.

First, with regard to our ABC cloud business.

The fundamental position differentiation is ABC, which is AI technology plus big data which is the data assets, Baidu's ecosystem is able to harness, and then overlay on top of a very strong set of cloud infrastructures and services.

With that in mind, our focus is to leverage ABC but deliver industry vertical-specific end-to-end solutions with big customers first, and then horizontalize.

And then build industry-specific ecosystems to grow our business.

And we've been showing strong tractions in that approach.

As I mentioned in the prepared remarks, we continually expand the industry verticals that we're covering and deepen the penetration in each of the verticals.

In terms of a pace of growth, we are growing at a very rapid pace.

And on the pace, essentially to double on an annual basis, or more than double on an annual basis.

So even though it starts from small numbers, it will become material over the coming 2 to 3 years.

So that's for our cloud business.

And with regard to FSG, so you mentioned the profitability.

This is indeed something the teams internally have been working on super hard.

At this point, we are not prepared to share the specific timing, but we are on a very healthy path for this business -to quickly become profitable.

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

Congratulations, Herman, for the new role.

My first question is on iQiyi.

I've noticed that your competitor has recently announced aggressive content purchase in the production plan.

I'm wondering, how should we foresee the competitive landscape for video content going forward?

And what is the trend for video price for the next year?

And secondly, on the core business, as you have been adopting AI and innovative products for core business, I'm wondering, what is the long-term potential for monetization improvements, such as lifting click-through rate and CPC?

And in particular, click-through rate and the CPC for search has been quite stable.

I'm wondering whether you have new opportunities to improve search monetization due to the AI adoption going forward.

Let me take both questions.

So first, with regard to iQiyi business and the content production and content cost question that you mentioned.

First of all, let me reemphasize iQiyi's, core competency.

The team has done tremendous job over the years building up a core competency, a combination of content procurement and content self-productions.

And this is very, very important.

If you look at the past track record, there's open public statistic available for you to look at.

iQiyi has been consistently procuring top-ranked video content.

And also, iQiyi was able to show a strong track record of self-producing content.

Overall, this is the key focus areas for iQiyi management team, so continue to strengthen the leadership positions in content procurement and the content self-production.

That's a very important part.

The other part I would like to emphasize is iQiyi also has been driving a lot of product innovations, particularly the personalized video feed recommendation products.

It has been growing very, very strongly, and that product also has a lot of monetization potentials.

So overall, we continue to have strong confidence in iQiyi, as the leading video entertainment platform for China, continue to drive strong growth by using engagement and monetization.

The second, with regard to using AI to improve the monetization for our core business, it's a great question.

That's indeed one area we have strong potentials, again, through a combination of AI technology and data.

In AI technology, I believe in the last quarter, I mentioned that we'll be using Deep Learning, using better models to be able to harness more signals from our conversion data and to improve conversion rates for our ad product.

As we all know, search advertising economics is fundamentally conversion economics.

As long as we keep improving conversions, we will be able to keep improving our ability to monetize.

That's number one.

Number two is the direction highlighted by our dynamic ads, which is our advertising partners are increasingly willing to share their structured data, their product catalogs and their user data.

By a combination of their structured data, by a combination of their user data, again, we will be able to use AI technology to harnessing more conversion signals, more user interest.

So those are core dimensions that will pay off in both search advertising and in feed monetization.

And third area is, as Mobile Baidu continues to grow through the twin engine of feed and search.

We will be able to draw more diversified ad budgets, not just focused on performance ads but, increasingly, brand advertising and rich media advertising.

Through AI technology, we will also be able to offer new interactions, as Herman mentioned, through face recognition, through AI.

These are all key avenues for us to systematically increase the yield of our ad platform over time again through the combination of AI and data assets.

Juan, let me add a few points on top of that.

When we talk about dynamic ads that Qi just talked about and data structure with partners, customers and so forth, let me just give you a couple of examples.

For example, when you look at Baidu Search, you can now search, for example, going to a destination, and by working with Ctrip, for example, you want to go to Beijing to Shanghai, when you search that, will actually get a display of the data coming from Ctrip.

And then on our website, even though behind it's powered by a Ctrip system, on our website, you'll actually get the display, you'll actually be able to go directly to Ctrip's platform and be able to consummate that transaction.

But everything will be done, from a user interface perspective, on Baidu's platform.

So the very fact that you are able to go in a path of just kind of doing a search, now you're able to actually consummate the transaction from a user experience directly on here, having a close loop.

That's pretty powerful.

Another example is if you're talking about financial services.

On the one hand, we're making micro loans, having asset management.

On the other hand, it's being able to get that user behavior, that technology, and then be able, for example, if you want to search for a loan based on different user profiles, we'll actually push you different products and be able to set the credit limit based on your past behaviors.

So these are kind of the steps we're going.

It used to be this kind of contextual search, searching for a word.

Now you're actually being able to customize the product based on different users using Baidu products.

So I think that is just significant amount of improvement.

And that's kind of the technology we're heading with AI.

And just a few more points on iQiyi.

I think we need to recognize the business model of online video.

Now if you look at in the U.S., there's basically 2 types of models.

And one type of model is, basically, you're just a distributor, right?

You license content that's already well known, you pay for heavy content cost, and what you're doing is you're just trying to arbitrage and trying to deliver on your platform.

That's one model, and we've seen that over the last few years people who license already very top brands and so forth, and the margin is very, very low.

The other type of business we're seeing, and we're seeing this is the one that's more successful, is companies that are able to leverage and bridge those with deep entertainment knowledge and technology.

And those are the type of companies that can actually self-produce content that become top hits.

So at the end of the day, that business model is basically trying to be an IP powerhouse.

Once you can make top hits, you can get a lot of memberships, attract a lot of people.

Now when you have that scale, that base, then you also prove to the entertainment industry that you really understand entertainment.

Other people would want to license their content to you, and all of a sudden, you have that inertia of both user scale and also that partnership.

And by having that kind of creative innovative leverage, then you can continue to make more and more content.

So this is kind of the path that we're seeing with iQiyi.

So I believe, in online video, it's important to understand that business model.

Those that actually can create great content while being a great technology company and continue to get more and more content, whether it's through self-production or through signing with a strategic partner because they trust you, they know that you understand entertainment.

I think that's where iQiyi is positioned, and I think that's where our strategic advantage is.

And our next question today comes from the line of Alvin Jiang from Deutsche Bank.

Congratulations on Herman's new role.

And my first question is on AI.

For AI new initiatives, and we can see there are other big Internet companies also doing the same exploration.

And do you think there will be much more competition in this field in 2 to 3 years?

And what is Baidu's key strength in AI comparing with peers?

And also on financial impact, how big is the investment, specifically on AI, in 2017, and what's the monetization plan?

I have a follow-up.

Okay.

Let me take both questions, and then Herman will chime in as he see.

So with regard to AI competitions over the next 2 to 3 years, it is indeed the case.

There's a lot of industry energies and investment across peer set of companies in AI.

However, Baidu has fundamental strengths around a few key dimensions.

First, as you all know, Baidu is among the very first companies to identify the importance of AI and proactively investing in AI technology and talent over many, many years ago.

It takes time to develop the core competency of talent base and technology.

That's number one.

Number two, we view the best strategy and best path forward for AI commercialization is to platformize it and to build an ecosystem.

And that will have scale advantage.

That will have increasingly bigger and bigger first-mover advantage.

For example, in our self-driving car, Apollo ecosystem, we are actually the world's very first open ecosystem, and our ecosystem is growing at a very, very rapid pace.

And that, over time, we have increasingly competitive barriers and advantage for Baidu.

And similar story is happening on our DuerOS platform.

At this point, we are clearly by far the best leading technology platform for conversational AI in powered devices for home, for in-car navigations.

Again, you will see scaled advantage, first-mover advantage in those front.

So overall, Baidu's combination of early investment, the buildup of talent base and technology, and the platform orientation and ecosystem approach will enable Baidu to accelerate the pace of commercialization and increasingly build up competitor barriers in AI competition.

With regard to AI investment, we've been very disciplined in running our overall internal operations.

We use a very systematic approach to ensure our OpEx, particularly R&D and sales marketing, are allocated proportionally to the economic long-term returns that we can see.

For example, we've been investing heavily in Mobile Baidu, in our feed, in our mobile search, because that's the area we see tremendous growth opportunity.

At the same time, the AI-enabled new businesses, the financial materiality will take time to come.

But we have to invest at this stage proactively.

The key is being very disciplined, being very efficient.

Overall, we are very pleased how everything plays out.

And over period of time, Herman, our CFO, will share more operating highlights with regard to cost and benefit for our AI initiative businesses over the coming quarters.

And Alvin, let me just add a couple of points.

With regards to competition, I think AI, at the end of the day, is just supercomputing, right?

So the power of your computing, the way you can actually leverage that is really the broad sets of data that you have, right?

When you think about Baidu, you look at the properties that we have, from maps to us -- years and years of search data and so forth, we really have the broadest set of data across the users in China.

So as a result, because you know the user so well, you know so deeply across spectrum of data, then, when you have that supercomputing power, then you can have a pretty amazing result.

And as we mentioned over and over that our AI is just focused on 3 platforms.

It's focused on mobile, it's focused on voice assist, and it's focusing on autonomous driving.

And really, when you're looking at peers that's in the space, you're really looking at basically a lot of global players that are kind of focusing on this direction.

So when you look at Baidu, I think you have to look at the computing that we're doing, which is AI, look at the inputs that we have, I think it's very different than other Internet companies because we're in the business of search for so many years and with the properties that we have across China.

And then separately, when we're looking at our sector that we're going into, trying to be an operating system for autonomous driving and for smart devices and so forth, it's a pretty unique position, I think.

So with regards to investment in AI, as I mentioned earlier, over the last year, we've been becoming more and more singular-focused, right?

We divested businesses that were not as synergistic as we think, for example, like Baidu games, like Baidu Deliveries and so forth.

And basically, as we're divesting from those things, we now have more capital to spend.

And the great thing about Baidu's new business model is that we're leveraging AI on our traditional business as well as our new business.

So as you're further developing the power of computing, mixed with the raw amount of data that we have, we're really able to leverage our existing business and also grow the new businesses.

So the total investment is quite huge, but a lot of it is already built into our financial model.

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

I have a very simple question, and this is addressed to Dr. Qi.

In which innings are we in the utilization of AI in improving search monetization according to you?

You're using a baseball analogy.

So I would say probably the second inning.

Somewhere between the second to third inning.

There's a long trajectory ahead of us.

Good question.

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

I'd just like to know, can you give us guidance about the various cost items, such as content cost, G&A, traffic acquisition cost and R&D?

I remember we talked about to double the content cost year-over-year early this year.

But if we look at the run rate so far, it seems like the spending is actually much lower than what we planned earlier.

So can you help us understand the gap there and update us with the latest guidance?

Yes, I think, rather than giving line-by-line guidance, I think it's probably easier just looking at our operating margin.

So when you look at our non-GAAP operating margin for the third quarter, I think it's around 24%, I think, historically, when you're moving from Q3 to Q4, you're going to see several points drop.

And really, our operating margin at the end of the day, a big factor of that is looking at our marketing or channel cost.

As I mentioned earlier, it's purely on an ROI basis.

If we think that there are opportunities where we can expand and we can increase our users and we think that the lifetime value of the user is worthwhile, we'll spend a little bit more.

So that's probably one of the factor that's going to decide what our ultimate operating margin is.

But we should expect a few points drop from Q3.

With regards to content cost, I think several factors in there.

The biggest factor, as you probably know, it's from iQiyi.

So as I mentioned earlier, in the fourth quarter, we expect iQiyi revenue to be lighter because of the environment that we're in.

Naturally, when your revenue is lower, does that mean that you're not going to buy a lot of hot series content?

So I think those things are related.

I think that's probably the major factor for our content going into our Q4.

Our next question today comes from the line of Ming Xu from UBS.

I just have one very quick follow-up on the video side.

Last month, one of your competitors actually announced a very impressive membership number.

So I remember, Robin, you mentioned your membership number was over 30 million during the last earning call.

So could you maybe update us on the latest membership count you have?

And can you maybe share with us your long-term targets on this one?

Yes, we noticed that some of our competitors are aggressively promoting their membership.

They either bundle the membership of their existing product or cut it with a very big discount.

So we no longer think the number of membership matters that much, but that the subscription revenue as a percentage of total revenue, iQiyi continues to lead, and we have a significant lead over the competition.

Our next question today comes from the line of Natalie Wu from CICC.

My question is regarding the feed ad.

As you just mentioned, we should look search and feed ad together, as they are in one single app or one unified product.

So does that mean feed ad is showing cannibalization effect for core search?

And as you mentioned in prepared remarks, feed ads generated USD 1 billion revenue on an annualized basis in the third quarter.

So does that mean your feed ad revenue in the third quarter reached the CNY 2 billion?

And is that number net of sales rebate or on a gross basis?

And does that number includes iQiyi's video feeds?

And also, how do you view the growth prospect of this business?

Will you consider launch individual app for that?

So let me take the first part with regard to cannibalization, and then Herman can talk about the number breakdown.

So the simple answer is, clearly, no.

Feed ads has been truly incremental to our overall advertising business.

There is a few key areas to further elaborate.

First, our search advertising budget and ad spend continue to remain strong and stable and growing.

So that's very, very important.

The second is we are increasingly adding more capabilities to offer to advertisers when they pick our feed ad product.

For example, ad creatives, ad authoring tools.

So that make it much easier for advertisers to use our feed product.

And it's also important to point out, many of search advertisers, they see the combination of search feed is very, very useful and helpful for their advertising campaign, because oftentimes, they want to cover their target customers across the different layers, consideration funnels.

So there's indeed campaigns across both search and the feeds.

But from ad spend perspective, it's very much incremental.

And more importantly over time the feed product would harness more and more brand advertising budget, particularly richer advertising creatives, ad interactions.

So overall, we see the combination of ad platform offering both search advertising and the feed advertising is net incremental and have very, very strong headroom and trajectory for long-term and sustainable growth ahead of us.

Natalie, let me just add a few points to that.

So I think your question just assumes that feed and search are 2 separate products.

But let me kind of put it in context with why we think that we should look at this as one.

If we start looking at these 2 as 1 product and add to it strategically for Baidu, we're going to be able to differentiate our product with other people.

For example, one way to look at this is, for example, the content ecosystem, right?

Because the idea is that the feed is a healthy ecosystem where you have a lot of bloggers that comment and actually use, for example, Baijahao, Baidu's feed account.

And what Baidu's able to do is once these users come and actually generate content on these accounts, Baidu also makes it available for people to actually search these accounts.

So in other words, we really don't have a preference whether the user actually looking at the content through feed or looking at the content through search, we see it kind of as 2 ways to display the same amount of content.

So on the one hand, we're expanding our content base by using Baijahao in addition to what probably Robin mentioned earlier, like Baidu Knows, other properties like Tieba and so forth.

So that's why I think the more we allow the users to leverage different ways to look at the content, we see it more as one product.

And that's a huge differentiator than the other parties.

Secondly, the question on the $1 billion, I mean, when we say annualized $1 billion, then what you need to do is look at Q3 just divide it by 4, then you get approximately where we are with Q3.

Okay?

And the question on iQiyi feed, we see that as a separate category, as I mentioned in the guidance.

And the feed product is within Baidu's other products.

Let me just add that, for search and feed, we can look at it from 2 fronts.

From the advertiser front, I think, as Qi mentioned, feed can attract a lot of brand advertisers.

But on the other hand, we do share a large amount of advertisers both on search and on feed.

So I view that as a strength than a weakness.

We have a very large advertiser base that we can distribute their ads both on search result page and the feed page.

So this is a very advantage point for Baidu.

And from the traffic point of view, I've been saying this over the past few years and many, many times, our benefit is very much traffic bound not budget bound.

So the more traffic you generate, the more revenue you generate.

Advertisers always want to buy more from our platform.

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.

Good day.

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