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Hello, and thank you for standing by for Baidu's First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time.
I would now like to turn the meeting over to our host for today's conference, Sharon Ng, Baidu's Director of Investor Relations.
Hello, everyone, and welcome to Baidu's first quarter 2018 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, Baidu's Chief Executive Officer; Qi Lu, Baidu's Chief Operating Officer; and Herman Yu, Baidu's Chief Financial Officer. 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 Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in our public filings with the SEC, including our Annual Report on Form 20-F. Baidu does not undertake any obligation to update any forward-looking statement, except as required under applicable law.
Our earnings press release and this call include discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures and is available on our IR website at ir.baidu.com.
As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be made available on Baidu's IR website.
I will now turn the call over to our CEO, Robin.
Hello, everybody, and thank you for joining today's call. We had a strong start in 2018, with our core business exhibiting robust growth, and we continue to execute on our strategy to strengthen Baidu's mobile foundation and lead in AI.
In the first quarter, our strong revenue growth was driven by strength in our traditional search business through better monetization capability, powered by AI technology. For search and feed, we have focused on improving the user experience of our twin engine Baidu App.
As we extend the content offering from Baijiahao or BJH accounts and enhance the algorithms of feed, in March, we saw the DAU of Baidu App reach 137 million, up 18% year-over-year and total daily time spent up 30% year-over-year.
Our flagship app has a strong, distinct advantage because we power our feed algorithms with Baidu's massive AI computing and big data assets to provide our users with personalized recommendations based on the wide range of activities that they conduct on our platform.
Let me talk a little about Baidu's product balance. We fundamentally believe that user engagement should be viewed on content that enrich our users and have a positive societal impact. For example, we proactively clean up indecent content and limit the volume of entertainment gossip news in one sweep. Our product philosophy is to broaden our user base and expand content consumption across a wide range of high-quality content.
We have improved information quality such as showing Baidu Encyclopedia content in feed, using space which was previously reserved for feed ads to help users to identify fake news. We use AI to identify and remove clickbait and vulgar content. Upholding such product values may mean putting in greater effort to grow our users and revenue. We believe such a strategy will pay-off in the long run.
On search, we are pushing the boundaries of Baidu App experience. Last November, we launched the Baidu Bear Paw Account, which enables brands and businesses to link their content from various websites and social platforms, display them in a standardized format and build social following through follow, announce, payment and PIN verification features.
In the first quarter, we strengthened the communication feature by enabling users to message or call friends and businesses with Bear Paw Account directly from their brand app. Such interactions are recorded in the user log enabling users to locate the brand at a later date, and enabling brands to continue the conversation with interested users through Bear Paw Account announcement.
By channeling the value of search results to enable the divestment of social assets in the Baidu App, Bear Paw Account significantly improves the value proposition of Baidu Search from brands and businesses. Equally important, Bear Paw Account now covers approximately 30% of Baidu Search results, resulting in a better search experience for Baidu App users.
On the advertising front, Baidu AI experienced robust growth in search and feed monetization. Dynamic ads, for example, uses machine learning and reach advertiser data sets such as product catalog to display highly relevant, personalized product ads to our users, driving higher conversion rate.
In Q1, we upgraded our dynamic ads by layering in Baidu big data on top of the product catalogs from advertisers. With the new AI-based dynamic image feature, each user sees a slightly different personalized ads based on the users preference on Baidu's platform. For example, in March, S-CAR, an automotive portal, was one of our dynamic ad customers, and used our AI-based dynamic image feature to promote the most fitting car model to users on a real-time basis.
Early results show dynamic app with the new dynamic image feature have increased click-through rates by double-digits and have the potential to serve advertisers with product catalog such as those from the retail, auto, real estate and travel agency spaces. We are in the early innings of leveraging AI to improve app relevance and effectiveness.
Beyond search and feed, AI is enabling Baidu to address two other huge markets: autonomous driving and voice-activated Internet. On Apollo, we are moving at China Speed. In the past few months, we have added leading domestic auto manufacturers like Great Wall Motor, BYD and Sokon Group to our list of strategic partners.
With the support of the Chinese government designating Apollo as the autonomous driving platform on the national TV selecting Apollo as the autonomous driving solution for the smart city of Xiongan and receiving autonomous driving licenses in Beijing, Chongqing, as well as Fujian province.
Apollo has a huge opportunity to become a world-class leader in autonomous driving. On DuerOS just added white (00:08:24) powered devices being adopted in the West, we are seeing signs of voice-activated Internet taking off in China.
In March, voice command on DuerOS surpassed 200 million times, more than double that of December's volume, which suggest conversational AI is fundamentally a more natural way to operate home electronics than remote control, switches and mobile apps.
DuerOS has a natural advantage in conversational AI which requires highly structured data set like those from search. We continue to see DuerOS expand its network of strategic partners, including leading TV manufacturers like Skyworth and leading home electronic manufacturers like Haier.
In March, our partner Ainemo launched DuerOS-powered Xiaodu @ Home, the first smart speaker in China with a display. Xiaodu @ Home, a portable app for entertainment, communication and education sold out its first 10,000 units within the first minute it went online.
Based on initial customer feedback, customer satisfaction reached 99%. We are very excited by the initial result of Xiaodu @ Home, which has the potential to be a category leader in the smart speaker with display space.
Turning to iQIYI, I would like to congratulate Gong Yu and the iQIYI management team for a successful IPO. iQIYI has led the online entertainment space in China by specializing in entertainment focusing on IP creation and leveraging AI computing to improve its hit list.
iQIYI numbers have been impressive. With the help of Baidu, Gong Yu and the iQIYI management team created a leading online video business with a valuation of over $13 billion in eight years. We hope to incubate more businesses with large market opportunities and strong synergies with Baidu in the future.
With that, I will now turn the call over to Qi who will go through our business highlights.
Thank you, Robin. Let me provide you with a set of next level operating details that are key to powering our Q1 operating highlights that Robin just went through.
For search, we are making steady improvements. Our engineering and product capabilities to index richer and higher-quality content to enable more search query modalities and to present search results via more engaging visual and interaction designs that work better on mobile devices. As a key indicator of search progress, the coverage of top one results whereby we satisfy user queries with the first search result has reached one-third of queries in Q1, up from 30% in Q4.
Another big part of our effort was devoted to building out and operating the Bear Paw Account platform, as it is a fundamental part of revitalizing the mobile web and fueling the future growth of search. In Q1, we secured a series of high-quality publishers and many of them managed their video content via Bear Paw Account.
For feed, we are making stride in elevating our engineering infrastructure and the product operation capabilities. For example, we deployed a new architecture that will enable much faster iterations of algorithm development, leading to a faster pace of product innovation. We are building and deploying more AI capabilities, especially in our Baijiahao content platform to offer AI-powered answering tools, which lead to more and high-quality content on our platform.
As a result, our product quality and the user engagement continues to gain ground throughout Q1. Video continues to be a key focus area for us. And in Q1, we further expanded our video content coverage in feed to 48%, up from 19% one year ago.
For flagship Baidu App, we continue to make good progress in elevating the underlying performance and AI capabilities of the client code base. At the same time, we systematically improved product capabilities, especially in richer user interactions through a variety of features, such as social sharing, micro channels and smoother content navigations.
On the advertising front, we'll continue to build up strengths by developing more advanced AI technologies, deeper and broader data assets and stronger operation capabilities. One highlight in Q1 is that for the first time, we deployed a powerful reinforcement learning based infrastructure that can significantly improve our ability to better match ads to our users and increase click through rates and conversions.
We also reached a new engineering milestone with a Dual Cloud DNN callback model, which has increased click through rates meaningfully. These are foundations on which we build up and operate an increasing suite of levers that can sustainably drive advertising performance.
Our OCPC program is one such strong lever. In Q1, with OCPC, we simplified the bidding process for our customers and are able to offer more reliable online and offline conversions. As a specific example, Chang'an, a Chinese auto OEM, used OCPC and saw click through rates increase significantly and the cost per conversion decline meaningfully.
As a result, Chang'an increased daily average spend on search and feed fivefold. We plan to roll out OCPC to more verticals throughout 2018. Dynamic ads and region action ads are additional such levers that will continue to enhance the monetization of our multi-channel marketing platform, as well as new advertising products, such as video advertising.
Next, I will talk about progress on our AI-enabled new businesses. For Apollo, we made a strong progress in our core technologies and the platform elevation. Specifically, we launched Apollo 2.5 with much greater capabilities such as support for multiple vehicle types, including sedans, SUVs, trucks, buses and utility vehicles; support for high speed road conditions at much higher cost efficiency, enhanced development facilities and ApolloScape, a substantially more powerful open data set for training powerful models that are key to autonomous driving.
The productization and commercialization of the Apollo ecosystem continues to accelerate with BYD joining us as the 100th partners last week. Even more importantly, as Robin emphasized earlier, safety is our highest priority, and we are working very hard to strengthen our development process to better safeguard vehicle safety. We are also working closely with multiple government departments and organizations to device a safety framework for autonomous driving in the future.
For DuerOS, we're focused on key smart home usage scenarios and building deeper and more complete experiences that can truly gain market adoption and user engagement. For example, we made a strong progress for product experience for smart speakers with graphical display. This led to the very successful launch of the Ainemo Xiaodu @ Home product that Robin mentioned earlier.
We are very focused on shipping more of such products and driving stronger usage as this type of products has genuine opportunities to be the primary control device for the future of smart homes. We also made a strong progress in platform capabilities, powering more and more devices from over 160 partners. Organizationally, we made the new Smart Living Group to better leverage our resources and drive stronger performance.
Our ABC intelligent cloud business continued its rapid growth in Q1 as we build up digital expertise vertical by vertical. For example, in the financial services vertical, we just formed a strategic partnership with China UnionPay subsidiary, China UnionPay Merchant Services, which provides comprehensive payment services for millions of merchants in China.
We will offer a full financial service solution to China UMS and their merchants, including ABC intelligent financial services cloud, China Merchants Bank, Ping An Life Insurance and other top-tier financial service providers that are also cooperating with Baidu Cloud. Overall, we are pleased with our progress, and we look forward to continuing our work in 2018.
With that, I'll turn the call over to Herman to go through the financials.
Thank you, Qi. Hello, everyone. Welcome to Baidu's first quarter 2018 call. As Robin mentioned, iQIYI successfully IPO-ed at the end of March raising approximately $2.37 billion. Also in March, Baidu raised $1.5 billion on debt offering [Technical Difficulty] (00:19:24-00:19:31)
In addition, we are in the process of spinning off Baidu's Financial Services Group, which had been classified as assets held for sale on our balance sheet. We will provide you with more information upon further development of this project. These financial transactions added together will provide Baidu with greater cash to invest in its core business.
Let me now go through the financial highlights. All monetary amounts are in renminbi unless stated otherwise. Note that starting on January 1, 2018, Baidu adopted ASC 606, the new revenue accounting standard, a net value added tax from the revenue and cost of revenue line items.
To increase comparability with Q1 2018 numbers, 2017 revenue numbers, for today's discussion, have been adjusted net of VAT. In addition, we require our non-GAAP net income to exclude investment disposal gain and loss, impairment of long-term investments and fair value change of long-term investments, adjusted for income tax effects. We believe excluding such items, mostly non-cash, will provide meaningful supplemental information about the operating performance and liquidity of our core business.
Total revenues in the first quarter of 2018 reached RMB 20.9 billion, up 31% year over year. Online marketing revenues were RMB 17.2 billion, up 23% year over year. We have approximately 475,000 online marketing customers in the first quarter, up 5% year over year.
Revenue per online marketing customer was approximately RMB 36,100, up 19% year over year. Other services revenue in the first quarter were up 85% year over year to RMB 3.7 billion, mainly as a result of robust growth in iQIYI membership and fee for our financial services business.
Revenue from Baidu Core was RMB 16.1 billion, up 26% year over year, while revenue from iQIYI reached RMB 4.9 billion, up 57% year over year. Moving on to cost of sales, cost of sales in the first quarter was RMB 9.9 billion, up (00:21:43) year over year.
Content cost in the first quarter was up 59% year over year to RMB 4.2 billion, mainly due to increased content purchasing by iQIYI. Other cost of revenues items decreased year over year and sequentially as a result of the new revenue recognition guidance, which requires the exclusion of VAT from revenue, cost of sales starting in Q1 2018.
Moving on to operating expenses, sales and G&A expenses in the first quarter were RMB 3.1 billion, up 12% year over year, mainly due to the increase in channel and marketing promotion, partially offset by the cutback in Baidu Deliveries and O2O promotion.
R&D expenses in the first quarter were RMB 3.3 billion, up 16% year over year, mainly due to an increase in personnel-related cost. Share-based compensation, which is associated to related cost and expense line items in the first quarter was RMB 778 million compared to RMB 631 million in the corresponding period of 2017.
Operating income in the first quarter was RMB 4.6 billion, up 128% year over year. Non-GAAP operating income was RMB 5.3 billion, up 103% year over year. Operating income from Baidu Core was RMB 5.6 billion, up 9% year over year.
Non-GAAP operating income from Baidu Core was RMB 6.4 billion, up 81% year over year. Non-GAAP operating margin for Baidu Core reached 39% compared to 27% last year.
Other income, net in the first quarter was RMB 1.9 billion compared to RMB 21 million (00:23:24) in the corresponding period of 2017. The increase was primarily due to the recognition of gain for the mark to market private investments in accordance with the new accounting standard investments taking effect January 1, 2018.
Income tax expense in the first quarter was RMB 1.1 billion compared to RMB 405 million in the corresponding period of 2017. Effective tax rate was 17%, compared to 19% last year.
Net income attributable to Baidu in the quarter was RMB 6.7 billion and diluted EPS was RMB 19. Non-GAAP net income attributable to Baidu was RMB 5.7 billion and non-GAAP EPS was RMB 16.
Adjusted EBITDA in the first quarter reached RMB 6.1 billion and EBITDA margin reached 29% compared to 23% for the same quarter last year. Adjusted EBITDA for Baidu Core was RMB 7.1 billion and adjusted EBITDA margin for Baidu Core was 44% (00:24:29) compared to 34%last year, reflecting the strong operating leverage of Baidu's AI-based platform businesses.
As of March 31, 2018, Baidu had cash, cash equivalents and restricted cash and short-term investments of RMB 110.5 billion or approximately $17.6 billion, which does not reflect the IPO proceeds that came in at the quarter end.
Our net operating cash flow and capital expenditures were RMB 8.5 billion and RMB 2 billion, respectively. Total head count at the end of the first quarter was 39,000 – approximately 39,000, down 10% year over year.
Turning to second quarter 2018 guidance, for the second quarter of 2018, we expect revenues to be between RMB 24.9 billion and RMB 26.2 billion, representing a 26% to 33% increase year over year. This forecast is our current and preliminary view and is subject to change.
With that, I'll now open the call for questions.
Thank you very much. The question-and-answer session of this conference will start in a moment. Your first question today comes from the line of Eddie Leung from Merrill Lynch. Please go ahead.
Hi. Good morning. Thank you for taking my question. I'm wondering if you could share a little bit more color with us on the performance of your news feed advertising product in the first quarter? And a follow-up on that, could you also comment on your thought on the pricing? For example, the eCPM of news feed advertisement in the industry, because it seems like, just in general for the industry, the eCPM went up quite a bit, especially, for example, for some of your competitors in news feed. So just wondering how much potential in general for the industry in this monetization front? Thanks.
Okay. Let me take this question. There's two parts. First is about our overall advertising performance in our feed part. First, as you all know, feed as a product experience is a natural extension of a search platform based advertising so that we can fully leverage our existing platform capability and our customer base.
At the same times, our feed also open up growth opportunities to get into brand advertising, because the user engagement is very much moving up into the consideration funnels towards upper part of the funnel. So therefore, our product is able to enable our other driving product (00:27:39) enable us to tap into those new revenue stream opportunities. Specifically, we are enriching a set of ad product. For example, in Chinese called [Foreign Language] (00:27:53) meaning that when you open up the app, you have a very graphical rich, engaging set of experiences, that's a – yeah, oh, this is called as canvas ads. Sorry. I was just reminded the English term is called canvas ads. That turned out to be performing very well.
The other type of advertising product which wasn't available earlier is guaranteed delivery, because in brand advertising, with feed products, GDS, guaranty delivery type of advertising delivers camping objectives for certain advertisers in a very effective way. Even more importantly, let me go back to the fundamental levers that I've talked about, OCPC, dynamic ads, legions, action ads, all those are powerful levers that naturally applies to our feed product, so it's a combination of all those. We see substantial headrooms ahead of us in terms of further improving our advertising products.
And the second part is about the overall trend of CPM. Let me just emphasize our advertising – the nature of advertising product. The nature of advertising product for the performance part is really conversion economics. So therefore, as long as we can keep improving conversion rates through AI technology, through bigger and the better data assets, we will be able to improve our CPMs over a period of time. So we see that again with substantial headroom for growth in front of us.
Yeah. Let me just add a few more points. Thanks, Qi. Yeah. So with regards to – I just want to clarify that Qi had talked about product ads and also [Technical Difficulty] (00:29:53) and just a quick clarification. When we talk about app opening, that's not part of our fee. Our fee is defined by the ads that we [Technical Difficulty] (00:30:02) just as a clarification, but Qi was explaining overall how by having these, we would also to be able to get more [Technical Difficulty] (00:30:10) [indiscernible] (00:30:11) in Q1, [Technical Difficulty] (00:30:17) [ph] slightly up in Q4 (00:30:19). As you know, the secular trend in China is that in Q4, you typically have a very strong spending, especially with [Technical Difficulty] (00:30:32) so the highlight [Technical Difficulty] (00:30:32-00:30:44) strong product, as Qi just explained, we were slightly up on a sequential basis.
Thank you.
Your next question comes from the line of Alicia Yap from Citigroup. Please go ahead.
Hi. Good morning, Robin, Dr. Lu, Herman and Sharon. Thanks for taking my questions and congrats on the solid results. Actually, my question is one or two follow up on a lot of the technology improvements. So can you elaborate a bit of the reinforcement learning for this Phoenix Nest online marketing system that you highlight on your prepared remarks? And what are the industry verticals that will be benefiting from that? And then, similarly for your OCPC, other than automobile, since – what other industry vertical could also be potentially benefit from these features the rest of this year?
And if you also good quantify the potential upside of the revenues and monetization ability driven by all these technology enhancements that you have implemented over the past few months, if you can share some of that, it will be good.
Okay. Let me take that question. First is about the new infrastructures deployed in Q1 that's based on reinforcement learning. A little bit background. Machine learning, as we all know, is very, very powerful capabilities that drives a lot of our industry.
Reinforcement learning is a particular kind. The key strength of reinforcement learning is that you do not – one is, you do not need the label data, meaning that you learn by the actual activity data, whether it's view or clicks or conversion data by itself, so the learning is a lot more
efficient.
And second, it is able to tap into more data signals, so that the ability to elevating economic yield and ad quality will be further improved. And third part is reinforcement learning is very much can be done in what we call online learning, meaning that you do not have to train the model offline then, move it to online.
So the speed of development is also efficient. As an example, in our industry, as we all know, reinforcement learning is the underlying technology delivered (00:33:13)
And there is also proven track record of applying reinforcement learning in other applications. In online advertising, we very much see this as a new strength that we are deploying into our advertising platform and over a period of time, it will give us ability to sustainably drive better performance.
And then the second part of question is with regard to the set of product levers that we talked about, particularly OCPC, which industry verticals can be applied to. Because of the nature of OCPC, it is essentially optimized form using conversion as optimization base line and use that to improve, not only the conversion ratio, but also the ad budget efficiency. As a result, because the marketplace design, the ad budget increase, the spend will increase and this can be applied in pretty much all verticals.
The key for us is to kind of prioritize our effort. Deploying OCPC in large verticals, more meaningful verticals first, but over a period of time, we fully expect to deploy OCPC in more and more verticals to deliver better economics across our all advertising product front, including both search and feed.
Yeah, great. And let me just add specific examples of what just Qi just said, OCPC, as mentioned, this is optimized cost per click. And as you know, Baidu system is based on number of clicks. But for many industries, what advertisers want is something that is more certain. For example, if you are in the business of developing apps, you are a app developer, what you want to know is not how much the cost per click is, you want to know, for example, how much cost would it be for a user to look at your ads and be able to download your apps, right.
And there are industries, for example, in autos and so forth that you want to know what's the cost per lead. What Baidu has done is, because we have a rich history of all these customers in the past, we can then run it through our huge AI computing power and be able to predict basically based on the type of ads you have, the kind of words you have, the kind of photos that you use and so forth and we help you optimize the content and so forth that we have – we're able to forecast if you spend this much on CPC, therefore, your result for CPA for these actions that you would like would be approximately this. That way it reduces the uncertainty of an advertiser and they will be willing to pay more because of that less uncertainty. So you can think of it that way. So for an industry that doesn't have a long history and we have a lot of data, we can help them optimize, and those are the potential that we have.
Operator, next question.
Certainly. The next question comes from the line of Grace Chen from Morgan Stanley. Please go ahead.
Thank you. Thank you for taking my questions and congratulations on your strong results. My question is about the progress of your autonomous cars. We understand that Baidu just celebrated one year anniversary for the Apollo project. We understand that development is still in the early stage, but in retrospect, what do you view as the key achievements in the past one year? And what would you do to do better? Looking into the future, what would be your key focus to stay ahead of the curve, given the intensified competition domestically? Thank you.
Yes. So first of all, with regard to the key progress over the last one year for the Apollo platform, there's several important area to quote. One is the platform capabilities. We deployed Apollo 1.0 within short span. Now, we just deployed Apollo 2.5. The platform capability and technology is moving at a rapid pace.
Second is, the ecosystem helps. Our developer community, member partners, the different agencies, government departments that are embracing, supporting Apollo has been growing leaps and bounds.
Third, which is more important, is the productization and the commercialization of our partners for L3 and L4-based vehicles is moving at a much, much faster pace than we originally anticipated, much, much faster.
Now going forward, our key focus areas will be continue to build up our technology foundations, but more importantly, to speed up the productization and the commercialization of vehicles.
For example, we mentioned in this year, we have a partner to commercially deploy L4 minibus vehicles. In next calendar years, we have several OEM partners deploy L3 commercially available vehicles. And as long as we keep excellent pace onto all those, the Apollo platform will continue to gain strength against the competition.
As we mentioned in the earlier calls, the Apollo ecosystem also have a very clear and healthy business model. We are very similar to Android, the platform technology is open for participating, open for use, but we also sell our services, just like Google, if you use Android to build a handset, you use Google Search services. In this case, it would be our HD map services and the future services that we'll deploy.
So overall, our focus is continue to speed up the development ecosystem, particularly the productization and the commercialization of our partners' vehicles. That will further increase Baidu's competitive strengths.
Operator, next question please.
Certainly. Your next question comes from the line of Gregory Zhao from Barclays. Please go ahead.
Hi, management. Thanks for taking my question and congratulations on the strong quarter. So my first question (00:39:25) is about Q2 guidance. If we exclude iQIYI guidance from your Baidu group level guidance, so based on my calculation, so the Baidu Core revenue growth will accelerate in Q2. So can you help us understand what's the key reason behind? Is your core search or your news feed the key drivers? And then, particularly in the early April, the government launched some new round of media and content censorship so your competitor like Toutiao and several other news app, the download was suspended for several days or weeks in the app store. So do you think Baidu news feed may benefit from these and attract some incremental advertiser budget from the advertisers?
And a quick follow-up question on the margin. So this quarter, you delivered quite strong operating margin expansion. I remember last quarter, you mentioned – you guided actually year-over-year margin compression in 2018. So after the strong quarter, do you still maintain the previous guidance? Thank you.
Okay. Hi, Greg. So let me try to answer your questions on revenues and on margins. Yeah, when Baidu – in our guidance, we build in and we factor in iQIYI, but I think we also consider just overall as a consolidated number. So we don't really separate what's iQIYI and then the rest is Baidu, just as an upright. But we expect actually, based on our guidance that our growth rate should be similar to what we saw in Q1 approximately on a year-over-year basis, okay.
Your question was on media censorship. I think as Robin mentioned in his prepared remarks that the way we position our products, we believe is really trying to optimize the user experience over the long term life of the user on our platform. So having clean content rather than having very quick wins and using content that's not very appropriate is really not our style. We would focus on more wholesome content, we focus on more diversified content and leverage on our AI to actually promote content that's – what's most relevant and best for the user.
So I think as a result, I think that – we think that we're better positioned for high-quality content. And with regards to what happened with Toutiao, I don't think that when you look at the size of our advertising dollar, our advertising market is focused head to head with Toutiao. I think what to look at is the current size of our sales and marketing market, which is very significant in China, and we then also look at our opportunity to actually go into key accounts and be able to get some of that brand budget as we see with our feed doing very well, with the content consumption on feed doing very well, gives us more inventory to actually do display and so forth.
So that's where we see the opportunity with the SME market with, as Qi mentioned, a lot of the new products that we've done with advertising leveraging big data so that it becomes more effective for our customers and with the KA (00:42:53) as feed increases, we'll have more brand inventories and then we'll be able to hopefully grow from key accounts. Those are kind of the key drivers for us to grow.
So just to sum up, I think the strong revenue and guidance can be attributed to technology innovation, both on the user front and on the customer front and less from impact of the regulatory environment changes.
And then, Gregory, on your question on margin. The way we see margin is, I think if you look at Baidu as a platform, last year, we were doing things such as O2O, on Nuomi, on Baidu Deliveries and so forth and we have other businesses that have since spun off. So last year was a transformation year.
And through that, our strategy has been more clear, strengthening our mobile and then also strategy in AI and as we restrategize our businesses around AI-based platform, there's a lot of synergy for that, even though we're in search, we're in feed, we're in autonomous driving, we're – to activate Internet.
So what you've seen in the first quarter since we have one lap around us (00:44:15) you're seeing the platform operating leverage. And we have that ability to continue. And as we said in the last call that while our profit margin is very interesting, especially when you break out iQIYI from that, we also are looking for opportunities to grow from the search side, we're looking at opportunistically to attack where we think strategically to expand, we're looking at optimizing dollars rather than margin. And also for our flagship Baidu App, we're also looking at areas where we can invest incrementally on the channel side, where we think it's going to have positive ROI.
So I think that that is continuing our plan this year and we're looking at it more opportunistically and looking at more long term at least on the economic side. And if we do find more opportunities there, it could hit our margins a little bit.
And as I mentioned earlier last time that if you spend more on the channel cost, the lifetime value of the user could be a positive on a costto quarter basis because you have to expense the channel cost in the quarter that you spend it, the margin could be dampened a little bit.
But I think longer term, that this better for Baidu. So we continue – we'll have that strategy going forward, but at the same time, that will be on an opportunistic basis.
Your next question today comes from the line of Piyush Mubayi from Goldman Sachs. Please go ahead.
And thank you for taking my question. Dr. Qi, a question on autonomous vehicle for you. We understand that the commercial application for AV may still be in an early stage, but you mentioned commercial vehicles twice. And I wondered if you could just compare and contrast the passenger segment and the commercial segment and take us through which ones could come to market faster and if you could potentially talk through the monetization opportunities relative to the two businesses.
Okay. So let me comment on the three aspects of what you just mentioned. So first of all, just as a matter of clarification and to put the facts in our statement. When we talk about commercially available vehicles, that's on the passenger side, meaning these are the L4 vehicles. These are six-seaters minibuses that will be commercially available later part of this calendar year and as several OEM partners will be available in 2019 and some in 2020. These are sedans. These are L3 vehicles meaning that the passengers still need to sit in the car in front of the wheel, but the vehicle is able to perform increasing more and more autonomous driving capabilities. Those are commercially available vehicles for passengers, not for commercial, let's say, trucks or logistic vehicle. That's the – make sure that we are clear and state the facts. That's number one.
Number two, on the commercial opportunities, the key thing I want to emphasize is that we need to think about the commercial deployment at the lowest speed, the more controlled environment, and that's the key. There are a lot more commercially viable opportunities, individual consumers or business customers are willing to pay for, but autonomous vehicle driving behaviors is at the lowest speed and more controlled environment.
The six-seater bus is a prime example of that because commercially, there's already stream of incoming bookings for that vehicle, you can imagine deploying those minibuses in a industrial park, in a tourist regions, they are operating in the lowest speed in a very much controlled environment. Therefore, safety can be guaranteed, can be fully protected, and similar for our L3 vehicles for next year.
And having said all of that, let me also talk about the relative areas of commercially viable opportunity for passenger vehicles and commercial vehicles. Indeed, in our inbound partnership requirements that we're working with more and more partners on commercial vehicle, for example, logistic vehicles, trucks and autos because there's even more opportunity to deploy those at the lowest speed and a more controlled environment. So that's the landscape that's evolving at the very fast pace, and Apollo is tend to gain substantial more opportunities.
Lastly is about the business model. For Apollo, we are very clear upfront in our business models. We make the platform available open – free for our partner to use, but they would need to use a key set of services, and one of those is HD maps, which stands for high-definition maps. These are maps not meant for human eye balls to see. These are maps for the sensor of the devices that's in the car to see. And this is the key part of our economic model and we're seeing very healthy adoptions of our HD maps by our customers, current customers and the future customers.
Your next question comes from the line of Juan Lin from 86Research. Please go ahead.
Hi. Good morning. This is Juan. Robin, Dr. Lu, Herman and Sharon, thank you for taking my questions and congratulations on the strong set of results. So my first question is on short video. I'm wondering if you could share with us the current progress of monetization for the short video content and what is the strategy in short video content production?
And the second question is regarding Xiaodu @ Home. I wonder what is your target for Xiaodu @ Home and any new hardware products that are going to be launched later this year. And when do we expect DuerOS partnership with hardware manufacturers to start generating revenue? Thank you.
I'll answer the short video question and Qi will address the Xiaodu @ Home one. Short video is an important content form for the Baidu App. The percentage or the penetration of short video content on the Baidu feed has been growing very, very quickly from the teens to almost half of our total distribution, so we're seeing strong demand on that. And in terms of monetization, we also see quickly improving monetization capabilities for short form video. And we believe this is going to be a very profitable business going forward.
And let me answer the second part of the question. First of all, just as kind of the strategic backdrop, as Herman and Robin made, the conversational Internet or voice-active Internet [voice-activated Internet] or conversational AI platform has tremendous and larger economic opportunity. For Baidu, we have a portfolio of investment on devices that can become hit devices that elevates the amount of usage and the user engagement enable Baidu to build up our DuerOS platform.
So, among all those devices, we have our first-party devices, which – we are the principals of building those devices, and third party devices are partner-built. And this particular device, Xiaodu @ Home, typically called a second-party devices. They are a strategic partner, meaning that they collaborate with us, our teams, very, very closely. The brand experience, the operation of this product, the design engineering is very much done together by the two teams. And we're super pleased with the momentum this device is able to generate.
At the same times, we fully expect, as part of – the remaining 2018, the DuerOS platform, we will roll out more devices across several categories. First is smart speakers with a graphical display. We believe this has the highly likelihood of becoming the future control devices for the smart home environment because there is the video screens. This product is a lot more programmable and operatable. In addition to music, simple instructions, people are increasingly using for content consumptions, for communication among family members and including to verticals for learnings, for telemedicines, there's tremendous growth potentials for that device. So we are planning to support more third parties and the future first-party devices in that category.
Having said that, there is also multiple devices we roll out. For example, speakers without a screen is also a important part of the mix because imagine a home where you have multiple room, cover larger space, you need those type of speakers who can respond to voice commands providing useful services back. In addition, we are fully expecting developing additional first-party hardware product and third-party hardware product. But the intent is to be super choosy and selective in those products. Each of those products will have the potential to become a hit device in terms of number of device volume that we can ship, but more importantly, the usage amount, the engagement that we can generate on those devices.
Lastly, let me talk about the general economics. This is a broad platform. The economics can be divied up into several segments. First, give device, give Baidu the opportunity to have future entry points for information, for content, for services, and advertising is the natural affinity. As a matter of fact, we already have ongoing early-stage advertising operations with partners for our DuerOS platforms. That's one.
The second is, the DuerOS is also a platform. Platform has economics such as licensing economics in the long term and are taking a bid, just like iOS will take a bid on any services sold to the platform, but these are very long term. Short term, we're very focused on building hit devices generating great experiences for users and usages. And focusing on little bit of short-term advertising because they are very natural and we do operate some advertising products with our partners as of today for our DuerOS platforms. The emphasize is really long term we can grow into substantial economics, but it will take time.
Your next question comes from the line of Thomas Chong from Credit Suisse. Please go ahead.
Hi. Thanks management for taking my questions. I have a question on the competition. Can management give us some color how we see the intensifying competition in conversational platform as well as autonomous driving? Should we expect us to step up the investment on this front because of competition? Thank you.
Yeah. So let me first talk about the competition on the autonomous vehicle front. Within China market, which is our key focus areas based on the – everything we have been seeing from the industry landscape, we believe Baidu is in a very strong position to drive the autonomous vehicle productization and the commercialization and the entire ecosystem forward. There's a few important reason behind that – we are enjoying a competitive edge. First is, Baidu as a company, we invest in the autonomous driving technology much earlier than most of the others. We started working on this more than four years ago. As a result, our technological capabilities is stronger.
The second is, we took a very important position that stand for open access to technology, building a collaborative ecosystem. As a result, we have been very broadly embraced pretty much by all OEM partners, tier 1 partners. And also, as a result of that, we are also being very much supported by various government agencies and departments. For example, the Chinese government designated Apollo as one of the four national open platforms. Particularly, Apollo is the platform of choice for autonomous driving. So, overall, in combination, we very much see Baidu is in a strong competitive position in the space of autonomous vehicle.
Relative to conversational AI, the competition is more intense as you observed. Having said that, Baidu is in a strong position for a number of important reasons: One is, Baidu's technological capabilities, the combination of speech recognition, the natural language understanding, and most importantly, Baidu's knowledge graph that's accumulated over the last 18 years because of our search engine heritage.
In order for the conversation platform to truly understand what the user means, you need to have a large knowledge graph. Otherwise, just the speech recognition won't be able to go enough to be able to stand the meaning of users. The second is, Baidu's search engine also brought suite of online services is an important part of the mix because we can provide a rich set of services interactions. For example, I talked about the smart speakers with a graphical display. Baidu has strong content assets in iQIYI. Baidu have strong content to predict upon search engine, whether it's knowledge from Baidu (00:58:48) or different verticals. So, in aggregate, Baidu is also be able to offer strong set of content services as part of the platform.
But more importantly is really the speed of innovation, particularly hardware, software in combinations. We are very pleased with the rate of iterations that our team has been able to do. As we mentioned, we are the first in the China market to have a smart speaker with graphical display, with very, very strong experiences, fully embraced by the consumers. And we have a very deep pipeline of products that's similar that consists of a strong portfolio of those product. As long as we keep up the intensity or pace of innovation fully leveraged by those strong assets, we are very, very confident Baidu will be able to continue gain more ground against competition in that arena.
Herman, do you want to address the margin question?
Yeah. I think we talked about the margins a little bit earlier. So with our margin – as you saw in Q1, our margin improved significantly from the year before, but part of it is the reduction in marketing costs with regards to our O2O. And we also increased the spending for our channels and so forth.
And I think going into our Q2, our margins – I think that we have the capability of having higher margins, but we want to spend opportunistically with regards to TAC and also with regards to the marketing dollars. So I think depending on what opportunity there would be, our margins may go down, but it all depends on the market situation.
Your next question comes from the line of Han-Joon Kim from Deutsche Bank. Please go ahead.
Great. Thanks for the opportunity to ask a question. The question revolves around kind of the pace of commercialization of autonomous driving versus kind of the voice-enabled speakers and so forth. So monetization of the HD maps on autonomous driving is pretty clear. What will be the comparable kind of element of how we monetize voice interactions or voice modality? And between the pace of the two, autonomous driving and voice search, which kind of do you think is tracking faster?
Yeah. Let me address two parts of the question. First of all, with regard to the commercialization of autonomous driving and relative clarity of our business model, based on everything we are seeing, pretty much every week when we talk to our OEM customers, our tier 1 customers, we see more commercially viable scenarios that our technology can be deployed.
So, overall, it is really accelerating. For example, this week there is Beijing auto shows. As a matter of fact, we just discovered new commercially viable opportunities just by talking to the partners during auto show exhibitions. So – and that is – it is really accelerating. And with regard to the Baidu economic opportunity, the HD maps itself is very long term, I emphasize long term, is very meaningful by itself. Having said that, we fully expect to tap into future economic opportunities for Baidu. There's more and more commercially viable opportunities as part of the Apollo platform Baidu will tap into.
For example, we publicly talked about building something called ACU, which stands for Apollo Computing Unit. You can imagine that. Essentially, we are doing a lot of R&D. It's a hardware box that you can plug a sensor into it, you can plug silicon into it and silicon-wise, you can use NVIDIA, Intel or Baidu has its own silicon solutions through FPGA. Another product will be ramped up very quickly. That can grow into another future economic opportunities. And there's a number of different services. As part of the announcement of Apollo 2.5, we launched a new set of cyber-security services initiatives. That itself – because of the future vehicles, there's a lot of security requirements. These security services can also be virtually monetized over a period of time. So that's the Apollo side of our economic opportunities long term.
On the conversational AI side, let me just recalibrate what I mentioned earlier. It's very, very important to talk through the economic opportunities and the relative speed of deployment. The speed of deployment – let me first talk about the speed of deployment. Based on the industry structure, the speed of the deployment of that conversational AI platform really depend on the hit devices.
In the United States, it's because Echo, Amazon pushed it into hit devices and then that platform started to take off. In China, it is going to go through a similar structural evolution. And we very much see Baidu is in the frontier of pushing that hit device, which we believe will be a smart speaker with graphical display because the China home environment is substantially different than the United States. So that's number one. And we will be able to on the leading front.
In that case, there will be – long term, there will be hardware economics for Baidu to tap into that's naturally. And then once the hit devices start to take off, the platform will be anchored. The platform will be used on more and more devices. On the platform side, first, these platform give Baidu new entry points, and directly these entry points will be able to create advertising revenue opportunities as I mentioned earlier. Right now, we are indeed operating with a few advertising partners as part of a deployment for our DuerOS devices, but I want to emphasize, we are very early – just a few partners we're working with.
And then second, outside of the entry points, advertising revenues. The platform itself has economics attached to it. The typical form – platform will be licensing revenues because the device will be richer and richer. We envision right now with speakers, can be many different form of devices. The platform will have licensing economics. And the platform will have VICs (01:05:32), essentially like App Store. If you sell your services on App Store iOS, Apple takes 30% of VIC (01:05:40). So that's, again, another future revenue streams once the platform gets established.
Again, relative speed, depends on the hit device, but the long-term economic opportunity can be tremendous for Baidu. The emphasis for us is really focusing on building great devices, great consumer experiences leading to high engagement and then over time, we'll be able to tap into those revenue streams.
Your next question today comes from the line of Karen Chan from Jefferies. Please go ahead.
Thank you management for taking my question, and congratulations on the strong set of results. So just a housekeeping question, sorry if I have missed it previously. Just wondering what's the revenue contribution from the news feed during the quarter. And how are we thinking about the growth trajectory going for the rest of this year? Are we still maintaining a 20% sequential growth target? Thanks a lot.
Yeah. Hi, Karen. As I mentioned earlier, feed this quarter was slightly up on a sequential basis because from Q4 to Q1, seasonally in China, advertising usually has dropped. So the fact that we can actually counter the drop and have a sequential quarter I think just shows the strength of our feed. And as I mentioned also on the last call that from Q4 to Q1 you should expect that. But Q1 to Q2, you probably have a seasonality. So we expect that will be up higher on a sequential basis in Q2 versus Q1. Thank you.
And that concludes our call today. Thank you, everyone, for dialing in. We'll join you guys next quarter.
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