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Baidu, Inc. (NASDAQ:BIDU)
Q4 2017 Earnings Conference Call
Feb. 13, 2018, 8:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, and thank you for standing by for Baidu's Fourth Quarter and Full Year 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to your host for today's conference, Sharon Ng, Baidu's Director of Investor Relations.

Sharon Ng -- Director of Investor Relations

Hello, everyone, and welcome to Baidu's fourth quarter and full year 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 will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to those outlined in our public filings with the SEC, including our Annual Report on Form 20-F. Baidu does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

Our earnings press release and this call include discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of the unaudited non-GAAP measures of the unaudited most directly comparable GAAP measures and is available on our IR website at ir.baidu.com. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will also be available on Baidu's IR website.

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

Robin Yanhong Li -- Chief Executive Officer

Hello, everybody, and thank you for joining today's call. 2017 has been a transformative year for Baidu. We did plan to exit non-core business, added new management talent and sharpened our strategic focus to strengthen our mobile foundation and lead in AI.

Our shift to make Baidu an AI first company is paying strong dividends. AI continues to be a main driver behind the growth of our twin-engine search and feed by accompanying AI computing with user data across Baidu's 20 plus apps, many with monthly active users in hundreds of millions, will generate amazing user insight to power Baidu's search and feed algorithm which in turn to add our top line growth and generate cash flow to fund our new AI businesses, autonomous driving, and conversational AI.

We had a solid quarter for fourth quarter. Total revenues reached ¥23.6 billion, growing 29% year-over-year which is a meaningful acceleration from the first half of 2017. Baidu's fourth-quarter revenue was driven by the robust growth of our feed revenue as well as strong traffic demand, particularly coming from e-commerce companies.

In December, we signed a strategic partnership with Huawei to cooperate in areas of technology, product, and content. Baidu will support Huawei in the development of AI-powered smartphones and make available our mobile apps such as our flagship Baidu app and Baidu maps, which are gradually upgraded with AI features such as Baidu's assistant, intelligent search, and augmented reality. Our comprehensive partnership with Huawei is at a new level of strategic cooperation and we hope to form comprehensive partnerships with other smartphone players in the future.

By working with handset makers at the onset of product design, we hope to enable a new generation of AI-powered phones which will significantly improve user experience especially when combined with Baidu AI enabled mobile apps.

I would like to point out that Mobile Baidu has been rebranded as Baidu app, the rebranding reflects Baidu app as the main channel to experience Baidu services. When we launched the Mobile Baidu several years back, the app was considered an extension of our PC services and the mobile channel to access Baidu Search. Today, the Baidu app is the main channel to access Baidu's twin-engine of search and feed and the contender that offers the best Baidu experience.

Our new AI venture, we launched the DuerOS 2.0 in November at our Annual Conference Baidu World. And last month announced Apollo 2.0 at the Consumer Electronics Show in Las Vegas. Baidu's autonomous driving platform, Apollo, has received great industry recognition and we have formed strategic partnerships with the industry heavyweights such as Intel, NVIDIA, NXP, and Renesas.

For Baidu's conversational AI platform, we continue to focus on growing the adoption of DuerOS at a rapid pace. Last November, we released our first 1st party showcased hardware the Raven H smart speaker, which received industry's accolades, including the Best of CES 2018 by the Wall Street Journal and One of the Best Gadgets of 2018 by WIRED. We now have over 130 DuerOS partners, who together have released over 50 DuerOS powered smart devices and we are excited to see the DuerOS install base and usage grow very rapidly. 2017 has proven to be a very fruitful year for Baidu. We look forward to continuing our momentum in 2018.

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

 Qi Lu -- Chief Operating Officer

Thank you, Robin. On our core business front, we remained very focused on strengthening our foundation for the long-term, particularly through leveraging AI technologies, to improve the user experience for search, feed and our flagship Baidu app, formerly named Mobile Baidu. For search, while making steady progress, our improving Baidu search experience and expanding the scope of search with richer content such as video, especially the coverage of our top one results, whereby we satisfy our users' intent with the first search result, has reached 30% of queries in Q4. We've also made strong progress in improving the coverage and the quality of video content for search with 15% of our search page views, returning high-quality videos, up from 11% in the previous quarter.

Note that in order to fully leverage the strong growth of video content, we introduced a more stringent quality measurement standard for quality video coverage starting in Q4. Even more importantly, last November, we successfully launched Bear Paw account [Foreign Language], a new platform for mobile web content that is designed to link the content from other platforms and deliver a significantly upgraded mobile search experience by enabling social tools such as user clicking to follow, business broadcasting features, transactional tools such as payment, and the content management tools.

The initial adoption has been very strong, over 25% of searches within Baidu app, returning content from Bear Paw account publishers. For feed, while making strides in improving the core foundation across the board, in Q4, our product quality continued to improve. As a result, the daily content distribute by feed grew over 20% in Q4 over the prior quarter. We continue to deepen user engagement with total daily time spent on the Baidu app growing approximately 30% year-over-year.

Video content has been a key growth driver, not only as a part of feed but also as part of our overall mobile product matrix. Specifically, the percentage of video content distributed in feed has grown to 40% on average in Q4, up from 14% a year ago.

We continue to improve our Baijiahao platform which connects content from self-media publishers with our feed users. We saw the number of content creators grow from over 200,000 at the beginning of last year to 1 million currently. We also provided content creators with cutting-edge AI tools through the launch of a content creator AI platform, [Foreign Language], which helps automatically review material for edits, intelligently splice video into images, and more.

Our flagship Baidu app, which offers the best Baidu product experience, continues to grow strongly driven by the twin-engines of search and the feed. We released the Baidu app Version 10.0 at Baidu World in November with a much-improved user experience, featuring smoother navigation in the content viewing, expansion of enriched content such as video, user-generated content, vertical channels, and live social sharing to name a few.

In addition, we are trailblazing to fully leverage AI capabilities to drive more and a faster pace of product innovation such as a brand new text-to-speech version of the Baidu app. On the advertising front, we continue to make steady improvements to advertising product offerings and ad platform to drive sustained growth in search and the feed monetization.

For example, we have seen strong adoption of dynamic ads. Dynamic ads can be used in search and feed and help our customers reach the right users on our platform by showing users highly relevant personally tailored ads driving significantly higher conversion rates. Dynamic ads have been widely adopted by our customers in transaction-driven verticals with structured product catalogs.

In Q4, we drove high adoption in existing verticals such as e-commerce and travel, and we expanded dynamic ads to new verticals including autos and the real estate with strong results. We're in the early innings of dynamic ads and see very promising opportunities ahead. We know that the ultimate end goal for our customers is leads-conversion at scale on our platform.

In the second half of last year, we introduced optimized cost per click or OCPC on the merged search and the feed ad platform. Customers can give us their budgets and the cost per conversion. And our ad platform will optimize search and the feed traffic to deliver the highest number of conversions that fall within their budgets. For example, in the online gaming vertical, customers can set a budget and target price per download. Our ad platform intelligently optimizes bid price and other criteria for both search and the feed traffic to guarantee as many app downloads as the budget allows.

The technology is a combination of efforts dating back to 2013 that entails the use of big data and proprietary machine learning models on converging tracking and traffic analysis. Overall, we're working hard to strengthen our value proposition to advertisers, offering the ability to obtain leads conversion at scale, through the breadth of our advertising platform, which includes search, feed, and various forms of display ads, through innovative ROI enhancing ad formats, which includes dynamic ads, action ads, augmented reality ads, and through constant upgrades we'll make to our technology in a data-driven ad platform. Of which, OCPC is a prime example.

Ninja and New Oriental [Foreign Language] are two such advertisers who use the range of ad products to reach their users they seek. Ninja, one of the largest real estate brokers chains in China, leverages Baidu search ads, feed ads [Inaudible], dynamic ads, mobile service ads, and image and video ads with the most advanced in services. Baidu's AI technology powers user targeting, knowledge growth, look-alikes and more. It is fundamental to delivering dynamic, customized, search and feed ads that significantly improves Ninja's lead conversion. Baidu delivers on average over 5 million high-quality traffic daily to Ninja, a scale which is multiple times that of any other advertising channel.

New Oriental, one of the largest private educational service providers in China, partners with Baidu to bring leads to that platform. New Oriental has been a long-standing customer of our search ads, and it has been an early adopter of feed ads. Over the past year, New Oriental increased their feed marketing budget six-fold.

Now turning to iQIYI. iQIYI has continued to lead the online video industry with its unique blend of entertainment and technology DNA. In December, according to iResearch, iQIYI's PC and the mobile app daily average active users reached 76 million and 158 million respectively. Monthly time spent on iQIYI's mobile app grew to 408 billion minutes, 22% higher than December 2016.

Next, I'll talk about our progress in our AI-enabled new businesses. For Apollo and our autonomous vehicles business, we made a big stride in Q4, especially with the launch of Apollo 2.0 at CES, which provides an unprecedented set of capabilities with simple urban road autonomous driving to our developers and our partners. This elevates the Apollo ecosystem to a new level, while we began an accelerated pace which we will call channel speed of productization and the commercialization of autonomous vehicles. Over the past quarter, we announced commercial volume production of L4 mini-buses in 2018 and of several commercial volume productions of passenger vehicles in 2019 and 2020. The Apollo ecosystem is growing rapidly, now with over 90 partners. Furthermore, Apollo has been designated by China central government as the national autonomous driving platform.

For DuerOS, our conversational AI platform, we launched DuerOS 2.0 at the Baidu World in November with much-elevated platform capabilities and a series of new innovative DuerOS powered products at the CES.

Now, more importantly, the DuerOS ecosystem is growing rapidly. We have teamed up over 130 partners and have released over 50 DuerOS powered and branded hardware products on the market, including televisions, speakers, smartphones, storytelling toys, white goods appliances and the car dashboard. And as a result, the overall DuerOS installed base of devices and aggregate users and usages are growing at a very rapid pace.

On our other AI enabled business, the ABC intelligent cloud business continues its rapid growth in Q4, particularly in key verticals such as media, financial services, and the mobile phone OEMs. Our financial services business also grew healthily and substantially improved its core capabilities in both consumer credit loan as well as asset management. We have also made good progress and established a new operating structure that would enable the FSG business to further innovate and pursue bigger opportunities.

Overall, we are pleased with our progress and then we look forward to continuing our work in 2018. With that, I will turn the call over to Herman to go through the financials.

Herman Yu -- Chief Financial Officer

Thanks, Qi. Hello, everyone. Welcome to Baidu's fourth quarter 2017 call. Let me go through the financial highlights. All monetary amounts are in renminbi unless stated otherwise. Q4 was a great quarter for Baidu. Our total revenues grew 29% year-over-year to ¥23.6 billion, which exceeded the high-end of our guidance. Non-GAAP operating income reached ¥5.8 billion, up 104% year-over-year. Adjusted EBITDA reached ¥6.9 billion or 29% of total revenues and was up 78% year-over-year, illustrating the operating leverage potential of our financial model as we simplify and align Baidu's businesses around AI. Let me give you more color on our financials.

During the quarter, we saw strong revenue growth coming from feed, and as a gateway to online traffic, Baidu benefited from the high season e-commerce activities. Our mobile revenue reached 76% of total revenues and compared to 65% for the same period last year. Baidu's online marketing services revenues in the fourth quarter grew 26% year-over-year to ¥20.4 billion. And we had approximately 460,000 online marketing customers in Q4, up 2% year-over-year. Revenue per online marketing customer was ¥44,300 showing a healthy increase of 25% year-over-year. Other services revenues in the fourth quarter were up 53% year-over-year to ¥3.1 billion mainly as a result of robust growth in IT membership and fees for our financial services business.

Total revenues in 2017 reached ¥84.8 billion, up 20% year-over-year. Online marketing revenues were ¥73.1 billion, up 13% from 2016. We had about 775,000 online marketing customers in 2017, down 21% from 2016 as we rebuilt our search business. Revenue per online marketing customer was approximately ¥93,500, up 43% from 2016. Other services revenues in 2017 were up 94% year-over-year to a ¥11.7 billion mainly as a result of robust growth in IT membership and fees for our financial services business. Moving on to cost of sales, cost of sales in the fourth quarter was a ¥11.4 billion up 18% year-over-year. Cost of sales in 2017 was ¥43.1 billion, up 22% from 2016. Content cost in 2017 was up 70% year-over-year to ¥13.4 billion mainly due to increased content purchasing by IT.

In 2018, we expect content costs to step up at a similar pace to 2017, we plan to continue to invest in self-produced content and high-quality license entertainment content to support IT. On the feed side, we plan to ramp up our content offering to support the fast growth of Baijiahao or BJH account.

Moving onto operating expenses, SG&A expenses in the fourth quarter were ¥3.6 billion, up 9% year-over-year, SG&A expenses in 2017 was ¥13.1 billion, down 13% from 2016 mainly due to the cutback in promotions from Baidu Deliveries and O2O initiatives. With promotions from Baidu Deliveries and O2O initiatives bottoming in 2017, we expect SG&A in 2018 to rise on a year-over-year basis as we ramp up the promotion of our flagship Baidu app and our plan app releases.

The magnitude of our channel and other promotional spending increase will depend on our ability to find marketing resources that can generate positive ROI over the lifetime of new app users. Since marketing revenue derived from a new user is spread over several quarters, while related channel and promotional costs are expensed in the quarter that they occur, successful promotion of Baidu apps may temporarily cause our margin to decline in the quarter of heavy marketing spending.

R&D expenses in the fourth quarter were ¥3.7 billion, up 25% year-over-year. R&D expenses in 2017 was ¥12.9 billion, up 27% year-over-year, mainly due to an increase in personnel-related costs. In 2018, we expect R&D expenses to continue to rise, perhaps at a pace higher as we plan to step up our investment in AI initiatives.

Share-based compensation, which is allocated to related costs and expense line items, in the fourth quarter was ¥977 million compared to ¥632 million in the corresponding period in 2016. Sales -- share-based compensation in 2017 was ¥3.2 billion compared to ¥1.8 billion in 2016. Operating profit in the fourth quarter was ¥4.8 billion, up 118% year-over-year. Non-GAAP operating profit was ¥5.8 billion, up 104% year-over-year. Operating profit in 2017 was ¥15.7 billion, up 56% from the corresponding period in 2016. Non-GAAP operating profit in 2017 was ¥18.9 billion, up 60% from 2016. Other loss net in Q4 was ¥294 million compared to other income net of ¥1.8 billion in the corresponding period of 2016.

Other income net in 2017 includes investment gain from the disposal of Baidu Deliveries, while other income net in 2016 included investment gains resulting from the exchanging Uber China shares with Didi. The income tax expense in the fourth quarter was ¥929 million compared to ¥401 million in the corresponding period of 2016. Fourth quarter 2017 effective tax rate was 18% compared to 9% last year. The decrease of which was mainly due to a tax refund received as a result of newly granted preferential tax licenses for certain PRC subsidiaries in 2016.

Income tax expense in 2017 was ¥3 billion compared to ¥2.9 billion in 2016. Effective tax rate in 2017 was 14% compared to 20% in 2016. The decrease in effective tax rate in 2017 was primarily due to non-taxable investment gain.

For 2018, we expect our effective tax rate to be in the high-teens. Net income attributed to Baidu for the fourth quarter was ¥4.2 billion, diluted EPS was ¥12. Non-GAAP net income attributed to Baidu was ¥5.2 billion and non-GAAP diluted EPS was ¥15. Net income attributed to Baidu in 2017 was ¥18.3 billion, up 57% from 2016. Diluted EPS in 2017 was ¥52.

Non-GAAP net income attributed to Baidu was ¥22.3 billion, up 68% from 2016. Non-GAAP diluted EPS was ¥64. Adjusted EBITDA in the fourth quarter reached ¥6.9 billion or 29% of total revenues and was up 78% year-over-year. Adjusted EBITDA in 2017 were ¥23.3 billion or 28% of total revenues, and was up 48% year-over-year.

As of December 31, 2017, Baidu had cash, cash equivalents and short-term investments of ¥100.5 billion. Our net operating cash flow and capital expenditures were ¥10 billion and ¥1.2 billion, respectively. Total headcount as of December 31, 2017, was about 39,300, down 14% year-over-year.

Turning to first quarter 2018 guidance. Let me first talk about ASC 606, which is a new revenue accounting standard taking effect on January 1 this year. ASC 606 requires Baidu to report revenues on a net basis, excluding value-added taxes. For fiscal 2017, our online marketing revenues would have been approximately 5.8% lower on a net basis. For first quarter 2018, we expect revenues net of VAT to be between ¥19.86 billion and ¥20.97 billion, representing a 25% to 32% increase year-over-year, or 6% to 11% decrease on a sequential basis. This forecast is our current and preliminary view subject to change.

I would like to open the call. Operator?

Questions and Answers:

Operator

The question-and-answer session of this conference call will start in a moment. In order to be fair to all callers who ask questions, we will take one question at a time from each caller. If you have more than one question, please request to join the question queue again after your first question has been addressed. To ask a question, please press *1 on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key.

Our first question comes from the line of Wendy Huang from Macquarie. Please ask your question.

Wendy Huang -- Macquarie Capital Ltd. -- Analyst

Thank you, management and congratulations on the solid results and guidance. I just wonder if you can give some color on your news feed's revenue target for 2018? And also, can you give us some update on your volume production target for the mini-bus collaboration with King Long? Thank you.

Herman Yu -- Chief Financial Officer

Hi, Wendy. Let me answer the first question, and then Qi will answer the second question. With regards to our feeds, as I mentioned in our prepared remarks, Q4 was one of the main drivers for our revenue growth and we're seeing a sequential growth of over 20%. And in 2018, our plan is baked in at a sequential growth at that rate.

Wendy Huang -- Macquarie Capital Ltd. -- Analyst

Quarterly? Each quarter sequential growth will be like around the 20% for each quarter in your 2018?

Herman Yu -- Chief Financial Officer

Yeah. In the fourth quarter, we saw that sequential growth. And currently, for 2018, we plan to grow at that kind of rate.

Wendy Huang -- Macquarie Capital Ltd. -- Analyst

Okay. Thank you.

Qi Lu -- Chief Operating Officer

Okay. Let me answer the second part of your question which is the planned L4 mini-bus model production with our partner King Long bus. First of all, the model production schedule for the product to be on the market is the second half of this calendar year. That's number one. And number two, we're already seeing very, very healthy inbound interest of early bookings for that product. That's number two. Number three, what I will emphasize here is the accelerated pace of our pro-business opportunities, especially in this particular category-L4 vehicles. The key is to think about L4 with lower speed and in a more constrained environment. Once you have that perspective, all of a sudden you will have much, much more commercialization, productization opportunities. L4 mini-bus commercial production for this year is a strong first step, but the inbound interest from our partners will have similar or different platform outcomes. Think about logistics.

For example, a logistics vehicle doesn't have to drive at a higher speed, it can drive at a certain limited hour-let's say from midnight to 4 am-in the constrained prime, planned set of routes. So, the overall is we're super, super happy and excited about the set pace of commercialization, productization of our autonomous driver platforms. You can think about King Long mini-bus in 2018 is the first step of gaining such and more expanded L4 opportunities for our partner.

Operator

Our next question comes from the line of Alicia Yap from Citigroup. Please ask your question.

Alicia Yap -- Citigroup Global Markets Asia Ltd. -- Analyst

Hi. Good morning, Robin, Dr. Lu, and Herman. Thanks for taking my questions, and also congrats on the solid set of results. My question's also actually related to the autonomous partnership and also the delivery of the vehicles. Specifically for these L4 buses with King Long, should we start to assume some service fee that Baidu will be able to generate starting second half this year? And in terms of other OEM partners, what would be the monetization potential once the delivery happens later in the 2019 and the 2020 level? And then separately on the housekeeping questions, on the sequential decline in the online marketing customer, what was the reasons for that, and how will they trend going into 2018? Thank you.

Qi Lu -- Chief Operating Officer

Okay. Let me take the first part of the question. With regard to the Apollo platform essentially our business model, we've been super clear from the get-go what's our business model, which is our business models will be selling services: a suite of expanding sort of services that's essential to power autonomous driving vehicles of different types. For example, HD maps is the first service that we are commercializing. And we are building a sales pipeline with an inbound set of commercial opportunities. On that parallel, you can think about Apollo and Android from a business model perspective is very similar. Android OEM-let's say Samsung-can take Android free to build the phones, but you have to use Google search services, which is Google monetize, as the primary vehicles for monetization. And then here for Apollo, at this phase of Apollo, it's very similar.

Our HD maps is our first services, but we have more and more services that's been planned and are in development. So, over time we see just services alone over the coming years will be growing to a very material and significant revenue source for the company. Having said that, the key caveats is this market will take time to build. We are focusing on building the health of the ecosystem, elevating the technological capabilities, ensuring more and more partners embrace our platforms, and over time sustainably, healthily build up that business. And the last thing I would say is, the Apollo platforms, the Apollo ecosystem, preserves many different options of future business model expansions. So, overall we are super bullish about the long-term economic earning capabilities. I will emphasize long-term, emphasize our focus on building a healthy ecosystem at this stage.

Herman Yu -- Chief Financial Officer

Hi, Alicia, good morning. Let me answer your second question with regards to the sequential drop on our customers. So, during the quarter, we started to wind down a local express business [Foreign Language], which is you can search for example for local restaurants and so forth. That business is probably at 1% of our revenue, but it has customers in the tens of thousands. So, I don't think that that is meaningful from a total customer perspective. I think it's more meaningful as a pattern that we have throughout all of 2017 is looking at where our core businesses are. And those that are not as relevant to our total core business, we started to tune back the budget so that we can focus on businesses that are focusing on AI.

Alicia Yap -- Citigroup Global Markets Asia Ltd. -- Analyst

Thank you. Can I ask, what is the Local Express? Is it related to the Nuomi?

Herman Yu -- Chief Financial Officer

Yeah. It was part of our Nuomi business unit.

Operator

Our next question comes from the line of Gregory Zhao from Barclays. Please ask your question.

Gregory Zhao -- Barclays Capital, Inc. -- Analyst

Hi management, thanks for taking my question, and congratulations on the strong quarter. First, I have a quick follow-up question to Wendy's question. So, for the 20% revenue growth in the news feed, do you mean in Q1 2018 and in Q2 2018, you both expect a 20% sequential news feed advertising revenue growth? That's my first question.

The second question is online marketing customers. So, your online marketing customers are showing a turnaround trend with like a 2% year-over-year growth compared to one year ago. So, I just want to understand which business category or segment are you seeing the strongest marketing customer rebound? Thank you.

Herman Yu -- Chief Financial Officer

Hi Gregory. Two questions, on the feed revenue growth, I think you brought up a good point. As I mentioned earlier, we saw a pretty good feed revenue growth on a sequential basis over the last two quarters. In Q4, it grew over some 20%. I would expect that going into 2018, you would be able to see that in the near future.

With that said, as you know historically when you're looking at our advertising business from Q4 to Q1, you typically have a seasonal change. From our guidance, you can see that we're actually guiding down on a sequential basis. So, you will not expect feed growth to be going from Q4 to Q1. But after that, at least in our plan, we expect to be growing at that kind of rate once we pass this seasonal sequential drop. On your question of marketing customers, the growth that we're seeing, we're seeing it from different areas; we're seeing from retail; we're seeing from e-commerce; we're seeing from games and so forth.

Qi Lu -- Chief Operating Officer

Let me add to just what Herman said, the growth on the customer category, the key from our perspective is to drive the capability of our ad platforms. If you look at the dynamic ads and look at the different type of programs such as OCPC, we see substantial increase of budget, increase of our key customers in e-commerce, in autos, in travels, in real estate categories because they're ROI increase. They are a converging increase in that budget spend, so the key driver will continue to sustain because these are driven by more data, better platform capabilities, and richer ad format, more interactive ad formats. Ultimately, it's a win for advertisers, and certainly, it's a win for our ad platform.

Operator

Our next question comes from the line of Juan Lin from 86Research. Please ask your question.

Juan Lin -- 86Research Ltd. -- Analyst

Hi. Good morning, Robin, Dr. Lu, and Herman. Thanks for taking my questions and congratulations on the strong set of results. My question is on the partnership with mobile phone manufacturers. Could you please elaborate your partnership with Huawei? And in which aspect of AI will be working with Huawei, and will search partnerships benefit you in terms of favorable app principle installation cost?

The second question was on DuerOS. So, DuerOS is the most advanced NLP platform in China and we have already made great progress in partnering with hardware and manufacturers. Going forward are you planning to increase investment in content behind the DuerOS as some of the audio content such as music has already been dominated by other players? I'm curious what is your depreciation strategy on this front? Thank you.

Qi Lu -- Chief Operating Officer

Okay. So, let me take the second part first then with regard to DuerOS. It is absolutely the case DuerOS is the leading conversational AI platform in China. Our platform scale, our partnership size, and our product innovation momentum speaks for itself. The question about content is indeed a good one. Music content at this stage for speaker product is the key part of the product experience.

The key thing I want to point out is the content licensing rights up to this point from labels, rights owners, they are more distributed through the delivery vehicles, the mobile APPs, and the website. The content distribution rights for smart devices is a new era, and in many ways, it's up for grabs. Think about it. So, we are actively engaging with labels, content producers because we have a leading platform. We have more partners using the platform through devices, and we will be able to build out over time a set of strong content rights, access to competing content through music-to offer users, to offer to our platform partners-and with a good set of economics because these are the new eras.

We are helping rights owners to monetize more, so a new type of endpoints. So, this is different from the traditional mobile app. So, this is the important perspective to keep in mind when we think about content for conversational AI devices. With regard to partnership with Huawei or other future OEMs, the key to have a context for is the following. AI is such a transformative technology way that would elevate phone to what we call a new mobile era. Each phone will have increased set of sensing capabilities: optical sensing, audio sensing, and also neural computing units, Apple iPhone X, and Huawei Mate 10. All are lead indicators of a future direction of this type of new mobile devices.

Imagine the future phone will be able to see the environment, will be able to hear at the much, much brand new sensitivities. And that's a great opportunity for Baidu because Baidu's AI capability in speech recognition, in vision, in 3D vision are able to help our OEM customers to build better capabilities of more future interactions such as speech-based interactions or vision-based interactions such as AR. And that can connect with core Baidu services such as search and the feed.

So there will be opportunities to lower our channel costs and also, more importantly, bring our content services to a set of new interaction modalities, enrich the user engagement, and certainly, that engagement will lead to future monetization opportunity. This is the heavy caveat. This is also very early, and we are happy, super happy to have a strong partnership with Huawei. But we're fully intent Baidu will continue to build out those AI capabilities coupled with our services to bring to more users, and this is net new opportunities because the mobile phone industry is driven by AI into what we call the new mobile era. The phones will be able to see and hear and offer new modality.

Herman Yu -- Chief Financial Officer

One thing also to add, Juan, on your first question in terms of content, what we're seeing with DuerOS is not just talking to smart devices on music. You're also seeing usage in other areas, content domains, where Baidu has a historical strategic advantage: things like Baidu Knows, things like Baidu Bar, Q&A stuff, things like a video with IT and so forth. So, when users are using, it's a whole wide variety of content. A lot of that Baidu has built through a strong foundation in the past.

Operator

Our next question comes from the line of Karen Chan from Jefferies. Please ask your question.

Karen Chan -- Jefferies Hong Kong Ltd. -- Analyst

Thank you management for taking my question, and congratulations on a solid set of results. My question is regarding how we should think about traffic acquisition cost trend go into 2018 as we step up our channel marketing apps with handset manufacturers. And, secondly, given the accounting treatment change, how should we think about that impacting the overall growth and operating margin? Thank you very much.

Herman Yu -- Chief Financial Officer

Hi, Karen. Two questions. First one is on TAC. I think when you look at TAC bidding in the past few months, you've seen that there's been a fierce competition. In the past, we focused on profit margins when we're bidding for TAC. I think with our gross margin higher due to our scale advantage, we are considering on opportunistic basis to put more emphasis on incremental profitability. So, on the one hand, we think there is an opportunity for TAC when we focus more on profitability than on our margin. On the other hand, we believe ultimately, strategically, it's more important to grow the Baidu app, our flagship app. So, we're also focusing on growing our overall channel cost where we see a positive ROI.

With regards to ASC 606 revenue recognition or revenue accounting change, we're now going to be reporting 2018 net of value-added tax. Obviously, when you have a lower base of revenue when excluding TAC, our margins should be improving as a result of that revenue accounting standard change on an apples-to-apples basis. But when we're looking at the overall margin of 2018 compared to 2017, as I said in the prepared remarks, there are three areas that could potentially cause our margin to be lower. And we'll have to look at that closer as we approach each quarter.

Number one is the content cost. We think that in addition to funding the great content IT producers and also the ones that they license, Baijiahao, BJH accounts, was starting to beef up that ecosystem. Secondly, on the marketing cost and promotional cost, which we talked about and lastly, R&D, we're probably going to grow at a similar pace to 2017, potentially higher as we look for opportunities to increase our investment for AI.

Operator

Our next question comes from the line of Ming Xu from UBS. Please ask your question.

Ming Xu -- UBS Investment Bank -- Analyst

Good morning, management, and congratulation for the strong quarter. So, I have two questions. First is how should we think about the competition in feed business and the video business particularly on the content side? Secondly is how should we think about the margin of the feed business, and then how does it compare with the core search business? Thank you.

Robin Yanhong Li -- Chief Executive Officer

Yeah, this is Robin. On your first question for the feed, I think that we consider part of the total service package for the Baidu app, which means search plus feed is the twin-engine for search for all kind of things that interest, will be reflected not only in the search results but also in the feed content. So, our feed is more personalized, more relevant to the user and has been growing very, very quickly as you can tell from our financial results as well as our traffic results from the third-party research firms.

For video, iQIYI continues to lead in the market. We are number one in terms of DAU, we are number one in terms of average time spent. We're number one in terms of number of paying subscribers, and we are number one in terms of profitability, although it's not profitable yet. But we lost a lot less than the competition. So, it's continued to do very well. In terms of margin, at this point, the margin for feed is lower than search. But longer term, I think the margin for feed will be very close to search. It's a very, very fragmented on the supply side. So, unlike long-form video, we have lots of choices to choose from.

And the platform has a lot of power to direct traffic. The key competency for the feed business is how can you efficiently distribute content instead of what kind of content you have. And the short form video or text or images, those kind of content, the price is not that high. The key value-add is how you find the right users for the right content.

Operator

Our next question comes from the line of Alex Yao from JPMorgan. Please ask your question.

Alex Yao -- JPMorgan Securities (Asia Pacific) Ltd. -- Analyst

Hi. Good morning, management, and thank you for taking my question. I appreciate your color on the feed ads growth outlook into 2018. Can you give us at least some preliminary thoughts on how you think about the core search will be growing in 2018, especially in the backdrop of a slowing down industry traffic particularly on the handset on the mobile side? What's the strategy to drive core search revenue growth in 2018? Thank you.

Herman Yu -- Chief Financial Officer

Yeah. Hi, Alex. I think a couple of things. Qi mentioned earlier how we're growing our core search. I think what you're seeing is a lot of the Baidu technology such as OCPC, such as dynamic ads, leveraging of data. I think that's on the one hand. You're seeing a lot of new feature sets that we're doing that we're allowing the users to come on our search, in addition, to be able to do transactions and so forth. So, that's on the one hand.

On the other hand, what you're also seeing is us focusing on our flagship Baidu app so that as we're getting more users on the app and so if they'll come, sometimes they'll maybe come to look at feeds, and sometimes they'll maybe come to do searches. So, you're seeing that as a combined. So, I think from an advertiser perspective, also from a user perspective, they benefit the two at the same time. So, you're probably going to see more and more of those two. If one grows, it's probably going to pull the other, because it's all wrapped up in one container.

Qi Lu -- Chief Operating Officer

So let me just add a little bit to what Herman said. Search is a fundamental service of human needs, and there's long-term growth perspective. There is no question. But when we think about a search product, it's all about driving long-term growth of users and usages and more content. There are two fronts. One is we're getting more and better and richer content into search. We talk about videos and strong growth of high-quality videos, and we're doing a lot of investment to steadily grow better quality richer content as part of search.

The others enable search to be done more with different types of modalities. There is keywords-based modality search, but there is a lot of growth potentials for voice, for image-based search capabilities. That's another front of search user and usage growth, and there is monetization growth. We talked about dynamic ads, talked about OCPCs. For each of the key search verticals, we believe there are opportunities to go deeper to harness better use. And there are things, when I emphasized and when Herman also said, we're going to strongly grow Baidu app because using Baidu app we have better opportunities to deliver a highly richer differential search experience. And for Baidu APP, we have zero TAC. So, it's all our traffic, all our monetizations. So, these pivots are driving long-term growth. The emphasis is long-term user and usage growth and the long-term profitability growth.

Operator

Our next question comes from the line of Thomas Chong from Credit Suisse. Please ask your question.

Thomas Chong -- Credit Suisse (Hong Kong) Ltd. -- Analyst

Hi. Thanks, management for taking my questions. I have a question on the internet finance initiative. Given the facts that we see, this business line is growing at a very fast momentum. Can management highlight the regulatory headwinds and the timeline for profitability? Thank you.

Herman Yu -- Chief Financial Officer

Hi, Thomas. You're probably referring to the regulatory headwinds that started in December, where the government is now banning products that are over 36% APR. With regards to that specific policy for Baidu, our financial services, we leverage Baidu's data. So, because what we're leveraging a huge set of data we're leveraging our AI computing power. We're able to actually be able to compete at a more efficient level, and we're able to offer products that are sub 36% APR. With that said, obviously, with the overall regulatory environment trying to get funding from banks, it has been harder since the announcement in December. So, in that sense, we are impacted from that.

With regards to profitability, we're still at a loss, but we're seeing the trend to be pretty positive. If you look at it sequentially for the last few quarters, our negative margin is getting less and less. So, we're pretty bullish on the future of our financial services.

Operator

Our next question comes from the line of Jin Yoon from Mizuho. Please ask your question.

Jin-Kyu Yoon -- Mizuho Securities Asia Ltd. -- Analyst

Hey, good morning, guys. A couple of questions regarding content. I think, Herman, on your prepared remarks you said that content cost should increase by the same rate in 2018 versus 2017. I apologize if I missed this, but is that on a percentage basis or in absolute terms? And in Q1, should we see the greatest or the most significant quarter-over-quarter jump because of the revenue push out in iQIYI, and the sequential jumps for the rest of the year should be a little bit more stable? Is that how we should look at it? Great, thanks, guys.

Herman Yu -- Chief Financial Officer

Hi, Jim. With regards to content, yeah, for 2018, I would expect our content cost to grow at least at a rate that we saw from 2016 to 2017, number one. And with regards to sequential of content cost, yeah, I would expect Q1 to be a little bit higher than Q4 because Q4, as you recall, iQIYI was impacted by certain events at the beginning of October. As we go into Q1, you no longer have that kind of content restriction environment. So, as a result, you will be able to probably see a better advertising, and we will probably have to have similar content costs.

Jin-Kyu Yoon -- Mizuho Securities Asia Ltd. -- Analyst

If I could just quickly follow up, that jump that you're talking about, is that on a percentage basis or an absolute dollar jump on 2016 to 2017, and 2017 to 2018?

Herman Yu -- Chief Financial Officer

Percentage basis.

Jin-Kyu Yoon -- Mizuho Securities Asia Ltd. -- Analyst

Percentage basis? Great. Thanks, guys.

Operator

Our next question comes from the line of Natalie Wu from CICC. Please ask your question.

Natalie Wu -- China International Capital Corporation Limited -- Analyst

Hi. Good morning, Robin, Dr. Lu, and Herman. Thanks for taking my question, and Happy New Year in advance. My question is regarding the search and feed app, what's the current spending around KA versus SME? I mean contribution wise. And what's the trend going forward should we be looking at? Thank you.

Robin Yanhong Li -- Chief Executive Officer

Hi, Natalie. Historically, we have not disclosed the exact percentage contribution for KA and SMEs, but a clear trend is that revenue contribution from KA or larger customers have been growing faster. That's in part because of our rich data, and coupled with our AI technology and also increasingly our customers-online marketing customers-are more willing to open up their data or exchange their data with our user data so that we can leverage the data on both sides to optimize conversion using our AI technology that resulted in faster growth of the KA revenue.

Natalie Wu -- China International Capital Corporation Limited -- Analyst

Thanks, Robin. Just wondering, is there any difference that you have witnessed between the search and the feed ad product regarding KA and SME spending progress?

Robin Yanhong Li -- Chief Executive Officer

Yes, there are overlaps between search and the feed customers, and there are also different that some of the advertisers they would prefer more specific requests using search queries. Others would probably target more certain specific demographic group, for example, age between 20 to 25 or revising 30 years age, things like that. We can use the feed to better target those kinds of advertisers.

Natalie Wu -- China International Capital Corporation Limited -- Analyst

Okay. Thank you.

Robin Yanhong Li -- Chief Executive Officer

Real estate, travel businesses are suitable customers for feed.

Natalie Wu -- China International Capital Corporation Limited -- Analyst

Thank you, very helpful.

Operator

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.

 

Duration: 63 minutes

Call participants:

Sharon Ng -- Director of Investor Relations

Robin Yanhong Li -- Chief Executive Officer

Qi Lu -- Chief Operating Officer

Herman Yu -- Chief Financial Officer

Wendy Huang -- Macquarie Capital Ltd. -- Analyst

Alicia Yap -- Citigroup Global Markets Asia Ltd. -- Analyst

Gregory Zhao -- Barclays Capital, Inc. -- Analyst

Juan Lin -- 86Research Ltd. -- Analyst

Karen Chan -- Jefferies Hong Kong Ltd. -- Analyst

Ming Xu -- UBS Investment Bank -- Analyst

Alex Yao -- JPMorgan Securities (Asia Pacific) Ltd. -- Analyst

Thomas Chong -- Credit Suisse (Hong Kong) Ltd. -- Analyst

Jin-Kyu Yoon -- Mizuho Securities Asia Ltd. -- Analyst

Natalie Wu -- China International Capital Corporation Limited -- Analyst

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