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Baidu (NASDAQ:BIDU) reported record revenues of RMB6.335 ($1.017 billion) for the quarter ending December 2012, but GAAP ($1.28) and non-GAAP ($1.31) earnings per share did not keep pace. Though both were the second best ever, the gross profit margin (68.5%) fell to an 11-quarter low preventing a push higher for earnings per share to a record. Lower margins offset higher revenues and resulted in lower income. This negatively impacted earnings per share.

Both revenues and earnings per share year over year growth slowed, which continued the downtrend. Revenues were +41.6% compared to the prior year December 2011. This was very close to the expectations of +41%. This is extraordinary growth - for anyone but Baidu. Earnings per share were a disappointing +36.1% year over year, which is a significant slowdown for Baidu. Expectations, again not really up to previous Baidu standards, were slightly higher at +39%.

Bottom Line: the annual push higher for earnings per share at the fourth quarter failed. Regardless of analyst estimates, for investor expectations this was a clear miss. The next quarter, ending March 2013, is usually a dip in earnings per share on an annual cyclical basis. Baidu is languishing near-term.

Revenues edged up to a record high, yet operating and net income dipped. Earnings per share followed suit on this drop created by lower margins.

Gross margin (68.5%) and operating margin (44.9%) fell to 11-quarter lows. Net margin (43.9%) decreased to a 10-quarter low. Gross margin was negatively affected by significant increases in traffic acquisition costs, bandwidth costs, content costs, and finally general operating expenses.

The traffic acquisition costs ratio (9.6%) reached a 10-quarter high and the bandwidth costs ratio (5.3%) rose to a 15-quarter high. A new reported category, the content costs ratio, was 1.9% of total revenues, compared to 0.6% the prior year December 2011. This and an increase in operating expenses explains why gross margin suffered accordingly. Baidu noted, "Content costs mainly consist of amortization of licensed content costs from copyright owners or content distributors, and costs of self-produced content. The increase was mainly due to the consolidation of iQiyi into the Company's financial statements."

Management's RMB revenue outlook for next quarter, the quarter ending March 2013, is the expected dip from the fourth quarter to RMB5.890 billion ($945.4 million) to RMB6.080 billion ($975.9 million). The $1 billion quarterly revenue run rate will not be sustained. This is a -4% to -7% quarter over quarter decrease but a +38% to +43% year over year increase. This would level off the descending year over year revenue trend. Now the great uncertainty is if costs can be contained so that earnings per share does not take an even bigger hit from lower margins.

Its financial position is strong and liquid. Baidu generates tremendous amounts of cash. The growth rates are still spectacular. The problem is BIDU stock was priced at exceptionally high growth rates that are now slowing. The 7-26-11 all-time closing high of $164.36 is gone and not coming back soon within the current operating parameters.

The long play on BIDU is with an eye towards the second quarter, the quarter ending June 2013. This next quarter, the quarter ending March 2013, financial results are expected to be a quarter over quarter dip. Then the June quarterly earnings should be a rebound. Therefore a price drop and apparent consolidation will be an entry point sometime after the first quarter earnings announcement. Be patient, there is plenty of time. Faster and more perceptive traders may see an earlier opportunity.

Three uncertainties are always in the background you should be aware of: the Chinese government, Chinese accounting and auditing standards, and Chinese corporate structuring. The totalitarian regime can make or break Baidu with their actions and censorship, their favor or disfavor. The reliability of Chinese financial statements, and the audit of same, have been questioned. The structuring of publicly held Chinese corporations for overseas investors has been questioned. Baidu has not been specifically named, but these issues should be researched and monitored by you as a Baidu or Chinese stock investor. Perform your due diligence.

Some amounts above are in Chinese renminbi, designated RMB. The currency conversion rate utilized by Baidu for December 2012 earnings: 1 USD = 6.2301 RMB.

Source: Baidu Earnings Disappoint: Revenues Up, Margins Down