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Executives

Victor Tsing - Investor Relations Director

Robin Li - Chairman of the Board, Chief Executive Officer

Jennifer Li - Chief Financial Officer

Haoyu Shen - Vice President of Business Operations

Peng Ye - Chief Operating Officer

Analysts

James Mitchell - Goldman Sachs

Jeffrey Lindsay - Sanford C. Bernstein

Gene Munster - Piper Jaffray

James Lee - Sterne Agee

Eddie Leung - Banc of America Merrill Lynch

Richard Ji - Morgan Stanley

Dick Wei - J.P. Morgan

Scott Tong - Oppenheimer

Jason Brueschke - Citigroup

C. Ming Zhao - SIG

Eric Wen - Main First

James Sullivan - Analyst

Stephen Ju - RBC Capital Markets

Hugh Bond - HSBC

Baidu.com, Inc. (BIDU) Q2 2009 Earnings Call July 23, 2009 8:00 PM ET

Operator

Hello and thank you for standing by for Baidu's second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Mr. Victor [Tsing], Baidu's Investor Relations Director. Please proceed, sir.

Victor Tsing

Hello, everyone and welcome to Baidu's second quarter 2009 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, and Jennifer Li, Baidu's Chief Financial Officer. After their prepared remarks, Robin and Jennifer will be joined by Peng Ye, our Chief Operating Officer, and Haoyu Shen, Vice President of Business Operations, to answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Baidu does not undertake any obligations to update any forward-looking statements except as required under applicable law.

As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on Baidu's corporate website at ir.baidu.com.

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

Robin Li

Hello, everyone and thank you for joining us today. The second quarter of 2009 was an exciting one for Baidu. Strong execution drove improvements in customer satisfaction and user experience and helped us realize revenue growth of more than 35% quarter on quarter.

During the second quarter, macroeconomic conditions remained challenging, even as we began to see some signs of recovery in the Chinese economy. That said, we are pleased that through relentless execution on both the user and customer fronts, we were able to drive a strong performance.

Chinese companies continue to realize the superior ROI offered by our P4P platform and are spending more with us. While SMEs remain our core revenue contributor, we are also seeing larger companies shifting marketing dollars more to our platform.

In addition to P4P solutions, we are actively engaged with these customers to explore various innovative marketing solutions to comprehensively fulfill their needs. For example, we most recently leveraged our popular Baidu [post-bar] community product to place targeted ads for Nike, middle school community sites, and we explored arrangements to market promotions directly on Baidu's homepage, such as the one we recently completed with Intel.

As you know, in April we officially launched the Baidu online marketing professional edition and enhanced the bidding platform for online marketing customers. Also known as Phoenix’s Nest. While still very much in its early stages, customer acceptance was very encouraging. Online marketers are appreciating the greater options in [inaudible] choice and budgeting capabilities, as well as Phoenix’s Nests’ enhanced tools for measuring ROI.

During this quarter, the rollout of Phoenix’s Nest went very well and we are pleased with the progress to date. As we continue to educate our customers and improve upon this product, we expect the benefit of Phoenix’s Nest to ramp up in the quarters to come in terms of intense monetization as well as improved ad relevancy.

Looking at our recent work on user experience, we are encouraged by our progress on Project Aladdin, which we launched in April as well, as an initiative to uncover useful parts of the [hidden web], Aladdin offers a powerful open platform for producing richer search results. We are working closely with webmasters to create growth for content inclusion and display formats to expand the utilities of the platform. As more and more content is picked up by Aladdin in Q3 and beyond, we will continue to see a better search experience with greater access to dynamic information, such as weather conditions and currency exchange rates.

In addition, for an increasing percentage of queries, we are generating locally relevant results, meaning that the results are dynamically tied in relevancy to the location where the search was performed.

In the context of providing dynamic and relevant information, Baidu aims to always stay ahead of the rapidly evolving needs of our users and customers. E-commerce in China is an emerging space with fast-growing activities. While we continue our work in this regard with [inaudible], we see the B2C sector in particular as having tremendous potential. We aim to work with major retailers to develop their online commerce.

For example, we recently worked with Sony to develop its online B2C business using our Aladdin technology.

Baidu stands to support more brand retailers to establish and conduct the transactions online. Large retailers usually have more ad budget. As more and more large retailers establish their independent presence on the web, Baidu is well-positioned to be a major beneficiary of the B2C e-commerce growth in China.

On the sales front, during the second quarter we continued to work closely with our distributors, rolling out a standard CRM system that has significantly improved customer satisfaction and sales efficiency. We also worked with some established distributors to expand into less developed areas in China.

This important future growth market for Baidu and we are confident that we have the right model and strategy in place, as well as a significant first mover advantage.

One of Baidu's key assets is our strong brand value and name recognition and we are committed to building upon our strong base through ongoing investment in marketing. Aladdin and Phoenix’s Nest are our main technology innovations for the year and we are excited to host the Baidu [Award] [inaudible], our yearly technology [exposition], in the third quarter to showcase our achievements.

In summary, by focusing on execution and staying ahead of the needs of our users and customers, Baidu has remained on a growth track in the last couple of quarters, despite turbulent economic conditions.

Looking forward, we have good reason to feel confident about our future and we are ready to see more growth opportunities that will come as the economy recovers.

China’s Internet user population continued to grow fast, reaching $338 million or 26% of the total population by the end of the second quarter 2009. So with an enormous potential market still ahead of us as China’s leading search engine, Baidu should continue to advise and educate the market, execute and deliver strong results.

Thank you once again for your continued support and now I will turn the call over to Jennifer for financial results.

Jennifer Li

Thank you, Robin. Hello, everyone. As Robin said, we are encouraged by our strong ability to execute on our strategy during challenging economic times. While we stay focused on our growth plans, we are also improving profitability through efficiency management and economies of scale. We’ll continue with our balanced approach to controlling costs while investing in important initiatives.

Now let’s look at some of the financial highlights for the quarter. The amounts mentioned are in RMB unless otherwise noted.

For the second quarter, total revenues were RMB1.1 billion, at the high-end of our guidance and represents a 35% increase over Q1. During the quarter, Baidu had approximately 203,000 active online marketing customers, a 12% increase from the corresponding period in ’08 and a 10% increase from the previous quarter.

Revenue per online marketing customer for the second quarter was approximately RMB5400, a 23% increase from both the corresponding period in 08 and the previous quarter.

Traffic acquisition cost as a component of cost of revenues was RMB175 million or 16% of total revenues, as compared to 12.7% in the corresponding period in 08 and 15.3% in the first quarter of 2009. The slight sequential increase over Q1 reflects the continued fast growth of our Union business. Going forward, we will place our focus on optimizing the quality of Union traffic to strengthen the contribution of this business. We will also expand revenue opportunities through higher quality contextual ads.

Bandwidth costs and depreciation costs as a percent of revenue both continued to decrease in the second quarter on a year-on-year basis. This demonstrates efficiency improvements, as well as increased scalability of the investment in capital expenditure.

We will continue to invest to ensure we have efficient infrastructure and sufficient capacity to serve the growing and evolving Internet development.

Selling, general, and administrative expenses in Q2 was RMB180 million. Over the past few quarters, we have focused on sales force productivity. With the ongoing rollout of Phoenix’s Nest, we expect to increase sales headcount to support the effective implementation of this new platform.

In addition, the Baidu World Forum, as Robin mentioned earlier, will also take place in Q3 as opposed to Q2 of last year. As such, different from last year, we expect Q3 SG&A expense to be higher sequentially than the Q2 level.

R&D expenses were increased 35% over the year-ago period, primarily due to increased headcount. Operating profit for the second quarter was RMB423 million, an increase of 53% over Q208, primarily driven by decrease in bandwidth and related depreciation expense, and the scalability of the expense structure that we have.

Total headcount as of June 30, 2009 was about 6,300, roughly 100 more than the previous quarter.

Income tax expense was RMB51 million for the second quarter. The effective tax rate for the second quarter was 11.8% as compared 9.7% for the corresponding period in ’08 and 12.9% in the previous quarter.

Net income was RMB383.3 million, a 45% increase from the corresponding period in 08. Basic and diluted EPS for the second quarter of 09 amounted to RMB11.09 and RMB11.02, respectively.

Net income excluding share-based compensation expenses, a non-GAAP measure, was RMB406 million, a 38% increase year over year. Basic and diluted EPS excluding share based compensation expense, both non-GAAP measures, were RMB11.75 and RMB11.68 respectively.

As of June 30, 2009, the company had cash, cash equivalents and short-term investments of RMB3.4 --

Operator

Oh my god. Please stand by, your conference will resume shortly. Again, please stand by.

Your line is open now.

Robin Li

We are ready for questions.

Operator

Okay, it will be one moment.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mr. James Mitchell.

James Mitchell - Goldman Sachs

Great. Thank you very much for taking my question. I wondered if you could talk a little bit more about the sequential increase in traffic acquisition costs as a portion of revenue. And also, you are guiding for faster sequential revenue growth in third quarter 09 than you achieved in third quarter ’08. Is that primarily because there’s no Olympics this year or is it because the macro environment is improving sequentially or is it Phoenix Nest or something else? Thank you.

Robin Li

Haoyu, can you take on the TAC question?

Haoyu Shen

TAC has increased sequentially against Q2 as I think Jennifer mentioned in her prepared remarks, it still continues to be mostly due to the faster growth of our revenue that comes from Baidu Union. So the same as before, the pay-out ratio is stable and we are seeing some of our Union performers very well, so that’s by and large the reason.

James Mitchell - Goldman Sachs

So the individual Union partners are growing faster, it’s not just that you are adding more and more Union partners?

Haoyu Shen

This quarter mostly because some of the existing partners are doing well.

James Mitchell - Goldman Sachs

Okay.

Robin Li

Regarding the sequential growth of revenue for Q3 compared to last year, yes, the main reason is Olympics during Q3 of last year. We are happy with the progress of Phoenix Nest so far but we are not ready to say that Phoenix Nest will have very positive revenue impact at this time because we are pushing out some of the paid results from the classic edition, which would reduce the revenue generation. Once this kind of process is complete, we will start to see net positive impact from the Phoenix Nest.

James Mitchell - Goldman Sachs

Great. Thank you very much.

Operator

Your next question comes from the line of Jeffrey Lindsay with Sanford Bernstein.

Jeffrey Lindsay - Sanford C. Bernstein

Thank you for taking my question. Could I ask, how -- which advertising sectors are looking strongest in your advertising business and how much further has Phoenix Nest to go? Are you at the very beginning at Phoenix Nest or are you part way through the implementation? And how much longer will the implementation take? Thank you.

Jennifer Li

I’ll take the first question -- in general, our overall sector kind of has a normal pattern in terms of the relative behavior. We do see in the economic down cycles some B2C sectors like medical, particularly are more resilient, education performance very strong in relative terms but all of these during these seasonal times are not out of the normal patterns.

On the second question --

Haoyu Shen

First, just to add more color to what Jennifer said, I think one thing is seasonality and also I think we are starting to see better performance of B2C sectors than B2B sectors, which is far different than what we saw at the end of last year, the slow down came last year we saw a drop of those B2C sectors and the B2B sectors. Now we are seeing B2C regaining the growth advantage over B2B sectors.

On Phoenix Nest, we see a very good adoption rate right now and it is -- I think the way to characterize it is probably we’ve gained strong footing already for this product. The customers who are using Phoenix Nest, although their spending on Phoenix Nest is still a small part, sort of a minority of their total spending with us, but they are happy with what they saw in terms of ROI but as Robin mentioned, right now we are still replacing some of the pay links that we had before in our sold system with the new Phoenix Nest links, Phoenix Nest paid links. So to be able to see positive or material positive impact on our revenue, it will probably still take a few more quarters.

Jeffrey Lindsay - Sanford C. Bernstein

Thank you very much.

Operator

Your next question comes from the line of Gene Munster with Piper Jaffray.

Gene Munster - Piper Jaffray

Good morning and a couple of quick questions. First in terms of the operating margin, almost 39% versus 34% a year ago -- can you give us some thoughts in terms of the sustainability of that higher margin? And second, the China [Joy] Conference that is going on right now, you guys had some events there too which surprised me a little bit. Maybe you could talk about what your strategy is in online games in China.

Jennifer Li

I’ll take your first question and allow Peng and Haoyu to answer your second. Our operating margin improved this quarter, as I mentioned earlier. It’s because of the continued leverage of our overall cost structure, as well as efficiency improvement that we have been able to implement, both on the equipment side as well as the overall operating expense structure side.

We have mentioned many times that this business model has inherent, very strong margin capabilities. However, what we need to be mindful is this -- China’s Internet industry is still in its early stage and we need to make investment in important initiatives. We’ve mentioned a couple of important initiatives in the past, such as Aladdin, such as Phoenix Nest, such as some of the marketing and branding activities that we are putting more focus on.

So going forward, we do have a very disciplined approach to cost but we do not have a margin target per se.

Going into Q3, as I mentioned earlier, we are picking up some investment in sales force capability build-out and resources build-up and we’ll also continue to invest in the equipment side to make sure we capture and we meet the market demand, as well as to stay ahead of the curves.

Marketing also, going into Q3 I mentioned, the Baidu World Forum will occur this year as compared to Q2 of last year, so sequentially you should anticipate some SG&A expenses to go up.

So on an ongoing basis, Jim, back to the question is tremendous margin capabilities, we do not focus on short-term margin targets. We’ll manage our cost base on a very disciplined approach and our focus is to drive revenue growth and to capture, stay ahead of the Internet development in China.

And I’ll pass over to Peng and Haoyu to comment on the China Joy event.

Haoyu Shen

Actually, Peng and I are still stuck in Shanghai right now because of a flight cancellation -- yes, we are at the China Joy event, and the reason is gaming has become a big sector for us as far as paid search customers, so it’s a good opportunity for us to get to know more about this sector to really talk to our customers and organize an event, almost a marketing and social event with our customers.

What we did was we gave sort of these games awards based on their search query volume on Baidu, so that’s what we were doing.

Peng Ye

We call it the very popular, so called the top popular games in China during the last year based on the search queries.

Gene Munster - Piper Jaffray

Okay, but you guys aren’t interested in getting into the gaming business, per se?

Haoyu Shen

We do not have any plans for getting into the game business.

Gene Munster - Piper Jaffray

Okay, great. Thank you and congratulations.

Operator

Your next question comes from the line of James Lee with Sterne Agee.

James Lee - Sterne Agee

Jennifer, I was hoping maybe you could talk about some of the costs structure into third quarter. You had said that expenses will go up because you are hiring more sales people for the Phoenix Nest system and also for the forum. Is that in percentage of revenues or is that the absolute amount? And can you give us any idea how much movement of increasing cost from 2Q to 3Q? And also along with TAC, do you expect -- it seems like you guys are trying to manage the TAC going forward to acquire high quality traffic. Should we expect the TAC rate to be somewhat stable or do we expect that to creep up in the second half of the year? Thank you.

Jennifer Li

James, I’ll take your first question and I’ll allow Haoyu to elaborate on the second. In Q3 basically there are two things that are happening -- one, as I mentioned, we are going to step up our sales force hiring to support Phoenix Nest implementation, so there will be more people costs related in the cost structure. In addition, we’ll host the Baidu World Event, particularly due to that, happen in Q2 last year. This Q3 versus Q2 will kind of break this expense trend a little.

Last year, if you’ll notice our Q3 SG&A expense was actually lower than Q2 and to answer your question in terms of how directionally you should think about that, if you look at Q1 and Q2 SG&A expense relationships in absolute dollar amounts, that kind of gave you an indication of the marketing related expense change going into Q3.

And obviously this year, we are stepping up on the headcount hiring efforts compared to last year, so you should bake a little bit of that in the picture for Q3 as well.

I also want to caution you also going into Q3, I mentioned in the past is typically the students graduate from school and will join on board from an R&D perspective so typically the seasonal pattern is R&D headcount will also increase in the later part of the summer months.

Haoyu, can you take the TAC question?

Haoyu Shen

James, on TAC, as you probably notice that we revisited our TAC pay-out policy recently and revised some of the terms. What we do is really to differentiate different types of partners, different types of traffics and give different pay-out rates and the principle here is we want to reward partners that are loyal to us, we want to reward partners that bring incremental traffic to us. We want to reward partners who can sort of give complementary search access points to our Baidu organic search. So this policy is just recently published so we will carefully monitor market response. My guess is some of the -- this will definitely encourage people to give us higher quality traffic so that they can get the high pay-out rate. On one hand, this might have impact of even increasing the proportion of search traffic that comes from partners but on a pay-out front, I think it will be stable, if not going slightly lower going forward.

So these two factors combined together, it’s very hard to say as a percentage in total revenue where TAC will be going forward, but as we mentioned a few times before, we do manage -- it’s a very competitive business. We also manage this business on a net of TAC, revenue net of TAC basis.

James Lee - Sterne Agee

Got it, and I just want to clarify Jennifer’s answer regarding SG&A -- it seems like we are going back to 1Q level in terms of SG&A; then we also need to add in recruiting of the new employees during the third quarter, so the level of the total SG&A will actually be higher than the $28.3 million that you are posting in 1Q?

Jennifer Li

I think directionally that’s right.

James Lee - Sterne Agee

Okay. Thank you.

Operator

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

Eddie Leung - Banc of America Merrill Lynch

Good morning, everyone. A couple of questions -- the first one is could you guys talk a little bit about the increase in accounts receivables in the quarter? And the second question is the user traffic trends -- could you let us know the user traffic trend changes within the second quarter and into the early parts of the third quarter? Thank you.

Jennifer Li

I’ll take your first question. Increased accounts receivable is -- there’s nothing abnormal going on there. It basically reflects the increased revenue particularly associated to the businesses that we do with large customers. In our traditional P4P business with SMEs, you know we basically have a prepayment kind of payment terms and we do have credit lines with the large clients and the increase of AR basically reflects higher revenue that we basically earned during Q2 and some of the payment terms that flow through the balance sheet.

So there’s payment terms is standard. The total quality of the outstanding accounts is normal, so basically AR is in line with revenue growth.

Haoyu Shen

On the user traffic front, we have seen very healthy traffic growth during the past quarter. When we compare this with previous years, meaning ’08 and ’07, we saw nothing [unusual] -- the traffic pattern has been very, very consistent with previous years. So we believe we have a solid footing on the traffic share front. We maintained, if not gained, traffic share during the past quarter.

Eddie Leung - Banc of America Merrill Lynch

Got that. Thank you very much.

Operator

Your next question comes from the line of Richard Ji.

Richard Ji - Morgan Stanley

My first question is regarding your Phoenix Nest -- and what I am just curious about is the penetration rate of Phoenix Nest among all your keywords -- in other words, what percentage approximately of your keywords have already used Phoenix Nest? And also, based on the initial feedback from your customer, are you seeing positive feedback across the board or there are still areas that your customer wants you to improve?

And my related question is regarding your development in terms of attracting large corporations, such as Intel, and as well as Nike, which are typically a so-called atypical advertiser for paid search and I’m just curious about whether you are offering a more competitive [inaudible] and especially relative to your previous listing rate, and [your offer to the small companies] and also versus the traditional online brand advertiser and what does the [inaudible] look like?

Haoyu Shen

So the adoption rate is very high if you look at the number of customers. I think on a given day, out of 100 customers who have received paid clicks from us, about half of them receive some Phoenix Nest clicks, but as I said, the spending on Phoenix Nest is still a relatively small percentage of total spending. And one reason is not all the keywords, they have -- the customers, a lot of customers have now put all of their keywords, all of their potential keywords on Phoenix Nest, yes, so that’s one of the areas we are focusing on going forward into the next quarter.

As far as feedback, I think we have pretty good feedback across the board, although there are some customers who spend more on Phoenix Nest, the feedback is more sort of comprehensive because they feel it, they feel the impact of Phoenix Nest, they feel the clicks are bringing them good conversion.

For those who are not spending much yet, it is still unclear, just because of the sheer amount they are spending with us is small.

But again, overall the general feedback is very positive.

Peng Ye

I will take your second question. Regarding the branded customers, I think to some extent you are right -- the SMEs, they measure their ROI in a much more simple way using our marketing platform but the branded customers, they measure ROI in terms of their marketing spending in much more comprehensive ways. So we offer them with much more comprehensive and completed online marketing solutions, not only P4P but also community products. So we do not give them the very competitive terms and conditions but we offer them a much more complete or comprehensive solutions.

So so far, they are very happy with our offerings.

Haoyu Shen

I’ll just add to what Peng said, that I think it is true when it comes to search, that the need from small advertisers and brand advertisers are different but we working with the brand advertisers really to show that there’s a lot of branding value that search can bring and I think that message is definitely sinking in, especially with some of our innovative search products.

Richard Ji - Morgan Stanley

Very helpful. Thank you.

Operator

Your next question comes from the line of Dick Wei.

Dick Wei - J.P. Morgan

Just two quick questions -- the first question is I just wonder, the customer growth seems to be slower than the ARPU growth. I wonder, is it going to continue? And what was the reason?

Peng Ye

I will take this one. A couple of reasons behind this situation. I think one is last year in Q3, we increased all the minimal customer deposits. As a result, you saw the sudden growth in terms of customer growth in the last year, Q2. Another issue is, another situation is that we during the last couple of quarters, we didn’t increase our sales force and on the other hand, we implemented the Phoenix Nest in the customer base and also transferred some of our existing customers to the new system. So that took some bandwidth of our sales force effort and -- but on the other hand, you will see the ARPU growth is very healthy. That is mainly because of the -- currently, the quality of our customer base has increased a lot, improved a lot.

Jennifer Li

And Dick, I just wanted to add a little bit more. Peng obviously offered some color but if you look at the prior year’s sequential trend, Q2’s ARPU sequential growth is always higher than the number of customer growth. You do know because of the strong seasonality, the nature of Q1 with Chinese New Year there, ARPU is particularly low an we typically enjoy a very strong rebound in Q2, so in general, we -- the sequential growth was 23% this year, it was 22% sequential ARPU growth last year. So the pattern is still there. There’s some variations but I think the general, the pattern is still very normal.

Dick Wei - J.P. Morgan

The second question maybe is for Robin -- I guess Alibaba launched some more pay for performance or search-based advertising services on both I guess the top [inaudible] site, [Alimama], or like on the domestic B2B site. And I wonder, have you seen any of your customers, like B2B or B2C customers shifting more ad budget to Alibaba and how do you look at ad budget changes for [inaudible] as the market evolves in China? Thanks.

Robin Li

Well so far, we haven’t seen any meaningful impact on our customers for the alternative ways of promoting their products and services.

I guess one of the key differences is that Baidu, as the dominant search engine, we are an open platform. We direct our users or consumers to our customers’ own site. We believe this is the future. We believe in the future especially on the B2B and B2C side, the Bs usually prefer longer term to have an independent presence on the web. That’s why we are quite confident that our customers will continue to spend on us more and more.

Dick Wei - J.P. Morgan

Great. Thank you very much.

Operator

Your next question comes from the line of Scott Tong with Oppenheimer.

Scott Tong - Oppenheimer

Good morning. Just a quick question on Baidu's [inaudible] -- can you just kind of let us know what is the key differences between Baidu's statistics versus Google’s analytics? And how does it improve monetization? Thank you.

Haoyu Shen

I think it’s about the new tool we launched, right? Okay, it’s code-named [inaudible]. The official name I think is Baidu Statistics. It is a web analytics tool where right now, we are launching it or pushing it to our paid search customers. We enable them to monitor and track their traffic, the source of the traffic and also after the click, what happens, so this will really give them a much better view of ROI of their search spending. And going forward, we’ll integrate this tool in terms of the data exchange with Phoenix Nest. And we also have plans to launch this product to our union partner.

So I think this is a very important tool that really demonstrates that we think by giving customers more data, giving them more transparency will enable them to appreciate the ROI of paid search more and eventually lead to higher spending on Baidu.

Does that answer your question?

Operator

Your next question comes from the line of Jason Brueschke from Citigroup.

Jason Brueschke - Citigroup

Thank you. Good morning, everyone. My question is on the ARPU, just a little bit of a follow-up to I think Dick’s question -- if we look at the year-over-year growth in ARPU this year, it seems to have decelerated from the year-over-year growth that we saw last year, and I’m wondering how much of that you would attribute to the -- maybe the overall still generally weak condition in the Chinese economy, and maybe how much of that might be attributed in some ways to some of the customer clean-up that you guys did at the end of the fourth quarter and into the early part of the first quarter? Thanks.

Robin Li

Sorry, we lost the Operator and we didn’t hear the first part of the question.

Jason Brueschke - Citigroup

The question involves your ARPU growth. It’s growing at a slower rate this year compared to the Q2 rate last year and I am wondering how much of that is due to the weakness in the economy and if there’s any lingering effect from some of the customer cleanup that you guys did at the end of the year and the beginning of Q1.

Jennifer Li

Let me understand your question -- ARPU sequential growth this quarter was 23%. It was 22% in ’08 sequential rate. It was 24% in 2007, so I don’t think I quite get your question.

Jason Brueschke - Citigroup

I think it’s about the year-over-year growth.

Robin Li

In terms of the year-over-year number, we explained it before that the Chinese New Year happened at a later time during ’08; therefore, from a seasonality point of view, Q1 would be lower in ’08. That’s why you see a stronger growth for ARPU during ’08.

Jason Brueschke - Citigroup

Great, thanks.

Operator

Your next question comes from the line of C. Ming Zhao with SIG.

C. Ming Zhao - SIG

Thank you. I have two questions. The first question is following that competitive landscape question, if you look at your today’s sales and the contribution from B2B and B2C, do you see a faster growth in the B2C business spending on the platform than the B2B?

Robin Li

Ming, as I mentioned, I think since the end of Q1, we are seeing B2C sector regaining the growth advantage over B2B sectors. If you -- when you are talking B2C, you mean B2C broadly, not online retail, right?

C. Ming Zhao - SIG

Correct, yes.

Robin Li

So yes, we are seeing the higher growth of B2C than B2B again.

C. Ming Zhao - SIG

Okay the second question is we see some news about the Baidu space, so can I ask you what is the plan there? How are you going to monetize that? Are you going to launch some web page games like some other competitors do?

Robin Li

Well, Baidu Space is a social networking product offering from Baidu. It’s being launched for a couple of years and we continue to make improvements in this product. We continue to add features. We opened the platform for other application developers to add games to our service.

In theory, there could be revenue potential from there but right now, we’re not counting on that.

C. Ming Zhao - SIG

All right. Thank you.

Operator

Your next question comes from the line of Eric Wen with Main First.

Eric Wen - Main First

I just have a question regarding your partnership with [inaudible] -- number one is how is search embedded into this product? And second is that is Baidu thinking of continuing this approach of basically working with large retailers, or more like your C2C platform, you are going to have a hosting platform for other companies to connect to your platform [to sell their products] regarding what your long-term vision is toward that.

And number three is if you can share with us some of your early thoughts on monetization -- is this going to be a one-time project fee or are you talking about revenue sharing going forward? Thanks.

Robin Li

As I mentioned, we have seen the B2C sector start to take off during the past quarter and the [inaudible] deal represents our effort to make things happen faster. The detail of the [inaudible] deal is like -- we would pretty much function as a consultant and help them to, but give them how to build their web presence and in addition, we would open a interface for them to feed their product information to our search results. We will [insert] those product information in the proper position of our web search results, which uses the Aladdin technology. So that will give our partners better exposure of their products.

Going forward, I think this will be the main way of our effort into the B2C sector, because we strongly believe that retail is all about brand and the traditional retailers need to have their independent presence on the web and once they realize that the Internet is going to be a major distribution channel for them, they will need to invest more and they will advertise on Baidu to drive traffic to their site, so we stand to become a very large beneficiary of this trend. So we do not plan to offer hosting services for large retailers. Our approach is to educate the market so that they will come online sooner, they will use the Internet channel sooner and better so we can benefit from this trend.

Eric Wen - Main First

Got it. Thanks.

Operator

Your next question comes from the line of James Sullivan.

James Sullivan - Analyst

Good morning and thank you very much for the call. Just a very quick question regarding the outlook for the Japan business. We’ve now seen [NHN’s] launch in Japan. I’m just wondering if there are any lessons learned or takeaways from that launch that you can potentially apply to your business moving forward, and what the expectation is in terms of when you will start to see revenue recognition off the Japan business. Thank you.

Robin Li

We continue to make progress in our Japan business. At this point, the main focus is still improvement of product quality. We continue to work on our web search. We also are working on a number of new product offerings for the Japan market.

Because Japan is a more mature market, at this time we do not have any plan to generate revenue because we strongly believe traffic needs to go first and before traffic, it’s product quality. So once our product is very competitive, we will start to find ways to generate traffic and revenue will then follow.

We at this time do not have definite schedule revenue generation for Japan.

Operator

Your next question comes from the line of Stephen Ju with RBC Capital Markets.

Stephen Ju - RBC Capital Markets

Good morning, everybody. I was wondering if you can give us an update on your mobile initiative. It seems like your competitor has been stepping up its efforts in product releases and advertising as of late. Thank you.

Haoyu Shen

We’ve been keeping a close eye on the mobile front. We have partnered with quite a few large players in this space, including some of the carriers, China Telecom, China Unicom, and companies like Samsung or Lenovo. We’ve placed our search services in some of the mobile phones with --

Operator

Your conference will resume in a moment.

You are now joined to the main call.

Unidentified Participant

I’ll hand the call back to Robin Li.

Robin Li

This is Robin. Sorry for the technical difficulties. We got lost somehow. I am not sure if my answer about the mobile scene was heard. Should I repeat that or should we move on?

I can’t hear. Okay, regarding the mobile question, we are seeing rapid changes in the 3G mobile market in China. We are making the necessary investments in all kinds of product features we are offering and we are working on some new products too but at this time, there are still lots of uncertainties regarding the wireless Internet, so it remains to be seen what would be the [inaudible] for wireless search or for mobile Internet in general.

But we’ve partnered with a number of companies, including carries like China Telecom, China Unicom, companies like Samsung, Lenovo, and we placed search features in some of the customized 3G mobile phones in China.

So Operator, let’s take the last question.

Operator

Your next question comes from the line of Hugh Bond with HSBC.

Hugh Bond - HSBC

Thank you for taking my question. My question is on the total number of advertisers -- compared with Q109, there is 18,000 new [inaudible] but compared with the Q4 number, there is only 6,000 new [ads]. During the Q1 call, you said that the decline of customers in Q1 was due to the majority of those [question] customers were still active in Q4 but removed in Q1. So can you illustrate how much of the new [ad hits] customers in Q2 is truly new [inaudible] and how much from Baidu's previous customers? Thank you.

Haoyu Shen

I didn’t quite get the essence of the question but it is true that the decline in Q1 versus Q4 is because of sector cleanup and the increase of Q2 versus Q1, sort of net addition to our customer base.

Hugh Bond - HSBC

Right, my question is how much of these 18,000 are truly new [inaudible] and how much are from Baidu's previous questionable customers coming back?

Haoyu Shen

Oh, I see what you mean. I don’t think there are many customers that advertised with us before Q4 last year but didn’t in Q1 but did again in Q2, so -- or in other words, these are truly new adds.

Hugh Bond - HSBC

Okay. Thank you.

Operator

We are now approaching the end of the conference call. I would now like to turn the call over to Baidu's Chief Executive Officer, Robin Li, for closing remarks. You may proceed.

Robin Li

Once again, thank you for joining us today and please do not hesitate to contact us if you have any further questions. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

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Source: Baidu Q2 2009 Earnings Call Transcript
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