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Baidu, Inc. (NASDAQ:BIDU)

Q3 2013 Earnings Conference Call

October 29, 2013 8:00 PM ET

Executives

Victor Tseng – IR Director

Robin Li – CEO

Jennifer Li – CFO

Analysts

Alex Yao – JPMorgan

Jiong Shao – Macquarie

Dick Wei – Credit Suisse

Alicia Yap – Barclays Capital

Gene Munster – Piper Jaffray

Philip Wan – Morgan Stanley

Ge Qing – HSBC

Wendy Huang – Standard Chartered

Eddie Leung – Merrill Lynch

Muzhi Li – Citigroup

Piyush Mubayi – Goldman Sachs

Ming Zhao – 86Research

Eric Wen – China Renaissance

Andy Yeung - Oppenheimer

Cynthia Meng - Jefferies

Operator

Hello and thank you for standing by for Baidu’s third quarter 2013 earnings conference call. At this time, all participants are in 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, Victor Tseng, Baidu’s investor relations director.

Victor Tseng

Hello everyone and welcome to Baidu’s third quarter 2013 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 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 statement, except as required under applicable law.

Our earnings press release and this call include discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP 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 Baidu’s CEO, Robin Li.

Robin Li

Hello everyone and thank you for joining today’s call.

We’re proud of the substantial progress we made in all our key strategic areas in the third quarter. Through continued improvements to our core products, we further cemented Baidu’s place at the center of China’s Internet.

Our upward momentum on the mobile front was especially encouraging. Mobile revenue continues to accelerate, outpacing mobile search traffic growth. And we’ve introduced an exciting new paradigm in app distribution, which I’ll talk about more in a moment.

Baidu believes in opening up the endless possibilities of the Internet to as many users, developers and customers as we can. We are building an open and accessible ecosystem that fosters innovation, and we strive to connect a growing number of developers to users across multiple channels. This quarter we made great strides toward that goal.

At Baidu World 2012, we announced our “Seven Weapons” for developers, offering free infrastructure, tools and resources to the developer community to create a vibrant app ecosystem. This year in the third quarter, we made the Baidu ecosystem even more compelling by significantly strengthening our app distribution capability, particularly in native apps.

Our acquisition of 91 Wireless, which closed on October 1st, significantly bolsters Baidu’s position in the vital area of app distribution. With the combination of 91 Wireless and Baidu’s mobile assistant app store and other distribution channels, Baidu is the #1 app distribution channel in China, distributing 80 million apps on a daily basis. And by working closely with developers and applying Baidu's unrivaled search capabilities to our vast combined library of apps, we are creating a new app search experience. Users looking for an app will no longer need to include a specific name, genre, or text in an app's description: Baidu will make any text or function within the whole app searchable, and recommend the most relevant apps for a given query. We have laid out a clear plan for integrating 91 Wireless. We are looking to leverage the distribution power of the Baidu and 91 Wireless platforms to have them cross promote each other’s products. We look forward to integrating the backend and bringing 91’s developer base onto an integrated Baidu cloud platform.

At the same time, we are pushing forward a new paradigm we called Light Apps, an initiative we unveiled at Baidu World a few months ago. While app stores are an excellent distribution channel for native apps, particularly for popular and frequently used ones, less frequently used apps can get lost. Currently, in China around 0.1% of apps account for 70% of all downloads. In other words the other 99.9% compete for the remaining 30% of downloads. Light Apps have all the power and functionality of native apps, and are easily discovered through Baidu search, but, unlike native apps, do not need to be downloaded. For this reason, they are an ideal format for that 99.9% of less well known, less frequently used apps.

To give you an example, a user may look through classified listings a few times a year for a used car or rental apartment. So there’s no real need to have a classifieds native app sitting on their device. Formatting those classified listings as a Light App gives the user the same functionality as with a native app without taking up space on the device. And again, the app is easily searchable, even if the user doesn’t know its name. There is tremendous potential to improve and streamline user discovery of mobile internet contents and services.

While we’re still in the early stages of development with Lights Apps – with a limited number of developers invited into this first phase - I’m convinced they have a big role to play in the future. With a daily active user base of 130 million and counting, our mobile search platform can be a powerful alternative distribution channel for app developers that are not benefitting from the current model. Native apps will continue to be important and coexist nicely with Light Apps. So for the next several quarters, our strategy is to gradually expand the Light App model to complement our native app distribution capabilities.

In terms of our core search offering, this quarter we made further improvements in natural language processing, deep learning, image recognition, voice technology and use of big data. These key technologies help us predict, better than ever, what users are searching for. For a fun example, I can input the search term, “What movies is Jennifer Aniston’s former husband’s partner in?” Baidu then deciphers the relationships in the search term and returns a comprehensive, structured data search page with Angelina Jolie’s movies as image tiles. The user doesn’t need to know the exact name of the actress and he can play one of the movies in three clicks or less. To the user, this result is simple and direct. But the search is powered in the back-end by our vertical landing page and sophisticated technology such as deep learning and natural language processing.

We also continued to deepen data integration across the board, with our own vertical services as well as with partners, to deliver a more interactive search experience to our users. For example, in our medical vertical, we are now partnered with over 700 hospitals to enable online advisory, medical-appointment booking, online reviews and other actions right on the Baidu search page. And our customers are seeing very meaningful returns with this vertical approach. In the online gaming vertical, for example, customers who opt in to our iwan.baidu.com online gaming portal have on average seen user registration conversions triple, and ROI increase nearly 50%, compared to standard search marketing. We’re already working on going deeper in additional verticals, such as online travel, financial services and education. Both for our customers and for us, the commercial potential here is significant.

As Baidu grows, so too does our responsibility to protect our users. That is why we are forging ahead with our Netizen Rights Protection initiative. This quarter, we removed the upper limit on the amount we compensate users who may have been defrauded or harmed by a sponsored link on the Baidu platform. Today, I believe that Baidu is doing more than any other company to foster a safer, fairer online environment in China. And this will inevitably benefit not just our users, but also our platform as a whole in the long run.

On the product side, uptake of our core services grew strongly in the third quarter. Our internal tracking shows that we are the clear #1 in mobile search and we are continuing to gain market share. The total install base of our flagship mobile search app at the end of the third quarter was over 330 million, representing an increase of 50% quarter on quarter. Our search app is an important source of organic traffic for Baidu, and its embedded features, such as voice search, image search, QR code scanning and OCR word translation, provide the best overall user experience. Its growth continues to accelerate and it has been the fastest growing source of Baidu mobile search traffic over the last several quarters.

Personal cloud storage usage has now reached over 100 million accumulated users, growing over 40% from the end of last quarter. We are now offering users 2 terabytes of free storage and the response has been great. Baidu PCS is increasingly becoming the service users turn to for all their content-storage needs across all forms of media, from their Baidu Music playlists and Baidu video television shows to their Baidu Library documents and photos from Baidu PhotoWonder.

Our LBS offering now has over 140 million monthly active users, up from nearly 120 million monthly active users at the end of last quarter. This growth is a reflection of the continuous improvements we are making to our LBS functionality and content. Baidu Maps continues to build on its strength as a key mobile gateway for local search, and it has grown into a broad platform facilitating a wide range of queries and transactions. In the past quarter, the number of transactions completed on Baidu Maps, including hotel bookings, movie ticket purchases, group buying and taxi bookings continued to increase. Hotel bookings on Baidu Maps, for example, doubled from the second quarter to Q3. We were the first to offer a free premium navigation product in the third quarter. And we’re now offering Street View in a growing number of cities.

Our majority investment in group buying site Nuomi, announced during Q3, boosts our ability to offer a fully integrated user experience. Nuomi’s depth of experience and geographical sales coverage in the dynamic group-buying industry make it a natural fit for our LBS offering.

Moving on now to the customer side, all signs this quarter pointed to our customers really embracing mobile. And monetization has ramped up very healthily.

Back in the second quarter, we rolled out our integrated PC and mobile bidding system, which continues to be well-received by customers. Now, three quarters of our mobile search revenue comes from customer spend through actively bidding on mobile. The same proportion of our mobile search revenue comes from spending from customers with mobile-optimized landing pages. We provide customers with a comprehensive range of ad formats, as well as a range of simple and powerful tools to facilitate the transition to mobile. Ad formats such as pay-per-call and click-to-chat, and easy-to-use tools like SiteApp, are helping our customers get better mobile results. Increasingly, our customers are saying that mobile search marketing is a channel they must employ, as the percentage of mobile traffic to their sites continues to rise and the trend of rapid mobile adoption continues. More and more of our customers – both SME and large customers across industries - see mobile search as a vital, complementary marketing channel to PC search. For example, an SME in Shanghai that operates a chain of vocational training centers has been a PC search marketing customer since 2005. They started mobile search marketing at the end of last year as a way to differentiate themselves from the competition, using Baidu’s SiteApp tool to optimize their mobile landing page. They’ve seen great results from their mobile search spend, which now accounts for 30% of their total marketing spend on the Baidu platform - that’s up from 8% last year. To share another example in a different segment, one of our large customers in the online travel space saw mobile as a portion of its business grow ten-fold in the span of a year. Baidu worked closely with the customer to optimize their mobile landing page and better target their users, resulting in a very meaningful increase in its mobile conversion rate. The customer has quadrupled their mobile search spend and nearly doubled their overall search spend on Baidu over the last couple quarters.

In the third quarter, we broadened our +V initiative, a program in which we vet our customer base for proof that they are legitimate, licensed businesses. A large majority of our customers now have +V verification, which provides them with a blue +V logo in sponsored links, and provides enhanced options to advertise on Baidu. The benefit of this is that we have a higher-quality customer base, which is good for both users and customers — and good for Baidu in the long run.

In the short term, this +V initiative may have a slight negative impact on our absolute customer number count. But demand for search marketing on Baidu continues to surge and customers continue to look to Baidu to bring a large of scale leads and measurable ROI. Our focus on servicing quality customers and improving our monetization capabilities has helped drive up ARPU.

In addition, we have started to make efforts to expand our business beyond just online marketing services. Online gaming is becoming a more important business for Baidu as we build a portfolio of gaming resources to leverage our distribution capabilities. PC search is a powerful channel for web games and the acquisition of 91 Wireless not only complements our pre-existing game distribution capability in mobile search and Mobile Assistant but also provides us with 91 Wireless’ capabilities as a mobile game operator. Gaming is a highly monetizable industry and it will become a more meaningful part of our business in the future. We see huge opportunities ahead and we will look to grow this area going forward.

A couple of updates here on our invested entities… The integration between PPS and iQiyi has gone smoothly. The combined platform is #1 by total monthly time spent on PC and mobile, according iResearch. Baidu will remain a strong supporter of iQiyi to grow its position in this important strategic vertical.

Finally, as you know, our invested entity Qunar has filed for an IPO. Baidu has been a majority shareholder in Qunar since 2011. As Qunar is currently in quiet period, we will not be able to elaborate more on this topic until their IPO process is finalized. You can refer to the publicly available IPO prospectus for additional details.

So, in summary, we were delighted to maintain strong momentum into Q3 after a breakthrough second quarter. Our leading position in search, app distribution, LBS, and cloud computing continues to promote a rich and diverse ecosystem, and we substantially bolstered our app distribution capabilities with the acquisition of 91 Wireless and the introduction of Light Apps.

All this is translating into strong traffic and revenue growth, with mobile playing an increasingly important role. There is still a long road ahead, but for us it’s about continuing to execute on the strategy that has proven so successful over the last couple of quarters.

Over to you Jennifer for a deeper look at the financials.

Jennifer Li

Thanks, Robin. And thanks everyone for joining today’s call.

We were pleased to maintain strong financial growth this quarter as we continued to expand our business and ecosystem. It’s clear that the investments we have been making in mobile are paying off, with mobile continuing its strong momentum both on the usage and monetization front.

Also during the quarter, we continued our aggressive investments in sales and marketing, infrastructure and R&D, with particular focus on mobile.

Q3 also marked the first full quarter that PPS was consolidated into our financials. 91 Wireless closed on October 1st and Nuomi is expected to close in the fourth quarter.

Looking ahead, we expect our core search business to continue its solid growth. We are focused on building our organic fundamentals, further complemented with strategic investment. Our business is on a solid trajectory and we will continue our aggressive investments in sales and marketing, infrastructure and R&D, with particular focus on mobile. We will also continue to support our video business through investments in bandwidth and content.

Now moving to the financials… All monetary amounts are in RMB unless stated otherwise.

For the third quarter, total revenues were 8.9 billion, representing an increase of 42% year-over-year.

During the third quarter, Baidu had approximately 464,000 active online marketing customers, a 19% increase from the corresponding period in 2012 and a 1% decrease from the previous quarter. The slight drop was a consequence of the broader rollout of our +V verified account program, which improves the quality of our customer base. Revenue per online marketing customer for the third quarter was approximately 19,100, a 19% increase from the corresponding period in 2012 and an increase of 19% from the previous quarter.

Traffic acquisition cost as a component of cost of revenues in Q3 was 1.0 billion, or 11.7% of total revenues, as compared to 8.6% in the corresponding period in 2012 and 11.6% in the second quarter of 2013. The increase in TAC costs mainly reflects the increased contribution of contextual ads and hao123 promotions through our network.

Bandwidth and depreciation costs as a percentage of revenues in Q3 were 5.8% and 4.2% respectively, compared to 4.3% and 4.4% in the corresponding period of 2012. The year-over-year increase in bandwidth costs was mainly due to the consolidation of iQiyi.

Content costs as a component of cost of revenues were 222 million, representing 2.5% of total revenues, compared to 0.5% in the corresponding period in 2012, and 2.0% in the previous quarter. The increase was mainly due to iQiyi.

Selling, general and administrative expenses in Q3 were 1.4 billion, an increase of 115% year-over-year, primarily due to promotional expenses for mobile products.

R&D expenses in Q3 were 1.1 billion, an increase of 77% over the corresponding period in 2012, primarily due to an increase in the number of research and development personnel.

Share-based compensation expenses, which were allocated to related operating costs and expense line items, increased in aggregate to 143 million in the third quarter from 57 million in the corresponding period in 2012. The increase was primarily due to the lengthening of option term of some grants.

Operating profit for Q3 was 3.3 billion, an increase of 1.2% over Q3 2012.

Total headcount as of September 30, 2013 was about 26,400 employees, of which roughly 5,000 were accounted for by Qunar, iQiyi and PPS. We added 2,400 more employees from the previous quarter, primarily in R&D.

Income tax expense was 588 million for the third quarter. The effective tax rate for the third quarter was 16.3% compared to 13.5% in the corresponding period in 2012, and 16.3% in the previous quarter.

Net income attributable to Baidu for Q3 was 3.0 billion, a 1.3% increase from the corresponding period in 2012. Basic and diluted earnings attributable to Baidu per ADS for the third quarter of 2013 amounted to 8.65 and 8.63, respectively.

Net income attributable to Baidu, excluding share-based compensation expenses, a non-GAAP measure, for Q3 was 3.2 billion, a 4.1% increase year-over-year. Basic and diluted earnings attributable to Baidu per ADS excluding share-based compensation expenses, both non-GAAP measures, were 9.06 and 9.04, respectively.

As of September 30, 2013, the Company had cash, cash equivalents and short-term investments of 43.3 billion. Net operating cash inflow for the third quarter of 2013 was 4.3 billion. Capital expenditures for the third quarter of 2013 were 780 million.

Now, let me provide with you with our top-line guidance for the fourth quarter 2013. We currently expect total revenues for the fourth quarter to be between RMB9.220 billion and RMB9.480 billion, representing a 45.5% to 49.6% year-over-year increase. Please note, this forecast reflects Baidu's current and preliminary review and is subject to change. I will now open the call to questions.

Operator, please go ahead.

Question-and-Answer Session

Operator

The question-and-answer session of this conference call will start in a moment, in order to be fair to all callers who wish to 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. (Operator Instructions).

Your first question comes from Alex Yao from JPMorgan. Please ask your question.

Alex Yao – JPMorgan

Hi, good morning everyone. Thank you very much for taking my question, and congratulations on a very strong quarter.

My question is on new initiative you guys launched recently, the internet banking service. Can you talk about your thoughts this initiative, how you guys want to position yourself in this year and how do you think about the monetization potential. Thank you.

Robin Li

Alex, I think the internet banking service we just launched a couple of days ago, it's in line with our overall strategy which we call Landing Page. There are quite a number of very important verticals for Baidu many of the large customers come from. But we just don't believe that a simple title and summary which leads the user to a website from those traditional industries (inaudible) [users to that]. In fact we can come up with better user experience by integrating more services into this kind vertical websites. So we have been doing this for travel, for video, for education, healthcare. Finance is not an exemption.

We also see a lot of opportunities when the whole world, I mean whole China, the offline is moving online but they are not very sophisticated in gracing the internet and they need help. So we came up ways to do our work which is traditionally more than a typical search engine would do but we think that would provide a better user experience. So the internet banking services which launched in line with this and we believe finance is a very important vertical for Baidu going forward.

Operator

Your next question comes from Jiong Shao from Macquarie. Please ask your question.

Jiong Shao – Macquarie

Hi, good morning. Thank you for taking my question. I have a question on Light App. I know you launched that initiative or announced it at Baidu World. I was hoping you can share with us [some] metrics at this point, for example how many apps right now in your Light App platform or on your Light App platform, and what's the daily download look like? What type of apps sort of fit best with this platform, and how easy it is for developers to change or modify their native apps to Light App? Thank you.

Robin Li

Yes, we have received a lot of inquiries from all kinds of different verticals, many of them have very strong monetization potential. But we'd like to start from something that's easier for the developers to manage and we, at current state, only selectively opened this up to a number of developers in verticals like news or classified. The developers or customers who work with us have seen very encouraging results. But this is a very early stage product, so we are continuing to improve our technology and to make this available to -- we'll make this available to more verticals that can benefit more from the Light App ecosystem.

Operator

The next question comes from Dick Wei from Credit Suisse. Please ask your question.

Dick Wei – Credit Suisse

Hi. Thank you for taking my questions and congrats on the strong quarter and guidance.

I have two quick questions on mobile. First of all, whether you can comment on the monetization gap between mobile search and PC search now, how does that gap trend for the past couple of quarters, and then what about going forward? And also just related to mobile also, whether you can comment on the TAC, TAC dynamics. It looks like we are relatively stretched as TAC as a percentage of revenue. Was it mainly because of the lower TACs from mobile because of large organic traffic, or was it because we have less reliance on the PC traffic from the third party? Thank you.

Robin Li

Okay. I'll talk about the mobile monetization and let Jennifer talk more about the TAC thing.

Mobile monetization have been growing very, very quickly over the past couple of quarters. So the CPM or RPM growth is faster than the traffic growth, even faster than the traffic growth, yet it's not reaching the level of PC monetization yet. We certainly see the gap is quickly closing, but exactly when they will catch up is another question. And right now we think the highest priority is still to provide the best user experience so that they will very much depend upon the Baidu search app to get information and services. Once we are more confident about that, we will give you more quantitative numbers on the monetization thing.

Jennifer Li

And with regards to TAC, TAC over the past couple of years has been on the trajectory to increase as a percentage of revenue. We've stated that the main factor driving that is the effort to grow our contractual apps business as well as promoting our hao123 product. Each quarter, because of the mix component of all the contributing factors, you might see some slight variations, but I wouldn't say that this Q3 TAC percent of revenue is a reflection of the future trend. We continue to use the -- our partners' sites, the networks to promote our contractual ads business as well as use that to promote our home products, and I do expect our continued -- the TAC percent of revenue will continue to increase.

Operator

Your next question comes from Alicia Yap from Barclays. Please ask your question.

Alicia Yap – Barclays Capital

Hi, good morning. Thanks for taking my questions. So I actually have a follow-up question on the TAC going forward. So I think, Jennifer, you just mentioned that it will be continue to increase. But just wanted to understand, with some of the new business with consolidations on 91 and Nuomi, how should we look at for the gross margins trend? Would that be more positive impact or negative impact? And as well as on the sales and marketing trend, will the consolidations actually lead to higher expenses and, you know, some margins pressure or margin expansion? Thank you.

Jennifer Li

You know, as I stated, we are in the mode and continue in the phase to aggressively promote our products. With regards to gross margin, the consolidation of new business in the fourth quarter will not materially impact the gross margin per se. I would say if you're looking at the forecast for our business, the fundamentals continue to be driven primarily by our core business, not these invested entities.

They, in general, do not make the kind of margins that the search business model does. So in general they do not, you know, help per se, but because their relative size is so small, they don't make material impact, these two ventures you just talked about.

Specifically with regard to operating expenses, we have our foot on the pedal to really push on sales and marketing, aggressively promoting our mobile product. As you have seen over the last quarter, the installed app for our search -- for search app is growing -- is growing by 50% quarter by quarter. You can see that, you know, we're really aggressively pushing our products to this channel. And we'll continue to use these different channels and ways to build our product presence. And you should expect that. You know, I'm not seeing that we are lessening our efforts in promoting our products and you should continue to see the step-up of SG&A expenses as a percent of revenue.

Operator

Your next question comes from Gene Munster from Piper Jaffray. Please ask your question.

Gene Munster – Piper Jaffray

Hey, good morning and congratulations. I apologize if I missed this, but can you give any context into how 91 factored into the revenue guidance for the December quarter? Thanks.

Jennifer Li

For the Q4 guidance, the main driver as you can see, we operate such a large base and our core search business is the organic fundamental of our business. That business continue on its solid growth. Q4 will be the first quarter that we consolidate 91 Wireless. And from priorly made available public information, you can get a feel of the scale of its revenue size as relative to the Baidu overall picture.

I mean in comparison, it is really low in terms of the overall contribution. But because if you're looking at 91 was zero in Q3, of course it's an added benefit for Q4 sequentially. But overall I would say our business continue to grow and the strong guidance in Q4 is a result of our core business that continue to perform very well.

Operator

Your next question comes from Philip Wan from Morgan Stanley. Please ask your question.

Philip Wan – Morgan Stanley

Hi. Thank you for taking my question. I have a follow-up question on your Light App strategy. I wonder if management have any target say by the end of this of how many applications or developers would you like to have on your Light App platform. And then also, what is your plan to monetize your Light App platform going forward? Thank you.

Robin Li

Yeah. Right now I think that the main hurdle for mobile search is that many of the content oriented websites do not have a mobile friendly version yet. So for the whole year, this year, until the end of the year, my team -- my mobile search team's priority is really to help convert those PC-centric content into mobile friendly content. Light App would be a more material thing next year. We're working with many prospects to come up with Light App. But eventually Light App will be an integral part of the overall mobile ecosystem which, you know, includes the data or content-driven mobile sites, the Light Apps, native apps, they will combine to -- they will be combined to serve the needs of our users.

So I at this stage, this is quite early, I'm not going to give you a number on the number of developers or percentage of [results] showing Light App. We hope we will be able to do this sometime next year.

Operator

Your next question comes from Alan Hellawell from Deutsche Bank. Please ask your question.

Unidentified Participant

Hi. This is [Vivian] on behalf of Alan. We have a question regarding the competition on the mobile search front. How do you view the competition from the new combined entity of Sogou and Soso which is reported already to have around 16% of market share and probably we're expecting more synergies with Tencent's support? As mentioned on the sales and marketing front, as most -- we probably will still see the surge in sales -- SG&A for promoting mobile. Just try to understand the landscape here of competition on the mobile search front. Thank you.

Robin Li

Mobile search is still very early. We've talked about our strategy of integrating PC content, mobile content, Light App and native apps. We quickly making a lot of improvements from mobile search and we think at this time Baidu mobile search provides the best user experience, far ahead of any competition. And as a matter of fact, we, based on our internal tracking, we continue to gain market share over the competition. And we probably invested a lot more than any of the competitors in the mobile search front because it's the nature of this early-stage development, we'll continue to aggressively invest both in the R&D front and in the sales and marketing front to prevent the Baidu mobile search options, especially the mobile search apps, in front of our users. We think this kind of investment is very worthwhile, is actually a very precious timing to spend the money of this. We think this year and next year will be very, very crucial for the eventual success of the overall mobile strategy for Baidu.

Operator

Your next question comes from Ge Qing from HSBC. Please ask your question.

Ge Qing – HSBC

Good morning and congratulations on a very good quarter and guidance. I was wondering if you can give us an update on your video business, if you can talk a little bit about what's happening on the competitive front as well as the trends on mobile as well as mobile monetization. Thank you.

Robin Li

Yeah, I think the video games both on desktop and mobile in terms of time spent and video views are growing very, very quickly. Right now it's not a very profitable business yet, but the traditional, you know, advertising industry is shifting the TV commercial budget to video and we think eventually this will become a very material part of the overall online advertising business. So our focus right now is still to continue to build the best user experience for video both on desktop and mobile. And there's no doubt that eventually this will become a profitable business for us.

Operator

Your next question comes from Wendy Huang from Standard Chartered. Please ask your question.

Wendy Huang – Standard Chartered

Thank you. I wonder if you can share your thoughts on the major difference of China's mobile search market versus the US and Korean search market. And what will Baidu do differently versus your global peer such as Google and Naver, is there mobile search technology or mobile advertiser [accretion]? And also I noticed that Google recently actually started to provide [the full payment] and getting deeper into e-commerce front. So Baidu actually used to have some major effort on the -- actually the e-commerce front. Could you give us some update on that as well?

Robin Li

Again I think for all of the countries or markets you mentioned, China, US, Korea, mobile search is in its early stage. So we are exploring all kinds of different things to better serve our users' needs.

One trend we have seen is that mobile users in China increasingly are expecting an end-to-end solution instead of just fact finding. So users are not satisfied enough to just find information or find a link to some website on their mobile phones. They expect to be able to [be served]. For example, when a user search for a movie title, we should be able to let him or her to buy the movie ticket at a theater nearby without leaving the mobile search app. So this is the so-called end-to-end solution, and we're doing this more and more. We see this as a trend in China.

Whereas for other markets which I'm not very familiar with, so I will just, you know, take some anecdotal things to compare. So in the US, people probably are more used to do this kind of thing through a vertical app or a map service, but in China, I think more of our users prefer to start from the Baidu search box or the Baidu search app.

Also because China's nature as a developing market, the offline businesses, the traditional business are not very savvy in terms of internet, especially mobile. So we need to do more than the internet players in the developed markets. This also presents, you know, additional opportunity for Baidu. If we do more, we should be able to make more of this kind of services.

Operator

Your next question comes from Eddie Leung from Merrill Lynch. Please ask your question.

Eddie Leung – Merrill Lynch

Hey, good morning. Thank you for taking my question. You guys have been making quite some progress on mobile search. But I have a question on your PC search. I understand that -- it seems that you have been improving your results as well as your monetization system on PC search, while some of your competitors are probably focused more on distribution. However, according to different traffic reports recently, it seems like your competitors [increased] some profit share. So just want to get some of your thoughts on the longer-term competitive landscape on PC search. Thank you.

Robin Li

Eddie, I think longer term the market share is going to be divided largely by the quality of the search or the user experience you provide. And on this front, we, you know, undoubtedly has the edge over our competition. Having said that, we are [challenged] that a small percentage of search traffic can be directed through certain control of channels like a browser. So you see that Microsoft controls the IE browser. So they can gain certain amount of search traffic with that browser, certain, you know, domestic competitors in China also control a percentage of the browser market so they can control certain percent of the search traffic from PC.

But at the end of the day, Baidu is a very strong brand in search in the mind of Chinese internet users and we provide a superior user experience for those users who do care the quality of search, we think Baidu is the choice for them. So going forward we are quite confident that by providing the best user experience, combining with the strong search brand, we will continue to dominate the PC search market.

Operator

Your next question comes from Muzhi Li from Citigroup. Please ask your question.

Muzhi Li – Citigroup

Hi, good morning. Thanks for taking my questions. I have a question about the mobile monetizations. What's the revenue contribution from the mobile side in the third quarter? And in terms of the mobile search category, what is the top advertising category on the mobile side? Is there any big difference from the PCs? Thanks for that. Yeah, thank you.

Robin Li

We decided not to disclose the exact percentage of mobile revenue quarter by quarter. We just like to qualitatively say, you know, how pleased we are about the mobile traffic monetization growth and the potential. We will probably disclose this number when we think there's a material change that will shape the -- shape the overall business for Baidu.

In terms of top categories, we think it's pretty much similar to the desktop search. Jennifer, do you have more color on that?

Jennifer Li

I think there's -- our customers are, as you know, using -- basically there's a [billing] system to promote their products and services on our platform both through the PC as well as mobile. So there is no -- not much of the advertising sector difference compared to the -- compared to PC.

Operator

Your next question comes from Piyush Mubayi from Goldman Sachs. Please ask your question.

Piyush Mubayi – Goldman Sachs

Robin, Jennifer, congratulations on a very strong number and your guidance for the fourth quarter. Could you talk about the contribution from key customer categories in the fourth quarter and in the last quarter? And in particular, could you shed some light on how e-commerce is panning out? Thank you.

Jennifer Li

If we look at our key sectors where the revenue contributions are, you know, amounting the top. In the past we've provided the fop five sectors, and in this quarter, you know, I would name the top five sectors continues to be consistently the same, namely, medical/healthcare, education, travel, machinery equipment, and online games. So these sectors have been consistent.

With regards to e-commerce, you know, we do separately from a different angle to look at e-commerce growth. And overall e-commerce grow very strongly. I would say both on the Q-on-Q and year-on-year basis, it's growing faster than the larger -- the overall average.

Operator

Your next question comes from Andy Yeung from Oppenheimer. Please ask your question.

Andy Yeung - Oppenheimer

Hi, good morning. Thank you for taking my question. Can you give us some color on the trend for your natural traffic versus acquired traffic in both PC and mobile search? And how would you see those trends impacting your traffic acquisition costs in the long run?

Robin Li

As I said in the prepared remarks, the natural traffic requires organic traffic for Baidu, has been growing faster than the acquired traffic. We see this as a trend, as a very positive trend that we are providing, good user experience. And our plan is better recognized by the mobile users. And in terms of PC, I think the traffic mix has been relatively stable.

Jennifer Li

And with regards to the TAC composition related to search traffic, as I've highlighted, the TAC changes are mainly driven by contractual business that's non-search traffic-related, as well as hao123 promotion. So it's -- the TAC itself, its movement is not a reflection of, you know, it's consistent with what Robin is saying.

Operator

Your next question comes from Ming Zhao from 86Research. Please ask your question.

Ming Zhao – 86Research

Thank you for taking my questions. My question is on the vertical approach. As I assume you were talking about [Quqin] system, I understand that is good for user experience and to keep them on your [properties] for a longer time. But from monetization perspective, does that mean a significant increase in ad inventories? So is it addition to the Phoenix Nest or is it going to replace it in the long run?

And also maybe, Jennifer, could you comment on margin outlook for the fourth quarter and beyond? Thank you.

Robin Li

Yeah. In terms of the [Quqin] vertical, we are trying to change the format of both the content and the sponsored content. We just don't believe that, you know, simple title and summary is the best way to present this kind of information to our users. By having a more sophisticated way of presenting this kind of information, we are able to, in general, create better ROI for our customers. So that will increase monetization eventually. And it's not really an apple to apple comparison in the inventory. It's more about a different form of inventory.

Jennifer Li

And with regards to margin, as you know, we're very focused on growing our top line business and manage prudently our investments which go through the expense line items. The margin is never a target for us. But I do, you know, I have in the past provided some guidance to try to be helpful.

Over the past two quarters, I've said that for the whole year, the last two quarters are reflective of the year over year, for the whole year's operating margin kind of change, for the yearly basis. And for the past Q3, as you can see, a lot of the line items, the pattern continues to hold. I would highlight that going into Q4, the TAC will continue to increase as the general trends consistent with last year. At the same time, we are stepping up our SG&A expenses to promote our mobile products. So this I've indicated in the past that, you know, second half SG&A expenses will step up because a lot of our products are ready.

So for the whole year, I think the guidance will be consistent, as I've said in the past. And I would say, over the past two quarters, Q1 and Q2, if you see 12% to 13% as indicative for the whole year's operating margin change level, I would say towards more the higher end as now we fold it into PPS and, you know, new business entities that are not generating the kind of operating margin as the main business.

Operator

Your next question comes from Eric Wen from China Renaissance. Please ask your question.

Eric Wen – China Renaissance

Hi. Thanks for taking my questions and congratulations on the good quarter and guidance. I just have one question. In terms of 91 Wireless, how should we model the intangible amortizations and goodwill allocations heading into fourth quarter and beyond? Thanks.

Jennifer Li

There will be some intangible amortization going to operational cost line items. We have, you know, going through this line item in the past you have seen related to Qunar, to [Qiyi] as well as PPS, and there will be further items going through this.

It's hard, you know, I think to specifically pin down this at this point is not the way we have done in the past. I have tried to give you the indication between operational cost and content cost. If you look at that, you know, together, the Q4 level I would say step-up compared to Q3 mirrors the Q2 and Q1 relationship -- or Q3 and Q2 relationship.

Operator

Your next question comes from Cynthia Meng from Jefferies. Please ask your question.

Cynthia Meng - Jefferies

Thank you, Jennifer and Robin, and congratulations for good results. My question is regarding the CPC on mobile. We hear anecdotal comments about mobile CPC being 50% of that of PC. Just want to know if management is seeing any trend that the gap between mobile CPC and PC CPC being narrowed. Thank you.

Robin Li

I kind of answered this question previously. The gap is certainly narrowing, but the CPC for mobile is still lower, meaningfully lower than on PC.

Operator

We are now approaching the end of the conference call. I will now turn the call over to Baidu’s chief executive officer, Robin Li, for his closing remarks.

Robin Li

Once again, thank you for joining us today. Please don’t hesitate to contact us if you have any further questions.

Operator

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

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