Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Baidu Inc. (NASDAQ:BIDU)

Q1 2010 Earnings Call Transcript

April 28, 2009 8:00 pm ET

Executives

Victor Tseng – IR

Robin Li – Co-founder, Chairman and CEO

Jennifer Li – CFO

Haoyu Shen – SVP, Business Operations

Analysts

James Mitchell – Goldman Sachs

Alan Hellawell – Deutsche Bank

Dick Wei – JP Morgan

Catherine Leung – Citigroup

Ming Zhao – SIG

Eddie Leung – Bank of America

Andrey Glukhov – Brean Murray

Richard Ji – Morgan Stanley

Wallace Cheung – Credit Suisse

Stephen Ju – RBC Capital Markets

Eric Wen – MainFirst Bank

Yu Jin – CICC

Wendy Huang – RBS

Jin Yoon – Nomura

Paul Wuh – Samsung Securities

Elinor Leung – CLSA

Jake Li – Guotai Junan

Operator

Hello and thank you for standing by for Baidu’s first quarter 2010 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 Mr. Victor Tseng of Baidu. Please proceed, sir.

Victor Tseng

Hello everyone and welcome to Baidu’s first quarter 2010 earnings conference call, we distributed Baidu’s first quarter 2010 earnings release earlier today. You can find a copy of the press release on the company’s 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 Haoyu Shen, Senior 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 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 risk 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 mostly directly comparable GAAP measures and is available on our IR website at ir.baidu.com.

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

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

Robin Li

Hello everyone and thank you for joining us today. We delivered another strong quarter with record top line results and strong earnings growth. This is very encouraging especially given the seasonality we typically see with the Chinese New Year Holiday during the first quarter. A big reason for our strong top line growth is the successful ramp up of Phoenix Nest, our upgraded online marketing platform. I will address this in a minute.

Also contributing to our growth this quarter was an improved economic environment compared to one year ago. And we believe that the recent change in our competitive landscape has had some marginal benefit to the business as well. Going forward I expect our growth will be predominantly driven by our efforts to grow customer base and improve monetization capabilities through Phoenix Nest.

Since completing the migration to Phoenix Nest on December 1st last year we have been focused on advocating customers on how to elaborate the sophisticated tool available on the new system. We are seeing the results as customers appreciate Phoenix Nest’s, higher quality, more relevant paid links and wider keyword coverage. Our customers can now purchase a greater number of keywords with higher click-through rate over a wider range of queries.

With these expanded functionalities and superior ROI, we believe customers are allocating a larger portion of their overall online marketing budget to us. This is especially true for larger customers. We are confident that Baidu has the most effective online marketing platform available in China. And we will continue to invest in enhancing Phoenix Nest and educating our customers to ensure that the platform reaches its full potential.

We are also making progress in our customer acquisition efforts. This is largely the result of our investment since the third quarter of 2009 in expanding our sales team and enhancing sales efficiency and productivity. In particular, we saw customer acquisition accelerate especially after the Chinese New Year and we are encouraged by the outlook on this front for the full year.

Turning to our Union business. Starting in the second half of last year we have been implementing new pay out policies based on the quality of traffic that Union members bringing in. And in the first quarter of 2010, we began to see noticeable results in the form of both higher quality Union traffic and lower traffic acquisition costs as a percentage of revenue.

We are encouraged by the (inaudible) and expect to keep optimizing our Union traffic as well as rolling our contextual ad business.

As e-commerce continues to develop we believe Baidu is well positioned to benefit as a major enabler of Chinese online retail market. As more and more retailers enter into the online B2C [ph] space they rely happily on Baidu to establish their online presence, drive traffic and build their e-business and brands. So, we're seeing not just rapid growth from established online merchant, but also less concentrated growth spread out over an increasing number of players.

So far this year, we have seen spending on Baidu’s platform from the online retail sector grow well over 100% compared to a year ago. That’s significantly faster than the overall online retail industry according to independent analyst reports. We see enormous opportunity and we will keep investing in initiatives to educate and foster this important market. This includes RakuBai, our Beijing based JV this Japanese e-commerce site Rakuten which we are looking forward to the official launch in the third quarter of this year.

Also on the theme of educating the market we just kicked off a nationwide marketing campaign covering nearly 100 cities in China. This campaign is aimed at educating both large and small businesses and potential Union partners about the benefits of search engine marketing. This event, an ongoing theme within Baidu.

As a pioneer in China and given the nascent state of Chinese internet we – our overriding focus remains on educating and developing users and customers alike as they embrace the benefits of internet search.

Finally, all of our efforts to grow, innovate, and improve our reliance on the quality of our people, we seek the best minds in our industry and we are prepared to invest in great talent in R&D and sales to support our investment strategy.

Our ADS to ordinary share ratio exchange which we announced today will give us greater flexibility to attract and retain the best people, so we are very confident and focused on this front.

Thank you again, and I will now turn the call over the Jennifer for financial highlights.

Jennifer Li

Thank you, Robin. Hello everyone. As you have seen our top and bottom line results this quarter were both very strong. Well, revenue has increased with ramp up of Phoenix Nest, we maintain effective cost discipline and saw a lower traffic acquisition costs leading to improved profitability.

As Robin mentioned, we see 2010 as a year of investment as we expand our sales team, drive R&D and further develop our network infrastructure to give our users and customers the best search experience and to ensure continued growth going forward.

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

Total revenue for the first quarter of 2010 were 1.294 billion a 60% increase year-over-year. Baidu had around 221,000 active online marketing customers in the first quarter of 2010, a 19% increase from the corresponding period in 2009 and a 1% decrease from the previous quarter. This slight sequential decline was mostly caused by customer attrition at the end of Q4 ’09 due the Phoenix Nest transition per our expectations.

We have seen strong ramp up in Q1 with the number of active customers at the end of Q1 2010 greater than at the end of Q4 of 2009. The improved customer ROI and increased spending from larger customers we saw post transition helped push revenue per online marketing customer in the first quarter to approximately 5900, a 34% increase from the corresponding period in 2009 and a 4% increase from the previous quarter.

Traffic acquisition costs as a component of cost of revenue were 171 million were 13.2% of total revenues as compared to 15.3% in the corresponding period in ’09 and 16% in the fourth quarter of ’09. The decrease in TAC as a percent of total revenue is attributable to Union traffic improvement efforts. We will continue our efforts on this front and expect TAC as a percent of total revenues to largely remain at this level with moderate fluctuations.

Bandwidth cost as a component of cost of revenue were 58 million representing 4% of total revenue compared to 6% in the corresponding period in ’09. Depreciation cost as a component of cost of revenue were 66 million representing 5% of total revenue compared to 7% in the corresponding period in ’09. The decreases in bandwidth depreciation costs as percentages of total revenues reflect efficiency improvement as well as increased scalability [ph] of investment in capital structure – in capital expenditures.

Selling, general & administrative expenses in Q1 were 215 million, an increase of 5% year-over-year primarily due to increased sales headcount partly offset by lower marketing expenses. R&D expenses were 122 million, a 43% increase from the year ago period primarily due to increased R&D personnel expenses.

Share based compensation expenses which were allocated to related operating costs and expense line item decreased in aggregate to 20 million in the first quarter of 2010 from 23 million in the corresponding period in ’09.

Operating profit was 531 million, a 167% increase year-over-year. Total headcount as of March 31, 2010 was about 7900 roughly 500 more than the previous quarter. The increase in headcount comes mainly from sales and R&D. In 2010, we are going to continue investing heavily in R&D and sales and marketing to drive growth in our business.

Income tax expenses were 71 million from the first quarter. The effective tax rate for the first quarter were 12.8% as compared to 12.9% for the corresponding period in ’09.

Net income was 481 million a 165% increase from the corresponding period in ’09. Basic and diluted EPS for the first quarter of 2010 amounted to 13.82 and 13.77 respectively. Net income excluding share based compensation expenses in non-GAAP measure was 500 million, a 144% increase from the corresponding period in ’09. Basic and diluted EPS excluding share based compensation expenses both non-GAAP measures were 14.38 and 14.33 respectively.

As of March 31, 2010 the company had cash, cash equivalent and short-term investments of 4.9 billion, net operating cash inflow and capital expenditure for the first quarter of 2010 were 426 million and 105 million respectively.

As we mentioned earlier, we will continue to aggressively invest in infrastructure and equipment in 2010 to support growth.

As a follow up to our previously announced licensed online video joint venture GD.com, the JV received a US$50 million capital injection from Provident Equity Partners in March. According to the terms of the agreement, Baidu will maintain a majority stake as both parties will retain joint control over the JV we will adopt an equity method accounting treatment, we expect the impact of this JV on our overall P&L to be immaterial in the foreseeable future.

Lastly consistent with our commitment to corporate social responsibility, Baidu donated RMB10 million to Qinghai earthquake rescue effort in April.

Now let me provide you our top line guidance for the second quarter 2010. We currently expect total revenue for the second quarter 2010 to be between 1.83 billion and 1.87 billion which would represent 67 to 70% year-over-year growth. This forecast reflects Baidu’s current and preliminary view which is subject to change.

I will now open the call to questions. Operator, please go ahead.

Question-and-Answer Session

Victor Tseng

Operator?

Operator

The question and answer session of this conference call will start in a moment. (Operator Instructions) Your first question comes from the line of James Mitchell. Please proceed, sir.

James Mitchell – Goldman Sachs

Thank you very much for taking my question. Robin, you mentioned in your opening remarks that customers can buy a wider range of queries than before which I have seen reflect the broad match technology. When you look at your customer base, are most of them comfortable using automated broad match or does it require lot of education by yourselves to get them on to the broad match?

Robin Li

James, I’ll let Haoyu to answer your question.

Haoyu Shen

Hi James, yeah broad match is something that that is introduced by Phoenix Nest. Now, the adoption of broad match is pretty high at this point, of course it takes some explanation and also (inaudible) sales force. And also the relevance of broad match must be high enough to be accepted by customers. So far we are very happy with the adoption rate.

James Mitchell – Goldman Sachs

Thank you.

Operator

Your next question comes from the line of Alan Hellawell, please proceed.

Alan Hellawell – Deutsche Bank

Thank you. Amazing results, congratulations on that. First I note Jennifer's comment that TAC as a percent of revenues may bounce around a bit but broadly will remain consistent, and I just have a simple question around that. Given the favorable competitive dynamics and various other favorable factors, why wouldn't that just continue to go down?

Haoyu Shen

Hi Alan, this is Haoyu. Yes, as Jennifer mentioned, we saw meaningful decline of TAC ratio as a percentage of the revenue in Q1 versus what we saw in previous quarters, and this is really largely driven by some initiatives that we started since second half of last year, I think we talked about this a few times in previous calls. We started looking at different types of partners who bring in different type of traffic to us, and we will reward those who bring us incremental – bring us traffic of more incremental nature to us, and pay less to those whose traffic – who bring traffic that more likely will cannibalize their own traffic.

So we're seeing the impacts starting from this quarter really because a lot of – we need to wait until some of the contracts expire to introduce these new terms. And as we said, the TAC ratio will probably stay at this low level for the foreseeable future with some fluctuations.

Alan Hellawell – Deutsche Bank

Okay, I – go ahead.

Haoyu Shen

It's a very – yeah and, it's still very competitive environment, with – the competitive landscape has changed, but there's still a lot of other search engines who are probably willing to, at some point, get into affiliate business to increase their market share, so we should be on the lookout on this front.

Alan Hellawell – Deutsche Bank

That makes a lot of sense, I appreciate that. One really quick follow up, we all note that SG&A was up a mere 5%. Jennifer, I was just wondering, can you give us a – that does not seem to speak to a very explosive growth in sales headcount, but I'm assuming that will grow. Can you kind of – how do we think about SG&A for the full year?

Jennifer Li

SG&A will continue to ramp up. If you look at year-over-year comparison, last year in Q1 you will recall we spent additional dollars on the marketing and branding front, and that's not the case this year. However this year, we do have a lot more sales people compared to last year.

If you look at sequentially, the numbers are largely consistent versus Q4, a slight decline, and this is a result of some true-up of bonus and compensation accrual. And we did hire more sales people in Q1, and mostly towards the end of the quarter. So the full impact of the expense will be picked up in Q2.

Going into Q2, you should also be reminded that we do have our annual merit adjustment, so we do expect SG&A to continue to increase.

Operator

Your next question comes from the line of Dick Wei with JP Morgan. Please proceed.

Dick Wei – JP Morgan

Hi. Good numbers there and thanks for taking my questions. So I have a question on the contextual ad. Wondering after Phoenix Nest launch how does that qualitatively change in terms of revenue or some of the matrices for contextual ad, thanks?

Haoyu Shen

Hi Dick, it's Haoyu. So before Phoenix Nest, we did have contextual ad product, which is very much coupled with the old search product. So as soon as Phoenix Nest, the majority of our contextual revenue now comes from an independent contextual product which we call Baido [ph], I assume you've heard of.

And now so it's a very big push for us this year both on the customer acquisition side, meaning that selling this product to customers, and also more importantly on the product engineering side, so putting a lot of resource behind this product. Right now it's still a very small component of our affiliate business, but we expect it to become more meaningful going forward.

And just one comment on the TAC ratio, usually the affiliates contextual has a higher TAC payout because we're really using our publishers' traffic. So if this product becomes more meaningful than today, it will indirectly impact the total TAC ratio if that makes sense.

Operator

Your next question comes from the line of Catherine Leung with Citigroup. Please proceed.

Catherine Leung – Citigroup

Hi, good morning, and congratulations also on the strong results. My question is on your sales team expansion which you had mentioned. Would you be able to share more detail with us on are you mainly expanding the teams in existing cities to increase your existing direct sales efforts? Or are you considering expanding your direct sales efforts into cities that you're currently working with distributors?

And related to this, are you seeing any differences in how customers are adjusting to Phoenix Nest in your direct sales versus the distributor cities? Thank you.

Robin Li

Catherine, I'll answer the first part of your question, and let Haoyu answer the second part. It's very simple; we are expanding our sales force just only in the current regions operated by direct sales.

We're not planning to expand the Baidu employee to distributor owned regions. Haoyu?

Haoyu Shen

For sales people selling Phoenix Nest versus our old keyword auction system, it's not very much different, because at the end of the day, it is pay search marketing. The concept is very easy to understand, and after the selling process, our customer service staff will do most of the education. So we're not seeing easier or more difficult selling process after the Phoenix Nest launch.

Catherine Leung – Citigroup

Thank you.

Operator

Your next question comes from the line of Ming Zhao with SIG. Please proceed, sir.

Ming Zhao – SIG

All right, thanks for taking my question, congratulations also. Let me ask you a question on the new product front. I wonder if you can give us some color on your future new initiatives, maybe some color on the P4P ads, in the format of display like image, Flash or video? Also any plan for doing something like travel search? Thank you.

Haoyu Shen

Hi, Ming. All the app product from innovation, we do have some resource pooling behind that. We are – on the search result page, we are – we are probably going to do some small scale experiments with images or also we're thinking about how it can be integrated with maps for example for some types of merchants. But these will be very small scale experiments, and I don't foresee immediate impact on our total revenue.

Now as far as display, we always have display as – on our non-web search traffic, and it is still contributing to our total revenue, but as we mentioned few times, it's a very small component of the revenue. The advertisers' acceptance of UGC traffic is still not very high in China.

But I think we'll probably benefit from the recovery of brand advertising this year just as other internet properties.

Ming Zhao – SIG

And travel?

Haoyu Shen

You mean getting to travel search?

Ming Zhao – SIG

Yeah.

Haoyu Shen

We have no plans at this moment.

Ming Zhao – SIG

Thank you.

Operator

Your next question comes from the line of Eddie Leung with Bank of America. Please proceed, sir.

Eddie Leung – Bank of America

Good morning everyone. Could you guys comment on the trends you see on the CPC and (inaudible) sites? Thanks.

Haoyu Shen

So after Phoenix Nest, the overall monetization has improved a lot. You can break down to the CPM or total monetization into coverage and CPC and click-through rate. So specific on CPC, it's growing at a healthy rate, and coverage. Coverage also has been going up a little, and we are – Phoenix Nest enables us to recall more ads and more relevant ads to show on the search result page. So both metrics are driving the monetization improvement.

Eddie Leung – Bank of America

Got that. Thank you, guys. Thanks.

Operator

Your next question comes from the line of Andrey Glukhov with Brean Murray. Please proceed, sir.

Andrey Glukhov – Brean Murray

Yes, thanks for taking the question. Robin, I think in your prepared comments you talked about the fact that you're seeing a disproportionate growth in spending from large advertisers who are presumably a little bit more adept at sort of absorbing the improvements in Phoenix Nest. When do you expect the tail of the advertisers to catch up to the same rate of spending? Thanks.

Robin Li

This is a trend we have seen for the past few quarters as larger companies increasingly realize the potential or the better ROI to advertise on a platform like Baidu and any other alternatives. So there has always been a great level of interest for larger companies to spend their marketing dollars on Baidu platform. With the Phoenix – with the completion of the Phoenix Nest transition, these larger advertisers are able to spend more because they can buy more key words and they have lot of (inaudible) to tune the performance.

Regarding to the long tail, there's probably a steep learning curve for them to really fully take advantage of the Phoenix Nest system. They will catch up, but the trend for the larger advertisers has been happening for the past few quarters.

Andrey Glukhov – Brean Murray

Great, thanks.

Operator

Your next question comes from the line of Richard Ji from Morgan Stanley. Please proceed, sir.

Richard Ji – Morgan Stanley

Sure. And hi, Robin, Jennifer, how are you? Good morning. And congrats on a very strong quarter, sure.

Robin Li

Thank you, Richard.

Richard Ji – Morgan Stanley

Thank you. Let me start with a question regarding the Google's so-called semi-exit from China. So far have you seen significant cannibalization of their customer base? And ever since your – the roll out of Phoenix Nest, have you seen you are catching a big piece of the market share and from your arch rival? Thank you.

Robin Li

Well like I mentioned, Richard – this is Robin – like I mentioned in my prepared remark, we saw marginal benefit from the so-called semi-exit of Google. I also mentioned during our last earnings call, we saw higher confidence level and higher customer loyalty on Baidu’s platform coupled with our enhanced Phoenix Nest system, we are certainly benefiting from this. But at the end of the day, I think that today’s market that the China search market is still being – it is very early stage, the performance of Baidu are largely driven by our own execution, not by the competitive landscape change, especially when we already have north of 75% of the total traffic share. If we can execute well, we will certainly benefit from the growth – the huge growth opportunity of this market. If we cannot, there are lots of competition that are ready to take up (inaudible)

Richard Ji – Morgan Stanley

Okay. Thank you. And a related question regarding your Baidu Union growth plan, and in particular – and I would be interested in the relative growth rate – if you are Baidu Union customer as compared with your direct customer? And also their average spending level, as well as the adoption rate for Phoenix Nest in this group of customers.

Robin Li

Richard, maybe I didn't get your question right. We don't really have Baidu Union customers versus our own Baidu.com customers; they're the same group of customer. Their paid links can show up on search result page from the traffic – from our organic traffic or traffic brought by Union members.

If your question is about which – the two sorts of revenue, which is growing faster, the answer is historically – at least in the past few quarters our Union revenue has been growing faster than our organic traffic – organic revenue. And that differential is still there in the past quarter, but the differential has narrowed quite a lot.

Richard Ji – Morgan Stanley

Okay. That's very helpful. Thank you, Robin and Haoyu.

Operator

Your next question comes from the line of Wallace Cheung with Credit Suisse. Please proceed, sir.

Wallace Cheung – Credit Suisse

Hi, good morning, congratulations on a good quarter. Just wanted to get an update on the first quarter headcount numbers and also the sales and the R&D headcount, as well as how is the headcount planning for the full year 2010? Thank you.

Jennifer Li

At the end of Q1, we had about 7900 in total headcount. About 4700 is in sales, about 2700 is in R&D. We have – as both Robin and myself have mentioned, this is year of investment in people and in talent, and from the sales side, last year if you'll recall, we hired about additional 900 heads. In this year we'll continue to aggressively step up the sales force hiring going forward. So that will give you a reference.

R&D has been – the investment in R&D has been the key theme for the company, and we will not divert from that trend, and we will continue to grow our R&D capabilities and headcount in line with the prior year trend.

Wallace Cheung – Credit Suisse

Okay thank you.

Operator

Your next question comes from the line of Stephen Ju with RBC Capital Markets. Please proceed, sir.

Stephen Ju – RBC Capital Markets

Hi, good morning everybody, and congratulations on the strong results. Did your hiring activities in the first quarter for sales and R&D happen toward the end of the quarter or towards the beginning of the quarter? And I know Qiyi is brand new right now, but do you have any plans to run ads against that inventory at the moment, and who would be sorting that inventory and employing the sales force? Thank you.

Jennifer Li

I'll take the first part and Robin will answer the second half. For both R&D and sales force, most of the hiring occurred after the Chinese New Year, which is the later part of the quarter.

Robin Li

Yes, for the Qiyi ad sales issue, they will have their independent sales team to sell ad. They advertise their interest on Qiyi – it's very high, we have already signed the first contract.

Stephen Ju – RBC Capital Markets

Okay, thank you.

Operator

Your next question comes from the line of Eric Wen. Please proceed, sir.

Eric Wen – MainFirst Bank

Hi, thanks very much for taking my question, and congratulations on the amazing quarter. Just a quick question, I think the Union traffic contributes more and more to the revenues, and how is the concentration of this Union traffic historic has been and going forward, and how do you reinforce your partnership with those Union members going forward? I think especially important in the next one year or so as Google basically weakens its competitive position in the Chinese market. Appreciate it, thanks.

Robin Li

Hi Eric, as I think I mentioned earlier, the Union revenue growth – has been growing faster than organic revenue in the past quarter, but the differential – the gap is not very large, the differential has narrowed a lot from previous quarters. So we're seeing a quite balanced growth of organic traffic and Union traffic.

And also as far as your question of given the competitive landscape change, how do we maintain relationship with the Union members. I think we just keep doing what we have been doing. We want to make sure that Union members are bringing complementary traffic to us, and we reward accordingly. Of course from time to time we'll adjust to market situations, adjust to competitive situations.

On your question about concentration, we have a pretty diversified Union member portfolio; I don't think we are too concentrated on any one or few partners. So I think we're in a good position.

Eric Wen – MainFirst Bank

Thanks.

Operator

Your next question comes from the line of Yu Jin with CICC. Please proceed, sir.

Yu Jin – CICC

Hi, good morning, and thanking to take my question. And really congratulations on the strong results and even stronger guidance. I have one brief question on (inaudible). For the second quarter we have – we see very strong guidance. So if we're looking to the growth (inaudible) CPC ARPU. And then I have a follow on question strategy.

Robin Li

Jin, as I mentioned during the prepared remark, Phoenix Nest transition helped to boost the ARPU for Q1, and will certainly contribute a significant portion of our Q2 growth. And also true is that right after the Chinese New Year we saw an accelerated new customer acquisition trend which we are very happy to see. And Q2 growth will also be attributed to that.

So we are expecting very healthy growth in terms of number of advertisers the ARPU. CPC is actually an independent matrix, maybe Haoyu if you want to talk about that?

Haoyu Shen

Right, and when we look at ARPU revenues, number of customers. The other then is really monetization where you have traffic and you have coverage and click through rate, and CPC. I think on any of the four matrix, I think we'll continue to see growth in Q2 versus Q1. And Phoenix Nest really contributes to the last three components of the monetization equation, which is coverage, CPC and click through rate.

Yu Jin – CICC

Thank you, it's very helpful. (inaudible)?

Robin Li

Well – this is Robin – I believe that search engine is at the centre stage of the total internet value chain. We enjoy a dominant position in the Chinese search space, so we are benefiting from all kinds of trends that businesses are increasingly taking advantage of internet. So on the e-commerce front, we – as I mentioned – we saw a lot of online retailers speed up their spending on Baidu, and we believe that our search is still the best platform for them to drive traffic and build brands.

On the online video venture, it's the same thing. Because we are at the centre stage, lots of users send queries to us that is video related. They're searching for – they're looking for video content. We have been seeing this trend for quite a few years before we decided to launch a JV to provide a licensed video content. We believe those licensed video contents are of higher quality, and can satisfy our users' information needs better. When that happens, we will try to direct traffic to the JV's website.

So at the end of the day, what we care most is our user experience for Baidu.com search, and as long as we can satisfy our users' information needs better than anyone else, we'll continue to be at the centre stage of the internet value chain.

Yu Jin – CICC

Okay, thank you. Just a very brief one on equation. I remember that the company (inaudible) in the last couple of years. So with the exit of our largest competitor, do we have an update on our kind of expectation on the overall growth of China's search industry in the next several years or maintaining the same?

Robin Li

All right, Jin, you know, we are only giving guidance for the next quarter, it is very hard for us to give you guidance on the overall industry growth for the next few years.

Yu Jin – CICC

Okay, thank you.

Robin Li

Thank you.

Operator

Your next question comes from the line of Wendy Huang with RBC. Please proceed.

Wendy Huang – RBS

Hi, actually I'm from RBS, not RBC. One very quick question, how will the Google's exit affect your relationship with Taobao [ph] and how are you positioning yourself among the competition in the online retail market?

Like I said before, we believe that the best way for online retail promote their brands and drive traffic is to advertise on Baidu. We think – and from the experiences of other markets – that search engine is the right way to go for e-commerce, and search engine is the biggest beneficiary of the e-commerce growth in many markets, and China is no exception. And we have seen the trend moving towards this during the past few quarters.

So search – it’s not competing with any e-commerce sites, in fact we are helping all of the e-commerce sites to get customers and build brands.

Operator

Ladies and gentlemen, as a reminder, please limit yourself to one question. Your next question comes from Jin Yoon with Nomura. Please proceed, sir.

Jin Yoon – Nomura

Hey guys, thanks for taking my questions, fantastic results and even better guidance. I guess I wanted to talk about I guess your customer profile, or the profile of your customers. Like you mentioned that bulk of the spending is coming from your I guess bigger SMEs and bigger – clients with bigger – deeper pockets, but that being said, like to know – given the profile of these clients, are they more exporters? SMEs that export, SMEs that are more involved in localized or a national search? Because what I'd like to get a better handle on is how much more incremental spending is there from this point onward, before the long tail actually catches up? And I have a follow up question after that. Thanks guys.

Haoyu Shen

Hi Jin, this is Haoyu. As far as the profile of our customers is concerned, we don't have many customers who are in export business because we – they buy on Baidu.com in Chinese, doesn't help exporters much. Most of our customers are domestic business oriented. They could be in manufacturing, they could be in service businesses, and we – a few quarters back, we mentioned that B2C sectors have been growing faster than B2B sectors, and that's still true, and that's more or less a reflection of how the economy is changing in China anyway. Some of these customers are national advertisers; some are very local, because we do have an option for them to show their paid links within certain regions.

And so ARPU has been growing very healthily in the past few quarters, and I think that will continue to grow as our traffic grows, as our monetization capability grows. And the long tail of the ARPU – I think ARPU is probably growing across the board, even the smaller advertisers who used to spend say RMB50 with us every day, they're probably spending RMB60 with us every day. But it's probably true that we'll see large customers grow their ARPU faster than the small customers, just because they are – they can buy more key words, they can benefit more from a more advanced keywords system.

Jin Yoon – Nomura

Sure, and just a follow up question regarding that is that the ARPU from bigger companies or bigger SMEs ramping up faster, can you give us a better idea of what kind of revenue runway some of these larger SMEs have. Are we talking about companies with billion plus in revenues in USD, or 500 million plus, or $100 million plus. Again, I'd like to get a better handle on incrementally how much more spending is there left to go or improvement is there left to go before the long tail actually catches up?

And second one, regarding your TAC costs, certainly that's going to fluctuate in the near term. However, is there a bigger concentration, a bigger payout among a smaller group of companies, or is there a general cut across revenue share over TAC cost – is there a general cut across the board? And is that a risk going forward given the fact that if some of your competitors offer a higher payout, that they could – some of the smaller ones could switch over? I'll stop there guys, thanks.

Haoyu Shen

Your first question about how much runway is still left, it's very hard to predict, what I can tell you is our customers – the bigger guys in SME sector – they are a very different sector. Some of them rely on search very much. They could be spending anywhere from 50% to maybe 80% of their marketing dollar on search, so for them I think the runway is probably shorter, if you will. And for some other companies in other sectors, they're probably only spending 10%, 20% of their marketing dollar on search, and that percentage must have – must be have been increasing over years, so the runway is probably very long going ahead.

As far as the size of these SMEs, I think I will not be surprised to see many of our so-called SME big customers probably generating revenue in the hundreds of millions RMB range. So that's – I don't have the exact stats, but that's the sort of the general profile.

On TAC ratio, we don't have a general cut. As I said, we – and I think I answered the concentration question already – we're comfortable with the concentration level of our partners. As far as payout, we don't have a general cut.

In the past, it's more of a general cut meaning if you reach – if you bring this much traffic to us we're paying you this much. That's a sort of across the board, does not depend on what kind of partner you are, does not depend on what kind of traffic you bring to us. Now the new system – the new payout policy we started implementing since second half last year differentiates partners by the type of traffic they bring to us.

And I think – as Jennifer mentioned, TAC – we expect TAC to stay at low level, but you might see fluctuations. Exactly as you said, it's still a competitive situation, there are few other search engines out there probably who are willing to get into affiliate business to get traffic, in a more easier – in an easier way. So we need to be on the lookout to make sure that we maintain our strategic search partners, and that will probably have impact on TAC payout.

Operator

Your next question comes from Paul Wuh with Samsung Securities. Please proceed.

Paul Wuh – Samsung Securities

Hi guys. My question is related to some of your new initiatives, specifically on Japan, if you could talk about developments and what's going with search in Japan, and also with Yoa.com and when we might see monetization of either of those two businesses?

Haoyu Shen

Okay, regarding to Japan, we are still in the investment stage. We are continuing improving our product quality, we believe that once our product is ready we will start to –marketing that. And once we get traffic, we'll start to think about revenue, so it's still years away from any meaningful revenue for the Japan initiative. But we think longer term, we as a company need to expand outside of China to establish presence in Japan and maybe other markets.

For Yoa, the original purpose for this unit is to promote better quality information – e-commerce related information – for our Baidu.com users. We think we are achieving this goal. In the meantime we are also exploring alternatives that can bring in revenue from just the Yoa products. We will give you an update once we have a clearer picture of the new initiative.

Paul Wuh – Samsung Securities

Thank you.

Operator

Your next question comes from the line of Elinor Leung with CLSA. Please proceed.

Elinor Leung – CLSA

Hi, thanks for the call, and congratulations on the strong result. My question is regarding your advertisers. What is the top-five sectors on your platform spending money right now, and do you see any particular sector which is growing a lot faster now?

Jennifer Li

Elinor, for Q1 our top five sectors remain largely the same, namely the medical healthcare sector, machinery, equipment, education and travel. What we have seen this quarter which we mentioned last quarter is that strong growth in the business service sector – last quarter I did note that, in this quarter it actually made it to the top five.

Business service represents online hiring, translation, organizing for exhibition and that kind of services. So we're seeing continue the main dominating sectors, but that gives you a little color.

And in our comments earlier we did mention in the online retail sectors, we're also seeing very strong momentum.

Elinor Leung – CLSA

Thank you.

Operator

Your next question comes from the line of Jake Li with Guotai Junan. Please proceed.

Jake Li – Guotai Junan

Good morning, hello. My question is regarding the TAC. We learned from local news that you will increase the profit sharing to Union members by 10% to 15%. Could you give us some comments about the TAC and gross margin trend? And in my view I think this is because of the Google's exit, but in a longer perspective, what is your strategy on the profit sharing? Thank you.

Robin Li

The 10 to 15 percentage point increase on payout we mentioned a few weeks – a few days ago in our Affiliates Summit was refer to or contextual product. As I mentioned earlier we have a strong push for contextual this year, and we are willing to pay more to our – to third party publishers, to our partners, to drive adoption of this product. And that will also – having more traffic will also help us to improve the product, and help us in selling this product to customers.

But it's – right now compared with search, it's a small component of our total affiliate business. If – as I said – if it grows into a bigger percentage of our affiliate revenue, it will – you will probably see some impact on total TAC. That will probably be a few quarters going forward.

Jake Li – Guotai Junan

Okay, great, thank you.

Operator

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

Ming Zhao – SIG

Thank you. I wanted to ask a follow up question. If we look at the customer deposits, it's down quarter over quarter. And you said there's an acceleration in the customer acquisition at the end of March versus at the end of December. So my question is was that because you – your accelerated acquisition customer is happening to the big advertisers which don't put deposit down, that causes difference?

Jennifer Li

Ming, in general, customer deposits will give you a good indication in the out quarters, but I've said in the past, towards year-end, there will be all kinds of noises depending on the customer situation, whether they want to use up their budget or whatever. What happened in Q4 of 2009 as you'd know, we had the Phoenix Nest transition. So the customers spending patterns were continuing to evolve and developing, so with that noise going on, I wouldn't read too much into the year-end number. And I would say this Q1 number give you kind of – bring you back to the normal behavior of the customers.

Ming Zhao – SIG

Okay, thank you.

Operator

Your next question comes from the line of Dick Wei with JP Morgan, please proceed.

Dick Wei – JP Morgan

I guess if you can share some of your latest thoughts on share-based compensation. Historically, I guess Baidu has very low – I guess number of shares granted as compensation, just you mentioned that there could be some increase with the ADS ratio change. I wonder how it's going to change, and if the shares going to be allocated more the senior versus some of the middle level engineers, if you can discuss that, some of the thoughts behind it, that would be great. Thanks.

Jennifer Li

Share-based compensation is always an important component of our overall compensation to employees, with particular focus to our R&D talent. We have decided on the ADS lid to give us more leverage and flexibility that we want to retain and encourage and attract talent. So we have always made it a very significant, meaningful portion of our – of the SPC to be total – in the total picture, and that will continue to be the way.

If you look at the ongoing trend, our SPC hasn't changed that much. You know, you do have slight variations, and going forward I think it will be in a very manageable manner and controlled manner, but I do not expect that to be going out of proportion simply because of the split itself.

Robin Li

Just to add, that most employees are like retail investors. We like to hear a bigger number of shares, so I think that – also helps them to decide every month when something gets vested that they can manage that in the easier way, so that's the reason we are splitting the ADS.

Dick Wei – JP Morgan

Great, so in terms of kind of percentage, dilution is probably will be somewhat similar to before?

Jennifer Li

Yeah, you can assume that.

Dick Wei – JP Morgan

Great. Thank you.

Operator

Your next question comes from the line of Wallace Cheung, please proceed sir.

Wallace Cheung – Credit Suisse

Hi, a quick question on the ratio between the operating cash flow and the EBITDA. Since the net operating cash flow – that percentage actually came down quite a lot to only 66%; can you explain the reasons behind?

Jennifer Li

I don't quite get – sorry, can you repeat that Wallace?

Wallace Cheung – Credit Suisse

Sorry, let me just go for the numbers, the net operating cash flow is RMB426 million, the cash inflow and the EBITDA number is RMB641 million. Because in previous quarter, that ratio actually – not stable, but more healthy like, sometimes more than 100% sometimes. So is that (inaudible) changes so far?

Jennifer Li

The biggest driver is probably the payable, Wallace. Towards year end we had payables that mostly related to ARPU taxes and the employee bonuses, and those have been paid out in Q1.

Wallace Cheung – Credit Suisse

Okay. Okay thank you very much.

Operator

Ladies and gentlemen, that is the end of our Q&A session. We are now approaching the end of the conference call. I'll now turn the call over to Baidu's Chief Executive Officer, Robin Li, for his closing remarks. Please proceed.

Robin Li

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

Operator

Thank you for participation in today's conference, this concludes the presentation. You may now disconnect. Good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Baidu Inc. Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts