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Baidu, Inc. (NASDAQ:BIDU)

Q2 2014 Earnings Conference Call

July 24, 2014 8:00 p.m. ET

Executives

Sharon Ng – Senior Manager of IR

Robin Li – Chairman and CEO

Jennifer Li – CFO

Analysts

Eddie Leung – BofA Merrill Lynch

Dick Wei – Credit Suisse

Alan Hellawell – Deutsche Bank

Alicia Yap – Barclays

Thomas Chong – Citigroup

Ella Ji – Oppenheimer

Wendy Huang – Standard Chartered

Piyush Mubayi – Goldman Sachs

Jiong Shao – Macquarie

Ming Zhao – 86Research

Cynthia Meng – Jefferies

Philip Wan – Morgan Stanley

Chi Tsang – HSBC

Natalie Wu – CICC

John Choi – Daiwa

George Askew – Stifel Nicolaus

Tian Hou – T.H. Capital

Operator

Hello, and thank you for standing by for Baidu's Second Quarter 2014 Earnings Conference Call.

[Operator Instructions]. 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, Ms. Sharon Ng, Baidu's Senior Manager of Investor Relations.

Sharon Ng

Hello everyone, and welcome to Baidu's second quarter 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 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. We had a great quarter and there are exciting things happening at Baidu, generating tremendous energy and having strong forward momentum.

In the mobile era, search can be even more powerful as it connects users not only to information but also to services. Search is one of the top two most used applications on mobile according to a CNIC [ph] report released this week.

This quarter, mobile monetization again progressed very well, with mobile revenue, which is largely comprised of mobile search revenue, accounting for 30% of our total revenue. The healthy mobile search monetization ramp is a testament to search as a proven business model with vast potential.

As a bit of a refresher, Baidu's mission is to provide the best way and most equitable way for people to find what they're looking for. Users come to Baidu to discover. In the mobile age, connecting people with what they're looking for includes not only information, content and apps, but also services, a natural extension of our platform.

We hold leading positions in the key mobile entry points of search, maps and app distribution. We are making investments to facilitate the seamless connection of users to services in a closed loop, which allows us to have a better understanding of user behavior and conversion for merchants. Over the longer term these investments will increase the size of our addressable market.

In our core search business, we remain the clear, dominant, cross-channel search leader. Mobile search traffic, again, drove overall traffic growth. In the second quarter, for the first time in history, during some holidays and weekends, when people were out and about, mobile traffic exceeded the traffic of desktop search.

Our mobile search service grew to over 500 million monthly active users in June. In Q2, we continued to aggressively invest and innovate, to create a better experience for our users. We revamped our homepage, and our users who log in now get personalized pages with automatically refreshed content.

We continue to deliver ever-richer, more dynamic results directly on the search page by working with partners in verticals such as healthcare, e-commerce, education and travel. In the automotive vertical, for example, we partnered with Bitauto and Autohome to integrate customized auto vertical content.

We boosted our search response time, customized through technology improvement query prediction. Search response time on PC is 10 times faster now than the beginning of the year. In fact, the majority of our PC search response is now literally faster than the blink of an eye.

Baidu continues to be an online marketer's preferred platform to capture leads on a large scale and generate and generate the best ROI. It's been a little over a year since we implemented our integrated PC and mobile bidding system, and the feedback continues to be overwhelmingly positive.

Our customers are truly embracing the diverse range of ad formats adoption mobile has to offer, with over 90% of our customers choosing click to action mobile ad format that includes click to- call, click-to-chat, and click-to-download, which directly tie query to conversion. We continue to proactively drive the effort to further develop the mobile ecosystem by educating our customers and providing them with the right infrastructure and tools to optimize for mobile.

In search monetization, the number of paid clicks, CPMs and click-through rates are trending higher year on year in large part due to our investments in mobile and technologies like deep learning. For instance, we launched a personalized click-through rate prediction initiative on both PC and mobile search, to make search ads more relevant and useful for individuals. And we are already seeing increases to click-through rates.

City level bidding, which we launched at the beginning of the quarter is attracting new customers to our platform. And we've seen overall spend from customers who participate in city level bidding increase as well. Over the short course of three months, a quarter of our customers have already opted to participate in city level bidding. And we are very pleased with this positive early sign.

Mobile Baidu, our search-focused app, now boasts nearly 70 million daily active user, which put us among the most popular native apps in China. It continues to be our largest and fastest-growing single channel for mobile search.

We upgraded Mobile Baidu by adding more personalization features and refreshed content. With the new light apps that are being added, Mobile Baidu is a powerful, seamless way for our users to discover and connect with new information and services, by tying together multiple Baidu products, including Baidu Search, Mobile Map, the Nuomi group buying service, and Baidu Wallet.

For example, a Baidu movie ticketing purchase can originate and be fulfilled all within the Mobile Baidu app. Here, a user snaps a photo of a movie poster, opens a light app, chooses a nearby theater, the movie and seats, and then purchases the ticket with Baidu Wallet, all without leaving the Baidu Mobile app. We ran some movie ticket promotions in Q2 to highlight this feature and saw the movie tickets sold nearly triple in the span of a month between May 1st Labor Day holiday to Dragon Boat holiday in early June.

In LBS, our flagship Mobile Map continued to extend its leading position by gaining market share, with the monthly active user base surpassing 200 million in the second quarter. We are currently the only mobile map in China with turn-by-turn voice navigation for walking. We also added more real-time road and parking updates.

Our group buying platform Nuomi celebrated its fourth anniversary this quarter, and the platform continued to grow and scale up nicely, with GMV in mobile tripling and the number of users doubling since we consolidated the business in the fourth quarter last year. Our sales force reseller network is already providing additional feet on the ground to help Nuomi scale up.

As the number one native app distribution platform, we gained further traction with the combined Baidu and 91 Wireless platform distributing over 130 million apps on a daily basis.

The process of integrating and unifying the platforms has progressed smoothly. The revenue contribution from our app distribution platform continues to grow meaningfully, monetizing through both advertising and mobile games.

We have a rich gaming platform, and we partnered with six exclusive games in the second quarter.

Our personal cloud storage product continued its strong momentum, growing to nearly 200 million registered users in Q2, from 160 million registered users in Q1. Our personal cloud storage product delivers a great user experience and drives continued user adoption of the product.

Technology and big data are at the crux of our efforts here at Baidu. And we made some meaningful wins that reinforce Baidu's renown as a world-class technology company. We are thrilled to have Andrew Ng, a pioneer in the field of artificial intelligence and the foremost researcher in deep learning, join us as our new Chief Scientist and lead Baidu's overall research efforts. Andrew shares our vision that AI will transform the internet and truly change the world.

This quarter, we opened up a new R&D center in Sunnyvale, California, and we announced three new research labs, two of which focus on artificial intelligence, and the third, big data.

Deep learning already touches on much of what we do, from speech recognition to image-based search, and from ad ranking to big data analytics. It will fundamentally improve our ability to understand natural language, to provide more accurate translation, and to make more intelligent recommendations.

Baidu brings together the raw computational power, the talent, and the enormous amount of data to break new ground in AI research. We are building neuron networks of unprecedented size and power, whose performance increases with the number of neuron connections.

We have applied our big data capability to a broad range of data sets and have seen impressive results. Our World Cup predictions had the most accurate record of predicting results from the group of six games to the championship.

Soon we will also be introducing predictive data-driven products for real estate prices and even likely box office for theatrical releases. Though these examples may just be showcases, they provide a peek at what is possible. As we continue to aggregate more data and improve our big data capability, we will provide big data prediction for behavior, movements and trends.

On the international front, I'm happy to announce that we launched Portuguese search in Brazil last week.

Now to update you on our online video operations. iQiyi's Q2 performance continued to be robust, and we are very pleased with the progress. iQiyi is now number one in PC monthly and daily unique visitors, and number one in both PC and mobile by monthly time spent respectively, according to iResearch. The long-term prospects for online video and iQiyi are very attractive and we remain supportive of the platform.

The true power of Baidu platform is our open system. We work with all forms of applications and services, and support all formats of web pages, native apps and light apps. This enables us to offer a rich, seamless, integrated Baidu experience, combining search, LBS, and our wide range of consumer products, all delivered with unmatched speed and reliability, from China's most advanced and powerful cloud infrastructure.

We are still only in the early stages of realizing the full potential of our platform, and our technology and data capability. We are excited to demonstrate what we are really capable of achieving and how large the Baidu platform can really become.

I want to take this opportunity to remind you all that Baidu World will be held this year, on September 3 in Beijing. I look forward to seeing many of you there.

Jennifer Li

Thanks, Robin. Hello everyone.

We're excited to deliver a solid set of results in Q2, with mobile strongly anchoring our business. The vast customer base continues to expand and we are encouraged by the strong progress, as we continue to innovate and our customers further embrace our services.

We remain committed to investing aggressively in our strategic focus areas, namely search, mobile cloud, consumer business, LBS, and our international business. We will manage our business in a disciplined fashion, as always. These efforts, centered with our dedicated focus on investing in technology, will help fulfill our broader mission to also connect people with services.

Now moving to the financials, all monetary amounts are in RMB, unless stated otherwise.

For the second quarter, total revenues were RMB12 billion, representing a 59% year-on-year growth. During the second quarter, Baidu had approximately 488,000 active online marketing customers, a 4% increase from the corresponding period in 2013 and a 9% increase from the previous quarter. Revenue per online marketing customer for the second quarter was RMB24,200, a 50% increase from the corresponding period in 2013, and an increase of 16% from the previous quarter.

Traffic acquisition cost as a component of cost of revenues in Q2 were RMB1.5 billion, or 12.7% of total revenues, compared to 11.6% in the corresponding period in 2013 and 12.4% in the first quarter. The increase reflects increased contribution of contextual ads, mobil, and the promotion of hao123. Bandwidth and depreciation cost, as a percent of revenue in Q2, were 5.8% and 3.9% respectively, compared to 6% and 4.7% in the corresponding period in 2013.

Content cost as a component of cost of revenues was RMB354 million, representing 3% of total revenues, compared to 2% in the corresponding period in 2013. Content costs are mainly related to iQiyi. Selling, general and administrative expenses in Q2 were RMB2.1 billion, an increase of 99% year on year. The increase was primarily due to increased promotional spend for mobile products. R&D expenses in Q2 were RMB1.7 billion, an increase of 84% over the corresponding period in 2013. The increase was mainly due to an increase in the number of R&D personnel.

Share-based compensation expenses, which were allocated to related operating costs and expense line items increased in aggregate to RMB221 million in the second quarter from RMB83 million in Q2 2013. SBC increased due to more shares being granted to Baidu employees.

Operating profit for Q2 was RMB3.6 billion, an increase of 23% over Q2 last year. Total headcount on a consolidated basis, including invested entities, was about 40,500 as of Q2. This represents an increase of 17%, as compared to the end of last quarter. Income tax expense was RMB606 million for the second quarter. The effective tax rate for Q2 was 15.4%, compared to 16.3% in Q2 last year.

Net income attributable to Baidu for Q2 was RMB3.5 billion, a 34% increase from the corresponding period in 2013. Basic and diluted earnings attributable to Baidu per ADS for the second quarter amounted to RMB10.12 and RMB10.09, respectively.

Net income attributable to Baidu excluding share based compensation expenses, a non-GAAP measure, for Q2 was RMB3.8 billion, a 38% increase year on year. Basic and diluted earnings attributable to Baidu per ADS excluding share-based compensation expenses, both non-GAAP measures, were RMB10.75 and RMB10.72, respectively.

As of June 30, 2014, the Company had cash, cash equivalents and short-term investments of RMB48.7 billion. Net operating cash inflow and CapEx for the second quarter were RMB4.1 billion and RMB864 million respectively.

Now let me provide you with our top-line guidance for the third quarter of 2014. We currently expect total revenues for Q3 to be between RMB13.42 billion and 13.78 billion, representing a 50.9% to 55% year-on-year increase. Please note, this forecast reflects Baidu's current and preliminary view and is subject to change.

I will now open the call to questions. Operator, please get ready to take questions.

Question-and-Answer Session

Operator

Certainly. 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 question, 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 after your first question has been addressed.

[Operator Instructions]

Your first question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.

Eddie Leung – BofA Merrill Lynch

Hi, good morning. Thank you for taking my questions. Just a questions on your mobile business. In the second quarter we learned that UCWeb has established a relationship with Alibaba. So just wondering if you have seen any impact on your mobile traffic as well as on your TAC spend. Thank you.

Robin Li

Eddie, so far the impact has been very limited. As I mentioned during the prepared remarks, Mobile Baidu are making apps for search. It's the fastest growing and largest source of our mobile search traffic. Longer term, the search app will provide a different and much better user experience for our users. And we believe this represents the trend in users will increasingly rely on the Baidu native app to get information and services.

On the TAC, Jennifer?

Jennifer Li

Yes, in terms of TAC, Eddie, as you see, sequentially TAC as a percent of revenue continued to increase, as we have indicated consistently over the past quarters. The majority of the TAC is related to -- especially the changes are related to increased contribution from contextual business, from mobile as mobile's contribution is becoming a larger part of the overall picture, as well as the Hao123.

And we do manage the union partners' relationship dynamically. And we manage our TAC spend dynamically. But direction related to UC is not anything significant. But over time, as we have indicated in the past, we will continue to see TAC as a percent of revenue growth.

Operator

Thank you. The next question comes from the line of Dick Wei, Credit Suisse. Please ask your question.

Dick Wei – Credit Suisse

Hi, good morning. Congrats on a very strong quarter. My question is on the margin trend. I think prior quarters' guidance is Baidu is going to spend more in pre-installation marketing during the very fast growth phase of mobile internet growth. What is the outlook? What is the current thinking over the next couple of quarters or maybe next year? And how is the margin trends going to be reflective of those strategy? Thank you.

Jennifer Li

Hi, Dick. The way we manage our business is really focused on the top-line growth and at the same time manage our expenses in a very disciplined manner. To date we have delivered very strong top-line results. And as we look into Q3, that momentum will continue to carry.

For investment allocation on the strategically important areas, we are deploying resources currently as planned. And so as you see, most of the investments are in R&D, in sales and marketing, as well as in infrastructure.

Over the past few years, you have seen that we consistently invested in R&D and infrastructure. And for our products and technology, some of these investments are immediate and others are longer term. Particularly related to sales and marketing expenses, they can be -- they can vary, quarter over quarter, depending on the event or when the product is ready to have massive marketing support.

And so as we look out, the plan hasn't really changed. Our strategic focus areas will remain, and our dedication of resources in these areas will continue to carry.

And if you look at second half of the year, we will continue to spend in an accelerated manner in sales and marketing, related to mobile products, LBS, security products and our international efforts.

Operator

Thank you. The next question comes from the line of Alan Hellawell from Deutsche Bank. Please ask your question.

Alan Hellawell – Deutsche Bank

Thank you very much. A little bit of a follow-on to Dick's question, really just focusing on pre-install. Jennifer, could you give us a sense of how we would consider contouring pre-install, for instance as a percentage of revenues, for the rest of this year and next year. And I guess, could there be more upside as a percentage of revenues? Or have we achieved the desired effect of pre-install, which is to encourage the behavior by which people more proactively summon the application? Can you give us a sense of the contouring?

Jennifer Li

Right. In terms of the sales and marketing expenses, really, other than the people-related costs, for marketing and promotional efforts, there are three areas. One is pre-installation, as you mentioned. And there is also marketing branding efforts that will require resources. And there certainly will be promotional activities, promotional campaigns, as we try to push for certain products.

Last year, as we have said in the past, predominantly a majority of the marketing expenses were related to pre-installations. And that was timely, rightly so. And as throughout the quarters, as our products established its foothold, and users becoming more and more reliant on our products, over the past few quarters, we will -- we are seeing a slightly declining percentage of the overall marketing spend on pre-installation.

But at the same time, as I mentioned in the past, it's important for us to continuing reaching out to the user base to educate on our products, our brand, and the same time, also use promotional activities to drive new products and services. For example, in driving LBS, location-based related services, there will be promotional campaigns that either drive transaction activities, or promote a certain products, and those will be part of the overall marketing spend.

So the mix of the overall marketing spend does change and vary. But overall this item will continue to be a focal resource item for us going forward.

Operator

Thank you. The next question comes from the line of Alicia Yap from Barclays. Please ask your question.

Alicia Yap – Barclays

Hi. Good morning, Robin, Jennifer and Sharon. Thanks for taking my questions, and congratulations on a very strong set of results.

My question is regarding your international initiative. So could you share with us a rough total cost of investment that you have spent or plan to spend for your overseas commitment? And also, could you share with us any timeline or expectations for revenue contributions that you expect to generate from the overseas market?

And then lastly, could you share with us the view -- your view on the difference and similarity between the Brazil market, versus the Japan market where you also launched the service a few years ago? Thank you.

Jennifer Li

The international effort is one of our strategic focus areas. We would say the international business to us is medium, longer term, strategically important. At this point, we are in a very early stage to launch our international services and products, and in some identified markets.

And these markets typically are emerging markets with continued fast growth in the usage of internet. And at the same time our mobile becomes increasingly a factor in the overall access to the internet. So compared to more mature markets in your example, these markets that we are targeting are emerging markets and fast growth. And in those kind of situations, opportunities exist.

From a [indiscernible] perspective, we are as I mentioned in the early stage. To date we haven't incurred much expenses at all, but we do have products that we can leverage from our China-based R&D team, and we can launch these products in the international markets. As I mentioned, they are medium and longer-term significant and we will take our time to penetrate in these identified markets.

Overall, if we compare the scale and opportunities of the business both from a revenue and expense perspective, international is not compared to the domestic efforts in terms of resource allocation is really a small amount. And at the same time, as I think of the immediate focus, is to launch the product, make sure that these products are adopted in local markets, and over time begin to generate revenue, and revenue is really not the near-term priority for us.

Operator

Thank you. The next question comes from the line of Thomas Chong from Citigroup. Please ask your question.

Thomas Chong – Citigroup

Hi. Good morning, Robin, Jennifer and Sharon. Thanks for taking my questions, and congratulations for a great quarter. I have two questions.

The first question is, can you comment about how the mobile CPC right now is compared to PC?

And secondly, with regard to mobile traffic contribution to your total traffic, can you give us some color whether it has already exceeded 50%, if I have missed that out?

And thirdly, regarding the mobile search, is it true that your organic traffic has already exceeded the inorganic traffic? Thanks.

Robin Li

Okay. On the mobile CPC, the trend continued to go up, as I mentioned before, but it's not as high as the desktop CPC yet. On the traffic, as we said during the prepared remarks, that during certain holidays and weekends mobile traffic surpassed the desktop traffic. But during most of the weekdays, desktop traffic is still larger in Q2 of last year.

For the mobile traffic, organic mobile traffic, it's already the majority of our total mobile traffic.

Operator

Thank you. I'll move on to the next question.

The next question comes from the line of Ella Ji from Oppenheimer. Please ask your question.

Ella Ji – Oppenheimer

Good morning, Robin, Jennifer and Sharon. I have two follow-up questions. Firstly, relating to international business. Do you plan to build it on your own or are you seeking M&A opportunities?

And secondarily, still relating to the margins, since you have performed very strongly in the first half, can we revisit your target that you mentioned earlier in terms of your full year net income growth target? Thank you.

Jennifer Li

To your first question, I think we're,- you know, the company has very strong core products and technologies which we can leverage for the international marketplace, to the extent corporation or M&A makes sense to us, we remain open-minded as always.

To the margin question, I commented on that earlier. Our strategic focus areas hasn’t really changed. The plan to deploy resources to drive those focal areas will remain. So the plan hasn’t really changed. For us, the way we manage business is drive top line growth and manage the expense. And these -- we don’t have a specific margin target. And to the extent, you know, to the performance today, I think we have delivered very solid top-line growth.

And the expense and resource plans really hasn’t changed.

Operator

Thank you. The next question comes from the line of Wendy Huang from Standard Chartered. Please ask your question.

Wendy Huang – Standard Chartered

Thank you. Congratulations on the strong results. I just want to follow up on the M&A question. From your view, what are the missing pieces in Baidu's ecosystem today? And also, how would you actually differentiate yourself from other big internet companies In terms of .your M&A approach? And also in the longer term, what kind of a different internet ecosystem that you are going to build compared to other internet companies? Thank you.

Robin Li

Yes. There are missing pieces in our ecosystem but we do not necessarily need to make this out through M&A. We, as always, we are open to all kinds of opportunities whenever it presents to us. But I think principally we still rely on organic growth to complete our overall strategy, be it mobile or otherwise.

I think the key difference between the Baidu ecosystem and other ecosystems on the market is that we are more often open system, as I mentioned earlier, meaning that we work with many of the standard service formats like native app. You know, we drive traffic to many of the native apps. We are the largest app distribution provider in China. We also have our light app mechanism. We work with many of the service providers in that format too. We're also a search engine, so we drive traffic to a lot of the mobile websites in standard HTML5 format.

Longer term, we believe an open ecosystem will be more powerful, more popular. If you look at the mobile operating system, you can see that Android is much more popular than iOS because it's more of an open system.

Operator

Thank you. Your next question comes from the line of Piyush Mubayi from Goldman Sachs. Please ask your question.

Piyush Mubayi – Goldman Sachs

Thank you for taking my questions. Robin, you talked about the fact that in the second quarter you've seen the automobile sector kick in and with increased revenues from two participants there. I'm curious whether you're seeing this happen in other verticals, and also I'm curious whether you could give us a sense of what the split is between SOEs and non-SOE from an either traffic perspective or a revenue perspective. Thank you.

Robin Li

Yes. I used automobile as an example for the vertical content providers or partners, but we, yes, we do partner with other content and service providers in other verticals. I mentioned healthcare, e-commerce and many others. So the philosophy is the same, if there's any vertical players who have better user experience, better data, better content, we would like to work with them, and in the meantime, that will provide more revenue opportunities for us.

On the SOE and non-SOE, we don’t classify our advertisers and customers this way. But I would guess that a super-majority of our customers are non-SOE.

Operator

Thank you. The next question comes from the line of Jiong Shao from Macquaire. Please ask your question.

Jiong Shao – Macquarie

Hi. Thank you for taking my questions. I have a couple as well.

Robin, you mentioned earlier about the city-level bidding, about 25% of your customers already adopting city-level bidding. I was hoping you can share with us your view on local classified market, whether or not that market will be sort of augmenting your city-level bidding or it may compete with your city-level bidding. That is my first question. Thank you.

Robin Li

Yes. I think the city-level bidding is predominantly used by our existing customers. And yes, we are signing off new customers too, but it's still quite different from the local classified. We are targeting a smaller ticket and more fragmented market, which is not the mainstream of our customer base.

Operator

Thank you. The next question comes from the line of Ming Zhao from 86Research. Please ask your question.

Ming Zhao – 86Research

Thanks. I just have a housekeeping question. We see that the R&D expense and the CapEx up pretty significant quarter over quarter. I just wonder if you could share with us the major components in there. Thanks.

Jennifer Li

Hi, Ming. We continue to invest, as I mentioned, in R&D and infrastructure, and that is our core competency and focus. R&D, we did add additional headcounts during the quarte,r and R&D expense line item is predominantly people related.

CapEx, bear in mind, CapEx in this year, other than the normal servers and data centers, data network that we acquire for CapEx purposes, there is also construction related expense line item -- construction related CapEx as well.

As I indicated, at the beginning of the year, from an infrastructure network investment perspective, it's not going to be too much different from prior years and any incremental CapEx would be more construction related.

Operator

Thank you. The next question comes from the line of Cynthia Meng from Jefferies. Please ask your question.

Cynthia Meng – Jefferies

Thank you, Robin, Jennifer and Sharon, and congratulations for a strong quarter. My question, there are two.

We saw very strong growth in average revenue per customer this quarter, and just wondering if management can give some more color what's driving this. Was it mainly due to the advertising budget placed in the mobile search area?

And the second question is related to mobile game. Given the consolidation of Baidu, DouKu and 91Wireless, can management give us some more detail on Baidu's positioning in the mobile game value chain and eventually will Baidu management consider going into content development in mobile game as well? Thank you.

Robin Li

Okay. The ARPU growth, I think that the trend has been there for a number of quarters. Mobile certainly contributed to that. But I think overall the nature of the search business is that, as long as you have the traffic, the demand is there, customers just cannot buy enough amount of traffic in these. And so this has been the case for many, many years. We just need to come up with the necessary products that -- the necessary format and try to educate our customers to take advantage of our platform. So, mobile is a driver but the trend and the nature of the business has been like that for many, many years.

On mobile games, as you know, that we are the largest distributor of native apps and this model for app distribution comprises of two major categories. One is the advertising which is our main business but in a slightly different format which is distributing native apps. The other is mobile games. Because we have such a large distribution power, we naturally would be able to take advantage of this by running mobile games. We currently do not have any plan to develop our own games.

Operator

Thank you. Your next question comes from the line of Philip Wan from Morgan Stanley. Please ask your question.

Philip Wan – Morgan Stanley

Hi. Good morning, Robin, Jennifer and Sharon. Thanks for taking my question. And also congratulations on a very strong quarter.

My question is about your customer volume growth. Could you comment on that as this has been decelerating for the past couple of quarters? Would you expect any recovery in terms of growth rate for customer volume? Thank you.

Robin Li

Did you get the question?

Jennifer Li

Personal cloud, I think, yes. I think he's asking for PCS.

Robin Li

Philip, were you asking about the personal cloud service?

Philip Wan – Morgan Stanley

No. In general, the customer volume growth. It has been slowing down for the past couple of quarters. Yeah. So and I know there has been some cleanup initiative in the past couple of quarters. So what should we expect for the customer growth trend going forward? Thank you.

Robin Li

Yes. As you know that we have been tightening our criteria in terms of customers that slowed down the customer growth a little bit over the past year or so. I think that kind of process have largely completed during the second quarter, so going forward we do expect continued customer growth. But over the past few years, you have probably the same, our strategy, you know, shifts from number of customer to ARPU and ARPU from -- from ARPU to number of customers.

It really depends on the market condition, the demand from our customers and our capacity to serve the customers' needs. So I wouldn’t guarantee that going forward either the number of customers will grow faster or that the average spending per customer will grow faster. It will depend on the market condition and our capacity.

Operator

Thank you for your question. The next question comes from the line of Chi Tsang from HSBC. Please ask your question.

Chi Tsang – HSBC

Hello. Thanks for taking the question. Congratulations on a really good set of results.

Maybe actually just really one question. In terms of on the mobile CPC, I'm wondering sort of what's your current expectation in terms of if you think your mobile CPC will be able to reach parity or even sort of be higher than desktop CPC. And I'm wondering also, are there any components, are there any categories of mobile CPC today that are already more expensive than desktop CPC? Thank you very much.

Robin Li

Yes, there are cases that mobile CPC is already higher than desktop CPC today. But overall, like I said before, the mobile CPC is still lower than that of desktop. And I'm very optimistic about the future of mobile search. And in the sense of monetization, I think people have more devoted attention and communication on mobile is more natural and so the conversion mix here can be better.

But exactly when the CPC mobile will surpass that of PC, I would not speculate right now. I think our current priority is still to innovate to make a better user experience for our mobile product, I think the monetization will follow.

Operator

Thank you for the question. The next question comes from the line of Eric Wen from China Renaissance. Please ask your question.

Mr. Wen, your line is open. Please ask your question.

We'll move on to the next question. The next question comes from the line of Chao Wang from Nomura. Please ask your question.

Mr. Wang from Nomura, your line is now open. You may unmute locally.

We'll move on the next question. The next question comes from the line of Natalie Wu from CICC. Please ask your question.

Natalie Wu – CICC

Hi, good morning, Robin and Jennifer. Thanks for taking my question, and congratulations on a solid quarter.

Just wondering, I remember that you mentioned that the revenue generated from acquired companies like iQiyi, Qunar and 91Wireless, accounted for less than 10% in last quarter. So what is the latest status and I mean the percentage of the revenue? And can you give us some color on the detailed composition of TAC? What is the weight of mobile and TAC and what is the growth outlook? Thanks.

Jennifer Li

To your question on the revenue contribution, we are -- the main entities that is outside, you know, running as independent companies are iQiyi and Qunar. Qunar is a public company and so you get an idea of their contribution and revenue level. And overall, iQiyi, we don't -- we have never in the past separated the contribution from these smaller entities. The point is there are disclosure requirements and threshold, and to the extent they are -- they do not account to the materiality level, there is no separate breakdowns.

So the overall revenue is predominantly continue to be search and are the strong growth that you are seeing is mainly because the strong search business and mobile search business, and that is really going very well.

To your question on TAC, I did mention earlier, the TAC increase as a percent of revenue is mainly because of increased contextual revenue contribution as well as mobile revenue contribution and Hao123 promotion.

There's no real separate breakdown but these are the three main items that drives the movement of TAC.

Operator

Thank you for the questions. The next question comes from the line of John Choi from Daiwa. Please ask your question.

John Choi – Daiwa Securities

Hi, good morning and congratulations on a very strong quarter and thanks for taking my question. My question is on the content cost. If you look in the second quarter numbers, it is down on a quarter on quarter basis, is it just because simply it is more of a seasonal effect, iQiyi was less aggressive in acquiring content.

And also, the second question with regards to that, we are also hearing the iQiyi will be launching in-house built studios and co-produce several films. Will this be something of a long-term strategy and impact your cost line going forward? That is it. Thank you.

Jennifer Li

The content cost is mainly related to iQiyi and the fresh content is very important for iQiyi. It is the platform that require, you know, basically, that the license to content and also complemented by its self-produced content and the user-generated contents. Content cost can be a quite jumpy quarter-over-quarter but clearly we are committed to having fresh content for iQiyi and continued growth of our user base and its market leadership position.

It will be a complement of different items and you know, we are not slowing down content acquisition. And in absolute dollar terms, iQiyi is not slowing down its content cost. So quarter-over-quarter variations, there's really not any strong indications that you should read to.

Operator

Thank you. The next question comes from the line of George Askew from Stifel. Please ask our question.

George Askew – Stifel Nicolaus

Yes, thank you very much. Congrats on a great quarter. Two quick questions. First on user behavior, what -- can you give us a little color on the number -- average number of searches for a user -- a mobile user compared to the average searches for a desktop user. Just kind of user behavior there.

The second question, you mentioned that you had a couple of exclusive games in the quarter. Are those being recognized as growth revenue and if so, how significant an impact it would have to the revenue. Thank you very much.

Robin Li

On the user behavior question, the number of searches per user on mobile is -- less than that of desktop right now. And I think it is easy to understand that people generally would like to sit in front of desktop computer when they are serious about something, they want to do research, they want to spend a lot of time to draw their conclusion. So that will increase the number of searches per user. Whereas for mobile, people are more instant, when they have anything in mind that they pull out the phone and do a search and get a quick answer. I think that by nature the number of searches on mobile is smaller.

Jennifer Li

And to the question, if I understand your question, the game revenue is recognized on a net basis.

Operator

Thank you. The next question comes from Tian Hou from T.H. Capital.

Tian Hou – T.H. Capital

Thank you for taking my question. So Jennifer, I have a question related to your traffic equities and cost. So one driver for the traffic equities and cost to go out was contextual ads. So as you further develop contextual ads, and expect this contextual app for their drive -- traffic acquisition cost and also as today, with the percentage of the contextual app contribute to the total revenue. And so going forward, what is our outlook, what is you know, at the mature level, how much contextual ads will contribute to total revenue? That is my question.

Jennifer Li

Okay, the contextual business has been the business focus for us for a couple of years and it is the phenomenal product because this generates incremental revenue for us and we do share the benefit with the union parties and hence, the traffic acquisition cost. Over the years, we have been growing the contextual business and the potential for that will continue to be huge as we think about it, not only in the PC world, in the mobile stage, whether it is in the union partnerships in the form even in native apps, there will be in app contextual ads related revenue that can be generated.

So we continue to improve our technology, at the same time occupy ad space where we can promote our advertisers as products and services. And to date the contractual business has been growing to be a very meaningful part of the overall revenue that comes from union-related businesses. No separate breakdown for them but this is one of the, obviously, the driver and also the fast-growing segment of our business and it will continue to have potential.

Operator

Thank you. Next we have a follow-up question from Dick Wei from Credit Suisse. Please ask your question.

Dick Wei – Credit Suisse

Yeah. Hi, thanks for taking my questions. Just wanted to see on the mobile revenue side, if we were to break out the different advertising format, maybe on a cost per call or cost per click or cost per download or CPC [ph] model, how are those mix we are looking at right now, and which ones would be the more faster-growing format going forward? Thank you.

Robin Li

Dick, I think that it's probably too early to draw a conclusion now that we are experimenting on all kinds of different app format and we are also constantly changing the format too. All of those click to call to action formats are welcomed by most of our customers. And I think it is the nature of mobile is that it enables easy communication between potential customers and merchants. But exactly going forward, what is going to be the mainstream format remain to be seen, we are still doing all kinds of experiments to get a better sense on the conversion. And I also mentioned already that our yield situation will be closed loop. We will be able to track from query to fulfillment. In that case, the format could differ from the -- dramatically from the existing click to call format. And so I think we should wait for a few more quarters to give you a better sense on that kind of trend.

Operator

Thank you. The last question comes from the line of Jiong Shao from Macquarie. Please ask your question.

Jiong Shao – Macquarie

Thank you for taking my follow-up. At the beginning of the year, you talked about this year you are not expecting any profit growth. I was wondering, does that still hold or you feel like the first half margins may be the baseline for Baidu going forward? Thank you.

Jennifer Li

Yeah, I think, Jiong,, we commented on that question two times in the call. The -- as we said at the beginning of the year, we do have identified strategic areas, strategic focal areas that will require resource deployment. That plan hasn’t really changed.

At the same time we are very pleased to see that the top line is growing very solidly and as we look into Q3, and that momentum will continue to carry. Naturally, whatever the operating margin or profit will be is just a falloff of the top line and the expenses.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Baidu's (BIDU) CEO Robin Li on Q2 2014 Results - Earnings Call Transcript

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