Hello. And thank you for standing by for Baidu’s Third Quarter 2011 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. (Operator Instructions)
I would now like to turn the meeting over to your host for today’s conference, Victor Tseng, Baidu’s Investor Relations Director.
Hello, everyone. And welcome to Baidu’s third quarter 2011 earnings conference call. We distributed Baidu’s third quarter 2011 earnings release earlier today. You can find a copy of the press release on the company’s IR 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 proceed, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations.
Potential risks and uncertainties include, but are not limited to those outlined in our public filings with the SEC, including our annual report on Form 20-F. Baidu does not undertake any obligation to update any forward-looking statement except as required under applicable law.
Our earnings press release and this call include discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of the unaudited non-GAAP measure 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 be available on Baidu’s corporate website.
I will now turn the call over to Baidu’s CEO, Robin Li.
Hello, everyone, and welcome to today’s call. I’ll start today by reviewing our results for the third quarter and taking a lot as a key trend and growth drivers. Then, I’ll talk about the exciting new initiatives we launched recently. And finally, I’ll update you on our strategic investment projects.
Looking first at our results, that being another stellar quarter for Baidu. This revenue is accelerating 85% year-on-year. In particular, we see three main factors underpinning robust revenue growth in Q3. First, traffic growth maintained its strong momentum in the quarter.
Second, we made solid progress on monetization. ARPU growth was at a record high of more than 65% year-on-year. This was largely driven by the enhancement to our Phoenix Nest platform. For example, we introduced a new keyword matching option called advanced [quick] match. This is more focused than the traditional broad match, but offers more flexibility and higher coverage than the exact match.
So, it better captures user intent and improves clickthrough rate -- improved clickthrough quality. And we are seeing very encouraging adoption rate so far. And there are few many other levers in Phoenix Nest that we can pull out to drive further monetization efficiency.
The third factor influencing our strong revenue growth was increasing spending by our large accounts, which has been a priority for Baidu.
One fourth of strong revenue growth was once again the e-commerce sector, in particular the revenues contributed by the online retail sector retained impressive momentum, growing over 100% year-over-year. Separately, classified information website spending also maintained a strong upward trend, increasing by over 50% quarter-on-quarter.
So you can see that because of our central position in China’s internet ecosystem we can always benefit enormously from emerging growth area. While it is difficult to predict the future of any single industry category, the overall online marketing spending trajectory for our large account remained very positive.
Another area of strong revenue growth was in customers from more traditional industries. We benefited as these customers transitioned from offline to online marketing. The auto industry is a good example of this emerging trend. This established offline businesses increasingly recognize the value of Baidu’s online marketing platform and are allocating larger percentages of their amortizing budget to us. Meanwhile, our top verticals continue to grow healthily as well and remain an important part of Baidu’s revenue makeup.
In Q3, we continue to optimize our sales process. The goal is to ensure customer quality and improve sales efficiency for small and medium-sized customers. Complementing this pushed, we have deepened our commitment to creating a better cleaner internet ecosystem. Under the banner of Operation Sunshine, Baidu has forced alliances its major stakeholders including government ministries and HSD industry associations and the media. Operation Sunshine is part of a long-term effort of which the Chinese government has been very supportive.
Let’s now move on to talk about some of our new initiatives. Baidu’s new personalized homepage feature online in the beginning of September. The personalized homepage represents the next step in the evolution of Baidu. From simple web search to open data, to open applications and now to personalized and direct fees that instantly meet users need. This new feature give users who are sign in Baidu, a more personalized experience based on their historical search behavior.
For example, if a frequent movie guard tends to search for local cinema times. We’ll include that link on a personal homepage or if a user in Beijing often searches for weather we will include our link on the Baidu homepage to updating weather forecast automatically. So the personalized homepage provide not just a general information but personal information as well. This is a good example of how Baidu is integrating search with user social activity. We will kindly integrate Baidu’s own search social products like Baidu post bar and space, also as external social platforms to satisfy user social need.
Another important thing about our personalized homepage is that users don’t have to do anything and intelligent recommendation engine customizes their homepage for them based on their behavior and social interactions. This means that the success of the homepage does not depend on users being proactive. These features will ensure that Baidu is the logical starting point for more and more Internet users and will keep users on our sites longer.
Turning now to our mobile strategy, where we’ve also made important progress. First, we are extending our partnerships with mobile phone makers. Baidu is now the default search engine on over 80% of branded handsets using the Android operating system build in China so far this year.
As a result, we have made tremendous progress in ensuring that Baidu is the gateway to the Internet for Chinese users, whether they are going online on PCs or on mobile devices. At the same time, last quarter, we announced our new E-mobile platform. E is design to provide Baidu services to users on the go. We have an incredible suite of products and we want Baidu users to be able to use them anywhere, anytime.
Once device is featuring our platform available in the mass-market, Baidu E will give mobile users easy access to our search box, let them stream their music through Baidu stream, find their destination on Baidu Maps and use a growing number of web-based apps. This [is list] access to Baidu’s product across platforms, while increase users technique and ensure that we remain as a center of online experience for Chinese users.
All of these features will be currently integrated with Baidu’s evolving cloud computing offering and we have plenty more exciting features in the pipeline. Also, through Baidu E third-party developers will gain access to Baidu’s suite of mobile products and services. Developers will have API to increase search, mass payments and more into the apps for the E-platform.
Lastly, I’d like to update to our strategic investment. Our online leading platform GE continues to grow at a very encouraging rate. During Q3 with a monthly unique visitor jumped to 191 million from 160 million in Q2. Both Comstore and I research showed that GE is one of the leading video sites a user type spend on site.
One of the key factors letting GE apart from the competition is differentiated high quality content. To keep its edge, GE has signed licensing agreement with the Big Six the top-tier movie content providers, including Warner Brothers, Paramount, 20th Century Fox, Sony, Disney and Universal. We are really encouraged by how quickly GE has captured a huge share of this very competitive market. Baidu is fully committed to supporting GE to grow further and we will backing this up further investment.
As you know, we recently invested in online travel vertical Qunar. With that deal now completed high quality travel related information from Qunar have been further integrated into Baidu search in areas like hotels, airlines and train information. For example, when user search for hotel chain like [Home Being] on the result page, they will see a Baidu map that automatically picks up the users location and provides a comprehensive list of [Home Beings] hotel option in that geography, along with pricing information, or a flight search will show you the recent price trend for your desired flight, so you can see if the context being falling or increasing. The net effect of this upgrade is broad vast computing coverage of travel related keyword for our users and better fixed rate.
In conclusion, Baidu’s strategic investment combined with our robust organic growth and new innovated products, solidifying our position as a heart of Chinese Internet ecosystem. We have every reason for confidence in our prospects for the future.
With that, let me now turn the call over to Jennifer for financial highlights.
Thank you, Robin. Hello, everyone. As Robin mentioned, Q3 was another solid quarter that exceeded expectations. This was driven by traffic growth, monetization improvement and strong spending by large account. In order to ensure that Baidu continues to stay ahead of the curve, we maintain investment in critical areas, R&D, infrastructure and strategic initiatives.
Going forward, aggressive investment will remain central to our long-term growth strategy and driving topline growth. I would like to highlight that starting in Q3, Qunar financials have been consolidated into our financials. The overall impact on Baidu’s financial has so far been insignificant.
Also, as Robin mentioned, we’ll continue to support Qiyi rapid growth. Our cash investment of US$23 million in Qiyi this quarter was recorded as a loss over the equity accounting method. Our overall EPADS would have been US$91 – US$0.91 without this charge. We anticipate a similar level of cash investment in Qiyi in this Q4. After that, we’ll assess from time-to-time what are the optimal options available for Baidu is supporting Qiyi. Baidu and its partners will firmly support Qiyi.
Now, let’s look at the financial highlights for the quarter. All amounts mentioned are in RMB, unless otherwise noted. Online marketing revenues for the third quarter of 2011 were RMB4.2 billion, a 85% increase year-on-year. Baidu had around 304,000 active online marketing customers in the third quarter of 2011, a 12% increase from the corresponding period last year and a 2% increase from the previous quarter.
Revenue per online marketing customers in the third quarter reached approximately RMB13,700, a 65% increase from the corresponding period in 2010 and a 19% increase from the previous quarter. Traffic acquisition costs as a component of cost of revenue was RMB334 million or 8% of total revenue, as compared to 8.9% in the corresponding period in 2010 and 7.9% in the second quarter of 2011.
As we noted before, in the longer term we expect Traffic acquisition costs as a percent of revenues to gradually increase based on the extent of contractual advertising growth. Contractual ads are an important initiative for Baidu and require a higher payout ratio to Baidu Union partners.
Then with costs, as a component of cost of revenue was RMB166 million, representing 4% of total revenue, compared to 3.8% in the corresponding period in 2010. This increase was mainly reflects increase in server capacity to accommodate traffic growth, new product services and higher competing requirement.
Depreciation costs as a component of cost of revenue was RMB177 million, representing 4.2% of total revenues, compared to 3.7% in the corresponding period in 2010. The increase was mainly due to an increase in network infrastructure capacity. We will continue to aggressively invest in network infrastructure and building more office space.
Operational costs were RMB125 million, representing 3% of total revenue, compared to RMB85 million and 2.5% in Q2 of 2011. A main part of the sequential increase was due to pickup of intangible assets amortization related to Qunar transaction. The useful life of this intangible asset runs from three to 10 years, so we expect this will be an ongoing item in the foreseeable future.
SG&A expense were RMB460 million, an increase of 22% quarter-over-quarter. This increase primarily reflects increased personnel costs, marketing expenses and of course, Qunar financial consolidation.
Research and development expenses was RMB383 million, a 28% increase quarter-over-quarter. This increase primarily reflects increased headcount and of course, including Qunar financial consolidation.
Share-based compensation expenses, which were allocated to related operating costs and expense line items increased in aggregate to RMB39 million in the third quarter of 2011 from RMB24 million in the corresponding period in 2010. Operating profit was RMB2.2 billion, an 88% increase year-over-year.
Loss from equity method accounting was RMB156 million, this increase mainly reflects the cash investment we made in Qiyi this past quarter. Total headcount as of September 30, 2011, was about 14,700, roughly 1,900 more than the previous quarter. This includes about 800 employees from Qunar, now consolidated in our headcount.
Income tax expense was RMB318 million for the third quarter. The effective tax rate for the third quarter was 14.5%, as compared to 13.6% for the corresponding period in 2010. The year-on-year increase was due to exploration of some PRC subsidiaries preferential tax rate.
Net income attributable to Baidu was about RMB1.9 billion, an 80% increase from corresponding period in 2010. Basic and diluted earnings attributable to Baidu Inc. per ADS for the third quarter of 2011 amounted to RMB5.39 and RMB5.38, respectively.
Net income, attributable to Baidu Inc., excluding share-based compensation expenses, a non-GAAP measure was about RMB1.9 billion, a 79% increase from the corresponding period in 2010. Basic and diluted earnings attributable to Baidu Inc. per ADS, excluding share-based compensation expense both non-GAAP measures were RMB5.50 and RMB5.49, respectively.
As of December 30, 2011, the company had cash, cash equivalents and short-term investments of RMB11.4 billion. Net operating cash inflow and capital expenditures for the third quarter of 2011 were RMB1.8 billion and RMB490 million, respectively.
Now, let me provide you with our topline guidance for the fourth quarter 2011. We currently expect total revenue for the fourth quarter of 2011 to be between RMB4.41 billion and RMB4.54 billion, which would represent a 79.9% to 85% year-over-year growth. This forecast reflects Baidu’s current and preliminary view, which is subject to change.
I’ll now open the call to questions. Operator, please go ahead.
(Operator Instructions) The first question comes from the line of Dick Wei from JP Morgan. Your line is open.
Dick Wei – JP Morgan
Hi. Good morning, and congrats on the very strong quarter. My first question is on the revenue contribution from SME. Robin mentioned that very strong growth in large customer and classified sites. I wonder what is the revenue contribution of SME customer, what is the growth rate and what the kind of ARPU for design long tailed customer? If you can share some insight that will be great? Thanks.
Hi, Dick. I think this quarter across the Board, all the different customer basis grow very strongly and they all contributed to the end of the day the revenue growth. The large accounts outperformed the SME, but SME continue to grow very strongly both on year-on-year basis, as well as on sequential basis. We have year-on-year 85% increase, both SME and larger comps did well. But larger comp is growing faster than SME for this quarter and is actually has been the trend for the past few quarters.
Dick Wei – JP Morgan
Okay. Great. Thank you.
The next question comes from the line of Jiong Shao from Macquarie Securities. Your line is open.
Jiong Shao – Macquarie Securities
Thank you very much for taking my questions and congratulation on very strong results. For Q3, a strong growth of roughly 85% year-over-year, I was wondering, could you please sort of roughly break it down for us in terms of, okay, how much was due to the traffic growth, how much was the monetization improvement, how much is sort of price appreciation and any color on those metrics for 2012 would be appreciated? Thank you.
I think, it’s combination of all factors. Traffic continued to grow strongly. The ACP increase was pretty much due to the revenue mix because of internal larger accounts willing to pay higher prices. We’re also seeing a good contribution from existing verticals and as well as, newly emerging verticals.
The B2C e-commerce has been very strong virtually almost all of them larger B2C sites are large customers of ours and we see very strong momentum of that mega trend, the [O2O] mega trend offline to online, a lot of that virtual industries are moving there from offline to online, so we’re a big beneficiary of that. It’s very hard to separate all the factors and pick out which one contributed more, but what we can tell is that the advertiser staff generally very happy about the performance, so that helps us. We still have lot of room to grow.
The next question comes from the line Catherine Leung from Goldman Sachs. Your line is open.
Catherine Leung – Goldman Sachs
Hi. Good morning and also congratulations on the strong results. I was wondering in term of just business enhancement that you discussed, are you seeing this as contributing already a material proportion of your page clicks in the third quarter or going forward in the third quarter? Thank you.
Yes. I have mentioned during the prepared remarks, advanced to pre-match did contribute quite significantly to the overall revenue growth in particular to number of page clicks. In the past advertisers while customers only have two options, they be either chose the exact match or the broad match, some thought that the broad match was too broad, some thought the exact match doesn’t match all the user queries with their interest, with the customer interest.
But this new option more advertise their or customers can become more aggressive in being showing there at our core page links result. This started in Q3 and we’ll benefit from now, so Q4 we will also benefit from this. There are still quite a few things like this we are working on. We’ll report that as we achieve those goals.
The next question comes from the line of Jin Yoon from Nomura. Your line is open.
Jin Yoon – Nomura
Hi. Good morning, everyone. Just a follow-up on the previous question. How much impact in your guidance is really attributable to the new tweak in the Phoenix Nest, compared to any material contributions from the new homepage or are you expecting any greater, greater than expected contributions from Qunar? Thanks.
Let me answer the first part of the question. The new homepage does not have a positive impact on revenue yet. It even has a slight negative impact because users would search a little less with the new homepage. But the new homepage obviously weak here and we hope going forward people will stay longer on Baidu site and use our site as the starting point more frequently. So the improvements we’ve made in the Phoenix Nest contributed the most from and product point of view.
Any improvement, we’ve done on monetization front those will carry forward and will continue to refine and improve the monetization capability as Robin mentioned. To your question on Qunar contribution, as I mentioned Qunar’s overall impact to the Baidu overall picture is really small and it doesn’t really make sense for us to isolate that Qunar revenue per say are just for the Q4. And as Qunar becomes the more meaningful part of Baidu, we’ll certainly separately disclose that but I think in the near-term it’s very minimal.
The next question comes from the line of Eddie Leung from Merrill Lynch. Your line is open.
Eddie Leung – Merrill Lynch
Good morning, guys. Two questions, the first one is about your other revenues and could you give us more colors on the increase of other revenues in the quarter. And then, secondly, could you also give us the top five advertiser categories and are we all nine companies are flash newcomers are banned within the ranking of your advertiser category? Thanks?
Yeah. You all noted there is a slight other revenue number in our reported financial and our main revenue is online marketing services. And we have set up the some business ventures as you are aware like Baidu HR to provide other services. So this is more other revenue is basically a reflection of those non-online marketing services that we generate.
As to your second question related to the top five sectors and these remain largely the familiar once the medical and healthcare sector at the patient, machinery equipment, travel and business service. Those were the top five sectors for us in Q3.
As we mentioned in our script, online e-commerce continues to be a main driver and continue to grow very strongly. As we’ve mentioned in the past Eddie, we do not separate any five these because that will distort the way that would actually traditionally track our different sectors. So I tell, we will – we are able to tell you the online e-commerce sector continues to outpace the general 85% increase and has been growing by over a 100% for the Q3 still.
The next question comes from the line of Paul Wuh from Samsung Securities. Your line is open
Paul Wuh – Samsung Securities
Thank you for taking my question. I have a question related to your personalized homepage. I was wondering, if you could give us an idea of how many people have signed up for this service already? And related to that, is this service on your way to do more of an SMS like features like Google has done with Google Plus? Thank you.
Hi, Paul. For Baidu’s new personalized homepage, users do not need to separately sign up. As some athletes have regular accounts who never be logging, they loss their personalized homepage as their default homepage, the adoption rate has been healthy. I think users are acceptable to this new homepage setting.
The benefit of this is obviously users being a lot of easy, do not even need to search to reach the site that they are interested in and also they can reach feed they sign up on other social sites. So, users will be able to view a lot more information than before on the Baidu homepage that includes the social information both where with Baidu social product like Post Bar or Baidu Space, as well as social feed from other sites.
We believe that personalization is a fundamental need from our users and is also underserved our efforts and ability to choose this direction instead of balancing its bingo social networks that’s being our strategy.
The next question comes from the line of Richard Ji from Morgan Stanley. Your line is open.
Richard Ji – from Morgan Stanley
Hi, Robin, Jennifer. Thanks for taking my call. A question regarding GE and two-part, can you just give us a little more color on advertising spending trend on GE, especially given it’s robust unique visitor growth, as well as type of growth? And going forward shall we able to see more cost downing and advertising service between Baidu and GE?
GE is a joint venture. We have been pretty much focused on expanding the user base and improved user experience. Because of the nature of online video, I think this model is quite clear, which is advertising and we are basically competing for [Media Time] on this front. So we’re not so worried about the revenue opportunities of this venture. We have talked to the GE team on cross-selling, but we have not really done much in the past, going forward that certainly will be a possibility.
Your next question comes from the line of Gene Munster from Piper Jaffray. Your line is open
Gene Munster – Piper Jaffray
Good morning and my congratulations. I was seeing impressive growth and an impressive guidance. Maybe you could talk a little bit about what (inaudible) to further improvements you’ve got or you can still make and perhaps, compare that to Google’s platforms? And at what stage are you in terms of your platforms relative to Google? Thank you.
It’s very hard for us to compare this with our competitor, we don’t know exactly what we have done and what they are doing, but we have stated that we have a lot of room for improvement in the Phoenix Nest system. Basically there are two main areas that we can improve up on, one is the mechanism system side, as I mentioned, like quick match, it’s just basically a change mechanism.
The other side is the account management so to speak. The CRI system hardly provide tools for our customers to better manage their marketing campaign. We just got started on that front. We believe a better management system or more tools, well how happy customers, especially the small and medium customer to spend more comfortably our platform. So what I can tell you is that we have lot of levers here and we are consistently monitors the ROIs for our customers. We believe as we move up where I’ll be able to release the buying power from both the large customers and SMEs.
The next question comes from the line Ming Zhao from SIG. Your line is open.
Ming Zhao – SIG
Thank you. Good morning. I have a question on the custom acquisition. It seems like you added about 6,000 customers in the quarter, the year-over-year growth has some deceleration there, but you also in the meantime focused on ARPU growth. So my question is, is it because you have a lot of large customers with stronger spending power that has threaten some of the SME customers, so the customer acquisition has slowed, so any color on that will be appreciated? Thank you.
I think it’s, number of reasons, first, you correctly realize that our focus was more on the larger accounts over the past couple of quarters. The desire to spend and the budget to spend, our platform is really high.
Secondly, we also realized that there is some macroeconomic reason for the China is slightly moving away for the export oriented economy. So there is the rebalancing of the macro economy some of our export oriented customers are not doing so well and certainly that the SMEs do not really have the necessary tools to really spend on our platform and we are working on that too.
The next question comes from the line of Alex Yao from Deutsche Bank. Your line is open.
Alex Yao – Deutsche Bank
Hi. Good morning, everyone, and thank you very much for taking my question. Hey, Robin, can you talk about the number of trade clicks growth in this quarter and how would you envision this to continue to grow in the next fiscal quarters? Thank you very much.
Alex, clicks rates grew very helpfully in this quarter. As we mentioned we continue to improve our monetization capability and that in itself helps improve the clicks rate and generates the number of clicks that will automatically deliver the customers the ROI. We continue to have ways to refine our monetization platform and we anticipate clicks paid clicks as usual the financing increasing and growing helpfully of our customers and that, so there is no reason for us to think why that shouldn’t be the case going forward.
Alex Yao – Deutsche Bank
The next question comes from the line of Alicia Yap from Barclays Capital. Your line is open.
Alicia Yap – Barclays Capital
Good morning, Robin, Jennifer and Victor. Question is on, have you seen any increase in attraction from the Contractual Act and how will the TSE be trending in the next few quarter and what should be expect from the -- in terms of the margin in fourth quarter and 2012? Thank you.
Yeah. Contractual Act is very important initiative for us and we have been focused on improving on the technology, the product and also develop customer understanding to adopt the tool. The business initiative is tracking well. We’re pleased to see the progress. And as I’ve indicated in my script, over the longer term as we gradually improve and taking traction on this business, you should expect the tag rates to increase accordingly, because for this business is important initiative and we do payout, a higher payout issue to our union partners. So overtime gradually as we gain traction from this business you should expect that to increase.
The next question comes from the line of Wallace Cheung from Credit Suisse. Your line is open.
Wallace Cheung – Credit Suisse
Hi. Good morning. Thanks for taking my questions. Just recently did some stop policy restricting some from -- some (inaudible) company not to spend on the TV advertising in 1 to 6 p.m. Would that policy actually be positive or negative to Baidu as pharmaceutical is pretty much one of the biggest industry segment for Baidu? Thank you.
We – in that regard, Wallace, we are aware of that development, but we don’t have any indication to see if there is any specific regulation that will actually affect our online marketing services to the medical and healthcare service providers. What we have, well, we have control over is our own process. We have put a lot of effort as part of our normal business process to ensure that we service our end users good quality contact information and we are vigilant in terms of developing our advertisers. There is – that is very hard for us to say one way or another how this will affect us, but I don’t – we are doing things that we have control over.
The next question comes from the line of Jenny Wu from Citi. Your line is open.
Jenny Wu – Citi
Thank you for taking my question. Hi, Robin, would you please share with us your observation on advertiser spending behavior, such as, is that a general trend that more and more at large advertisers will adopt this paid search as a key advertising platform and currently, what industries are your existing larger comps are? Thank you.
Yeah. Sure. I think that is definitely true that the large comps are very much aware of the trend from the companies or customers I have been talking to, they all have amended from the higher level that they should allocate more of their budget -- more of their advertising budgets to online search. And among all the advertising forms, search obviously provides the best performance.
So, it’s much easier for them to show to their boss that how exciting that advertising camping is on Baidu while for the other advertising platforms online or offline, it’s much harder to demonstrate that. So, search has definitely become a key advertising platform for them.
And in terms of the large accounts, some of the sector players, our customers, as we mentioned you’re familiar with some more fee auto vertical, auto players like the manufacturers, the OEMs we have the game sector that’s pretty good. Our retail online services these are all brand players and they are large accounts for us.
The next question comes from the line of Cynthia Meng from Jefferies. Your line is open.
Cynthia Meng – Jefferies
Thank you for taking my questions and congratulations for a great quarter. I have two questions from your current business development activities especially with the SMEs, does management sees stronger take off of search marketing from third tier and interior of China? And then, do you anticipate any or can you observed any weakness from the current credit crunch in some other places for SME companies?
And the second question is the management gave any guidance expected run rate investment in Qiyi and Qunar for 2012? Thank you.
I’ll answer the first one, Baidu’s business is largely consumer on domestic consumption oriented. The large cities, still contribute super majority of our revenue and the growth rate is also higher. You can probably imagine if these large accounts are growing faster than the revenue contributing from the major cities are getting larger instead smaller.
So from this point of view the third tier cities are not, they are growing fast but not as fast as the large cities because of our limited exposure to build very small cities and very, very small enterprises we have not got anything on this impact of the credit crunch you mentioned.
And with regards to support from Baidu towards Qiyi and Qunar. On Qiyi as I mentioned we supported Qiyi with cash investment in Q3 and will do a similar cash investment in just into Qiyi in Q4 and after that we will address from time to time, what is the optimal options that we have to support this venture. So if we – as the time comes, I will let you know if there is any new development.
With regards to Qunar, we acquired the majority of the company and Qunar has sufficient cash. On an ongoing basis Qunar’s own business is growing very healthily, has a very little demand for additional cash from our perspective. So in the near-term, I do not expect that Qunar will call for cash contribution from Baidu.
The next question comes from the line of Andy Yeung from Oppenheimer. Your line is open.
Andy Yeung – Oppenheimer
Hi. Good morning. Congratulations on a very strong quarter. I just want to ask a little about the mobile space. Can you give us some insight into the mobile search area? How much of your current search volumes come from mobile devices and also is there a difference or any difference between your online and mobile pay click behaviors and how do you actually monetize those clicks?
Mobile search is a little bit different from the PC search. It’s kind of hard to compare on an apple-to-apple basis, each mobile page is generally much shorter than PC page, so number of page views on the mobile site is different from the number page views on the PC side.
The industry, I think it’s very hard to say, we’re still trying to optimize the mobile search experience we have not been very aggressive monetizing the mobile classic yet. We do plant to optimize the three advertising part of mobile in two, for example, we would allow our customers to show the phone number and consumers can just click on those numbers and they’ll make phone calls. This is not possible on the PC side. So mobile is growing faster than PC, but it’s still a relative small part from the page view point – page point of view and even smaller part from the revenue point of view.
The next question comes from the line of Gary Ngan from UBS. Your line is open.
Gary Ngan – UBS
Thank you very much for taking my questions. I had a question on competition especially on vertical searches like (inaudible) so I think in rest of world we don’t really – we haven’t really seen a successful vertical search elsewhere. But neither do we -- have we seen a country which have 80% of the gross merchandise value has been controlled by one company. So I just want to get your sense of how did you see the competition, competitive landscape going forward in this particular vertical search, what do you think is the advantage of Baidu versus your competitor? Thank you.
Yeah. Our fundamental belief is that users, most of the users are lazy. They don’t want to distinguish their information needs from shopping to car to lifestyle, so any type of information needs they naturally come to Baidu and search for it. And we have the largest user base and we have the most sophisticated search technology, so we are quite confident users who are increasingly relying upon by Baidu for all types of information needs.
This is also true for e-commerce related information needs. Like I mentioned before, virtually all of the large B2C e-commerce site advertise on us, that’s because we can drive traffic, we can drive very quick quality traffic to the site end users, it’s a trend actually probably also create that more of the shopping activity we’re having on those quite larger e-commerce site and we are certainly a big beneficiary of that trend.
The next question comes from the line of Muzhi Li from Mizuho Securities. Your line is open.
Muzhi Li – Mizuho Securities
Hi. Thank you for taking my questions and congratulation on a great quarter. I would like to ask more insight about your feelings of the slowdown in the e-commerce like group buying and some – and also some general merchandise e-commerce website that they closed down their service and how this industry contraction will affect your fourth quarter’s results and going forward into 2012? Thank you very much.
In general, I think we saw a big increase in terms of group buying site getting promotional activities on our platform and there has been in our sector some level of consolidation. On our platform we continue to see the group buying sites are spending with us. The e-commerce site, as I mentioned, continues to go very strongly. So these sectors over the past few quarters has been growing very nicely.
As Robin mentioned, we are really at the center stage in terms of the overall internet activity development and the growing of transition of users to take advantage of internet space to do e-commerce activities. Ultimately Baidu will be the beneficiary. At this they do not make us to be the top sectors in terms of revenue contribution, so any slight variation in that sector does not really have majority impact to our bottom line, but of course, we’re very excited to see the e-commerce sector growing nicely and Baidu is right in the center of all the activity.
The next question comes from a line of Mayuresh Masurekar from Collins Stewart. Your line is open.
Mayuresh Masurekar – Collins Stewart
Thanks for taking my question and congratulations on a great quarter. Large advertisers are clearly playing a big roles here. So what percentage of the large advertisers total marketing budget and online advertising budget is currently being spent on search, and in your opinion how high can that number go? And then I have a follow-up question.
It really varies from customer-to-customer and from industry-to-industry. Some of the more internet savvy accounts spent virtually all of your budget on the Baidu search platform. Well, for the other more offline oriented businesses that do only allocate a very small percentage of their total advertising budget to us.
So it varies from like 80%, 90% of the budget for those really online centric side to like less than 10% online marketing budget for those more traditional budget. But the trend is that we’re allocating more budgets to online and even larger percentage is allocated to search.
Of course, you can tell that a much larger portion of the economy comes from those offline businesses and in general they spent around like 10% of the advertising budget online and then on online they spent like 30%, 40% on search. So we definitely have a lot of room for growth there.
Mayuresh Masurekar – Collins Stewart
Thanks. And my follow-up question is, the (inaudible) is one of the major advertiser verticals for you. So as you integrate Qunar into Baidu, what is the reaction that you’re getting from your travel sector advertisers? Does it change your role as a partner and what is the benefit to monetization that you might be getting from the travel page clicks?
Well, Qunar is essentially a vertical search engine. It satisfies the needs of our users travel activities. So it’s very hard to separate the Baidu searches from the Qunar searches. We continue to serve our customers from all kinds of our travel related businesses. They have a choice to run their marketing campaign around the Baidu platform or on the Qunar platform. Qunar is more retail oriented, more specific on a lot of things, for Baidu we are more generic.
So in this sense maybe more of the Baidu users, they may not have that clear intention of where to go or what to do, that sort of things. They will come to Baidu and we try to convert that into the real travel customers. But for Qunar, the users in general have a better idea of what they would like to do and where they would like to go, so they go there and find the right information?
The objective for us to acquire Qunar is really to ultimately provide our users a better search, a better overall search experience, as they are looking for travel related information. So, as they get in to Baidu and they are looking for travel information, they really aligned on premium high quality vertical travel search information.
And in general, we are providing travel search information and as you are looking for travel businesses, there are a whole slew of different players and the different stage of activities that the user will carry out, such as transaction, such as commenting. And just in terms of our relationship, we see other travel sector players, we don’t see any slowdown in terms of their advertising activities on our platform. And in fact, in Q3, sequentially, travel was a very strong sector that is a strong sequential growth. And the notable travel players that you won’t have to familiar names, they are all increasing their spending in Q3 with us.
The next question comes from the line of Wendy Huang from RBS. Your line is open.
Wendy Huang – RBS
Hi. I have two housekeeping questions. First is regarding your margin, gross margin and operating margin both hold up quite well in Q3, despite of increasing bandwidth costs and also integration costs for intangibles. So can you give some color for operating margin, gross margin for Q4, especially sale marketing cost, how will that change up in Q4?
And my second housekeeping question is regarding Qunar, just to double check, if this Qunar revenue included in the online marketing revenue in the revenue breakdown, is that the case has your number of advertiser figure in all absolutely included Qunar contributions as well?. Thank you?
Great. On your first question in terms of margin, margin is really a reflection of the seed of our revenue growth and also the seed of our investment. Our top priority is really focused to try the topline growth and as I have mentioned in quite few quarters and as you have seen, we have aggressively invested in R&D, in infrastructure and in strategic initiatives.
And in these expenses, we’ll add up and flow through our expense line. So the operating margin is really a natural flow of what the revenue is and what the expenses are. You have seen in the past quarter the trend in terms of all the line items are expenses and that should give you a pretty good idea in terms of the speed or investment factor we’re actually carrying out. In terms of marketing costs for Q4, we do anticipate continued increase in SG&A expenses and particularly marketing per say.
We do note a Q3 step up and we would anticipate Q4 continued step up in terms of marketing spend, what actually happens in Q4 is, this year marks the 10th anniversary of Baidu’s commercial product. So well do a number of our celebrations and events to carry out to continue to develop the market and to promote search engine marketing.
So some we may even carryout some TV commercials in certain cities. So continue to expect that we will do the marketing efforts to develop the markets and promote the brand. So sequentially to your question, you should expect, marketing expenses to go up.
And on your second question with regards to Qunar’s revenue, Qunar’s financials are completely consolidated into Baidu’s financials. So both the revenue, as well as each expense lines are added and Qunar’s revenue is included in the online marketing, in revenue dollar amount. And Qunar’s customers and their customers’ ARPU also contributed to Baidu’s overall picture. But as I mentioned, Qunar’s overall impact is very insignificant.
The next question comes from the line of Jiong Shao of Macquarie Securities. Your line is open.
Jiong Shao – Macquarie Securities
Thanks for taking my follow-up question. Just a follow-up on operating margin comments, last quarter you correctly predicted that in the near-term because of the massive investments you’re making, the operating margins should trend down and it did. I was wondering, going forward [don’t have to be this projects] just generally like for the next few quarters, the duration of the sort of the operating margin, how should we sort of handicap that? Thank you.
It’s a, I really wouldn’t want to venture specifically into the margin predictions, as we don’t typically do that. As we mentioned, we will continue to drive the topline growth. And you have already, I think grasp a good pattern of the way we invest and the expense line items, how that should form out. I think in the Q2 and Q3 expense development gives you an idea in terms of the magnitude and the pace of how that’s going.
If we’re looking longer-term, E search is a beautiful business model and has tremendous ability. And our focus really is to drive the topline growth at this stage, because we’re really at very early stage of letting the market space, knowing the beauty of search engine marketing and really continue to spend a lot more with us and we deliver the kind of our icon customers.
And we don’t really focus on the margins, I can’t really give you quarter-on-quarter predictions, but this is the beautiful margins, beautiful business and we are managing this business with very discipline approach and we invested prudently to develop future opportunities to drive long-term growth.
Jiong Shao – Macquarie Securities
Okay. Thanks for the comments.
The next question comes from a line of Dick Wei of JP Morgan. Your line is open.
Dick Wei – JP Morgan
Yeah. Thanks for taking my follow-up. My first question is a longer term question, if I look at Q3 sequential revenue growth around like 22%, but if I looked at account receivables is up like 60%, so I assume that was obviously should not be impacted the large customers are spending much more in Q3, as well as I guess, in your prepare remarks that as you said there is also 50% sequential growth, so you said SME growth is very much slower than the 22% revenue growth. So I wonder that like three, five years, how was that kind of mix we change, if you can shed some light that will be great and I have follow-up as well? Thanks.
Yeah. Like I mentioned that the larger comps growth much better, actually better than we had expected too. But the point is really that because of our central position in China’s internet ecosystem, we are able to react the benefits of any emerging sectors. So last quarter, classified website suddenly emerged as they put up their advertising on us and certain verticals would go often down but it’s always macro trend that once they are in position to expand their benefit, they will advertise our platform.
I also mentioned because of the relatively difficult environment for the export-oriented businesses, some of the SMEs are not doing so well. But the overall customer portfolio is very healthy and we just need to come up with the right products or right tools for them to really benefit from our online marketing platform.
Dick Wei – JP Morgan
Great. One, I think, just follow-up on that is, what are you seeing in terms of the sentiment for some of the large advertisers on SME as well you said that macro uncertainties, any particular sectors that were seeing stronger sentimental, weaker sentiments or any delays on spend as well, any general macro comment will be great? Thanks.
Honestly we have nothing much sentiment on the macro economy with the exception of export oriented since it’s in the tougher position. Our top verticals are all doing very well and if you know we are more domestic consumption focused and this sector is growing very, very nicely and we haven’t seen anything slow down on this front.
The next question comes from the line of Wallace Cheung from Credit Suisse. Your line is open.
Wallace Cheung – Credit Suisse
Hi. Thank you. Financial related questions, it seems that customer departed in the third quarter and substantially jump a lot, but the differ revenue actually coming down, can you explain and also one more is, it seems the minority interest loss is actually doing much better, it is more related to Qunar? Thank you.
Yeah. Hi Wallace. On the customer deposits basically these are the deposits that customers make with us, primarily the SMEs they will do a cash deposit and then they will incur their spending. So when you see a customer deposit increase and of course, first that a good indicator of strong customer desire in terms of spending with us.
Deferred revenue some times it is more less related to the large accounts. Large accounts have payment terms and more complicate contract, so to meet the revenue recognition test, a lot of the criteria’s are need to be met and all the duties need to be fulfilled. So you will see some movement of deferred revenue but that is not a real indication of revenue going forward.
And in terms of minority interest in the P&L line, you are -- in the P&L line I think for the equity accounting that I was pointing out those are related to the equity accounting related -- the entities that we invest and that those accounting treatments are under equity accounting method and as you are looking at less income that over loss attributable to non-controlling interest and those are other interest that we hold – that really have very small impact to the overall picture. And I think if we sure trying to get to what is this minority interest that’s related to Qunar. Qunar is financially doing pretty healthily, it can stand on itself.
We are now approaching the end of the conference call. I will now turn the call over to Baidu’s Chief Executive Officer, Robin Li for his closing remarks.
Once again thank you for tuning up today and please do not hesitate to contact us if you have any further questions.
Thank you. Thank you for your participation in today’s call. This concludes the presentation. You may now disconnect. Good day.
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