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Baidu.com, Inc. (NASDAQ:BIDU)

Q1 2007 Earnings Call

April 26, 2007 8:00 pm ET

Executives

Lynn Lin - Investor Relations

Robin Li - Chief Executive Officer

Shawn Wang - Chief Financial Officer

Analysts

Jason Brueschke - Citigroup

Robert Peck - Bear Stearns

C. Ming Zhao - SIG

Nat Schindler - Piper Jaffray

Anthony Noto - Goldman Sachs

James Mitchell - Goldman Sachs

Steve Weinstein - Pacific Crest

James Lee - WR Hambrecht+CO

Richard Ji - Morgan Stanley

Stephen Ju - RBC Capital Markets

George Chu - UBS

Eddie Leung - Deutsche Bank

Wallace Cheung - Credit Suisse

Gene Munster - Piper Jaffray

John Pitts - Steadfast Financial

Presentation

Operator

Good evening and thank you for standing by for the Baidu first quarter 2007 earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Lynn Lin, Baidu Investor Relations.

Lynn Lin

Hello, everyone. Welcome to Baidu's first quarter 2007 earnings conference call. We did distribute Baidu's first quarter 2007 earnings yesterday. You may find a copy of this press release on the company’s website as well as on newswire services.

Today you will hear from Robin Li, Baidu's Chief Executive Officer, and Shawn Wang, Baidu's Chief Financial Officer. After their prepared remarks, Robin and Shawn will be available to answer your questions.

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

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

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

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Robin Li

Hello, everyone and thank you for joining us today. We are pleased to report that in the first quarter of 2007, we exceeded the top end of our revenue guidance with revenues growing 103% year over year. After two quarters of transitioning, we believe we have set a solid foundation for future growth.

We continue to build our market share by expanding Baidu's position as the premier platform for Chinese language information online. Our traditional search service and other search related product continues to be the key driver of growth.

In particular, our community-based products, including Baidu Knows, Baidu Space, and Baidu Encyclopedia are among our fastest growing and most exciting products. Currently, Baidu Knows has about 15 million answers for the questions, and during the first quarter the number of Baidu Space users almost doubled.

We are also seeing good user response to our new product and content initiatives. In the first quarter, we introduced Baidu Video Search and we expanded our digital entertainment offerings through further collaborations with the leading record companies.

We believe in the long-term market potential for advertising-supported digital music and content providers continue to show great interest in working with us. We remain on the lookout for strategic partnerships that help to enhance user experience and revenue.

Developing the best sales team in China is an important part of our strategy, and that is why we have promoted Mr. Hailong Xiang to be our Vice President of Sales. Mr. Xiang has successfully headed our direct sales team in both Shanghai and Beijing and we are confident that he will be instrumental in the ongoing development of our sales network.

Despite the late Chinese New Year, our active online marketing customers grew by over 4,000 as we continued to build our direct sales team in major cities and strengthen our distributor network. We believe that our commitment to customer service will continue to translate into a growing customer base and higher average spending per customer. This should also help existing customers transition to our improved P4P online marketing platform.

As we announced earlier today, we have accepted David Zhu’s resignation as COO. David has made a valuable contribution to Baidu's growth and has helped us build a strong team. We wish him all the best and we are considering options to fill the COO role.

In the meantime, we continue to develop homegrown talent. In fact, two of the newest members of our senior management team have both been with us for over five years. Mr. Jun Yu has been promoted to Vice President of Products to lead the design and promotion of new and existing Baidu products and services. Mr. Xuyang Ren has been promoted to Vice President of Marketing and Business Development and oversees our marketing, strategic partnerships and international business development.

We pride ourselves on creating a great place to work and grow and we will continue to hire and develop the best talent.

Today, the Internet market in China is still in its infant stage, with only around 10% Internet penetration. With this enormous market potential before us, we are strongly committed to investing in the long term growth. This is reflected in our aggressive investment during the quarter in technology, bandwidth and network capacity.

Lastly, I am pleased to report that we are progressing very well with our Japan initiative. Many of you will have noticed that we began operating a limited beta site this quarter, Baidu.jp, and the initial indications have been very positive. We are on track to officially launch Baidu Japan later this year and we will keep you updated.

I will now turn the call over to our CFO, Shawn Wang, to discuss our financials.

Shawn Wang

Thank you, Robin. Good morning and good evening, everyone. As many of you know, our first quarter results tend to be affected by the seasonality from the long Chinese holiday, Chinese New Year holiday. Regardless of this, we exceeded our guidance and posted a healthy revenue growth in the first quarter of 2007. This was achieved by the strength of our customer service and the increased awareness of P4P online marketing in China.

I will take a few minutes to walk you through some of the important factors contributing to these results and a few other financial highlights.

Our first quarter total revenues were approximately RMB276 million, slightly exceeding the top end of our guidance and up 103% from the year-ago period. Online marketing revenue was RMB275 million, which is a 108% growth year over year. A number of factors contributed to our growth, including the year-over-year increase in the number of active customers of 51%, as well as a year-over-year increase in per customer spending of 41% approximately.

Traffic acquisition costs as a component of costs of revenues was RMB28 million, or 10% of total revenues, compared to 9% a year ago. The increase reflects the continued growth of revenue contribution from Baidu Union.

Bandwidth costs as a component of cost of revenues was RMB22 million, or 8% of total revenues, compared to 6% a year ago. Depreciation costs as a component of cost of revenues was RMB26 million, or 9% of total revenues compared to 8% a year ago. The increase in bandwidth and depreciation costs was mainly due to new data centers established in southern China and in Japan.

Share-based compensation expenses decreased marginally to RMB12 million from RMB13 million in the year-ago period.

SG&A expenses were RMB75 million. That is a 49% increase from a year ago.

Research and development expenses were RMB25 million for the quarter. That is a 61% increase from the year-ago period.

As Robin mentioned, our Japan initiative is progressing well. Baidu Japan incurred operating costs and expenses in the first quarter of RMB11 million in aggregate.

In the first quarter of 2007, income tax expense was RMB1 million approximately.

Net income for the quarter was RMB86 million, representing a 143% increase year over year. Net income excluding share-based compensation expenses, a non-GAAP measure, was RMB98 million. That is a 125% increase from a year ago.

Basic and diluted EPS excluding share-based compensation expenses were RMB2.9 and RMB2.82, translating roughly to $0.38 and $0.37 U.S. respectively. The above costs and expenses related to Japan operations impacted our EPS by $0.04.

Net margin excluding share-based compensation expenses for the first quarter was 35%, up from 32% in the year-ago period. The year-over-year increase primarily reflects the scalability of our business.

Moving on to our balance sheet, we ended the first quarter of 2007 with cash, cash equivalents and short- term investments of RMB1.2 billion, or $151.4 million. Operating cash flow the quarter was RMB113 million, representing a year-over-year increase of 20%.

Capital expenditures for the first quarter was around RMB154 million, up from RMB12 million a year ago. The significant increase in capital expenditures was primarily due to the establishment of data centers in south China and Japan.

Adjusted EBITDA, again a non-GAAP measure, was RMB118 million for the first quarter, representing a 126% increase from the year-ago period.

Please allow me to provide you our top line guidance for the second quarter of 2007. We currently expect total revenues to be between RMB378 million and RMB388 million, which would represent a year-over-year growth of 97% to 103%, and a quarter-over-quarter sequential growth of 37% to 41%.

I do wish to emphasize that this forecast reflects Baidu's current and preliminary view that is subject to change.

I will now turn the call back to Robin for some closing remarks.

Robin Li

Thank you again for joining us today. While we are pleased with the results we have achieved to date, we believe that the best is ahead of us. We look forward to continuing to provide the best search experiences for our users and continuing our strong growth path in the coming quarter and years.

I will now open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Jason Brueschke. Please proceed, sir.

Jason Brueschke - Citigroup

Thank you. First of all, good morning, Robin and Shawn, and congratulations on your quarter and especially on the outlook. It looks very, very strong. My first question, and I will get back at the end of the queue, is the transition period seems to have come to an end, and that is something that you guys have said would happen going into Q2. Could you just give us some color on really what has changed? I guess what I am interested in is have we seen a decrease in customer churn in Q1, and I guess your expectations for Q2 as well? Have we seen customers that maybe have stopped coming and advertising on Baidu because of the changes in the algorithm, relevancy and dynamic bidding? Have they been coming back?

And could you maybe comment on why the ARPU seems to be growing very well. Is that now the latent effect of these changes to the algorithm or was there something else going on in the market? Thanks.

Robin Li

Jason, as we mentioned earlier, we went through about two quarters of transition and that was actually initiated by some of the algorithmic changes we made in our paid search platform. That change caused some customer confusion and we tried to solve that problem by improving our customer service team, our sales team. Now what we are seeing is that more and more customers, including the new customers we signed up during the past couple of quarters, and many of the existing customers can appreciate our effort. When they look around and try to compare the performance of Baidu platform and the other alternatives, they found that Baidu is still the most effective way for them to promote their products and services. That is why we are seeing the results are getting better and better.

Regarding the increase in ARPU, I would say it is driven by a number of factors, including the traffic growth we experienced during the quarter. We expect the traffic growth will continue for the rest of the year and also, better customer service, better sales team and better execution in other operations metrics.

Operator

Your next question comes from the line of Robert Peck with Bear Stearns. Please proceed, sir.

Robert Peck - Bear Stearns

I just wanted to touch really quickly on the sequential increase in the top line. It looks like it is mostly coming from new customers as opposed to increased customer spend. Could you talk about when you look at the guidance, the sequential growth for 2Q being about 40%, how should we think about that mix for the quarter? Thanks.

Robin Li

I think, as I mentioned earlier, it is a combination of new customers coming to us and the increase in ARPU. The sequential growth really reflects the preparation we did during the past few quarters. As we also mentioned in the last conference call, seasonally Q1 is slow and last quarter was especially slow because of the late Chinese New Year, so we are actually starting from a relatively low base when you are comparing the sequential growth from Q1 to Q2. But overall I think we are very happy about the execution we did during the last quarter. We are quite confident things are back on track.

Operator

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

C. Ming Zhao - SIG

Thank you. Good morning, everyone. Congratulations. Just a question on your Japanese investment. I know you have spent RMB11 million on the P&Ls, so what is the amount you put on your balance sheet? Is that the part of the fixed asset increase?

Shawn Wang

Ming, I am not sure if I heard your question completely but let me try to give -- if I don’t answer your question, you can ask again. In terms of the P&L charges that are appearing on our quarter, as you can see this is really, the biggest increases are coming from the bandwidth and depreciation. To tie that, you can see a very significant CapEx investment that was made during the first quarter associated with our building up of data centers in South China and Japan.

Our building of network capacity has always been a function and this is, as you can tell, the amount of investment is more than the CapEx investment we made. It was almost about the same, or slightly more than what we did for the whole year of ’06, so that reflects a very -- it reflects the optimism, the confidence we have in our business. We have been saying that it is time to make an investment and that is what we did in this quarter.

Robin Li

The RMB11 million number is on a GAAP basis. It includes depreciation costs.

Shawn Wang

Okay, yes, -- that’s absolutely --

C. Ming Zhao - SIG

Does that mean for the remaining three quarters, you are still expecting to spend $14.5 million on the P&L?

Shawn Wang

In the future quarters, assuming you are still talking about Japan, the expense level we have seen for this Q1 will continue to increase, because the Q1 expenses related to Japan in most parts are still the network and fixed asset related. In future quarters, we continue to expand our operations in Japan and incur additional R&D expenses. We would expect that will continue to increase. The Q1 number is not to be repeated.

C. Ming Zhao - SIG

I understand that but I just wanted -- from all -- do you still expect full-year expenses to be in the range of $15 million?

Shawn Wang

Yes, we talked about $15 million, that was an estimate that we gave out for the whole year of 2007.

C. Ming Zhao - SIG

Thank you very much.

Operator

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

Nat Schindler - Piper Jaffray

Hi, this is Nat Schindler calling in for Gene Munster. I wanted to -- in the past, except for the last two quarters where some of your issues with churn increased related to the number of changes you made, you had a relatively stable net new customer adds per quarter and it seemed to be, it looked like it related to the number of sales people you had.

Assuming Q2 has a nice growth in ARPU, it would still, to make your guidance, you are going to have to have a very large growth in net new customers, much bigger in aggregate numbers than you have had in the past. Is this due to more feet on the ground, approaching the sales people, going out and getting new customers? Or is more just simply search getting bigger in China?

Robin Li

We cannot exactly break down the contribution on new customer additions and the increase in ARPU. What I can tell you is that ARPU is primarily driven by the traffic increase. After the Chinese New Year, typically the traffic will increase quite dramatically. If you estimate the overall page view we get during Q2, it should be significantly higher than Q1.

Of course, this is based on the assumption that the customers are willing to spend as much as we can provide in terms of traffic inventory. Also, after the Chinese New Year, the sales team can go out full force to talk to potential customers, so we also expect the number of new customers to be better, much better than Q1.

Operator

Your next question comes from the line of Anthony Noto with Goldman Sachs. Please proceed.

Anthony Noto - Goldman Sachs

Thank you very much. Robin, I was wondering; a year ago, the seasonality in the June quarter versus the March quarter, your sequential growth in new online customers was 45%, but at that time you had a very different model than you do today. Given the number of internal sales people you have on incentives, do you think you could accelerate that sequential growth compared to the seasonality a year ago? Thank you.

Robin Li

I really cannot provide a guidance on the number of new customers for the coming quarter. It is actually in the percentage terms but I would say that Q2 is typically a strong quarter in terms of new customer additions. Our revenue guidance for Q2 does reflect a combination of number of customers and the ARPU.

Operator

Your next question comes from the line of James Mitchell. Please proceed, sir.

James Mitchell - Goldman Sachs

A kind of narrow-focus balance sheet question; if I look at your customer deposits, they were up about 4% quarter on quarter. I think this time last year, they were up about 25% quarter on quarter, but your Q-on-Q revenue growth for the second quarter is the same as it was this time last year, so you are obviously enjoying very strong secular growth. Has there been a change in the nature of how customers pre-pay for your services? Are there more customers paying by credit card rather than through the deposit mechanism? I am just curious why the revenue is growing faster than the deposit. Thank you.

Shawn Wang

First of all, I think the credit card is not becoming any material way for payment of our business customers. We have seen more use of online payments from other methods, but it is still not the mainstream at this moment.

But when you try to compare it to the last year number, I think there are some changes in how we collect a deposit from a customer in the course of the past few quarters. I think in the original way, we used to collect a standard minimum payment basically nationwide. In the course of the last year, we modified the practice so we do recognize different markets, different customers who may have a different payment habit or pattern. So we actually did abolish this one standard payment metric for the whole market. Instead, we did allow different markets to set a different minimum deposit limit, so that I think the historical record may not actually be a good indication.

Robin Li

Also, as the market gets more mature, customers typically pay on a more frequent basis rather than pay a less sum and wait for a long time. I think it has to do with the market maturity or customer maturity.

James Mitchell - Goldman Sachs

So just so I am clear, in the smaller cities previously the minimum deposit was a barrier to entry, so you reduced or removed that barrier to entry to accelerate growth in your lower income customers, and then some of your biggest customers simultaneously are paying on a more regular basis, not making big lump payments once every few months?

Shawn Wang

That’s about right.

Operator

Your next question comes from the line of Steve Weinstein with Pacific Crest.

Steve Weinstein - Pacific Crest

Thank you. I just want to make sure I understand Shawn’s commentary around the CapEx and the bandwidth spending. You indicated, and this is consistent with your comments in the past, this would be step function with the growth and understanding that you had some additional headwind there as you are moving into a new geography.

How should we think about CapEx and bandwidth costs growing for the rest of the year? Have you completed this step-up and we should see more normalized spending over the next three quarters, or are you still somewhere in the process of taking that next step higher and we should --

Shawn Wang

The larger scale set-up is mostly complete. We will be returning to a normal -- we will continue to spend on CapEx but it will be a normal pattern. It is not going to be the same type of jump that you saw in Q1.

Operator

Your next question comes from the line of James Lee with WR Hambrecht.

James Lee - WR Hambrecht+CO

Good morning, Robin and Shawn. Can you just help me sort of clarify the seasonality in 1Q? Maybe you could break down the revenues by quarter and give us a sense of what percent of revenue you book in January, February and March? And maybe a run-rate in April a little bit versus March? That would be very helpful. Thank you.

Shawn Wang

Let me comment in general, I think the Chinese holiday tends to affect -- the biggest impact is the Chinese New Year, which it could be in the month of January, it could be in the month of February, and in this particular quarter it happened in the second-half of February, which means between January and the Chinese holiday, there is a longer period than last year. Last year I think it was end of January.

What we have experienced is the longer the time span between New Year’s, January 1st, and the Chinese holiday, the bigger impact of the holiday. People are in the festival atmosphere for a little longer and that affects our business.

What normally happens is after the Chinese holiday, and I think the Chinese holiday will last roughly about a week to 10 days or so, depending on different cities and parts of China. So in this particular case, when we entered into March then we started to see the recovery from the Chinese holiday. What we saw in this March is a very strong recovery in both traffic and business.

James Lee - WR Hambrecht+CO

Shawn, could you quantify that a little more? Is it fair to say the majority of the revenue during the quarter was booked in March? Over 50%?

Shawn Wang

I would not go into specific month by month, but I think what I told you is roughly -- will help you to understand how the numbers keep moving.

James Lee - WR Hambrecht+CO

Can you compare the April run-rate so far versus March?

Shawn Wang

James, I think our practice is to give you forward guidance on the quarter, like we did. We will not be going into specifics.

Operator

Your next question comes from the line of Richard Ji with Morgan Stanley.

Richard Ji - Morgan Stanley

Somehow my line got disconnected, so I apologize if the question has been asked. I have two questions. Number one is regarding your Japanese venture. I am just curious, how will you differentiate your Japanese search service from the local leaders, such as Google and also Yahoo! Japan?

Second question is after you changed your monetization scheme, have you seen the churn rate of your customer base stabilize?

Robin Li

On the Japan venture, I think our current priority or current goal is to first make the web search and image search, which are the two services we beta launched towards the end of last quarter to be competitive, to be comparable in terms of service quality. We do believe that there are a lot more things we can do in terms of differentiating or providing more localized service to the Japanese consumers.

At this time, we really cannot get into the details. Our goal is not really to differentiate from the current market leaders but do a better job than the current market leaders.

On the churn rate, I think I mentioned during the last conference call, the whole transitioning process is more like a wash. Some of the older customers did not accept the new pricing scheme. They left. More and more new customers signed up and they are happy about the performance we can deliver to them.

Operator

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

Stephen Ju - RBC Capital Markets

Good morning. What tax rate should we be thinking about for the balance of the year and going forward?

Shawn Wang

Again, it is difficult to predict that with any degree of accuracy in the environment because it is -- we do have various operating entities and they get different tax breaks from various government agencies from time to time. But I think it is probably okay to assume at this time we will be somewhere in the mid-single digits.

Operator

Your next question comes from the line of George Chu with UBS.

George Chu - UBS

Good morning, Robin and Shawn. A few quarters ago, I think -- if I’m correct -- I heard a comment from you on the call that you find for the new customers that were just signed on recently, you find that it tends to take them a few quarters to become real contributors in terms of revenues. Is the same trend still true or are you finding new customers are spending more money faster than the customers you were signing on a year or two years ago? Thank you.

Robin Li

That is still true. It is not really a trend. It is actually a fact that has been true for a long time. Usually when a customer signs up, it will take them some time, typically a few months, to get familiar with our online marketing platform. Once they get used to the platform, they know how to track their performance, they will be happy, they will spend more. That has been the case for quite a long time.

George Chu - UBS

I see. And I recall, if I may, I recall I think two years was a period that you mentioned before, meaning it takes a customer two years before it becomes a real contributor? Is that correct or am I mistaken?

Robin Li

I don’t think we gave a number like two years but I think as a trend, new customers are spending more, not only because they are more mature but also because we have more inventory, we have more traffic to deliver.

Operator

Your next question comes from the line of Eddie Leung with Deutsche Bank.

Eddie Leung - Deutsche Bank

Good morning. Could you talk a little bit more about your new products? For example, the roadmap for products that are going to be launched in China? As far as the traction you see in some of the products launched in the past year, which ones match your expectations, which ones not?

Robin Li

We typically do not pre-announce products we are going to launch, with the exception of Japan because that would incur a significant amount of expense. For the Chinese market, as I mentioned earlier, we have launched Baidu Video Search during Q1 and many of the existing or relatively new services we launched during the second half of last year or even earlier are doing very well.

We are approaching the Chinese market not to launch a lot of new products but once we decide to bet on a product, we would target the number one or number two position. Currently, almost all of the products we launched met or exceeded our original expectations in terms of traffic.

Operator

Your next question comes from the line of Jason Brueschke with Citigroup. Please proceed, sir.

Jason Brueschke - Citigroup

Thank you. Two follow-up questions; first of all, you acquired I believe a news license that might enable you to go into brand advertising and you have announced some new music partnerships. Could you let us know if you are expecting material revenues from these two new initiatives to come in the second quarter of this year?

The second question I have is could you maybe discuss what your sales and your go-to-market strategy for Japan is going to be? Are you going to try to do more of a direct sales effort with advertisers, or will you look to leverage some third parties that may exist already in that market? Thanks.

Robin Li

Jason, on the brand advertising issue, it is still a very small percentage of our revenue. We have been trying to offer a little bit of brand advertising within the channels other than web search. So far, the effectiveness or the performance has been very good. I think advertisers typically found that the brand advertising on Baidu has better performance than the traditional portal companies.

We also mentioned during the previous conference calls, we launched an advertising form called [inaudible]. It is really a behavioral targeting based on user behavior and we deliver graphical ads to them based on what the user did on our platform and on the websites we have control of.

We think going forward brand advertising will have very nice growth but for the next few quarters, it is not going to be a very significant contributor to the overall revenue.

Regarding Japan, I think for the first year our goal is to develop the best product and service for Japanese consumers. We have not thought about how we are going to do sales there but because the Japanese search market is a relatively mature market, I think it is going to be relatively easy for us to get revenue once we get traffic.

Operator

Your next question comes from the line of Robert Peck from Bear Stearns.

Robert Peck - Bear Stearns

Two quick questions here, one is if I add back the RMB11 million invested in Japan, the margin still seems to drop a little bit here. Could you tell us what is causing that and how we should think about it going forward? Secondly, could you also comment a little bit about the delta or the change in the market share of Baidu versus Google? Thank you.

Shawn Wang

On the margin number, there is a significant investment that was incurred during Q1 and we would expect that the impact of that, namely depreciation and bandwidth, will last at least -- it will continue to impact our earnings for the next few quarters. I want to caution you; I think the margin for the next immediate quarters will continue to reflect this investment, but the inherent scalability of our business is not to be affected by this. I think the investment was really on the heel of our strength and confidence in the business, so I do expect beyond the immediate quarters, we will see improved margin.

Robin Li

About the market share question, again there is no authoritative number on that. We do not have the exact traffic or user base number for our competitors. What we have seen is that after the Chinese New Year our own traffic increased quite quickly. It is doing a job better than we had expected.

Operator

Your next question comes from the line of Wallace Cheung with Credit Suisse.

Wallace Cheung - Credit Suisse

Good morning. Just a quick question on the [inaudible] costs. Could you explain a little details on how do you drive beta Baidu Union [inaudible] first quarter? Can you comment on the trend of the [inaudible] as a percent of total revenue going forward the next few quarters? Thank you.

Shawn Wang

Wallace, there has not been any change in our Union status. We will continue to -- we already have the largest union network in China. We will continue to expand that. And also to the extent that we could serve other companies with our monetization platform, we are open for that opportunity.

As you will recall, we did enter into a corporate agreement with MSN in China. We started to power some of the monetization, some of the traffic started in Q1 and I think the number, the TAC increase reflected that slightly.

In the future, we will continue to recruit third party traffic to the extent that it will contribute to our margin, but the TAC number itself [inaudible].

Wallace Cheung - Credit Suisse

I’m sorry, could you repeat that again, the last sentence?

Shawn Wang

What I was saying is that in the future, we will continue to try to recruit more third party traffic to utilize our monetization platform, so the TAC number in absolute dollar amount, it will not increase. As a percentage of total revenue, that could fluctuate.

Operator

Your next question comes from the line of Ming Zhao from Susquehanna International.

C. Ming Zhao - SIG

Thank you. I have several quick housekeeping questions, if you can provide for me. One is, can you tell me roughly how many Baidu Space users are there right now?

Robin Li

We do not disclose that kind of number. It is a tricky metric. It depends on how you calculate the number of users. Is that the number of registered users or number of active users? And if it is active users, how active is active? Is that just once a week log in, or once a month log in -- it is quite difficult to give a clear indication of how the service is doing.

But what you can track is you can go on to some third party website to see the traffic percentage of the Baidu Space service, which is hi.baidu.com. I think that will give you a relatively good picture on how our Space is doing.

C. Ming Zhao - SIG

Also, could you update us with the headcount at the end of the quarter? Also, including the sales force at the end of the quarter, please?

Shawn Wang

The line is not very clear. Could you repeat your question again?

C. Ming Zhao - SIG

I would like to know the total number of employees by first quarter, and among them, how many are sales people?

Shawn Wang

Okay. At the end of the quarter, we have close to 4,000 employees, and the majority of them, close to 70% of them are in sales and customer service.

C. Ming Zhao - SIG

Also, what was the CapEx exactly in the first quarter?

Shawn Wang

How much exactly is the CapEx?

C. Ming Zhao - SIG

Yes, in Q1.

Shawn Wang

It was about RMB150 million -- 154.

C. Ming Zhao - SIG

Thank you.

Operator

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

.

Gene Munster - Piper Jaffray

Yes, quickly one housekeeping question; did you just say 4,000 employees, or did mis-hear that?

Shawn Wang

Close to 4,000, yes.

Gene Munster - Piper Jaffray

Okay, and then one follow-up question; as you had issues switching over customers from the Beijing distributors, you had to build up your sales force in Beijing, do you feel comfortable now with the level you are at or is there still more room to grow the Beijing sales force to just get yourself back to stabilized in Beijing?

Shawn Wang

Well, there is room to grow not only in Beijing, I think nationwide. As Robin mentioned earlier, I think we did see that the market still has tremendous room to grow and we think with improved customer service and with an expanded direct sales forces, we will continue to do a better job. Of course, our distributor will also play a very important role in this, so we will continue to grow direct sales in Beijing and other parts of China as well.

Gene Munster - Piper Jaffray

Final question; what was the headcount number at the end of Q4 again?

Shawn Wang

It was about 3,200, roughly.

Operator

Your next question comes from the line of James Mitchell with Goldman Sachs.

James Mitchell - Goldman Sachs

I know you do not give full year guidance about items like this, but just very broadly speaking, can you help us think about CapEx to revenue ratios over time? I understand the first quarter was kind of an anomaly on the way up, but I am wondering if the ongoing CapEx would be somewhere between where it was last year and the first quarter trend level, or it would revert to the level last year, relative to revenue?

Shawn Wang

The CapEx in the first quarter is basically if you look at our history, this is a record level. As I mentioned earlier, it is basically [more than] the last year’s combined, so this is a very large scale CapEx build-up.

In the next few quarters we will not have anywhere close to this level of CapEx build-up again. I could not give you an exact number but I think it would be somewhat back to the normal pattern.

James Mitchell - Goldman Sachs

Sorry, you say that the CapEx will not see this level of build-up, but will the actual dollar or RMB figure for the next few quarters be similar to this quarter, or would it revert to somewhere between this quarter and where the previous --

Shawn Wang

When you build a new data center, you do not keep on building it. You build it once and then you just add more service and just on a normal pattern, which we experienced in the past year.

James Mitchell - Goldman Sachs

Okay, great. Thank you.

Operator

Your next question comes from the line of Steve Weinstein of Pacific Crest.

Steve Weinstein - Pacific Crest

When I look at the sequential growth impact, it grew faster than I guess the sequential growth in overall revenue. As I am working through my model, I was wondering; did the revenue on Baidu properties actually grow sequentially or was all the sequential growth really out of the Union numbers?

Shawn Wang

The significant contribution of revenue growth came from Baidu properties. Baidu Union did grow as well, it just -- if you look at the increase, it was probably from 9% to 10%. The Union revenue did grow as well and is certainly not anywhere close to tip the balance.

Steve Weinstein - Pacific Crest

Sorry, the line was breaking up a little bit. So on a sequential basis, you are saying that those grew, both the Baidu property revenue as well as the Union revenue?

Shawn Wang

Yes.

Steve Weinstein - Pacific Crest

Okay.

Operator

Your next question comes from the line of James Lee with WR Hambrecht. Please proceed, sir.

James Lee - WR Hambrecht+CO

Robin, could you just elaborate your banner program just a little bit? I visited your MP3 channel recently. It seems like you have quite a bit of banners there, the anchor banner plus a banner on the right side. Can you just give a sense -- it seems like there is quite a big demand in that channel, it is pretty healthy. Can you give a sense of how much inventory do you plan to introduce to your advertisers over the next few quarters, especially heading into the peak season in 3Q?

Robin Li

I think our MP3 channel has done very well on a relative basis comparing to the past. More and more advertisers now realize the MP3 channel has a lot of traffic and the user base for MP3 channel, or the user quantity for the MP3 channel is very good. We have a number of positions for advertisers to place MP3-related services. Meanwhile, we signed up a number of record companies and we can show more ads on the MP3 channel, essentially of the streaming part of the service, where users stay for multiple minutes on one page. So the media time for that traffic or those page views is much longer than the typical webpage.

Going forward, I think we will continue to deliver good performance for the advertisers on the MP3 properties. But once again, that is not a significant part of our revenue yet.

James Lee - WR Hambrecht+CO

Is it fair to say going forward, besides the MP3, all the other channels you have, i.e. Knowledge, i.e. the news channel will start to see more and more banner ads, at least inventory will be available to advertisers?

Robin Li

Yes, on a relative basis we will gradually add more graphical ads in the non-web search channels, but a significant part of those ads will be behavior targeted. It is not shown on every page for every user. We actually try to differentiate which users should see which ad.

James Lee - WR Hambrecht+CO

I understand the behavior target based that is based on. That is P4P, right? You only get paid when someone actually clicks on the impression?

Robin Li

Yes, that is true.

James Lee - WR Hambrecht+CO

Thank you.

Operator

Your next question comes from the line of George Chu with UBS.

George Chu - UBS

Thank you. Just a follow-up on new customer adds, just thinking, given Baidu has such a high profile and the search market in China also has been getting a lot of attention, I would just like to know, for the new customer adds, do they bring a high marginal revenues or do you feel the best customers have already been captured? Thank you.

Robin Li

Well, as we have said again and again, this market is still in a very nascent stage. We have not seen any limit as we add more and more customers, they typically can appreciate our platform very much. So in terms of quality, decrease in customer quality and as I have said before, there’s the wash. Some of the lower quality customers may decide to leave but new customers typically spend more longer term. Again, it may take a few months for them to get up to speed.

Operator

Your next question comes from the line of John Pitts with Steadfast Financial.

John Pitts - Steadfast Financial

Thanks for the question. I was wondering if you could give us any information on which third party websites or companies that track things like your search market share, your market share in Baidu Spaces, answers and video, even though that one is relatively new. Which ones do you guys use and maybe you could give us a little information on where you stand in just ranking, not so much the actual traffic numbers.

Robin Li

On the Alexa.com website, you can typically see a breakdown of our traffic. You can also compare our traffic rank reach with other Chinese websites. It is a relatively accurate measure when you are comparing to other Chinese websites. They do fluctuate from time to time compared to websites outside of China because of the connectivity issue or adjustments in their algorithm.

Domestically, there is a firm called iResearch. They have been tracking the Chinese search market for a long time. There are a number of other third party research firms. Each has a different angle but I think we still primarily rely on internal analysis to make our decisions. We think we have the best understanding of the Chinese search market.

John Pitts - Steadfast Financial

You mentioned that there were some metrics based on registration or users based on the last month or the last quarter or the last week. Is there any measure you can give us in terms of traffic for Baidu Space?

Robin Li

Well, we do not really look at that in that way. What we look at is that we measure the page view for each of our services, including Baidu Space. We measure the user session. Each user may generate a number of page views in each session and we try to deliver ads based on the user’s behavior. So we care more about number of users who visit our website, our web services Baidu Knows or Baidu Space and we care how much time a user spends during a typical session. We look at those metrics to decide or to assess how successful our services are.

Operator

Your final question comes from the line of Wallace Cheung with Credit Suisse.

Wallace Cheung - Credit Suisse

Two quick follow-ups; I think first of all on the MP3 lawsuit, is there any further update on the resolution with the other record labels besides EMI? The second question will be on the CapEx breakdown in first quarter. I think CapEx spending on both China and Japan, could you roughly tell us how much you are actually spending in the Japan market? Thank you.

Shawn Wang

On the MP front, as you know we actually did spend a good part of last year having legal battles with the record companies. I think that came to a good results when the court issued a positive court order for Baidu. After that, we started working with a number of record companies, both leading international labels as well as the local players. We have been experimenting in the entertainment forum. We truly believe advertising is the right model and I think that that belief has been shared by some of our record company partners.

So we are pioneering this field together and we are encouraged by some of the prospects we have seen so far.

In terms of -- the MP3 -- a number of the other record companies did appeal, and there were seven record companies involved in last year’s litigation. After the verdict, a few chose to work with Baidu and a few others appealed and that litigation is still ongoing and I cannot comment on that, and surely I cannot comment on the others either.

In terms of CapEx, the CapEx spending is a combination of both China in operations as well as for Japan. I think the Japan CapEx, because it is from scratch so that -- the CapEx model for Japan is a little more than what we did for south China, but I am not going to give you an exact number, but it is just a little more in Japan than China for Q1.

Wallace Cheung - Credit Suisse

Thank you very much.

Robin Li

Thank you very much for joining us today. Please do not hesitate to contact us if you have any further questions.

Operator

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

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Source: Baidu.com Q1 2007 Earnings Call Transcript
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