Baidu (BIDU) Yan Hong Li on Q1 2016 Results - Earnings Call Transcript

| About: Baidu, Inc. (BIDU)

Baidu, Inc. (NASDAQ:BIDU)

Q1 2016 Earnings Call

April 28, 2016 8:00 pm ET

Executives

Sharon Ng - Director-Investor Relations

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Xinzhe Li - Chief Financial Officer

Analysts

Eddie Leung - Bank of America Merrill Lynch

Dick Wei - Credit Suisse (Hong Kong) Ltd.

Poon Erica Werkun - UBS Securities (Asia) Ltd.

Vivian Hao - JPMorgan Securities (Asia Pacific) Ltd.

Chi Tsang - The Hongkong & Shanghai Banking Corp. Ltd. (Broker)

Wendy Huang - Macquarie Capital Ltd.

Juan Lin - 86Research Ltd.

Robert Lin - Morgan Stanley Asia Ltd.

Piyush Mubayi - Goldman Sachs (Asia) LLC

Natalie Wu - China International Capital Corp.

Thomas Chong - Citigroup Global Markets Asia Ltd.

George Alan Hellawell - Deutsche Bank AG (Hong Kong)

Bo Pang - Oppenheimer & Co., Inc. (Broker)

Eugene Charles Munster - Piper Jaffray & Co. (Broker)

Jin-Kyu Yoon - Mizuho Securities Asia Ltd.

Alex Liu - Daiwa Capital Markets (Hong Kong) Ltd.

Tian Li Wen - Blue Lotus Capital Advisors Ltd.

Operator

Hello and thank you for standing by for Baidu's First Quarter 2016 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. If you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to your host for today's conference, Sharon Ng, Baidu's Director of Investor Relations. Thank you.

Sharon Ng - Director-Investor Relations

Hello, everyone, and welcome to Baidu's first quarter 2016 earnings conference call. Baidu's earnings release was distributed earlier today, and you can find a copy on our website as well as on Newswire services. Today, you will hear from Robin Li, Baidu's Chief Executive Officer, and Jennifer Li, Baidu's Chief Financial Officer. After their prepared remarks, Robin and Jennifer will answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations.

Potential risks and uncertainties include, but are not limited to, those outlined in our public filings with the SEC, including our Annual Report on Form 20-F. Baidu does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

Our earnings press release and this call include discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures and is available on our IR website at ir.baidu.com.

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

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

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Hello, everyone, and thanks for joining today's call. We had a terrific start to 2016 with strong performance in the first quarter. Search and iQiyi grew strongly, and GMVs ramped rapidly, increasing nearly fourfold year-over-year. Mobile grew particularly well this quarter and hit a new milestone, contributing 60% of total revenue, off the back of improving search monetization capabilities driven by product and technology innovation.

This quarter, we made notable progress in executing on our mission of connecting users with information and services. And we made grew headway towards providing our customers and merchants with a fully integrated platform, one that meets their needs not only for online marketing but for transaction services as well.

We have invested heavily not only to enhance but ultimately to redefine the search experience. We continue to innovate to improve the search interface by further improving the accuracy of voice and digital search and upgrading search results to make them more personalized, targeted, action-oriented and content rich. This improvement drove the year-over-year upward trend in both mobile and PC CPM and Baidu brand. Our name for Baidu's AI infrastructure as well as the tight integration of products across our platform made this possible.

Baidu has a unique platform that users turn to in order to discover and connect with whatever it is they are looking for across any vertical and category at any time and from any place. More and more, they are able to fulfill through a seamless closed loop. Our users touch multiple Baidu products every day. And the insights that we bring from their use of multiple products enable us to personalize and tailor the experience and give our users the fastest path to what they are looking for.

We parlay the high intent that search users bring into great ROI for merchants. Customers both large and small partner with Baidu, and we match them to the user demographic they seek and do it at large scale. Increasingly, we provide our customers with a full integrated solution that leverages Baidu's wide range of products and infrastructure.

This sets us apart from our peers in both online marketing and in transaction services. Search, Maps, and our local service platform, Nuomi, are cornerstones of our integrated offering that mutually share content and enrich each other. Search provides a very meaningful portion of traffic to both Maps and Nuomi. Maps and Nuomi in turn also further enrich search results with local extensions and transaction capability.

So therefore, as of end of March, Baidu Maps had 1.5 million points of interest that enabled closed loop transactions. Nearly 70% of those points of interest were provided by Nuomi, which tripled its merchant coverage year-over-year. Access merchant listings, points of interest and services is easily down through any of these gateways, and users can complete transactions whenever they start – wherever they start.

We offer local merchants a compelling, unparalleled value proposition. Baidu helps connect online to offline and helps merchants to drive user foot traffic to storefronts across a broad range of local services. We made it easy to get started on the Baidu platform by offering solution that best suits their needs and by offering top notch infrastructure with low startup cost.

Earlier this week, Nuomi announced that it would be weaving take rate and provide a cost per click marketing model for newer emerging local service verticals such as wedding services, health and beauty, and home services, to name a few. This is one of the many ways Baidu can work with merchants in underpenetrated verticals to bring them on our platform and provide them with an opportunity to experience Baidu's value proposition.

Our Local Express infrastructure ties together our powerful cornerstone products of search, Maps and Nuomi and has expanded merchant scale dramatically. Local Express reached over 200,000 merchants by the end of March and verticals covered by Local Express now include retail, education, healthcare, and property and now many more.

A great example is Chow Tai Fook, the popular jewelry retailer. Baidu worked with Chow Tai Fook to drive leads through our online marketing platform and enable a closed-loop transaction through Nuomi.

In mid-April, over 2,000 Chow Tai Fook stores launched their Local Express account and in the first week after the launching, early March, Chow Tai Fook offers sold by Nuomi were up nearly tenfold from the week before, driving foot traffic to their offline stores.

Baidu Takeout Delivery also continue to grow rapidly. We are the market leader in most of top tier cities like Beijing, Shenzhen, and Guangzhou among the non-student demographic. From the beginning, Baidu Takeout Delivery has catered to the working age demographic which has significant spending power and values high quality food and superior service. This was the right strategic decision and our focus on the demographic as higher spending power has given us lasting advantage.

Takeout Delivery offers an ever-expanding range of carefully vetted merchants and continues to improve logistical efficiency. We've seen the number of orders delivered per delivery person per day and the on-time ratio increase steadily quarter-over-quarter.

At the end of 2015, Baidu Takeout Delivery became a separate entity and this week we signed to close another round of financing from Baidu and other financial sponsors at a post-money valuation of $2.5 billion.

Baidu remains very supportive of the Baidu Takeout Delivery business and continues to hold a majority stake. Baidu Wallet also gained strength with activated Baidu Wallet accounts growing in the quarter from 53 million at end of 2015 to 65 million at the end of Q1 2016.

In the first quarter, we ran various holiday promotions and deepened integration across 15 Baidu products include Mobile Baidu, Baidu Cloud, Maps and Post Bar.

Nuomi and Takeout Delivery also continue to observe increased share of orders completed with Baidu Wallet. With our vast distribution platform, merchant network and unparalleled data and technology capabilities, Baidu is uniquely positioned to play a transformative role in financial services.

With our data and technology capabilities, we can better evaluate credit risks and provide educational institutions through our core search capability. And we have a much better understanding of the quality of their training programs.

Baidu began working with over 250 educational institutions to provide credit loans to qualifying students. This credit loans aids the growth of education industry and enable credit-worthy students, students who might not otherwise have had the means, to take the courses they need.

Our multiyear investment in artificial intelligence, and particularly in deep learning, continues to pay dividends across many products. Baidu Brain supports all product lines and now enable us to offer a more relevant result to users, higher click-through rates to customers, faster delivery time for Takeout Delivery, highly naturalistic text-to-speech features for news users, just to name a few.

Deep learning will be one of Baidu's key technology advantages, we move forward – as we move forward in autonomous driving. We believe that automobile is the next major computing platform and that advances and innovation will happen quickly, especially here in China, where the problems that autonomous driving addresses are so pronounced. We are aggressively beefing up our R&D efforts in this area, both here in China and at our U.S. R&D center in Silicon Valley.

Baidu's returns in high definition mapping and in deep learning-powered computer vision will prove to be decisive advantages and we are on track now to deploy autonomous vehicles powered by Baidu technology in 2018, with production at scale by 2020.

Moving now to iQiyi, iQiyi continued to perform robustly, holding the leading position by MAU and user monthly time spent, according to iResearch in March 2016. In the first quarter, iQiyi subscriptions grow particularly well off the back of iQiyi's exclusive and very popular Korean drama, Descendants of The Sun, which aired in Korea and on iQiyi in China at the same time.

iQiyi has established its place as the online video platform of choice and a hub for popular culture. Online video is an important vertical for Baidu with iQiyi providing invaluable high quality content. iQiyi benefits from its strategic cooperation with Baidu across multiple fronts, including search traffic, ad targeting and big data. We look forward to maintaining a close strategic partnership with iQiyi.

Over the last year, Baidu has opened a number of our quality assets to outside investors. And under this program, we have now received investments in Baidu Takeout Delivery, Baidu Music, (14:27), 91 Desktop and, more recently, Baidu's video aggregation platform. These initiatives help unlock hidden value for Baidu and provide an alignment of incentives and success to management and teams of this business.

As announced in our earnings press release earlier today, Mr. William Decker will step down from our board, having served as a board member and Audit Committee Chairman since October of 2005. On behalf of Baidu's board of directors, I would like to express my gratitude to Bill for his long-lasting dedication and invaluable contribution to Baidu.

Meanwhile, I would like to welcome Mr. Brent Callinicos as our new Audit Committee Chairman. Brent has served as an independent director on our board since October last year and brings extensive industry experience to the position. We look forward to his leadership on our Audit Committee.

I'm very excited to unfold what Baidu has in store for 2016 and beyond. Baidu plays a key role in driving innovation in China. With our accumulated investments in technology, particularly in artificial intelligence and our large scalable platforms and infrastructure, we are uniquely positioned to capture the vast opportunities in China.

Our core search business is robust and opens up new opportunities for Baidu. We will actively pursue new opportunities where we have competitive advantage and drive change that will help transform people's daily life. The transformation of financial services industry and the transportation sector through technology, through innovation like autonomous driving and Internet finance, are but a few of the opportunities on the horizon. Progress in these new areas should be viewed over a long-term time horizon and we are confident these investments will create long-term value for shareholders.

With that, I'll now turn the call over to Jennifer for an update on financials.

Xinzhe Li - Chief Financial Officer

Thank you, Robin. We're very pleased to report a very strong quarter driven by superb performance of our core search business and iQiyi. We also further executed on our mission to build the next Baidu.

I would like to reiterate that the annual cost expense guidance that I provided last quarter for full-year 2016 continues to hold. The pace of spend may vary quarter-on-quarter based on the timing of events and activities kicking in.

At the beginning of this month, we released our 20-F, and for the first time, we provided segment reporting for search services, transaction services and iQiyi. We plan to provide segment reporting on an annual basis in our 20-F.

On a quarterly basis, we will continue to report on the margin impact of transaction services and iQiyi. Our business will evolve over the next few quarters and we will provide the appropriate level of visibility to the investment community. And we'll continue to update you our metrics that reflect the state of our business.

Also bear in mind that Q1 was our first full quarter of deconsolidation of Qunar, and for ease of comparison, we have provided apples-to-apples financials, excluding Qunar. In Q1, we recognized in other income two months of equity pickup of Ctrip's fourth quarter 2015 net income. For Q2 onward, we will recognize a full quarter of equity pickup of Ctrip's net income on a quarter lag basis.

Now, moving onto financials. All monetary amounts are in RMB unless stated otherwise. For the first quarter, total revenues were RMB 15.8 billion, representing a 24% increase from the corresponding in 2015. The year-over-year increase is 31% excluding Qunar in the first quarter of 2015.

During the first quarter, Baidu had approximately 587,000 active online marketing customers representing a 12% increase from the corresponding period in 2015. And a 24% year-over-year increase excluding Qunar in the first quarter of 2015.

Revenue for online marketing customer for the first quarter was RMB 25,400 a 6.7% increase from the corresponding period in 2015, a 1.6% year-over-year increase excluding Qunar in the first quarter of 2015 and an 18% decrease compared to the fourth quarter of 2015. Traffic acquisition cost as a component of cost revenue in Q1 was RMB 2.2 billion representing 14% of total revenue, flat from the corresponding period in 2015.

Bandwidth cost as a component of cost revenues were RMB 1.1 billion, representing 6.9% of total revenues, compared to 6.7% in the corresponding period in 2015. Depreciation cost a component of cost of revenues was RMB 707 million, representing 4.5% of total revenues, compared to 4.6% of the corresponding period in 2015.

Operating cost – operational cost as a component of cost of revenues, were RMB 1.1 billion, representing 6.95% of total revenues, compared to 4.7% in the corresponding period in 2015. This increase was mainly due to transaction services, and iQiyi-related operating cost.

Content cost as component of cost of revenue were RMB 1.4 billion, representing 8.7% of total revenue, compared to 4.8% in the corresponding period in 2015. This increase was mainly due to iQiyi's increased content cost.

SG&A expenses in Q1 were RMB 3.9 billion, representing a increase of 33% from the corresponding period in 2015 and a year-over-year increase of 64% excluding Qunar in first quarter of 2015. The year-over-year increase was mainly due to an increase in promotional spending for transaction services.

R&D expenses in Q1 were RMB 2.1 billion, an 8.1% decrease from the corresponding period in 2015, and a year-over-year increase of 5% excluding Qunar. The increase was mainly due to a increase in the number of R&D personnel.

Share-based compensation expenses, which were allocated to related operating costs and expense line items were RMB 309 million in Q1 compared to RMB 291 million in the corresponding period in 2015. Excluding Qunar, the SBC cost was RMB 201 million in the first quarter of 2015. This year-over-year increase with Qunar's impact excluded was a result of increased share grants to employees.

Operating profit was RMB 2.2 billion, representing a 2.6% increase from the corresponding period in 2015 and a year-over-year decrease of 12% after excluding Qunar's impact in the first quarter of 2015. Non-GAAP operating profit were RMB 2.5 billion, a 3% increase from the corresponding period in 2015 and a year-over-year decrease of 6.7% excluding Qunar.

Income tax expenses were RMB 675 million for the first quarter. The effective tax rate for the first quarter was 25.4% compared to 20.7% in Q1 2015. The increase of effective tax rate for the first quarter of 2016 reflects that some loss generating entities in the group cannot be consolidated for tax persist under PRC law.

The net income attributable to Baidu for Q1 was RMB 2 billion, a 19% decrease from the corresponding period in 2015. Basic and diluted earnings per ADS for the first quarter amounted to RMB 5.4 and RMB 5.38, respectively.

Non-GAAP net income attributable to Baidu for Q1 were RMB 2.4 billion, a 14% decrease year-on-year. Non-GAAP diluted earnings per ADS were 6.8. As of Q1, the company had cash, cash equivalents and short-term investments of RMB 71.3 billion. Net operating cash inflow and CapEx for the first quarter were RMB 4.7 billion and RMB 826 million respectively.

Total head count on a consolidated basis including invested entities was about 43,500 as of the end of first quarter of 2016. This represents an increase of 5% compared to the end of last quarter.

Now, let's provide you with our top line guidance for the second quarter of 2016. We currently expect total revenues for the second quarter to be between RMB 20.11 billion and RMB 20.58 representing a 21.3% to 24.2% year-over-year increase.

On an apples-to-apples basis excluding Qunar from Baidu's financials, the guidance represents a 28.1% to 31.1% year-over-year increase. Please note, this forecast reflects Baidu's current and preliminary view and is subject to change.

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

Question-and-Answer Session

Operator

Thank you. The first question comes from the line of Eddie Leung from Merrill Lynch. Please go ahead.

Eddie Leung - Bank of America Merrill Lynch

Good morning. Thank you for taking my question. Just two quick ones. The first one is about your advertising number. It was a pretty good quarter in terms of sequential growth. So, could you share more color with us? Did you add back some of the travel-related clients from Qunar or were they related to your O2O business and then secondly, EBITDA longer term – about the longer-term outlook, there seems to be a trend that Internet users are consuming video content within social media. So, will these trends affect the usage of search down the road and how Baidu can deal with the trend? Thank you.

Xinzhe Li - Chief Financial Officer

Hi, Eddie. We did deconsolidate Qunar for this quarter, and of course, Qunar's business was concentrated on the travel verticals. But even having said that, travel verticals is one of the major verticals for us for many years and it continues to be a major vertical for us.

For the online travel agents who do advertising with us, they would be counted as online marketing customers and not particularly transaction service-related customers. So, if there are – because we do have thousands of customers in that vertical, did not really track specifically the Qunar-related marketing customers, whether they are or not including in this past quarter. But bear in mind, Baidu's search is a very powerful and performance-based marketing platform and there are clients that would do advertising activities on multiple platforms and Baidu continues to be a very attractive platform for many of these advertisers.

So, just to conclude, the travel verticals continues to be one of our major verticals.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

So on video content, yes, they are popular not only among social media but it's also very popular across the board, on all Internet and mobile products. That's why you see iQiyi constantly ranked among the top two in iPhone's App Store and we also invested in other short-form video content companies like (28:29). And we fully and seamlessly integrate this kind of video content in our Baidu core search, Mobile Baidu app and users who search for video content on Baidu can get the most comprehensive and the best user experience for video content and we did see that the click-through rate for video content and exposure for video content in our search results increased significantly over the past quarter.

Operator

The next question comes from the line of Dick Wei from Credit Suisse. Please go ahead.

Dick Wei - Credit Suisse (Hong Kong) Ltd.

Hi. Thanks for taking my questions. I have a question on the recent company restructuring. I wonder what is the strategic reason for the restructuring and how should we expect Baidu's focus to change in terms of strategy and in terms of maybe the amount and area of investments. Thank you.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Yeah. Basically before the restructuring, Mobile Baidu and Maps was under one leadership and Baidu search and Nuomi was under another leadership. We combined this two to form the Baidu search company. I think this basically is the core business for Baidu and other than that or outside of the Baidu search, we do have those new areas such as Internet Finance, autonomous driving and the underlying technology such as artificial intelligence.

I personally would probably spend more time on this newer business initiatives and technologies. The core search including transaction services under one leadership would make the company more efficient and robust.

Xinzhe Li - Chief Financial Officer

Just to add on that, if the internal organization change, we have not formed a separate legal entity. The effort is, as we've mentioned, we're building an integrated platform. And this arrangement will help us make better internal alignment and help us service our users and merchants more effectively.

Operator

Your next question comes from the line of Erica Poon Werkun from UBS. Please go ahead.

Poon Erica Werkun - UBS Securities (Asia) Ltd.

Thank you. I've got two questions here. The first one, just wondering, if you can update us on any changes to the competitive landscape for the various O2O segments you're engaged in and if you can just let us know where you are in terms of investments like over O2O.

And the second question is on Baidu Maps. I'm just wondering if you can share with us the progress of monetization for Baidu Maps. How many of the merchants shown on Baidu Maps are actually paying advertising customers? Thank you.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Yeah. On O2O, I think, Nuomi has made a significant progress both in terms of overall experience including the coverage for merchants and the number of deals available. And we also continue to take market share from the competition, and quarter after quarter, I think our market share started around 10% at the beginning of last year and now we are well over 20% as of last quarter and the trend continue as we entered into the current quarter.

While we see all this kind of better and better metrics, our investment is prudent. I think, we pay a lot of attention to our eye for subsidies for the Nuomi business. And like I mentioned during the prepared remark, we view this as a integral part of the overall Baidu core business, including search and Maps. They cross-leverage with each other and we do not necessarily need to use just one piece to compete with other companies.

Map is, right now, not really focused on monetization, but more focused on connecting users with services. We pay attention to the daily active users. We pay attention to number of closed-loop transactions enabled with the attention to the points of interest that's available to our users, the quality of those POIs and the rich content about those POIs.

Operator

Your next question comes from the line of Vivian Hao from JPMorgan. Please go ahead.

Vivian Hao - JPMorgan Securities (Asia Pacific) Ltd.

Hi. Thank you for taking my question. My question is just also around the O2O area. For Takeout Delivery, what percentage of orders are fulfilled by our in-house delivery team right now? And also, what is our long-term goal in terms of local logistics development, and also investment? Thank you.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Yeah. For Takeout Delivery, as I mentioned, we target the more high end, affluent user demographic. So we care a lot about the service quality, both for the supplying restaurant, as well as the delivery team. So right now over 50% of the orders are delivered by our logistics people. The long-term goal is really to continue to lead in the top-tier city among this white collar demographic, who are not that price sensitive. And we will continue to improve the service quality and continue to integrate this service with existing Baidu services from Nuomi and other products.

Operator

Your next question comes from the line of Chi Tsang from HSBC. Please go ahead.

Chi Tsang - The Hongkong & Shanghai Banking Corp. Ltd. (Broker)

Hi, good morning. Thanks for taking my questions. I wanted to ask you about AI. In particular, I was wondering if you could discuss the business model for autonomous vehicles. And secondly, if you can give us an update on Dumi, your virtual assistant, how is the product developing and what sort of activity levels are you seeing? Thank you so much.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Yeah. We have invested in AI for many, many years. We believe we are leading in this sector not only in China, but around the world. This enables us to do disruptive things like autonomous driving. And it's kind of early for us to talk about this model because right now our focus is to solve those technical problems; the first to make that autonomous driving fully autonomous. Our target is not to drive – to self-drive like in 90%-95% of the cases, but to really release the driver from the driver seat. So, this will take a couple of years. We will worry about the business model later on.

Regarding to Dumi, it's tracking very well, and especially for our speech recognition capability and natural language understanding capability. We have a Dumi function in the Mobile Baidu and lots of people use it from there; but more importantly, on the homepage of Mobile Baidu, we have a large microphone button that enables people to talk to Mobile Baidu and get the search results both in text and in speech. And that has grown very dramatically over the past couple of quarters because of the accuracy of our speech recognition, and we believe that this well continue to trend up in the future.

Operator

Your next question comes from the line of Wendy Huang from Macquarie. Please go ahead.

Wendy Huang - Macquarie Capital Ltd.

Thank you. My question is mainly on the O2O. You reported RMB 16 billion GMV for this quarter, and every quarter. Last quarter, it was actually close to RMB 15 billion. It seems a small incremental increase quarter-over-quarter. So, I just wonder if you're seeing any actual competitive landscape change that resulted in this kind of more addition sequentially. And also, you mentioned about some new business model you are adopting for the Nuomi in your prepared remarks. Can you elaborate that a little bit? How would this actually affect the net take rate and also the O2O revenue in the near term? Thank you.

Xinzhe Li - Chief Financial Officer

Hi, Wendy. The GMV did sequentially increase, as we mentioned earlier. Our focus to provide the transaction services is really an integrated approach. I think on the front of the O2O transaction per se, the business – the GMV is growing healthily and solidly.

We also mentioned earlier that we note that our market share for the O2O service is expanding. So, we're pleased with the results that we're accomplishing. And of course, at the same time, we're executing on the O2O strategy, building the momentum, building quality and focusing on returns of the promotional activities we put in. So, the GMV number, I think, reflects solid progress.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

And regarding to the take rate, I think for the existing core Nuomi services, such as dining and hotel and movie tickets, we will continue to enforce the take rate, but for the newer verticals, especially for those high-ticket lower-frequency ones, we think advertising model is a better one.

Operator

Your next question comes from the line of Ming Zhao from 86Research. Please go ahead.

Juan Lin - 86Research Ltd.

Hi, good morning. This is Juan Lin on behalf of Ming. So, I have two question related to O2O. First, you recently announced a zero commission policy for merchants of many verticals on Nuomi and I'm wondering whether you will extend the policy to the core O2O categories, such as dining and movie ticket, or at least a lower – lower the commission rate to keep competitive and whether such policy impact your monetization plan for O2O. And also, does it mean that your O2O strategy is now transiting from standardizing consumers to a more focus on recruiting merchants?

And the second question is about O2O monetization. I'm wondering what is the current advertising model for Nuomi, Wei-mei (41:15), and Baidu, whether you have adopted bidding systems for all your O2O assets. And if not, whether you will launch bidding system on O2O in the near future. Thank you.

Xinzhe Li - Chief Financial Officer

Hi. We just commented on the take rate. I think for some of the basic services, (41:49), those business -- those take rate arrangements has been established. But we are expanding our verticals to cover more of the O2O services.

And for these ways, really because of the powerful integrated platform approach that we're taking, Baidu do have different angles to service our merchants and work with them. And so for the other ones that we do not intend or plan to take on take rates, and there are other ways that our merchants can work with us to promote their business. So, the overall value proposition that Baidu really works with the merchants sets us apart from other O2O players. And so I think for us to continue to expand further into wider coverage of the O2O services, we do have multiple tools to work with the merchants.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Yeah. And just to add, Local Express is a short answer for O2O monetization in addition to take rate. For some of the core verticals, take rate continues to be there, but for others, the Local Express is a better way to monetize and not only through Nuomi's own platform, but through the overall Baidu platform including Mobile Baidu and Baidu Maps. And the Local Express is a bidding system.

Operator

The next question comes from the line of Robert Lin from Morgan Stanley. Please go ahead.

Robert Lin - Morgan Stanley Asia Ltd.

Hi, management. Thanks for taking my questions. I guess in terms of net customer add, we saw about 32,000, it's higher than last quarter quarter-on-quarter add, can we split what the contribution was on Local Express, and I guess that's the ex-Qunar number?

The second question, I think recently there was an announcement that we are doing cooperation with Alibaba in terms of Olympics advertising, obviously it's benefiting both parties. Is one big significant announcement worthwhile for the two companies? Can we talk about what the format in channels, how we're doing these joint marketing efforts for? Thank you.

Xinzhe Li - Chief Financial Officer

We did have a net – very strong net add of customer base over the past quarter. Yeah, a part of that is a result of the launch of the Local Express. For we do have many, as we mentioned, about 200,000 customers signed up with us and we launched the product in Q4 of last year and continue to refine the product.

So, as you see, when we count for online active customers these are customers that has spend with us during the past quarter, and so, I would say, as you see the net add because of these customers taking for Local Express because they take advantage of the product they start spending with Baidu and they would be counted as the online marketing active customers.

We have many people signed up with us, and that really demonstrates the potential of the base of customers that could really take advantage of the product and we'll continue to refine the product and drive further growth of Local Express.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

And Olympics is the perfect event for online marketing and we fully take advantage of this and started early to work with many of our partners and customers and Alibaba, of course, is one of the more important partner and customers for us, we work with them and try to drive traffic to them through this kind of events.

Operator

Your next question comes from the line Piyush Mubayi from Goldman Sachs. Please go ahead.

Piyush Mubayi - Goldman Sachs (Asia) LLC

Thank you. Question for Jennifer. Jennifer would you be able to shed color on the SG&A plan for 2016, in terms of what is allocated for user acquisitions, spending on the logistic network for example? Also when you refer to the variability of SG&A on a sequential basis through 2016, what are the events you refer to? And again, related to SG&A and the ROI of the spend, are there any early data points in customer retention, et cetera, that you could share with us? Thank you.

Xinzhe Li - Chief Financial Officer

As I mentioned last quarter, we provided some colors and insights into how you should expect the SG&A expense into shape for the 2016. And that guidance continues to hold. Namely, we really started kickoff our transaction services efforts in the second half of last year and we expect that would be the kind of norm momentum for us to continue to invest in this sector.

Most of the investment on SG&A would go to customer acquisition, promotional events and cross-selling opportunities, getting users to really take advantage and use the new vertical areas that we are developing. And so these are a bunch of variety of activities. And sometimes we can take advantage of holidays to kickoff campaigns or take advantage of certain product offerings to promote specific verticals. And for certain cities, we might focus on a regional buildup of market positions.

So, whether it's vertical or regional, this would be where the promotional money would go to. We do have closer tracking of the data and continue to learn from our experience. We have ROI targets for longer range and for every campaign and the team focus very much on ensuring that, one, we continue to improve on the returns and customer retentions as we carry out these activities.

And also how we really enhance value proposition to our merchants and users building more personalized – building on the data and the technology and building on more personalized service to these people that we serve. So, the O2O will continue to be a investment, a significant investment area for us. But I think we're building great momentum and will continue on the positive trend.

Operator

Your next question comes from the line of Natalie Wu from CICC. Please go ahead.

Natalie Wu - China International Capital Corp.

Hi, good morning. Thanks for taking my question. Regarding O2O business and AI distinctly ramping (49:30), which part do you think will be granted with largest outstanding (49:35) budget in three years to come, Nuomi or AI? And also could management elaborate on the top five categories in terms of your advertisers? Do you expect any structural change this year or a typical category to outgrow or under grow, say, healthcare, e-commerce, et cetera. Thank you.

Xinzhe Li - Chief Financial Officer

I think both – we do – we are right in the middle of the investment for O2O and we also mentioned we see great future for autonomous driving, taking advantage of our technology accumulation over the years. The O2O is a important strategic area and we will continue on that path to build.

The driverless autonomous cars is in its early stage. A team are making – testing, making technology improvements, making great progress. I think when the team hits certain milestones, over time, budget might go up. But I think at this time as we look, autonomous car driving is more longer term, down the time from a horizon perspective and O2O is right – I think we're right in the middle of it.

So, I think both fronts are strategically important areas and both areas carry significant potential just for – simply from just business perspective, disruptive opportunities that they create. So, it's difficult to pin down the exact, but I think one is more near term, one is longer term. But – and both are important.

For the top verticals, we mentioned last quarter as we look at the macro developments and how Baidu as a powerful platform penetrating into the various sectors in the economy. We do see very solid strength in the consumer and service verticals. And so if we – we roll up some of the sub-verticals, we continue to see local services, retail, medical services, education and even financial services as our top sectors.

Operator

The next question comes from the line of Thomas Chong from Citigroup. Please go ahead.

Thomas Chong - Citigroup Global Markets Asia Ltd.

Thanks for taking my questions. I have two quick questions. First is about the recent move into the PGC area in online video. So, should we think about Baidu is going to do it independently or it will be integrated into iQiyi in the future?

And the second question is about other revenue. Given the fact that the pay subscription is on the rise, any color why it drops on a q-on-q basis? Thanks.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

So, on your first question, iQiyi has PGC content and the recently spun-off Baidu Video we will focus on PGC too. I think video is a very large and fast-growing sector. Baidu, overall, we will try to address all kinds of different mediums and different content format through various Baidu product and offerings.

Xinzhe Li - Chief Financial Officer

And for other revenues, yes, you are right. As subscription base continues to grow and the revenue generated from subscription fees continue to rise. What's included in other services – other revenues are all the non-online marketing related services, so these includes other user paid services and also includes, for example, content exchange, where content sales of iQiyi's business that would be recorded as revenue and for those kind of other items they do move around, but I think there is no worry really on the subscription-based revenue, it does continue to growth.

Operator

The next question comes from the line of Alan Hellawell from Deutsche Bank. Please go ahead.

George Alan Hellawell - Deutsche Bank AG (Hong Kong)

Yeah, hi. Questions about Baidu Wallet. I'm just wondering, how we might want to conceptualize the margin profile of the emerging payments business. I know Jennifer mentioned rising at operational cost attributable to transaction. Can you classify what the impact might be? Also curious as to what percent of Baidu Wallet GMV might be non-Baidu O2O and characterize the frequency of use by the Baidu Wallet users. And then finally, just would love to get an update on the proposed management buyout of iQiyi, what approvals may still be required and what timeline we might want to consider. Thank You.

Xinzhe Li - Chief Financial Officer

I think the Baidu Wallet user base continue to grow and we do take advantage of the consumption scenarios that happens on the Baidu platform and the majority of the transactions on Baidu Nuomi and a growing part of other services are using the Baidu Wallet. So, the Baidu Wallet is really built on top of the Baidu consumption scenario and help us build the data, the closed-loop services for our customers.

Within operating costs are related transaction services expenses going up. Part of that is, of course, the transaction for payments. There are also other operating costs, like customer service, ground troops that help in doing the promotion. So, it's – doing Wallet, the payment fee is part of the cost, but I think for us, it's – we are building it majority within the Baidu umbrella and that is valuable data for us as we build ancillary business, and financial services in particular. Those kind of data are valuable.

With regards to your question on the management buyout for iQiyi, we do have a special committee that continues to work with the financial advisor, as well as external legal counsels to assess the strategic options and also the various details related to the transaction. I think it's really up in the special committee's hands to make decisions and make assessments. To the extent we do have progress information that we are ready to share, we will make it available to the investment community.

Operator

Your next question comes from the line of Jason Helfstein from Oppenheimer. Please go ahead.

Bo Pang - Oppenheimer & Co., Inc. (Broker)

Thank you for taking my question. This is Bo speaking for Jason. So, basically, I have two questions. Number one, I just want to follow-up on the gross margin. So, the gross margin come in a little bit lower than expected, pretty much away by the increasing investment on iQiyi and also the increasing tax. So, just want to – just wondering if management can comment a bit on there; any rationale behind how should we look at the long-term trend over there. And second question, just want to reconcile a bit on the R&D expenses and your budgeting throughout the year, given that even on the apples-to-apples basis, the expenses barely grow. Right, I was just trying to understand why – how should we look at that as well?

Xinzhe Li - Chief Financial Officer

On the gross margin, a couple of moving items that I provided some indication how you should expect the parts to move around the last quarter. And I think the ones that would move more meaningful and materially are operational costs and content costs.

Operational costs relates to a lot of the cost for transaction services, as I mentioned earlier. And content cost is almost all related to iQiyi's investment in content. And for operational cost, I mentioned last time that last year, in 2015, you would note that increased by 75% and we expect that to increase in similar pace very aggressively, maybe slightly moderately; same thing for content cost.

I think within gross margin, infrastructure buildup would have some impact on bandwidth cost, and as we grow the contextual business tag with traffic acquisition cost as a percentage of revenue might also edge up. And so, I think these are all within our plan and targets, and these trends should have already past references that you can look at.

For R&D expenses on the Q1 year-over-year comparison, there are – there is a slight increase excluding Qunar. You'll recall that in the second half of last year, and particularly in Q4, we slowed down in our hiring. We tried to realign the efforts to the internal realignments to make sure our workforce is put in the best place for efficiency and productivity, and so that, as you see in Q1, might have some reflection in that.

But having said that, R&D has been the consistent investment area for us. And as we talk about building the technology capabilities for autonomous driving, and recently you do see that we announced that we're building the teams in both the U.S. and China, we will continue to invest in R&D capabilities.

Operator

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

Eugene Charles Munster - Piper Jaffray & Co. (Broker)

Good morning. Just a follow-up question for Robin on the autonomous cars, just to – so we fully understand. Is the goal to create – basically, use a lot of Baidu Maps to improve the experience in China, or is this an opportunity that you could export outside of China? Thanks.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Yeah. I think from a technology point of view, it's universal. It should – basically, it works in China, it should work elsewhere in the world. Actually, China probably has the worst traffic situation and the most complicated situation that we need to handle. So, right now we are spending most of our time and effort on the China market. And while we also have testing cars in Silicon Valley, too, like I mentioned before, I think this is still in the early stage. We are focusing on pretty much technology itself and later on we will worry about business model and which market to target.

Operator

Your next question comes from the line of Jin Yoon from Mizuho Securities. Please go ahead.

Jin-Kyu Yoon - Mizuho Securities Asia Ltd.

Hey, good morning, guys. I apologize if this question has been asked before. I just kind of dialed the call a little bit late. How much of your search revenues is O2O-driven, given the fact that advertising – given the fact that Nuomi's pretty important to search? And going forward, is there a possibility that we may actually see kind of the O2O being up – advertising being priced on a CPC model or a transaction model? Thanks, guys.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Yeah. I think it's not a good idea to separate revenue contribution from O2O because we view this as an integral part. O2O is just trying to satisfy the user needs. We try to connect people with information and connect people with services, too, and O2O is one the most important sectors for services. Right now, O2O has both the CPC model and the (1:03:17) model, but direct revenue contribution for search is still minimal. It's sort of function more like a user feature that helps to attract user to the Baidu platform. They rely on us for everything from information to services. To give you a better color, about 10% of our search queries is related to local services and about 40% of the queries on Map is related to local services. So, this is a very significant part of user demand and we try to satisfy that first and worry about revenue later.

Operator

Your next question comes from the line of Alex Liu from Daiwa. Please go ahead.

Alex Liu - Daiwa Capital Markets (Hong Kong) Ltd.

Hi, good morning. Thanks for taking my questions. I just want to ask Robin, I think it from a high level basically, what do you think about the search market going forward in China, I think, specifically for the search advertising as a format, comparing to other formats of advertisings, for example the social ads formats and the feed ads and native ads format. So, I think Mobile is now 86% of the total revenue, what do you think about mobile search ramp up, specifically in the next one year to two years? Thanks.

Yan Hong Li - Co-Founder, Chairman & Chief Executive Officer

Yeah. We've been in the search business for many, many years and it's always pretty much traffic bound. Customers or advertisers can never buy enough amount of traffic for search, because the ROI, the performance for them is so good. They always want more traffic from us. So, to Baidu, we try our best, our very hard to satisfy users' needs so that users continue to depend on us to find information to find services.

So, I think the business model for search will continue to be pretty much on a marketing dollar basis and it's just way better than any other advertising format available on the Internet or off the Internet for that matter. We – our focus is really to provide the best experience through technology, through product innovation, and you will see that the mobile search is very different from PC search right now and it will continue to evolve over the next one year to three years.

Operator

Due to the time limit, our last quarter comes from Eric Wen from Blue Lotus. Please go ahead.

Tian Li Wen - Blue Lotus Capital Advisors Ltd.

Thanks to management for taking my question. Robin, Jennifer, and Ms. Sharon. I have some additional questions on Local Express. You mentioned about the customer add. How is the revenue per customer look like comparing to your traditional search customers and how big is its growth potential in terms of CTR, CPC and coverage ratio. And lastly, if you can elaborate how much revenue contribution do you expect in this year for Local Express, (1:07:17)? Thanks.

Xinzhe Li - Chief Financial Officer

Yes. Eric, we launched Local Express last quarter and many customers signed up. These customers are Nuomi customers or existing Phoenix Nest customers as well as new customers who signed up. The – basically and I think the beauty of that is since with mobile and with more targeted locations, traffic, local traffic can be better monetized and serve the merchants as well.

These are typically, compared to the Phoenix Nest customers, a much smaller merchants and I think their ad budget, as a result, is not as high as the traditional search customers that you would have seen. And so, I think we're in the early stage to monetize and help these merchants to take advantage of the products. Revenue contribution from Local Express is still small, but I think given the customer base and the enthusiasm that we see, I think this is the product that will bear a lot of potential.

Early to say what the CPC, CTR would be. I think we'll continue to refine the product and also educating the customers to use the product. Over time, we think it is going to be a very a valuable product for both us as well as the merchants because they do have multiple ways to promote their products and services and not only to – possibly, not only to search, but also to many other gateways within the Nuomi platform and within the Map gateways as well.

So, I think for Local Express, it's really early, and – but I think we will work hard and it bears a lot of potential.

Operator

We are now approaching the end of the conference call. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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