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Baidu.com, Inc. (NASDAQ:BIDU)

Q3 2007 Earnings Call

October 25, 2007 8:00 pm ET

Executives

Lynn Lin - IR

Robin Li - CEO

Shawn Wang - CFO

Analysts

Dick Wei – JP Morgan

Megan Barker for Anthony Noto – Goldman Sachs

Jason Brueschke - Citi Investment Research

Robert Peck - Bear Stearns

Steve Weinstein - Pacific Crest

Ming Zhao - SIG

Wallace Cheung – Credit Suisse

Gene Munster - Piper Jaffray

James Mitchell - Goldman Sachs

Stephen Ju - RBC Capital Markets

Eleanor Long

Operator

Thank you for standing by for the Baidu third quarter 2007earnings conference call. Aftermanagement’s prepared remarks, there will be a question-and-answersession. Today’s conference is beingrecorded. If you have any objections,you may disconnect at this time.

I would now like to turn the meeting over to your host fortoday’s conference, Lynn Lin, Baidu Investor Relations.

Lynn Lin

Hello, everyone. Welcome to Baidu’s third quarter 2007 earnings conference call. We released our third quarter earningsearlier today. You may find a copy ofthe press release on the company’s website, as well as on news wire services.

Today, you will hear from Robin Li, our Chief ExecutiveOfficer, and Shawn Wong, our Chief Financial Officer. After their prepared remarks, Robin and Shawnwill be available to answer your questions.

Before we continue, please note that the discussion todaywill contain forward-looking statements made under the Safe Harbor provisionsof the U.S. Private Securities Litigation Reform Act of 1995. Baidu does not undertake any obligation toupdate any forward-looking statements, except as required under applicable law.

As a reminder, this conference is being recorded. In addition, a webcast of this conferencecall will be available on Baidu’s company 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. I am pleased to report another solid quarterof growth as revenues grew 107% year over year. Our positive results were driven by our industry leading online searchservice and search-related products.

This quarter, we continued our focus on working hard to knowour users and staying ahead of the trends. This is why Baidu Search continues to be the market leader by a widemargin. Our innovative community-basedand entertainment products are becoming major drivers of user traffic in theirown right.

During the quarter, we launched several new products. Some of them include the Olympic Channel, theGame Channel and Baidu TV, a new form of advertising we are offering to ourmembers. This joined our alreadyestablished list of products such as Baidu Knows and Baidu Says, which continueto grow in popularity.

Our focus on providing the best customer service continuesto show strong returns. We added 15,000new active online marketing customers during the quarter. This brings the total to 143,000. Spending per online marketing customersincreased 11% quarter over quarter to RMB 3,500.

We continue to build our reputation as the advertiser ofchoice for SME and during the quarter we began to more aggressively targetlarger advertisers. Both SMEs and largerbusinesses in Chinaare realizing the outstanding ROI of their spending on paid search, so weexpect spending per online marketing customer to continue to trend upwards.

As you know, we have been transitioning SME sales andservices from third-party distributors to direct sales in selected major markets. We have already completed this in Beijingand in Shenzhen the transition is progressing on plan.

Our focus on technology also continues to pay off. We are continuously improving our paid searchplatform and search relevance. We willkeep investing in R&D and hiring top engineering talent. Next year, we also plan to use our R&Dcapacity in Shanghai and Tokyo.

An exciting service we recently announced is our firstecommerce initiative. This willinitially be a consumer-to-consumer platform. According to iResearch, 49% of China’scurrent C2C users conducted searches before visiting ecommerce sites, so Baidu’shigh search traffic and large online community will be an enormous advantage. Weexpect to launch this initiative in 2008 and will have updates as we moveforward in the development process.

Also new for this quarter is our partnership with rock musicgroups to use an online music streaming service. The advertising-supported platform will give ourusers rich audio content and provide online advertisers with a powerful marketingtool.

Our Japaninitiative is also progressing according to plan and we will remain on track tolaunch officially before the end of the year.

The search market in Chinais developing rapidly. In the thirdquarter, we continued to expand our leading market share. Today, according to the China Internet Network Information Center,Baidu is the first choice for nearly 75% of Chinese search users. We will keep working to innovate andunderstand user needs. I’m confidentthat this is the right strategy to keep us growing and well ahead of thecompetition.

I’ll now turn the call over to Shawn to go over ourfinancials.

Shawn Wang

Thank you, Robin. Hello everyone. As Robinmentioned earlier, we delivered solid revenues and earnings results in thethird quarter. I will now walk youthrough the factors contributing to these results and other financialhighlights.

Our third quarter total revenues were approximately RMB 497million for the quarter. That is a 107%increase from the year-ago period. Othermarketing revenues were RMB 496 million, representing 24% growth sequentially,and 109% growth year over year. Growthhere was driven by a number of factors, including increased traffic, asequential increase in the number of IT customers of 12%, as well as asequential increase in per-customer spending of 11%.

Traffic acquisition costs as a component of cost of revenue,was RMB 59 million, representing 12% of total revenues, compared to 9% in thecorresponding period of 2006. Theincrease in tax as a percentage of total revenues primarily reflects thecontinued growth of revenue contribution from Baidu members.

Bandwidth costs as a component of cost of revenue was RMB 32million representing 6% of total revenues compared to 4% in the third quarterof 2006. Depreciation costs as a cost of revenue was RMB 41 million,representing 8% of total revenues, compared to 6% in the corresponding periodof 2006. The increase in bandwidth and depreciation costs as a percentage oftotal revenues reflect expansion of network capacity to support Baidu’s long-termgrowth.

Our share-based compensation expenses, which were allocatedto related operating costs and expense items, decreased in aggregate to RMB 5million in the third quarter of 2007, from RMB 16 million in the correspondingperiod of 2006.

Selling, general and administrative expenses were RMB 110million, up RMB 57 million from the year-ago period, primarily due to the expansionof the direct sales force.

R&D expenses were RMB 37 million, representing a 53%increase from the year-ago period. The increase was primarily due to theexpansion of R&D headcount.

During its third fiscal quarter, Baidu Japanincurred operating costs and expenses of RMB 20 million in aggregate. Theincome tax expenses for the quarter was approximately RMB 3 million.

Our net income was RMB 182 million, representing 113%increase year over year. Net income excluding share-based compensationexpenses, a non-GAAP measure, was RMB 187 million, representing an 84% increasefrom the corresponding period of 2006.

Basic and diluted EPS, excluding share-based compensationexpenses -- also a non-GAAP measure -- were RMB 5.51 and RMB 5.38 translatingroughly to $0.74 and $0.72 respectively.

Now moving on to the balance sheet, we ended the thirdquarter with cash, cash equivalents and short-term investments of RMB 1.4billion. Operating cash flow was RMB 255 million; CapEx for the third quarterwas RMB 150 million, primarily focused on capacity expansion and the BaiduCampus building.

Adjusted EBITDA, again a non-GAAP measure, was RMB 223million, representing a 99% increase year over year. Now let me provide you ourtop line guidance for the fourth quarter of 2007. We currently expect totalrevenues to be between RMB 560 million to RMB 575 million, which wouldrepresent an annual growth of 106% to 112% and a sequential growth of 13% to16%.

Allow me to emphasize that this forecast reflects Baidu’scurrent and preliminary review, which is subject to change.

I will now open the call to questions.

Question-and-AnswerSession

Operator

Your first question comes from Dick Wei – JP Morgan.

Dick Wei – JP Morgan

Good morning, Robin and Shawn. A question regarding some of the news on theInternet data center shutdowns in September and October timeframe.

I am wonder if youcould quantify if they are any impact on your Baidu Internet traffic and aswell as how long do you think those impacts are going to last? The last part ofit is, how much impact is factored in your guidance for this quarter?

Robin Li

Yes, there were some shutdowns in some of the data centersduring September and October, but it is a little hard for us to quantify thedamage that it caused to us. It’s not only affected the Union traffic it alsoactually affect our organic traffic because when you have some web sitesunreachable it will actually discourage people from searching on theInternet.

Our traffic is decided by a very sophisticated number offactors, so it is very hard for us to quantify. I wouldn’t say that it will cause any material impact on our revenue inQ3 and our guidance in Q4.

Dick Wei – JP Morgan

Thanks Robin.

Operator

Your next question comes from Anthony Noto - GoldmanSachs.

Megan Barker forAnthony Noto – Goldman Sachs

Hi, it’s Megan Barker on for Anthony. You spent $6.5 million on the JapanInitiative so far this year. I think theoriginal plan was for about $15 million. Can you just discuss how we should be thinking about that for the fourthquarter and then into 2008?

Also just a quick housekeeping question, how should we bethinking of the tax rate going forward? Thanks.

Shawn Wang

On the Japaninitiative, I think when we’ve provided our guidance, saying that in the firstyear we expect to have the P&L impact of up to $15 million for the firstyear of our initiative in Japan. Three quarters went by, we have incurredslightly less than $7 million up to now, but we are looking to launch ourproducts and services in the last quarter, so we would expect a bigger increasein the fourth quarter.

As this is only the beginning of the fourth quarter, ouractual launching plan is being finalized, so I can’t give you an exactquantity. However, I will stay with thestatement that our first year expenses related to Japan will be still up to $15million.

On the second question, the tax rates, a number of ourentities in Chinaare still under tax holiday, which gives us the relatively low single-digitincome tax rates. Going forward, I thinkin the near term in the coming year, I think we will still enjoy somepreferential tax rates, but beyond that, as some of the entities’ tax holidaywould start to expire, as part of the benefit we receive, they will becancelled.

When that comes, I would expect our tax rate in the near term,in the next two to three years, will still be in the single-digits.

As to even longer term, as you know, the China tax regime isundergoing pretty substantive reforms, and there’s been some new tax rules thathas been issued; but an implementation guide has now become available, so we’llkeep a very close eye on those matters, and when the situation becomes clearer,we’ll provide you with more detail.

Operator

Your next question comes from Jason Brueschke - Citi InvestmentResearch.

Jason Brueschke -Citi Investment Research

Good morning, Robin and Shaw. My question is about the planned launch ofthe C2C platform, as you call it, a couple questions around this. Is this goingto be a separate auction site similar to Taobao, or this going to be just moreof a kind of a packaging of your existing search services in targeting, saypower users that might be using C2C?

If it is the former, that you’re going to have a formalsite, can you maybe help us understand how you plan to compete with Taobao giventhe fact that it’s a dominant player, it’s private so it doesn’t have to makequarterly earnings and the parent group is probably going to pick up about $1billion in cash here from a spin-off of one of its [listings].

Finally, to the extent that you may be competing with them,could you maybe help us understand how much advertising this Taobao and theother auction sites put on your paid surf site today and will you be basicallycutting those competitors off so that you can have some type of a competitiveadvantage in the market and what would be the impact to your revenues if youwere to cut eBay or Tom Internet or Taobao off?

Robin Li

As we announced before, we are going to launch a C2C auction-likeplatform next year. We already have aseparate team working on the product development; whether it’s going to beunder a different domain name or under the Baidu domain, we have notdecided. But it’s going to be arelatively independent service, just like Baidu news search or Baidu MP3 search.It’s going to be one of the services Baidu offers. Because it’s got a strong relationship withproduct search, we believe that we can save lots off of marketing dollars byleveraging our dominant positioning in this search market.

Right now, [Pipi] doesnot advertise with us and they probably never did and Taobao is still acustomer of ours. They are waiting tospend money on our platform; we welcome them to do so. We’d like to compete on a fair basis. We’dlike to build an equally good or better service for the consumers who wouldlike to shop online.

We’ve studied a number of markets including Japan,Korea, U.S.and China; wefound that in some markets you can support two C2C sites like Korea;in some markets they are the dominant portal and search player and has theleading C2C service.

In some markets like China,you have a latecomer who can overtake an early mover in relatively shortterm. So we think that in the Chineseecommerce market, at inception, at early stage, we still have lots of opportunitiesto work out a site that’s going to be better and that will serve our usersshopping convenience.

Jason Brueschke -Citi Investment Research

Great. Thankyou. I appreciate that.

Operator

Your next question comes from Robert Peck - BearStearns.

Robert Peck - BearStearns

Shawn, I was wondering, there were reports during thequarter that some of your competitors may have had traffic redirected, and Iwas curious if you could tell or quantify for us, first of all, did ithappen? Did you see any impact in 3Q, ormaybe any continuing impact that’s occurring right now in 4Q? Thanks.

Robin Li

Hi, this is Robin. Let me take on this question. Welearned that event from the media. Thenwe immediately went back to our traffic statistics. We did not see any change in our trafficpattern, so there was no impact on our traffic revenue whatsoever.

Operator

Your next question comes from Steve Weinstein - PacificCrest.

Steve Weinstein -Pacific Crest

Thank you for taking my question. I was hoping to get a little betterunderstanding of the investments in Japan. In the quarter, how did that really flowthroughout the P&L? Where are we seeingthat $2.7 million, and how does that relate to investments you’re planning tomake in ‘08? Where will we see thoseinvestments on the P&L? How is thatgoing to change as you ramp that up? Thank you.

Shawn Wang

A large amount of the Japanexpenses at this stage are related to our bandwidth and capacity and depreciation,and to a lesser degree, how it isreflected in the G&A expenses.

Robin Li

Going forward, we plan to build up an R&D center in Japan,so we will have some amount of R&D expenses that relate to Japan,as well. But I think I would expect thepredominant portion will still be the bandwidth and depreciation of servers.

Steve Weinstein -Pacific Crest

Great, thank you.

Operator

The next question comes from the line of Ming Zhao - SIG.

Ming Zhao - SIG

Thank you for taking my question. I have a question on BaiduTV. When do you think we can see some meaningful revenue on this new product?If that happens, would you be able to possibly break down the lines intocredit, advertising and search and if you can also update us, how’s the brandadvertising doing right now? That’s my question.

Shawn Wang

Baidu TV is a property we launched fairly recently, and Ithink the programs initially were well-received by both the advertisers and thevarious advertising agencies. We have been setting up various distributionagreements with agencies.

As to the actual revenue generating, I think we’re still ata very early stage. I’m not going to give you an expectation that in the shortterm there will be a very significant revenue stream coming from that. It issomething that we’re pioneering and we’re really bridging the traditional TVadvertising, bringing them into the Internet world. I think it’s a process that requires a lineshift, so we are in the process of doing that.

As to whether going forward we will separately disclose that,it’s still one form of advertising on the Internet, the nature of which isdrastically different from what we offer today. So we do not have a plan atthis moment to separately disclose the product, the information on that.

Your second question is how are we doing in general onbranded advertising? I think if we continue our momentum with our tailoredsolutions business, as Robin mentioned earlier, we’re focusing very much onserving the large customers. The large customer needs often come both on paidsearch and also on some portion of the branded advertising.

I think Baidu sees mixed chances of being able to provideboth. This gives us a strong momentum to grow our branded advertising as well.I’m happy with how we’ve been doing in that regard.

Operator

Your next question comes from the line of Stephen Ju - RBCCapital Markets.

Stephen Ju - RBCCapital Markets

Good morning, Robin and Shawn. CapEx in the third quarterwas a bit more aggressive than EBITDA. How much of the CapEx was for capacityexpansion and how much was toward the new campus, and what do you expect theCapEx to do in the near future? Thankyou.

Shawn Wang

Steven this is actually a good question. Now we are in the process of building BaiduCampus and we actually started digging the grounds during the third quarter andso we started to incur a substantial amount of building-related CapEx. The building is, we are currently looking toor expect to complete that building process early part of 2009. So either between now and the early part of2009 I think there will be a substantial amount of CapEx to be incurred.

For this particular quarter, the third quarter, there wasapproximately RMB150 million CapEx and one-third of that relates to Baidubuilding. So if you purely look at thecapacity servers and network equipments, Q3 actually stays at the same level ofQ2, which was approximately RMB100 million.

Operator

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

Wallace Cheung –Credit Suisse

I just wanted to ask a question about the trafficacquisition costs. It seems to me thatas a percentage of the total revenue it is going up, can you comment a bitabout the trend in the next few quarters? Thank you.

Shawn Wang

Wallace, the TAC, did you ask if the TAC was going down?

Wallace Cheung –Credit Suisse

Oh no, as a percentage of the total revenue, the TAC isactually going up?

Shawn Wang

There has been a slight going up on a fairly consistentbasis in the past few quarters. As Imentioned during the prepared remarks, the TAC increase is largely a reflectionof Baidu’s strengths in our Union Network. We have been able to generate strong Union revenues, which arecontributing to our revenue and I think the TAC increase reflected that.

Going forward, I think we would like to keep the flexibilityof striking sensible deals where there is meaningful traction and we would haveacquired them. As long as thecontribution from that bottom line is positive. I think our strategy has worked well in the past and will continue topursue that direction.

However, if traffic, if our position doesn’t make economicsense, we would not touch that. On thisparticular point, I think I also wanted to emphasize in the past quarter wehave started basically an organizational effort with our Unionbasically strengthening the management of our Union Network. You know putting our Union members indifferent brackets and having a different level of members and differentcertifications and making sure that our Union members are being well organizedand well rewarded in the meantime.

That doesn’t necessarily mean there is any mature increasein the payout ratio. But I think it doesreflect improved management, strengthening of management of our Union Network.

Operator

The next question comes from the line of Gene Munster - PiperJaffray.

Gene Munster - PiperJaffray

Good morning. Shawn,you talked a little bit about the CapEx extending and I know that when we lookat the Baidu model there’s definitely some operating margin expansion over thenext several years. How should we thinkabout the OpEx expansion at least generically and the context of some of yourbringing more sales in direct and creating R&D centers and the like?

Shawn Wang

Well, the CapEx, first of all, let me take the easyone. The expansion of the direct salesforces doesn’t really affect CapEx any. I think mostly what’s affecting CapEx in the near-term will be ournetwork capacity as well as our Baidu building. I think our Baidu building between now and 2009 we are looking to incur,my estimate at this time is probably $60 million to $70 million or so, andgiven that the construction is still in progress, that would be a very bigchunk of our CapEx.

But this CapEx is really for the long-term; our buildings,the land use right is about 70 years so there is a really long-term CapEx andthat’s what we’re looking at. We all knowwhat’s the hot real estate prices have been appreciating in Chinaso we think we have a great deal going.

The general network capacity CapEx extension, and that’s afunction of many different things, our traffic and our products that we’reputting out up online, I think I have tofollow our usual practice of not providing guidance on these numbers.

Gene Munster - PiperJaffray

Again, just to be clear on my question, I was talking aboutthe operating margin expansion potential and how should we even think about it,because my fear is that as the revenue keeps going up, people are going tostart to kind of run away with their expectations as far how the operatingmargin leverage is going to come.

So maybe just talk with us about, you talked about Japan,are there any other factors that are going to be limiting to you havingmeaningful operating margin expansion in 2008?

Shawn Wang

Sorry, Jim, I missed your question; let me try again. I think one thing you have to recognize isthat we have a very strong, solid search business, and it’s highly leveragable,and there is a strong revenue growth, aswell as margin expansion on that. At thesame time, a search market in China,or an Internet, or ecommerce in general in China,as well as United States, I think there are many opportunities we see;and particularly, given our leadership in traffic in China,and our strong brand in China,there are things that we have to do to capture the long-term growthpotential.

We keep on saying this, and I will repeat this again, thatwhen we run our business, we really look at the long term. So if the people are shooting the short-termmargin target as a measure of making an investment in Baidu, I think that’sprobably missing the big picture.

Operator

Your next question comes from James Mitchell - GoldmanSachs.

James Mitchell -Goldman Sachs

Thank you. Justfollowing up on Jason’s question, I wanted to confirm your C2C project will besimilar to Yahoo! Japan, in that you will actually have storefronts, ratherthan just being a listing service providing [links] to storefronts. If that isthe case, do you see any risk that sellers might choose to create freestorefronts on ecommerce sites, rather than buying key words?

Robin Li

I am not quite clear on what the conflict has been betweenbuying a keyword and opening storefronts on our C2C platform; I think in mostcases, opening a store online on our C2C a platform is free. We will figure outa way to charge money later on, when we have enough number of transactionsgoing on, on the platform.

James Mitchell -Goldman Sachs

Okay. Great.

Operator

Your next question comes from the line of Dick Wei - JPMorgan.

Dick Wei - JP Morgan

Can you give an update on the change in distributortransition, and how long would it take, and any other plans as well?

Shawn Wang

The transition is still underway. The approach we are taking is on one side, wetried to build our direct sales presence. At the same time, we talk to our distributors and try to transition theexisting customers to our direct salesforce and direct customer service force,and that process is ongoing.

We would expect to wrap that up by the end of the year. Buthaving said that, again, I think I mentioned before that whenever we try tomake this transition from a third party to direct sales, it generally takes upto a year, three quarters to four quarters, to have the full impact be felt.

Dick Wei - JP Morgan

Is it the reason also that your third quarter number isslightly below the midpoint of the guidance? Was it one of the main issues if you can explain that a bit?

Shawn Wang

Well, I think like Robin mentioned earlier, just these kindof data center issues, these things are hard to quantify. There are many different things that happenedthis summer, expected and some are not expected. It’s really hard to quantify each. Ithink in the aggregate when we look at our overall business, I think we arewithin the range of the guidance and I think some of the unexpected events arejust a fact of life.

Dick Wei – JP Morgan

Great. Thank you.

Operator

Your next question comes from Steve Weinstein - PacificCrest.

Steve Weinstein -Pacific Crest

I think I just missed it when you were talking aboutexpectations for tax rates going forward. Did you say they were going to be single-digit in 2008?

Shawn Wang

Yes, I believe so.

Steve Weinstein -Pacific Crest

Okay. Thank you.

Operator

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

Wallace Cheung –Credit Suisse

This new product that you anticipate launching the GameChannel, can you talk a bit about the model of this product?

Robin Li

Yes, as you probably know, gaming is a very large market in Chinaand a lot of companies make very significant profits from offering online gamesand the marketing of those games has become a big deal. We have the largest website in China,of course, that attracts lots of users who have this kind of need.

Offering a games channel will help direct our users to gamesthey are interested in and help to attract advertising spending from the gameproviders. That’s the basic goal or thedisposition of our game channel. It’s a relatively simple search-like site.Basically you can search for all kind of games in our game channel search box.

Wallace Cheung –Credit Suisse

So basically it’s sort of like a sponsorship or self-advertisingif someone wants to promote the game to the end users?

Robin Li

Well it’s a combination of content and soft advertising.

Wallace Cheung –Credit Suisse

Thank you.

Operator

Your next question comes from the line of Stephen Ju - RBCCapital Markets.

Stephen Ju - RBCCapital Markets

I’m still trying to understand the decision to enter the C2Ccommerce market. Is it a fair characterization to think that your decision toenter that market resulted from your interactions with your SME clients and yousaw the opportunity to upsell additional products?

Robin Li

Not really. It’s more about our observation on the use; Wesee a lot of users coming to our site looking for product-related informationand also, I believe, most of the outside traffic from the ecommerce side comesfrom the search engine. We see great synergy between our search service and a C2Cauction site. That’s why we are going to offer this kind of services.

Operator

Your next question comes from the line of Gene Munster - PiperJaffray.

Gene Munster - PiperJaffray

Robin, back on theC2C site, you mentioned it could be a stand alone or it could be internal. So,if you look at for example Google and some of their product sites, it’s kind ofembedded within the Google site. Is that how we should be thinking about it? Orwe shouldn’t be thinking anything about it and you guys will tell us in thefuture?

Robin Li

Like I mentioned before, we haven’t made the decision yetwhether to have a separate domain. But it’s going to be integrated into the Baiduservice platform. It’s just like we are offering web search. We are offeringnews search. We’re offering knowledge search. Now we’re offering a C2Cplatform. When people want to shop, they can search that platform.

I personally don’t think there’s not much difference betweena separate brand and an integrated service under Baidu.com.

Gene Munster - PiperJaffray

Thank you.

Operator

The next question comes from the line of Dick Wei – JP Morgan.

Dick Wei – JP Morgan

Thanks for taking my questions again. My question is on the deferred revenue sincethe end of the third quarter, deferred revenues are up around 27% quarter overquarter and if the revenue particularly has some decent relationship with yournext quarter growth and given your guidance around the mid-teens level, I don’tknow if that is guiding more conservatively or if there are some changes in thecustomer deposit policy in the quarter?

Shawn Wang

Dick, deferred revenues different from customerdeposit. Let me explain, there are acouple of categories. Customer depositis a fee business, where an advertiser would pay us upfront and buy keywords.These are what we call the customer deposits.

Deferred revenue tends to be the tailored solutioncustomers. When we recognize revenue for these large spending advertisers, wehave to customize the contract. Sometimes the contract takes longer. It may bethe time where finally when we got the contract, the payment has been delayedand the ad has already been shown. In which even, we follow a consistent U.S.GAAP, the same practice before and as it is today.

When we recognize revenue, we need a piece of evidence, adocument. There may be times that thedocument has to be a full contract, which takes time, so that is what is contained in the deferredrevenue.

In terms of the business practice, there have not been anychanges in how we book this revenue and how we account for this.

Robin Li

Regarding the sequential growth, I think it is a normalgrowth rate for our size if you look at the related [Q] the more than 100%growth rate year-over-year is probably still the highest growth rate you canfind. Like Shawn mentioned earlier, weare really targeting to grow this business for a very, very long time goingforward. We would rather not push too hard to make some short-term numbers, butwe’d like to set a solid foundation for the growth for years to come.

Operator

The next question comes from the line of Jason Brueschke -Citi Investment Research.

Jason Brueschke - CitiInvestment Research

A follow-up to James’ question and I think one other. Youindicated that the move into the C2C commerce site was in some ways triggeredby just your analysis of search patterns in traffic. But at the same time, youguys have a large direct sales force, and you are increasingly taking your largestmarkets away from distributors to your direct sales force which meanseffectively that you are developing a direct relationship with a lot of theseSMEs between the company and those advertising SMEs.

Is there not a larger community opportunity? Not to beviewed just as a search engine but as the beginning of a community wherebecause you have a direct relationship with SMEs, you’re selling them C2Cadvertising that you have an opportunity over time to sell more and moreservices into that SME customer base which, as you guys know, stands clearlyabove 143,000 because those are just your active customers.

Could you comment on, is that a way to be thinking aboutmaybe a longer term potential of this business you have, or is this somethingthat you guys are not really interested in pursuing? Thanks.

Robin Li

Let me put it this way. I think during the past six or sevenyears, we accumulated a large number of SME customers. In the past, we focusedon providing simple keyword search services to them, but we did realize theyhave other kinds of needs related to Internet and we think in some aspect wecan help them to solve their problems.

So yes, we will start to do things that make them happier.We classify this on our customer service effort. We try to serve our customersbetter and better. I think going forward, by doing that they will be able toappreciate our search service more, and spend more on our search site. That’sat least the near-term plan.

Longer term, yes, there could be some synergetic services wecan provide and generate revenue from them.

Jason Brueschke -Citi Investment Research

Great, thanks.

Operator

Your next question comes from the line of Eleanor Long.

Eleanor Long

Hi, thank you for taking my question. My question is related to the Baidu TV. Canyou tell us what kind of format it would be like? Is it like advertising at the beginning ofthe content? If that’s the case, wheredo you get the content?

Shawn Wang

The Baidu TV is, to put it in very simple terms, the typicalTV commercial that we sell, that is always on TV screen now; if you go onto oneof your favorite websites, and the website happened to be our Union member,when you go to their web page, and on the bottom right-hand corner as itcurrently stands, there will be a video clip. That’s the TV commercial that will appear.

Eleanor Long

So there will be content after the TV commercial?

Robin Li

No, it’s pure TV commercial on the regular web page, in mostcases.

Operator

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

C. Ming Zhao - SIG

I have a follow-up question -- just looking at some of yourcompetitors raising tons of cash now and the prospectus they talk about, a lotof it will be used for acquisitions. It seems like Baidu has always been ratherfocused on organic growth. I wonder if you could talk about, is this somethingyou would also be looking at?

Robin Li

Well, as you can see, we have a very liquidable stock.People pay a lot of attention to us. We do have the flexibility to raise cashif that’s what we want, but even without raising the cash, I think our stock is-- [that still is not better] than cash.

Operator

The next question comes from the line of Wallace Cheung. Please proceed.

Wallace Cheung- Credit Suisse

Regarding the [inaudible] platform, can you talk a bit moreabout the payment solution? Actually, there is one more follow-up questionregarding payment solution; once you have implemented some kind of paymentsolution, is there any incentive for you to migrate all your S and D customersthrough your [inaudible] without going through [disclosures] or direct sales sourceanymore? Thank you.

Robin Li

Well, that’s really a longer term decision for us. Rightnow, we are focusing on developing a C-to-C platform. We are still evaluatingwhat to do with the payment solution. We may develop it in-house. We mayoutsource it to a third-party and we may even buy a payment solution goingforward.

Operator

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

Stephen Ju- RBC Capital Markets

What was your headcount at the end of third quarter? Howmany people were in sales at the company, sales people or headcount in generaldo you think you will add in the fourth quarter?

And not to keep harping on the subject of C-to-C, but itseems like -- and that product as it pertains to SMEs, do you see this productevolving into more of a local search product at some point in the future? Thankyou.

Shawn Wang

Let me first take your question on the headcount and then onthe C-to-C, I’ll hand it to Robin. Headcount at the end of the quarter, weactually have slightly over 4,700 people and we -- that’s an addition of about300 people during the quarter.

Going forward in the next quarter, we are continuing hiring.Among the people that we have today, over 3,000 are in the sales, direct salesand services component.

Robin Li

Regarding to C-to-C, and its synergies with SMEs and locals,I think that eventually, yes, that these three things share something incommon, but at this stage, I think it is too early to tightly integrate them.We’d like to first provide a more regular service on the shopping platform, andthen start to find synergies and to integrate things together.

Operator

The next question comes from the line of James Mitchell withGoldman Sachs. Please proceed.

James Mitchell -Goldman Sachs

I apologize for asking about the 10,000th C-to-C question,but just to maybe wrap it up, from my side anyway, when we think about modelingout Baidu in 2008, should we expect the operating expense on creating a C-to-Cplatform to be comparable to the operating expense this year on creating the Japansearch engine? Or would it be dramatically smaller, since there is moreopportunity to leverage your existing cost base? Thank you.

Robin Li

I think the cost will be significantly smaller than our Japaninitiative. As I mentioned before, we have a very strong search platform thatwill help drive traffic to the C-to-C platform. That is probably the major costfor some of the other C-to-C service providers.

Regarding the product [inaudible], I think we can have avery good team and we need to make the necessary investments, but that’s notgoing to cost as much as the Japaninitiative.

Operator

The next question comes from the line of Gene Munster withPiper Jaffray. Please proceed.

Gene Munster - PiperJaffray

Shawn, if you could go over a little bit, just to recap, the[union members] revenue share, you said that there’s no increase in theoverall, but it’s kind of -- you put it in [tears] to better manage it. Can youtalk a little bit -- so basically -- how should we think about that relative toTAC going forward?

Shawn Wang

I think I mentioned the effort that we made was more improvethe over relationship and management of this relationship with our unionmembers. This effort I do not expect will be any significant changes in the TACratio by itself. However, we are -- we have been successfully growing ourthird-party traffic, so the TAC increase that we see in the past few quartersis a reflection of our successful uptake of the third party traffic.

We like to continue to look for opportunities to bring inthird party traffic at the terms that are economical.

Operator

We are now approaching the end of the conference call. Iwill now turn the call over to Baidu’s Chief Executive Officer, Robin Li, forhis closing remarks.

Robin Li

All right. Once again, thank you for joining us today andplease do not hesitate to contact us if you have any further questions.

Operator

Thank you for your participation in today’s conference. Thisconcludes this presentation. You may now disconnect. Good day.

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Source: Baidu.com Q3 2007 Earnings Call Transcript

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