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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 2007 earnings conference call. 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, Lynn Lin, Baidu Investor Relations.

Lynn Lin

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

Today, you will hear from Robin Li, our Chief Executive Officer, and Shawn Wong, our Chief Financial Officer. After their prepared remarks, Robin and Shawn will be available to 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. Baidu does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on Baidu’s 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 quarter of growth as revenues grew 107% year over year. Our positive results were driven by our industry leading online search service and search-related products.

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

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

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

We continue to build our reputation as the advertiser of choice for SME and during the quarter we began to more aggressively target larger advertisers. Both SMEs and larger businesses in China are realizing the outstanding ROI of their spending on paid search, so we expect spending per online marketing customer to continue to trend upwards.

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

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

An exciting service we recently announced is our first ecommerce initiative. This will initially be a consumer-to-consumer platform. According to iResearch, 49% of China’s current C2C users conducted searches before visiting ecommerce sites, so Baidu’s high search traffic and large online community will be an enormous advantage. We expect to launch this initiative in 2008 and will have updates as we move forward in the development process.

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

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

The search market in China is developing rapidly. In the third quarter, 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 and understand user needs. I’m confident that this is the right strategy to keep us growing and well ahead of the competition.

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

Shawn Wang

Thank you, Robin. Hello everyone. As Robin mentioned earlier, we delivered solid revenues and earnings results in the third quarter. I will now walk you through the factors contributing to these results and other financial highlights.

Our third quarter total revenues were approximately RMB 497 million for the quarter. That is a 107% increase from the year-ago period. Other marketing revenues were RMB 496 million, representing 24% growth sequentially, and 109% growth year over year. Growth here was driven by a number of factors, including increased traffic, a sequential increase in the number of IT customers of 12%, as well as a sequential 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 the corresponding period of 2006. The increase in tax as a percentage of total revenues primarily reflects the continued growth of revenue contribution from Baidu members.

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

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

Selling, general and administrative expenses were RMB 110 million, up RMB 57 million from the year-ago period, primarily due to the expansion of 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 the expansion of R&D headcount.

During its third fiscal quarter, Baidu Japan incurred operating costs and expenses of RMB 20 million in aggregate. The income 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 compensation expenses, a non-GAAP measure, was RMB 187 million, representing an 84% increase from the corresponding period of 2006.

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

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

Adjusted EBITDA, again a non-GAAP measure, was RMB 223 million, representing a 99% increase year over year. Now let me provide you our top line guidance for the fourth quarter of 2007. We currently expect total revenues to be between RMB 560 million to RMB 575 million, which would represent an annual growth of 106% to 112% and a sequential growth of 13% to 16%.

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

I will now open the call to questions.

Question-and-Answer Session

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 the Internet data center shutdowns in September and October timeframe.

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

Robin Li

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

Our traffic is decided by a very sophisticated number of factors, so it is very hard for us to quantify. I wouldn’t say that it will cause any material impact on our revenue in Q3 and our guidance in Q4.

Dick Wei – JP Morgan

Thanks Robin.

Operator

Your next question comes from Anthony Noto - Goldman Sachs.

Megan Barker for Anthony Noto – Goldman Sachs

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

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

Shawn Wang

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

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

On the second question, the tax rates, a number of our entities in China are still under tax holiday, which gives us the relatively low single-digit income tax rates. Going forward, I think in the near term in the coming year, I think we will still enjoy some preferential tax rates, but beyond that, as some of the entities’ tax holiday would start to expire, as part of the benefit we receive, they will be cancelled.

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 is undergoing pretty substantive reforms, and there’s been some new tax rules that has been issued; but an implementation guide has now become available, so we’ll keep 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 Investment Research.

Jason Brueschke - Citi Investment Research

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

If it is the former, that you’re going to have a formal site, can you maybe help us understand how you plan to compete with Taobao given the fact that it’s a dominant player, it’s private so it doesn’t have to make quarterly earnings and the parent group is probably going to pick up about $1 billion 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 the other auction sites put on your paid surf site today and will you be basically cutting those competitors off so that you can have some type of a competitive advantage in the market and what would be the impact to your revenues if you were to cut eBay or Tom Internet or Taobao off?

Robin Li

As we announced before, we are going to launch a C2C auction-like platform next year. We already have a separate team working on the product development; whether it’s going to be under a different domain name or under the Baidu domain, we have not decided. But it’s going to be a relatively 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 with product search, we believe that we can save lots off of marketing dollars by leveraging our dominant positioning in this search market.

Right now, [Pipi] does not advertise with us and they probably never did and Taobao is still a customer of ours. They are waiting to spend money on our platform; we welcome them to do so. We’d like to compete on a fair basis. We’d like to build an equally good or better service for the consumers who would like to shop online.

We’ve studied a number of markets including Japan, Korea, U.S. and China; we found 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 the leading C2C service.

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

Jason Brueschke - Citi Investment Research

Great. Thank you. I appreciate that.

Operator

Your next question comes from Robert Peck - Bear Stearns.

Robert Peck - Bear Stearns

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

Robin Li

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

Operator

Your next question comes from Steve Weinstein - Pacific Crest.

Steve Weinstein - Pacific Crest

Thank you for taking my question. I was hoping to get a little better understanding of the investments in Japan. In the quarter, how did that really flow throughout the P&L? Where are we seeing that $2.7 million, and how does that relate to investments you’re planning to make in ‘08? Where will we see those investments on the P&L? How is that going to change as you ramp that up? Thank you.

Shawn Wang

A large amount of the Japan expenses at this stage are related to our bandwidth and capacity and depreciation, and to a lesser degree, how it is reflected 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 the predominant 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 Baidu TV. 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 into credit, advertising and search and if you can also update us, how’s the brand advertising doing right now? That’s my question.

Shawn Wang

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

As to the actual revenue generating, I think we’re still at a very early stage. I’m not going to give you an expectation that in the short term there will be a very significant revenue stream coming from that. It is something that we’re pioneering and we’re really bridging the traditional TV advertising, bringing them into the Internet world. I think it’s a process that requires a line shift, 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 is drastically different from what we offer today. So we do not have a plan at this moment to separately disclose the product, the information on that.

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

I think Baidu sees mixed chances of being able to provide both. 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 - RBC Capital Markets.

Stephen Ju - RBC Capital Markets

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

Shawn Wang

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

For this particular quarter, the third quarter, there was approximately RMB150 million CapEx and one-third of that relates to Baidu building. So if you purely look at the capacity servers and network equipments, Q3 actually stays at the same level of Q2, 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 traffic acquisition costs. It seems to me that as a percentage of the total revenue it is going up, can you comment a bit about 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 is actually going up?

Shawn Wang

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

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

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

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

Operator

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

Gene Munster - Piper Jaffray

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

Shawn Wang

Well, the CapEx, first of all, let me take the easy one. The expansion of the direct sales forces doesn’t really affect CapEx any. I think mostly what’s affecting CapEx in the near-term will be our network 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, and given that the construction is still in progress, that would be a very big chunk 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 and that’s what we’re looking at. We all know what’s the hot real estate prices have been appreciating in China so we think we have a great deal going.

The general network capacity CapEx extension, and that’s a function of many different things, our traffic and our products that we’re putting out up online, I think I have to follow our usual practice of not providing guidance on these numbers.

Gene Munster - Piper Jaffray

Again, just to be clear on my question, I was talking about the 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 to start to kind of run away with their expectations as far how the operating margin 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 having meaningful 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 is that we have a very strong, solid search business, and it’s highly leveragable, and there is a strong revenue growth, as well as margin expansion on that. At the same 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 growth potential.

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

Operator

Your next question comes from James Mitchell - Goldman Sachs.

James Mitchell - Goldman Sachs

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

Robin Li

I am not quite clear on what the conflict has been between buying a keyword and opening storefronts on our C2C platform; I think in most cases, opening a store online on our C2C a platform is free. We will figure out a way to charge money later on, when we have enough number of transactions going on, on the platform.

James Mitchell - Goldman Sachs

Okay. Great.

Operator

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

Dick Wei - JP Morgan

Can you give an update on the change in distributor transition, 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, we tried to build our direct sales presence. At the same time, we talk to our distributors and try to transition the existing 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. But having said that, again, I think I mentioned before that whenever we try to make this transition from a third party to direct sales, it generally takes up to 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 is slightly 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 kind of data center issues, these things are hard to quantify. There are many different things that happened this summer, expected and some are not expected. It’s really hard to quantify each. I think in the aggregate when we look at our overall business, I think we are within the range of the guidance and I think some of the unexpected events are just a fact of life.

Dick Wei – JP Morgan

Great. Thank you.

Operator

Your next question comes from Steve Weinstein - Pacific Crest.

Steve Weinstein - Pacific Crest

I think I just missed it when you were talking about expectations 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 Game Channel, 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 China and a lot of companies make very significant profits from offering online games and 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 games they are interested in and help to attract advertising spending from the game providers. That’s the basic goal or the disposition 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-advertising if 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 - RBC Capital Markets.

Stephen Ju - RBC Capital Markets

I’m still trying to understand the decision to enter the C2C commerce market. Is it a fair characterization to think that your decision to enter that market resulted from your interactions with your SME clients and you saw the opportunity to upsell additional products?

Robin Li

Not really. It’s more about our observation on the use; We see a lot of users coming to our site looking for product-related information and also, I believe, most of the outside traffic from the ecommerce side comes from the search engine. We see great synergy between our search service and a C2C auction site. That’s why we are going to offer this kind of services.

Operator

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

Gene Munster - Piper Jaffray

Robin, back on the C2C 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 of embedded within the Google site. Is that how we should be thinking about it? Or we shouldn’t be thinking anything about it and you guys will tell us in the future?

Robin Li

Like I mentioned before, we haven’t made the decision yet whether to have a separate domain. But it’s going to be integrated into the Baidu service platform. It’s just like we are offering web search. We are offering news search. We’re offering knowledge search. Now we’re offering a C2C platform. When people want to shop, they can search that platform.

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

Gene Munster - Piper Jaffray

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 since the end of the third quarter, deferred revenues are up around 27% quarter over quarter and if the revenue particularly has some decent relationship with your next quarter growth and given your guidance around the mid-teens level, I don’t know if that is guiding more conservatively or if there are some changes in the customer deposit policy in the quarter?

Shawn Wang

Dick, deferred revenues different from customer deposit. Let me explain, there are a couple of categories. Customer deposit is 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 solution customers. When we recognize revenue for these large spending advertisers, we have to customize the contract. Sometimes the contract takes longer. It may be the time where finally when we got the contract, the payment has been delayed and 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, a document. There may be times that the document has to be a full contract, which takes time, so that is what is contained in the deferred revenue.

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

Robin Li

Regarding the sequential growth, I think it is a normal growth 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 can find. Like Shawn mentioned earlier, we are really targeting to grow this business for a very, very long time going forward. We would rather not push too hard to make some short-term numbers, but we’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 - Citi Investment Research

A follow-up to James’ question and I think one other. You indicated that the move into the C2C commerce site was in some ways triggered by just your analysis of search patterns in traffic. But at the same time, you guys have a large direct sales force, and you are increasingly taking your largest markets away from distributors to your direct sales force which means effectively that you are developing a direct relationship with a lot of these SMEs between the company and those advertising SMEs.

Is there not a larger community opportunity? Not to be viewed just as a search engine but as the beginning of a community where because you have a direct relationship with SMEs, you’re selling them C2C advertising that you have an opportunity over time to sell more and more services into that SME customer base which, as you guys know, stands clearly above 143,000 because those are just your active customers.

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

Robin Li

Let me put it this way. I think during the past six or seven years, we accumulated a large number of SME customers. In the past, we focused on providing simple keyword search services to them, but we did realize they have other kinds of needs related to Internet and we think in some aspect we can 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 customers better and better. I think going forward, by doing that they will be able to appreciate our search service more, and spend more on our search site. That’s at least the near-term plan.

Longer term, yes, there could be some synergetic services we can 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. Can you tell us what kind of format it would be like? Is it like advertising at the beginning of the content? If that’s the case, where do you get the content?

Shawn Wang

The Baidu TV is, to put it in very simple terms, the typical TV commercial that we sell, that is always on TV screen now; if you go onto one of 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 it currently 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 most cases.

Operator

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

C. Ming Zhao - SIG

I have a follow-up question -- just looking at some of your competitors raising tons of cash now and the prospectus they talk about, a lot of it will be used for acquisitions. It seems like Baidu has always been rather focused on organic growth. I wonder if you could talk about, is this something you 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 cash if 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 more about the payment solution? Actually, there is one more follow-up question regarding payment solution; once you have implemented some kind of payment solution, is there any incentive for you to migrate all your S and D customers through your [inaudible] without going through [disclosures] or direct sales source anymore? Thank you.

Robin Li

Well, that’s really a longer term decision for us. Right now, we are focusing on developing a C-to-C platform. We are still evaluating what to do with the payment solution. We may develop it in-house. We may outsource it to a third-party and we may even buy a payment solution going forward.

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? How many people were in sales at the company, sales people or headcount in general do you think you will add in the fourth quarter?

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

Shawn Wang

Let me first take your question on the headcount and then on the C-to-C, I’ll hand it to Robin. Headcount at the end of the quarter, we actually have slightly over 4,700 people and we -- that’s an addition of about 300 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 sales and 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 in common, 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, and then start to find synergies and to integrate things together.

Operator

The next question comes from the line of James Mitchell with Goldman 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 modeling out Baidu in 2008, should we expect the operating expense on creating a C-to-C platform to be comparable to the operating expense this year on creating the Japan search engine? Or would it be dramatically smaller, since there is more opportunity to leverage your existing cost base? Thank you.

Robin Li

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

Regarding the product [inaudible], I think we can have a very good team and we need to make the necessary investments, but that’s not going to cost as much as the Japan initiative.

Operator

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

Gene Munster - Piper Jaffray

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 the overall, but it’s kind of -- you put it in [tears] to better manage it. Can you talk a little bit -- so basically -- how should we think about that relative to TAC going forward?

Shawn Wang

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

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

Operator

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

Robin Li

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

Operator

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

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Source: Baidu.com Q3 2007 Earnings Call Transcript
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