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Baidu.com, Inc. (NASDAQ:BIDU)

Q4 2007 Earnings Call

February 13, 2008 8:00 pm ET

Executives

Linda Sun - IR

Robin Li - CEO

Haoyu Shen - Vice President of Business Operations

Analysts

Gene Munster - Piper Jaffray

Jason Brueschke - Citi Investment Research

Dick Wei – JP Morgan

Robert Peck - Bear Stearns

Eric Winn – Bear Stearns

Wallace Cheung – Credit Suisse

Ming Zhao - SIG

Richard Ji – Morgan Stanley

Steve Weinstein - Pacific Crest

James Mitchell - Goldman Sachs

George Chu - UBS

Eddie Long – Merrill Lynch

Richard Chow – Alliance Bernstein

Stephen Ju - RBC Capital Markets

James Lee – Stern Agee Capital Markets

Eleanor Long

Tsei Chen – Shaw Capital Markets

Kar Kwong – Needham & Co.

Operator

Good evening and thank you for standing by for Baidu’s fourth quarter and full year 2007 earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Linda Sun.

Linda Sun

Hello, everyone. Welcome to Baidu’s fourth quarter 2007 and full year 2007 earnings conference call. We distributed Baidu’s fourth quarter and fiscal year 2007 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, Baidu’s Chief Executive Officer, and Haoyu Shen, Baidu’s Vice President of Business Operations. After their prepared remarks, Robin and Haoyu 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 corporate website at ir.baidu.com.

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

Robin Li

Hello, everyone and thank you for joining us. I am pleased to report strong fourth quarter and full year 2007 results. Total revenues for the fourth quarter grew 110% year over year. This was driven by healthy increases in both of our key growth drivers, the number of active online marketing customers, and revenue per customer.

Our active online marketing customers grew to 155,000 approximately a 44% increase year over year. Revenue per online marketing customer rose to RMB 3,700 up 48% year over year.

Our leading market share in Chinese search also grew as users continued to choose Baidu’s suite of search and community-based offerings, such as Baidu Knows and Baidu Post Bar. New products like [Baidu’s channels], statistical search and pattern search.

According to iResearch, Baidu’s web search share rose to nearly 72% in the fourth quarter, up from nearly 69% in the third quarter of 2007. A study recently released by comScore found that Baidu is the third most popular search engine.

Spending by large advertisers started to outpace our traditional SME customer base as they realize the importance of integrating search with other online and offline campaigns. In particular, we have seen increases in large advertisers from the financial services, IT, electronics and automobile industry.

Compared with other online media platforms, Baidu has the advantage of offering a variety of advertising products in bundles. This can combine traditional search, banner ads, behaviorally targeted ads or target placement and ad space on our Union sites.

We can also incorporate our newly launched branding service. We expect our bundled advertising offerings to continue to gain traction as we generate increased traffic and enhanced brand recognition for our customers.

Also of note from the fourth quarter is that in Shenzhen we have transitioned away from third party distributors and are now using a direct sales model. We now have direct sales teams in Beijing, Shanghai, Guangzhou, Shenzhen, Taiyuan, Tianjin and Fooshan.

Looking at our new initiatives, we are very excited to officially launch Baidu Japan this past January. As you know, we had a well-received beta site live since last March and the day after the official launch, user traffic quadrupled. We are already offering web search, video search, image search and blog search on Baidu.jp. This year will be the year of products and our on-the-ground team is dedicated to creating more search services that suit Japanese user needs. With Baidu’s search technology and focus on local users, we are confident that we can create a dynamic competitor in the Japan search market. In 2008, we are expecting to invest about $20 million to $25 million in this.

Another initiative that we announced last quarter is our C2C auction platform. Plans for a launch in 2008 are on track. We have established a unit of professionals currently working on the details of this model including placement, layout and payment mechanisms. We will be keeping you informed as we move ahead on this.

One thing we are really excited about is Baidu’s growing importance in China’s pop culture. Since lots of people already come to Baidu to search for entertainment-related information, we have become a leading destination for entertainment-based online communities. So we are actively working to position Baidu as the hub of China’s fast-growing digital entertainment ecosystem.

Part of this effort is online. Our new entertainment channel, for example, serves as a community for all kinds of discussions and we will continue leveraging our brand recognition to increase collaboration with entertainment industry players to bring users advertising-supported online music, video and more.

We believe that our efforts have paid off so far. In 2007, Baidu became the first Chinese company to join the NASDAQ 100 index. With 2,010 million users today China’s Internet population continues to grow fast from a relatively small base. Baidu’s dominant market share, well-received products and strategic initiatives such as C2C position us perfectly to benefit from this growth.

Today, web-based search is our main source of revenue, but only accounts for 40% of our total traffic. That means non-web search including users accessing our community and entertainment platform accounts for 60% of traffic, but a much less as a proportion of revenue. We see many opportunities to monetize this non-web search traffic, creating new revenue streams to support our long-term growth.

On a separate note, as you know, in late December our CFO, Shawn Wang passed away while on vacation with his family. This has been a very difficult and sad time for us, as Shawn was an important and much-loved presence at Baidu. While we conduct our search for a permanent CFO, our Vice President of Business Operations Haoyu Shen will be responsible for our financials.

By way of background, Haoyu joined Baidu in June of 2007, coming to us from American Express where he served as the Vice President in charge of U.S. Consumer Card Acquisition. Haoyu has an MBA and holds a CFA charter, and previously worked for Mackenzie and Company in Greater China and New York.

Haoyu will now take you through fourth quarter and full fiscal year 2007 financial results.

Haoyu Shen

Thank you, Robin and hello, everyone. As Robin mentioned earlier, we delivered healthy revenues and earnings results in the fourth quarter. I will walk you through some important factors contributing to these results and other financial highlights before you taking through highlights and financials for the full fiscal year 2007.

Our fourth quarter total revenues were approximately RMB 571.1 million within our guidance range and up 110.5% over the year-ago period. Online marketing revenues were RMB 570 million, representing 111% growth year over year.

The growth was driven by a number of factors, including traffic growth, an increase in the number of active online marketing customers of over 8% over the third quarter of 2007, as well as a nearly 6% sequential increase in per-customer spending.

Traffic acquisition costs as a component of the cost of revenues was RMB 72 million or almost 13% of the total revenues compared to nearly 9% in the year-ago period. The increase in TAC as a percentage of total revenues primarily reflects the continued growth of revenue contribution from Baidu Union members.

Share-based compensation expenses increased to RMB 13 million in the fourth quarter of 2007 from RMB 7 million in the year-ago period. SG&A expenses were RMB 132 million, an 86% increase from the fourth quarter in 2006. Excluding share-based compensation expenses, SG&A rose 95% year over year.

Research and development expenses were RMB 47 million, a 123% increase from the corresponding period in 2006. Excluding share-based compensation expenses, R&D expenses rose 99% year over year, mainly due to the expansion of headcount.

Costs and expenses related to the Japan operations in the fourth quarter of 2007 were RMB 25 million in aggregate. Net income for the quarter was RMB 225 million, up 79% year over year. Net income, excluding share-based compensation expenses, a non-GAAP measure, was RMB 233 million, a 79% increase from the fourth quarter of 2006.

Basic and diluted EPS, excluding share-based compensation expenses, were RMB 6.84 and RMB 6.70, translating roughly to $0.94 and $0.92 respectively.

Net margin excluding share-based compensation expenses for the fourth quarter of 2007 was 41%, down from 48% in the year-ago period.

Now moving on to the balance sheet, we ended the fourth quarter of 2007 with cash, cash equivalents and short-term investments of RMB 1.6 billion, or $218 million.

Operating cash inflow for the quarter was RMB 335 million or $46 million, a year-over-year increase of 96%. Capital expenditure for the fourth quarter of 2007 was RMB 166 million, up from RMB 23 million in the year-ago period.

Adjusted EBITDA – again, a non-GAAP measure – was RMB 247 million for the fourth quarter, an increase of 87% from the corresponding period in 2006.

Now turning to fiscal year 2007 results, total revenues were RMB 1.7 billion, representing a 108% increase from the previous year. Online marketing revenues were RMB 1.7 billion, a 110% increase from the previous year. The growth was driven by a number of factors, including traffic growth, an increase in the number of active online marketing customers of nearly 50% over 2006, as well as a year-over-year increase in per customer spending of nearly 40%.

Traffic acquisition costs were RMB 205 million, representing 12% of total revenues compared with 9% in 2006. SG&A expenses were RMB 411 million, up 64% from 2006 mainly due to expansion of the direct sales force and a strengthening of the distributor network.

R&D expenses totaled RMB 141 million, a 78% increase from 2006, largely due to expansion of R&D headcount.

Costs and expenses related to the Japan operations were RMB 73 million in aggregate. Net income was RMB 629 million, an increase of 108% from 2006. Net income excluding share-based compensation expenses, a non-GAAP measure, was RMB 669 million, representing a 94% increase from 2006.

Basic and diluted EPS, excluding share-based compensation expenses, were RMB 19.79 and RMB 19.26, translating roughly to $2.79 and $2.64 respectively.

Net margin excluding share-based compensation expenses for the fiscal year 2007 was 38%, down from 41% for 2006. Full year net operating cash inflow and capital expenditures in 2007 were RMB 979 million and RMB 569 million respectively. Adjusted EBITDA was RMB 768 million in 2007, a 101% increase from 2006.

Now let me provide you with our top line guidance for the first quarter of 2008. As many of you know, our first quarter results tend to be affected by the seasonality from the long Chinese New Year holiday. This year the seasonality was amplified by the severe snow storms across large portions of the country. In the first quarter of 2008 we currently expect total revenues to be between RMB 533 million RMB 548 million, which would represent an annual growth of 93% to 99%.

I do wish to emphasis that this forecast reflects Baidu’s current and preliminary view which is subject to change. I will now turn the call back to Robin for his closing remarks.

Robin Li

Thank you again for joining us today. With our focus on tailoring online products to meet users and customers needs, and our commitment to making strategic investments for the long term, we are confident that we will continue to lead the Chinese Internet search market and enjoy growth well into the future. I will now open the call to questions.

Question-and-Answer Session

Operator

Your first question comes from Gene Munster - Piper Jaffray.

Gene Munster - Piper Jaffray

Good morning, everyone. Congratulations. Robin, if you could speak a little bit about the first quarter in terms of the outlook? You guys always say the strong December quarter, but how should we think about the guidance being down a couple percent relative to last year it was up 3%? Could you give us some framework in terms of timing of the New Year may be the best way to think about that. Thank you.

Robin Li

As Haoyu mentioned in his prepared remarks, this year for Q1 the revenue was not only affected by Chinese New Year but also by the severe snow storms across a large portion of the country. At this time, we just passed the Chinese New Year holiday; it is difficult for us to give an accurate projection of our Q1 revenue.

At this point, based on what has already happened in January and in the first part of February, our current projection is that revenue will be in that kind of range.

Gene Munster - Piper Jaffray

The revenue per user was up nicely in the quarter. What was driving that sequential increase?

Robin Li

The revenue per customer is basically decided by the traffic we have or inventory we have, as more and more users come to Baidu to do their search, we will have more opportunity to monetize that traffic and we also continue to improve the monetization upward so that advertisers have more flexibility in spending. We do believe that there is still lots of potential in the monetization algorithm, we can have more ways to deliver more relevant ads in front of the targeted consumers.

As long as our traffic continues to grow and we continue to optimize our monetization algorithm, I think the revenue per customer will continue to grow.

Gene Munster - Piper Jaffray

So we should think of that as it should be increasing in the March quarter.

Robin Li

If you look at the March quarter during the previous year, because of the Chinese New Year, traffic usually goes down quite dramatically during the holiday season, so we cannot really say revenue per customer will grow sequentially; but year over year that is certainly true.

Operator

Your next question comes from Jason Brueschke - Citi Investment Research.

Jason Brueschke - Citi Investment Research

First of all, Robin, allow us here at Citigroup to convey our heartfelt condolences to you and Baidu on the passing of Shawn Wang. He was a great person that we enjoyed working with and a great CFO and he will be sorely missed.

Robin Li

Xie xie.

Jason Brueschke - Citi Investment Research

Turning to a couple of the business items, I had two questions. First of all, can you tell us how much revenue you are going to expect to generate in Japan in 2008, please?

Robin Li

We currently do not have plans to monetize on our Japanese traffic. So for year 2008 we would expect zero revenue from Baidu.jp.

Jason Brueschke - Citi Investment Research

A housekeeping question. Can you tell us how much CapEx you ended up spending in 2007 on Japan? I know at the beginning of the year you indicated 15 million, and I am not sure if you ended up spending that amount by the time we got to the end of the year.

Haoyu Shen

The 15 million in guidance we gave at the beginning of 2007 was impact on P&L, so at the end of year, as I mentioned in the prepared remarks, we spent RMB 73 million in aggregate. That is slightly over $10 million U.S. As far as CapEx for Japan, we don’t give detailed numbers but it is probably over $10 million U.S. CapEx spend for Japan.

Jason Brueschke - Citi Investment Research

Regarding the C2C initiative, can you give us a little bit more of an update on your strategy, having had another quarter to look at it? The two things I am most interested in are:

Are you still planning on building your own platform or have you considered going to try to buy or license somebody else’s platform?

Could you give us an indication of how much spend and the impact on the P&L that you expect from this initiative in 2008?

Thanks.

Robin Li

We are going to build our own C2C platform. The product or the service will launch sometime this year. We do not expect any revenue for the current year.

Jason Brueschke - Citi Investment Research

How much is the spend we should be modeling for this?

Robin Li

The spending will be significantly lower than what we spend in Japan so at this time we do not plan to announce a number on the spending.

Operator

Your next question comes from Dick Wei – JP Morgan.

Dick Wei – JP Morgan

Good morning, Robin, Haoyu and Linda. On the first quarter guidance, is it possible to give more color on the guidance? Your guidance for ’08 is actually worse than ’07. Do you expect it to be a similar trend for the month of March as well compared to last quarter? I remember last year March revenue was about 50% of your total quarterly revenue. Do you expect to see a similar trend as well for this quarter? Is it coming more from the customer adds or is it going to come from the average spend per customer?

Robin Li

Dick, I think every year is a little bit different. The Chinese New Year happens in Q1 for every year, there is the timing of Chinese New Year that is a little bit different from year to year. Last year the Chinese New Year was quite late in February so the revenue for February was quite low. That takes the Q1 revenue for last year and also resulted in March representing 50% of Q1’s revenue.

This year, although the timing of the Chinese New Year is kind of normal, it is in early February, the snow storms which were unexpected to us, happened a couple of weeks before the Chinese New Year so our revenue was affected even in January. But the dip in February would not be as large as it was last year. So March, according to our current projections, would not be as large as last year too.

So combining all of these factors as well as a larger revenue base, we are comfortable to give the guidance that Haoyu talked about in his prepared remarks.

Dick Wei – JP Morgan

Can you comment on the snow storm? Is it more impacting your traffic or customer spend, or the new customers that you are able to sign up? Have more customers stopped their search campaign during the period?

Robin Li

I think it impacted as many of the people were stuck on the road when they tried to go back home for the Chinese New Year holiday so traffic was negatively affected. Customer spend was also slightly affected because if they run out of money, they don’t have the chance to renew it before the Chinese New Year holiday. New customers were certainly affected because our sales people were not able to contact potential customers during that period.

Operator

Your next question comes from Robert Peck - Bear Stearns.

Robert Peck - Bear Stearns

Could you comment about Google’s plans in the market and the idea of them offering free search or free downloadable MP3s and how you think that could impact Baidu going forward?

Robin Li

We have been in this market, [23Search] for music related file search for a long time. I think we have a very good understanding of the customer needs or user needs for additional music. We firmly believe in advertising supported digital music. We think that the Internet is a new form of media that can help record companies to promote their artists and songs. We have been working with many record companies and they are happy about the results we are offering.

As a search engine, we try to provide as much information as possible that is publicly online, so we do believe in an open system that allows all of the record companies, all of the artists all kinds of files to be found on our search platform.

Operator

Your next question comes from Eric Winn – Bear Stearns.

Eric Winn – Bear Stearns

Can you outline how Baidu plans to increase traffic of Baidu Japan?

Robin Li

Frankly I think that question is still an open question for us. We employed a number of local people, local Japanese people who helped us to study the market and come up with ways to attract Japanese consumers. We are very happy about the progress so far, as I mentioned. Our traffic for Baidu.jp quadrupled the day after our public launch, even though the service was publicly available for the past 10 or 11 months. The public announcement really helped Baidu become known to more and more Japanese users.

At the end of the day, I think the search business products and services speak for themselves. As long as we can provide high quality search services that satisfy Japanese users needs, I would not worry about the traffic growth. Our main focus will be on delivering the best search quality and search services to the Japanese consumers.

Eric Winn – Bear Stearns

Robin, you talk about your bundling strategy for your branded ads. Could you give us some examples of how you bundle your branded ads with your search ads? Particularly, what is the pricing for the display ad at this point, if you can disclose?

Haoyu Shen

What we are seeing in the recent quarter is advertiser spending on Baidu has been increasing because we have the advantage of being able to offer bundled products including search, display ads and behavioral-targeted ads as well, either in text format or display format.

I think the reason they enjoy the bundled products is they can really integrate all of these different forms and different advertisements for their different campaigns, and also it is a great way for them – especially search – is a great way for them to integrate with even their offline campaigns.

So be it multinationals or domestic, brand advertisers are increasingly realizing the synergy between search and other forms of online and offline campaigns.

As far as pricing for display ads, we do look at what our competitors do and look at the advantage we have, look at the page views we have and we believe our pricing of display ads is very competitive in terms of ROI that can be achieved by advertisers.

Operator

Your next question comes from Wallace Cheung – Credit Suisse.

Wallace Cheung – Credit Suisse

On the online brand advertising, what is the percentage of revenue in the fourth quarter coming from this business?

Also, a product question on the first quarter guidance. As brand ads have a typical slow season in the first quarter, does this have any implication on the first quarter guidance and they have a lower revenue guidance that you have given out? Thank you.

Robin Li

I think sometimes it is very difficult to separate brand ads from performance-based ads. Even for search-related traffic, for example, Brand Link, our new product launched last quarter, search or any brand ads, our customers come to us for a number of needs. We try to come up with proposals that will satisfy all of them. It is very hard for us to separate brand ads from performance-based ads.

At this time, the trend we are seeing is that more and more larger companies, multinational companies or national companies, domestic companies, they increasingly realize that our platform , especially a search-centric platform can help them to not only deliver performance but also help on their brand advertising campaigns.

Haoyu Shen

If I can just add, because you did ask what the percentage is of revenues from brand advertisers, comparing with our revenue from SME, it is still a small portion of our revenue but we do see a lot of good traction from these advertisers.

Operator

Your next question comes from Richard Ji – Morgan Stanley.

Richard Ji – Morgan Stanley

You have been actively recruiting a direct salesforce over the past year. Can you help us better understand your future expansion plans?

A related question about Baidu Union which has been a significant traffic driver for your company. Can you help us also understand your current thinking, especially given your archrival Google has been aggressively pursuing a like alliance with some leading websites such as Sina? Thank you.

Robin Li

I will talk about the joint sales force and Haoyu will take the Union question. As we mentioned in the prepared remarks, we already have direct salesforces in all the tier 1 cities in China, namely Beijing, Shanghai, Guangzhou Shenzhen and a couple other smaller cities. At this time we do not have plans to convert other regions from channel to direct.

I think the efficiency for direct sales in all of the regions we currently have presence still have lots of room to improve and we already have a very sizeable direct salesforce in these areas and we will continue to work on improving the efficiency of the sales team and we will also continue to support our channels in other regions. The growth potential for them is still huge and managing the channel system better is also a priority for our company.

Haoyu Shen

To the question on Baidu Union, Baidu Union is, according to a piece of research put out by iResearch last year, we are the leading Internet ad network in China. I think we command over 35% of market share, well ahead of our competitor. We have seen very healthy growth in Union traffic in the past few quarters, and we are constantly on the look out for identifying great partners to work with; to give us traffic, to provide great content.

Also as some of you may know, we launched a new product called Baidu TV which is one format of ad we put on the Union content sites and that is indicative of our continuous efforts of exploring new monetization formats for our Union members.

So with our continuous effort we are confident that we will continue to be the leading Internet ad network in China.

Robin Li

Richard, if you look at TAC as a percentage of revenue it has been increasing which represents the increasing importance of revenue contribution from Baidu Union. That says something about the strength of our Union system; we believe we have a very competitive incentive system for the Union members and going forward, it should have a lot of potential too.

Operator

Your next question comes from Ming Zhao – SIG.

Ming Zhao - SIG

A question on the Tianjin distributor; is this at the end of November that the Tianjin distributor was acquired and consolidated in to your numbers? Also the revenue from the Tianjin distributor, can we think about that as comparable to Guangzhou?

Robin Li

We do not disclose the revenue scale for individual cities or regions. What we can say is that the Tianjin distributor was a very important distributor in our channel system and converting them into direct has been an important task for us. We have been preparing for this for some time and even though the transaction has closed, I would say it is going to take us a couple more quarters for the direct sales team in Tianjin to get really up to speed and release the power of customer acquisition and customer service.

Ming Zhao - SIG

On the branded advertising, when we look at the balance sheet, especially the accounts receivable line, is this mainly the big advertisers? Assuming that the small and medium-size companies, when they do the search marketing they will pay upfront?

Robin Li

That’s right. The accounts receivable on the balance sheet is mostly for these brand advertisers.

Operator

Your next question comes from Steve Weinstein - Pacific Crest.

Steve Weinstein - Pacific Crest

Just looking at the growth in TAC, it does continue to grow at a rate much faster than revenue and is becoming a more meaningful part of your cost structure. I was hoping you could give us a little more insight into what is happening there. You’ve already called out growth in terms of Baidu Union, but I am wondering, is there any TAC expense associated with revenue? Not from the Union, but from the Baidu proprietary traffic such as toolbar distribution being loaded on a PC, et cetera.

I think the last time you disclosed the percentage you were paying to the Union members was around the time of the IPO. Has there been any movement, or how much movement has there been, since that time in the percentage that you are sharing with the members?

Robin Li

The question on TAC, as you can see on the P&L, TAC as a component of total revenue has been on an upward trend in the past few quarters. It is really largely a reflection of the fast growth of revenue from Union members.

On the other hand, especially when we look at strategic deals, when we look at strategic partners that we want to work with to recruit them to become our Union members we don’t have a strict payout rate that we have to stick. On the video deals we do look at revenue net of TAC from that perspective. I think a slow upward trend for TAC is really a combination of two factors.

I didn’t quite get the second question.

Steve Weinstein - Pacific Crest

Is there any TAC associated to drive any of the Baidu direct traffic, like toolbar distribution or anything like that.

Robin Li

Yes there are. If we strike a deal with some of the distributors to distribute the toolbar or otherwise search boxes for Baidu, that is considered as Union traffic not organic traffic, even though it shows the Baidu URL that is Union revenue and Union traffic.

Operator

Your next question comes from James Mitchell - Goldman Sachs.

James Mitchell - Goldman Sachs

You had a big reinvestment tax rebate in the quarter. Looking forward, as long as your CapEx remains at high levels, should we expect you to continue getting reinvestment tax rebates and continuing to enjoy very low or negative effective tax rate? Thank you.

Robin Li

The RMB 21 million tax refund we got in Q4 is really a one-time event so going forward, if you exclude that one-time refund I think when you look at the effective tax rate for 2007 it is about 1.3% and as we mentioned in previous conference calls, we have different entities in China. Some of the tax holidays they have been enjoying are going to expire so going forward for 2008 I think we were probably looking at a single-digit tax rate.

Because China’s tax system is undergoing reform in 2008 and the detailed implementation guideline has not been published yet there is some uncertainty to it, but I think it is safe to assume that the tax rate in 2008 will be in single digits.

Operator

Your next question comes from George Chu – UBS.

George Chu - UBS

Could you help us to think about how much you will be spending in your Japan operation for 2008?

Robin Li

For 2008 we expect to spend anywhere between $20 million and $25 million, that is the P&L impact.

Operator

Your next question comes from Eddie Long – Merrill Lynch.

Eddie Long – Merrill Lynch

Could you comment on the litigation risk with your MP3 share and how would that affect your plans to become the hub for music-related services? For example, will you change your promotion and marketing messages, et cetera?

Haoyu Shen

I think you are referring to a lawsuit that was brought by EMI. Again, we read about it in the press as well. Up to yesterday we didn’t get any notification from any authority so we really can’t comment on that.

As Robin mentioned earlier, we believe in an advertising-supported digital music business model and we have already been working with EMI and some other music labels and those are just examples of this. We believe that will continue to play an important role in the digital music industry in China.

Operator

Your next question comes from Robert Peck - Bear Stearns.

Robert Peck - Bear Stearns

Robin, can you give us any sort of feel; there are concerns out there of a global consumer recession going on, or potentially going to occur. Could you give us your thoughts and your feel on the insular capabilities of Baidu and an impact that analysts should be baking in for any potential recession in 2008?

Robin Li

I am not an economist, so it is very hard for me to predict if there is going to be a recession. Having said that, I think the potential for the Internet industry in China and search in particular is so huge it really largely depends on our execution, our improvement in the search quality, our improvement in the monetization algorithm and our efforts to educate companies, enterprises to better understand the benefit of paid search.

In my mind, if a company even has $1 to spend on marketing, they should spend the $1 on the Baidu platform. So in that sense, I don’t think any kind of economic downturn – unless it is very, very severe – would have a material impact on our revenue growth.

Operator

Your next question comes from Richard Chow – Alliance Bernstein.

Richard Chow – Alliance Bernstein

Congratulations on the results. I have a question regarding the C2C platform. Can you tell us when you expect a more formal plan being laid out regarding your own built-up platform? Also, when are we going to see the monetization of the revenue model? Thanks.

Robin Li

The reason we decided to launch our C2C product is because we realized that a lot of Baidu users search for product in our main search box. We are really trying to satisfy our user needs better by providing an online auction platform to help benefit the ecommerce infrastructure and educate Chinese users to use ecommerce-related services more.

We currently do not have any new plans to monetize that kind of service. We are just trying to satisfy the information needs for our existing users.

Operator

Your next question comes from Stephen Ju - RBC Capital Markets.

Stephen Ju - RBC Capital Markets

What is your CapEx outlook for 2008 and what is the headcount as of the end of the year?

Haoyu Shen

The headcount at the end of the year is just above 6,000. As far as a CapEx for 2008, we don’t give guidance on the CapEx on an annual basis, but I think we will as we continue to invest for the future, I think CapEx still will be significant in 2008.

Another thing that shouldn’t be missed is CapEx on Baidu Campus. The campus construction is well in progress, the construction will end in the early part of 2009. So between now and the early part of 2009 I think there will be around $50 million to $60 million CapEx spent on Baidu Campus.

Operator

Your next question comes from James Lee – Stern Agee Capital Markets.

James Lee – Stern Agee Capital Markets

Good morning, Robin. Can you talk about the competitive dynamic in your tier-2 markets a little bit, given the fact that you have cemented your market position in tier-1 markets. I am curious what kind of competitive activities are you seeing from Google and Yahoo!? Thanks.

Robin Li

I need to talk about it from two aspects. The first is on the user aspect. I think in the tier-2 cities Baidu enjoys even a higher traffic share for our search services because we are local, we do have features and products that really tailor to the needs of the local users.

On the customer or advertiser side, we have been building a channel system or a distribution system since the year 2002 and this system has been I think the strongest in the Internet space in China. We are so far ahead of any competition in this front.

Operator

Your next question comes from Ming Zhao – SIG.

Ming Zhao - SIG

Very small, the RMB 1 million other revenue in your top line. Can we understand what that is? Also there is a RMB 12 million other income below the operating income line. That is up from the RMB 4 million in the prior quarter. Can you talk a little bit about that? Thanks.

Robin Li

If I understand you correctly, Ming, under other income there is RMB 12 million interest income and there is another RMB 13 million other income and the bulk of that is a tax related subsidy from the government, and also a one-time event.

Operator

Your next question comes from Dick Wei – JP Morgan.

Dick Wei – JP Morgan

Can you give out the headcount breakdown? Also, if you can break out the CapEx for the fourth quarter, how much was spent in servers versus on the campus?

Haoyu Shen

Dick, we don’t give detailed breakdown of headcount but as I said, at the end of the year the total headcount is slightly over 6,000 and what I can say is over 4,000 is in sales and marketing.

As far as CapEx in Q4, the total CapEx in Q4 is RMB 166 million; over one-third of that was for Baidu Campus.

Dick Wei – JP Morgan

So if I looked at [inaudible] is for the campus?

Haoyu Shen

Well the total is RMB 166 million and more than one-third of RMB 166 million is for Baidu Campus.

Operator

Your next question comes from Wallace Cheung – Credit Suisse.

Wallace Cheung – Credit Suisse

On the share-based compensation, it tends to go up a lot in the fourth quarter. Is it going to have much higher growth in the next few quarters?

Haoyu Shen

The SBC in Q4 is slightly higher, and that is really a function of the grants we are giving in Q4 and that is really a function of our hiring of senior positions, so it does fluctuate from quarter to quarter. But I don’t expect it to continue to go up.

Operator

Your next question comes from Eleanor Long – [Elsa].

Eleanor Long – [Elsa]

You mentioned Baidu considering a Hong Kong listing before. Are you still considering that option?

Robin Li

We are always open to all kinds of listing options, if that can serve our shareholders better. At this time, the plan is very preliminary. We need to find a way to prove that this would be beneficial to the existing shareholders, employees and customers.

Eleanor Long – [Elsa]

Does that mean it is unlikely to happen this year?

Robin Li

Right, I think it is unlikely for this year.

Operator

Your next question comes from [Tsei Chen] – Shaw Capital Markets.

Tsei Chen – Shaw Capital Markets

Regarding the Microsoft/Yahoo! acquisition, have you prepared for how this acquisition is going to affect you?

Robin Li

As you may know, these two players do not have significant market share in terms of Chinese search and the deal will probably take quite some time to complete, if it ever completes. It is very hard for us to speculate on the impact on Baidu.

Operator

Your next question comes from Kar Kwong – Needham & Co.

Kar Kwong – Needham & Co.

During this last quarter you had a pretty nice reacceleration in the year-over-year change in customers; it went from 40% in Q3 to 44% this quarter. I was wondering, to what extent is that being driven by an increased percentage of repeat customers?

If you could also comment to what extent the faster pace of growth in the large advertisers compared to the SMEs is driving the ARPU growth that we are seeing?

Robin Li

I think the number of active online customers is really a reflection of our execution capability of the sales teams. The potential for this market is huge. They are more than 10 million or 20 million enterprise in China, and every company, every enterprise can take advantage of our paid search platform. It is just a matter of market maturity and how we execute in terms of customer acquisition.

I think the numbers in Q4 really is a reflection of our execution in the salesforce. ARPU, large customers generally spend more on our system so that certainly helps in increasing ARPU.

Kar Kwong – Needham & Co.

Do you think you could disclose the percentage of your customers that are repeating that have spent with you in the past?

Robin Li

It is really hard to define what a repeating customer is. We are basically offering this like a service. People, in theory, should just keep putting money in the system but sometimes they would decide to stop for a while and come back later. They may stop for a week, they may stop for a month, they may stop for a year.

It is really difficult to define what a repeating customer is.

Kar Kwong – Needham & Co.

For example, a customer that has spent with you –

Robin Li

I think overall the customer loyalty is very high and the performance we are delivering is very good for all of the customers. They are very satisfied.

Kar Kwong – Needham & Co.

How about the mix between large advertisers and SMEs?

Robin Li

As I mentioned before, we see increasingly higher interest from the larger companies. But SMEs are still a major part of our revenue contribution and like I mentioned, the potential is still very, very large and we don’t really see any limit in new customers or customer spending. It is really about marketing maturity and execution.

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

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

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Source: Baidu.com Q4 2007 Earnings Call Transcript
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