Call Start: 20:01
Call End: 21:04
Baidu, Inc. (NASDAQ:BIDU)
Q3 2012 Earnings Call
October 29, 2012 8:00 p.m. EDT
Victor Tseng – IR Director
Robin Li – CEO
Jennifer Li – CFO
Dick Wei – J.P. Morgan
Eddie Leung – Bank of America Merrill Lynch
Alicia Yap – Barclays Capital
Jiong Shao – Macquarie Research
Jin Yu – CICC
Alex Yao – Deutsche Bank
Wendy Huang – CIMB
Andy Yeung – Oppenheimer
Gene Munster – Piper Jaffray
Philip Wan – Morgan Stanley
Cynthia Meng – Jefferies & Co.
George Askew – Stifel Nicolaus
Piyush Mubayi – Goldman Sachs
Chi Tsang – HSBC
Muzhi Li – Citigroup
Hello and thank you for standing by for Baidu's third quarter 2012 earnings conference call.
[Operator Instructions]. 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, Victor Tseng, Baidu's Investor Relations Director.
Hello, everyone, and welcome to Baidu's third quarter 2012 earnings conference call. Baidu's earnings release was distributed earlier today and you can find a copy on our website as well as on newswire services. Today you will hear from Robin Li, Baidu's Chief Executive Officer, and Jennifer Li, Baidu's Chief Financial Officer. After their prepared remarks, Robin and Jennifer will answer your questions.
Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in our public filings with the SEC, including our Annual Report on Form 20-F. Baidu does not undertake any obligation to update any forward-looking statement, except as required under applicable law.
Our earnings press release in this call includes discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited mostly directly comparable GAAP measures and is available on our IR website at ir.baidu.com.
As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on Baidu's IR website.
I will now turn the call over to Baidu's CEO, Robin Li.
Hello, everyone, and thanks for joining today's call. This was another solid quarter for Baidu. We posted revenue in line with guidance despite evolving industry dynamics. Our focus on integrating our services to provide a seamless experience for users and to deliver unparalleled ROI for our customers continues to prove very successful. And as mobile traffic continues to [take off], we are investing aggressively to cement our leadership with users. We're also working hard to close the mobile monetization gap, although this will inevitably involve a period of transition.
As you know, we hosted our Annual Baidu World Conference in September where we shared a clear vision for our future in mobile and cloud. I'll say more on this later on the call.
First, turning to our performance for the quarter, we achieved a record net customer add of 38,000 quarter on quarter, and that's a 28% customer growth year on year. As we continue to help SMEs in second and third-tier cities leverage the Baidu platform for their marketing needs. This was due largely to improvements to efficiency of our sales teams. Much work remains to be done on this front and we've just begun to realize the potential here.
More traditional advertisers are also -- came onboard from sectors like food and beverage, cosmetics and retail in this quarter. These customers are still new to the online space and we are well-positioned to benefit as they move budget to online marketing. We continue to see strong contributions from the travel vertical where spending on Baidu has outpaced industry growth. We are well-placed to capture future opportunities in this important sector.
Lastly, there is tremendous room to improve monetization technologies and tools to create efficiencies for our customers. This will continue to be a focal point and we expect to continue seeing gradual contributions on this front. As you know, success ultimately rests on user experience and that's the reason we work so hard to integrate reach rather than content with web search. And this doesn’t just mean Baidu content. It includes all other vertical partnerships, third-party apps, content, website and sponsored links. This is what box computing is about, and on desktop and on mobile platforms, we are delivering this experience on about 80% of our searches.
What's even more impressive is that over 50% of these box computing results involve integrated Baidu products, our vertical products like Post Bar, Baidu Knows, Baidu Encyclopedia, Baidu Maps, Baidu Image Search and Video Search, travel site Qunar, and video site iQiyi are all leaders in their respective fields and are improving all the time. By more closely integrating them with web search, we are taking the user experience to the next level.
We've also integrated hundreds of thousands of apps as well on our platform. This means the Baidu search box can now apply semantic intelligence to return relevant app search results. For example, if a user searches for an accounting app to keep track of her finances, she will be served with a variety of relevant apps right on the search result page. This is the kind of seamless experience PC and mobile users demand and will continuously improve our ecosystem growth.
We truly believe that whoever offers users the best experience will win in the long term. And with our deep experience and understanding of China's internet, we are confident that we can do this better than anyone else.
I also want to emphasize the progress we've made with iQiyi, which is a key strategic vertical for us. China's online video industry is growing rapidly. Monthly user time spent increased by over 100% year on year in August, which is an incredible number. During this crucial period of growth, we are pleased that iQiyi has established itself firmly as a premier player in the market. It has reach and diverse content that's driving brand recognition and greater high-quality content. It's now number one in China in terms of time spent per user and number two in terms of total monthly time spent, according to iResearch. Monthly unique visitors reached 407 million in Q3 compared to 250 million last quarter, due to increasing brand awareness and seasonal factors. And mobile traffic now accounts for about 20% of the overall traffic.
We believe in the mobile future, and that future is arriving fast. And Baidu is in a great position to meet the challenges and exploit the opportunities brought by this PC to mobile evolution. To give you a sense of this, mobile search traffic was up 110% from Q3 last year and 25% from the previous quarter. And based on our internal tracking, we continue to enjoy an ever-stronger position in the mobile search market. Following this trend, we have seen some good progress on our mobile monetization even though this may be coming off a low base.
While we are encouraged by this growth, it is still going to take customers time to catch up with the shift to mobile, as we've seen in more developed mobile markets. Enhancing efficiencies on the mobile monetization platform, educating and encouraging customers to adopt this channel, and developing mobile-ready websites are just some of the tasks ahead.
I would like to remind everyone that this is not the first time Baidu has navigated a complicated transition. About four years ago when we realized the ever-larger internet search volume and customer number required a more sophisticated monetization system, we started something called Phoenix Nest. Educating customers was of paramount importance. We needed to encourage them to leverage the new SEM tools offered by Phoenix and we had to demonstrate the system's clear benefits.
After much careful planning and extensive customer outreach, we made the decision to fully roll out Phoenix Nest to our customers in late 2009. The transition's rapid success proved our execution capabilities. The large majority of our hundreds of thousands of customers transitioned to this new monetization platform smoothly and efficiently. And today the Phoenix Nest system serves as the sturdy foundation for our business.
The PC to mobile shift is in some ways similar and creates new opportunities for us. This shift will also require a period of retooling and customer education as we show them how to take full advantage of the mobile internet opportunity. We are fully committed to pushing this transition forward and confident that our efforts in mobile monetization will pay off in the long run.
Let me update you on our mobile and cloud products. Staying ahead of industry developments, creating a seamless mobile internet experience and growing mobile users and usage are key priorities. Our progress on this front is reflected in the strong market position of both our mobile search and LBS products like Maps.
At this year's Baidu World Conference, we announced that we will now open up our sophisticated cloud infrastructure to third-party app developers. We officially rolled out powerful new tools and resources for developers, what we call our Seven Weapons. These are designed to enable developers to build, distribute, manage, store and optimize their apps on the Baidu cloud platform. Already, over 100,000 developers have registered on the Baidu platform. And as more come onboard, the value of Baid cloud to users will increase exponentially.
In mid-September, we launched Version 4.0 of our Mobile Maps app, which further integrates our industry-leading LBS functionality. This involves our free proprietary online voice navigation service and real-time information for users on the go. That includes real-time bus arrival times.
We are particularly excited by the new indoor navigation functionality. We realize it isn't enough to simply tell users how to get to the mall or the theater. This function means they can find their way to the exact shop or the exact ticket office they need to get to. And Baidu LBS now covers restaurants, movie theaters, karaoke house, malls, hotels, public transportation, supermarket, parks and all kind of services. So the commercial potential here is huge.
Related statistics from Analysis International ranked Baidu Mobile Maps number one in daily active user accounts, and we are building on this position all the time. As you know, we announced a few days ago that we established an LBS business unit which will cover all map and previous local-related products. This is an indication of how important LBS is strategically for us. Total user numbers are increasing exponentially, at nine times year on year this quarter. The new division will be focused on accelerating the expansion of our LBS services to build on the strong base we have already. So there's a lot more to come here.
And as part of our mobile ecosystem, we also launched a new improved mobile browser this quarter. Our aim here was to produce a highly compatible, versatile interface for users to enjoy all the rich services that Baidu and Baidu's developing ecosystem can provide. The browser features the fastest HTML 5 engine on the market today. It's gaining good traction and have seen over 10 million activations in the first few weeks since its launch.
To conclude, the transition in search to a more mobile-centric model is well underway in China. And while we are naturally very excited by this new opportunity, we also understand well the challenges that any evolution of this scale inevitably brings. I want to emphasize that there will be a transition period lasting a couple of years before the mobile monetization gap will close. But I also want to make it clear that there is much Baidu is already doing to close the gap. We are educating customers about the new possibilities afforded by mobile marketing. We are optimizing monetization for mobile. And perhaps most importantly, we are building a compelling mobile ecosystem around Baidu core products like mobile search, maps and LBS, and around Baidu's unrivaled cloud capabilities.
The reward that mobile stands to bring are huge, and with superior strategy and size, we are focused, confident and ready to win the future.
With that, I'll now turn the call over to Jennifer to go through the financials.
Thank you, Robin. Hello, everyone.
We posted another solid quarter, with good top and bottom-line growth. As Robin laid out in his prepared remarks, this is a transitional time for the industry and the internet in China. To make sure we're capturing the tremendous market opportunities we see ahead, we'll continue to increase the pace of investment in our key businesses and products, key personnel, key [peddlers], and core infrastructure facilities. Prudent M&A will continue to complement organic investment, particularly in mobile and cloud technology and vertical content.
Now I'd like to go through our financial results for the quarter's review. All amounts are in RMB unless otherwise noted.
For the third quarter, total revenues were RMB6.3 billion, representing a 49.7% increase year on year. During the third quarter, Baidu had approximately 390,000 active online marketing customers, a 28% increase from the corresponding period in 2011 and an 11% increase from the previous quarter. Revenue per online marketing customer for the third quarter was approximately RMB16,000, a 17% increase from the corresponding period in 2011 and an increase of 3% from the previous quarter.
Traffic acquisition cost as a component of cost of revenue in Q3 was RMB538 million or 8.6% of total revenues, compared to 8% in the corresponding period in 2011 and 8.3% in the previous quarter. The increase was mainly driven by increased promotion of Baidu's products and services such as contractual apps and Hao123 to our network.
As previously stated, Baidu Union is an important network for us. We have greatly improved the quality of the network in the past two years. We managed a dynamic relationship with our partners, and we will leverage it to drive our own products, current and new.
As indicated before, we expect tax as a percent of revenue to trend upwards in the coming quarters as a result. Bandwidth and depreciation costs as a percent of revenue in Q3 were 4.3% and 4.5% respectively, compared to 4% and 4.2% in the corresponding period of 2011. This increase was mainly due to an increase in network infrastructure capacity.
SG&A expense in Q3 were RMB643 million, an increase of 40% year on year, primarily due to an increase in marketing and promotion-related expense and people-related expenses. For the coming quarter, we have a lot of exciting new products and features that we'll look to promote. R&D expenses in Q3 were RMB615 million, an increase of 61% over the corresponding period in 2011, primarily due to increased headcount, reflecting our continued strategic investment in R&D talent.
Share-based compensation expenses which were allocated to related operating costs and expense line items increased in aggregate to RMB57 million in the third quarter from RMB39 million in the corresponding period in 2011. Share-based compensation is an important component of our overall compensation and incentive structure. We plan to put more emphasis of this to attract and incentivize key talent.
Operating profit for Q3 was RMB3.3b, an increase of 48% over Q3 2011. Total headcount as of September 30, 2012 was about 18,660, roughly 1,300 more than the previous quarter.
Income tax expense was RMB468 million for the third quarter. The effective tax rate for the third quarter was 13.5% compared to 14.5% in Q3 2011. Net income attributable to Baidu for Q3 was RMB3 billion, a 60% increase from the corresponding period in 2011. Basic and diluted earnings attributable to Baidu per ADS for the third quarter of 2012 amounted to RMB8.60 and RMB8.59 respectively. Net income attributable to Baidu excluding share-based compensation expenses, a non-GAAP measure, for Q3, was RMB3.1 billion, a 60% increase year on year. Basic and diluted earnings attributable to Baidu per ADS excluding share-based compensation expenses, both non-GAAP measures, were RMB8.76 and RMB8.76 respectively.
As of September 30, 2012, the company had cash, cash equivalents and short-term investments or RMB21.3 billion. Net operating cash inflow for the third quarter of 2012 was RMB3.8 billion. Capital expenditures for the third quarter of 2012 were RMB504 million.
Now let me provide you with the top-line guidance for the quarter -- for the fourth quarter of 2012. We currently expect total revenues for the fourth quarter of 2012 to be between RMB6.155 billion and RMB6.345 billion, which would represent a 37.6% to 41.8% year-on-year increase. I do wish to emphasize that this forecast reflects Baidu's current and preliminary view which is subject to change.
I will now open the call to questions. Operator, please go ahead.
The question-and-answer session of this conference call will start in a moment. In order to be fair to all callers who wish to ask questions, we will take one question at a time from each caller. If you have more than one question, please request to join the question queue again after your first question has been addressed.
Your first question comes from the line of Dick Wei of J.P. Morgan. Please ask your question.
Dick Wei – J.P. Morgan
Hi, good morning. Thank you for taking my questions. I believe a couple of dynamics play out in the second half of the year, including macro slowdown in China, some change in the competitive landscape, maybe mobile traffic changes, as well as increase of SME customer number. I wonder if management can comment how this factor impacted the Q3 results and what are you factoring in for the Q4 guidance as well. Thank you.
Hi, Dick. Good morning to you. As we have laid out the main drivers for the business, we had a very solid quarter in Q3, we had record net add in terms of number of customers, and we continue to make good progress with traditional advertisers on the large account basis. The overall market macro situation obviously, if we compare that to last year, is softer, not as strong as last year. And I think we continue to have very solid financial performance in this environment.
We did put much emphasis in our prepared remarks to talk about the opportunities that lay ahead that the transition affords us between PC to mobile. And I think there is tremendous opportunities that's laying ahead and there is much work, great progress that has been made by us. The opportunities is huge and we are excited about that, we stand ready to [attend to] the market, to help our customers and to take up financial rewards from the new universe that mobile brings to us.
So if we look at, you know, comparatively to last year, the macro environment isn't as healthy, but I think from an execution standpoint, the team continues to demonstrate that we can really deliver on continue to develop the market, and it also shows the market potential is huge. The industry is going through a transition, mobile traffic is going up very fast, and I think we're all very excited about the new opportunities. So these are the factors that played into the Q3/Q4 numbers.
Back to your comments on the competitive landscape, no new entrants really had a material impact to us in Q3 or in our Q4 forecast.
Your next question comes from the line of Eddie Leung of Merrill Lynch. Please ask your question.
Eddie Leung – Bank of America Merrill Lynch
Good morning. I have two questions. The first one is, we have seen -- it seems like there has been a deterioration in the deferred revenue and customer deposits growth. So, could you comment on those front?
And the second, you also mentioned that you haven't seen any material impact from new entrants on your financial results in the third quarter as far as your fourth quarter guidance. How about on the traffic side? Have we seen any impact on the traffic side? Thank you very much.
Eddie, deferred revenue and customer deposits, I think you're right in looking at some of these metrics as, you know, if there's any trend. I think the majority, you know, of our business is from the SME business. And the SME business, they pay an upfront deposit. I think on this Q3, if you look at our balance sheet, the customer deposit continued to post a sequential very handsome increase. The deferred revenue is more a timing issue. It has something to with part of our large account business depends on the tests such as, you know, if the contract has been circulated back and we have all the proper paperwork in place, there is a little bit of timing difference. But deferred revenue itself is not really an indication of future business.
When we talk about the financial impacts and traffic impacts, I feel -- I think, you know, if you guys have followed Baidu all along, throughout our history, we've had multiple entrants, multiple, you know, we're always very familiar with competition. And what we believe is the player that ultimately serves the highest quality of search results to the users, that can really address the users' needs will win. And the traffic trend that we're seeing, as we talked about in our prepared remarks, the tremendous opportunities on mobile, and much, if we look at the overall users' needs, they today come from multiple devices, and our ultimate goal is to address the users' needs, their search needs regardless of what kind of end-device it's coming from. So this is the overall trend that we're seeing. Obviously, as I mentioned earlier, mobile is growing very fast and we are excited about that opportunity.
Your next question comes from the line of Alicia Yap of Barclays. Please ask your question.
Alicia Yap – Barclays Capital
Hi, good morning, Robin, Jennifer and Victor. Thanks for taking my questions. My question is regarding mobile. So in your view, what are your strengths or competitive advantage as the traffic moves from PC to mobile? And what do you think is your weakness or the areas that you believe you need improvement as we face the traffic dilution from PC? Thank you.
Yeah. As you know, we have a very dominant position in the desktop web search. We have been building the best-quality search service for the Chinese users for more than 10 years and we have a great brand for search. When users shift from PC to mobile, they naturally would look for the same brand, same quality of search services. So we enjoy a lot of benefits on the mobile front. Having said that, mobile search is different from desktop search in certain ways. That's why we are working very hard to come up with search experiences that better address those unique needs for mobile users.
In terms of challenge, as I mentioned over the previous prepared remarks, there's a shift, so, many of our customers are not really ready for the shift. Their sites are not so mobile-friendly and they are not very used to come up with creatives that uniquely fill the mobile users' needs.
In terms of the starting point, desktop search is the undisputed gateway or starting point for most of the internet users on PC or on desktops. But on mobile, things are evolving very quickly. We have seen users to use their -- use apps, they spend a lot of time in apps but less times in browser. So we offer both browser and an app especially designed for our search product. We also have the best service in terms of LBS, especially Baidu Maps. I also mentioned that has been growing tremendously.
So, going forward on the mobile, there might be multiple starting points like search or maps and we are working hard to prepare for that. And I believe that we will continue to be the center of the internet ecosystem in the mobile age.
Your next question comes from the line of Jiong Shao of Macquarie. Please ask your question.
Jiong Shao – Macquarie Research
Good morning. Thank you very much for taking my questions, and thanks for all the comments on mobile so far. I also want to follow up on mobile as well. Could you remind us, what's the mobile search query, just for search, what the mobile search query as a percentage of the total query? And also, could you please comment on your thoughts on the differences between coverage ratio, click-through rate and keyword price for mobile, let's say, a couple of years out? Thank you.
The mobile traffic as a percentage of total search traffic continues to grow. And like I mentioned, year on year, mobile traffic grew triple digits. So you can get a sense that traffic mix continue to shift. And in terms of monetization, we have done a lot of things and we're trying all kinds of different techniques to help educate our customers.
And the coverage, click-through rate, cost per click all depend on the maturity of the mobile search market or mobile paid search market. So the monetization algorithm will continue to improve user experience, or user interface will continue to improve. But more importantly, our advertisers or customers, they need to come with ways to fully take advantage of that. As I mentioned before, we expect this will take a couple of years to close the gap.
Your next question comes from the line of Jin Yu of CICC. Please ask your question.
Jin Yu – CICC
Good morning, Robin, Jennifer and Victor. Thank you for taking my question. So, first, congrats on the strong results against the [inaudible] market. I have a question, one is for mobile and the other is on verticals. So the first question is on Qunar. So, can you update the company's performance in the first quarter?
The second question is also regarding to mobile, so, currently, there are several debates in the area of mobile operating system. Why is Alibaba [inaudible] was forced out by Google, given the dispute? And the other is, Huawei's management complained that they are not invited by Microsoft to the conference of -- the launch of the Windows 8, for Windows 8. So my question is, any thoughts from the management about the trend? It seems that there will be a kind of pressure that ecosystem based on different operating systems will become more and more closed. And if that, you know, all big three operating systems all become more closer than before, so what kind of strategy that we can take to deal with that kind of challenges? So I will stop here. Thank you.
Jin, good morning. I'll take your first question with regards to performance of Qunar. Qunar continues to perform very well. As we highlight in our own business, the travel vertical outperformed the industry average in this past quarter. So we see strong travel vertical performance on our own platform. And since we consolidate the Qunar overall financial numbers, the Qunar business itself also posted strong Q3 performance. I think both -- that really proves that the travel vertical has great potential, and we're well-positioned to continue to perform well in this vertical.
On the mobile OS question, our belief is that going forward, an operating system on any single device will become less and less important. The power side, the cloud side and the integration, seamless integration between the terminal devices and mobile operating system and the cloud computing power, we believe the system will continue to offer opportunities, at least Linux-based Open Source, is not closed. Android has promised to be open. But if they are not, a single operating system on a single device will become less relevant. So we have the technology to come up with necessary capabilities and we are distributing our computing power and infrastructure on the cloud side and we're trying to fully integrate the client side and cloud side. And going forward, we believe this will become a trend and developers will follow us of this.
Your next question comes from the line of Alex Yao of Deutsche Bank. Please ask your question.
Alex Yao – Deutsche Bank
Hi. Good morning, everyone, and thank you for taking my question. Can you share with us the traffic -- the search traffic growth trend on the PC and the mobile side, and also the paid click growth? Specifically, I remember you guys mention in the first quarter conference call that mobile search represented about 20% of the total traffic. So right now it's still at 20%? They imply the PC traffic growth will be similar to the mobile traffic growth? Thank you.
First, on the traffic growth, as I mentioned, mobile is growing very quickly, triple digits over -- year over year. PC traffic is certainly not as exciting. But overall, consumers do have information needs, be it on desktop or mobile device or even television. Going forward, there'll be multiple screens for consumers and, wherever they are, we just try to meet their information needs. The overall search market will continue to grow; we just need to come up with the right monetization algorithm and educate our customers to take full advantage of this new computing environment and new devices.
And on your question on paid click growth, sequentially the paid click continues to grow and is of course one of the drivers that drove the Q3 results in terms of sequential revenue increase.
Your next question comes from the line of Wendy Huang of CIMB. Please ask your question.
Wendy Huang – CIMB
Thanks for taking my question. My question is on ARPU front. Historically, Q3 actually has been a strong season for the sequential ARPU increase, but this quarter we have been seeing very small ARPU increase. So, is it effect of the dilution with new customer or is it because your pricing power or paid click growth has reached a certain limit? Thank you.
I think, Alicia -- Wendy, as you know, our revenue is driven by the number of customer growth as well as ARPU per account. We did add a lot of new customers this past quarter, and these are customers, a majority of them, are SMEs. And SMEs, as we developed in second third-tier cities, their spending power of these new players are not as strong as the existing or more, bigger players. So that's one of the elements that's driving the ARPU number.
I think one of the reference I would refer to was last year. Last year, ARPU did pose very strong sequential growth. And last year, you'll recall, we had a significant outstanding performance by a large account. And the large account, not only because it was good services and players recognizing the value of our platform to allocate more budgets, we also had hot sectors like e-commerce and group buy, and these people were spending millions with us. So that was the driver for ARPU in the past year. And this year, as you have consistently seen, the SME development has been the theme, and the SMEs' ARPU capabilities, of course, is no comparison to the large accounts.
Wendy Huang – CIMB
So, just to follow up on that, so, looking to the future, will your future focus more on the small customers or big customers?
We continue to have room on both fronts. I think what we have posted in terms of net customer adds, it shows that when you put and emphasize and continue to really try to improve the process, the market potential is there, is really waiting for us to develop. And on the large client business, I think we have highlighted some of the online players, that they really know how to take advantage of search engine marketing. And traditional players, it takes time for us to develop and cultivate.
This year in particular, the macro sentiment is more tight compared to prior year. So we continue to do work on that front, but I think the bigger environment does not really allow the large customers to really grow at a fast pace. But from what we are seeing, the large clients continue to have huge budget opportunities, that it takes us and them to work together to move their budget over.
So in terms of potential, it's there, I think both on the large client and SME businesses. It takes our work to continue to develop the market.
Your next question comes from the line of Andy Yeung of Oppenheimer. Please ask your question.
Andy Yeung – Oppenheimer
Hi, good morning. Thank you for taking my question. First, let me apologize if the audio is not very good because we're having a storm here in New York. My first question is about your current traffic expansion costs and investment levels. I think during the quarter, your cost and as a percent of revenues actually came down a little bit on a sequential basis. But do you think that level of expense are sustainable during the transition period between desktop, mobile and some of the internet search industry competitive landscape change? And how should we model the level of your spending on traffic expansion costs and R&D and sales and marketing going forward?
Right. I think as I said, we posted very solid Q4 financial performance. We continue to enjoy high operating margin, but I have indicated for some time that we are in the investment cycle and we should expect that this high level of operating margin will last forever.
And in terms of investment, I made a clear indication that we're going to accelerate our investment pace. In terms of expense line item, some of the items that you referred to tag. As I said, we manage our dynamic relationship with our partners and we leverage this Union network to promote our products and services. And this may include contractual ads which help us generate incremental revenue; it also help -- we use this network to promote our products such as Hao123, such as new services and products that we want to push out to the Union network.
So, through dynamic changes, we expect that tag rates to increase. I think if you look at the historical trends, historical ranges of the tag, it is dynamic and could move up quite sizably. This past quarter we have seen some marginal tick-up, and as I indicated clearly, we expect the trend to go up in the quarters.
In terms of other line item investments, people, we have consistently invested in our R&D talent, and that has established a pattern and will be continuing to be our focus. I did indicate that SBC is a strong -- is a very valuable item for us to leverage to incentivize our staff, and that's one item that will continue to -- that we can leverage going forward.
The infrastructure has been the theme for us to invest to support our strategic initiatives like cloud and mobile, and we have increased our pace in infrastructure setup, and that momentum will carry. Sales and marketing, if we look at that, we have many exciting new products, particularly on the mobile front to push out, and we'll use these line items to push our new products.
I also indicated that mobile affords much new opportunities and it takes, you know, we’d need speedy executions and we may leverage M&A to complement our organic investment to position us strategically in a timely fashion. So that's basically if you look at the activities going forward, this is kind of the picture I would give you a view as you look forward.
Your next question comes from the line of Gene Munster of Piper Jaffray. Please ask your question.
Gene Munster – Piper Jaffray
Hey, good morning. Jennifer, if you could talk a little bit about the money, the expenses related to new customer adds. You seem to have seen an acceleration in customer adds, some of the marketing dollars remained pretty consistent as a percentage of sales. And so, are you just getting more leverage or is that theme -- do you think that theme is going to continue? I seem to hear a message about you're going to be in investment mode, but maybe you can just talk a little bit about that, specifically the new customer adds. Thank you.
New customers that we really brought onboard in the past quarter are primarily SME and impose the direct sales force as well as the distribution networks, the partners we have, both contributed to the customer growth. And some of the, you know, these, for customers, they come from the second, third-tier cities and they are across the industry sectors. There are some new sectors that are calculated in these different markets, sectors like agriculture even, or local services like restaurants or business services. So these are smaller businesses that can -- may have little marketing budgets to begin with.
What we are doing on the sales team front is, one, to train them to really understand the search engine marketing, on the other hand, to give them better, more user-friendly interface in terms of system so that they can self-service. So while we develop these customers and their budget may be slow, we hope that we will educate them and they can see improved and great ROIs and they can continue to work with us. So I think on the top-line hand, the market opportunities there, the SMEs are out there and we are reaching out to them to develop the market. So I think on those themes, it doesn’t change.
I think one of the features which relates to SME is we did make note that we're seeing tremendous growth in mobile and customers take time to really understand the benefit. And I think this particularly true for SMEs. So their position to take advantage of the mobile front will be timely -- will be time-consuming and will take a lot of efforts from our end. But mobile, it is the future, and so it's -- we have been talking about the opportunities in mobile and the investment that we need to do there. And the investments were very clear what we need to do. We have updated you about the progress we made on the mobile front. And I think over the next some, you know, few quarters, even a number of years, we will be I think positioned to really shape the mobile picture and really educate the customer to bring them onboard to mobile front and they can leverage and take advantage of it. So this is the dynamics that's going on.
Your next question comes from the line of Philip Wan of Morgan Stanley. Please ask your question.
Philip Wan – Morgan Stanley
Hi, good morning. Thanks for taking my question. Very quickly, could you share with us your top spending category for this quarter? And also do you foresee any change in terms of customer mix in the near term? Thank you.
Top spending category. Yes. Let me offer you this information. The top five sectors for us in the past quarter include the following: medical healthcare, education, travel, machinery equipment, and franchising. So if you look at the top sectors, these are the familiar sectors that you have seen in the past. We always have some sector, one or two, that changes, partly because of seasonal reasons.
So when we look at the sector growth, we feel the main sectors are the same but some sectors like machinery are not as strong. And as indicated in the past, that we do see the B2C sectors seem growing steadily and healthily and the B2B seem to be relatively depressed. In the last economically slowing period, we witnessed the similar phenomenon.
Your next question comes from the line of Cynthia Meng of Jefferies. Please ask your question.
Cynthia Meng – Jefferies & Co.
Thank you, management. I have just one question. Can you talk about your strategy on Qiyi. Is it still going to be treated as one product -- one product offering or does Baidu have any plan to incorporate Qiyi in the overall mobile offering and for the future? Thank you.
Yeah, we right now have a large stake in iQiyi and we are very pleased about the progress Qiyi has made. We believe management is very strong, all the numbers I mentioned during the previous remarks showed that Qiyi has a very solid leading position. Going forward, we see consumers spending more and more time on online video, and we will try to integrate the Qiyi content more seamlessly in the overall Baidu search services, that includes mobile.
Your next question comes from the line of George Askew of Stifel Nicolaus. Please ask your question.
George Askew – Stifel Nicolaus
Yes. Thank you for taking my question. As you stated, the company added more customers in the third quarter than in any quarter in history. So, obviously, customers want to be on the Baidu platform. My question is, what are your customers saying about the evolving dynamics and competition in the market? And do you expect competition to help grow the overall search market in China? Thank you.
I think on developing these customers, particularly there SMEs, it takes a lot of our outreach to educate them. Our focus is to service them well. And for these customers, I think they can't get enough of us. The traffic -- the search engine marketing model is performance-based, as you know. So, for the spending that they have with us, we drive relevant traffic to their business, and that creates business opportunities for these customers. So, our focus with these customers is how can we improve the ROI, how can we drive more traffic to these customers. And if they see the benefit of that, I mean they will increase their spending with us. So that has been the constant theme.
I think the beauty of search is it is performance-based and the customers will be happy to spend more with us if we can really drive relevant business opportunities for them.
Your next question comes from the line of Piyush Mubayi of Goldman Sachs. Please ask your question.
Piyush Mubayi – Goldman Sachs
Thank you for the opportunity, and congratulations on a good set of numbers. Could I just check with you, you talked about change in the customer growth rate as several people have asked, several analysts have asked. If you exclude the growth that you're seeing in SMEs, what would the ARPU trend for your large customers be? Thanks.
I feel -- I mean, it doesn’t -- I don’t know if this is the right way to look at our business. I can't exclude the SME businesses because the SME is the majority of our business. Our large client, if you look at that, there are maybe a thousand of them in the country, and these are typically brand players that they would have multiple marketing promotional needs, and that can be addressed by different platforms. So these large players, if you look at them, they do have spending on traditional media platform, they also take advantage of display apps in internet, and they use search to drive high performance kind of promotional needs.
The large client business has been increasing very strongly over the years. Last year was an exceptional year, and this year, obviously, the macro environment does not -- is not as strong as last year, and so we have indicated that the large client business is not as, you know, growing as the triple-digit kind of scenario that we saw over the past year or so.
But having said that, we continue to see very strong performance on the large clients. There is much opportunity we have, and these large players have huge budgets and the opportunity is for them to really bring their budget over. So, for large clients, the opportunity is in the ARPU, but large client business is only a small part of the overall business.
So I think the business for us is we really serve a wide range of advertisers' needs. If you have a low budget, you can do advertising with us. If you have huge budgets, we can also be the platform that service them. So I think the question is, you know, the SMEs I can't exclude them, they are smaller spenders, large client business ARPU is opportunity and we'll continue to develop a relationship and help them see the value that we can offer to them.
Your next question comes from the line of Chi Tsang of HSBC. Please ask your question.
Chi Tsang – HSBC
Good morning, evening. Thank you for taking my question. Can you give us an idea of what you're expecting for search market revenue growth to be in 2013 and your ability to either maintain or grow share given your initiatives in both expanding SMEs as well as mobile? Thank you.
I think you would understand that at this time we're not giving next year's outlook. Coming into the Q4 results, we typically give out a quarter's outlook, and I hope next time around that give you a feel of next year's picture.
In terms of market opportunities, I think we've been always very focused on servicing our customer. And as the industry leader, we need to develop the marketplace. And as I said throughout the call, we see continued potential and opportunities for us to develop the market. I think the opportunity that's exciting lying ahead of us is what mobile development is really panning out. The mobile offers our advertisers new universe to present themselves, to target audience in higher frequency and more precision. So we're excited about this opportunity.
The market -- customers are there. I think ultimately users access Baidu for their search needs through multiple device. And as the users take more advantage of the services we offer, that gives the opportunity for the advertisers. So in terms of growth initiatives, we talked about all that. I think the potential continues to be huge. But obviously, the market final results is not, you know, we can single-handedly push it through. So the market awaits us to develop and the mobile is great opportunity, but we need to educate the customers and we need to develop the market.
So overall, I think back to your question, it's not just looking at where we are today on the PC front. I think we look at a dynamic multiple screen industry evolution.
And your next question comes from the line of Muzhi Li of Citigroup. Please ask your question.
Muzhi Li – Citigroup
Hi. Thanks for taking my questions. My first question is, do you see the PC search traffic volume growth for the year to date? And also I would like to ask about the pricing scheme. Does Baidu offer the same price on the PC versus mobile? And how do you think this pricing range will -- pricing scheme will change in the next couple of years during the transition period? Thank you.
As I mentioned before, PC traffic is not as exciting as mobile traffic. We are not disclosing the exact growth numbers. We haven't done that before. So we can only give you at this time for qualitative descriptions.
In terms of pricing, desktop and mobile, right now pricing on mobile is lower in terms of cost per click. As I mentioned, we are working very hard to improve the monetization system for mobile and to educate our customers to take full advantage of the mobile. And we expect that that will take some time to close the gap.
We are now approaching the end of the conference call. I will now turn the call back to Robin Li, Baidu's Chief Executive Officer, for his closing remarks.
Thank you, everyone, for being with us on today's call. Please do not hesitate to get in touch with us if you have any further questions. We look forward to speaking again soon.
Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.
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