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Operator
Good day, ladies and gentlemen, and welcome to the fourth quarter and full year 2005 conference call. [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, Ms. Cynthia He, Baidu’s Investment Relations Manager.
Please proceed.
Cynthia He - Investment Relations Manager
Thank you.
Hello, everyone, and welcome to Baidu’s fourth quarter and fiscal year 2005 earnings conference call.
My name is Cynthia He, Baidu’s IR Manager.
We announced our fourth quarter and fiscal year earnings earlier today.
You may find a copy of the press release on the companies’ website as well as on other wire services.
Today, you will hear from Robin Li, our Chief Executive Officer; and Shawn Wang, 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 US Private Securities Reform Act of 1995.
Forward-looking statements involving [inaudible] risks and uncertainties.
As such, our results may be materially different from those expressed today.
A number of potential risks and uncertainties are outlined in our public filings with the SEC.
Baidu does not undertake any obligations 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 - CEO
Thank you, Cynthia.
Hello, everyone.
Thank you for joining us this morning or evening as your case may be.
I’m pleased to report that Baidu has achieved another quarter of strong revenue and earnings growth as well as solid full-year results.
During the fourth quarter of 2005, we generated total revenue of RMB115 million, which significantly exceeded our previous guidance top end revenue of RMB106 million.
We also saw a strong improvement in our bottom line which will be discussed in further detail by our CFO, Shawn Wang.
We continue to extend our lead as China’s No. 1 search engine as demonstrated by healthy traffic growth in the fourth quarter.
According to a survey in January 2006 conducted by Hai [ph] Research, an independent research firm in China, Baidu further strengthened our position as the most frequently used search engine in China with 56.6% of Chinese search users choosing Baidu to conduct Internet searches on a regular basis compared with 44.7% in 2004.
The survey estimates that the gap between us and the competition is widening.
We believe this trend is the result of our focus of providing the best search experience for our Chinese users.
The Baidu brand continues to grow stronger in China thanks, in part, to the effect the IPO had on our brand recognition, the popularity of our product and services, and the growing awareness by Chinese companies that key word search can bring real [inaudible] gain.
In the fourth quarter, we saw strong performance from our Guanjo direct sales office, which we opened during the third quarter.
We also strengthened our distributor network.
These initiatives helped to attract new customers and reinforce loyalty for existing customers.
As a result, we saw an increase in the number of our active online marketing customers from 53,000 to 63,000 during the quarter, and we saw spending per customer increase by approximately 10%.
We continue to see tremendous potential for China’s search market.
It is growing faster than the overall online marketing sector.
There are strong signals that this trend will continue.
In order to fully benefit from this growth and ensure our long-term success, we are concentrating our efforts in several areas.
Firstly, we continue to focus on providing the best search experience for our Chinese users.
We are monitoring consumer trends very carefully in order to stay ahead of our user preferences and develop as a product and services most valued by Chinese users.
Our deep understanding of the needs and habits of the Chinese Internet user is a key advantage for us in the area of user experience.
Secondly, we are growing our direct sales force as well as our distributor network.
Our on-the-ground sales team allows us to deliver a high level of service to more mature advertisers facing large and more [inaudible] while our distributor network reaches the rapidly growing SME customer base with less-sophisticated marketing needs.
As our results demonstrate, this strategy is paying off well for us with strong customer base extension and increased spending per customer.
Finally, we are investing in the future, especially in technology R&D, management infrastructure, and in people.
We continue to place great emphasis on hiring the best talent in the business.
Beyond our reputation as the leading search engine in China, we are building a strong reputation as a great place to work.
And I’m proud to tell you that Baidu was named one of the top 10 employers of the year in 2005 by China Central Television.
We are very confident that our focus investment effort position us well to take advantage of the vast potential of China’s search market.
Now I will turn the call over to Shawn Wang, our CFO, to discuss our financials.
Shawn Wang - CFO
Thank you, Robin.
I will first lead you through our fourth quarter results and then summarize the full-year developments.
The figures I discuss today are in RMB unless otherwise indicated.
Our strong financial results in the fourth quarter and the fiscal year 2005 reflected continued traffic growth, customer base expansion, and scalability [inaudible].
As Robin said, we experienced our early advantage in the total revenue [inaudible] and [inaudible] fourth quarter.
This represents a 29% increase from the previous quarter.
Online marketing revenues, which accounted for 97% of our total revenue in the fourth quarter, were RMB112 million, representing a 30% increase.
Growth was driven by solid increase in the number of active online marketing customers, a moderate increase in per-customer spending.
Baidu had more than 63,000 active online marketing customers during the quarter, representing a 19% increase from the previous quarter, and average revenue per customer increased by 10% from the previous quarter to over RMB1,700.
The number of online marketing customers and spending per customer are very important measures to measure Baidu’s performance, and we’re very encouraged by their rates of growth.
On our network operation side, a major data center expansion was largely completed by the end of the third quarter.
As a result, in the fourth quarter depreciation expenses and bandwidth costs remained at similar levels as the previous quarter.
And cap expenditures and fixed assets declined.
The frequency of [inaudible] expansion depends on the growth rate of our traffic.
While we will continue to incur capital expenditures, we currently do not expect network-related Cap Ex increase in the immediate quarters to be at the same pace as Q3 of 2005.
Selling, general, and acquisition expenses for the fourth quarter were RMB42 million, representing a 41% increase from the previous quarter.
This increase was mostly driven by the head count addition in sales during the quarter and by incremental expenditures associated with being a public company.
SG&A expense as a component of total revenue was 37% for the quarter compared to 34 in Q3 of 2005.
Operating profit on a GAAP basis was RMB40 million, representing a 106% increase sequentially from the previous quarter.
Operating profit, including share-based compensation expense, a non-GAAP measure, was RMB25 million for the fourth quarter, a 39% increase sequentially.
Now turning to nonoperating items.
Interest income doubled from RMB4 million in the third quarter to RMB8 million in the fourth quarter.
This increase was due, for the most part, to the increased cash balance from the IPO proceeds.
In Q4, we reported a net income tax benefit of RMB2 million as compared to the net income tax expenses of RMB2 million in the third quarter.
The Q4 tax benefit included mainly 2 items -- incremental current-quarter deferred tax asset of RMB1 million and the reversal of RMB3 million valuation allowances against deferred assets, which were recorded in the past three quarters.
Turning to our bottom line, our net income, excluding share-based compensation, was RMB35 million.
This represents an 81% increase from the previous quarter.
This EPS, excluding share-based compensation, was RMB1.06, equivalent to $0.13 in US dollars.
Net margin, excluding share-based compensation, for the fourth quarter was 30%, up from 20% in the previous quarter, a 22% increase [inaudible].
Operating cash flow for the quarter was RMB62 million, representing a 16% sequential increase.
Now turning to fiscal year 2005 results.
Total revenues for the year totaled RMB319 million, representing a 172% increase from 2004.
Online marketing revenue was RMB307 million, representing a 188% increase from 2004.
We made significant investments in several areas in 2005 -- namely, technology, marketing and distribution infrastructure, and human resources, which increased our total operating costs and expenses to RMB283 million from RMB106 in 2004.
Accordingly, depreciation expenses as a component cost of revenue [inaudible] 267 [inaudible] to RMB25 million.
And finally, [inaudible] cost increased 1% to RMB21 million.
Capital expenditures in 2005 totaled RMB89 million, up 249% from the previous year.
SG&A expenses in 2005 were RMB112 million, representing an increase of 187% from the previous year.
This is mainly due to our increasing investment in branding, the expansion of our direct sales force, strengthening our distribution network, as well as incremental expenditures in starting the fourth quarter associated with being a public company.
R&D expenses totaled RMB34 million in 2005, representing a 202% increase from the previous year, primarily due to expense of R&D headcount.
On non-operating items, we saw a significant increase of interest income from 1 million in 2004 to RMB40 million in 2005.
This increase was due to IPO proceeds and accumulation of free cash flow from operations.
Income tax increased to RMB2 million in 2005 from RMB0.5 million in 2004.
The increase was mainly due to the significant growth in total revenues and taxable income in 2005.
Our expected tax rate in 2005 was around 4%, at a similar level to that of 2004.
Net income excluding share-based compensation for fiscal year 2005 was RMB81 million, representing 185% increase from the [inaudible] question.
This EPS, excluding share-based compensation for 2005, was RMB4.1 [million].
Moving on to our balance sheet, we ended the year with cash and cash equivalents of RMB901 million.
Our net operating cash flow for fiscal year 2005 was RMB162 million compared to 57 in 2004.
As previously announced, we plan to build a new headquarters in Beijing.
The aggregate consideration for this, for acquiring the land use rights, is approximately RMB92 million and we have made a prepayment of RMB77 million against our noncurrent assets.
In summary, we had a very solid quarter as well as a very solid year.
We will continue to invest aggressively and are confident that our focusing methods will produce strong future growth.
Now let me provide you our top-line guidance for the first quarter of 2006.
As you may be well aware, our Q1 results tend to be affected by the seasonality of the long Chinese New Year holiday.
In Q1 ’05, our revenues grew by 6% sequentially from Q4 of 2004.
For the first quarter of 2006, we currently expect total revenues to be in the range of RMB125 million to RMB 130 million, which will represent a quarter-on-quarter growth of 9 to 13% increase.
I do wish to emphasize that this forecast reflects [inaudible] in the preliminary deal, which is subject to change.
I will now turn the call back to Robin for closing remarks.
Robin Li - CEO
Thank you again for joining us today.
We are very proud of the progress we have made in a relatively short time.
Going forward, we will continue to execute our winning strategy of listening to our customers and users and providing them the best user experience.
Today, we are excited about what is to come in the Chinese Internet industry.
We’ve never been more confident in the future of Baidu.
I will now open the floor for questions.
Operator
Thank you. [Instructions] Your first question comes from Jason Bruesche with Citigroup.
Please proceed.
Jason Bruesche - Analyst
Good morning, Robin and Shawn.
First of all, congratulations on a very super quarter.
Let me just-- I’ll just limit myself to two questions.
The first question is, it looks like the number of new customers slowed in the quarter both in terms of a percentage basis and in absolute terms.
My question is, are we seeing the effects of competition coming in and making it harder for you to add new customers; or is this more a function of, say, seasonality at the end of the year?
Robin Li - CEO
Obviously, Q3 was a very special quarter to Baidu where we had our IPO.
So the number of new customers added during that quarter was kind of special.
Also, we do not expect, percentage-wise, the number of new customers to grow at a constant rate; that’s not a realistic target.
We are, actually, very happy about the pace we are adding new customers at the Q4 rate.
At the end of the day, two metrics decide our success financially -- the number of active online marketing customers and well as the per-customer spending.
I’d like you to review both metrics going forward.
Shawn Wang - CFO
And if I may just supplement that as well, there is a small factor of seasonality during Q4 given that we have a Chinese national holiday that’s roughly off from the third quarter.
So that does affect it a little bit.
But I think the primary reasons are what Robin alluded to.
Jason Bruesche - Analyst
Okay, great.
My second question is, there have been some recent reports about music pirating crackdown by the Chinese government -- they seem to have closed around 75 or so pirated music sites.
Could you maybe describe for us what the impact on your business is going to happen if this move continues?
Because on the one hand, if it becomes harder to find these music sites, we could see that people are using Baidu to search out and find them more.
But on the other hand, if the government really were to crack down significantly across the board on music, I know that’s a material part of some of your traffic with young people, at least.
How do you think this plays out?
Shawn Wang - CFO
Our interpretation-- Shawn again.
First of all, I think it’s very important that we all understand that Baidu is the leader in information search, and that certainly includes the information of entertainment in nature.
We see that the license not only properly licenses the digital entertainment market, it’s fundamentally strong and good for Baidu’s future.
So I think we’re encouraged by some of the measures the government has taken.
At the same time, Baidu is in the business of providing search, and we’re not related to any of the music download and upload activities.
So we have not seen any changes in the way that our users come to search information on our website and we have not seen anything that, as a result of what you alluded to, has impacted the way we operate and how we conduct our search.
Jason Bruesche - Analyst
Great.
Thanks again, and congratulations again.
Cynthia He - Investment Relations Manager
Hello, everyone.
I would just like to remind everyone that we’re limiting our question-and-answer session to one question per person at one time.
If you have more than one question, please go back to the end of the question-and-answer queue and we’ll give you an opportunity to ask your questions again if there’s time.
Thank you.
Operator
And your next question comes from Anthony Noto with Goldman Sachs.
Please proceed.
Anthony Noto - Analyst
Thank you.
Hi, Robin and Shawn.
I was wondering if you could comment on what the revenue in the quarter was from acquisitions?
And then I’ll ask my second question back in the queue.
Thank you.
Shawn Wang - CFO
Anthony, we did not execute any material acquisitions during the past quarter, so there were not a material addition of revenue that was a result of acquisitions.
Anthony Noto - Analyst
Thank you.
Operator
And your next question comes from Safa Rashtchy with Piper Jaffray.
Please proceed.
Safa Rashtchy - Analyst
Good morning, Robin and Shawn.
Congratulations on a good performance.
Could you talk about the level of investment that you’re making in R&D, in particular?
I noticed that that dropped down, and I realize some of it may have to do with the depreciation comments that you had, Shawn.
But given the competitive environment, could you assess for us how you see the competition, especially from Google and some of the other players?
And what level do you think you need to sustain to effectively compete and improve on your technology?
Thank you.
Shawn Wang - CFO
Let me take on the first part and I’ll leave to the competition part to Robin to talk about.
In terms of R&D.
As we understand, the R&D expenses mostly relate to the headcount and our R&D expenses remain at roughly a similar level, whereas in Q3 there’s a pretty significant jump.
And that coincides with the summer season -- our new recruits came to join us.
And also partly because of the half-year bonus we awarded.
A pretty good bump in hiring.
So there’s not any material changes in terms of the R&D efforts.
And our R&D team has been strengthened very much during the year and we’re working on projects that are very exciting in the future to come.
Safa Rashtchy - Analyst
Okay.
Robin Li - CEO
Safa, I think in terms of R&D, we have been very aggressive during the past quarter of Q4.
We were as aggressive as before.
We try to hire as many talented engineers as possible and as quickly as possible.
So far, we have a very steadily growing engineering team and we will continue to try to attract more talent, especially technical talent.
Operator
And your next question comes from Richard Ji with Morgan Stanley.
Richard Ji - Analyst
Hi, Robin and Shawn.
I just want to find out, what is the retention rate of your existing online marketing customer?
Shawn Wang - CFO
We have not discussed that metric in the past and we’re not changing that practice at this time.
But we’re very confident that there’s a very-- an increased level of customer loyalty to our people because I think it’s really gaining momentum.
Robin Li - CEO
Yeah, let me add a few more words.
Search performance is a new business model in China, and more and more companies are now realizing the benefit the superb RI offers this model.
So as companies understand more about search promotion, search marketing, I think they will be more loyal to our business than any other competing business.
Operator
And your next question comes from James Mitchell with Goldman Sachs.
Please proceed.
James Mitchell - Analyst
Good morning.
I wonder if you could talk a little bit about TAC -- traffic acquisition cost.
It looks like it was up around 50% q-on-q, outstripping the growth in revenue.
Thank you.
Shawn Wang - CFO
We-- there’s a slight increase in terms of the traffic ratio to revenue, which reflects our extension of our third-party [inaudible] traffic, which were very successful.
There’s-- it doesn’t necessarily reflect any changes in the cost-sharing arrangement.
It’s rather the incremental traffic that we have added.
Robin Li - CEO
Yeah, in addition to the fast-growing organic traffic, we do partner with many of the smaller content providers as many of the content providers are realizing search could bring them more benefit.
In terms of revenue generation, we may see more revenue coming from partner sites.
Going forward, we would like to maintain the flexibility of growing the organic traffic and the partner traffic.
But right now, I don’t see anything material going on between the third quarter and fourth quarter.
Operator
And your next question comes from Lea Howell with Thomas Weisel Partners.
Please proceed.
Lea Howell - Analyst
Hi.
Good morning, Robin and Shawn.
I have a question regarding your strategy on direct sales force versus using distributors.
First of all, in Q4 results, your average spending per account -- could you give me a breakdown in terms of the benefit from switching from distributor to direct sales force versus the pricing increase?
And secondly, if you could lay out your progress and your plans for switching over to a direct sales force in Tier 1 cities versus Tier 2 and Tier 3, that’ll be great.
Thank you.
Shawn Wang - CFO
Well, let me first address the point in terms of our increase in the per-customer spending.
The direct sales efforts were recent efforts that we commenced mostly during 2005.
And to understand our business, we are a recurring business in nature.
So a lot of the direct sales effort in expanding new customer basis doesn’t necessarily add to our revenue basis initially.
So in an accounting sense, these are expenses; but in real [inaudible] these are actually an investment in building a customer base for the longer term.
So a short answer to your question is there are no material changes as a result of these direct sales that are adding to the per-customer spending.
Robin Li - CEO
Also, we are not switching from the distributor model to a direct sales model.
We are just saying the mature markets-- like before IPO, we acquired the Shanghai distributor because the Shanghai market was more mature.
Now we are operating a meaningful team in Guanjo because that market is also mature.
But China is a big country; there are lots of places that are still very, very underpentrated in terms of paid search, and we will continue to rely on our distributors in those areas to bring business to us.
In terms of average spending per customer-- at this time, it has nothing to do with the balance between direct sales and distributor network.
Operator
And your next question comes from Tang Ki [ph] with Foreign Technology Research.
Please proceed.
Tang Ki - Analyst
Yeah; good morning, Shawn and Robin.
One question.
Before a company becomes your customer, is it necessary for that company to have a website?
Robin Li - CEO
Yes or no.
The company needs to have a website in order to use our paid search platform, but a vast majority of our distributors do have a side business that constructs websites for companies who do not have one yet.
So it is not really a limiting factor for our business.
Tony Ki
Okay.
Operator
And your next question come from Robert Peck with Bear Stearns.
Please proceed.
Robert Peck - Analyst
Yeah, I was wondering if you could touch a little bit on the ROI.
You said ROIs have been improving for your advertisers.
Could you maybe give us a little more color around some of the certain metrics -- where you’re seeing the cost per clicks growing; the click-through rate?
And then ultimately conversion rates into sales.
If you could just touch, even qualitatively, on what you’re seeing directionally on those items.
Robin Li - CEO
Well, I did not say ROIs were improving -- I just said that the ROI for our paid search is much, much better than any alternatives on the market right now.
As we stated previously, we do not disclose the cost per click or clicking-through rates because we don’t think that’s the right method to track this business.
In terms of measuring ROI, different customers do have different ways of doing that.
We are helping some of the larger customers to do more data analysis on the click-through rate -- the lead generation as well as some other metrics they prefer to use.
But at the end of the day, people are very, very happy about our business and the results we can generate for them.
They can usually measure the results, especially for the small and medium enterprises, by the number of orders they can make after spending a certain amount of money on our website.
So I think that’s the most important thing to our customers.
Operator
And your next question comes from Tony Tang with Lucite [ph] Research.
Please proceed.
Tony Tang - Analyst
Hi.
Good morning.
My question for you is regarding your traffic acquisition cost.
Baidu reported that number is around 8% total revenue for 2005.
However, Google reported its number as around 80% of its total network revenue and about 35% of its total revenue.
So I just wonder if you could tell us a little bit about this number -- why your number is so low.
And then, what are the components in this traffic acquisition cost for you?
And in the future, how should we look at these numbers?
Thank you.
Robin Li - CEO
Tony, this is Robin.
I think we are just at different stages of development for the search market.
In China, search is still a very young business and our organic traffic is growing very, very fast.
So a simple majority of our revenue is generated from our own website’s traffic.
On the other hand, we are quite open to work with content providers to help them multiply their traffic.
We are seeing more and more websites that realize search can bring them additional revenue.
That’s why we have a line of business that works with the content partner.
In terms of revenue-sharing, we actually can add more value than simple money.
We work with those content partners to help them to grow their own traffic to grow their own business, and we have a long-term relationship with many of the partners.
They believe in us; they have confidence that partnering with Baidu will bring them more and more benefit.
Operator
And your next question comes from Robert King with Peninsula Capital.
Please proceed.
Robert King - Analyst
Robin, hi;
Shawn.
Bob King here.
Both
Hi, Bob.
Robert King - Analyst
How are you?
Congratulations.
That year-end number of 56.6% was just terrific in terms of execution on your part.
Relative to MP3 search, in terms of it being a share of total searches, can you give us some sense as to where we are today and the direction it’s moving?
Is the share, MP3, of total number of searches -- is it increasing, decreasing?
Where are we today on that?
Robin Li - CEO
Bob, as you know, we do not disclose the traffic breakdown for different types of searches.
But as a reference point, you can go electra.com and see a rough distribution of our traffic.
I believe that number is around 15% of the total traffic.
As we stated before, we focus on providing the best user experience for our Chinese search users.
And as you know, the most important information need is the web page search.
We did aggressively invest in areas like community oriented search.
Our Postmark -- the career-based community -- has been doing very well.
And our knowledge search -- Baidu Knows -- is now the No. 1 knowledge search site in China.
We launched that in June of 2005 and by November 2005, we already became the No. 1 knowledge search website.
Operator
And your next question comes from Wallace Cheung with Credit Suisse.
Please proceed.
Wallace Cheung - Analyst
[Silence]
Operator
Mr. Cheung?
Wallace Cheung - Analyst
Hello?
Hello?
Shawn Wang - CFO
Hi, Wallace.
Wallace Cheung - Analyst
Hi.
Congratulations, Robin and Shawn, on the great results.
I’m sorry that I’m actually a little bit late to the conference.
Has someone actually gone through questions like [inaudible] costs?
Shawn Wang - CFO
Twice already.
Wallace Cheung - Analyst
Okay, sorry.
Okay, let me ask some questions like, how do you see the overall pay search market grow into the wide, wide revenue growth in this year?
And also, I think the first quarter revenue guidance is pretty encouraging and even supports the fourth quarter gross revenue absolute numbers.
And it seems to me, before we-- I expect there should be some seasonality in 2005 and since-- do we expect similar seasonality may happen, be replicated, in 2006 and 2007?
So that’s two questions.
First is the overall growth in ’06 and seasonality in ’06.
Thank you.
Robin Li - CEO
That’s a lot of questions. [Laughs] In terms of the seasonality, if you look on the quarter-on-quarter growth, Q4 over Q3 of ’05 was up 29% sequential growth.
For Q1 of ’06, we are guiding about roughly 9 to 13% of growth.
So that shows the seasonality of this business.
However, we do believe that the online search market is growing at a rate much faster than the overall online advertising business in China.
Baidu has a large market share in China’s search market and we are expanding quickly.
In addition to the market factor such as Internet penetration rate, the market maturity of the paid search, the SME’s understanding of the Internet business, our execution, Baidu’s execution, will, by and large, dictate the market growth going forward.
Operator
And your next question comes from Andrew Collier with New York Global Securities.
Please proceed.
Andrew Collier - Analyst
Yes, good morning.
Thank you.
Could you comment a bit on Google?
What kind of impact are you seeing?
Or, if you’re not seeing any impact at all at this point, when do you expect there might be some impact in terms of revenue generation through both your own sales force and your leading distributors?
Robin Li - CEO
We are not the first one to provide Chinese search in this market.
We were actually later than Google.
We quickly caught and surpassed everyone in this market in terms of traffic.
Now we are generating more and more revenue.
We believe, longer term, as long as we focus on what we do best and we focus on providing the best Chinese user experience, we will be able to maintain and extend our current leadership position.
Sometimes competition will actually do us a benefit because the market is so early and more market education could bring in more customers for the paid search engines.
Operator
Your next question is a follow-up from Anthony Noto with Goldman Sachs.
Anthony Noto - Analyst
Thank you.
Robin and Shawn, there have been a lot of questions about traffic acquisition costs and other investments.
I’m just wondering if you can give us some perspective on a band of operating income margin excluding stock-based compensations that you think the business could achieve in 2006?
And to help you frame it, the margins were down in full-year 2005 given the investments that you made in going public as well as some other employee hires.
Do you see significant leverage in 2006 at the operating margin line to get margins back to the 30% range?
Or is it going to be more muted in terms of leveraging that?
Thank you.
Shawn Wang - CFO
Anthony, I think-- as you know, we’re a relatively young company operating in a very dynamic and early-stage market.
So our practice at this point at this point is providing top-line, again, quarter on quarter.
But also, as we told you during our road show, we’re very confident that [inaudible] as long as we continue to make the right investment, it’s just a matter of time that market improvement will come.
Of course, some of the investment you’ve seen in 2005 -- for example, the [inaudible] G&A expenses associated with the public company -- that is highly scalable [inaudible].
That’s just a general sense.
Some similar argument may be made for some of the other items.
I can’t give you any more details, but we’re more confident in scalability.
Operator
Your next question is a follow-up from Safa Rashtchy with Piper Jaffray.
Please proceed.
Safa Rashtchy - Analyst
Thanks; my question has been answered.
Operator
Your next question is a follow-up from Jason Bruesche with Citigroup.
Please proceed.
Jason Bruesche - Analyst
Thanks.
My follow-up is a follow-up, actually, to Anthony’s last question.
And that is -- Shawn, you said in your prepared remarks that you don’t expect, in the immediate quarters, to need to do another data-center expansion or major investment in your infrastructure.
Should we be thinking that this is something likely to happen in the second half of the year as your traffic demand continues to grow?
Or should we be thinking that, really, the rest of 2006 you’re really in a good position because of the investments that you made in Q3?
Shawn Wang;
I think there are two points worth noting.
One is the fact that the-- our pace of data center expansion is a function of our traffic growth.
The traffic growth itself, we can’t really look into the crystal ball to tell you with any particular precision.
But what I can also tell -- the second point is, if you noticed during Q3, it’s-- sequentially in Q3, our CapEx spending almost close to tripled the level of spending that we incurred in Q2.
So that’s a very significant bump.
What I’m telling you is we will continue to incur CapEx; we’ll continue to add servers and upgrade our service, but it will not be at the same-- at the level of increase that we experienced in Q3.
Robin Li - CEO
Also, I’d like to add that data center expansion is a good problem for us to have.
The more traffic we can attract, the better we’re positioned to benefit from the rapidly growing Chinese Internet market.
Operator
Your next question is a follow-up from Richard Ji with Morgan Stanley.
Please proceed.
Richard Ji - Analyst
Hi, Robin and Shawn.
I have a question regarding competition, and I’m especially interested in the geographic breakdown of your customer base.
Maybe you can give me some color about what percentage of customers are coming from the Yangtze River delta where Ali Baba [ph] is based?
Thanks.
Shawn Wang - CFO
Our customer concentration -- there’s not any special pattern.
I think it’s pretty much given that we have a fairly large customer base.
Our experience has been that it coincides pretty much with the-- I guess the degree of economic development throughout China.
As we told you during our road show, we have over 60 distributors scattered throughout China, so in the economically active regions we certainly have more presence and we do see our customer expansion coinciding with that pattern.
Robin Li - CEO
Yeah.
Also, I think the more mature the market, the more revenue we can generate, even percentage-wise.
So you can expect, for all the major city areas, we are doing very well.
As more companies realize how search works, why search is much better than any alternative, they will stay with us and spend more and more on our platform.
Operator
Your next question is a follow-up from James Mitchell with Goldman Sachs.
Please proceed.
James Mitchell - Analyst
Thank you.
I guess this is a follow-up to Lea’s question earlier.
I guess if I’m a keyword buyer in Guanjo, previously I was buying from one of your distribution agents.
So the revenue you’d have reported from me would have been two-thirds of what I was actually spending, with the other third going as a discount to the distributor.
When you take my sales force in house -- when you operate a direct sales force in Guanjo -- then the revenue you report from me, personally, would increase, I guess, by up to 50% as you recapture the distribution discount.
Was that process of recapturing distribution discounts material in terms of your quarter-on-quarter revenue per customer growth or was it immaterial?
Thank you.
Shawn Wang - CFO
Jim, it is not material.
Robin Li - CEO
Yeah, the Guanjo sales operation just got started in Q3.
The initial success was more of the increase in terms of number of new customers we can attract.
In terms of spending power, it’s going to take some time to see the real effect.
But percentage-wise, Guanjo still represents a small percentage of the overall China market.
Operator
Your next question is a follow-up from Tony Tang with Lucite Research.
Please proceed.
Tony Tang - Analyst
Hi.
My question, this time, is about the technology side.
Could you comment about what’s your R&D investment plans for the next 12 to 18 months?
What types of technology are you looking at and developing right now?
Robin Li - CEO
Well, as I said before, we are a very focused company.
We believe that the search market in China is growing very, very fast.
There is still a lot of potential here.
We are probably the only public-listed company that focuses exclusively on Chinese search.
That has been our strategy and it will be our strategy going forward.
So our investment in terms of technology still largely surrounds Chinese search problem.
Most of our efforts are still on the existing product, especially web page search, as well as some of the community-oriented search services -- Postmark, Baidu Knows.
And going forward, we will continue to carefully study consumer trends to find out what new search needs they will have, and then we’ll roll out new services to satisfy their needs.
We decided not to use new product launch as PR strategy, so we don’t merely talk about new products before those products become significant contributors to our traffic and user base.
Operator
Your next question is a follow-up from Wallace Cheung with Credit Suisse.
Please proceed.
Wallace Cheung - Analyst
Hi.
Can you give us a little bit of update on the new building plans that-- you have already spent around RMB77 million as a prepayment for the land usage right.
So what time are you going to launch the new building and the CapEx [inaudible] to spend in the next few years’ time?
And also, any update in terms of the marketing plans and spending in 2006, both regarding advertising and number of, like, new hires for your sales and marketing people?
Thank you.
Shawn Wang - CFO
Wallace, let me just give you a quick update on the building plans.
We finally contracted to acquire land use right, and that’s really step 1.
The land use right is providing over RMB90 million, and we’ve paid the first down payment -- 77 million.
So we are still waiting for the final government approval to go through that, and we’re in the process of evaluating our architecture for [inaudible].
So it’s at the very early stage right now.
The timetable for any building of such scale to be completed, I think, will be roughly 2 to 3 years.
There’s still a lot of approval that has to go through and we’re very excited that we will have a campus, but it will take some time to complete.
Operator
Your next question is a follow-up from Andrew Collier with New York Global Securities.
Please proceed.
Andrew Collier - Analyst
Yes, thank you.
The 10% increase in average spend per customer -- did that primarily come from your existing-- your older customer base in the Beijing-Shanghai-Guanjo areas, or are you seeing a fairly even pattern of old and-- expenditures between old and new customers?
Shawn Wang - CFO
The new customer-- definitely, the new customers have been coming throughout different times during the quarter.
There will be-- the addition of new customers will have a drag on the per-customer spending.
So the increase actually has come from the most existing customers and their increase of spending, I think, for the most part.
Robin Li - CEO
The key message, I guess, is that distance is not really limited by customer buying power.
It’s more limited by market maturity, by the amount of related traffic we can offer.
Operator
[Instructions] Your next question is a follow-up from James Mitchell with Goldman Sachs.
Please proceed.
James Mitchell - Analyst
Thank you again; sorry for pestering you.
I believe that, earlier, you mentioned that the R&D cost was unusually high in the third quarter because you paid a mid-year bonus.
Going forward, would you pay mid-year and full-year bonuses to all your staff or just your R&D staff?
And does that mean that your operating expenses will be higher every first and third quarter, or will you accrue them evenly through the year?
Shawn Wang - CFO
We’re actually harmonizing our-- there’s [inaudible] compensations scheme revealed that we’ve been doing now for some time in the recent past.
I think there are some components are that we will try to reward our staff leading toward more cash component versus in the past, or pre-IPO, where there was a significant amount of option grants, or share-based compensation.
I think going forward, we will focus more on cash.
And also, there will be a more even quarterly bonus in place.
Operator
Your next question is a follow-up from Wallace Cheung with Credit Suisse.
Please proceed.
Wallace Cheung - Analyst
Hi.
Can you give us some guidance on the effective tax rate in 2006 and ’07?
And any reason why the effective tax rate overall in ’04 and ’05 is relatively low?
Thank you.
Shawn Wang;
Well, the effective tax rate in ’04 and ’05-- as you know, our actual statutory tax rate during those two years was 7.5% for our online-- for the all the operations in China whereas our netcom [ph] was 33%.
And our effective tax rate was relatively lower due to a number of factors, one of them a tax holiday itself.
And then also, there’s some what I called deferred tax assets.
You could see this deferred tax asset relationship to fixed asset, the CapEx we invested in during the year.
Now, into 2006 and 2007, there are a number of factors that will make it-- a couple of factors need to be taken into consideration.
One is that we are growing our southern China operations significantly and we are contemplating to set up a new investment entity in southern China which, as a new entity, they would-- We’re expecting some additional tax holiday to be granted to that entity, but the details of which are still subject to confirmation with the local Chinese government.
Whereas our existing operations in Beijing, the effective tax rate will increase-- our statutory tax rate will increase to 15%.
So that will be-- that would give us a bit of higher tax expenses for the Beijing operation.
So put that all together, I think the real tax rate will be somewhere in between.
It will also be affected by the pace of our geographic investment.
Operator
Ladies and gentlemen, we are approaching the end of the conference.
If there are no further questions, I will turn the call back over to Robin Li.
Robin Li - CEO
Once again, thank you for joining us today and please do not hesitate to contact us directly if you have any further questions.
Thank you.
Operator
Ladies and gentlemen, thank you for your participation in today’s conference.
This concludes the presentation.
You may now disconnect.
Good day.