百度 (BIDU) 2006 Q1 法說會逐字稿

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  • Operator

  • Good evening and thank you for standing by for Baidu first quarter 2006 earnings conference call.

  • At this time all participants are in a listen only mode.

  • After management's prepared remarks, there will be a question and answer session.

  • Today's conference is being recorded.

  • If you have any objection you may disconnect at this time.

  • I would now like to turn the meeting over to your host for today's conference, Miss Cynthia He, Baidu's investor relations manager.

  • Please proceed.

  • Cynthia He - IR Manager

  • Thank you.

  • Hello everyone and welcome to Baidu's first quarter 2006 earnings conference call.

  • This is Cynthia He, Baidu's IR manager.

  • We announced our first quarter earnings earlier today.

  • You may find a copy of the press release on the company's website as well as our news 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 Litigation Reform Act of 1995.

  • Forward-looking statements involve inherent risks and uncertainties.

  • As such our results may be materially different from the views expressed today.

  • A number of potential risks and uncertainties are outlined in our public filings with the SEC.

  • 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 - Chairman and CEO

  • Hello everyone.

  • Thank you for joining us.

  • Baidu posted strong performance in the first quarter of 2006.

  • We exceeded the top end of our previously announced revenue guidance.

  • We are particularly pleased with our results given that the first quarter is generally the slowest because of the long Chinese New Year holiday.

  • Our traffic growth remained strong again this quarter as we continue to improve our search experience.

  • Already this year we have rolled out a number of new products and features all tailored to the specific taste and preferences of Chinese users, including Ancient Chinese Literature Search, Government Search, Postal Code Search and Baidupedia.

  • We noticed more and more users are relying on search engines as the gateway to information and their information needs are becoming more and more diverse.

  • We study users' needs and focus on providing products and features to address them.

  • We recently launched the Baidupedia.

  • Together with Baidu Post Bar and Baidu Knows, form a trio of knowledge-based search products that draws from the minds of users, while offering a strong sense of community.

  • Baidu Knows was launched in June of 2005 and is already the number one knowledge search site in China.

  • Our deep connection to Chinese users and our focus on providing the services and products most desired by them is the real differentiator for Baidu and has helped us become the number one Chinese search engine.

  • We are confident that as long as we continue to provide the best user experience, we will be able to maintain and extend our current leadership position.

  • Our customer base also shows healthy growth in the first quarter.

  • We served over 74,000 active online marketing customers; that's 11,000 more than what we did in the previous quarter.

  • There were two key drivers of our customer expansion; first more Chinese companies are realizing the benefit of Baidu pay-for-performance marketing platform.

  • And secondly, we improved the sales efficiency of both our direct sales offices and distribution network.

  • We did this through a combination of sales force training, customer [agitation] and additional headcount, particularly in our direct sales offices.

  • We are very pleased about the pace of our customer expansion in which we believe we will continue to provide strong support through our future growth.

  • We also rolled out new strategic partnerships that [influenced] our focus on providing the most convenient way for people to find information.

  • In March we announced a partnership with Nokia to make mobile search easier in Chinese.

  • A selection of Nokia high-end phones were offered Baidu search services via a user friendly search icon on the screen in [inaudible]; four of Baidu's most popular services will be installed on the mobile phones.

  • Web search, news search, image search and Baidu Post Bar.

  • We also recently signed a memorandum of understanding with Intel to cooperate on developing Internet search and related applications in China.

  • This cooperation will combine Intel's total solution platform with Baidu's leading search applications to make search more convenient outside of traditional computer environment.

  • This is a long term collaboration and it is intended to bring opportunities for the future.

  • As the company focused on search, the goal of both the partnerships is to make search more widely available through non-traditional devices such as mobile phones and additional home appliances as well as to broaden the role of internet in people's lives.

  • We are focused on providing the best Chinese search experience for our user [base] as well as over the long term.

  • Given our proven [inaudible] performance and the huge potential of China's search market, we will continue to make investment in technology, product innovation, sales and distribution as well as explore strategic partnerships, whatever we believe it takes to continue providing the best search experience for our users and best online marketing platform for our customers.

  • I will now turn the call over to our CFO, Shawn Wang to discuss our financials.

  • Shawn Wang - CFO

  • Thank you Robin.

  • Hello everyone.

  • We posted another strong quarter.

  • We saw very healthy expansion in our revenue, user traffic and customer base.

  • Our strong top line growth drove robust earnings growth which will reflect the scalability in our business model.

  • We also benefited from the seasonality impact of Chinese New Year as being less than anticipated.

  • I will walk you through our financial highlights using RMB currency, unless otherwise indicated.

  • Our first quarter total revenue was 136 million RMB.

  • That represents an 18% increase from the previous quarter and 197% increase from the first quarter of 2005.

  • This result exceeded the top end of our earlier guidance of 130 million RMB.

  • Online marketing revenues were 132 million RMB, that's 97% of our total revenues.

  • This represents 18% sequential and 2007% year-over-year growth.

  • The growth was primarily driven by a solid 18% sequential increase in the number of active online marketing customers to over 74,000.

  • IP revenue -- average revenue per active online marketing customer remained steady from the last quarter at just under 1,800 RMB.

  • Traffic acquisition costs as a component of cost of revenues was 12 million RMB and that's 9% of total revenues.

  • This compares to approximately 8% in the previous quarter, a slight increase as a result of the increase in the number of union members and continued growth of contextual marketing products on union websites.

  • Capital expenditures for the first quarter was 12 million RMB primarily related to routine upgrade of our network.

  • Before I discuss headcount related expense, I would like to highlight two related accounting principle changes.

  • First we adopted SFAS 123(R) on January 1, 2006.

  • Under these new accounting standards, share-based compensation expenses are measured by applying a fair value method which caused our aggregate share-based compensation charges for the quarter to increase to 13 million RMB from 10 million RMB in the previous quarter.

  • Our second accounting principle change is the adoption of SEC Staff Accounting Bulletin No. 107.

  • Pursuant to the requirements of this new standard, share-based compensation expenses are now presented in the same manner as cash compensation as opposed to a separate line item on the income statement.

  • For the following discussions related expenses in all historical periods were restated to conform to this new presentation format.

  • Now coming back to the headcount related expense, R&D expense for the quarter was 60 million RMB, a 9% increase from the previous quarter and 137% increase from the first quarter of 2005.

  • This increase was primarily due to the expansion of R&D headcount.

  • On income tax, our effective income tax rate for the first quarter of 2006 was 16% versus 4% for the fiscal year of 2005.

  • The increase was primarily due to the expiration of a preferential tax holiday for one of our operating subsidiaries, Baidu Online.

  • I will now turn your attention to earnings measures.

  • Net income on a GAAP basis was 35 million RMB representing a 44% sequential increase and more than 1,300% increase year-over-year.

  • Typically our non-GAAP measures exclude share-based compensation expenses.

  • In this quarter they also exclude the accumulated effect of changes in accounting principle which I mentioned earlier that related to the adoption of SFAS 123(R).

  • Non-GAAP net income was 43 million RMB, a 24% increase sequentially and a 403% increase from the first quarter of 2005.

  • Basic and diluted EPS has been measured using non-GAAP measures of 1.31 and 1.26 RMB respectively.

  • They both translate roughly to US$0.16.

  • Net margins measured on a non-GAAP basis for the first quarter were 32%, up from 30% in the previous quarter.

  • Now moving on to our balance sheet, we ended the first quarter with a cash and cash equivalents of 976 million RMB.

  • Operating cash flow for the quarter was 95 million RMB representing a 52% sequential increase.

  • Adjusted EBITDA, again a non-GAAP measure, was 52 million RMB for the first quarter, representing a 43% increase from the previous quarter and a 270% increase from the corresponding period in 2005.

  • Now let me provide you our top line guidance for the second quarter of 2006.

  • We currently expect total revenues to be in the range of 186 million RMB to 193 million RMB which would represent a year-over-year growth of 167 to 177% or sequentially an increase of 37 to 42%.

  • I do wish to emphasize that this forecast reflects Baidu's current and preliminary yield which is subject to change.

  • I will now turn the call back to Robin for his closing remarks.

  • Robin Li - Chairman and CEO

  • At Baidu we believe that the secret to success in Internet search and online marketing in China consists of three factors; technological leadership, local insight and effective execution.

  • These doesn't sound complicated but it is very hard to capture.

  • I believe that Baidu possesses all of these factors for success and I have great confidence in our ability to serve the market, to create exceptional value for our users, customers and shareholders.

  • Thank you again for joining us today.

  • I will now open the call to questions.

  • Operator

  • Thank you.

  • The question and answer session of this conference call will start in a moment. [OPERATOR INSTRUCTIONS].

  • Your first question comes from the line of Anthony Noto.

  • Please proceed.

  • Anthony Noto - Analyst

  • Thank you very much.

  • Shawn and Robin, congratulations on another strong quarter.

  • I was wondering if you could comment specifically on the growth either sequentially or year-over-year in the core Baidu business as opposed to the growth that was contributed from your union members?

  • As I look at the tax and I try and keep it constant, it looks like the tax dollars have accelerated faster than the year-over-year revenue growth which you imply; more of your growth has come from union members than from the Baidu side, while the Baidu side is growing faster.

  • I'm trying to get a sense for what the underlying core growth rate of Baidu is, either sequentially or year-over-year.

  • Thank you.

  • Robin Li - Chairman and CEO

  • Hi Anthony, this is Robin.

  • I think we are not an exception in terms of growing our [inaudible] both from the organic side and from the union side.

  • As you have seen that tax only represents a single digit of our total revenue and depending on the market condition, the market maturity and competitive landscape, we would make our judgment on how aggressive we will expand our union membership.

  • But at this time the gross revenue and net revenue, I mean revenue net after tax, both are growing quite nicely.

  • We don't see anything alarming here.

  • Anthony Noto - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Wallace Cheung.

  • Please proceed.

  • Wallace Cheung - Analyst

  • Hi Robin, Shawn.

  • Hello?

  • Robin Li - Chairman and CEO

  • Yes.

  • Wallace Cheung - Analyst

  • Hi, congratulations on a very good quarter.

  • A quick question on [inaudible].

  • Can you comment on the direct sales force contribution firstly on the first quarter revenue?

  • And secondly on your guidance for the second quarter?

  • Thank you.

  • Robin Li - Chairman and CEO

  • The direct sales force contribution continued to remain a small portion of total revenue that we have generated.

  • You notice that we've been making investment including our direct sales force over the last two quarters, but given the recurring nature of our business, all these investments have not brought in immediate revenue contributions change.

  • So in terms of the revenue breakdowns, there's not a significant change in pattern at this time.

  • Shawn Wang - CFO

  • I would add that if you look at the customer acquisition contribution, I think direct sales is contributing more and more.

  • Robin Li - Chairman and CEO

  • That's right.

  • Shawn Wang - CFO

  • In the customer base.

  • Operator

  • Your next question comes from the line of Jason Brueschke.

  • Please proceed.

  • Jason Brueschke - Analyst

  • Thank you.

  • My question is about the average revenue per active customer.

  • It seems to have been flat the last two quarters, and on the one hand that's good because the growth is coming from your new customer acquisition, and on the other hand it represents a potential accelerator to your growth going forward.

  • So could you maybe discuss in qualitative terms of why that number is flat?

  • Is it a function of the price per key word?

  • Is it a function of the amount of query traffic per customer?

  • Or is it something to do with the timing of the average of when you're bringing on these new active customers in the quarter?

  • Thanks.

  • Robin Li - Chairman and CEO

  • Jason I think it's mainly due to seasonality.

  • As we mentioned much more times that during the Chinese New Year holiday our traffic would suffer a decrease and some of the customers would stop their online advertising campaigns.

  • So it's purely a factor of seasonality, nothing else.

  • Operator

  • And your next question comes from the line of Safa Rashtchy of Piper Jaffray.

  • Please proceed.

  • Nat Schindler - Analyst

  • Hi this is Nat Schindler calling in for Safa Rashtchy.

  • Congratulations on another good quarter.

  • I wanted to get a little -- your take on how well your small and medium enterprise customers are doing with search advertising right now, specifically the ones that still lack their own web pages and are using the service.

  • Do you have any sense of the ROIs they're getting and are these ROIs transparent enough to the customer that they're not churning out of the service without knowing whether or not they've got their money's worth?

  • Robin Li - Chairman and CEO

  • Yes the majority of our customers, small and medium enterprises, they usually have little alternative when it comes to promote their product and services, and Baidu provide a unique opportunity for them to do so.

  • Yes, many of the SME customers do not have a good way to measure the return on investment for the area promotional efforts, that is -- that had two implications for our business -- number one it means that the current online marketing [inaudible], the situation in China is that during the early stage most of the SMEs do not understand how to take advantage of our marketing platform.

  • Secondly, also shows the potential because once more and more small and medium enterprises realize how to measure the ROI, we will find that Baidu is the best way to promote their products and services.

  • Lots of the SMEs -- many of the SMEs offer a product or service in certain kind of mix, it's really hard for them to find alternatives. [inaudible] spent a small fraction of money on us in order to achieve similar results for performance, so what -- we have not seen any ceiling on the ROI [inaudible] for the SMEs at this time.

  • Operator

  • Your next question comes from the line of Robert Peck of Bear Stearns.

  • Please proceed.

  • Unidentified Audience Member

  • Hi, it's actually Lilian for Bob, congratulations on excellent quarter.

  • My question is actually in light of the recent speculation that we have been hearing about recently, about a potential consolidation of Internet traders in a [inaudible] market.

  • Is there an opportunity for Baidu, might be looking to pursue or maybe you can just give us some directions where Baidu might be thinking, for example in a wireless direction, is there a possibility of that area?

  • Robin Li - Chairman and CEO

  • We constantly monitor the change in the market place and the landscape, we believe that Baidu's [inaudible] still growing and works faster than most [inaudible] we have seen in the Internet industry in China, however we will keep our minds open if there's any opportunity that fits out strategy, we would consider that.

  • Unidentified Audience Member

  • Thanks.

  • Operator

  • Your next question comes from the line of Dick Wei, please proceed.

  • Dick Wei - Analyst

  • Hi, morning Robin and Shawn.

  • I have a question, it's more like a qualitative question on the competitive landscape.

  • I guess I noticed that a lot of other search engines like Yahoo and Google are including their efforts in China.

  • I wonder from your observations on the advertisers, do they typically put key words, buying key words from those other search engines, because they are not seeing enough beats coming up in Baidu, or do you see that they're actually reducing the spending in Baidu, including some of the advertising dollars into other search engine?

  • Robin Li - Chairman and CEO

  • We do not see any -- anything like reducing spending on Baidu because of the competitive offerings.

  • As I mentioned before, we think the industry is still in its very, very early stage; the main challenge for us is marking maturity, that most of the companies in China do not understand how to [manage] our paid search.

  • So we think we are not affected by any competitive pressure in terms of customer acquisition and customer spending.

  • Dick Wei - Analyst

  • [Inaudible] do you notice most of your customers like good advertisements on many of the search engine or typically do only Baidu [inaudible]?

  • Robin Li - Chairman and CEO

  • It will depend, we don't have the -- we don't have a concrete number on the percentage but we certainly have the largest online marketing customer base among all our [paid] search providers.

  • Dick Wei - Analyst

  • Great, thanks Robin and congratulations for the quarter.

  • Operator

  • Your next question comes from the line of James Mitchell, please proceed.

  • James Mitchell - Analyst

  • Hi good morning.

  • I guess if I look at your business sequentially quarter-on-quarter, you grew revenue by around 21 million and you grew expenses by just 8 million, so obviously you had a substantial operating profit margin expansion.

  • Looking forward, what's the sequential cost stroke in the first quarter, is that artificially [inaudible] or is that slowed down by seasonality, do you normally have -- looking at last year slower cost growth in the first quarter of the year and then a re-acceleration in future quarters?

  • Robin Li - Chairman and CEO

  • James, I think first of all I think what you observe is right, there is a very strong scalability in average regional business and that is inherent, but at the same time your second observation is also right in a way that, the first quarter, because of the holiday season some of the investment initiatives were delayed.

  • We will be continuously making investment in technology and upgrading our network and [beating] our direct sales, so in the next few quarters we will expect you will see a strong increase in some of the investment initiatives.

  • James Mitchell - Analyst

  • Okay, great.

  • Operator

  • And your next question comes from the line of Safa Rashtchy.

  • Please proceed.

  • Nat Schindler - Analyst

  • Yes once again this is Nat Schindler calling in for Safa Rashtchy.

  • Just a kind of a macro-level question about where you see growth in online advertising in China, and as experts and insiders in the field what you think is happening to branded advertising growth, image-based advertising growth versus search and the paperclip models that you're doing, and where do you think those growth curves will go in the next year to two years?

  • Robin Li - Chairman and CEO

  • As I mentioned before we are quite confident the long term sustainability of the paid search market in China, we think it will continue to grow at a very fast pace, branded advertising apparently growing slower than paid search and we are aware that some of our board of colleagues announced mid-30s annual growth rate.

  • Baidu is not very much exposed to image or graphic-based online advertising or branded advertising, so I think maybe those people can provide a better outlook of the overall branded marketing or advertising [inaudible].

  • Nat Schindler - Analyst

  • Do you see -- thank you.

  • Operator

  • Your next question comes from the line of Andy Collier of New York Global Securities.

  • Please proceed.

  • Andy Collier - Analyst

  • Yes thank you.

  • There was a boycott among about 750 distributors for -- it's my understanding for both Baidu and Google earlier in the quarter.

  • I noticed that your -- obviously the expenditure per customer was flat, did you see any impact from that boycott?

  • Is it over?

  • And was that part of the reasons why expenditure was flat or was that not relevant at all?

  • Thank you.

  • Robin Li - Chairman and CEO

  • That boycott had nothing to do with Baidu; none of the 700 distributors belonged to Baidu's distribution network.

  • I think the media misreported that maybe in part to catch people's attention.

  • Andy Collier - Analyst

  • So you're saying they were completed related to Google?

  • Robin Li - Chairman and CEO

  • I'm saying we are completely unrelated to the boycott of the distributors.

  • Andy Collier - Analyst

  • I see, unrelated to Baidu, thank you.

  • Operator

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

  • Please proceed.

  • Wallace Cheung - Analyst

  • Hi thank you.

  • I just wanted to have an update [inaudible] headcount at the end of first quarter and any planning like -- at the end of this year or at the end of second quarter?

  • Thank you.

  • Shawn Wang - CFO

  • Our headcount at the end of the quarter is around 1,800, that's a pretty increase from the previous quarter which was around 1,300.

  • That increase mostly is due to the expansion of the direct sales effort that we're building.

  • Going forward the next few quarters we will continue to make advancement in the areas that we're going to make, but I don't necessarily expect it's necessarily every quarter, 400 or 500 sort of pace at this time.

  • Wallace Cheung - Analyst

  • Sorry, I just want to have an update on the R&D headcount as well?

  • Shawn Wang - CFO

  • The R&D headcount has also increased at the same rate as the previous quarters.

  • That’s just a steady normal increase.

  • Wallace Cheung - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Your next question comes from the line of Steve Weinstein of Pacific Crest.

  • Please proceed.

  • Steve Weinstein - Analyst

  • Okay.

  • Thank you.

  • I just want to ask Anthony’s question a little bit differently.

  • Can we use the growth rate in traffic acquisition costs as a reliable proxy for the growth in the Baidu Union or is there some change taking place in the tax rate that would make that a bad assumption?

  • Robin Li - Chairman and CEO

  • I think, historically, yes.

  • But going forward we can see their task as a form of investment.

  • So we would like to maintain the flexibility of the tax asset percentage of total revenue.

  • So, whatever it takes to extend the business to make Baidu the largest online marketing platform and to grow our revenue, both in terms of net revenue and the growth, then we will do that.

  • Steve Weinstein - Analyst

  • Okay.

  • And did that apply in the current quarter?

  • Based on the tax rate change in the current quarter.

  • Robin Li - Chairman and CEO

  • I think I already said that the tax, for the current quarter, as a percentage of total revenue will not have a material change from the Q1 of this year.

  • Steve Weinstein - Analyst

  • Great.

  • Thank you.

  • Operator

  • Your next question comes from the line of Anthony Noto of Goldman Sachs.

  • Please proceed.

  • Anthony Noto - Analyst

  • Thank you very much.

  • Shawn, I definitely appreciate the seasonality in the expenses given the first quarters how they impact, and we expect expenses to accelerate, but do we expect the expenses to accelerate faster than the rate of growth in revenues so that the margins probably come down over the next couple of quarters?

  • My guess is you don’t want to have margins and EBITDA level, excluding stock-based comp in the 40 plus percentage rate given all the growth opportunities ahead of you.

  • And that was just an outcome of really strong revenue performance against modest expense mainly because of the holiday.

  • Is that accurate?

  • Shawn Wang - CFO

  • Yes.

  • Let me just re-emphasize again.

  • When we were looking at our business, making [rational; decisions we certainly -- not necessarily having the most important or the only parameter as achieving a certain margin level.

  • We are making investment in an area where we think we will be able to grow our revenues in the longer term.

  • We believe this is still very early stage.

  • This regards the Q1 strong bottom result.

  • It was a reflection of the inherent scalability and also stronger than expected top line growth.

  • Going forward, we will continue to make investments.

  • Robin Li - Chairman and CEO

  • I think, Anthony, the goal is not to keep the margins low for the current quarter or the quarter after.

  • The goal is to set a solid foundation for the long term growth of this company.

  • So we will make necessary investments whenever we see opportunities.

  • That’s why we haven’t given any bottom line guidance for the past three quarters.

  • Anthony Noto - Analyst

  • Great.

  • Thank you.

  • Operator

  • Your next question comes from the line of Jason Brueschke of Citigroup.

  • Please proceed.

  • Jason Brueschke - Analyst

  • Thank you.

  • My question has to do with a lot of the direct sales force.

  • You added a lot of headcount in Q1.

  • A lot of that you said was the expansion of the direct sales force.

  • Two questions.

  • Are those all organic hires or are you acquiring some of your distributors and bringing them in-house and adding to your direct sales force that way?

  • And to the extent that you are adding organically to your direct sales force, could you maybe discuss about how you’re thinking about the potential channel conflict between a direct sales force out calling on potential customers versus your distributors who may be out there calling on the same customers.

  • Thanks.

  • Shawn Wang - CFO

  • Our direct sales force.

  • In terms of the adding the direct sales force we are not actually doing it in -- we are only doing it in a selective markets where we believe there is a -- there is potential for instance we gain.

  • Some of the -- if our distributors are not necessarily performing to the standard we set out for them to do, we will consider using a direct sales force.

  • And so far there hasn’t been any conflicts that would turn out to be an issue for us at this time.

  • The direct sales force’s addition is mostly organic growth rather than acquisition.

  • We’ve seen the overall stronger service quality and efficiency in the direct sales force.

  • Now, going forward, we will continue to maintain the same strategy we laid out which is basically having a different strategy in different markets.

  • Whereas in more sophisticated, more developed market that has a high demand for customer services, we will provide the more direct sales service approach.

  • Whereas, in other markets, we will continue to rely and support our distribution network to grow.

  • Robin Li - Chairman and CEO

  • Right.

  • So there’s no conflict between direct sales and channel sales because each sales team is dedicated to specific geographic location.

  • Jason Brueschke - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Robert Peck of Bear Stearns.

  • Please proceed.

  • Unidentified Audience Member

  • Hi.

  • It’s Lilian again for Bob.

  • My question is a little bit more on the technology innovation side.

  • We have noticed your initiatives recently in unit generated content especially in light of the recent launch of Baidupedia, Baidu Post Bar, Baidu Knows, Baidu Community.

  • What is your thought on the Web 2.0 phenomenon such as tagging or social media, social networking, going forward?

  • Thanks.

  • Robin Li - Chairman and CEO

  • From my point of view, Baidu was that the [inaudible] company since day one because we never generated any content by ourselves.

  • We don’t have any editor to edit the content.

  • Originally, we provide a search function to allow people to find information that’s been created by somebody else, other websites.

  • Later on we found that, given that we have -- we had a large user base, we could enable our user base to communicate with each other and help each other to solve their problems and to find information for them.

  • That’s why, in 2003, we launched the Baidu Post Bar which is the [query] based community and now it’s probably one of the most popular community -- on line community in China.

  • Later on, last year, we launched Baidu Knows, a knowledge-based search survey.

  • And last month we launched Baidupedia to allow our users to edit the official definition for certain concepts and queries.

  • We believe, given our -- to enhancing our user base we are very well positioned to take advantage of the trend that users will have better ways to participate in the creations of content.

  • Having said that, I emphasize that Baidu is a search-centric company for whatever we do, those functions are surrounded [search end] and the purpose is to enable people to find information in a better way.

  • Unidentified Audience Member

  • Just a quick query.

  • Just in terms of priority, how does your initiative in user generated content compare to other technology innovations, such as Logo or Wireless is there like a difference in priority or is there pretty much all priorities for you guys?

  • Robin Li - Chairman and CEO

  • Well, the goal, or our mission, is to provide the best way for people to find information.

  • We will sort out the priority based on how a product can help achieving this goal.

  • Unidentified Audience Member

  • Okay.

  • Thanks.

  • Robin Li - Chairman and CEO

  • Yes.

  • Operator

  • Your next question comes from the line of James Mitchell of Goldman Sachs.

  • Please proceed.

  • James Mitchell - Analyst

  • Hi.

  • A super-quick question.

  • Could you provide guidance on the tax rate for ’06.

  • Shawn Wang - CFO

  • Yes.

  • I’m sorry.

  • As I mentioned earlier, our tax rate for this quarter was 16% effective tax rate.

  • And that is due to the fact that we are one of the main operating subsidiaries Baidu Online.

  • The tax holiday has expired last year, so we’re going into a newer phase.

  • We are in the process for negotiating with the Government authorities in both Beijing and in Shanghai.

  • In Shanghai, that relates to our newly set up [inaudible] China.

  • We are in the process of applying certain additional tax benefits but, at this time, it’s too early to give any specific forward-looking information on that.

  • Operator

  • Your next question comes from the line of [Chang Kwi] of Foreign Technology Research.

  • Please proceed.

  • Chang Kwi - Analyst

  • Right.

  • Good morning and congratulations.

  • Yes.

  • Robin.

  • I have one question for you.

  • Earlier, in last conference call you kind of mentioned competition health in terms of educating the market.

  • And recently you were quoted as saying, in five years, Google will not be around in terms of a Chinese search.

  • And can you elaborate a little bit more here?

  • Robin Li - Chairman and CEO

  • First off.

  • I think, I still think that competition helps to educate the market.

  • Because -- solely because of the early stage of this business.

  • I think media kind of misreported my comment about the competitor landscape in the future.

  • I said, in five years, Baidu would be the dominant player in the Internet search base in China.

  • That is true today and I believe that will be true five years down the road.

  • Chang Kwi - Analyst

  • Okay.

  • Thank you.

  • Operator

  • And your next question comes from the line of Tony Tang of Lusight Research.

  • Please proceed.

  • Tony Tang - Analayst

  • Hi.

  • Thanks for taking my call.

  • My question is related to some legal issues.

  • Recently Google and Yahoo and some US search engines was involved in the -- accused of false [inaudible].

  • Then Google agreed to pay, if I remember correctly, it will be $50 million as compensation.

  • So I just wonder does Baidu see anything happening in China in the market?

  • And if so, what’s Baidu’s situation on this issue and [inaudible] and is Baidu developing any new technology to prevent this happening?

  • Thank you.

  • Shawn Wang - CFO

  • I’m sorry, Tony.

  • Are you -- the question relates to fraudulent [clicks]?

  • Tony Tang - Analayst

  • Yes.

  • Shawn Wang - CFO

  • Is that what your question?

  • Tony Tang - Analayst

  • Yes.

  • That’s right.

  • Thank you.

  • Shawn Wang - CFO

  • Okay.

  • Baidu was the first search engine in China.

  • So, from the very beginning the measures to prevent fraudulent clicks has always been high on our priorities.

  • We have set up numerous measures, both through automated technology and also through manual efforts to prevent that from happening.

  • And we have engaged third parties to help us to test this system as well.

  • I think, so far, it has proved to be very effective anti-fraudulent click measures and our customers have been generally happy with the results.

  • We haven’t received the [type of] complaints or even the suggestion of litigation of that time in China.

  • And also, my understanding of that, I don’t think the Chinese legal system has a practice of allowing class actions at this stage.

  • So -- but that’s a minor point.

  • Fundamentally, we are investing aggressively in anti-fraudulent click measures and so far it’s been working very well.

  • Tony Tang - Analayst

  • Okay.

  • Thank you.

  • Can I -- one more thing about your projection for the online market customers.

  • I know you have 74,000 customers.

  • Could you provide geographical distribution for these 74,000 customers?

  • And then, going forward, what kind of rate do you see this customer growth?

  • Shawn Wang - CFO

  • The 74,000 customers continue to represent a very diverse and scattered representation of the industries.

  • Our customer compensation was very much -- I think in the previous quarters -- I have the status roughly, about 40 industries plus or minus is represented by the top 80% of our customers.

  • And that trend continues.

  • And I think that we will see a somewhat even more diversification as our customer base continues to expand.

  • Tony Tang - Analayst

  • What about geographical distribution of the --?

  • Shawn Wang - CFO

  • Geographically, there is not a fundamental change either.

  • It continues to represent basically the economic activities of China.

  • Throughout China.

  • Tony Tang - Analayst

  • Okay.

  • Alright.

  • Thank you.

  • Operator

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

  • Please proceed.

  • Wallace Cheung - Analyst

  • Hi.

  • Question.

  • Can you comment on the user experience and advertisers’ experience in the past?

  • Are they improving or deteriorating?

  • And any specific [key TI] you are looking at internally.

  • Thank you.

  • Shawn Wang - CFO

  • We have a very large team of people who study the user experience of our product and features on a daily basis.

  • We continue to make changes to our existing products while launching new products.

  • The basic measurement for user experience is actually [patrial].

  • We totally monitor the [patrial] increase of each of our products and features.

  • If our users like it the [patrial] will likely increase.

  • If our users do not like it the [patrial] will likely to remain flat or grow slowly.

  • That’s how we look at our user experience.

  • Wallace Cheung - Analyst

  • And the advertisers’ experience?

  • Shawn Wang - CFO

  • The advertising?

  • Robin Li - Chairman and CEO

  • Advertisers.

  • Shawn Wang - CFO

  • Oh.

  • In terms of advertisers, I mentioned during our previous conference call [inaudible] that pay-for-performance is still a very young [inaudible] model and we have been continuously improving the marketing platform.

  • So the experience for our advertisers have been improving and we will continue to make improvements on our advertising platform customer interface, things like that, going forward.

  • Wallace Cheung - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Your next question comes from the line of [Ray Bean] of Deutsche Bank.

  • Please proceed.

  • Ray Bean - Analyst

  • Hi.

  • Yes.

  • Just stepping back a little bit.

  • There seems to be an uprising of a lot of new companies and so many existing players focused on your end customer base, the small/medium business.

  • Could you just give us a sense of how you think, over the course of this year, the environment will change as a lot of companies, both large and small, start to target the small/medium businesses in China, trying to help them go online, trying to reach more customers?

  • Robin Li - Chairman and CEO

  • Yes.

  • More player coming into this place actually validates our position that SME market is a fast-growing and promising place.

  • I think by far, Baidu has the largest advertising network, online advertising network in China.

  • And, on one hand, we continue to grow our traffic, both organically and through union, so that advertisers can reach the broadest audience possible when they come to Baidu.

  • On the other hand, we also aggressively grow our customer base or advertiser base so that any traffic can be [inaudible] as to Baidu’s online marketing platform.

  • That’s why we report number of online active customers each quarter.

  • We think that’s also very important.

  • Ray Bean - Analyst

  • As the space gets more crowded, and as you say it’s an immature market where a lot of the SMEs don’t understand the power of search, are you going to change the way you approach the market or the way you sell in order to make sure the customer base is educated?

  • I think, of the course of this year, it looks like they’re going to get bombarded with different opportunities or ways to get online.

  • And it seems like there could be a lot more confusion rather than clarity going forward.

  • Are you going to change your marketing strategy at all, or?

  • Robin Li - Chairman and CEO

  • Yes.

  • You are right that many of our customer [base] have been approached by some of the other players in this space but I think time is working for us.

  • As the SMEs get more mature, they understand more about Internet promotion or marketing, they will realize that Baidu is the best way for them to promote their services and products.

  • So we have -- what we have been doing during past years is to regularly launch our nationwide road shows to educate the SME market on how to take advantage of our platform and the results seem to be very satisfactory.

  • Once the SME come to us to try our service, they will realize that we can provide the best results for them.

  • Ray Bean - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Your next question comes from the line of Steve Weinstein of Pacific Crest.

  • Please proceed.

  • Steve Weinstein - Analyst

  • Great.

  • Thanks a lot.

  • In the press release you talked about EBIT growth in [your potential] advertising products.

  • I was just wondering if you can give us a sense of the scale of that product today and kind of where you are in the development of it and where you think it’s going?

  • Robin Li - Chairman and CEO

  • Unlike some of the US search companies, we do not make sudden change of our online marketing platform.

  • We continue to make improvements and changes here and there to make sure our customers have a smooth transition of the online experience.

  • So we made some changes in Q1 and we will make more changes in the current quarter.

  • The change has been related to the way we display the paid or the sponsored links.

  • How many links we display, the way advertisements are bid against each other, things like that.

  • We think the result for the change has been very satisfactory.

  • The past result, as well as the Q2 guidance, does reflect our judgment on the improvement of the pay-for-performance platform.

  • Steve Weinstein - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Robert Peck of Bear Stearns.

  • Please proceed.

  • Unidentified Audience Member

  • Hi.

  • It’s Lilian for Bob again.

  • One last question on my side and I’ll let someone else go.

  • I want to quickly follow up on the direct sales force effort that you just talked about.

  • Is there any metrics or indicator that we look at to get a feel as to whether the direct sales expansion is a good financial decision for the company?

  • Shawn Wang - CFO

  • Right now we’re still at a very early stage as I said.

  • I think what we’re looking at is the people we put in place and the quality of the customers they generate and the speed at which they generate.

  • The results we’ve seen is very encouraging in comparison to our distribution networks in the same market that has performed before.

  • But in terms of the actual dollar contribution, it is -- it’s yet time to come.

  • At this time there is -- since we haven’t broken down the revenue contribution between the direct sales and network service, I guess it’s hard for you to tell at this time.

  • Unidentified Audience Member

  • Okay.

  • I understand that you didn’t break down the percentage of revenues generated from direct sales force versus independent retailers but just directionally does the percentage increase or decrease compared to previous period?

  • Is there any clue on that?

  • Shawn Wang - CFO

  • Well, all along our term, as I mentioned, since we informed the market we are expanding the scale of direct sales operations, at the same time direct sales operations does have a stronger performance than their predecessors.

  • So the share of the contribution will increase.

  • And I think this is on the beginning ramp -- beginning period of increase in contribution.

  • Unidentified Audience Member

  • Thanks a lot.

  • Operator

  • Your next question comes from the line of Safa Rashtchy of Piper Jaffray.

  • Please proceed.

  • Nat Schindler - Analyst

  • Yes.

  • Hi.

  • This is Nat Schindler once again with a final question.

  • You mentioned growth in traffic was strong.

  • Are there any metrics you can give us on traffic growth.

  • There’s, as you know, probably very limited access to information sources for Chinese traffic growth.

  • I was hoping for page views or unique users or something on that order.

  • Robin Li - Chairman and CEO

  • Yes.

  • For obvious reasons we do not disclose the page views we serve but if you look at the third party service as well as some of the online websites like [Alessa], you will see that Baidu traffic continue to grow and we -- the gap between us and other Chinese websites are widening.

  • Internally, we have noticed that our traffic continue to grow at a very healthy rate.

  • Nat Schindler - Analyst

  • Okay.

  • I know that giving exact numbers are difficult but wouldn’t -- would percentage changes or percentage growth quarter to quarter compromise you competitively?

  • Robin Li - Chairman and CEO

  • I think each quarter has its seasonalities.

  • It’s really hard to say that a 20% growth quarter on quarter is good or bad, if you don’t look at the historical numbers for the past few years.

  • So, at this time, we prefer not to give any percentage for quarterly change on the traffic.

  • Nat Schindler - Analyst

  • Understand.

  • Thank you.

  • Operator

  • Your next question comes from the line of Richard Ji of Morgan Stanley.

  • Please proceed.

  • Richard Ji - Analyst

  • Hi.

  • I have a question regarding your initiative on mobile and the local search.

  • What are their status right now and what are your plans?

  • Thank you.

  • Robin Li - Chairman and CEO

  • I think local search is still at a very early stage.

  • Nobody has figured out how to do it yet.

  • However, we know that local represent a very large opportunity sometime in the future so we are totally monitoring the development of local search.

  • Speaking of mobile.

  • As many of you are aware, that China will roll out the 3G mobile network in a year or two which will enable many cell phone users to access Internet in a better, faster and cheaper way.

  • We have been working with some of the industry leaders in this space to take position so that whenever the user's habit changes or the user's preference changes we will be able to notice that and tailor our services to better serve those mobile Internet users.

  • Operator

  • And your next question comes from the line of Ari Shrage of SAC Capital.

  • Please proceed.

  • Ari Shrage - Analyst

  • Hey guys.

  • Congratulations.

  • Great quarter.

  • If you could give a little clarification on the costs.

  • I realize you're not giving specific guidance on the costs, but you guys are talking about, at the mid-point, about 40% sequential increase in revenues.

  • How fast do you think you can ramp up the expenses?

  • It doesn’t seem like you can increase the expenses by 40% sequentially.

  • Robin Li - Chairman and CEO

  • I think this question also relates to Anthony’s question previously.

  • It’s very hard to say a stable margin or a margin increase or decrease is good or bad to the company results looking at the fundamentals, the market conditions, the market majority and the competitive landscape.

  • We will continue to do whatever we think is the best for the long term growth of the company.

  • That is, in the meantime, we cannot really make a short-term prediction of how aggressive we will stand to achieve that goal.

  • Mainly in the past or historically you see that our [inaudible] have very good scalability and I believe longer-term they will remaining so, but we just cannot see -- we just cannot say whether the current quarter will be a quarter for aggressive investment.

  • Ari Shrage - Analyst

  • Can you talk about the areas where you would be spending the money if you would be and how fast you think you can ramp those?

  • Shawn Wang - CFO

  • Ari, I think I can comment on in terms of the areas we would like to make investment.

  • First of all, we will continue to make investment in the network capacity, upgrading our network.

  • And secondly, in R&D, in new product and services we will continue to do that.

  • And thirdly, is the continued expansion and improvement of our distribution network which involves both the strengthening of direct sales as well as providing additional stronger support for distribution network.

  • I think all these areas we expect to see continuing investment.

  • Ari Shrage - Analyst

  • It sounds great.

  • Congratulations.

  • Great quarter and great guidance.

  • Thanks.

  • Robin Li - Chairman and CEO

  • Thank you.

  • 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.

  • Please proceed.

  • Robin Li - Chairman and CEO

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

  • Operator

  • Thank you for your participation in today’s conference, this concludes the presentation.

  • You may now disconnect.

  • Good day.