百度 (BIDU) 2006 Q4 法說會逐字稿

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  • Operator

  • Good evening and thank you for standing by for Baidu's fourth quarter and full year 2006 earnings call -- conference call. At this time, all participants are in 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 objections, you may disconnect at this time. I would now like to turn the meeting over to your host for today's conference, [Rory McPherson].

  • Rory McPherson

  • Hello everyone and welcome to Baidu's fourth quarter and full-year 2006 earnings conference call. We distributed Baidu's fourth quarter and fiscal year 2006 earnings earlier today. You may find a copy of the press release on the Company's website as well as on newswire services.

  • Today, you will hear from Robin Li, Baidu's Chief Executive Officer, and Shawn Wang, Baidu's Chief Financial Officer. After their prepared remarks, Robin and Shawn will be available to answer your questions.

  • Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor Provisions of the U.S. Private Securities Litigation Reform Act of 1995. Baidu does not undertake any obligation to update any forward-looking statement 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

  • Hello everyone, and thank you for joining us. I'm pleased to report strong fourth quarter and full-year 2006 results. Our growing brand recognition combined with our -- we have new and existing search and community-based offerings, drove market expansion in the fourth quarter.

  • As the Baidu brand continues to gain recognition, more and more Chinese Internet users are making Baidu their search engine of choice. In fact, according to the independent research firm, iResearch, in October 2006, 63.7% of online users in China chose Baidu as their most favorite search engine.

  • While traditional web search continues to be the largest traffic contributor, we are also seeing encouraging uptake of our leading community-based offerings. For example, Baidu Space and Baidu Knows have grown significantly in popularity and both products are now featured on Baidu's home page.

  • We are always creating new products that improve user experience. In the fourth quarter, we added Baidu Blog Search and Baidu Favorites. And, most recently, we added a Video search service. We also recently received a news publishing license and we will use this opportunity to broaden our reach and increase the impact of the Baidu news service.

  • Improving customer service quality is one of our key strategies for building our customer base and increasing average spending per customer. So during the quarter, we continued to expand and train our direct sales force in major cities. We are confident this strategy will help to drive future revenue growth.

  • Focus on our customer service is key in helping our customers to transition to and take advantage of our improved P4P monetization platform. We are pleased with our progress thus far and will continue to improve service and fine tune our monetization model going forward.

  • During the quarter, we announced a new partnership with content and Internet industry leaders aimed at expanding our online presence and enhancing user experience. During the fourth quarter, we partnered with MTV Networks to distribute video and music content. And we recently linked with EMI to stream their music online.

  • We believe that the EMI agreement represents a major milestone for the ad-supported digital music industry in China. We also just launched an online portal for downloading virus protection software made by a number of leading international and domestic brands, including Trend Micro, Symantec and McAfee. These collaborations provide users with improved options for legal content download and extend Baidu's reach on the Internet.

  • On the monetization side, we formed a strategic alliance with Microsoft to display our paid-search listings on various Microsoft properties as well as the 114 search services offered by China Telecom and its affiliates. In 2007, we will continue to look out for partnerships that enhance our core user experience and provide revenue-generating opportunities.

  • Another exciting initiative for Baidu is our upcoming entrance into the Japanese search market. We believe that with our proven strength in Chinese language search and our focus on delivering the best user experience, we will be able to provide Japanese users with a quality alternative to existing search engines.

  • Also, considering that Japan has over 50% Internet penetration, and our familiarity with the two leading players, we feel there is a strong long-term market opportunity here. We have been making excellent progress building our Japan team and marketing our Japanese language search technology. And we will keep you updated on developments.

  • Currently, we estimate to incur approximately $15m expenditures to developing our Japanese initiatives in 2007. Also in 2007, we will continue to focus on our strength and deliver the best online search experience to our users.

  • We continue to be very confident in the long-term growth potential of Chinese search market and we are also excited about the opportunities in the Japanese search market. And we are committed to making the long-term investments in innovation, infrastructure and people that will fuel our growth and create exceptional value for our shareholders.

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

  • Shawn Wang - CFO

  • Thank you, Robin. Hello everyone. As Robin mentioned earlier, we delivered healthy revenue and earnings results in the fourth quarter. I will walk you through some important factors contributing to these results and our financial highlights. Again, the numbers I refer to will be in renminbi, unless otherwise indicated.

  • Our fourth quarter total revenues were approximately RMB271m. That is within our guidance range and up 136% over the year-ago period.

  • Online marketing revenues were RMB270m, representing 141% growth year over year. This growth was driven by a number of factors including traffic growth, a year-over-year increase in the number of active customers of 71%, as well as a year-over-year increase in per-customer spending of 41%.

  • Traffic acquisition cost as a component of cost of revenues were RMB24m. That is 9% of total revenues, compared to 8% in the year-ago period. The slight increase reflects increased revenue contribution by our union properties.

  • Share-based compensation expenses decreased to RMB7m in the fourth quarter 2006. That was from -- a decrease from RMB10m in the year-ago period. The decrease primarily reflects reduced option grants during the quarter, decelerated amortization of existing options granted before 2006 and changes in actual and estimated option forfeiture rate.

  • SG&A expenses were RMB71m, representing a 44% increase from the fourth quarter in 2005. Excluding share-based compensation expenses, SG&A rose 53% year over year.

  • Research and development expenses were RMB21m, representing a 46% increase from the corresponding period in 2005. Again, excluding share-based compensation, R&D expenses rose 81% year over year. That is mainly due to the expansion of head count.

  • In the fourth quarter, one of our PRC subsidiaries qualified for income tax preferential treatment for 2006 and the following two years. As a result, the income tax benefit in the fourth quarter included a reversal of RMB7m tax expenses that was provided in the previous quarters.

  • Our net income for the quarter was RMB123m, representing a 400% increase year over year.

  • Net income excluding share-based and compensation expenses, a non-GAAP measure, was RMB130m, representing a 272% increase from the fourth quarter of 2005.

  • Basic and diluted EPS, excluding share-based and compensation expenses, were RMB3.87 and RMB3.75, translating roughly to $0.50 and $0.48 respectively.

  • Net margin, excluding share-based compensation expenses for the fourth quarter of 2006 was 48%, up from 30% in the year-ago period. The year-over-year increase primarily reflects the scalability of our business and the tax reversal during the quarter.

  • Now moving on to the balance sheet. We ended the fourth quarter of 2006 with a cash, cash equivalent and short-term investments of RMB1.2b. That is roughly $157m.

  • Operating cash flow for the quarter was RMB171m, or $22m, representing a year-over-year increase of 175%.

  • Capital expenditure for the fourth quarter of 2006 was RMB23m, up from RMB21m in the year-ago period. We expect an increased level of capital expenditures during 2007, however, as we begin construction of our Baidu Campus, as we continue to upgrade our network infrastructure and increase our network capacity.

  • Adjusted EBITDA, again, a non-GAAP measure, was RMB132m for the fourth quarter, representing a 261% increase from the corresponding period in 2005.

  • Now a few highlights on the fiscal year 2006 results. Total revenue for the year was RMB838m, representing a 162% increase from the previous year. Online marketing revenue for the year were RMB828m, representing a 170% increase from the previous period -- from the previous year.

  • Traffic acquisition costs were RMB75m, representing a 9% of total revenues compared to 7% in 2005. Again, that is increase -- reflecting increase in the revenues by union properties. Selling, general and administrative expenses were RMB250m, representing an increase of 86% from 2005, mainly due to the expansion of the direct sales force and a strengthening of our distribution network.

  • R&D expenses totaled RMB79m, representing a 79% increase from 2005, largely due to the headcount expansion.

  • Net income was RMB302m, representing a 534% increase from 2005.

  • Net income excluding share-based compensation expenses and the cumulative effect of change in accounting principle, again that's a non-GAAP measure, the number was RMB345m, representing a 326% increase from 2005.

  • Basic and diluted EPS, excluding share-based compensation expenses and the cumulative effect of accounting principle change were RMB10.38 and RMB10.01 translating roughly to $1.33 and $1.28 respectively.

  • Net margin, excluding share-based compensation expenses and the cumulative effect of changes in accounting principles for the fiscal year 2006, again, that margin was 41%, up from 25% for 2005. Again, the margin increase was mainly due to the benefit of the economy for scale for our business.

  • Full-year net operating cash flow and capital expenditures in 2006 were RMB526m and RMB128m respectively. Adjusted EBITDA was RMB382m in 2006, representing a 270% increase from 2005.

  • Now let me provide you our top-line guidance for the fiscal -- for the first quarter of 2007. As many of you know, our first quarter result tends to be affected by the seasonality from the long Chinese New Year holiday. In the first quarter of 2007, we currently expect total revenues to be between RMB265m and RMB275m, which would represent an annual growth of 95% to 103% respectively. I do wish to emphasize that this forecast reflects Baidu's current and preliminary view which is subject to change.

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

  • Robin Li - CEO

  • Thank you, Shawn. With our focus on tailoring online products to meet user needs and our commitment to making strategic investments for our future, we are confident that we will continue to lead the Chinese Internet search market and enjoy growth well into the future. I will now open the call to questions.

  • Operator

  • [OPERATOR INSTRUCTIONS]. And your first question comes from the line of Anthony Noto from Baidu (sic). Please proceed.

  • Anthony Noto - Analyst

  • Hi, it's Anthony Noto from Goldman Sachs. Robin and Shawn, I was wondering if you could comment on the growth of the overall industry and delineate for us, potentially, what you're seeing for the growth of the industry, vis-a-vis the slowdown that you may still be seeing from the unsophisticated advertisers and their desire to have to continue to increase their knowledge of how to bid under your new system. Thank you.

  • Robin Li - CEO

  • Yes. You probably know, we are the market leader in the paid search industry in China. We probably have over -- well over 50% in market share. So our growth rate pretty much represents the growth rate for the whole industry. Having said that, we don't exactly know how much revenue some of our competitors generate, but from all of the regions across China, what we heard is that we continue to be the dominant player in each of the Chinese provinces and cities. We do not think competition is a major threat at this point.

  • Anthony Noto - Analyst

  • Have you noticed an improvement in the ability of your unsophisticated advertisers to deal with the changes that you've made in monetization and minimum bids now versus what you said on the last two calls?

  • Robin Li - CEO

  • Yes, we did notice that many of the new advertisers, our customers do accept and appreciate the new system. As I discussed during the previous conference call last quarter, Q4 and this quarter will be a transition period for the company. There will be some churn for the customers. Some of the old customers who did not want to accept the new pricing policy may choose to leave. And so far we've found that we have no problem to attract new customers and new customers can very well accept the new monetization upgrades.

  • Shawn Wang - CFO

  • Anthony, if I just add a few -- one more point to Robin's explanation, I think we're also seeing a market where there tends to be a sophisticated presence, more presence of sophisticated advertisers, or whereas we have our customer service teams have been present for a longer period of time, which is providing a better service. We see in those areas, the transition is much smoother and is much better.

  • And that gave us the confidence. I think the key is in the customer service, is in the elevated -- the awareness among the Chinese advertisers, and I think that's a function of time.

  • Anthony Noto - Analyst

  • Great. Thank you.

  • Operator

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

  • Jason Brueschke - Analyst

  • Great, thank you. And good morning, Robin and Shawn. My question is similar along the thought lines of Anthony's.

  • You guys only grew your active new customers by about 6,000 in the quarter which is a deceleration in the rate of those new customers, at least active. Is this due to maybe the move away from your distributor network to your direct sales network, such that it might be temporary and you'll see a re-acceleration in that? Or is it maybe perhaps a reflection of the immaturity of the market?

  • And maybe perhaps if you could comment on it, whether there is an early adopter phenomenon that at 100, maybe 120,000, those are the early adopters in China that you may get to being close to penetrating that and, thus, we should expect to see, at least over the near term, maybe a continued either flat line or deceleration in the active new customers? Thanks.

  • Robin Li - CEO

  • Jason, I think it's a combination of both factors and they are inter-related. When we made the change in the monetization algorithms, the weakness in customer service was exposed. And, at the same time, we converted the basic market from distribution to direct sales. And that made things a little worse.

  • So all those factors combined, we saw some customer churn and we -- as I discussed in the prepared remarks, we have been improving the customer service function. We are building a stronger sales team in Beijing. So we see things are improving quite healthily.

  • And as Shawn pointed out earlier, for the more mature market, we see better reception of our new policy. And even for this holiday season we can see that the tier-one cities are less affected by the Chinese New Year holiday. That gives us confidence on the healthiness of this business and the paid search industry in China.

  • Jason Brueschke - Analyst

  • Great. Thank you. I'll just get back in the queue.

  • Operator

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

  • Robert Peck - Analyst

  • Yes, hi guys. I have a couple quick questions first. One, when we talk about the TAC rate we see it decreased about 30 bps sequentially. Could you talk to us a little bit about what you're seeing there with the growth rate of the union sites are versus the core?

  • And then number two, bigger picture, when we think about some of the new stuff you've done, the news license and some of the monetization capabilities there, could you give a little color around that and talk about does it affect your tax status at all? Thank you.

  • Shawn Wang - CFO

  • Okay. Well Bob, this is Shawn here. Let me give it a try. I think on your first question, how do we see the union development. It's very difficult to give a prediction of how this will evolve in the future. I think we can look back. What we have seen is both organic revenue as well as the union revenue has been increasing in [both] rapidly. And the form of the increase came from -- in a different avenue, so sometimes a new type of property, sometimes a new channel or sometimes it's related to our new products.

  • Some of the products we talked about in the previous calls were, for example, [talktisements], which was a behavioral type of advertising, and also the ProTheme, which is similar to a [compactual] ad type of advertisement.

  • So there has been experiment of different products and there also has been an expansion of types of properties that we included as our union. And we like to keep that flexibility in terms of broadening our range to more union websites -- union properties. And what we have managed to do in the past is grow [both] an organic union very rapidly.

  • Going forward, we will continue to explore the -- if there's opportunity on the union front we will do it, but it's hard to say exactly how -- will that be growing faster that the organic? Will it be slower? That is very difficult to say. So I'm not going to be able to give you a prediction to how the tax ratio to the revenue will fluctuate.

  • On the second question, if I understand correctly, you were talking about those new products we were doing and the grant of the news license, how is it going to affect our tax rate? Is that the question?

  • Robert Peck - Analyst

  • Yes, the modernization around the news license and then ultimately, does it affect your tax status?

  • Shawn Wang - CFO

  • Right. Let me leave the news license discussion to Robin to comment a little bit. But one thing I can tell you is we do not expect any changes on the tax rate because of all those new initiatives and new products.

  • Robert Peck - Analyst

  • Thanks Shawn.

  • Robin Li - CEO

  • Okay. With our news license we are now able to display news articles on the Baidu.com website instead of only providing search functions. And, more broadly, I think, Baidu is a very large website, actually the largest in the Chinese world. And over 50% of the traffic comes from now web search. We have been studying all kind of options to better monetize that part of the traffic. Right now some of the channels already display contextual ads from our P4P customer base but we think there are a lot of potentials for us to grow that revenue there.

  • Robert Peck - Analyst

  • Thanks Robin.

  • Operator

  • Your next question comes from the line of Paul Keung from CIBC World Markets. Please proceed.

  • Paul Keung - Analyst

  • Yes, hi. Good evening, Robin and Shawn. One quick question. You mentioned that the -- you tried to explain the transition of the advertisers. You mentioned it was smoother in some markets than over others. Are you able to maybe give us some differences in terms of how that growth has been, let's say, between tier-one and tier-two cities or between Beijing and some of your other cities?

  • Robin Li - CEO

  • We cannot to break down city by city and region by region. I can only discuss a general phenomenon that for the more mature markets, we are seeing better customer reception and better growth potential for the P4P service. As you know, that we transitioned the Beijing market from channel to direct and that will take some time to reaccelerate the growth in the Beijing market.

  • Paul Keung - Analyst

  • Can I -- what does -- okay. Okay, since you can't -- I have another question if you don't mind. The R&D spend, if you go back the last couple of years, obviously you tend to spend the most in the third quarter, a little less in the first, and the second and fourth tend to be a little flattish. Should we expect the same types of patterns next year on terms of how you're going to ratch your R&D spend through '07?

  • Robin Li - CEO

  • Yes, it will be similar. The reason that Q3 now has a higher R&D spending is because we hire mostly fresh graduates out of school, and they graduate in fall. They can only start in fall.

  • Paul Keung - Analyst

  • Okay, great. Thanks.

  • Operator

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

  • Richard Ji - Analyst

  • Hi Robin, Shawn. And the question regarding your direct sales force. You said you expanded your direct sales force in key regional markets, and other than Beijing, can you shed a little more color on what other markets you have ventured into and what are your future plans?

  • Robin Li - CEO

  • Okay. In addition to Beijing, we have direct sales forces in the city of Shanghai, Guangzhou, Dunhuang, [For Shan] and [Jiung Shan]. At this time we think we have a very good balance, distribution and direct. But going forward, we will continue to strengthen the direct sales force team if we find any region that the distributors are not doing so well, we may need to take necessary actions.

  • Richard Ji - Analyst

  • Yes, and my follow-up question is what is the, approximately, the churn rate for your existing customer after you changed your monetization [scheme] about a quarter ago?

  • Shawn Wang - CFO

  • Let me try to address that. I think -- again, Richard, it's very difficult for us. We do talk about customer chain. But the real fact is that our customers' spending were somewhat suspended. A part of our effort in increasing our focus on customer service is making sure that our customer service -- we reach out to these customers who always have a relationship with us and to help them to understand our service.

  • So it's really -- it's very misleading to define these customers who are -- may suspend or reduce some of the spending as churn customers. So it's hard for me to give you the statistics.

  • Richard Ji - Analyst

  • Okay. Yes. Thank you.

  • Operator

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

  • James Mitchell - Analyst

  • Hi. Thank you for taking my question. Could you just repeat what you said you'd be spending in Japan in 2007 and also break that down between what you'll be expensing through the profit statement and what you'll be capitalizing on the balance sheet? Thanks.

  • Robin Li - CEO

  • Shawn?

  • Shawn Wang - CFO

  • I'm sorry Jim, you're asking how much we plan to spend in 2007?

  • James Mitchell - Analyst

  • I think that in the preamble remarks you gave a figure for what you intended to spend in Japan.

  • Robin Li - CEO

  • 15m.

  • James Mitchell - Analyst

  • On 2007. Yes, 15m. That's which currency?

  • Shawn Wang - CFO

  • It's $15m. And that is discussed in the context of our estimated expenditure to be incurred in association with the Japanese initiative.

  • James Mitchell - Analyst

  • And how much of that would be expensed through the profit statement versus capitalized on the balance sheet?

  • Shawn Wang - CFO

  • I think that is discussed mostly in the context of P&L impact.

  • James Mitchell - Analyst

  • Okay, that's great. That fully answers my question. Thank you.

  • Operator

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

  • Wallace Cheung - Analyst

  • Hi. Morning, Shawn and Robin. Two quick questions. The first, again regarding Japan strategies, can you give us more details or at least can we understand what is the domain name that you have chosen?

  • Secondly is regarding your new media strategy, or your new live news reporting team. How much will be the increase in terms of a headcount or G&A expense? Thank you.

  • Robin Li - CEO

  • Okay. Regarding to Japan, the domain name will be baidu.jp. We have started the initiative roughly two or three quarters ago. But Japan is the more mature market and we need some time to do preparation, and we need to have patience to wait for the right time to monetize it. So right now all of our focus is on building the right team to execute, invest in the technology and infrastructure.

  • On the news reporting thing, we actually have not decided what to do on that front. For the past seven years in Baidu's full history, we actually try not to produce any content by ourselves. We rely on our users and other website owners to create content for us.

  • We understand that news is very important in the Chinese Internet landscape. So we already have a news service, largely oriented to search. We are currently evaluating all kinds of options to make our news service better, more user-friendly and make more impact in the Chinese news space -- online news space. But right now we have not decided how much to invest and whether we need to hire reporters and editors.

  • Wallace Cheung - Analyst

  • Okay. Thank you very much and Happy New Year.

  • Robin Li - CEO

  • Thank you.

  • Operator

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

  • Safa Rashtchy - Analyst

  • Hi. Good morning, Robin and Shawn. Just a couple quick questions. As the seasonality of Q1 this year is much more pronounced than in the past and hence your guidance of nearly flat revenues, how much of that do you think will be shifted to second quarter and how much do you think will be lost? And also I think [inaudible] sufficient for margins going forward, can you just repeat those, please?

  • Robin Li - CEO

  • Okay. Regarding to the seasonality, I think -- it's hard for us to give any guidance for Q2 at this time as it's kind of early. But I would say that the current guidance for Q1 reflects a true picture of both Baidu and the online advertising industry in China. If you look at the whole online advertising industry, you probably would reach a conclusion that sequentially it would be a down quarter from Q4 of last year.

  • Shawn, do you have anything to add?

  • Shawn Wang - CFO

  • No, I agree with you. I think it is difficult to say because we are dealing with over 100,000 small to medium-sized advertisers or online marketing customers. If you look at some of the existing, I guess, in the likes of -- those online advertising businesses that have a limited number of large customers, they tend to have a budget concept and then they move around a bit. But for us it's really a function of a large number of small businesses. And it's hard to use the concept of who is pushing budget into the next quarter or not.

  • But always, in the past we've seen the second quarter a much stronger pickup compared to the first quarter. Now the second question --.

  • Safa Rashtchy - Analyst

  • Go ahead, yes.

  • Shawn Wang - CFO

  • Safa, you did ask a second question. I wasn't very clear. You were asking a question regarding margins?

  • Safa Rashtchy - Analyst

  • Yes, because I thought, Shawn, in your opening comments you talked -- you gave some color on how we should look at margins going forward. I thought I missed it.

  • Shawn Wang - CFO

  • I don't think I gave any color on the margin going forward, other than what we discussed about our Japanese initiative.

  • Safa Rashtchy - Analyst

  • Okay. All right, thanks.

  • Operator

  • Your next question comes from the line of George Chu from UBS. Please proceed.

  • George Chu - Analyst

  • Good morning, Robin and Shawn. Just a question on the expenses side, in particular on the selling, general and administrative costs, (inaudible) expenses is flat on a Q-on-Q basis. I'm just curious, could you just give us some color on how that's going to be evolving in the future?

  • Is this an indication that you think you have sufficient [book] trends in China and the growth in these costs were moderate going forward, or do you think that at some point in time in the future, we're going to see a real acceleration of growth for this particular expense. Thank you.

  • Shawn Wang - CFO

  • Well George, I think that SG&A in the course of the past few consecutive quarters, the proportion of SG&A to revenue has been steadily declining, and that is a reflection of the leverage that is inherent in our business. But you mentioned about a bit of a a flattish increase this quarter compared to the previous quarter. I think that that number is somewhat -- you have to really -- excluding share base and compensation.

  • If I recall correctly, I think on a GAAP basis, that number increased less than 2%, SG&A compared to the third quarter. However, if you take away the share base and compensation expense, the increase was much more than that. Cash-based, the expense increase was close to 8%. So we will continue to expect the actual dollar amount to increase in the future quarters, and also we would expect the percentage of that to total revenue will -- I think it will continue to show the scalability.

  • George Chu - Analyst

  • Okay. Just, if I may just sneak in a quick follow-up question. On the TAC, the percentage, I think, is declining slowly or is down on a sequential basis. Could we take that as a sign that competition is using that as a way to buy traffic in China and that's affecting the number by the unit or that's affecting the percentage revenue sharing?

  • Robin Li - CEO

  • I think for tax rate it does fluctuate from quarter to quarter. In our view there is no material change in the percentage of revenue for TAC. We continue to believe that we have the strongest union system or alliance program in China's paid-search industry. And we are able to retain all of the key partners, common partners we have.

  • And, as I mentioned previously, we've signed a deal with Microsoft, including their affiliate with China Telecom on the syndication deal. So we do not see any increased pressure or threat from competition.

  • Shawn Wang - CFO

  • Just to add to that, I think our TAC ratio as a percentage of total revenue has been pretty much -- basically the same in the past few quarters. This quarter was 8.7%. The quarter before was 9%. And that's just a very small fluctuation.

  • George Chu - Analyst

  • Okay, thank you.

  • Operator

  • Your next question comes from the line of James Lee from WR Hambrecht. Please proceed.

  • James Lee - Analyst

  • Good morning. Robin, can you talk about maybe guidance into 1Q '07? Maybe give us a little more clarification, what do you think sort of the underlying changes to your customer accounts versus ASP that's implied by your guidance?

  • Robin Li - CEO

  • The ASP?

  • James Lee - Analyst

  • Yes. I was thinking, with your guidance pretty much flattish quarter over quarter, what should we read into in terms of customer accounts going from 4Q to 1Q versus ASP going from 4Q to 1Q?

  • Robin Li - CEO

  • Well, it's hard to quantify at this point. During the Chinese New Year, many of the customers choose to pause their advertising initiatives. That will lower the average spending per customer. And right after New Year we have about one month, or actually a little less than one month to attract new customers.

  • We do expect to have a strong March. However, when you combine January and February, the number of active customers could also be flattish. So it's hard for us to say which one contributes more, but I think both factors affected by the seasonality.

  • James Lee - Analyst

  • Okay. Is it fair to say that you expect the revenue driver to continue to be more from your existing customer base versus coming from your customer given the fact that 1Q is a [inaudible] quarter?

  • Robin Li - CEO

  • I think both will grow longer term. I think there are probably more potential in terms of average spending per customer as -- because our understanding is that the clicking price cost per click in China is much lower than the industry average in other markets. There are very few IT-related products or services. That's so cheap in China or so much cheaper in China than in other markets of the world.

  • James Lee - Analyst

  • Also Robin, you say you talk about you still experience some churn from smaller customers and small city in 4Q. Have you seen any activity from 1Q? Maybe some of the customers that churn away in 4Q coming back onto your platform because they experience inferior results from other search platforms?

  • Robin Li - CEO

  • Yes, we see a lot of customers coming back to us. That's very usual. Usually when some of the customers decide not to advertise with us, they may not even go to a competitor. They just stop doing paid search. That's because of the immaturity of the market. They just psychologically would not accept the new pricing policy, but they really cannot find any better alternative in this market.

  • James Lee - Analyst

  • Okay, great. Let me go back on the queue. Thanks.

  • Operator

  • As a reminder ladies and gentlemen, could you please limit your questions to one. Your next question comes from the line of Steve Weinstein from Pacific Crest. Please proceed.

  • Steve Weinstein - Analyst

  • Thank you. Just looking at your guidance, you're suggesting that there's potential for the rate of deceleration in the first quarter to actually be greater than it's been for the last several quarters. And understanding seasonal factors and understanding transitional issues with your sales force, do you think that that's nearing a bottoming in terms of the rate of deceleration? You would expect more -- is that the point we should be thinking of going forward?

  • Or do you think you can get some re-acceleration as you get your sales force aligned and you're not going against negative seasonal factors? Or would you expect to continue to step down in terms of growth as you progress through the year?

  • Then also I missed the CapEx that was spent in the quarter, if you could repeat that.

  • Robin Li - CEO

  • Yes, I think as I said before, for Q4 and Q1 would be our transitional period. After that we do expect stronger growth for the rest of year, not necessarily in absolute growth percentages, but relatively speaking I would think that we will see a better picture going forward.

  • Steve Weinstein - Analyst

  • Okay, thank you. And the CapEx in the quarter?

  • Robin Li - CEO

  • Shawn?

  • Shawn Wang - CFO

  • CapEx for Q1?

  • Steve Weinstein - Analyst

  • What was it for Q4? You said in the --.

  • Shawn Wang - CFO

  • Q4 was about 20 -- 20-something million. It basically remains at a similar level as the previous quarter. But I did mention that a CapEx for '07, we would expect a very significant pickup in '07 as we will be upgrading our network capacity and also building our campuses in '07.

  • Steve Weinstein - Analyst

  • Okay. Thank you.

  • Operator

  • Your next question is a follow-up question from the line of Anthony Noto from Goldman Sachs. Please proceed, sir. Mr. Noto, your line is open.

  • Anthony Noto - Analyst

  • Thank you. Shawn, I had a follow-up question on operating margins. The December quarter operating margin, excluding stock-based compensation, was 40%. And I'm just trying to get a sense -- I know you're not guiding to margins specifically for 2007, but you did give a sense for the $15m that you'll spend in Japan that will flow through the P&L.

  • There's one way to think about the methodology to come up with a forecast aligned with what you said, is to think that you're at a 40% margin ending December 2006. And you've been able to really achieve about 200 basis points of margin expansion in each quarter. So if you flow out that trend through 2007 in China and then layer on top of that a $15m hit, that you'd come up with about the operating margin in the range of what you'd be expecting without specific guidance?

  • Shawn Wang - CFO

  • Well, Anthony, I can't -- I think the math is pretty straightforward. That will give expense. And I think in terms of how that -- the amount will be allocated in each quarter, that is really depending on how we are progressing in some of the detailed operational matters. It's really hard to see how it's going to affect each quarter. But on a year-over-year basis, that's going to be an expense and it will be the actual investment in a long-term international strategy.

  • Anthony Noto - Analyst

  • Maybe the better way for me to ask it is would your margin -- operating margin in '07, excluding Japan, be up on the order of magnitude of 400 to 500 basis points in '07 for the full year and then obviously it's offset by that?

  • Shawn Wang - CFO

  • Okay, well let's take -- if we take the Japan factor on outside the equation, we haven't seen anything that would suggest a change to our pattern in the recent quarters. We've seen revenue growth and investment in various aspects -- in CapEx and in sales and distribution network. And all this investment has been fairly aggressive, but the scalability in our business has been strong. And I think that that theme will continue if we take the Japanese factor away from the equation.

  • Anthony Noto - Analyst

  • Okay, great. Thanks.

  • Operator

  • Your next question comes from the line of Ming Zhao from Susquehanna Financial Group. Please proceed.

  • Ming Zhao - Analyst

  • Thank you. Good morning, Robin and Shawn. Just a question on your community products. The question is how are you going to monetize that? I think that people think about contextual ads and the branded advertising. So if you could, could you break down your revenue, Q4 revenue, and how much of that is already coming from the contextual ad and the branded ad? Thank you.

  • Robin Li - CEO

  • For the community oriented products and services it's -- excuse me -- the contribution -- revenue contribution is still very small as a percentage of total revenue, so I don't think we need to break down in terms of branding ads and the contextual ads.

  • As I said before, we are still experimenting all kinds of possibilities to better monetize the traffic. We have lots of traffic related to community and other type of searches. And the growth is very nice. We see a lot of growth potential in terms of [pay view] and user and reach. But we just need to figure out how to monetize the traffic better.

  • Ming Zhao - Analyst

  • Yes, but for the past few quarters do you see the contextual ad becoming a meaningful product in the next couple of quarters?

  • Robin Li - CEO

  • It is meaningful. It's got a very good growth trajectory. But it's small, percentage-wise.

  • Ming Zhao - Analyst

  • Okay, thank you.

  • Operator

  • Your next question comes from the line of Tony Kim from Artisan Partners. Please proceed.

  • Tony Kim - Analyst

  • Hi guys. Most of my questions are answered but I'm just wondering, on -- just for Japan when I look at the Japan spending, is that -- how would you look at that? Is it more back-end loaded or front-end loaded, because that's a pretty big number from what you guys are planning on?

  • And secondly, just on -- I just wanted the CapEx again was -- can you clarify what that number was and what was the depreciation?

  • Shawn Wang - CFO

  • Tony, I think I mentioned it earlier, it's fairly difficult to really allocate the total number in the different quarters as we are still going through the exercises. So I will probably [inaudible].

  • Tony Kim - Analyst

  • Okay. Can I ask something else on Japan then? You said you started the investment two or three quarters ago. Was that a material amount or was that really just kind of --?

  • Shawn Wang - CFO

  • No, it wasn't material what was done in the past. I think there was a limited amount of investment. I think it was mostly from the [people] side, but it doesn't really show up in a material amount in terms of dollar amount.

  • But, going forward, we will be [viewing] our networks. We will be hiring folks on the ground. We will be incurring operation expenditures. That's -- I think that's where the dollar amount will kick in. That's what we talked about the 15m for 2007.

  • Tony Kim - Analyst

  • Okay. And then the CapEx. What was the full CapEx for the year in '06?

  • Shawn Wang - CFO

  • The CapEx for the full year, let me give you the number.

  • Tony Kim - Analyst

  • And the D&A as well.

  • Shawn Wang - CFO

  • Yes, it's close to about RMB130m for the whole -- that's '06. In '07, we do expect a significant increase in that because we -- we're at the moment that we're very confident, and I think that again, it's time to make investment.

  • Tony Kim - Analyst

  • No, I understand. And what do you see as eventually the normalized tax rate? You had the tax credit this quarter, but what's kind of the normalized tax level going forward?

  • Shawn Wang - CFO

  • Well, I think the question was asked before. I think my answer was it will be high single digit or close to 10. That was in the previous quarters. I think last quarter we did receive a qualified status for one of our major subsidiaries. I think we take that factor into consideration. We're looking at our effective tax rate in the next few quarters to be in the range between 5 to -- mid to high single digit. I think that's what we're talking about.

  • Tony Kim - Analyst

  • And just finally, Japan. The hiring and stuff, is that more going to be in China to build out the database or will it also include -- kind of be on the street in Japan?

  • Robin Li - CEO

  • We are hiring both in Japan and in China. In terms of operation, I think eventually all of the operation will be localized. We do plan to place servers in Japan.

  • Tony Kim - Analyst

  • Thank you so much.

  • Operator

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

  • Jason Brueschke - Analyst

  • Thank you. Two quick follow-up questions. First of all, could you give us more color on your strategy to differentiate yourself in the market in Japan? Unlike China where you have been the market leader practically since day one and people have been playing catch-up, those rules seem a little bit reversed in Japan.

  • And then the second question would be, with respect to your push more into the news offering and monetizing some of the community, would you guys consider doing any M&A to beef up either your capabilities there or just your market share in and around the brand advertising area? Thanks.

  • Robin Li - CEO

  • Okay. Regarding to Japan, let me tell you this. Baidu was not number one in China from day-one. We actually started quite late, later than probably most of the Chinese search players you hear on the market right now. So we are familiar with how you play catch-up game.

  • We have been doing all kinds of studies for a few quarters, but it's still too early for us to say what exactly we will do better or different from the other players in the Japanese search industry. As time passes by, I think we will have more to talk about.

  • In terms of news and community, it's the same strategy as our other businesses. We are open to all kinds of possibilities, including management, acquisition, etc. But at this time there's nothing material we can talk about.

  • Jason Brueschke - Analyst

  • Great. Thank you.

  • Operator

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

  • Robert Peck - Analyst

  • Yes, I was wondering if you could give us a little more color around some of your content relationships, particularly with the new deal with EMI. Do you foresee seeing a bunch of those types of deals going forward and how you view video contact rights going forward as well? Thanks.

  • Robin Li - CEO

  • Well, we believe that the future for digital music is in an ad-supported media business. So we've been pushing this concept for quite a few quarters. We actually signed up more than 20 record companies to support our initiative, mostly domestic record companies. EMI was the first major international record label to work with us on an ad-supported strategy, digital music strategy. And, in fact, they have the largest market share in China for Chinese music.

  • So we are quite optimistic about the future of this kind of partnership. Although it may take a few years to really become a significant business, we do believe that's the future. Video content is, as even in an earlier stage in China, we do see a lot of interest, and we do believe in the future of online video. But in terms of monetization, I think it will take longer.

  • Operator

  • Your next question comes from the line of Paul Kim from CIBC World Markets. Please proceed.

  • Murray Vesch - Analyst

  • Hi. This is [Murray Vesch] calling for Paul. Google just announced a mobile search deal with China Mobile, and I was wondering if you could talk about Baidu's mobile search strategy going forward and if you are looking at any partnerships.

  • Robin Li - CEO

  • Well, we are also optimistic about the future of mobile search. We have been closely monitoring the progress in this space. We believe we have a very good understanding of the current situation of mobile Internet.

  • We believe in the future things could change very dramatically, so we are -- have been working on a number of mobile-related products, including the web search, the community-oriented products. We have web versions for many of our existing services. But I think it's too early to say who we would partner and under what kind of arrangements. We just think it will take some time to gear up in the mobile search landscape.

  • Murray Vesch - Analyst

  • Thank you.

  • Operator

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

  • Robin Li - CEO

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

  • Shawn Wang - CFO

  • And Happy Chinese New Year to you all.

  • Operator

  • Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.