百度 (BIDU) 2007 Q3 法說會逐字稿

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  • Operator

  • Thank you for standing by for the Baidu third quarter 2007 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 objections, you may disconnect at this time.

  • I would now like to turn the meeting over to your hosts for today's conference, Lynn Lin, Baidu Investor Relations.

  • Lynn Lin - IR

  • Hello, everyone.

  • Welcome to Baidu's third quarter 2007 earnings conference call.

  • We distributed out third quarter earnings earlier today.

  • You may find a copy of the press release on the company's website as well as newswire 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 provisions of the US Private Securities Litigation Reform Act of 1995.

  • Baidu does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

  • As a reminder, this conference is being recorded.

  • In addition, a webcast of this conference call will be available on Baidu's corporate website at ir.baidu.com.

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

  • Robin Li - CEO

  • Hello, everyone, and thank you for joining us today.

  • I am pleased to report another solid quarter of growth, as revenues grow 107% year over year.

  • Our positive result was driven by our industry-leading online search service, and search-related products.

  • In the quarter, we continued our focus on working hard to know our users and staying ahead of the trends.

  • This is why Baidu search continues to be the market leader by a wide margin, and our innovative community-based and entertainment products are becoming major drivers of user traffic in their own right.

  • During the quarter, we launched several new products.

  • Some of these include the Olympic Channel, the Game Channel, and Baidu TV, a new form of advertising which we are offering to our Union members.

  • This joins our already established list of products such as Baidu Knows and Baidu Space, which continue to grow in popularity.

  • Our focus on providing the best customer service continues to show strong returns.

  • We added 13,000 new active online marketing customers during the quarter.

  • This brings the total to 143,000, and spending per online marketing customer increased 11% quarter over quarter to RMB3500.

  • We continue to build our reputation as the advertiser of choice for SMEs, and during the quarter we began to more aggressively target larger advertisers.

  • Both SMEs and larger businesses in China are realizing the outstanding ally of their spending in paid search.

  • So we expect spending per online marketing customer to continue to trend upward.

  • As you know, we have been transitioning SME sales and services from third-party distributors to direct sales in selected major markets.

  • We have already completed this in Beijing, and in Shenzhen, the transition is progressing on plan.

  • Our focus on technology also continues to pay off.

  • We are continuously improving our paid search platform, and search relevance, and we will keep investing in R&D and hiring top engineering talent.

  • Next year, we also plan to build our R&D capacity in Beijing and Tokyo - in Shanghai and Tokyo.

  • Our exciting service we recently announced is our first e-commerce initiative.

  • This will initially be a consumer to consumer platform.

  • According to our research, 49% of China's current C2C users conducted searches before visiting e-commerce sites.

  • So Baidu's high search traffic and large online community will be an enormous advantage.

  • We expect to launch the initiative in 2008 and will have updates as we move forward in the development process.

  • Also new to this quarter is our partnership with Rock Music Group to build an online music streaming service.

  • The advertising-supported platform will give our users reach of new content, and give online advertisers a powerful marketing tool.

  • Our Japan initiative is also progressing according to plan, and we remain on track to launch officially before the end of the year.

  • The search market in China is developing rapidly, and in the third quarter, we continued to expand our leading market share.

  • Today, according to the China Internet Network Information Center, Baidu is the first choice for nearly 75% of Chinese search users.

  • And we will keep working to innovate and understand user needs.

  • I am confident that this is the right strategy to keep us going and well ahead of the competition.

  • I will now turn the call over to Shawn to go over our financials.

  • Shawn Wang - CFO

  • Thank you Robin.

  • Hello, everyone.

  • As Robin mentioned earlier, we delivered solid revenues and earnings results in the third quarter.

  • I will now walk you through the factors contributing to these results and other financial highlights.

  • Revenue meeting guidance.

  • Our third quarter total revenues were approximately RMB497 million for the quarter.

  • That is a 107% increase from the year ago period.

  • Online marketing revenues were RMB496 million, representing 24% growth sequentially, and 109% growth, year over year.

  • Growth here was driven by a number of factors, including increased traffic, a sequential increase in the number of active customers of 12%, as well as a sequential increase in per-customer spending of 11%.

  • Traffic acquisition costs, as a component of cost of revenues, was RMB59 million, representing 12% of total revenues, compared to 9% to the corresponding period of 2006.

  • The increase in TAC as a percentage of total revenues primarily reflects the continued growth of revenue contribution from Baidu Union members.

  • Bandwidth costs, as a component of costs of revenue, was RMB32 million, representing 6% of total revenues, compared to 4% in the third quarter of 2006.

  • Depreciation costs as a cost of revenue was RMB41 million, representing 8% of total revenues, compared to 6% in the corresponding period of 2006.

  • The increase of bandwidth and depreciation costs as a percentage of total revenues reflect expansion of network capacity to support Baidu's long-term growth.

  • Our share-based compensation expenses, which were allocated to related operating costs and expenses items, decreased, in aggregate, to RMB5 million in the third quarter of 2007 from the corresponding period in 2006.

  • Selling, general, and administrative expenses were RMB110 million, up 57 from the year ago period, Primarily due to expansion of the direct sales force.

  • R&D expenses were RMB37 million, representing a 53% increase from the year ago period.

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

  • During the third fiscal quarter, Baidu Japan incurred operating costs and expenses of RMB20 million in aggregate.

  • The income tax expenses for the quarter was approximately RMB3 million.

  • Our earnings.

  • Net income was RMB182 million, representing 113% increase year over year.

  • Net income excluding share-based compensation expenses, a non-GAAP measure, was RMB187 million, representing an 84% increase from the corresponding period of 2006.

  • Basic and diluted EPS, excluding share-based compensation expenses, also a non-GAAP measure, were RMB5.51 and RMB5.38, translating roughly to $0.74 and $0.72 in US dollars, respectively.

  • Now, moving on to the balance sheet.

  • We ended the third quarter with cash, cash equivalents, and short-term investments, of RMB1.4 billion.

  • Operating cash flow was RMB255 million.

  • Capital expenditure for the third quarter was RMB150 million, primarily focused on capacity expansion and Baidu campus building.

  • Adjusted EBITDA, again a non-GAAP measure, was RMB223 million, representing a 99% increase year over year.

  • Now let me provide you our top line guidance for the fourth quarter of 2007.

  • We currently expect total revenues to be between RMB560 million and RMB575 million, which would represent an annual growth of 106% to 112% and a sequential growth of 13% to 16%.

  • Allow me to emphasize that this forecast reflects Baidu's current and preliminary review, which is subject to change.

  • I will now open the call to questions.

  • Operator

  • (OPERATOR INSTRUCTIONS).

  • Your first question comes from the line of Dick Wei with JPMorgan.

  • Please proceed.

  • Dick Wei - Analyst

  • Hi, good morning, Robin and Shawn.

  • Just questions regarding some of the news on the Internet data center in Shenzhen in September and October time frame.

  • I wonder if you can quantify if there is any impact on your Baidu Union traffic, as well as how long do you think those impacts are going to last.

  • And I guess the last part of it is have you factored those in, how much have you factored in those in your guidance for this quarter.

  • Thanks.

  • Robin Li - CEO

  • Hi, Dick.

  • This is Robin.

  • Yes, there were some shutdowns in some of the data centers during September and October, but it is really hard for us to quantify the damage that caused to us.

  • It not only affected the Union traffic, it also actually affected our organic traffic.

  • Because when you have some websites unreachable, it will actually discourage people from searching on the internet.

  • But our traffic is decided by a very sophisticated number of factors, so it's very hard for us to quantify.

  • I wouldn't perceive that that had caused any material impact on our revenue here in Q3 and guidance in Q4.

  • Dick Wei - Analyst

  • Okay, great.

  • Thanks Robin.

  • Operator

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

  • Please proceed.

  • Megan Barker - Analyst

  • Hi, it's Megan Barker on for Anthony.

  • You spent $6.5 million on the Japan initiative so far this year.

  • And I think the original plan was for about $15 million.

  • Can you just discuss how we should be thinking about that for the fourth quarter, and then into 2008?

  • And then also, just a quick housekeeping question - how should we be thinking about the tax rate going forward?

  • Thanks.

  • Shawn Wang - CFO

  • On the Japan initiative, I think we provided our guidance saying now that the first year we expect to have the P&L impact of up to $15 million for the first year of our initiative in Japan.

  • Yes, three quarters went by, we have incurred less than, slightly less than $7 million up to now.

  • But we are looking to launch our product services in the last quarter, so we would expect a bigger increase in the fourth quarter.

  • As this is only the beginning of the fourth quarter, and our actual launching plan is being finalized, so I can't give you an exact quantity.

  • However, I will still stay with the statement that will be our first year expenses related to Japan will be still up to $15 million US.

  • On the second question, the tax rates - a number of our entities in China are still under a tax holiday, which gives us relatively low single-digit income tax rates.

  • Going forward, I think in the near term, in the coming year, I think we will still enjoy some preferential tax rates, but beyond that, as some of the entities' tax holiday start to expire, and as partial to the benefit we receive, we have to - there will be, it will be cancelled.

  • When that comes, I expect our tax rate, in the meantime, in the next 2-3 years will still be in the single digits.

  • As to even longer term, as you know that China's tax regime is undergoing pretty substantive reforms, and there's been some new tax rules that have been issued -- but implementation guidance has not become available.

  • So we'll keep a very close eye on those matters and when the situation becomes clear, we will provide you with more detail.

  • Megan Barker - Analyst

  • Great.

  • Thank you.

  • Operator

  • Your next question comes from the line of Jason Brueschke with Citi Investment Research.

  • Please proceed.

  • Jason Brueschke - Analyst

  • Thank you, and good morning, Robin and Shawn.

  • My question is about the planned launch of the C2C platform as you call it.

  • A couple of questions around this - is this going to be a separate auction site similar to Tao Bao?

  • Or is it going to be more of a kind of packaging of your existing search services in targeting, power users that might be using C2C?

  • If it is the former, that you're going to have a formal site, can you help us understand how you plan to compete with Tao Bao given the fact that it is the dominant player, it's private, it doesn't have to make quarterly earnings, and the parent group is probably going to pick up about $1 billion in cash here from a spinoff of one of its listcos.

  • And then, finally, to the extent that you may be competing with that, could you maybe help us understand how much advertising does Tao Bao and the other auction sites like Paipai -- how much does it put on your paid search site today?

  • And will you be basically cutting those competitors off so that you can have some kind of competitive advantage in the market and what would be the impact to your revenues if you were to cut eBay or Taobao or Paipai off?

  • Thanks.

  • Shawn Wang - CFO

  • As we announced before we are going to launch C2C auction-like platform next year.

  • We already have a separate team working on the product development.

  • Whether it's going to be under a different domain name or under the Baidu domain, we have not decided.

  • But it's going to be a relatively independent service, just like Baidu News Search or Baidu MP3Search.

  • It's going to be one of the services that Baidu offers.

  • Because it's got a strong relationship with product search, we believe that we can save lots of marketing dollars by leveraging our dominant position in the search market.

  • Right now, Paipai does not advertise with us; they probably never did, and Taobao is still a customer of ours.

  • If they are willing to spend money on our platform, we welcome them to do so.

  • We'd like to compete on a fair basis.

  • We'd like to build an equally good or better service for the consumers who'd like to shop online.

  • We've studied a number of markets including Japan, Korea, US and China, and we've found that in some markets you can support two C2C sites like Korea.

  • In some markets, the dominant portal and search player has the leading C2C service.

  • And in some markets like China, you have a latecomer, Taobao, who can overtake a early mover in a relatively short term.

  • So we think that in the Chinese e-commerce market at such an early stage, we still have lots of opportunities to work out a site that is going to be better and will serve our users' shopping needs.

  • Jason Brueschke - Analyst

  • Great.

  • Thank you.

  • I appreciate that.

  • Operator

  • As a reminder, ladies and gentlemen, we will take one question at a time from each caller.

  • If you have more than one question, please request to join the question queue again.

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

  • Please proceed.

  • Robert Peck - Analyst

  • Shawn, I was wondering - there were reports during the quarter that some of your competitors may have had traffic redirected.

  • And I was curious if you could quantify for us if first of all did it happen?

  • Did you see any impact in 3Q or maybe any continuing impact that is occurring right now in 4Q?

  • Thanks.

  • Robin Li - CEO

  • Hi.

  • This is Robin.

  • Let me take on this question.

  • We learned that event from the media.

  • Then we immediately went back to our traffic statistics.

  • We did not see any change in our traffic patterns.

  • So there was no impact on our traffic revenue whatsoever.

  • Operator

  • The next question comes from the line of Steven Weinstein with Pacific Crest.

  • Please proceed.

  • Steve Weinstein - Analyst

  • Thank you for taking my question.

  • I was hoping to get a little better understanding of the investment in Japan.

  • In the quarter, how did that really flow throughout the P&L?

  • Where were we seeing that $2.7 million?

  • And how much investment are you planning to make in '08?

  • Where are we going to see those investments on the P&L?

  • How is that going to change as you ramp up there?

  • Shawn Wang - CFO

  • A large amount of the - Steven, this is Shawn here - a large amount of the Japan expenses at this stage are related to bandwidth and capacity depreciation.

  • And to a lesser degree, that is reflected in our G&A expenses.

  • Going forward, as we plan to build out an R&D center in Japan, so we will have some amount of R&D expenses that relate to Japan as well.

  • So I would expect that the predominant portion will still be the bandwidth and depreciation of servers.

  • Steve Weinstein - Analyst

  • Great, thank you.

  • Operator

  • The next question comes from the line of Ming Zhao with SIG.

  • Ming Zhao - Analyst

  • Thank you for taking my question.

  • I have a question on the Baidu TV.

  • When do you think we can see some meaningful revenue on this new product?

  • And if that happens, would you be able to possibly break down the line between branded advertising and search?

  • And if you could also update us on how is the brand advertising doing right now?

  • That's my question.

  • Shawn Wang - CFO

  • Ming, this is Shawn here.

  • Baidu TV is a product we launched fairly and I think the programs initially were well-received by both the advertisers and the various advertising agencies.

  • We have been setting up various distribution agreements with agencies.

  • As to the actual revenue generating, I think we're still at a very early stage.

  • I'm not going to give you an expectation that in the short term there will be a very significant revenue stream coming from that.

  • It is something that we're pioneering and we're really bridging the traditional TV advertising, bringing them into the Internet world.

  • I think it's a process that requires a line shift, so we are in the process of doing that.

  • And as to whether going forward we will separately disclose that, it's still one form of advertising on the Internet, the nature of which is drastically different from what we offer today.

  • So we do not have a plan to, at this moment to separately disclose the product, the information on that.

  • Your second question is how are we doing, in general, on branded advertising?

  • I think if we continue our momentum with our tailored solutions business -- as Robin mentioned earlier, we're focusing very much on serving the large customers.

  • The large customer needs, often comes in both on paid search and also on some portion of the branded advertising.

  • I think Baidu's unique strength is being able to provide both.

  • It has given us a strong momentum to grow our branded advertising as well.

  • I'm happy with how we've been doing in that regard.

  • Operator

  • Your next question comes from the line of Stephen Ju of RBC Capital Markets.

  • Please proceed.

  • Stephen Ju - Analyst

  • Good morning, Robin and Shawn.

  • CapEx in the third quarter was a bit more aggressive than we thought.

  • How much of the CapEx was for capacity expansion and how much was toward the new campus?

  • And what do you expect the CapEx to do in the near future?

  • Thank you.

  • Shawn Wang - CFO

  • Stephen, that is actually a good question.

  • Now we are in the process of building the Baidu campus -- and we actually started digging the grounds during the third quarter.

  • And so, we started to incur a substantial amount of building-related CapEx.

  • The building is, we are currently looking to or expect to complete that building process early part of 2009.

  • So either between now and the early part of 2009 I think there will be a substantial amount of CapEx to be incurred.

  • For this particular quarter, the third quarter, there was approximately RMB150 million CapEx and one-third of that relates to Baidu building.

  • So if you purely look at the capacity servers and network equipments, Q3 actually stays at the same level of Q2, which was approximately RMB100 million.

  • Operator

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

  • Please proceed.

  • Wallace Cheung - Analyst

  • I just wanted to ask a question about the traffic acquisition costs.

  • It seems to me that as a percentage of the total revenue it is going up.

  • Can you comment a bit about the trend in the next few quarters?

  • Thank you.

  • Shawn Wang - CFO

  • Wallace, the TAC, did you ask if the TAC was going down?

  • Wallace Cheung - Analyst

  • Oh no, as a percentage of the total revenue, the TAC is actually going up?

  • Shawn Wang - CFO

  • There has been a slight going up on a fairly consistent basis in the past few quarters.

  • As I mentioned during the prepared remarks, the TAC increase is largely a reflection of Baidu's strengths in our Union network.

  • We have been able to generate strong Union revenues, which are contributing to our revenue and I think the TAC increase reflected that.

  • Going forward, I think we would like to keep the flexibility of striking sensible deals knowing where was meaningful traffic when we acquire them, as long as the contribution from their bottom line is positive.

  • I think our strategy has worked well in the past and we'll continue to pursue that direction.

  • However, if traffic acquisition doesn't make economic sense, we would not touch that.

  • On this particular point, I think I also wanted to emphasize in the past quarter we have started basically an organizational effort with our Union, basically strengthening the management of our Union network.

  • You know putting our Union members in different brackets and having a different level of members and different certifications and making sure that our Union members are being well organized and well rewarded in the meantime.

  • That doesn't necessarily mean there is any increase, any mature increase in the payout ratio.

  • But I think it does reflect improved management, strengthening of management of our Union network.

  • Wallace Cheung - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Gene Munster with Piper Jaffray.

  • Please proceed.

  • Gene Munster - Analyst

  • Good morning.

  • Shawn, you talked a little bit about the CapEx spending, and I know that when we look at the Baidu model there's definitely some operating margin expansion over the next several years.

  • How should we think about the OpEx expansion at least generically and the context of some of your bringing more sales in direct and creating R&D centers and the like?

  • Shawn Wang - CFO

  • Well, the CapEx -- first of all, let me take the easy one.

  • The expansion of the direct sales forces doesn't really affect CapEx any.

  • I think mostly what's affecting CapEx in the near-term will be our network capacity as well as our Baidu building.

  • I think our Baidu building between now and 2009, we are looking to incur, my estimate at this time is probably $60 million to $70 million or so, given that the construction is still in progress.

  • So that would be a very big chunk of our CapEx.

  • But this CapEx is really for the long-term; our building's land use right is about 70 years.

  • So there is a really long-term CapEx and that's what we're looking at.

  • We all know how the real estate prices have been appreciating in China so we think we have a great deal going.

  • The general network capacity CapEx extension, and that's a function of many different things, our traffic and our products that we're putting out up online, I think I have to follow our usual practice of not providing guidance on these numbers.

  • Gene Munster - Analyst

  • Again, just to be clear on my question, I was talking about the operating margin expansion potential and just wondering should we think of this as - or how should we even think about it?

  • Because my fear is that as your revenue keeps going up, people are going to start to kind of run away with their expectations as far how the operating margin leverage is going to come.

  • So maybe just talk with us about, you talked about Japan, are there any other factors that are going to be limiting to you having meaningful operating margin expansion in 2008?

  • Shawn Wang - CFO

  • Sorry, Gene, I missed your question.

  • Let me try again.

  • I think one thing fundamentally that you have to recognize is that we have a very strong, solid search business, and it's highly leverageable, it's very - it's giving us a strong revenue growth, as well as margin expansion on that.

  • At the same time, the search market in China, or the Internet, or e-commerce in general in China, is at a very early stage.

  • And I think there are many opportunities we see, and particularly, given our leadership in traffic in China, and our strong brand in China, there are things that we have to do to capture the long-term growth potential.

  • And I think -- we keep on saying this, and I will repeat this again, that when we run our business, we really look at the long term.

  • So if the people are shooting the short-term margin target as a measure of making an investment in Baidu, I think that's probably missing the big picture.

  • Gene Munster - Analyst

  • Great.

  • Thank you.

  • Operator

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

  • Please proceed.

  • James Mitchell - Analyst

  • Just following up on Jason's question, I wanted to confirm your C2C project will be similar to Yahoo!

  • Japan, in that you will actually host storefronts, rather than just being a service through providing storefronts.

  • If that is the case, do you see any risk that sellers might choose to create free storefronts on e-commerce sites, rather than buying key words on your search engine?

  • Robin Li - CEO

  • I am not quite clear on what the conflict has been between buying a keyword and opening storefronts on our C2C platform.

  • I think in most cases, opening a store online on our C2C platform is free.

  • We will figure out a way to charge money later on, when we have enough number of transactions going on, on the platform.

  • James Mitchell - Analyst

  • Okay.

  • Great.

  • Operator

  • Your next question comes from the line of Dick Wei with JPMorgan.

  • Please proceed.

  • Dick Wei - Analyst

  • Can you give an update on the Shenzhen distributor transition, and how long would it take?

  • And any other plans for other cities as well?

  • Thanks.

  • Shawn Wang - CFO

  • Dick, it's Shawn again.

  • The transition in Shenzhen is still underway.

  • The approach we are taking is on one side, we tried to build our direct sales presence.

  • At the same time, we talk to our distributors and try to transition the existing customers to our direct sales force and direct customer service force, and that process is ongoing.

  • We would expect to wrap that up by the end of the year.

  • But having said that, again, I think I mentioned before that whenever we try to make this transition from a third party to direct sales, it generally takes up to a year, three quarters to four quarters, to have the full impact be felt.

  • Dick Wei - Analyst

  • Is that part of the reason also that your third quarter number is slightly below the midpoint of the guidance?

  • Was it one of the main issues or was that the data center issue?

  • Shawn Wang - CFO

  • Well, I think like Robin mentioned earlier, just take these kind of data center issues, these things are hard to quantify.

  • There are many different things that happened this summer, expected and some are not expected.

  • It's really hard to quantify each.

  • But I think in the aggregate when we look at our overall business, I think we are within the range of the guidance and I think some of the unexpected events are just a fact of life.

  • Dick Wei - Analyst

  • Great.

  • Thanks.

  • Operator

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

  • Please proceed.

  • Steve Weinstein - Analyst

  • I'm sorry -- I think I just missed it when you were talking about expectations for tax rates going forward.

  • Did you say they were going to be single-digit in 2008?

  • Shawn Wang - CFO

  • Yes, I believe so.

  • Steve Weinstein - Analyst

  • Okay.

  • Thank you.

  • Operator

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

  • Please proceed.

  • Wallace Cheung - Analyst

  • Sorry -- this new product that you anticipate launching, the Game Channel, can you talk a bit about the business model of this product?

  • Robin Li - CEO

  • Yes, as you probably know, gaming is a very large market in China and a lot of companies make very significant profits from offering online games, and the marketing of those games has become a big deal.

  • We have the largest website in China, of course, that attracts lots of users who have this kind of need.

  • Offering a game channel will help direct our users to games they are interested in and help to attract advertising spending from the game providers.

  • That's the basic goal or the disposition of our Game Channel.

  • It's a relatively simple search-like site.

  • Basically you can search for all kind of games in our Game Channel search box.

  • Wallace Cheung - Analyst

  • So basically it's a sort of like a sponsorship or self-advertising kind of site, that if someone wants to promote the game, they would be a priority kind of search?

  • Robin Li - CEO

  • Well it's a combination of content and soft advertising.

  • Wallace Cheung - Analyst

  • Thank you.

  • Robin Li - CEO

  • Okay.

  • Operator

  • Your next question comes from the line of Stephen Ju with RBC Capital Markets.

  • Please proceed.

  • Stephen Ju - Analyst

  • I'm still trying to understand the decision to enter the C2C commerce market.

  • Is it a fair characterization to think that your decision to enter that market resulted from your interactions with your SME clients and you saw the opportunity to upsell additional products to them?

  • Robin Li - CEO

  • Not really.

  • It's more about our observation on the user query.

  • We see a lot of users coming to our site looking for product-related information and also, I believe, most of the outside traffic from the e-commerce side comes from the search engine.

  • We see great synergy between our search service and a C2C auction site.

  • That's why we are going to offer these kind of services.

  • Stephen Ju - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Gene Munster with Piper Jaffray.

  • Please proceed.

  • Gene Munster - Analyst

  • Robin, if you could -- back on the C2C site, you mentioned it could be a stand alone or it could be internal.

  • So, if you look at for example Google and some of their product sites, it's kind of embedded within the Google site.

  • Is that how we should be thinking about it?

  • Or we shouldn't be thinking anything about it; you guys will tell us in the future?

  • Robin Li - CEO

  • Like I mentioned before, we haven't made the decision yet whether to have a separate domain.

  • But it's going to be integrated into the Baidu service platform.

  • It's just like we are offering web search.

  • We are offering news search.

  • We're offering knowledge search.

  • Now we're offering a C2C platform.

  • When people want to shop, they can search on that platform.

  • So I personally don't think there's not much difference between a separate brand and an integrated service under Baidu.com.

  • Gene Munster - Analyst

  • Thank you.

  • Operator

  • The next question comes from the line of Dick Wei with JPMorgan.

  • Please proceed.

  • Dick Wei - Analyst

  • Hi.

  • Thanks for taking my questions again.

  • My question is on the deferred revenue.

  • Since the end of the third quarter, deferred revenues are up around 27% quarter over quarter and if the revenue particularly has some decent relationship with your next quarter growth and I guess, given your guidance around the mid-teens level, I don't know if that is guiding more conservatively or if there are some changes in the customer deposit policy in the quarter?

  • Shawn Wang - CFO

  • Dick, deferred revenue is different from customer deposit.

  • Let me explain, there are a couple of categories.

  • Customer deposit is a straightforward for fee business, where an advertiser would pay us upfront and buy keywords.

  • These are what we call the customer deposits.

  • Deferred revenue tends to be the tailored solution customers.

  • When we recognize revenue for these large spending advertisers, we have to customize the contract.

  • Sometimes the contract approval process takes longer.

  • It may be the time where finally when we got the contract, the payment has been delayed and the ad has already been shown.

  • In which event, we follow a consistent US GAAP, the same practice before and as it is today.

  • When we recognize revenue, we need a piece of evidence, a document.

  • There may be times that the document has to be an approved contract, which takes time, so that could be, that is what is contained in the deferred revenue.

  • In terms of the business practice, there have not been any changes in how we book this revenue and how we account for this.

  • Robin Li - CEO

  • Regarding the sequential growth, I think it is a normal growth rate for our size.

  • If you look at the related Qs, the more than 100% growth rate year-over-year is probably still the highest growth rate you can find.

  • We've, like Shawn mentioned earlier, we are really targeting to grow this business for a very, very long time going forward.

  • We would rather not push too hard to make some short-term numbers, but we'd like to set a solid foundation for the growth for years to come.

  • Operator

  • The next question comes from the line of Jason Brueschke with Citi Investment Research.

  • Please proceed.

  • Jason Brueschke - Analyst

  • Thank you.

  • A kind of a follow-up to James' questions and I think one other.

  • You indicated that the move into the C2C commerce site was in some ways triggered by just your analysis of search patterns in traffic.

  • But at the same time, you guys have a large direct sales force, and you are increasingly taking your largest markets away from distributors to your direct sales force, which means effectively that you are developing a direct relationship with a lot of these SMEs between the company and those advertising SMEs.

  • Is there not a larger community opportunity?

  • Not to be viewed just as a search engine, but as the beginning of a community where, because you have a direct relationship with SMEs, you're selling them C2C advertising that you have an opportunity over time to sell more and more services into that SME customer base which, as you guys know, stands clearly above 143,000 because those are just your active customers.

  • Could you comment on, is that a way to be thinking about maybe a longer term potential of this business you have, or is this something that you guys are not really interested in pursuing?

  • Thanks.

  • Robin Li - CEO

  • Let me put it this way -- I think during the past six or seven years, we accumulated a large number of SME customers.

  • In the past, we focused on providing simple keyword search, paid search services to them, but we did realize they have other kinds of needs related to Internet and we think in some aspect we can help them to solve their problems.

  • So yes, we will start to do things that make them happier.

  • We classify this under our customer service effort.

  • We try to serve our customers better and better, I think, going forward.

  • By doing that, they will be able to appreciate our search service more, and spend more on our search site.

  • That's at least the near-term plan.

  • Longer term, yes, there could be some synergetic services we can provide and generate revenue from them.

  • Jason Brueschke - Analyst

  • Great.

  • Thanks.

  • Operator

  • The next question comes from the line of Elinor Leung.

  • Please proceed.

  • Elinor Leung - Analyst

  • Hi, thank you for taking my question.

  • My question is related to the Baidu TV.

  • Can you tell us what kind of format it would be like?

  • Is it like advertising at the beginning of the content?

  • If that's the case, where do you get the content?

  • Shawn Wang - CFO

  • This is Shawn again, Elinor.

  • The Baidu TV is pretty, to put it in very simple terms, the typical TV commercial that we sell, that is always on TV screen now.

  • If you go onto one of your favorite websites, and the website happened to be our Union member, when you go to their web page, and on the bottom right-hand corner as it currently stands, there will be a video clip.

  • That's the TV commercial that would appear.

  • Elinor Leung - Analyst

  • So there will be content after the TV commercial?

  • Shawn Wang - CFO

  • It's actually --

  • Robin Li - CEO

  • No, it's pure TV commercial on a regular web page, in most cases.

  • Elinor Leung - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Your next question comes from the line of Ming Zhao with SIG.

  • Please proceed.

  • Ming Zhao - Analyst

  • I have a follow-up question -- just looking at some of your competitors raising tons of cash now and the perspectives they talk about, a lot of it will be used for acquisitions.

  • It seems like Baidu has always been rather focused on organic growth.

  • I wonder if you could talk about, is this something you would also be looking at?

  • Robin Li - CEO

  • Well, as you can see, we have a very liquidable stock.

  • People pay a lot of attention to us.

  • We do have the flexibility to raise cash if that's what we want, but even without raising the cash, I think our stock is as good, if not better, than cash.

  • Operator

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

  • Please proceed.

  • Wallace Cheung - Analyst

  • Regarding the C2C platform, can you talk a bit more about the payment solution?

  • Actually, there is one more follow-up question regarding payment solution - it's once you have implemented some kind of payment solution, is there any incentive for you to migrate all your SME customers through your (inaudible) without going through your distributors or direct sales force anymore?

  • Thank you.

  • Robin Li - CEO

  • Wow, that's really a longer term decision for us.

  • Right now, we are focusing on developing a C2C platform.

  • We are still evaluating what to do with the payment solution.

  • We may develop it in-house.

  • We may outsource it to a third-party and we may even buy a payment solution going forward.

  • Wallace Cheung - Analyst

  • Okay.

  • Operator

  • The next question comes from the line of Stephen Ju with RBC Capital Markets.

  • Please proceed.

  • Stephen Ju - Analyst

  • What was your headcount at the end of third quarter?

  • How many people were in sales at the company, sales people or headcount in general do you think you will add in the fourth quarter?

  • And not to keep harping on the subject of C2C, but it seems like -- and that product as it pertains to SMEs, do you see this product evolving into more of a local search product at some point in the future?

  • Thank you.

  • Shawn Wang - CFO

  • Stephen, this is Shawn here.

  • Let me first take your question on the headcount and then on the C2C, allot it to Robin.

  • Headcount at the end of the quarter, we actually have slightly over 4,700 people and we -- that's an addition of about 300 people during the quarter.

  • Going forward in the next quarter, we are continuing hiring.

  • Among the people that we have today, over 3,000 are in the sales, direct sales and services component.

  • Robin Li - CEO

  • Regarding to C2C, and its synergies with SMEs and locals, I think that eventually, yes, that these three things share something in common, but at this stage, I think it is too early to tightly integrate them.

  • We'd like to first provide a more regular service on the shopping platform, and then start to find synergies and to integrate things together.

  • Stephen Ju - Analyst

  • Okay.

  • Operator

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

  • Please proceed.

  • James Mitchell - Analyst

  • Hi -- I apologize for asking about the 10,000th C2C question, but just to maybe wrap it up, from my side anyway -- when we think about modeling out Baidu in 2008, should we expect the operating expense on creating a C2C platform to be comparable to the operating expense this year on creating the Japan search engine?

  • Or would it be dramatically smaller, since there is more opportunity to leverage your existing cost base?

  • Thank you.

  • Robin Li - CEO

  • Jim, this is Robin.

  • I think the cost will be significantly smaller than our Japan initiative.

  • As I mentioned before, we have a very strong search platform that will help drive traffic to the C2C platform.

  • That is probably the major cost for some of the other C2C service providers.

  • Regarding the product development, I think we can have a very good team and we need to make the necessary investments, but that's not going to cost as much as the Japan initiative.

  • James Mitchell - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Gene Munster with Piper Jaffray.

  • Please proceed.

  • Gene Munster - Analyst

  • Shawn, if you could go over a little bit, just to recap, the Union member revenue share?

  • You said that there's no increase in the overall, but it's kind of -- you put it in tiers to better manage it.

  • Can you talk a little bit -- so basically, TAC -- how should we think about that relative to TAC going forward?

  • Shawn Wang - CFO

  • I think I mentioned the effort that we made was more to improve the overall relationship and management of this relationship with our Union members.

  • This effort, I do not expect, will be any significant changes in the TAC ratio by itself.

  • However, we are -- we have been successfully growing our third-party traffic, so the TAC increase that we see in the past few quarters is a reflection of our successful uptake of the third party traffic.

  • We'd like to continue to look for opportunities to bring in third-party traffic at the terms that are economical.

  • Gene Munster - Analyst

  • Okay.

  • 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.

  • Robin Li - CEO

  • All right.

  • 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 this presentation.

  • You may now disconnect.

  • Good day.