百度 (BIDU) 2008 Q4 法說會逐字稿

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  • Operator

  • Good day ladies and gentlemen and welcome to Baidu's fourth quarter and full year 2008 earnings conference call.

  • My name is Misal and I will be your coordinator for today.

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

  • We will be conducting a question and answer session towards the end of this conference.

  • (Operator Instructions).

  • As a reminder, this conference is being recorded for replay purposes.

  • I would now like to turn the presentation over to your host for today's call, Ms.

  • Linda Sun from Baidu, Investor Relations.

  • Please proceed.

  • Linda Sun - IR

  • Hello everyone and welcome to Baidu's fourth quarter and full year 2008 earnings conference call.

  • We distributed the Baidu's fourth quarter and fiscal year 2008 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 Jennifer Li, Baidu's Chief Financial Officer.

  • After their prepared remarks, Robin and Jennifer will be joined by Peng Ye, our Chief Operating Officer, and Haoyu Shen, Vice President of Business Operations 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.

  • 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.

  • 2008 was a year of strong growth for us with total revenues up over 80% from 2007.

  • That said, the fourth quarter was a very special quarter for us.

  • In particular China's economy experienced a sudden slowdown, and many businesses, including our customers became more cautious in their marketing spending.

  • Also during Q4 we removed questionable paid search listings from several sectors.

  • Despite these factors, we still delivered a 58% revenue increase from Q4 of 2007.

  • These results underscore our strong ability to execute.

  • And coming out of this quarter, the quality of our customer base is now higher and our operational controls are now tighter.

  • Going into Q1, we expect many of our customers will continue to be affected by weak macro conditions and the typical seasonality around Chinese New Year.

  • However we have already observed some positive trends during Q1 which I would like to share with you.

  • First, our advertising campaigns have generated positive feedbacks from our users, customers and employees.

  • During the Chinese New Year period we launched an advertising campaign that included prominent placement on the CCTV New Year Eve Gala.

  • Over 90% of Chinese (inaudible) viewed this program.

  • Second, I am pleased to note that in the weeks following Chinese New Year we have seen significant traffic growth and customer spending.

  • Moving on, I would like to discuss our main focuses for 2009.

  • First on the customer front, one of our primary efforts in the new term is to educate the market.

  • We will let more people know that the best way to get revenue during a difficult time is to market their products and services on Baidu.

  • Our addressable customer market is huge.

  • Of the approximately 40m SMEs in China, currently about 200,000 are Baidu customers.

  • And we are confident that with our increased sales efficiency and marketing efforts we will successfully educate an increasing number of Chinese businesses about the advantages of our performance-based platform.

  • Furthermore, our sales model, a combination of direct sales and local distributors, is unique in its ability to reach out to SMEs nationwide.

  • Another significant effort we are undergoing in this area is a new online marketing system code named Phoenix Nest which has been in beta phase since Q4 of last year.

  • The objectives of Phoenix Nest are to improve relevancy in paid search and increase value for customers, thus driving monetization efficiency.

  • Phoenix Nest achieves this objective through an enhanced algorithm that serves more relevant marketing messages.

  • It also provides customers additional tools and information to help them better manage their spending to achieve higher ROI.

  • We have been receiving positive feedback from customers so far.

  • And we plan to make Phoenix Nest broadly available in the second quarter of 2009.

  • With the rollout of Phoenix Nest we expect Baidu's monetization capabilities to rise to a new level.

  • Moving on to the user side, a key new innovation that was announced in December is Aladdin.

  • Aladdin is an ongoing R&D effort aimed at uncovering useful parts of the hidden Web in order to enrich search results for our users.

  • The core of Baidu's search experience is offering constant improvements to the abundance, timeliness and relevance of search results.

  • Aladdin will do just that, improve user experience gradually but surely.

  • Another ongoing user focused project that many of you are familiar with is our C2C platform, Baidu Youa.

  • We launched Youa in the fourth quarter of 2008.

  • We believe in the synergies between search and ecommerce, and our enormous user base gives us a unique advantage in this space.

  • Baidu Youa has been met with lots of excitement.

  • As of the end of 2008, a short two months after its beta launch, we had almost 140,000 sellers and over 15m commodities listed on Baidu Youa.

  • We will continue to grow Youa in the quarters to come and we'll keep you updated on the progress.

  • To briefly update you on all Baidu's -- on Baidu Japan, which we officially launched in January 2008, the focus in 2009 continues to be on product development.

  • And also in 2009 we anticipate starting to drive overall traffic.

  • We will keep you updated on our progress too.

  • Before concluding I would like to say that we have the right strategies in place to tackle the current economic challenges.

  • And, at the same time, we all are well-positioned to capture the benefit of our market's long-term potential.

  • According to CINIC the Internet population in China reached 298m in 2008.

  • This means Internet penetration grew from 16% to 22.6% in one year.

  • But this level is still far below that of mature markets.

  • And with Baidu's status as the market leader, we have 73.2% of market share according to iResearch.

  • Our long-term prospects remain tremendous.

  • Combining all of this with our great business model, experienced management team and strategies to generate growth and profitability, Baidu is uniquely positioned for success.

  • Now I will turn the call over to Jennifer for financial highlights.

  • Jennifer Li - CFO

  • Thank you Robin.

  • Hello everyone.

  • Good morning and good evening.

  • First of all, we apologize for the brief delay getting into the call.

  • We had a very unusual snowfall in the city and many of the drivers are relearning how to drive on the street.

  • So a couple of the key participants were delayed.

  • Getting back to the content for the call, as you know the economic slowdown in China combined with the removal of certain paid search listings caused us to revise top line expectations for the fourth quarter.

  • We're pleased to have exceeded the revised guidance.

  • Now let's look at some of the financial highlights for the quarter.

  • The amounts mentioned below are in renminbi except as otherwise noted.

  • Total revenue for the quarter was CNY902m, a increase of 58% year-over-year.

  • For Q4 Baidu had more than 197,000 active online marketing customers, representing a 1.5% increase from the previous quarter and 27.1% increase from the corresponding period in 2007.

  • Revenue per online marketing customer for the fourth quarter decreased slightly from the third quarter primarily as a result of the removal of some of the paid search links.

  • For the full year 2008 the number of active customers increased 32.7%.

  • And revenue per online marketing customer increased 38.3% from the previous year.

  • Traffic acquisition cost as a component of cost of revenue was 14.6% of revenue versus 11.8% for Q3 and 12.7% a year ago.

  • Included in the Q4 TAC number was a one-time adjustment which accounted for 0.7% of revenue.

  • Without this adjustment, TAC for the fourth quarter would have been 13.9% of total revenues.

  • 2008 TAC as a percent of revenue was 13.1% versus 11.7% in 2007, reflecting growing Baidu Union contribution to revenues.

  • Bandwidth cost and depreciation cost as a percent of revenue both decreased in the fourth quarter compared to the year ago level primarily due to increased equipment efficiency and scalability of our network.

  • Selling, general and administrative expenses increased 32.6% over Q4 '07 and up 60.5% on an annual basis mainly due to increased compensation cost and greater marketing expenses.

  • R&D expenses increased 84% over Q4 '07 mainly due to additional headcount.

  • Total R&D expenses for 2008 was CNY286m, a 103% increase from 2007, reflecting continued investment in our R&D capabilities.

  • Share based compensation expenses, which were allocated to related operating costs in expense line items, increased in aggregate to CNY21.5m in the fourth quarter from CNY13.3m in the corresponding period in '07.

  • The increase in share based compensation expenses primarily reflects increased options and share grants.

  • Operating profit increased 73% over Q4 '07.

  • For the year operating profit reached CNY1.1b, double the level of 2007.

  • Total headcount as of December 31, 2008 was about 6,400 roughly 400 fewer than at the end of Q3.

  • The net change in headcount includes increases in R&D workforce and decreases in sales and marketing due to efficiency improvements.

  • Income tax expenses was CNY41.8m.

  • The effective tax rate increased from 9.1% in the third quarter to 12.7% in the fourth quarter of '08, primarily due to tax rate catch up for our software enterprise subsidiary based on new local tax interpretation.

  • For the other subsidiaries we have been informed that under the new tax law these entities qualify as new high tech enterprises.

  • As such they will continue to enjoy the preferred corporate income tax treatment.

  • The effective tax rate for the full year 2008 was 10%.

  • For 2009 we expect our effective tax rate to be in the low teens.

  • As of December 31, 2008 the Company had cash, cash equivalent and short term investment of CNY2.7b.

  • Net operating cash flow and capital expenditure for the fourth quarter of 2008 were CNY482m and CNY61m respectively.

  • Full year net operating cash flow and capital expenditure were CNY1.6b and CNY418m respectively.

  • The Company's strong cash flow generating ability will allow us to stay on track with our strategies during a weak economic environment.

  • Now an update on Baidu's share repurchase program.

  • On December 16 Baidu's shareholders approved a $200m share buyback program.

  • Subsequently Baidu entered into repurchase agreement before the blackout period started.

  • As of now the Company has bought back over 30,000 shares.

  • We'll continue to execute the repurchase program based on market opportunities.

  • Looking into 2009 we'll continue to take a disciplined and a strategic approach to cost.

  • While we focus on growing the top line and making responsible cost decisions, we'll continue to invest in our core R&D capability and strategically important initiatives.

  • Looking into Q1 we typically have higher marketing expenses during this quarter related to annual events such as the Boiling Point party which promotes our products and services related to entertainment search.

  • This year in particular we incurred additional marketing spend during the Chinese New Year.

  • Our incremental marketing budget for the first quarter of 2009 is approximately CNY40m more than that of Q4.

  • As an update our Internet TV channel outsourcing agreement with UiTV which was signed in the third quarter of 2008 entails a total income of $15m.

  • This income will be gradually recognized as (inaudible) as other income.

  • We will inform you when the deal is officially closed and when we have more clarity on the timing for the income.

  • In 2009 we expect to invest approximately $25m to $30m in Baidu Japan.

  • As compared to the $19m spent in 2008, the incremental expense will mainly be incurred in R&D where we plan to devolve more resources to product and technology development.

  • In 2009 we'll make additional $30m to $40m investment into the construction of Baidu Campus.

  • The total spend is in line with our previous budget.

  • Now let me provide you our top line guidance for the first quarter 2009.

  • The current economic downturn has proven to be widespread in its impact, affecting all industries to varying degrees.

  • We believe, with our focused sales effort and our cost effective and flexible marketing platform, both established online marketers and new SME customers will increasingly seek out the measurable ROI that our platform offers.

  • We expect a moderate year-over-year growth for the first quarter of 2009 primarily due to two factors.

  • One, a portion of our online marketing customers may scale back on marketing spending given today's market environment.

  • Two, we expect that the removal of certain sponsored links during the fourth quarter of '08 has resulted in a net loss of around 5% of revenue which impacts Q1.

  • We currently expect total revenues for the first quarter of '09 to be between CNY780m and CNY800m which would represent annual growth rate of 36% to 39%.

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

  • I will now open the call for questions.

  • Operator, please go ahead.

  • Operator

  • (Operator Instructions).

  • Your first question comes from the line of Eddie Leung with Bank of America.

  • Please proceed.

  • Eddie Leung - Analyst

  • (Microphone inaccessible) to a full rollout of Phoenix Nest.

  • Could you guys tell us the difference between the current trial versions and the full versions of Phoenix Nest?

  • And my second question is related to the increase in Phoenix Nest revenues as a proportion of total revenues in the fourth quarter.

  • Was it more driven by an increase in partnerships or just directing more advertising links to your partners?

  • Thanks.

  • Robin Li - CEO

  • Haoyu?

  • Haoyu Shen - VP Business Operations

  • Yes, thanks.

  • Eddie, how are you doing?

  • So for Phoenix Nest it's a new auction system different from the old one that we're testing in -- starting from Q4 we're testing.

  • But the work started actually early part of 2008.

  • Now we're just testing it.

  • I'm sorry.

  • I was on mute.

  • So Eddie this is Haoyu.

  • The question about Phoenix Nest, so Phoenix Nest is a new (microphone inaccessible) auction system we're testing.

  • The work, we started working on this early part of 2008.

  • We started testing it in beta version starting from Q4.

  • Now we have over 600 customers participating in it.

  • And it's invitation based only.

  • So the difference right now between -- there's a lot of differences between the Phoenix Nest and the current system in terms of the different data, the more data that customers can get, the more tools we give them to manage their budgets.

  • And also the set up is different.

  • Now the other difference right now is it's only tested on right hand side.

  • But the goal is to eventually make this -- first of all, to make this more broadly available to other customers, which we're planning to do within Q2.

  • And also in Q2, potentially, we'll open up some space on the left hand side, the top left hand side space, to Phoenix Nest as well.

  • As far as the revenue contribution in Q4 from Phoenix Nest, it's still very small because it's invitation based and we only have a few hundred customers participating in it.

  • And it's very important to note that the system, over time, will get better.

  • Once we accumulate more data and more experience from the customers, it will definitely get better.

  • Monetization efficiency will increase.

  • Eddie Leung - Analyst

  • Hi Haoyu.

  • Just one quick follow-up.

  • So this new system will be run in parallel to the current paid listing mechanism, right?

  • Haoyu Shen - VP Business Operations

  • Right.

  • For a while.

  • We don't know how long it's going to be yet.

  • And for a while it will be run in parallel.

  • Eddie Leung - Analyst

  • Got it.

  • Thanks.

  • Operator

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

  • Please proceed.

  • Ming Zhao - Analyst

  • Good morning.

  • Thank you for taking my question.

  • I have a question -- in terms of the impact from the macro economy, I think last quarter management mentioned that manufacturing and franchise are the two verticals impacted.

  • Heading to 1Q, have you seen other verticals that are negatively impacted such as education and training and maybe the dotcom companies, the Internet companies?

  • Peng Ye - COO

  • Hi.

  • This is Peng Ye.

  • I think only a very small percentage of the customers has got lot of wins.

  • It is true that many of our customers are cautious and have scaled back their spendings.

  • But we have already seen after Chinese New Year that very strong pick up after Chinese New Year holiday season, and also both in terms of customer spendings on their marketing budgets and also the new customer acquisition.

  • That's the kind of situation.

  • We do not have the visibility on their marketing budgets beyond this quarter.

  • Haoyu Shen - VP Business Operations

  • So Ming, this is Haoyu.

  • The question about education, my sense -- our sense is it's impacted, but it appears to be more resilient than many of the other sectors.

  • Ming Zhao - Analyst

  • Okay.

  • Thank you.

  • Operator

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

  • Please proceed.

  • Dick Wei - Analyst

  • Hi.

  • Thanks for taking my questions.

  • I have a question on TAC.

  • How should we look at the TAC going into 2009, particularly I believe there is more -- new initiatives such as the content network that's going into the Baidu Union space.

  • I don't know if that will significantly drive up the TAC cost, or it will still be going up gradually.

  • And also I wonder if you've seen any impact from some of the smaller sites being shut down due to the government's tighter control began earlier this year.

  • Thanks.

  • Haoyu Shen - VP Business Operations

  • Hi Dick, it's Haoyu.

  • So TAC, as Jennifer mentioned, that in Q4 we had some one-time adjustment.

  • So that made the TAC in Q4 high.

  • But excluding that, we think TAC increases are in a very comfortable range.

  • So if you look at the whole year of 2008 it ranges from 11% to 13%.

  • And it really largely reflects the faster growth of Union contribution to Baidu overall.

  • If you look at our TAC rate, or TAC as a percentage of Union revenue, it is very stable.

  • So we're not -- over time we're not paying a higher percentage of our Union revenue to our Union partners.

  • Going forward, I expect it is possible that Union revenue will continue to grow faster, but I don't think it will grow dramatically faster than our organic revenue.

  • Our organic revenue is also growing at a pretty healthy rate.

  • And you mentioned the content network, so if you look at our Union business, there are basically two parts.

  • One is search, search network right?

  • Third party partners bring search traffic to us and we share revenue with them.

  • The other is content network and contextual links.

  • So contextual links in terms of revenue it's still a small -- it's a minority in the total Union revenue contribution.

  • And we were putting a lot of effort into that in the past.

  • We will continue -- we will probably even increase our focus this year on that part of the business.

  • That business does tend to have a higher TAC ratio than the search business, but as I said it's a smaller percentage of our Union revenue.

  • And that's something we're putting a lot of focus on.

  • And I think that's one of the biggest growth areas going forward for the Company.

  • Robin Li - CEO

  • And on the tighter control on content by the government, we have not seen any meaningful impact to our business yet.

  • Dick Wei - Analyst

  • Great.

  • Thank you very much.

  • Operator

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

  • Please proceed.

  • Wallace Cheung - Analyst

  • Hi.

  • Good morning.

  • I just wanted to understand a bit more about the C2C business in terms of the cost impact in 2008 and any guidance in 2009.

  • Thank you.

  • Jennifer Li - CFO

  • Hi Wallace.

  • It's Jennifer.

  • On the C2C investment, you know we have informed everybody in the past that we leverage our R&D capabilities.

  • And the cost related to the platform to date has not amounted to a material amount which warrants a separate disclosure.

  • At this point it's still the case.

  • Going forward we'll continue to grow the business.

  • And we'll invest accordingly.

  • When it comes to the material level for separate disclosure, we will provide more information.

  • Wallace Cheung - Analyst

  • Just quickly, I think last time you mentioned [debt] expenses to be substantially lowered in Japan.

  • Does this hold on?

  • Jennifer Li - CFO

  • Still the case.

  • Wallace Cheung - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Eric Wen with Main First.

  • Please proceed.

  • Eric Wen - Analyst

  • Hi.

  • Good morning.

  • Thanks for taking my questions.

  • I just wanted to -- Jennifer, can you elaborate a little bit more on other income.

  • You mentioned that -- I didn't hear it clearly -- is it Baidu TV that is being recognized and why it needs to be amortized instead of just equity-- recognition of income?

  • Jennifer Li - CFO

  • First of all the deal, Eric, was signed in Q3 of '08.

  • It's not completely closed, the deal, yet.

  • So we do in the structure of the transaction have [$15m] that should be categorized as other income.

  • And it depends on the terms of the payment.

  • We believe it should be amortized over time rather than a one-time.

  • So it all depends on the final closure of the deal.

  • And the intent of me to inform everybody is we will provide more clarity on the timing and we'll provide the information on the transaction and when that's going to happen.

  • Eric Wen - Analyst

  • Sure.

  • Can you just add on, going forward is this going to be equity, investment -- equity or investment?

  • Basically your ratio is more than 20% or less than 20%?

  • Jennifer Li - CFO

  • As we disclosed in the initial transaction, Eric, we have 8% of the equity in UiTV.

  • Eric Wen - Analyst

  • Right.

  • Okay.

  • So it's going to be an ongoing investment.

  • Okay thanks.

  • Operator

  • Your next question comes from Jeffrey Lindsay with Sanford Bernstein.

  • Please proceed.

  • Jeffrey Lindsay - Analyst

  • Thank you for taking my question.

  • Could I ask why you feel the need for diversification, either geographic in the case of Japan, or into new business areas like ecommerce in China.

  • Does that imply that there's not sufficient growth in the Chinese search business?

  • Robin Li - CEO

  • We strongly believe that there's tremendous opportunity for growth in the Chinese search area for many, many years down the road.

  • But our ambitions go beyond Chinese search.

  • That's why we are making investment in areas like search in Japan and related areas like ecommerce related search services.

  • We really feel this kind of initiatives have good -- great synergies with our existing business.

  • The Japanese search share very fundamental core technology with our Chinese search.

  • And our ecommerce, the C2C initiative share a very good customer or user base with our existing Chinese search services.

  • As a high growth and innovative company we will continue to innovate and try different things.

  • These are two of the larger initiatives.

  • We also have many other smaller projects going on.

  • And I think that's the right strategy for the Company.

  • Jeffrey Lindsay - Analyst

  • Thank you.

  • Operator

  • Your next question comes from James Lee with Sterne Agee Capital Markets.

  • Please proceed.

  • James Lee - Analyst

  • Morning.

  • Can you guys give more color about the customer feedback on the Phoenix Nest system?

  • Can you give a sense what do your customers like about the system, any specific thing that they want you to improve, that you're going back to the lab and try to make it better?

  • And do they view it as a core system, or do they sort of view it as a complementary system?

  • And also, Robin maybe you can talk about this, can you talk about the click through rate of the new system versus the old system, maybe compare the CPC a little bit?

  • And lastly, maybe talk about some of the verticals that are most receptive to the new system so far.

  • Thanks.

  • Robin Li - CEO

  • I'm going to let Haoyu handle this but (inaudible).

  • Haoyu Shen - VP Business Operations

  • So James, as I said Phoenix Nest is now invitation based.

  • It's on the right hand side only, a few hundred customers are participating.

  • So far they like it.

  • We see good participation.

  • They like it for a few reasons.

  • One we give them more choices of keywords because it's on the right hand side.

  • We offer broad match, phrase match, not just exact match because we only do exact match in our old system.

  • And also we give them more tools to manage their budget.

  • In the back end we also give them more data and more reporting so that they can measure their ROI more clearly than before.

  • So right now because we have these systems running in parallel, some of them probably view this as complementary.

  • But we also made it very clear -- we will make it very clear to our customers when we make it broadly available that this is the future.

  • We will make it a success.

  • And this will be a better system for them.

  • This will be a better monetization system for us.

  • So eventually I think Phoenix Nest will just be Baidu's new auction system.

  • As far as some of the statistics you mentioned, CPC and CTR, now CTR, because it's still on a small scale, it's very hard to tell whether the difference with the current system is material, especially because now it's only on the right hand side.

  • So a lot of statistics may not indicate what's going to happen when we open up more space, meaning the left hand side for Phoenix Nest going forward.

  • James Lee - Analyst

  • Haoyu can I ask you a follow-up question?

  • In theory when you have the new auction system or bidding system on the right, in theory the click through rate should be lower than what you're typically facing -- experienced in the past on the left side.

  • Is it kind of fair to say?

  • Haoyu Shen - VP Business Operations

  • That is definitely fair to say for anyone.

  • I think the click through rate on the right hand side is lower than the left hand side.

  • James Lee - Analyst

  • Okay.

  • And are you able to balance it maybe with a higher CPC, assuming people click on the right side they have a greater intention of going to your customer site and doing a transaction.

  • So in theory you can offset that with a higher CPC pricing in the future.

  • Haoyu Shen - VP Business Operations

  • That is right.

  • That is conceivable but at the end of the day we don't set price.

  • It's an auction system.

  • James Lee - Analyst

  • Okay, great.

  • Thank you.

  • Robin Li - CEO

  • James, let me add a little more about the Phoenix Nest system.

  • A key part of the Phoenix Nest system technology is the relevance ranking technology.

  • It's very much like a miniature search engine.

  • We need to find the best match between user queries and the marketing messages submitted by our online marketing customers.

  • We are working on this part.

  • So to start with that the relevancy could be similar to the existing system, the paid search system.

  • But going forward the relevance will improve and we expect click-through rate will go up too.

  • Operator

  • Your next question comes from Paul Wuh with Nomura International.

  • Please proceed.

  • Paul Wuh - Analyst

  • Hi.

  • Just a quick question for you on -- you mentioned the right side and left side.

  • Can you give a sense of what percentage of your revenue is actually coming from the right side versus the left side?

  • Haoyu Shen - VP Business Operations

  • We can but we don't want to go into the detailed numbers.

  • But left hand side contributes the majority of our revenue today.

  • Paul Wuh - Analyst

  • And then a follow up is also I saw that your customer deposits increased significantly in the fourth quarter to CNY422m from CNY357m in the third quarter.

  • Why do you think that this happened and do you expect this trend to continue?

  • Jennifer Li - CFO

  • Typically that would be a good indication leading into your revenue projections.

  • But for Q4, I think this is a special period that we went through.

  • We all know that customers tend to scale back their marketing expenditures in difficult times.

  • So more customers tend to set limits.

  • So we have a deposit with us and they went up during the Q4 period.

  • I wouldn't directly interpret this as increase in revenue.

  • But this is a customer driven kind of activity.

  • Paul Wuh - Analyst

  • Thank you.

  • Operator

  • Your next question comes from Wendy Huang with RBS.

  • Please proceed.

  • Wendy Huang - Analyst

  • Hi, just a quick question on R&D.

  • Could you give some guidance for 2009 and what kind of incremental R&D expenditure do you budget for 2009?

  • Jennifer Li - CFO

  • We mentioned in the call -- in the script that we'll continue to invest in the core R&D capabilities.

  • I do not anticipate the scale of growth from a expense perspective will be in line with in the past but it will be a continual growth and probably one of the biggest growth area in terms of expense for us.

  • Wendy Huang - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Your next question comes from Elinor Leung with CLSA.

  • Please proceed.

  • Elinor Leung - Analyst

  • Hi.

  • Thanks for the call.

  • My question is related to the Phoenix Nest.

  • Am I correct that you're only going to implement it on the right hand side in the top part of your website?

  • You're not going to incorporate it in your left hand side amongst the free search results.

  • Does that mean that you want to gradually migrate your sponsor links to better separate them from the free search results?

  • Haoyu Shen - VP Business Operations

  • So I think I mentioned earlier now the test is on the right hand side only.

  • But in Q2, when we open up for more customers we'll potentially also open up the top left space for Phoenix Nest.

  • So that's what we're going to do.

  • And also as I mentioned, we think this will be a better monetization platform, a better auction system.

  • Eventually it will be very broadly used in Baidu's system.

  • Elinor Leung - Analyst

  • I just have a follow up question.

  • So you will not include that among the free search results.

  • The auction system will not be implemented in the left bottom, (inaudible) among the free search results system.

  • Haoyu Shen - VP Business Operations

  • I think eventually it will.

  • Elinor Leung - Analyst

  • Okay, thanks.

  • Haoyu Shen - VP Business Operations

  • It's a new, it's a better auction system.

  • It increases [APP], it increases CTR.

  • Elinor Leung - Analyst

  • Thanks.

  • Operator

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

  • Please proceed.

  • Stephen Ju - Analyst

  • Good morning, guys.

  • How much was branded advertising in the fourth quarter and where do you think your conversion rate for the CPC platform stands versus for some of your competitors?

  • So in other words you have the traffic already, do you feel like you offer a more efficient platform versus your competitors at this point?

  • Thank you.

  • Haoyu Shen - VP Business Operations

  • So as far as conversion rate, we don't have a lot of visibility into our customers' conversion rate, because it's a CPC model.

  • It's not a CPA model.

  • But I think our past growth in terms of ARPU and also in terms of our customers shows that they're probably getting better returns on their spending with us.

  • Robin Li - CEO

  • Was that your question?

  • Stephen Ju - Analyst

  • And how much was branded advertising in the fourth quarter?

  • Haoyu Shen - VP Business Operations

  • How much is brand advertising?

  • Robin Li - CEO

  • Yes, fourth quarter.

  • Haoyu Shen - VP Business Operations

  • It's still a small percentage of our business and we don't disclose the exact percentage.

  • Stephen Ju - Analyst

  • Okay.

  • Thank you.

  • Operator

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

  • Please proceed.

  • James Mitchell - Analyst

  • Great.

  • Thank you for taking the question.

  • Could you talk a little bit more about your headcount initiative?

  • It seems like you're taking headcount out of sales and marketing and into research and development.

  • Jennifer Li - CFO

  • Yes James.

  • As we mentioned we continue to look at ways to improve the efficiency particularly in the sales and marketing workforce.

  • On the other hand we continue to invest in the R&D capabilities.

  • And that's why we see the balancing of -- shifting a little bit more and more R&D capabilities and investment and improve the efficiency, as a result reduce the headcount on the sales and marketing front.

  • James Mitchell - Analyst

  • Does that reflect your customers becoming increasingly capable of self-serving rather than relying so much on human being intermediation?

  • Jennifer Li - CFO

  • Not yet.

  • James Mitchell - Analyst

  • Okay.

  • Jennifer Li - CFO

  • I think it's more internal efficiency improvement.

  • James Mitchell - Analyst

  • Thank you.

  • Operator

  • Your next question comes from Jason Brueschke with Citigroup.

  • Please proceed.

  • Jason Brueschke - Analyst

  • Thank you.

  • My question is about linearity of demand in the first quarter.

  • I think there was a previous question on the level of deposits being up significantly.

  • And some of the commentary on the call suggests that post Chinese New Year, that we've seen demand pick up.

  • We also had commentary that the economy is really bad.

  • Can you maybe go into a little bit more detail?

  • Are people putting the deposits in and just simply not allocating these?

  • Or are they bidding less per click?

  • And could you maybe give us some more color about how much of a change you've seen from maybe before Chinese New Year in the quarter to the period after Chinese New Year.

  • Thanks.

  • Jennifer Li - CFO

  • Hi Jason.

  • The trend that we have seen at year end I have elaborated on why we think that the customer deposits went up.

  • I think after Chinese New Year, we continue to see the customer making deposits and at a faster rate.

  • But this you know I would interpret that data very differently.

  • Prior to Chinese New Year, I think there was a lot of negative sentiments or cautious sentiments and people are cautious with their spending.

  • Right after the Chinese New Year, the kind of trends that we have seen as Robin mentioned is very positive and upbeating.

  • And we have seen the traffic went up and we have seen the customers really coming back to the platform and more actively engaging in marketing on our platform.

  • So the trend that we have seen over the past month or two or so, I think lessened out a little bit of the cautious sentiment that we observed at the year end.

  • Jason Brueschke - Analyst

  • Great, thank you Jennifer.

  • And maybe a follow up to that.

  • I know historically Baidu has done very little offline marketing.

  • You've relied upon your strong brand and word of mouth.

  • In light of the tremendous success that you've received or you've obtained from the CCTV Chinese New Year initiative, does that change in any way your thoughts as to how you will try to grow traffic in Japan?

  • And should we expecting that because you're actually getting something from those efforts that you might lead more with a formal advertising campaign, offline and online in Japan versus just simply relying on word of mouth and bar room marketing?

  • Robin Li - CEO

  • Hi, this is Robin.

  • Let me try to answer your question.

  • The advertising campaign during Chinese New Year period offline was indeed something new to the Company.

  • We did that in order to find out how effective this kind of advertising campaign would be in terms of educating the market, helping users realize the benefit of search and helping customers have a better understanding or a better sense of what Baidu can do for them.

  • But after all we believe that the traffic growth for the search service it really depends on a high quality user experience, or search service.

  • For Baidu Japan we are not at that stage yet.

  • Our focus will continue to be on product and technology.

  • For our Chinese business this is something new.

  • We are still in the process of evaluating how effective the campaign is and how should we do things like this in the future.

  • So that's the current view of this kind of initiatives.

  • Jason Brueschke - Analyst

  • Great.

  • Thank you.

  • Operator

  • Your next question comes from Richard Ji with Morgan Stanley.

  • Please proceed.

  • Richard Ji - Analyst

  • Thank you, Robin and Jennifer and Haoyu.

  • And I have two questions.

  • The first, regarding the clean up measure of your medical listings and is the clean up measure largely over?

  • And if so what percentage of your medical listing customers have resumed the service with Baidu and have they already gotten proper license yet?

  • And then I have a follow up.

  • Jennifer Li - CFO

  • Hi Richard.

  • Yes, we have gone through a thorough review of our customer base.

  • And as you know in November we removed all of the medical and pharmaceutical sector customers.

  • Only with proper licenses and documentations will we allow our customers to come back.

  • As we mentioned in the press release a large portion of the customers already come back.

  • And frankly Baidu has went beyond and taken additional steps to remove additional questionable links.

  • So net-net that's why we have a negative kind of revenue impact going into Q1.

  • But at this point we are at the stage that we have gone through the thorough reviews of the customer base.

  • We'll continue to monitor the customer base on an ongoing basis.

  • However, I don't expect that any additional action we take will result in this kind of a material revenue impact.

  • Richard Ji - Analyst

  • Thank you.

  • And the second question is regarding your margin trend.

  • And obviously 4Q we saw soft margin, with a margin compression of about 6 percentage points quarter-on-quarter.

  • And is your Company taking any cost saving measures for 2009, especially in the -- given the macro headwind that's clearly looming?

  • And are you planning scaling back your cost initiatives for your non-core service such as B2C, instant messaging etc.

  • Thank you.

  • Jennifer Li - CFO

  • Yes, Richard.

  • As I mentioned in my script our priority is to grow the top line and at the same time maintain a disciplined and strategic approach to cost.

  • There's a tremendous scalability in this business model as I've said many times before and our margin is very sensitive to the top line.

  • In the Q4 and possibly in Q1, you know that we have near term revenue setbacks.

  • But that does not change the business model.

  • It does not result in the structural change of the way we conduct our business.

  • So despite these setbacks and maybe a short term margin compression, the long term story holds and the fundamentals remain strong.

  • So we will not forego important strategic investment opportunities for the sake of short term margin management.

  • As we have always mentioned there is tremendous scalability in the business model and as China's Internet industry is still emerging it will be unwise to forego investment opportunities that's right.

  • And frankly the whole organization takes a very disciplined approach to cost and we're very responsible as we make the cost decisions.

  • Richard Ji - Analyst

  • Thank you.

  • Operator

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

  • Please proceed.

  • Steve Weinstein - Analyst

  • Great.

  • Thanks.

  • I just wanted to make sure I understand the dynamics impacting the top line here.

  • It looks like Q4 was obviously an anomaly and it's hard to draw any kind of trend from that.

  • But looking at your guidance right now, it looks like you're looking for high 30s for revenue growth.

  • And if you hadn't had to remove those links you'd probably be somewhere in the low 40s percent type of growth.

  • That's a pretty big drop off from what we were seeing in the Q3 level.

  • Would you say that the difference in growth is all economically driven?

  • Or are there other factors hitting your business now that would make up for such a drop?

  • And then are things like Phoenix Nest and other initiatives that you might have in the works, enough to accelerate the growth as you go forward?

  • Or is it really those are incremental and the economy is the big headwind and you'll do whatever the economy allows you to do?

  • Robin Li - CEO

  • Hi Steve, this is Robin.

  • Let me try to answer your questions.

  • We already gave reasons for the Q1 guidance.

  • The removing of certain sponsor links represents like 5% of our revenue and the rest is pretty much seasonality and the impact of macro conditions.

  • If you look at the sequential growth it is like 11% to 13%.

  • If you back out 5% then the rest is pretty much seasonality and the macro conditions.

  • If you look at our Q1 of '08, it was pretty much flat compared to Q4 of 2007.

  • So Q1 is generally the weakest quarter of the year and this year it's especially so because of macro conditions.

  • And another reason we speculate is that during the past quarter or past few months, when the Chinese economy experienced a sudden slowdown everyone was shocked.

  • So they did not do anything for the near term.

  • After the Chinese New Year, I think people realized that they still need to do business and the best way to promote their products and services is to go through Baidu.

  • So we do expect with our execution capability or depending on our execution capability, there's a lot of room for growth in the future.

  • Steve Weinstein - Analyst

  • Okay, thank you.

  • Can I ask one follow up question?

  • Robin Li - CEO

  • Certainly.

  • Steve Weinstein - Analyst

  • The [CNY15m] in other income you're going to recognize, is that -- (inaudible) that's going to be recognized over the course of 2009.

  • Will there be continuation of that into 2010 as well?

  • Jennifer Li - CFO

  • It depends on the starting point.

  • When we're starting to recognize that we'll recognize the amount over about a five year period (Company corrected after the conference call).

  • Steve Weinstein - Analyst

  • Okay, so a year from when you start it, not --

  • Jennifer Li - CFO

  • Yes.

  • Steve Weinstein - Analyst

  • Okay.

  • I got it.

  • Thank you.

  • Operator

  • Your next question comes from the line of Tian Hou with Pali Capital.

  • Please proceed.

  • Tian Hou - Analyst

  • Thanks for taking my call.

  • I have two questions.

  • One is regarding your Phoenix system.

  • And I just wondered after you officially launch it, are you going to just launch it in the right hand or you're going to also implement that in the left hand?

  • So where that's going to be.

  • Haoyu Shen - VP Business Operations

  • Okay.

  • So I think I said this a few times.

  • Now it's on the right hand side.

  • In Q2 we'll make it more available and essentially open it up for the left hand side as well, the left top space.

  • Tian Hou - Analyst

  • So that will only exist in the top place in the left hand.

  • Is that the case?

  • Haoyu Shen - VP Business Operations

  • That's what we're going to do in Q2.

  • So I also -- in an answer to another question, we believe if the system becomes successful, it will eventually be the only auction system we have.

  • So it will probably eventually take over the main panel links as well.

  • Tian Hou - Analyst

  • So eventually, as what you said, it will take the current system.

  • So does it mean eventually on the left hand you'll only have the top several positions are the Phoenix auction based advertisement and the rest will be natural search results.

  • Haoyu Shen - VP Business Operations

  • That could be one scenario but you know as it evolves we will adjust our strategy accordingly and it will definitely be a cautious and measured approach.

  • Tian Hou - Analyst

  • So you don't have a precise answer at this point, that's the case.

  • Haoyu Shen - VP Business Operations

  • No we don't have a precise timeline right now.

  • Tian Hou - Analyst

  • Okay.

  • So the other question is after the CCTV report in November -- in December I just wondered what kind of permanent measurements have management put together to prevent those problems from happening again.

  • Peng Ye - COO

  • Hi, this is Peng here.

  • We -- in response to the CCTV reports, we take actions to remove not only the medical and the pharma related questionable links but also other sectors as well.

  • Now we have -- after that we enhanced our internal control process and tightened the internal control (inaudible) so as to ensure all those customers will have appropriate documents with us even though at this stage, there's no any regulations that require us to do so.

  • In the meantime we also provide the training programs to our employees to ensure the service quality as well.

  • Thank you.

  • Tian Hou - Analyst

  • And have you put this monitoring or training system whatever, to other sectors beyond healthcare?

  • Peng Ye - COO

  • Yes.

  • Tian Hou - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Your next question comes from Kar Kwong with Needham & Company.

  • Please proceed.

  • Kar Kwong - Analyst

  • Hi guys.

  • Thanks for taking my question.

  • Just a couple of them.

  • I was wondering the 5% reduction in revenues in the first quarter, does that include some of the listings that were removed in 4Q or are these all new listings that were removed in 1Q?

  • And is that revenue likely to come back or is that revenue that is more or less expected to be lost on an ongoing basis?

  • Jennifer Li - CFO

  • These are the links that's related to the removal activity that we did in Q4, before year end.

  • And you can consider this as a permanent loss.

  • Kar Kwong - Analyst

  • Okay.

  • And also maybe you could give some more color on labor costs.

  • What kind of salary increases are we likely to see this year?

  • Jennifer Li - CFO

  • We haven't mapped out the budget for this year.

  • And typically in the past we monitor the [CPI] situations and implement our (inaudible) increases accordingly.

  • What I want to stress though is that Baidu values its talent pool of people.

  • And this is an exciting place for many people to start their career.

  • And we value our people and we make our compensation packages competitive in the marketplace.

  • Kar Kwong - Analyst

  • Excellent.

  • And I'm just wondering, I think you mentioned that in 1Q the marketing budget would be CNY40m more than in Q4.

  • I was just wondering how does this trend for future quarters?

  • I guess you had a lot of success with your advertising campaign in the first quarter.

  • Will we see similar investments in the future?

  • Jennifer Li - CFO

  • As Robin mentioned earlier we are not completely done with this advertising campaign yet.

  • Once it's over we'll carefully evaluate the benefit, the effect of it and what we have learnt from it.

  • The important matter is we do put branding and marketing initiatives as a priority for us.

  • So we'll continue to work on that activities in this regard.

  • However, I just want to give you some sense, the Chinese New Year Eve Gala is once in a year event.

  • The impact for an event like this is only once -- only one time in the whole year's program, where you can reach out to 90% of the Chinese households.

  • So it's unlikely to produce another event like this for the remainder of the year.

  • So I don't anticipate a massive spend like the Q1 will re-occur.

  • However, we do want to do more work in the marketing end, (inaudible) initiatives on those fronts and therefore we want to spend -- we'll allocate resources accordingly, but maybe not to this magnitude.

  • Kar Kwong - Analyst

  • Got it.

  • And you mentioned the campaign was not finished.

  • When do you expect to wrap it up?

  • Jennifer Li - CFO

  • It's getting close.

  • Kar Kwong - Analyst

  • Okay.

  • And just two quick housekeeping questions.

  • I was wondering what the CapEx related to Campus construction was in 4Q.

  • And also I think you mentioned earlier the Japan cost in 2009.

  • I missed that number, if you could give that again please.

  • Thanks.

  • Jennifer Li - CFO

  • The Japan expense budgeted for '09, is between 25m to 30m.

  • And for Baidu Campus -- Baidu Campus actually capital expenditure for Q4 amounted to a larger proportion of the CapEx for the quarter.

  • For the whole year Baidu Campus accounted for about 40% of the CapEx incurred in 2008.

  • And we have spent -- as I mentioned $30m to $40m that we will spend, US dollars on Baidu Campus going into '09.

  • Kar Kwong - Analyst

  • Thanks.

  • Operator

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

  • Please proceed.

  • Dick Wei - Analyst

  • Thanks for taking my follow up.

  • I noticed that some of the paid search displayed format in Baidu will cover some of the paid search result highlighted in a grey box.

  • I'm not sure if that is some display related with the Phoenix Nest or it is just related to the core search system.

  • Now if you can comment on some of the longer term thoughts in terms of the paid result display format, that would be very helpful.

  • Thanks.

  • Haoyu Shen - VP Business Operations

  • Hi Dick.

  • I didn't quite get your question.

  • Where did you see those links?

  • Robin Li - CEO

  • It's the display ads on the search results pages.

  • Haoyu Shen - VP Business Operations

  • Alright.

  • We do have those -- one thing is BrandLink that we launched last year.

  • It's got some display on the right hand side and a little bit display on the left hand side as well.

  • And we're testing I think we're also testing display only links on the right hand side for brand advertisers.

  • So it is in a testing mode and it's for brand advertisers, their customers.

  • Robin Li - CEO

  • Right now they have nothing to do with the Phoenix Nest system.

  • Dick Wei - Analyst

  • Okay.

  • Let me refine my questions.

  • I guess I've been seeing some paid search results that are highlighted in like a grey box.

  • I don't think it is related to the brand or is it?

  • Haoyu Shen - VP Business Operations

  • Now if you see shaded links at the top on the left, those we had those paid links from -- for quite a long time.

  • And those are not directly managed by the customers.

  • So that's a space we'll potentially open up in Q2 for Phoenix Nest.

  • Dick Wei - Analyst

  • Okay, great.

  • Thanks.

  • Operator

  • Ladies and gentlemen, your final question comes from the line of Paul Keung with Oppenheimer.

  • Please proceed.

  • Paul Keung - Analyst

  • Hi.

  • My question has to do with the advertisers.

  • I was wondering if you can tell me when you look at what it looks like in fourth quarter, first quarter, did you see any unusual weakness or strength in terms of which categories those advertisers are coming from.

  • Any change in the churn rate of customers?

  • And how many of those customers really are like new first time trials versus old returning customers?

  • Haoyu Shen - VP Business Operations

  • In terms of sectors, we did look at Q4, even coming into the New Year and Chinese New Year.

  • What we saw is the sectors such as machinery, electrical engineering, tools, chemicals, these were impacted more both in terms of ARPU and also in terms of number of active customers.

  • Paul Keung - Analyst

  • So have your churn rates been impacted?

  • I'm trying to understand how many of these customers are actually first time because there's a sizeable increase of advertisers for this quarter.

  • Haoyu Shen - VP Business Operations

  • Right.

  • So before Chinese New Year, the customer acquisition is slow and it's always slow before Chinese New Year.

  • And we're seeing good pick up after the Chinese New Year both in terms of existing customer spending and also the speed of customer acquisitions.

  • Paul Keung - Analyst

  • Okay.

  • Because we had heard that -- what are the churn rates in your mind?

  • Historically your churn rate you've told us is like low teens.

  • Has that changed at all?

  • Haoyu Shen - VP Business Operations

  • I don't think we ever disclosed churn rates because it's very hard to define.

  • So in some sectors, in some regions we did see the higher attrition in Q4 and coming into Q1.

  • But in terms of our total customer portfolio we didn't see massive increased attrition of customers.

  • Paul Keung - Analyst

  • Okay, that makes sense.

  • Thank you.

  • Operator

  • Ladies and gentlemen, this concludes our question and answer session.

  • I will now turn the call over to Robin Li, Chairman and CEO for closing remarks.

  • Please proceed.

  • Robin Li - 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 disconnect and have a wonderful day.