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Operator
Hello and thank you for standing by for Baidu's first-quarter 2009 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 host for today's conference, Linda Sun of Baidu.
Linda Sun - IR
Hello everyone and welcome to Baidu's first-quarter 2009 earnings conference call.
We have distributed Baidu's first-quarter 2009 earnings release 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, Baidu's 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 statement except as required under applicable law.
As a reminder, this conference is being recorded.
In addition, a webcast of this conference call will be available on Baidu's corporate website at ir.baidu.com.
I will now turn the call over to Baidu's CEO, Robin Li.
Robin Li - CEO
Hello everyone and thank you for joining us.
We are pleased to report solid results for the first quarter of 2009, as total revenues increased 41% from the year-ago period, exceeding our topline guidance.
As you know, the first quarter was not an easy one, particularly due to the economic uncertainty.
But by focusing relentlessly on execution and things we have control over, we've been able to act quickly and efficiently in a tough environment with our highly-energized and effective workforce.
In particular, during the quarter, we took action to drive sales focus.
We implemented programs to elevate customer services.
We developed incentives to drive overall results.
At the same time, we launched, successfully, branding and marketing campaigns.
This focus on execution and the ability to leverage our accumulated experiences, and the scale of our customer base and sales force allowed us to deliver strong results in this challenging time.
China's Internet industry is only just emerging.
We have, and we will continue to benefit from user growth and the growing appreciation of performance-based search engine marketing.
Now I would like to talk a bit more about a couple of key initiatives we've recently announced.
First, this month we officially launched an enhanced bidding platform for online marketing customers, called Baidu Online Marketing Professional Edition, also known as Phoenix Nest.
This new platform will run concurrently with our original bidding platform, or Classic Edition, during a customer transition period.
Professional Edition is the result of a long process of looking at how to optimize our paid search algorithm for the benefit of customers and users.
Specifically, for online marketing customers, this new platform enables customers to have more choices for keywords, more tools to manage their marketing budget, and more data points to measure and analyze their returns.
For search users, we believe it can improve relevancy of paid search results through a more sophisticated keyword matching system.
And for Baidu, the Professional Edition will employ more advanced monetization algorithms which we expect, over time, to result in enhanced revenue.
While this is still a new initiative, customer reaction has been very positive ever since the beta launch in the fourth quarter of last year.
We will keep you updated on the progress here.
Also, as you may know, we have been working on an initiative codenamed Aladdin, which is aimed at improving search experience by uncovering useful parts of the hidden Web.
As part of this initiative, this month we beta launched a data -- an open data-sharing platform which allows webmasters and developers to submit data to Baidu in order to generate direct search results for dynamic information such as flight schedules and foreign currency exchange rate tables.
With a wide range of potential applications, we are confident that Project Aladdin will be a long-term driver of user traffic growth.
Branding continues to be a focus for us.
And leveraging our core competency in search to make positive social contributions is an important part of this.
Most recently, we launched a search service especially designed to serve the rapidly-growing senior age online population in China.
Along these lines, we also launched search services dedicated to the blind, youth and the (inaudible) traditional Chinese literature.
Even though these are not revenue contributors, we believe that these services yield important dividends in the form of reputation and goodwill.
Looking ahead, we are feeling encouraged on a number of fronts.
First, following the Chinese New Year holiday, we have seen a healthy pickup in both user traffic and online marketing activities.
With our strong execution capability and persistent focus on user and customer needs, we are confident that Baidu's cost-effective, performance-based model will continue to be the online marketing platform of choice, particularly in this kind of economy.
Of course, we are constantly monitoring market trends to stay ahead of the rapidly-evolving needs of our users and customers.
Thank you again.
And I will now turn the call over to Jennifer for financial highlights.
Jennifer Li - CFO
Thank you, Robin.
Hello everyone.
Before I go into the financial details, I would like to introduce our new Investor Relations Director, Victor Tseng.
Victor joins us from Deutsche Bank, where he was an equity research analyst covering the China Internet sector.
We're confident that Victor's sector experience and his unique perspective will be beneficial to our IR program.
So welcome, Victor.
As Robin mentioned, we're very pleased with our financial results for the quarter, driven by our execution capabilities and the fundamental strength of our platform.
During the quarter, our balanced approach to controlling cost, while investing in important initiatives, also allowed us to maintain healthy margins.
Now let's look at some of the financial highlights for the quarter.
The amounts mentioned are in CNY unless otherwise noted.
Online marketing revenues for the quarter were CNY810m, a 41% increase year-over-year.
For the first quarter, Baidu had more than 185,000 active online marketing customers, a 15% increase from the corresponding period in '08 and a 6% decrease from the previous quarter.
Revenue per online marketing customer for the first quarter was approximately CNY4,400, a 22% increase from the corresponding period in '08 and a 4% sequential decrease.
Traffic acquisition cost, as a component of cost of revenue, was CNY124m or 15.3% of total revenue, as compared to 13.3% in the corresponding period in '08 and 14.6% in the fourth quarter of '08.
The increase in TAC as a percent of revenue, reflects strong performance of some of our partners continuing to drive fast growth of our Union business.
In the near term, the trend may still fluctuate.
We'll monitor the Union strategy to ensure we continue to manage a healthy balance.
Bandwidth cost and depreciation cost as a percent of revenue both decreased in the first quarter versus a year ago.
This demonstrates continued efficiency improvement, as well as increased scalability of investment in capital expenditure.
Selling, general and administrative expenses increased to 39% (sic - see press release) from the corresponding period in '08, primarily due to the increase in marketing expense as part of our branding effort.
R&D expenses increased 67% over the year-ago period, primarily due to increased headcount.
We'll continue to prudently invest in R&D to ensure we're at the forefront of technological innovation.
Share-based compensation expenses, which were allocated to related operating cost and expense line items, increased in aggregate by 45% to CNY23m in the first quarter from CNY16m in the corresponding period in '08.
The increase in share-based compensation expenses primarily reflects increase in grants to the employees.
Operating profit for the first quarter was CNY199m, an increase of 35% over Q1 of '08.
Total headcount as of March 31, '09 was about 6,200, roughly 200 fewer than at the end of Q4 '08.
The decrease in headcount mainly comes from sales and marketing.
Our business is growing.
And we'll continue to invest prudently in human resources, particularly in R&D, while at the same time focusing on improving operational efficiency.
Income tax expense was CNY27m for the first quarter.
The effective tax rate for the first quarter was 12.9%, as compared to 6.9% in the corresponding period in '08.
The increase was primarily due to some Baidu entities migrating out of tax holiday status.
Net income was CNY181m, a 24% increase from the corresponding period in '08.
Basic and diluted EPS for the first quarter of '09 amounted to CNY5.25 and CNY5.22, respectively.
Net income, excluding share-based compensation expenses, a non-GAAP measure, was CNY205m, a 26% increase from the corresponding period in '08.
Basic and diluted EPS, excluding share-based compensation expense, both non-GAAP measures, were CNY5.93 and CNY5.89, respectively.
As of March 31, '09, the Company had cash, cash equivalents and short-term investment of CNY2.8b.
Net operating cash inflow and capital expenditures for the first quarter of '09 were CNY247m and CNY42m, respectively.
Now let me provide you our top-line guidance for the second quarter of '09.
We currently expect total revenue for the second quarter of '09 to be between CNY1.07b to CNY1.1b.
That would represent 32% to 36% sequential growth.
I do wish to emphasize that this forecast reflects Baidu's preliminary review, which is subject to change.
I will now open the call to questions.
Operator
The question and answer session of this conference call will start in a moment.
(Operator Instructions).
And the first question comes from the line of Mr.
Jason Brueschke with Citigroup.
Please proceed.
Jason Brueschke - Analyst
Thank you, and good every -- good morning, everyone.
Congratulations on the quarter and the guidance.
Jennifer, Robin, my one question I guess I'll limit myself to is about active customers.
The number, at 185,000, was down pretty significantly Q-over-Q.
And I'm wondering if you could give us a little color upon this.
Is this mostly as a result of the website cleanups that you guys initiated in the fourth quarter?
And to what extent is any of this maybe due to some diverting of resources from the sales force to learning and getting trained up on Phoenix Nest, ahead of the April launch?
And within that, could you maybe help us understand whether the number of active customers has stabilized in April?
And do you expect this number to grow sequentially in the second quarter?
Thanks.
Robin Li - CEO
Jason, Peng will answer your question.
Peng Ye - COO
Hi Jason.
This is Peng.
Let me answer your question.
I think the three factors contributing to this situation, number one is the seasonality, traditional seasonality in Q1.
Number two is the macroeconomic situation.
Number three is the ongoing actions we have been taking to improve the quality of the customer bases.
That's it.
Thank you.
Jennifer Li - CFO
Jason, let me just add a little color.
The active number of customers is defined to be active during the quarter.
So if you look at Q4, although we did take measures to improve the quality of our customer base, a majority of those customers were still active in that quarter.
Since we have done that and we have taken additional measures, as we mentioned, towards the end of last year, all of those removed customers that don't come back, the full extent will be felt in Q1.
So in Q1, that -- basically, the number of customers reflected that fact.
And in addition, as Peng mentioned, the normal seasonality, right before Chinese New Year, is typically a slower time to acquire new customers.
On top of that, the weaker economy.
That -- the combination of that is the result of the 184,000 customers.
At this stage we want to say, as I mentioned in the past, the activities that we have taken to improve the quality of the customer base, to a large extent, has -- is over.
But we will continue to monitor the healthiness of our customer base and continue to take measures, appropriately.
But we don't foresee any major change to the customer base, going forward.
Jason Brueschke - Analyst
Jennifer, that's an excellent point.
If I could maybe just ask you a quick follow-up.
Could you maybe give us an apples-for-apples comparison, because your point is well taken that someone who was there in October or November and was removed in December still shows up in Q4 and wouldn't show up in Q1.
But to let us understand what a -- if you were to kind of normalize Q4 for the actions you took at the end of Q4, did we see some sequential growth?
Or was the sequential decline less if you look at it apples-for-apples, when we look at Q1 versus what really happened in the end of Q4?
Jennifer Li - CFO
Jason, if you look at last year's trend, I think there was a slight increase of number of customers between Q1 and in the end of '07.
So I think the normal trend would put us back in line with that range.
It's hard to pin down exactly what's in the next -- the exact number of customers.
That is purely a result of the combination of the three factors we just mentioned.
Jason Brueschke - Analyst
Great.
Thank you very much.
Operator
And the next question comes from the line of Mr.
Gene Munster with Piper Jaffray.
Please proceed.
Gene Munster - Analyst
Hi.
Good morning and my congratulations.
Could you talk a little bit about Phoenix Nest and some of the changes in monetization?
I'm sure you guys have some data around the impact on monetization when you've been beta testing Phoenix Nest.
And second, can you talk about some of the potential impact regarding some of the transparency changes in the search results page and from the user side as far as click-through rates?
Thanks.
Robin Li - CEO
Haoyu.
Haoyu Shen - VP, Business Operations
Hi Gene.
First of all, as you must know that we made Phoenix Nest available to all customers Monday of last week.
So we're literally talking about a week ago.
So it's very early stage, but we like what we're seeing.
As far as how [mechanically] it improves monetization, I think we can look at a few different dimensions.
One is potentially coverage because we're opening up right now the left-top shaded area for Phoenix Nest.
So the recoverage of -- by relevant ads I think potentially will increase.
And also, CTR will also improve because we're using better keyword matching algorithms.
So CTR will eventually increase.
And also, as far as ACP, (inaudible) a more sophisticated algorithm.
A more sophisticated algorithm will encourage the bidders, our customers, to look at their ROI more closely, and enable them to look at their ROI more closely, so that potential ACP will also go up.
So this is -- all these three dimensions will eventually improve, leading to better monetization.
But right now it's really in early stage.
But we like what we're seeing.
A lot of customers are already online.
And the system is running smoothly.
Gene Munster - Analyst
In terms of the search results page, as you guys add more transparency so your users can see which ads are sponsored, is there any risk that your click-through rates on that left-hand side are going to decline, given the greater transparency?
Haoyu Shen - VP, Business Operations
No.
So Gene, I think there's something that we need -- I need to clarify here.
So Phoenix Nest is not about where the paid links are displayed.
So it's about a new auction mechanism, a new bidding mechanism.
So users don't really see it.
The surfers -- the searchers, they don't really see it.
So what we did now in April is we made Phoenix Nest manage the top-left shaded area, the sponsored search area right now.
So the users, as far as right now, they don't really see it.
So what you're talking about, left or right, more transparent separation between page and [matched results], that's about how we display paid links.
As we -- as Robin actually mentioned a few calls back, that model will also evolve.
But that's a different thing from the auction mechanism we're using, which we're launching now, the new auction mechanism (inaudible).
These two things are not totally independent from each other, but these are two things.
They will both evolve over time.
So we'll coordinate the evolution of the display form and auction mechanism very carefully to make sure we have a smooth evolution so to speak.
Gene Munster - Analyst
Okay.
One just follow-up question, just on the change in the search results page.
I realize that's independent of Phoenix Nest.
If you could talk about how long that transition is between having search results that are less transparent, to more of a Google-like model.
Is this going to be something that starts today and is going to be -- a year from now you'll be almost entirely having shaded results on the top left?
Or is it something that will be six months or three months or two years?
Any sort of timeframe in terms of how long that transition will take?
Robin Li - CEO
Okay.
Hi, Gene.
This is Robin.
I think we, at this time, do not have a definitive schedule for the full transition process.
I guess it will depend on how Phoenix Nest will do in the future and what kind of user experience we would like to offer, and general competitive landscape of this market.
The trend is going to more clearly separate paid and unpaid results, but we do not commit a definitive schedule at this time.
Gene Munster - Analyst
Great.
Thank you.
Operator
And the next question comes from the line of Mr.
Dick Wei with JP Morgan.
Please proceed.
Dick Wei - Analyst
Oh hi.
Thanks for taking my question.
I guess in Q4, you guys mentioned it, about there was a one-time issue.
That's why the traffic acquisition cost was higher.
I guess for Q1 if you can give some more color in terms of the sharing ratio or any changes in terms of TAC.
And also, is the management still maintaining that the bottom -- the absolute bottomline is still more important than the gross margin?
Or is that -- should we think that's [stopped]?
That would be great.
Thanks.
Robin Li - CEO
Haoyu.
Haoyu Shen - VP, Business Operations
Yes.
So Dick this Haoyu again.
We realize that the TAC as a percent of total revenue reached an all-time high this quarter.
As we said before, it still largely reflects the faster growth of revenues from our affiliate network than from organic.
Although in Q1, we're also seeing very healthy growth of revenue from organic search.
So I think we still maintain our position that we look at this business on a revenue net of TAC basis.
But we also are looking at -- we have been and will continue to look at this business on a strategic level and also a financial level.
It's very hard to -- so the TAC ratio fluctuates quarter-over-quarter because of many factors.
Some quarters we added a few big partners.
The next quarter, TAC may go up, just because the next quarter they start to perform.
So that actually, in large part, explains our high TAC ratio this quarter.
In Q4 and Q3 also we added a few big partners and they're really ramping up this quarter.
But going forward it's very hard to predict every quarter where the TAC ratio will be.
It's contingent on our different partners' performance and mix shift of our different offerings and mix shift of the kind of partners.
And also competitors move.
We realize that it's pretty competitive.
This business is in a pretty competitive [environment].
But just to add on, I think when we look at different type of partners, we look closely at what partners can bring us incremental revenue, either incremental users or incremental (technical difficulty).
We'll focus on those partners and we're more willing to enter into deals with (inaudible) partners.
So that's what [we've been doing] and we're going to continue to do it.
Operator
(Operator Instructions).
And the next question comes from the line of Mr.
James Lee with Sterne Agee Capital Markets.
Please proceed.
James Lee - Analyst
Thanks for taking my question.
I want to follow along Phoenix Nest a little bit.
Robin, maybe you can talk about this, if you can.
Who are the early adopters and which, specifically, vertical customers you are seeing maybe driving this adoption?
And is it more the B2B customer who are driving it or B2C?
And if I can add one more to that, what do they use Phoenix system specifically?
Is it kind of complementary to the old system that you have or do they -- do the new people coming onto the system use that as a -- Phoenix Nest as a main system going forward?
Thank you.
Robin Li - CEO
Hi James.
I think, at this time the Professional Edition or Phoenix Nest coexists with Classic Edition.
So customers are using both.
Those customers who are using Phoenix Nest are also using our Classic Edition.
Most of the users of -- or customers of Phoenix Nest are more mature customers.
They understand better how search marketing works.
And as they understand better how to measure the ROI.
There are a lot of customers from all kinds of different industries.
But overall, we would like to encourage more and more customers to shift from the Classic Edition to Professional Edition.
And I think those more mature customers would shift first.
And they contribute, probably, the majority of our current revenue.
Haoyu Shen - VP, Business Operations
James, just some more color to what Robin said.
So it's available to anyone.
Anyone can participate now.
But as far as we go out and target the -- first [the actual] customers to move more quickly into the system, we're targeting the bigger ones.
And those tend to be -- if you think about it on an ARPU basis, those tend to be the B2C type of customers.
Those are the early adopters.
And they're running -- the two systems are running parallel.
Our desire is definitely to have the customers move their spending more to Professional Edition because that's the system that will -- that's the one system that we'll use eventually.
But right now we're not -- for people who are on Phoenix Nest, we're not shutting down their Classic Edition.
We want to make sure that the transition is smooth.
Operator
Our next question comes from the line of Mr.
Alan Hellawell with Deutsche Bank.
Please proceed.
Alan Hellawell - Analyst
Yes, thank you very much.
I just wanted to congratulate you for the quantum gains on the investor relations front with your new appointment.
My only question is really just a broad 2009 question about Baidu Union.
How should we be thinking about it in 2009 versus 2008 in terms of contribution, margin profile, etc.?
Thank you.
Haoyu Shen - VP, Business Operations
So I don't think we give specific guidance on the revenue from affiliated network or TAC, but we can talk in general about our strategy here.
Basically there are two types of businesses that Baidu Union has.
One is search, the other is contextual.
So on search, which is a majority of our Union business in terms of revenue, as I said a few minutes ago, we have different types of partners.
And we are looking at the different types of partners, strategically and financially.
We want to make sure that the traffic they bring us is as incremental to us as possible, either traffic or users.
And we will have different policies, as far as TAC policy is concerned, for these different types of partners.
And payout ratio has been actually stable.
So it's very hard to make sure that the payout rate is stable.
But on the other hand, we realize and everybody should realize that this is a very competitive market.
On the contextual side, historically a smaller part of our Union business we're putting a lot of effort on it this year, as far as improving the product, as far as getting better partners, getting better content partners online.
So I think that business is all incremental to us because we're monetizing somebody else's traffic.
So we're working on that, mostly on the product side and the partner side.
So I don't know if I answered your question.
We don't give guidance on these numbers.
But that, in general, is what our strategies are for Baidu Union this year.
Alan Hellawell - Analyst
Thank you very much.
I'll follow up with your Director of IR.
Operator
And the next question comes from the line of Mr.
Eric Wen with MainFirst.
Please proceed.
Eric Wen - Analyst
Hi, good morning.
Thanks for taking my call.
I have two questions if I may.
The first question is I think -- let me try to limit to one.
The first question is I think in the first quarter Baidu did some marketing cost.
And there was even some number being provided.
I just wonder if this marketing cost is already behind us.
Is there any follow on payment in the following quarters?
And my second question is I notice there is a drop in customer deposits, where you have an increase in the first quarter '08.
Is this because of the clean up of medical advertisers?
If you can give some clarification there it will be much appreciated.
Thanks.
Jennifer Li - CFO
Hi Eric, it's Jennifer.
On the marketing cost, whatever the activity that we have taken in Q1, the payment is made and the expense booked.
So there is no lingering payments related to the Q1 activities.
However, as we mentioned in the past, branding is going to be -- has been our focus.
And it will be a stronger focus for us this year.
So I do anticipate a couple of more dollars to be spent on marketing.
However, it's unlikely for us to reproduce the magnitude of spend in Q1.
So hopefully that answers your number one question.
Number two, on the customer deposits, at the end of Q4 we did have a high level of deposit.
And you do see a slight decrease at the end of Q1.
I mentioned in our Q4 call, the year-end number for '08 on customer deposits was a little abnormal.
So I wouldn't take that as a normal trend and use that information because we all know at the end of '08 the economic situation was challenging.
And I did mention in the prior call that customers were cautious and were holding back on their spending.
So we had a lot of accumulated customer deposits.
I want to say the behavior of customer deposits has resumed to the normal level.
So what you're seeing in Q1 is the normal customer deposit state that you're seeing.
Eric Wen - Analyst
Thanks, that helps.
Operator
And the next question comes from the line of Jeffrey Lindsay with Sanford Bernstein.
Please proceed.
Jeffrey Lindsay - Analyst
Thank you and good morning.
Could we ask two things?
First, a technical question.
The cost of goods sold, outside of TAC, grew faster than revenues.
Given that you've reduced cost on staff and given that you've reduced on bandwidth, why was that?
Jennifer Li - CFO
Jeffrey, it's Jennifer.
I'm not sure which period you are comparing to.
If -- because Q1 is a seasonally low quarter, so we typically compare Q1 ratio to the prior year period.
If you look at the prior year period if you take out TAC, I think we actually had an improvement.
Jeffrey Lindsay - Analyst
We were looking sequentially.
Jennifer Li - CFO
Yes, sequentially, Q4 because of the typical seasonality, that's -- it's not directly comparable.
Jeffrey Lindsay - Analyst
Okay, thank you.
And then second, guidance is bullish.
Are you seeing signs of a recovery in the Chinese economy?
And if so, in which sectors?
Robin Li - CEO
Jeffrey, this is Robin.
The guidance is based on the revenue trend we have seen for the past couple of months, especially after the Chinese New Year.
As we mentioned during the last earnings call, after Chinese New Year economic activities as well as user traffic has been going up.
So based on that trend we calculated the 2Q revenue projection.
I think the -- so far we have not seen any dramatic change after Chinese New Year period.
So we -- that's why we've given a guidance like this.
Jeffrey Lindsay - Analyst
Thank you.
Operator
And the next question comes from the line of Mr.
Paul Wuh with Nomura.
Please proceed.
Paul Wuh - Analyst
Yes.
Could you perhaps talk about -- it's a follow up on that last question.
What are the top three industries you are seeing the most growth in?
Yes.
And also medical, perhaps you could talk about how medical is looking now, after all this clean up, as far as percentage of total.
Haoyu Shen - VP, Business Operations
Hi Paul, this is Haoyu.
So after Chinese New Year, [we saw] a broad pick up as far as different sectors are concerned.
So I don't think I have a sort of exact -- I can't pinpoint [exactly] the three sectors that grew the fastest.
So given the traditional B2B sectors we saw material softness before the Chinese New Year, we see pretty good recovery as far as we can see now, after Chinese New Year.
As far as medical, I think we mentioned before that once we collected all the paperwork that's needed, that the majority of the customers are back and the majority of the revenue is back.
So now it's one of the biggest sectors that we have right now.
And we think it will continue to grow at a healthy rate.
Paul Wuh - Analyst
Do you think it's more like 10% to 12% -- 10% to 15% of revenues again?
Haoyu Shen - VP, Business Operations
It's in the teens.
Paul Wuh - Analyst
Excuse me?
Haoyu Shen - VP, Business Operations
Less than 20%.
Paul Wuh - Analyst
Less than 20%.
Okay, thank you.
Operator
And the next question comes from the line of Mr.
James Mitchell with Goldman Sachs.
Please proceed.
James Mitchell - Analyst
Hi, great.
Thank you very much for taking my question.
Could you talk a little bit about headcount?
Do the recent headcount reductions flow from Baidu restructuring the sales teams that Baidu acquired in the three years after the IPO?
And if so, where do you think you are in the headcount sales force restructuring process?
Peng Ye - COO
Hi James, this is Peng here.
Yes, actually starting from the second half of last year we initiated a couple of actions to improve the sales operational efficiency, including the streamlined organization, flattening the organizational structure and also centralized a couple of the functions.
As a result of those initiatives, actually starting from the second half of last year, the headcount for sales organization decreased.
That is mainly the reason.
But on the other hand, we are looking at all the opportunities to make the strategic investment in the sales force, especially for the training organization and also for the development of the CRM system as well.
So we will take all opportunities to improve [ourselves].
Jennifer Li - CFO
James, it's Jennifer.
Let me just add to that.
Q1 you do see another sequential decrease also on headcount.
I just wanted to point out, as I mentioned in the prepared remarks, we continue to look for ways to improve operational efficiency and at the same time invest in R&D capability.
Q1 is a low period for us to recruit R&D resources.
Typically the hiring goes out in Q2 and Q3.
So I think this pace of headcount management is healthy for us.
And on the operation side, as Peng mentioned, we're definitely looking at ways to improving -- to improve the efficiency.
And there might be some resource shift to manage the kind of system capabilities that we have.
So I wouldn't take this one quarter as a trend going forward.
James Mitchell - Analyst
Great.
But if you look at the sales force in total, is it reasonable to assume that having brought your own sales forces in the big cities, you're now roughly where you want to be in terms of sales force and that most of the headcount adds are in research and development?
Jennifer Li - CFO
I think on balance, James, we have been executing a slow shift from a heavy concentration on additional sales force hire to a more R&D focused.
I think, on balance, the total organization the kind of state that we're in, with -- going into the Q2, Q3 hiring time, at that time things will stabilize.
James Mitchell - Analyst
Great, thank you.
Jennifer Li - CFO
Does that help you?
James Mitchell - Analyst
Yes, thank you.
Operator
And the next question comes from the line of Mr.
Richard Ji with Morgan Stanley.
Please proceed.
Richard Ji - Analyst
Thank you for taking my call and I have two questions.
First, starting with some of your new initiatives such as your online commerce initiative, as well as your Japan venture.
And as you significantly gear up your R&D force, how much of your new R&D headcount will go into these initiatives?
And when should we expect these initiatives to be a material or meaningful revenue contributor to your Company?
Robin Li - CEO
Hi Richard, this is Robin.
Regarding to the two new initiatives you mentioned, online commerce and Japan, we give a rough guidance at the beginning of the year on the costs associated with Japan.
So this year, the cost will be between $25m to $30m.
For the online commerce, because it's not material enough, we have not disclosed a separate cost for that.
These are long term investment opportunities that we view as strategically important.
So we're not counting on any revenue for this year.
And as time pass by and as the product, it gets more mature, we'll have a better idea of when to monetize that.
Richard Ji - Analyst
Thanks Robin.
And my follow up question is regarding Baidu Union, which obviously remains as a bright spot.
And given the fact that your arch rival Google China has been pretty aggressive in sealing partnership with the third party websites, going forward how would you -- how would Baidu differentiate from Google to attract more Union members?
Robin Li - CEO
Haoyu.
Haoyu Shen - VP, Business Operations
I think of course the number one concerns of any partner on search side or on the content side is TAC, how much revenue we share with them.
So this can only be achieved by better monetization -- the better monetization capability that we're developing.
Phoenix Nest is one of those.
And we're also launching some new products on the contextual side as well.
So money is one thing.
On the other hand, we are -- we do have a pretty dedicated team serving the Union partners, either the search side or contextual side.
I think we have a lot of advantages in terms of how we serve the needs of our partners, how we respond to their needs and how we communicate with them.
So it's a combination of many things, on the money side and also on the service side.
So it's competitive, but we do believe we have strong advantages on many fronts.
Robin Li - CEO
Just to add to what Haoyu just said Richard, I think when it comes to attract Union members or partners, two major forces will drive the competitiveness.
One is the number of customers or advertisers.
The more customers we have the better we can serve our partners in terms of revenue generation.
And the second force is the monetization capability or RPM.
So while we are working on a better system, actually we have been continuously improving the monetization capability of the traffic we acquire.
So with more customers and better monetization I think, going forward, our Union (inaudible) will be more attractive to potential partners.
Richard Ji - Analyst
Thank you Robin and Haoyu.
Operator
And the next question comes from the line of Mr.
Eddie Leung with Merrill Lynch.
Please proceed.
Eddie Leung - Analyst
Good morning everyone.
Could you guys share with us some of your plans regarding online music download, especially given some of the initiatives taken by your competitor recently?
Thank you.
Robin Li - CEO
Eddie, this is Robin.
I think it's important to clarify Baidu is a search company.
We provide all kinds of search services, be it text, image, audio files or video files.
Baidu MP3 has been an audio file search.
And we try to make everything publicly available online searchable by Baidu.
We have never provided any download service.
And we do not intend to become a content provider for music or whatsoever.
Eddie Leung - Analyst
Got that.
So there would not be any initiatives using banner advertising to monetize music, right?
Robin Li - CEO
We have been using banner advertising to monetize the search service, some of the search services, including MP3 search.
At the time of IPO, that's like almost four years ago, three and a half -- more than three and a half years ago, the revenue from MP3 related services represented roughly 5% of our total revenue.
Since then the percentage has gone down significantly.
So although we would very much like to see a good value chain and a good business model for digital music, so far the monetization capability for music has not been as strong as we expected.
And the user traffic for MP3 search as a percentage of our total traffic is also dropping.
Eddie Leung - Analyst
Understood very well.
Thanks.
Operator
And the next question comes from the line of Mr.
Stephen Ju with RBC Capital Markets.
Please proceed.
Stephen Ju - Analyst
Good morning everybody.
So CapEx in the first quarter was a bit low versus what we were expecting.
Is this a matter of timing?
And what is that outlook for the balance of the year?
Thank you.
Jennifer Li - CFO
Hi Stephen.
CapEx yes, was a bit low in Q1.
You know CapEx they do come in pretty lumpy.
But I wouldn't trend the Q1 actual for the rest of the year.
I mentioned in the last call, our CapEx for this year should be largely in line with last year.
Stephen Ju - Analyst
Okay.
On a percentage basis or on a renminbi basis?
Jennifer Li - CFO
On a renminbi basis.
Stephen Ju - Analyst
Okay, thank you.
Operator
And the next question comes from the line of Mr.
Steve Weinstein with Pacific Crest.
Please proceed.
Unidentified Participant
Hi.
Thank you for taking my question.
This is (inaudible) for Steve.
So the question we have is regarding the Q2 guidance.
So we notice that the Q2 guidance is implying a slower year-over-year growth than the Q1, what you [guided].
So we're wondering are we going to see any slower growth in April or you're just trying to be conservative here?
Robin Li - CEO
I guess it really goes back to a couple of quarters before, because of what happened during the previous quarters.
And our revenue mix changed, our customer quality improved.
And quarter-on-quarter growth would make more sense at this time than year-over-year growth.
Jennifer Li - CFO
I just wanted to add to that.
Q2 last year was a very strong quarter.
And we all know special things happened in Q3 and Q4.
We had the Olympic event and we had a very, very challenging quarter in Q4.
So you do have a lower base to work on.
And compared to the last year's strong performance just as Robin mentioned, I think at this point, the sequential ratio is more relevant.
Unidentified Participant
Thank you.
Robin Li - CEO
I think the economy is also a big factor year-over-year.
Operator
And the next question comes from the line of Elinor Leung with CLSA.
Please proceed.
Elinor Leung - Analyst
Hi, thank you for taking my call.
My question is regarding the Baidu Union.
What is the contribution in first Q '09 to your total revenue?
Do you expect the contribution to increase in 2009 based on your forecast?
Does that mean that -- if it does, does that mean that the TAC cost as a percentage of revenue will continue to go up into 2Q '09?
Robin Li - CEO
Haoyu.
Haoyu Shen - VP, Business Operations
So we never -- as a practice we never break down specifically how much revenue is from our Union business.
So we said that the recent increase of TAC ratio has -- is attributed to the fast growth of Union revenue.
As far as outlook, we can't predict whether it will continue to grow faster than organic revenue or how much differential there will be.
So I think we'll be talking about how we think about TAC and how we think about Union business in general.
We do have our strategies in place and our policies in place.
And we will continue to see TAC fluctuate quarter-on-quarter going forward.
Operator
And the next question comes from the line of Mr.
James Lee with Sterne Agee Capital Markets.
Please proceed.
James Lee - Analyst
If I could follow up with that 2Q guidance question.
And maybe you guys can help remind us what are the seasonal factors that's driving the quarter that we should be thinking about, what verticals and high season.
And maybe besides travel, which will be a good sector I believe in 2Q, in what other verticals are you seeing good demand?
And I guess lastly within your guidance assumption, are you guys including any improved monetization from the potential use of the Phoenix system during the quarter?
Thanks.
Robin Li - CEO
Hi James, this is Robin.
Regarding to the Q2, I think it's largely driven by the March performance.
Because of the seasonality, at the year right after Chinese New Year there's a sudden pick up in consumer activities, be it user or advertiser.
So based on what we have seen in March, we give out guidance for Q2.
One thing I forgot to mention about the year-over-year comparison is that last year the Chinese New Year was very late.
So you have less opportunity to monetize your traffic in Q1.
Therefore the Q2 versus Q1 growth will be stronger.
And this year the Chinese New Year is a little earlier.
So we've seen more revenue -- relatively more revenue in Q1.
And that's why we see the Q2 growth like what we guided in the press release and the prepared script.
In terms of monetization, it's an ongoing process.
We have been working on better monetization algorithms for the past few years.
And the most significant project has been Phoenix Nest.
That being said, Phoenix Nest is a revolutionary bidding system and it's just launched like a week ago.
The initial effect to revenue is actually negative.
But going forward, in the long run, we believe that this system will give us much better capability to monetize our traffic.
In terms of verticals, are we seeing anything different?
Haoyu Shen - VP, Business Operations
No.
Hi James, this is Haoyu.
So different sectors definitely have different seasonality.
So, for example in Q2, around -- quite prior to May 1 holiday we see pick up in travel, for example.
But we don't look at it in that kind of granularity.
How we give guidance is, as Robin told you, we really look at the performance of in terms of ARPU and the number of active customers and the new customer acquisition speed in recent weeks.
Then really look at how for example, April compares with March last year, how May compares with April last year.
Then we'll try to account for any differences this year, then give out our best forecast.
So I think seasonality is definitely there, depending on the sectors, each year.
But we don't look at it in that kind of (technical difficulty).
James Lee - Analyst
I just want to follow up Robin's comment about the initial negative impact of the new bidding system on your revenue flow.
He had said -- I just want to make sure I get that clear -- the initial impact will be negative and that negativity that you're assuming is factored into your 2Q guidance.
Robin Li - CEO
Yes, that is.
James Lee - Analyst
Thank you.
Operator
The next question comes from the line of [Joe King] with Oppenheimer.
Please proceed.
Joe King - Analyst
Good morning everyone.
My question is about the long term direction of your R&D and mainly does Baidu have any aspirations to be the provider of like online tools, beyond just basic search results and the search monetization?
Robin, you and spoke about this a couple of years ago, but I feel compelled to ask this again because in an earlier answer you said that the music downloads -- your answer to music downloads suggests your first priority is search and less of a priority on how to make search and downloads a better customer experience.
And I ask because if you look at the global search platforms out there, the market leaders tend to evolve in a direction where there is continuous (inaudible) development of online tools.
So in many ways I see your competitive [strength then] is as much as Google as well.
So again, your thoughts as to the R&D direction of the Company.
Robin Li - CEO
Let me put it this way.
I think for Baidu our goal is to become a media platform in the sense that we provide a platform that monetizes traffic for our owned and operated properties as well as our Union partners.
By doing that, the R&D focus will need to be, as you've seen, in two fronts.
One is the core Web search capabilities.
It's a very sophisticated and still evolving system.
We have a lot of effort putting in that.
And so far I think, on a worldwide basis, the most beautiful business model for Internet business is paid search.
And we need to have our own search traffic in order to drive long term growth for the Company.
And the second front is the monetization capability.
That front I think we've been late.
Only during the past couple of years, we started seriously investing in the monetization capability.
And Phoenix Nest is a result of that.
With more and more search traffic, or inventory, to sell and better and better monetization capability, I think this Company will be able to maintain a very high growth rate for the years to come.
So in that sense our R&D -- the long term focus for the R&D team has always been search related -- Web search related, be it natural search or paid search.
We have a number of vertical searches, image search, news search, MP3 search, video search.
Those are designed to help drive traffic to Web search, not to make money by themselves.
Operator
And the next question comes from the line of Mr.
James Mitchell with Goldman Sachs.
Please proceed.
James Mitchell - Analyst
Thanks very much.
I think that last quarter you disclosed that you'd spent about CNY40m on the CCTV sponsorship in the first quarter which, I guess, you took through your SG&A line.
Is it sensible at all to look at SG&A ex-that CNY40m?
Or should I assume that if you didn't spend the CNY40m, you'd have spent CNY10m or CNY20m or CNY30m on something else?
So that's one question.
And then since it's the back end of the call, a separate question.
I came across a news story about a confidence plan you've set up to encourage SMEs to experiment with Phoenix Nest, where you give them rebates.
Could you talk a little bit about the confidence program for the professional Phoenix Nest?
Jennifer Li - CFO
James, it's Jennifer.
I'll answer your first question.
Last quarter we provided guidance that sequential -- sequentially we anticipate a CNY40m incremental marketing-related expense.
Yes, CCTV is the majority of that incremental expenditure.
We typically also have other annual kind of events that happens in Q1.
So Q1, if -- I think your answer is, your guess is right.
If I take out the CNY40m related to marketing, the rest of that will be the other -- the main SG&A expenses primarily related to work force and just the normal activities.
Haoyu Shen - VP, Business Operations
Hi James.
First, about the confidence plan that we announced just in the past few days.
So it's really aimed at encouraging customers to adopt Phoenix Nest.
So how it works is if they qualify -- if they (inaudible) as far as the spending on Phoenix system in May, we'll provide rebates to the customers (technical difficulty).
So we target that (technical difficulty) as far as adoption of (technical difficulty).
James Mitchell - Analyst
I'm sorry.
I didn't fully catch the last.
The rebate will be treated as a contra-revenue item or it will be an expense item?
Haoyu Shen - VP, Business Operations
It will be contra-revenue, yes.
James Mitchell - Analyst
Okay, thank you.
Operator
And the final question comes from the line of Mr.
Dick Wei with JP Morgan.
Please proceed.
Dick Wei - Analyst
Hi.
I just wanted to get an update in terms of the mobile search.
I guess Robin made some comments in the past, like a couple of weeks ago.
And if you can give us some market share data in terms of Baidu's market share in WAP search that would be great.
Thank you.
Robin Li - CEO
Dick, in terms of mobile search, I think there are still lots of uncertainties going forward.
As you know that -- the 3G network infrastructure-wise just got started.
It's too early to place a huge [bet] on that.
Right now, the most popular form of mobile search is WAP.
And we believe that Baidu has the number one position in terms of mobile search, traffic-wise.
And we have a number of mobile search services, web search, Post Bar and a number of others.
But going forward we expect the format will change, the consumer behavior will change, the rate of wireless Internet access will change and a lot of things will change.
And we would like to work with the carriers to come up with better, more innovative solutions for the mobile search users.
But at this time, it's kind of too early to tell.
Dick Wei - Analyst
Great, thank you.
Robin Li - CEO
Thank you.
Operator
We are now approaching the end of this conference call.
I will now turn the call over to Baidu's Chief Executive Officer Robin Li for closing remarks.
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 now disconnect.