百度 (BIDU) 2010 Q2 法說會逐字稿

Hello and thank you for standing by for Baidu's Second Quarter 2010 Earnings Conference Call.

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

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

Today's conference is being recorded.

If you have any objections you may disconnect at this time.

I'd now like to turn the meeting over to your host for today's conference Victor Tseng, Baidu's Investor Relations Director, please proceed sir.

Hello everyone and welcome to Baidu's Second Quarter 2010 Earnings Conference Call.

We issued Baidu's Second Quarter 2010 earnings release earlier today.

You can find a copy of the earnings release on the Company's website as well as on newswire services.

Today you will hear from Robin Li, Baidu's Chairman and Chief Executive Officer and Jennifer Li, Baidu's Chief Financial Officer.

After their prepared remarks, Robin and Jennifer will be joined by Haoyu Shen, Senior Vice President of Business Operations, to answer your questions.

Before we carry on 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 call will be available on Baidu's corporate website at ir.baidu.com.

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

Hello everyone and thank you for joining us today.

I'm pleased to report another quarter of strong performance.

Successful customer acquisition was the main driver for our top line growth.

We saw a record number of customer additions, a total of 33,000 during the quarter.

This was driven largely by our successful nationwide marketing campaign and the favourable macro environment.

As part of the marketing campaign our team visited over 100 cities across China and attracted a significant number of new customers by educating the market about Baidu and the power of search engine marketing.

Also the rollout of our CRM system helped increase sales productivity.

Today, our current base of 254,000 customers is still just a tiny fraction of the total addressable market of millions of SMEs in China.

As the market leader we will continue to educate companies about Baidu's cost effective marketing platform.

During the second quarter we continued to implement enhancements to our online market platform.

We were able to monetise more effectively and large companies and SMEs are spending more with us.

This trend should continue as customers become more familiar with the platform functions and see potentially higher ROI.

Phoenix Nest's implementation is largely complete, but consider it as Version 1.0.

There is still much more room for further improvement on an ongoing basis.

Q2 also marked a big step forward for our vision of box computing.

We continued to add more applications in our search engine result page.

In other words, our box can do more, especially for time-sensitive queries.

The World Cup event is a great testimonial of this technology.

During that time we answered more than 100 million related queries with eight different apps on game schedule, match score, live broadcasting and recorded videos et cetera.

The social game we devised during the World Cup on Post Bar attracted millions of people to participate.

As a result we have seen good traffic patterns since the games started.

Typically, our lesser traffic is negatively impacted during large and newsworthy events.

This time there was an exception and, in part, because of the better than expected search traffic during the World Cup we were able to deliver Q2 revenue higher than previously guided.

Our close connection to our users has been a central factor in establishing Baidu's leadership, but new technologies are emerging all the time.

The market remains a very competitive place.

Overtime success depends on investing in long term to anticipate industry trends and keep up with technological investment, that's why recruiting top talent, especially in R&D, remains a focus for us.

In fact you may have heard we were in Silicon Valley, this summer, looking for top software engineers to expand our R&D team.

We are excited about the talented people we met and look forward to making some great hires.

In our Union business we benefited from our new policy which rewards high quality, incremental traffic.

This is an initiative we began in the Third Quarter last year.

By focusing on improving Union traffic quality and nurturing organic traffic growth, we saw a significant decline in traffic acquisition costs as a percentage of revenue.

We're also working on improving our contextual app business, although it is still relatively small.

As we approach the fifth anniversary of our IPO it is worth looking back at on how far we've come.

Since our NASDAQ listing on August 5th, 2005 China's internet population has grown from 100 million, in 2005, to 420 million today.

Baidu's revenue grew from RMB70 million in Q2 of '05, to RMB1.9 billion this past quarter.

We've gone from having 41,000 active online marketing customers to 254,000.

Keep in mind that while China already has the largest online population in the world, almost 70% of the country is still offline.

While we are proud of the exceptional share holder value Baidu has created as a public company, we are just getting started.

By keeping our focus on providing the best way for people to find what they're looking for, in the years ahead I'm confident that Baidu will become ever more central to China's internet ecosystem.

Thank you again for joining us today.

If you plan to be in Beijing on September 2nd we'd love to see you at our annual Baidu event where you will get a chance to witness the progress we're making.

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

Thank you Robin.

Hello everyone.

We had another great quarter; both top and bottom line results were very strong.

Robin explained that top line growth was driven by effective customer acquisitions, continuing improvements in monetisation and better than expected traffic.

At the same time we also effectively managed our expenses and as a result margins scaled to all time highs.

As we said last quarter, 2010 is a year of investment to ensure we continue to develop and serve our customers and users effectively and to provide the best search experience we will keep recruitment for sales and R&D teams as a priority.

You will also see aggressive investment in our network infrastructure which is entering a new investment cycle.

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

All amounts mentioned are in RMB unless otherwise noted.

Online marketing revenues for the second quarter of 2010 were RMB1.913 billion, a 74.5% increase year over year.

Baidu had around 254,000 active online marketing customers in the second quarter of 2010, a 25% increase from the corresponding period in 2009 and a 15% increase from the previous quarter.

The sequential increase was attributable to our successful marketing campaign and a favourable macro environment.

Since we first introduced our new online marketing platform we have seen strong customer acceptance.

This has led to increased customer spending.

Revenue for online marketing customers in the second quarter reached approximately RMB7500, a 39% increase from the corresponding period in 2009 and a 27% increase from the previous quarter.

Traffic acquisition cost, as a component of cost of revenue, was RMB186 million, a 9.7% of total revenue, as compared to 16% in the corresponding period in 2009 and 13.2% in the first quarter of 2010.

The substantial decrease in TAC, as a percent of total revenue, is attributable to improvements of Union traffic quality.

We expect TAC to remain at approximately this level with moderate fluctuations.

Bandwidth costs, as a component of cost of revenue, was RMB68 million representing 4% of total revenues compared to 5% in the corresponding period in '09.

Depreciation costs, as a component of cost of revenue, were RMB84 million representing 4% of total revenues, compared to 5% in the corresponding period in '09.

The decreases in bandwidth and depreciation costs, as a percentage of total revenue, reflects stability of the business model, as we invest in infrastructure depreciation costs will go up.

Selling, general and administrative expenses in Q2 were RMB265 million, an increase of 47% year on year, primarily due to increase to sales headcount and marketing spend.

R&D expenses were RMB159 million, a 66% increase from the year ago period, primarily due to increased costs associated with R&D headcount.

Share-based compensation, which were allocated to related operating costs and expense line items, decreased in aggregate to RMB22 million in the second quarter of 2010 from RMB23 million in the corresponding period in '09.

Operating profit was RMB972 million, a 130% increase year on year.

Total headcount, as of June 30th 2010, was around 9000, roughly 1100 more than the previous quarter.

The increase in headcount comes mainly from sales and R&D.

In 2010 we will remain focused on investing heavily in sales and R&D to drive growth in our business.

Income tax expense was RMB141 million for the second quarter.

The effective tax rate for the second quarter was 14.4% compared to 11.8% for the corresponding period in '09.

The increase in the effective tax rate was due to a new tax circular issued in the second quarter resulting in changes to the applicable tax for one of our subsidiaries in China.

Before going into NET income and ADS figures, I'd like to remind you that due to the 10 to 1 ADS to ordinary share reissue change in May earnings per ADS figures now represent one-tenth of the ADS value announced in previous quarters.

Net income was RMB837, a 118% increase from the corresponding period in '09.

Basic and diluted earnings per ADS for the second quarter of 2010 amounted to RMB2.41 and RMB2.40 respective.

Net income excluding shared base compensations, a non-GAAP measure, was RMB859 million, a 111% increase from the corresponding period in 2009.

Basic and diluted earnings for ADS excluding share base compensation expense, both non-GAAP measures, were RMB2.47 and RMB2.46 respectively.

As of June 30, 2010 the Company had cash, cash equivalents and short term investments of RMB5.9 billion.

Net operating cash flow and capital expenditure for the second quarter of 2010 were RMB1.24 billion and RMB 182 million respectively.

As we mentioned earlier we will aggressively invest in infrastructure and equipment in 2010 to drive innovation, enhance monetisation and support growth.

Now let me provide you with our top line guidance for our third quarter of 2010.

We currently expect total revenues for the third quarter 2010 to be between RMB2.2 billion and RMB2.26 billion which would represent 72% to 77% year on year growth.

This forecast reflects Baidu's current and preliminary view which is subject to change.

I will now open the call up to questions.

Operator, please go ahead.

Sure.

The question and answer session of this conference call will start in a moment (Operator's instructions).

Your first question comes from the line of Alan Hellawell with Deutsche Bank, please proceed.

Thank you very much and congrats on yet another fantastic quarter.

The one thing I wanted to focus on is something we've been badgering you guys about and still seem to be overly conservative on and that's traffic acquisition costs.

They just seem to be falling incredibly dramatically.

I'd like to know now that you're a couple of quarters into reviewing your Baidu Union terms what are the dynamics of this coming down?

Can you give us a sense as to you know how you're changing your revenue share or how - what the broad restructuring of these agreements is?

Going forward how much do you think we can know expect in terms of further TAC savings?

Thank you.

Hi Alan.

It's Haoyu.

Yes, we're seeing a significant decline of TAC as a percentage of total revenue this quarter.

As Robin mentioned in his prepared remarks, and also Jennifer, this is really a result of our continued initiative to improve the quality of our affiliate traffic, which these initiatives started in the second half of last year.

What we are doing, or what we did, is really we want to reward the traffic brought by affiliate partners that are more of an incremental nature rather than a cannibalisation nature, so we choose to - we become more selective in partnering with different kinds of players.

In some cases we reduce the payout rate if we believe traffic is less of an incremental nature to us.

In some cases we chose to not work with some type of partners because it's too much - we deem the traffic is be too much of a cannibalisation nature.

So the impact will be not only, I think at an overall level, the payout ratio is probably coming down and also some of the affiliate traffic we had before is now reverting to organic traffic, so both of these factors are working to cause a decline of TAC percentage.

Going forward we expect this TAC ratio to stay at a relatively low level.

I don't think it will go further down much more and - but I do want to caution you that affiliate search, or search in general, is still a very competitive business in China so we need to stay competitive, we need to stay flexible.

So going forward I'm sure we will continue to see some fluctuation of TAC ratio.

Broadly speaking - sorry just a quick flow up on the same topic.

We're obviously seeing the formation of some other unions and, to the best of your knowledge and very generically speaking, are they trying to gain traction by offering more generous revenue share or do you feel like everyone is clustered around the same revenue share terms as you guys are?

We don't know any details of how they're structuring their deals.

But, as I mentioned, this is still very competitive.

There are other search engines out there who are probably willing to come out and get some traffic, so we will need to stay flexible and stay competitive.

Thank you very much.

Your next question comes from the line of Dick Eve of JPMorgan, please proceed sir.

We can't hear.

Are you there?

His line is open.

His line maybe muted.

Sir is your line muted?

Your next question comes from the line of James Mitchell with Goldman Sachs, please proceed sir.

Thank you for taking the question.

When I look at the very strong customer adds in the second quarter, do you think there was any pent up demand from prior quarters when the sales force were busy with Phoenix Nest stuff?

Also did you see any trends which industries or provinces contributed most to the customer growth?

Yes.

First of all I think every year during the second quarter we have a nationwide market to educate the market and to allow the customers to sign up.

I guess also the Phoenix Nest transition was kind of a distraction for the past few quarters on Q2 of this year.

In terms of customer trends we are seeing strong customer demand from all kinds of sectors so we think this is a very healthy trend and may well go on for the next few quarters.

The next question comes from the line of Richard Ji with Morgan Stanley.

Please proceed Sir.

Thank you Rob and Jennifer.

Good morning and congrats on a strong quarter.

Thank you.

Let me start with - yeah sure.

The first question is regarding the revenue contribution from your big corporate clients.

Obviously we are seeing significant pick up in terms of (inaudible) spending from those folks.

If you elaborate a little more on their relative growth ratio - growth rate versus a small player.

What is the - roughly speaking the ballpark revenue contribution?

Do you also plan to have a dedicated sales force for service with corporate clients given...

Yeah.

Hi Richard, this is Haoyu.

As we commented a few times in the past the large advertisers are spending more with us and their spend with us has been growing faster than the spend by - total spend by SMEs.

I think that continued to be the case although yeah, a lot of - when you look at SMEs you can keep adding many more new customers every quarter.

But as far as large advertisers you only have a couple of hundred, a few hundred, less than a thousand to work with.

We're seeing very healthy growth on their outflow with us.

There is a buying surge for brand building purposes, a buying surge for transaction purposes.

A lot of companies are setting up their online stores so all the routine metrics are going in the right direction.

We always had a dedicated sales force serving - acquiring and serving these large customers and they are based in Beijing and Shanghai and Shenzhen and Guangzhou, so that team is continuing to deliver good results.

Thank you.

Okay.

You also highlighted your top listing categories and especially of the Phoenix Nest roll out.

Have you seen a pick up in any of these areas in terms of growth rate versus your previous stage?

You mean the key factors among large customers or overall?

Overall, overall yes, especially I'm curious about which sector has particularly more robust growth after the roll out of Phoenix Nest.

Okay.

I might go to get the orders - Jennifer you have the --

I think particularly the customers - large customers we said are more mature and they are the earlier adopters of Phoenix Nest.

We have seen sectors such as financial services, real estate really outpace the sector growth in other areas.

All sectors are growing very strong but these sectors that I just named, they were particularly strongly.

Okay, great, thank you.

Your next question comes from the line of Alicia Yap with Citi.

Please proceed.

Hi, good morning.

Congratulations on a strong quarter.

My question is on your new customer adds.

How much of that increase would you attribute to the new sales team hire versus the improved productivity of the existing sales team and where most of the increase come from the second and third tier city as a result of your nationwide campaign, or is that increase is more diversified among all the cities?

The new customers are very diversified among all kind of cities including the tier one major cities and the smaller cities.

I would say that the new customer is mainly attributable to the increase of our sales force because our productivity improvement just got started, although we have seen great results but it's not fully in function yet.

Okay, great, thank you.

Your next question comes from the line of Dick Wei.

Please proceed Sir.

Congrats on a good quarter.

Is it possible to update for the mobile search initiative and are there any new plans for that and for mobile search, approximately how much of the total search volume that accounts for?

Thanks.

During the last couple of years we have seen a faster growth in mobile search traffic versus PC based search but it remains to be a small percentage of our total traffic.

The mobile landscape is still not settled yet because the majority of the internet users who access the internet through mobile are still using 2G forms.

They are expensive and they are slow.

There are a small fraction of users who use 3G network but they obviously use mobile for search on a more frequent basis, but going forward we think the smart phone will take over and that the traffic will grow even faster.

We have designed a number of mobile related products and functions to adopt this kind of user behaviour but I wouldn't see that the direction for mobile search is settled yet.

There may be a lot of changes going forward.

Great, thank you and congrats on a good quarter.

Thank you.

Your next question comes from the line of Yu Jin with CICC.

Please proceed.

Oh hi.

Good morning Robin, Jennifer and Haoyu and congratulations on such a strong quarter.

Thank you.

One question is for Jennifer so as we're already launched with Qiyi and the company is already in the operation and we will launch Baidu Rakuten soon.

I think the (inaudible) should have a more accurate understanding of the investment amount, so can anybody elaborate a little bit how these two (inaudible) will affect our second half and the next year's financials?

On the Qiyi investment we have clarified last quarter because of the shareholding structure and the management control agreed upon between the parties, the investment is accounted for on an equity method basis.

I did mention last quarter that on a going forward basis we do not expect material impact from Qiyi, from the joint venture there unless there is a shareholder structure change.

So if there is a shareholder structure change we will update the investment community clearly so do not expect significant material impact from Qiyi.

On the Rakuten JV, the JV will officially launch in Q4 and will start to consolidate or start to include their results starting in Q4.

Because we own less than 50% of the venture we will likely account the Rakuten joint venture on an equity accounting method as well.

We do not anticipate within a year's time the Rakuten joint venture will have material impact to the bottom line.

We will give you more updates as we move into Q4 and you will get to see the picture.

Thank you Jennifer and a second question an open question for (inaudible) just following the wireless internet and so my question is so based on our practice can you tell us some difference like between wireless and wired internet, you would talk about like metadata method what kind of - I mean like product or kind of business category that we will see difference from the PC internet?

From the company's perspective what area we will focus in the near term beyond the search?

That's all from me.

Okay.

For wireless because the mobile phones generally have a much smaller screen users tend to flip pages more than the PC based users.

We tried to design the mobile user experience so that each page is simpler and lighter than the PC based ones.

Because people carry around their mobile phones all the time, they are location based information and it's more personal so local results are more useful in general to the wireless internet users than the PC users.

Like I mentioned, I think it's pretty much still an open area for wireless search going forward exactly what's going to happen to the user behaviour, I mean the search behaviour on the mobile side is still an open question.

And devices that have access to internet are also getting diversified.

You have tablet PC, you have mobile phones, smart phones, feature phones and laptop computers.

This kind of terminals all have different kind of user behaviours and we are still studying this kind of trends and try to come up with necessary products and functions to satisfy our users.

Okay, thank you.

Your next question comes from the line of Andrey Glukhov with Brean Murray.

Please proceed.

Yes, thanks for taking the question.

Two things if I may.

First, if I look at the customer trends, can you guys comment in addition to the strong just new customer acquisition, are you seeing any improvement or any changes in the essential advertiser churn levels?

Then separately Jennifer, if you can just comment what was the - why was the other income a substantial negative amount, that would help as well?

Thank you.

The first part of the question about customer churn, it's stable but generally we never disclose that number but the churn has been stable.

Although as part of the effort in improving processes and putting good CRM in place we are working hard to improve the attrition front of the customer retention.

So hopefully going forward we'll see some improvements but up to now it's stable.

On your other question Andrey, the other income is substantially negative this quarter.

We did disclose last - in our last earnings call because of the Yushu earthquake we donated mostly - most of the numbers because of the donation we made.

We donated RMB10 million to that tragic - to the suffered area.

That's great.

Congrats on the quarter.

Thank you.

Your next question comes from Eddie Leung with Bank of America.

Please proceed Sir.

Good morning everyone.

The first question I have is Robin, you mentioned that the existing customers are spending more throughout the quarter.

So in general, was it coming more from expansion of key words or driven by bidding prices?

I'm sorry, I didn't quite get your question.

Oh, I'm asking about the increase in spending of the old customers.

In general was it coming more from increase in key words or driven by bidding prices?

Eddie, if you look at the good growth of our pool, it's really driven by many things.

First of all, traffic right and when traffic grows up, click will go up, definitely you will see customer spending going up.

We are seeing customers' appreciation of the new system so their budget's going up so a lot of the times budget is a binding factor for how much they'll spend so a lot of customers are increasing their budget.

That's a prerequisite for our pool growth.

Of course the other monetization metrics such as click through rate and CBC, so all of these are contributing to the good growth of our pool this quarter.

Obviously Phoenix Nest allows our customers to pick out a lot more key words so that the bid, the cost per click is also going up but slowly I would say at a slower rate than before so we are very happy about this trend because our customers are getting better ROI because of that.

That's very helpful.

Then one housekeeping question.

Jennifer, could you give us the top advertiser industries for the same quarter?

Okay, certainly.

The top five sectors - they account for about 50% of the total revenue.

They are medical, healthcare, machinery equipment, education and travel and franchising for this quarter.

Thank you.

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

Please proceed.

Hello everybody.

I wanted to (inaudible).

Stephen you are breaking out.

Sorry about that.

I just wanted to see if you have a mobile operating system in the plans for you at some point?

Also the JV with Rakuten, I'm just wondering what is going to be the incremental value add or differentiating factor that is going to set the platform apart from Taobao or (inaudible) Thank you.

Alright.

We have a number of very exciting targets going on internally.

Obviously we are optimistic about mobile internet in the future but typically we do not preannounce products so I cannot give you a yes or no answer on the mobile OS thing.

For Rakuten, like I mentioned in the past few quarters we think the search engine is the biggest beneficiary of E-commerce so we try all kinds of things to nurture the e-commerce market and the Rakuten JV is just one of the endeavours.

So as far as we can tell company like Rakuten to set up platforms to allow more benefits to sell their products and services online, we think we will eventually benefit.

Rakuten owns more than 50% of this joint venture so they will take the lead and do whatever to make it successful.

The value we add is two-fold.

One is we can drive traffic to them, the other is that the Baidu brand is much bigger than Rakuten here in China so carrying the Baidu brand will help them to sign up more businesses, especially the larger businesses.

I think more choices to the Chinese businesses is better and we have seen a lot of interest, especially from the larger corporations who want to sell online on our Rakuten platform.

We're ready for the next question.

Your next question comes from the line of Aaron Kessler with ThinkEquity.

Please proceed.

Yes, hi guys, a couple of questions.

First, given the strength of the advertiser growth in the quarter do you feel comfortable with kind of a higher level of advertiser growth going forward given some of your recent initiatives in terms of the marketing campaign and added sales count?

Also just in terms of sales and marketing expense, it looked like it was pretty flat sequentially.

I would think that would be up a little more given the increase in head count.

Thank you.

I think the customer acquisition will follow the typical seasonality of the past few years.

Q2 generally we have quite strong customer acquisition momentum but Q3 and Q4 we are continuing to add new customers and Q1 is typically the slowest one.

Regarding the sales and marketing cost, Jennifer can --

Certainly.

Yeah, I think you are right Aaron.

You did notice that we added about 1100 head counts in the quarter and they come from sales and R&D.

Not everybody joins the company on the first day of the quarter so you only see part of the expense impact of these head count additions.

The full impact will be felt in the next quarter and on top of that of course, we continue to aggressively hire sales force and R&D so that's why we wanted you guys to fully be aware of that.

Right and do you just have a sense on the Phoenix Nest, how much modernisation improvements you've seen to this point, like what inning are you in, in terms of improvements for Phoenix Nest modernisation?

Hi Aaron, this is Haoyu.

I think that the steep part - steep part of the trajectory is largely behind us although going forward there is still a lot of work to put into improvements into Phoenix Nest but I think the monetization improvement will be more gradual than what you saw in the past two quarters.

Alright, thank you.

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

Please proceed Sir.

Hello, morning.

I wanted to ask about your SNS strategies as Google also wanted to develop some kind of SNS (inaudible).

Is it important for the search engine to get into the SNS?

Also, I wanted to hear your thoughts about any initiative on the real time search as well?

We already have an SNS type of service called Baidu Space.

It is a good complementary to our search business but I would say it's not very closely related to search.

The business model for SNS is quite different from search, especially in China.

The SNS companies typically charge end users, like they run online games and that sort of thing but for search we basically satisfy people's information needs.

Users come with something in mind and with an agenda when they come to our search services, but users usually log onto SNS services to kill time and say connected.

So I think these are very different type of user needs.

Regarding to real time search, it's actually not a new phenomenon.

More than 10 years ago search engines started to try to tackle the real time search problems but it's not an easy problem to solve, because when it's real time it's very easy to be spammed, so we are being cautious on this.

Having said that, we have a lot of ways to integrate real time information in our search result page.

For example, I mentioned in the prepared remark at the Oricon event we have real time information updated through our box computing technology or the Aladdin platform.

We can integrate the real time information from trusted sources so that's our take on real time search.

Thank you and congratulations on a good quarter.

Thank you.

Your next question comes from the line of Mayuresh Masurekar with Kaufman Brothers.

Please proceed.

Hi.

Baidu's revenue growth has been accelerating significantly over the last three quarters from 40% to 60% and now 74%.

Could you give us a rough estimate of how much of this growth is from the marketing campaign, how much from Phoenix Nest, how much from easy comps because of the economy and how much from share gains from your leading competitor and could you align those factors?

Well, I think there are a few factors that contributed to this phenomenon.

In 2009 it was a year of transition for the Company.

We launched Phoenix Nest in April 2009 but the system actually runs parallel with the classical version of our pay search system.

That has got a lot of distraction for the overall operation of the Company and also caused some confusion on the market.

We were able to successfully switch over 1 December of last therefore we were able to resume the normal growth trajectory we developed for market with great potential.

Along the way, based on third party research reports we have been gaining traffic share gradually, but because we already had a traffic share north of 70% so the share gain is kind of a smaller contributor to the overall picture.

Another factor I'll say is that internet - the business is small and large businesses in China increasingly start to appreciate the marketing power a search engine can bring to them.

China's internet is kind of different to the developed markets in the sense that the majority of the internet users are very young.

They started to use the internet for entertainment purposes.

Even today I think the majority of internet related revenues are entertainment and users - consumers pay to play games and to communicate and back up things.

But gradually we have seen a pick up on the business activities on the internet and I'm sure going forward more and more business activities will be conducted through the internet and therefore we will continue to benefit from this kind of trend.

Your next question comes from the line of Jake Li with Guotai Junan.

Please proceed, sir.

Morning, thank you taking my question.

Regarding the TAC in the second quarter is there any one time item reflecting the degrees of the issue?

I know the payout ratio of (inaudible) is relatively higher so excluding the contextual ad, what's the (inaudible) this is the first and second.

Regarding the contextual ads, I know the revenue contribution is relatively small currently, so what the trend is going forward, and I know you will increase by (inaudible) ratio by 10% to 15%.

So I think the contribution will be higher going forward, so can you give me more colour.

Thank you.

Hi, this is Haoyu.

There is no major onetime event related to TAC in Q2, so as I mentioned TAC will probably continue to stay at this relatively low level as far as we can see.

Contextual, we mentioned a few times before, we were very excited that contextual, the opportunity in contextual is going forward.

So we are putting a lot of our product management people and a lot of R&D people behind this effort, although up to now you're not seeing major impact on revenue yet.

It's still a relatively small percentage of a total value.

But as said, we are very excited and we are very much looking forward to having more revenue contribution from this product, maybe towards the end of this year and next year as well.

When contextual becomes a bigger part of revenue it will impact because typically the TAC payout is higher on contextual than on (inaudible) search just because the present inventory belongs to somebody else.

Soy we need to pay a higher rate.

When that happens it will probably have some impact on total TAC as a percentage of total revenue but that's a good thing to have but that's not going to happen in the very short-term yet.

Very helpful, thank you.

Your next question comes from the line of Wendy Huang with RBS.

Please proceed, ma'am.

Thanks for taking my question.

Two quick questions.

First, Google recently announced to acquire ITA so I wonder if Baidu will consider to acquire any vertical search engine such as the Travel search engine?

We already have a number of the so-called verticals.

In research we have Baidu Post Bar, we have Baidu Knows, we have Baidu Encyclopedia and we have technologies to integrate this kind of information in our web search result page.

We also have an open platform that allows third party information to be integrated in the related search result pages.

So at the end of the day we think about satisfying users' information need.

If any type of factions can help satisfy our users' information needs better we will do that.

We have internally user generated content and we integrate third party information sites.

If certain type of information is owned by someone who has unique content we may consider that too.

So going forward, we will look for more type of content, information content or valuable content.

We could generate it by ourself, we could integrate a third party and we could buy them.

Okay.

My second question is regarding your investments.

You're mentioned in the prepared remarks that you will invest aggressively in the infrastructure and equipment, so can you give me some idea for your budget for this type of investment in the next one to three years?

Also, apart from this investment in your core search business, what's the budget for the non-core business such as the mobile search possibly in the next three years?

Thank you.

As you can see from the Q2 capex number it's a step up from the Q1 level and going out in the out quarters we have plans to get into the new investment cycle and therefore significantly step up the spending.

So pretty immaterial going forward.

The infrastructure investment will be on enhancing the core search capability to enlarge our index size, to ensure we expand our computing power and also to build flexibility and a competency and capacity on the infrastructure side.

So there's plenty of things that we do surrounding the core search capability.

That's where the main investment comes from.

Robin, do you want to come in now?

Yeah, in terms of resource allocation we consider that's a media platform and anything that can either enhance our platform or take advantage of our platform we would invest in that.

Of course, central to the platform is our web search so roughly 70% of our resources will be devoted to web search and pay search, this type of business, and 20% of our resources will be invested in projects that could help provide traffic to our web search and the rest, 10%, will be invested in those kind of truly innovative projects.

That's very helpful.

Jen, so can you actually update your capex guidance for 2010, '11?

We don't give out capex forecasts that long.

Just to give you a sense, Q1 the spending was about RMB100 million and Q2 is about RMB180 million, so you can see the magnitude of step up, and continue to expect that kind of a momentum.

Right, thank you, that's all.

Your next question comes from the line of Welin Li with UBS.

Please proceed.

Good morning.

Congratulations for the strong results.

Just one question.

Can you share with us lost revenue breakdown among the tier one cities and tier two and tier three, and also which segments is growing faster.

Also, how much of revenue comes from the desk sales versus the agency sales?

Thank you.

We typically do not breakdown among the tier one, tier two, tier three cities, but what I can tell you is that the growth around these type of cities are roughly at the same pace.

We have seen very good growth rates among almost all major cities.

Like I mentioned before, probably one year or two years ago, direct sales still represent more than 50% of our total revenue.

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

Please proceed.

Thank you for taking another question.

You mentioned at the beginning that the World Cup Soccer event helped your traffic.

Did it also help your monetisation and your revenue?

I think in the past, events like the World Cup tended to be high traffic but low lead generation.

Typically, these key words are not very monetisable, although we monetise some of these key words through different methods.

I think what Robin really meant was during the World Cup a lot of people came to search engine and they searched for stuff related to World Cup, and that overall increased people's appreciation of how much search engines can help them.

So it's just like every Chinese New Year, after every Chinese New Year you see a major step up of overall search volumes, so a big event like World Cup this time also had that kind of impact on overall search volume.

Not so much the revenue growth is not so much due to the monetisation of these specific World Cup related key words, really.

The benefit we get from these World Cup related projects is that we really made our users more dependent upon Baidu services.

Understood, and the new tax circular in the second quarter that resulted in a 14% effective tax rates to companies, did you expect the tax rates to remain around those levels or this was a one quarter phenomenon?

We did provide, James, we did provide already in the year guidance for tax.

We said it's going to be mid to low-10.

We will remain at that guidance and probably more towards the mid-10s than low-10.

Great, thank you.

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

Please proceed.

Hi, just one quick question.

Regarding the latest (inaudible), because we know Baidu also has a Baidu pay service.

So are you going to apply for the payment licence as well?

Thank you.

Yes, we're going to apply for that licence.

Okay, thank you.

We are now approaching the end of the conference call.

I would now like to turn the call over to Baidu's Chief Executive Officer, Robin Li, for closing remarks.

Please proceed.

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

Thank you for your participation in today's conference.

This concludes the presentation.