Highlights From BIDU's Q3 Conference Call: Phoenix Nest Contributed 20% of Overall Revenues, But Sees Q4 Below Consensus

October 27, 2009 1:15 PM EDT

Baidu, Inc. (Nasdaq: BIDU) reports Q3 EPS of $2.16, ex-items, versus the analyst estimate of $1.81. Revenue for the quarter was $187.3 million, which compares to the estimate of $187.79 million. Shares are down over $48 (-11%) today

Highlights From BIDU's Q3 Conference Call:

• Sees Q4 sales of $174-$180 million, versus the consensus of $202.9 million.
  
• (CEO) The third quarter enjoyed solid growth in both revenues and net income.
  
• In addition, large customers are performing well and increasingly allocating more of their budgets to our platform.
  
• Phoenix Nest was launched six months ago and has been making good progress on its migration. Revenues from Phoenix Nest at the end of Q3 contributed to over 20% of our total revenue.
  
• In addition, we have seen key monetization metrics such as coverage and cost per click trending upwards.
  
• We are confident that customer acceptance for Phoenix Nest has reached a critical mass, and we are ready to complete the transition in Q4.
  
• While we are confident in our decision and our ability to execute the switch to Phoenix Nest, we do anticipate short term negative revenue impact as some customers may lag behind in ramping up their spending on Phoenix Nest.
  
• Moving to the user front, Project Aladdin an ongoing initiative to mine content from the hidden web is also moving along. The Aladdin open platform has received thousand of applications from webmasters since it was launched, and we have established information exchange interfaces with many of them.
  
• Aladdin is part of a larger initiative - box computing, which will increasingly be the backbone of future Baidu initiatives.
  
• We also launched a mobile search service in Japan, where 80% of Internet users also log on wirelessly. We are continuing to pushing forward innovations and strategic partnerships on this front.
  
• (CFO) For Q3, total revenue were RMB1.279 billion, within guidance, and represents a 39% increase year-over-year.
  
• Diluted EPS for Q3 was RMB14.14 or $2.07. This includes two non-reoccurring benefits in other income and income tax expenses amounting to RMB29.6 million. Without these the diluted EPS for the quarter would be RMB13.29 or $1.95.
  
• Baidu had approximately 216,000 active online marketing customers; a 11% increase from the corresponding period in 2008, and a 6% increase from the previous quarter.
  
• Revenue per online marketing customer for Q3 was approximately RMB 5,900; a 26% increase from the corresponding period in 2008 and a 9% increase from the previous quarter.
  
• Traffic acquisition cost, as a component of cost of revenue, was RMB196 million or 15% of total revenues, as compared to 12% in the corresponding period in 2008 and 16% in Q2 of 2009. The slight sequential decrease over Q2 reflects normal market fluctuations.
  
• Bandwidth cost and depreciation cost as a percent of revenue both continue to decrease in Q3 on a year-over-year basis. This reflects efficiency improvements as well as increased scalability of investment in capital expenditure.
  
• Selling, general and administrative expenses in Q3 was 198 million, an increase of 21% year-over-year.
  
• With the ongoing rollout of Phoenix Nest and overall sales expansion, we expect to continue increasing sales head count.
  
• R&D expenses was 117 million, an increase of 49% over the year-ago period, primarily due to increased head count. Operating profit for the third quarter was RMB521 million, a increase of 42% over Q3 2008, primarily driven by good management of expenses and platform scalability.
  
• Total head count as of September 30, 2009 was about 7,000. The increase in head count mainly comes from sales and marketing and R&D to support our many initiatives, including Phoenix Nest and Aladdin. We expect to continue increase sales and R&D head count.
  
• Net income was 493 million a 42% increase from the corresponding period in 2008. Basic and diluted EPS for the third quarter of '09 amounted to 14.23 and 14.14 respectively.
  
• Net income excluding share-based compensation expenses, a non-GAAP measure was RMB514 million, a 41% increase year-over-year. Basic and diluted EPS excluding share based compensation expenses both non-GAAP measures were RMB14.84 and 14.75 respectively.
  
• As of September 30, 2009, the Company had cash, cash equivalents and short-term investments of RMB4 billion. Net operating cash flow and capital expenditure for the third quarter of '09 were RMB734 million and RMB130 million respectively.
  
• (Guidance) We currently expect total revenue for the fourth quarter of '09 to be between RMB1.19 billion to RMB1.23 billion, which would represent 32% to 36% year-over-year growth. I do wish to emphasize that this forecast reflects Baidu's current and preliminary view, which is subject to change.
  
• (Q&A) Could you discuss, why you decided to accelerate the full conversion from Baidu Classic to Baidu Professional, to compete it during the fourth quarter rather than compete it next year? (A)I guess I'll break down the answer into two parts. One is the revenue part. And Robin mentioned in his prepared remarks, about six months ago, we launched the Phoenix Nest openly to our customers, who are seeing the key monetization metrics all go in the right direction. The actual coverage provided by Phoenix Nest is definitely increasing and the CPC, cost per click on the click brought by Phoenix Nest has also been increasing steadily since six months ago. So our monetization metrics, we're happy with
  where we are. And on the operation metrics, which Robin also alluded to in his remarks, on a monthly basis, we're seeing over 70% of our customers are already using Phoenix Nest. And overall, at the end of Q3 on a run rate basis, over 20% of our revenue is already coming from Phoenix Nest. So on both operation metrics and monetization metrics, we're happy with where we are. We feel we're ready. Then, I guess why now - that's another part of your question. Running two systems puts a lot of pressure and stress on management capacity, on our customers, and also on our customer service staff. So that's one thing. The other thing is it also puts some stress on our system. Running two options is basically suboptimal, because these two systems are artificially separated and segmented. So it will be hard for Phoenix Nest over time to reap its full potential with running two systems. So I think if we move now, we can free up a lot of resources on the management side, and customer service side, and also on customer side to focus on this new superior system, and also for our algorithm it can improve faster so that we have the chance to reap the full potential of Phoenix Nest faster. And we've been saying all along that this is a superior system. And in the past six months it has proved itself. So given all of the above reasons, I think we're ready to move now.
  
• And if it's a superior system and the monetization is improving, where does the temporary hit to revenue come from? Is it because CPCs are lower on Baidu Professional than Baidu Classic, or is it because you expect some customers to just stop spending? (A)The monetization improves a few metrics so on coverage, it gives us more coverage meaning we - the system can match more relevant pay links than we can before. So coverage will go up, so naturally click through rates will go up [inaudible] the total impression. And also eventually we think CPC will also go up just because the system that -- the auction system encourages the customers to tell the truth so that they can bid truthfully, eventually it will be better for them to measure their ROI which will lead to them spending
  from them at the internet. Also because of the transition we need to prepare for a lot of things especially for the customer service team they basically stopped doing improvements in the traffic addition, which we expect would affect the revenue in a negative way.
  
• If we can just revisit in terms of the impact from the shift toward the Phoenix, if we weren't going to do that transition all the way over this quarter, do you know what the impact would have been or what you would have guided to for December if that was the case? And I got one follow-up question. (A)Roughly we are - Gene we're looking at roughly about 10% negative impact on a quarterly basis because of the switch. As Robin mentioned, so there are two parts, leading into December 1, our customer service will be totally focused on working with the moving customers. And also, at the time of the switch, we would expect that some of these customers may lag behind. Either they are not ready to move immediately or even for some who move because it's a new system and they might scale back their spending with us. So in total, for this quarter, we think roughly the impact is about 10 percentage points.
  
• When does the actual - when does the switch flip over to Phoenix Nest? Is it - when will we be fully - is it going to be gradual throughout the quarter or is it going to be kind of a one-day event? (A) Practically, it will be gradual over the quarter, leading to December 1. We've noticed all of our customers today I think a lot of them will hear about this. We noticed some - we noticed our staff yesterday, and most of our customers will hear from our customer support staff staff today and we'll start the moving today. So practically, if you move today, you will have Phoenix Nest spending tomorrow. But December 1 is a clear cutoff date. From December 1, the old system will not be available.

Baidu, Inc. provides Chinese language Internet search services primarily in the People's Republic of China and Japan.

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