Baidu - Q1 2012

Transcript

Operator (participant)

Hello, and thank you for standing by for Baidu's First Quarter 2012 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 hand the meeting over to your host for today's conference, Victor Tseng, Baidu's Investor Relations Director.

Victor Tseng (Investor Relations Director)

Hello, everyone, and welcome to Baidu's First Quarter 2012 Earnings Conference Call. Baidu's earnings release was distributed earlier today, and you can find a copy on our 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 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 U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include, but are not limited to, those outlined in our public filings with the SEC, including our annual report on Form 20-F.

Baidu does not undertake any obligation to update any forward-looking statement except as required under applicable law. Our earnings press release and this call include discussions of certain unaudited non-GAAP financial measures. Our press release contains a reconciliation of the unaudited non-GAAP measure to the unaudited most directly comparable GAAP measures and is available on our IR website at ir.baidu.com. As a reminder, this conference is being recorded. In addition, a webcast of this conference call will also be available on Baidu's IR website. I will now turn the call over to Baidu's CEO, Robin Li.

Robin Li (CEO)

Hello, everyone, and welcome to today's call. We are pleased to begin the year with a strong set of results. As always, our excellent performance was driven by our team's relentless execution. In particular, we achieved a robust expansion of our SME customer base despite a seasonally slow quarter. We see huge opportunities to develop both our SME and large customer bases, and we have been working hard to capture these opportunities. Across a variety of product platforms, our user experience indicators rose strongly this quarter as well. Underpinning this progress in customer base expansion and user experience is our sustained investment in talent, infrastructure, and marketing. In the first quarter, we continued to push forward with our Box Computing initiative. Box Computing embodies our vision for the future of the Internet. As part of this, we made good progress on our open data and open application platforms.

In March, for example, searches for trending topics and breaking news on Baidu began returning results from all of China's major Weibo platforms. The market has responded well to our ongoing improvements. As of now, we have tens of thousands of registered developer accounts on the open application platform. These developers have created over 70,000 applications that are available to Baidu users. Traffic patterns demonstrate clearly that users are enjoying the easy access to these apps from our platform. Since our personalized homepage feature was launched in September of last year, we've continued to make it more convenient for users to enjoy. Feedback has been great and is translating into improved user stickiness on the personalized homepage. The daily clicks number has grown very nicely since the launch last September. Mobile search traffic maintained a strong growth trajectory in Q1. Mobile search is, of course, central to our overall strategy.

Mobile search traffic now accounts for close to one-fifth of the total web search traffic on Baidu. In Q1, we continue to leverage our advanced technology, as well as investments in R&D and engineering talent in mobile to make solid improvements here. As mobile usage has grown, we have started to explore monetization opportunities. For example, we have started to work on mobile Phoenix Nest account management, mobile ad display presentations, and mobile backend monetization technologies. As a result, we've seen encouraging progress in CPM for mobile ads. Mobile monetization is still at a very early stage, but we are excited about this tremendous opportunity over the long term. We're also very pleased with the reception of Baidu's iOS and Android apps.

These apps not only offer the standard Baidu Search experience optimized for mobile devices, but also enable many innovative new features like voice activation for both search and maps. Box Computing is especially well-suited to mobile users because it brings dynamic, up-to-date information straight to the results page. Mobile users are able to search and access information, content, and apps directly from search results. We're also seeing a significant uptick in both mobile Postbar and mobile Knows usage. This is just some of the mobile products that have experienced year-over-year usage growth in the triple digits. Ultimately, our focus remains consistent to ensure that mobile users get the best possible Baidu experience across all devices and operating systems. These are some of the many great examples of how we are leveraging our leading position to capture opportunities in the mobile arena.

The success of our mobile offering is built upon our industry-leading cloud infrastructure. Since mobile devices themselves have limited processing power, an optimal mobile experience depends on powerful cloud-based backend technology. Baidu's leadership in cloud technology gives us a real competitive advantage, allowing us to deliver data, content, and apps from the cloud to mobile devices. In March, we hosted our first-ever Developers Conference to promote our open application platform and raise awareness among developers of Baidu's large and effective traffic distribution platform, reliable cloud computing service, and strong user behavior analysis and monetization capabilities. I'm pleased to say that turnout was much larger than we expected. At the conference, we showcased three of our most exciting cloud-based initiatives. This includes the Baidu Application Engine, BAE, which enables developers to create and develop new apps for our open application platform at lower cost than was previously possible.

We also introduced our Mobile Test Bed, MTB, a cloud-based environment for developers to test the performance of their apps across dozens of operating systems and sites. Both of these will significantly lower the barriers to entry for small-sized developers who don't have a lot of capital or manpower. We rolled out an exciting new storage initiative we're calling Personal Cloud Service, PCS. As I said, mobile internet usage needs to be backed up by good cloud support. Under the PCS umbrella, we will gradually roll out many useful cloud-based products and services. As a first step, in March, we launched Baidu Wangpan, or Baidu Netdisk, currently in beta testing. Wangpan will allow users to store, manage, and share vast amounts of data for free across all terminal devices and virtually with no storage limitations.

We look forward to building out Wangpan's functionality and capability, and we expect to become the industry leader on this front as well. As I've mentioned before, although cloud computing is still at an early stage in China, it will become an integral part of the internet ecosystem and therefore represents a vital element in Baidu's growth strategy. Now, turning to our work on the customer front, we have made it a priority this year to better leverage the enormous opportunity with the SME market in China. Our sales and marketing team pushed hard into the second-tier markets, implemented innovative sales methods, and optimized an employee incentive scheme that ties competition more closely with sales. These efforts have resulted in significant expansion of our SME customer base against a seasonally slow quarter.

This is a good start, and we want to continue pushing hard to educate smaller companies about the power of search engine marketing. We also focus on enhancing existing customer satisfaction with innovative new products and tools. One example from Q1 is the intelligent account optimization system. This tool automatically provides suggestions to customers regarding account optimization. This includes better keyword selection, better paid search relevance, matching choices, display time slots, and much more. So far, the system has been well received by our beta testing customers, and we plan to open it to all customers in the near future. We are also continuing to build awareness among the large customers of the unique advantages of Baidu's platform. More and more of these large customers are now leveraging our innovative ad products to meet their sophisticated, performance-oriented marketing requirements.

We are excited about the progress we've made here already and about the tremendous opportunity to win even more of our large customers' ad budgets going forward. Let's turn to our important investment initiatives. I'm pleased to tell you that our investment in iQIYI continues to yield encouraging results. In March, iQIYI had more than 230 million unique visits from traditional PC users alone. In terms of time spent on site, iQIYI now ranks second in China among the online video service providers, according to both iResearch and Comscore. This is a real indication of the strength of the iQIYI user experience. We believe that we are well positioned to take advantage of the rapidly growing demand among users for online video content. We know that today's internet users crave visual information, and people are much more inclined to look at photos than to read text.

In light of this, in Q1, we revamped and relaunched Photo Wonder, an easy-to-use photo enhancement app for iOS and Android devices. Photo Wonder allows users to modify smartphone pictures with a huge range of preset filters and frames to easily create, collage, and to upload to popular social media sites. In a short time, we've seen exponential usage growth on both Android and iOS platforms. Photo Wonder now has more than 14 million activated users and is well on the way to becoming another hit product for Baidu. We are very excited about the opportunity here as social networking enters a more image-intensive age, and we are confident that Photo Wonder positions as well. We started the year strong. We made great progress across most crucial aspects of our core business that position us well for future growth.

We see tremendous opportunities in fast emerging sectors such as the mobile web and cloud computing, and our team is working hard to capitalize on all of these growth opportunities. With that, I now turn the call to Jennifer for financial highlights.

Jennifer Li (CFO)

Thank you, Robin. We started 2012 with a productive quarter. In order to maintain our leading position in the industry, we sustained a rapid pace of investment in talent, network, and office infrastructure while managing operational efficiency. This investment strategy is building a solid foundation for our future business progress. Looking forward, we'll continue this aggressive investment strategy in the quarters ahead. This month, for example, we have embarked on our annual nationwide search engine marketing tour. In the coming quarters, we also expect office construction and network infrastructure spending to ramp up. Now, let me go through some of the financial highlights for the first quarter of 2012. All amounts mentioned are in RMB unless otherwise noted. For the first quarter, total revenue was RMB 4.3 billion, representing a 75% increase year-over-year.

During the first quarter, Baidu had approximately 321,000 active online marketing customers, a 17.2% increase from the corresponding period in 2011, and a 3.2% increase from the previous quarter. Revenue per online marketing customer for the first quarter was approximately RMB 13,300, a 49.4% increase from the corresponding period in 2011, and a decrease of 7.6% from the previous quarter. Traffic acquisition cost as a component of cost of revenue in Q1 was RMB 331 million, or 7.8% of total revenues, compared to 8.2% in the corresponding period in 2011 and 7.9% in the fourth quarter of last year. Bandwidth and depreciation cost as a percent of revenue in Q1 were 5.2% and 5.5% respectively, compared to 5% and 5% in the corresponding period of 2011. As I mentioned just now, the increase was mainly due to an increase in network infrastructure capacity.

Selling, general, and administrative expenses in Q1 were RMB 479 million, an increase of 43.9% year-on-year, primarily due to an increase in personnel-related expenses. R&D expenses in Q1 were RMB 443 million, an increase of 85% over the corresponding period in 2011, primarily due to increased headcount reflecting our continued strategic investment in R&D talent. Share-based compensation expenses, which were allocated to related operating costs and expense line items, increased in aggregate to RMB 35 million in the first quarter from RMB 31 million in the corresponding period in 2011. Operating profit from Q1 was RMB 2.1 billion, an increase of 75.1% over Q1 of 2011. Total headcount as of March 31st, 2012, was about 16,500, roughly 400 more than the previous quarter. Income tax expense was RMB 331 million for the first quarter. The effective tax rate for the first quarter was 15.1% compared to 14.5% in Q1 of 2011.

Net income attributable to Baidu for Q1 was RMB 1.9 billion, a 75.9% increase from the corresponding period in 2011. Basic and diluted earnings attributable to Baidu per ADS for the first quarter of 2012 amounted to RMB 5.39 and RMB 5.38, respectively. Net income attributable to Baidu, excluding share-based compensation expenses, a non-GAAP measure for Q1, was RMB 1.9 billion, a 74.1% increase year-on-year. Basic and diluted earnings attributable to Baidu per ADS, excluding share-based compensation expenses, both non-GAAP measures, were RMB 5.49 and RMB 5.48, respectively. As of March 31, 2012, the company had cash, cash equivalents, and short-term investments of RMB 16.1 billion. Net operating cash flow for the first quarter of 2012 was RMB 2.4 billion. Capital expenditure for the first quarter of 2012 was RMB 298 million. Now, let me provide you with our top-line guidance for the second quarter of 2012.

We currently expect total revenues for the second quarter of 2012 to be between RMB 5.335 billion and RMB 5.46 billion in RMB, which represents a 56.2%-59.9% year-on-year increase. I do wish to emphasize that this forecast reflects Baidu's current and preliminary view, which is subject to change. I will now open the call to questions. Operator, please go ahead.

Operator (participant)

The question and answer session of this conference call will start in a moment. In order to be fair to all callers who wish to ask questions, we will take one question at a time from each caller. If you have more than one question, please request to join the question queue again after your first question has been addressed. As your first question comes from a line of Dick Wei of JPMorgan, please ask your question.

Dick Wei (Analyst)

Hi. Thank you for taking my question. My question is on the guidance. I wonder if you can share some assumptions on the second quarter guidance. Maybe first, within the second quarter, is the management assuming that May and June will be weaker versus May compared to prior years? Maybe you can share some stats on the spending by SME versus the large advertisers on Q2. That would be great. Thank you.

Jennifer Li (CFO)

Dick, good morning. We have always made our best to make projections. In Q2, we think the sequential pattern is normal. As we have, what we have demonstrated in Q1 is we added quite a number of customer accounts, and these accounts are primarily SMEs. What that really demonstrates is the market potential is huge, and our sales team, the kind of work that we have done in the past year, is bearing fruit. We continue to work a lot with the large advertising customers and bring in traditional customers and their ad budget allocation onto the Baidu platform. A lot of work is in the pipeline. I think both on the SME front and the large customer side, we continue to see tremendous opportunity. Month over month, between May, June, and July, we do not anticipate different patterns as we compare to prior years.

Last year in Q2, obviously, it was a very special quarter. As you would recall, in last Q2, there were particularly hot sectors, such as group buying sectors. A lot of hot money is getting into the sector. Q2 last year, if you recall, we provided sequential guidance in the range of 32%-35%. The actual performance exceeded our expectations and came in at 40%. If you look at the normal pattern of 32% and 35%, that was kind of the ballpark range that we were looking at last year. Building on the second quarter, third quarter, outstanding performance and the year-long performance in Q2, Q4, as well as this past Q1, I think on a very solid high base, this second quarter guidance is a very solid guidance.

This is a pattern that we do not, we're not seeing anything different, and this is the pattern that we're currently projecting.

Operator (participant)

Great. Thank you. Your next question comes from a line of Jiong Shao of Macquarie Securities. Please ask your question.

Jiong Shao (Analyst)

Good morning. Thank you very much for taking my question. Just to follow up on the revenue guidance question, if I look at the year-over-year growth of slightly below 60%, I think this is, you haven't seen anything less than 60% since the end of 2009. I was wondering, other than a higher base, could you talk about the visibility currently you have in the advertising and particularly in the search-based advertising demand in China? Thank you.

Jennifer Li (CFO)

I think we continue to see tremendous opportunity. As you just correctly noted, year-on-year comparison, we do have a large base last Q2. As we're seeing into the market segments, whether it's for SME or large customers that we have built, obviously, we see continued momentum in these people recognizing the search engine marketing platform as a very effective promotional platform for them. Our sales team is very focused on executing, educating, and developing the market, as well as servicing the customers. I think the market potential is there. The execution that we have demonstrated is a pretty good track record all along. We continue to think that we have very, very significant potential in developing the market. In terms of visibility and all that, we do not feel there's anything that much different.

Obviously, we have a very diversified portfolio and many, many more business and business sectors and customers to add on the platform. I think the outlook for us is continued tremendous potential, and we're focused on execution.

Dick Wei (Analyst)

Thank you very much.

Operator (participant)

Your next question comes from a line of Alex Yao of Deutsche Bank. Please ask your question.

Alex Yao (Analyst)

Hi. Good morning, everyone, and thank you very much for taking my question. My question is about your cloud computing strategy. Can you share with us your thoughts on the commercial perspective of the cloud computing strategy? Also, how should we think about the returns on those investments in terms of the cost structure which will be generated from this initiative? Thank you.

Robin Li (CEO)

Yes. Cloud computing is a very important infrastructure play. With our technology competitiveness, we can build very large-scale infrastructure that allows developers to build apps upon that. We are basically an ecosystem play instead of trying to bet on any of the specific apps. In the future, I think the business model for this would very much be like a commission-based structure. We will take a cut from all the apps running on our platform. Although this is a relatively longer-term picture, we would want to invest in this and bring in all the users so that their behaviors, their data can be used by all kinds of different applications. In the future, we think this will pay off based on our infrastructure and our monetization capabilities we have built over the past 10 years.

Alex Yao (Analyst)

Thank you. How will this impact the cost structure?

Robin Li (CEO)

It's all building our business plan. It's not going to be a sudden rise or sudden change for the cost structure.

Jennifer Li (CFO)

Alex, I think the way to think about it is if you look at the past two years of the investment pattern, I have stressed that we will continue this investment strategy. The approach will be consistent, and this is a part of our core business. As Robin mentioned, it's very important for us to set the solid foundation as we develop forward and to really solidify our position in the marketplace. This is part of our overall core business. The investment or related cost, if you're thinking about it, you can look at the patterns from the past two years, and that pattern will sustain.

Alex Yao (Analyst)

Got it. Thank you very much.

Operator (participant)

Your next question comes from a line of Jin Yoon of Nomura Securities. Please ask your question.

Jin Yoon (Analyst)

Thank you. Thank you for that. Just a couple of questions. Your traffic acquisition costs as a percentage of revenues, it looks like it declined a little bit this quarter. Has there been any material changes in how you allocate costs to how you share revenues as a traffic finance again? Is it just a function of the fact that contextual ads are probably not as growing as fast? How should we look at that? Second of all, just on your customer deposit having a relatively strong indicator of revenue, it was pretty strong this quarter. Does that mean that things should be going strong going forward after these new SME customers start to ramp up after this quarter? I'll stop right there. Thanks, guys.

Jennifer Li (CFO)

On your first question related to tag, what you are seeing in Q1 is a normal fluctuation. As we have indicated in the past, the tag expense that we are deploying today has more to do with the new product promotion that we're pushing through the network of union partners. The composition of the tag is shifting more towards the new product promotions rather than the traditional traffic acquisition cost. We are, as you know, we have been working on the contextual ads product. The product itself is making good progress. Obviously, this is not an overnight product that you should see significant differences. Therefore, I would point to the tag as a normal fluctuation compared to the prior quarter's patterns.

In your second question with regards to customer deposits, yes, as we have recruited more customers and these people would be putting their deposits with us, it does show that the customers are having confidence in our platform, are willing to spend with us. Obviously, as we execute on helping them spend on their promotional dollars, we help them along the way to generate the kind of the ROIs that they desire. It is a good indicator. It does not directly correlate with revenue projection. This is definitely a solid cash base and customers' confidence in us that we are having. This is a solid number. That's good to have.

Operator (participant)

Your next question comes from a line of Alicia Yap of Barclays. Please ask your question.

Alicia Yap (Analyst)

Good morning, Robin, Jennifer, and Victor. Thanks for taking my questions. Just quickly, can you remind us the top five customers and which verticals are showing stronger growth and which ones are facing more challenges in cutting back their spending, particularly in the first and the second quarter this year? Thank you.

Jennifer Li (CFO)

Our top five sectors for Q1 are namely medical health care, machinery equipment, education, travel, and software and games. There are, because Q1 is a seasonally special quarter, slight changes in the top five sectors. The other normal players that would typically show up here are business service and franchising. There are some seasonal patterns as Q1 comes in the picture. The mix of the top sectors is not really changing. I think particularly on the B2C side, we continue to see very strong growth. Because of the fact that we're seeing these sectors continue to be the top, you can expect that they are all enjoying very strong growth. Obviously, as I said, B2C is stronger than B2B.

Alicia Yap (Analyst)

OK. Great. Thank you.

Operator (participant)

Your next question comes from a line of Eddie Leung of Merrill Lynch. Please ask your question.

Eddie Leung (Analyst)

Good morning. Thank you for taking my questions. I have two questions. The first one is about your user traffic. In terms of search query growth, have you guys seen the impact from a slowdown in Chinese internet user growth? My second question is related to the contributions from Qunar. Could you discuss a little bit about the change in contributions to your top lines throughout the past couple of months from Qunar? Thanks.

Robin Li (CEO)

I mean, on the user traffic growth, we have seen very strong traffic growth over the past few quarters. It's been very consistent. Although the internet user base in China is quite large and the growth could slow down, our traffic not only depends on the number of new users coming in every day. It also depends on the time spent by each user because information or search is so fundamental, so essential to everyone's ordinary life. I think people are increasingly dependent on us to find information. That's why we're seeing very healthy growth in terms of user traffic or in terms of queries over the past few quarters.

Jennifer Li (CFO)

Eddie, on your question related to Qunar, if you look at our recently released 20-F, that gives you an indication of what Qunar's level of revenue looks like. Because we acquired Qunar and we're consolidating the results, their revenue number is included in our total number. The absolute number itself is so immaterial. It is really a very small part of the overall revenue that we're generating.

Eddie Leung (Analyst)

Got it. Thank you.

Operator (participant)

Your next question comes from the line of Catherine Leung of Goldman Sachs. Please ask your question.

Catherine Leung (Analyst)

Hi. Good morning. I was wondering if you could elaborate on the particular innovative marketing efforts you mentioned in the opening remarks, which have accelerated your SME customer base growth, given I think you have regularly organized these marketing events to the Tier 2 and Tier 3 cities over the past few years. Thank you.

Robin Li (CEO)

Yeah. We do this kind of nationwide marketing tour every year. What's different this year is that we implemented certain incentives for the sales to sign in more customers. We implemented a structural change in our sales force last year, which means we separated the inside sales from outside sales. There are certain dedicated teams who would go to the customer side and do onsite visits. The other team would do calling. This kind of structure allows us to sign up new customers more efficiently. Last year, because the large customers grow so rapidly, we were not able to spare a lot of resources to take care of the smaller customers. Starting from this year, you have seen that we were able to sign up a lot of new accounts from the 2nd tier and 3rd tier cities.

Catherine Leung (Analyst)

OK. Great. Thank you.

Operator (participant)

Your next question comes from a line of Richard Ji of Morgan Stanley. Please ask your question.

Richard Ji (Analyst)

Good morning, Robin, Jennifer, and Victor. Can you elaborate a little more on your mobile search initiative? Clearly, that has been very fast going and likely going to be a key catalyst going forward. When should we expect to see some meaningful revenue contribution? Can you also comment on the potential margin profile for the mobile search relative to PC-based search?

Robin Li (CEO)

Richard, what we are saying is that the mobile search traffic has been growing much, much faster, especially for those smartphone-based mobile searches. We are aggressively investing in improving the user experience for our mobile search, and we have seen very good results. What's different from the mobile is that at this stage, we need to probably share some revenue with the headset manufacturers or other distribution channels when we ask them to preload our search. In most cases, it's a default search on those phones. The monetization capability on mobile is relatively low. It's still much lower than PC-based search queries. We started to work on the monetization capabilities for our mobile traffic. We have seen very encouraging results. Going forward, you can expect that the revenue contribution from mobile will continue to go up.

For probably the rest of the year, it's still going to be a very small percentage. It's kind of early to talk about the margin difference because the overall traffic or overall revenue, rather, is still small. Once we have established the dominant position in mobile search, we may not need to pay out a lot of channel distribution costs in the longer term. I don't think it's so important to focus on margin right now.

Richard Ji (Analyst)

Yeah, thank you, Robin.

Robin Li (CEO)

Yeah.

Operator (participant)

Your next question comes from a line of Wallace Cheng of Credit Suisse. Please ask your question.

Wallace Cheng (Analyst)

Hi. Good morning. Thanks for taking my questions. Also, questions relate to mobile internet. It seems from some third-party company to track sort of Baidu market share in the mobile internet, it seems lower than the PC base. Can you explain a little bit the reasons behind why there's some discrepancy between PC and the mobile side? Is it related to, say, Baidu's strategies in the mobile browser as well? Thank you.

Robin Li (CEO)

I think there are a number of reasons. First is that I don't think there's an incredible market intelligence on the mobile search market share. A lot of those numbers are really based on the number of buyers transmitted to certain mobile search sites. Some of the sites actually host some very large files, such as music files on their site. The traffic share or number of buyers is really misleading when you think about the mobile search market share. Our current estimation is that we should have over 50% of the mobile search market at this point. As I mentioned before, mobile search is growing very, very fast. We just started to invest aggressively to improve the user experience.

That brings up the second reason, which is that we were not so focused on mobile before because we started this kind of early before there was healthy competition among the carriers. The mainstream phones were feature phones, which was very hard for users to use to surf the internet and search. This has changed. We will start to focus on that too. Certainly, I would like to point out that users would search more, given that they have a phone that can have access to the internet too. We do expect the vast majority of our existing users on PC, you know, China has more than 500 million users, and we have a very large reach or coverage for this kind of users.

When they have certain types of information needs, it's very natural for them to pull out their phone if a PC is not in front of them to find information. In that, we expect to see faster growth because of the mobile search phenomenon.

Wallace Cheng (Analyst)

Just one quick one, do you think your market share in the smartphone is even higher than the feature phone? Thank you.

Robin Li (CEO)

I really don't know. We don't have any credible third-party data, and it's very hard for us to get the numbers from other players. What we have seen is that mobile search has been growing much faster than PC, and the smartphone traffic is growing much, much faster than the overall mobile search traffic.

Wallace Cheng (Analyst)

Very much nice.

Operator (participant)

Your next question comes from a line of Ravi Sarathy of Citi. Please ask your question.

Ravi Sarathy (Analyst)

Good morning. Thank you very much for taking my question. I've got a question about your vision for the Personal Cloud Service that you spoke about in your opening remarks. I was wondering what your view is of how broad that cloud service will ultimately be in terms of the user experience, whether you see it encompassing as well as photos, music, video, and other types of data storage and sharing. Second, I'm wondering if that would encapsulate a streaming service. When you talked about sharing with friends for the Personal Cloud Service, I was wondering if that is around sharing with people who are already registered or additionally integrating with other social networks and social sites in China today. Thank you.

Robin Li (CEO)

Yeah. Like I mentioned before, Personal Cloud Service is really an infrastructure play. We have a very large infrastructure that can enable users to store their data, content, or apps on the cloud side at the cost, I mean, cost to us, because in most cases, it's free to the users, very cost-effectively. This kind of infrastructure can support a lot of apps. For example, we recently launched Baidu Wangpan that gives people virtually unlimited storage for them to store whatever they want. There are a lot of other apps that can take advantage of this infrastructure. For example, Photo Wonder. When people take pictures using their phone, they can actually store the data on the cloud side. There are a lot of other Baidu services from Baidu Knows to Postbar, a lot of user-generated content.

Anyone can choose to store a certain part of the content as their personal content so that they have a sense of owning some data. There are a lot of other developers, third-party developers who can develop apps and take advantage of this storage infrastructure, including sharing this kind of data among the social networks they prefer. It could be a Baidu social product. It could be any other popular product that's available on the internet. PCS is really an infrastructure play.

Ravi Sarathy (Analyst)

Understood. A quick follow-up somewhat related to that around mobile and the pre-installation of the Baidu range of apps, including search. I was wondering if you could update us on the potential Android handset as well as the development you have around iOS for the pre-install of Baidu Search and other apps.

Robin Li (CEO)

Right now, Android is growing much faster. I think the installer base is much larger and will become even larger because, based on the current market analysis, we expect a lot of, on the order probably of 100 million new Android-based phones becoming available this year. Right now, about 80% of the Android phones, branded Android phones, come with Baidu Search preloaded. We are very happy about the growth.

Ravi Sarathy (Analyst)

Thank you very much.

Operator (participant)

Your next question comes from the line of Gene Munster of Piper Jaffray. Please ask your question. The line of Gene Munster is open.

Gene Munster (Analyst)

Thank you. Good morning. Robin, can you talk a little bit about customer ads? They were better than expected. ARPU was a little bit weaker. Maybe a little bit about that trend going forward as you bring on more advertisers or these smaller businesses that might have a lower revenue opportunity. In general, how should we think about ARPU relative to customer ads over the next year or two? Thanks.

Robin Li (CEO)

Yeah. I would say that over the past couple of years, large customers generally grow faster than SME, as we talked about during the past few conference calls. That's because all of a sudden, a lot of the traditional advertisers and plus some of those hot sectors, group buying, they all came in and spent a lot of money on us. Starting from this year, we think that the customer mix will become more normal in the sense that a lot of the SMEs continue to sign up, and we were able to spare a lot of resources to take care of them. ARPU had a slight drop. It's pretty much because of seasonality. Q1 is always the slowest quarter for us. Over the next couple of years, I think we should see very healthy growth in a number of customers as well as ARPU.

It's just the customer mix may shift a little bit. Those larger customers, existing larger customers may not be able to double their spending on us every year. We do expect both the customer numbers and ARPU to grow very nicely.

Gene Munster (Analyst)

Great. Thank you.

Operator (participant)

Your next question comes from the line of Cynthia Meng of Jefferies. Please ask your question.

Cynthia Meng (Analyst)

Good morning. I have two questions. Number one is related to iQIYI. Is the R&D RMB 46 million loss from equity investment mostly from iQIYI? Can management give the outlook for the next few quarters? We also would like to hear from Robin, your view of ongoing online video consolidation, and what do you think this has implied to iQIYI-related loss? Will QIYI loss narrow? The second question is related to Baidu's strategy on the operating system. We read from recent news that Baidu is cooperating with Dell and also Foxconn to manufacture handsets based on the in-house OS. Can management give some more color on this? Thank you.

Jennifer Li (CFO)

I have a question related to the loss or gain from the equity cost accounting methods. What's included in this quarter's number mainly are two items. iQIYI is part of it, and there is also an element related to the Baidu [Yua] spin-off. If you read our 20-F, we obtained funding for Baidu [Yua], and we recognized a gain related to the transaction. On a going-forward basis, if the entity is loss-generating, we will pick up the related loss items. This quarter, the total amount is in the range of RMB 45 million. I expect this to be the range going forward on a consistent basis for the remaining quarters, maybe slight variations quarter over quarter, but that's largely the range that I'm looking at.

Robin Li (CEO)

Yeah. On the outlook for online video, I have mentioned this before. We see a tremendous amount of user demand for video content. A lot of users come to Baidu and search for video content. Our main goal is to satisfy this type of user needs. We invested in iQIYI so that they can bring us very high-quality, professionally produced, licensed content to our users, and we will continue to support that. We are also open to other types of other sources of online video content. In my mind, the online video business is not really a winner-take-all business. A lot of players have chances to benefit from this. On the one hand, the demand is huge. On the other hand, a lot of people have the capability to bring high-quality content online. We are very optimistic about the future of online video.

On the operating system thing, we continue to work on Baidu Yi, which is a platform for mobile handset manufacturers to preload. It comes with a lot of Baidu-flavored products and look and feel. We worked with Dell before, and we are working with other manufacturers for future release of mobile phones.

Cynthia Meng (Analyst)

Thank you. I have a follow-up question for Jennifer. Jennifer, you said the RMB 45 million loss per quarter is the estimate for loss related to [Yua]. I assume this does not include QIYI-related equity loss. If it doesn't, can you give some guidance as to what we should expect on QIYI-related equity loss going forward? Thank you.

Jennifer Li (CFO)

Yeah. What I said included in the line items are mainly two things. One is [Yua] and one is iQIYI. As I indicated last quarter, with the cash contribution we put into iQIYI, on a going-forward basis, we'll pick up our share of the financial results related to QIYI. Included in this number also has iQIYI's number. I just wanted to highlight that there is a new item related to [Yua] that's also included in this number. Going forward, largely, if business patterns are holding constant, this is the general range. You might see some variations quarter over quarter.

Cynthia Meng (Analyst)

Great. Thank you.

Operator (participant)

Your next question comes from a line of Wendy Huang of Royal Bank of Scotland. Please ask your question.

Wendy Huang (Analyst)

Thanks for taking my questions. First, why are you pushing into Tier 2 and Tier 3 cities and modifying your sales incentive systems? What kind of measures were you putting in place to avoid the risk and prevent medical ads from happening again? The capital expenditures seem to have come down dramatically in Q1 on both the year-to-year basis and the sequential basis. How should we view this trend going forward? Lastly, when you book the mobile advertising revenue, I wonder if you are booking the net revenue after distribution cost or you record the gross revenue. Thank you.

Robin Li (CEO)

I'll take it on the first. Jennifer will answer the rest part of the question. For the customers in the Tier 2 cities, as the vast majority of SMEs in China reside in the Tier 2 or Tier 3 cities, they start to realize the power of internet marketing or search engine marketing. We are just trying to satisfy their needs and help those SMEs in those regions to really take advantage of our platform. It is very natural that we start to shift some of the resources to the Tier 2 cities. Another point worth noting is that the growth rate for those Tier 2 areas is actually faster than the Tier 1 cities. It is only natural that more and more customers come from those areas.

Jennifer Li (CFO)

On the question related to CapEx, CapEx typically becomes pretty choppy quarter over quarter. Do not, you know, as I indicated, we are having consistent patterns when it comes to infrastructure investment. I also highlighted that other than data centers, we are also investing in office space. You should expect CapEx to pick up in the upcoming quarters. Typically, you know what's included in the CapEx, as you well know, is servers related. I think additional spending will occur this year related to constructions for infrastructure as well as office space. Related to your question on the mobile revenue, it is a very small part of the overall revenue picture today. Today, we're recording the mobile revenue on a growth basis, and any revenue sharing is going through the tax line item.

Wendy Huang (Analyst)

OK. Thank you.

Operator (participant)

Your next question comes from the line of [Fong Jiang of Berenberg]. Please ask your question.

Speaker 17

Good morning. My question is actually on the general advertising outlook for 2012. Since advertising overall in China has a pretty slow start with some soft macro and political uncertainty, I think our chat with advertisers seems to suggest 2012 could be second half loaded. I just wonder whether you see a similar trend with your business. Also, it would be extremely helpful if you could comment on the budget allocation trends for your big advertisers' first half versus second half. It seems like you had a pretty good start on small and medium enterprises. We want to get more color on the big advertiser side.

Robin Li (CEO)

Yeah. I would say that things are kind of different from the SME side to the large advertiser side. For SMEs, they are not that affected by this kind of budget allocation. Typically, their main way of doing online promotion is through Baidu, and it's very much performance-driven. As long as we can deliver the right result, they all depend on us. For the larger advertisers, the story is a little bit different in the sense that they generally have an annual budget for advertising, and then they allocate a certain portion of that budget to search or to Baidu. We usually sign a framework contract with them at the beginning of the year. We've seen very good acceptance from the large customers or large advertisers.

What we have heard is that many of the traditional advertisers are not increasing their overall advertising budget, but they would like to increase the percentage of their budget allocation to online platforms, especially on Baidu.

Speaker 17

Right. I guess the question is, is it fair to say we might see some recovery or improvement overall when we head toward the second half of the year?

Robin Li (CEO)

Our current read is that it's very possible, as you know, that Q1 is seasonally slow, and we signed a lot of framework contracts with the large advertisers. They are committed to spend. This year, we've seen very good acceptance from the large customers or large advertisers. What we have heard is that many of the traditional advertisers are not increasing their overall advertising budget, but they would like to increase the percentage of their budget allocation to online platforms, especially on Baidu.

Speaker 17

Right. I guess the question is, is it fair to say we might see some recovery or improvement overall when we head toward the second half of the year?

Robin Li (CEO)

Our current read is that it. This year, we've seen very good acceptance from the large customers or large advertisers. What we have heard is that many of the traditional advertisers are not increasing their overall advertising budget, but they would like to increase the percentage of their budget allocation to online platforms, especially on Baidu.

Speaker 17

Right. I guess the question is, is it fair to say we might see some recovery or improvement overall when we head toward the second half of the year?

Robin Li (CEO)

Our current read is that it's very possible, as you know, that Q1 is seasonally slow.

A lot of free work contract with the large advertisers. They are committed to spend a lot of money. I mean, a very healthy growth year on year. The second half should look better.

Speaker 17

Got it. Thank you very much, Robin.

Robin Li (CEO)

Yeah.

Operator (participant)

We're now approaching the end of the conference call. I will now turn the call over to Baidu's Chief Executive Officer, Robin Li, for his closing remarks.

Robin Li (CEO)

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

Operator (participant)

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.