Business Context and Reporting Period
This Form 20-F is the annual report for Baidu, Inc., a Cayman Islands-incorporated company and the leading Chinese language Internet search provider. The report covers the fiscal year ended December 31, 2006. Baidu operates primarily through wholly-owned subsidiaries and variable interest entities (VIEs) in the People's Republic of China (PRC) to comply with foreign ownership restrictions on Internet content and advertising businesses. The company's ADSs are listed on the NASDAQ Global Market under the symbol "BIDU."
Key Financial Metrics (Year Ended Dec 31, 2006)
| Metric | 2006 (RMB '000) | 2006 (US$ '000) | 2005 (RMB '000) |
|---|---|---|---|
| Total Revenues | 837,838 | 107,359 | 319,215 |
| Net Income | 301,766 | 38,668 | 47,605 |
| Operating Profit | 262,878 | 33,685 | 35,843 |
| Operating Margin | 31.4% | 31.4% | 11.2% |
| Cash and Cash Equivalents | 1,136,274 | 145,600 | 900,593 |
| Total Assets | 1,668,077 | 213,743 | 1,136,423 |
| Total Liabilities | 310,816 | 39,827 | 131,370 |
| Shareholders' Equity | 1,357,261 | 173,916 | 1,005,053 |
| Diluted EPS (US$) | — | 1.12 | 1.49 |
Note: US$ amounts are translated at the rate of RMB 7.8041 to US$1.00. The company reported no long-term debt obligations as of December 31, 2006.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased by 162.5% from RMB 319.2 million in 2005 to RMB 837.8 million in 2006. This was driven primarily by a 169.5% increase in online marketing services revenue.
- Profitability Surge: Net income jumped 533.9% to RMB 301.8 million, and operating profit increased by 633.4% to RMB 262.9 million, reflecting significant operating leverage.
- Customer Base Expansion: The number of online marketing customers grew from approximately 76,000 in 2005 to over 143,000 in 2006. Average revenue per customer increased from RMB 4,044 to RMB 5,800.
- Cost Structure: Total operating costs and expenses rose 102.9% to RMB 575.0 million. Notable increases included traffic acquisition costs (up 254.4%) and depreciation of servers (up 104.0%) to support traffic growth.
- Accounting Change: The company adopted SFAS 123(R) for share-based compensation in 2006, resulting in a cumulative benefit of RMB 4.6 million.
Guidance, Outlook, and Risks
Outlook and Strategy
- Japan Expansion: Baidu announced its intention to enter the Japanese search market in 2007, launching a beta trial in March 2007.
- Strategic Partnerships: Formed alliances with Microsoft (paid search on MSN/Windows Live), HP (pre-installed search engine), and eBay Eachnet (exclusive text advertising).
- Capital Expenditures: The company expects increased capital expenditures in 2007 and 2008 for the construction of a new corporate headquarters in Beijing and continued infrastructure upgrades.
Key Risks and Contingencies
- Regulatory Uncertainty (PRC): Significant risks exist regarding the interpretation of PRC laws on foreign ownership, Internet content, and advertising. Changes in regulations could require restructuring or result in sanctions.
- Intellectual Property Litigation: The company faces potential claims regarding copyright infringement (specifically MP3 search services) and patent infringement related to its Pay-for-Performance (P4P) platform.
- Corporate Structure: Operations rely on contractual arrangements with VIEs (Baidu Netcom and Beijing Perusal). If these arrangements are deemed non-compliant, the company could lose control of its core assets.
- Foreign Exchange: Appreciation of the RMB against the US dollar resulted in translation losses of RMB 28 million in 2006 and could adversely affect reported earnings and asset values.
- Competition: Intense competition from Google, Yahoo!, and Chinese portals (Sina, Sohu, Tencent) for users and advertising budgets.
Investor Verification Checklist
- VIE Compliance: Verify the status of contractual arrangements with Baidu Netcom and Beijing Perusal and any updates on PRC regulatory enforcement regarding foreign ownership of Internet services.
- IP Litigation Status: Monitor pending copyright and patent lawsuits, particularly those involving MP3 search and P4P technology, for potential financial impact.
- Tax Rate Changes: Assess the impact of the new Unified Enterprise Income Tax Law (effective Jan 1, 2008) on the company's preferential tax rates for its subsidiaries.
- Japan Market Entry: Track the progress and financial performance of the Japanese search operations launched in 2007.
- Customer Concentration: Confirm that no single customer or Baidu Union member accounts for more than 10% of revenue (as stated in the filing).