Sohu.com Limited
Q4 2005 Earnings Call Transcript

Published: 7 Feb 2006

[Operator:]

Good day ladies and gentlemen, and welcome to SOHU's First Quarter and 2005 Fiscal Year Earnings Conference Call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at anytime during the conference, please press the star followed by the zero. As a reminder this conference is being recorded today, Monday, February 6, 2006. I would now like to turn the conference over to Ms. Ingrid Shea, Investor Relations. Please go ahead ma'am.

[Ingrid Shea:]

Thank you for joining SOHU.com to discuss our Fourth Quarter and Fiscal 2005 Results. On the call today are Charles Zhang, Chairman of the Board and Chief Executive Officer, and Carol Yu, Chief Financial Officer. Before the management presentations I would like to read you the Safe Harbor statement in connection with today's conference call. Except for the historical information contained herein, the matters discussed in this conference call are forward-looking statements. These statements are based on current plans, estimates and projections, and therefore, you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements. Potential risks and uncertainties include but are not limited to SOHU's historical and possible future losses, limited operating history, uncertain regulatory landscape in the People's Republic of China, fluctuations in quarterly operating results and the company's reliance on on-line advertising sales, mobile phone related wireless revenues, online games and e-commerce for its revenues. Further information regarding these and other risks is included in SOHU's Annual Report on Form 10-K and other filings with the Securities and Exchange Commission. Thank you for your patience. Now I would like to the call over to Charles Zhang, Chairman and CEO. Charles?

[Charles Zhang:]

Thank you all for joining our conference call today. To start there is one key message that I want to emphasize on our call today. And that is our commitment for our core advertising business. SOHU's brand and research, we managed firm and the growth that we have seen this past quarter and throughout 2005 is representative of our growing strength in China's online advertising market. We look to further drive our business through continue development and the rollout of our own innovative products and the services to drive increased traffic and the usage on our sites. Now I'd like to discuss highlights for the quarter. We reported record total revenue of $30.5 million growing 8% sequentially and 27% year-on-year exceeding company guidance. Let me discuss the progress of our main business line. Advertising, overall we have seen a healthy fourth quarter and 2005 fiscal year in the advertising business. Advertising revenues for the fourth quarter were $20.3 million, up 8% quarter-over-quarter, which exceeded our guidance. For the full fiscal year 2005, Advertising revenue grew 27% year-over-year also exceeding our guidance of 20% to 25% year-over-year growth. Brand advertising revenue were $16.9 million, and the sponsored search accounted for $3.4 million, a sequential increase of 8% and 7% respectively in a traditionally weak quarter, and a year-on-year increase of 28% and 27% respectively. I'd like to give an overview of brand advertising first. In brand advertising, the 8% of sequential revenue growth was primarily due to heavy advertising spending sectors such as information technology, automobiles and real estate. On the other hand sectors that have experienced the fastest growth for the quarter has been financial services, travel and healthcare. More specifically, there are two very important and underling sectors which are as a core of our brand advertising strength and the strong future growth outlook. First, SOHU's Olympic sponsorship growth is a near-term and long-term growth catalyst for our brand advertising business. The fourth quarter was the first quarter of our constructing operating and hosting official Beijing 2008 Olympics website. The website www.beijing2008.com is now up in running in three languages

[Carol Yu:]

Thank you, Charles. I would like to take this opportunity to discuss some key financials for the fourth quarter and 2005 fiscal year. One, Revenues

[Operator:]

Thank you. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press the '*' followed by “1”on your pushbutton phone. Again that's '*' '1' to ask a question. If you would like to decline from the polling process, press the ‘*’ followed by ‘2’. You will hear a three tone prompt acknowledging your selection, and the questions will be pulled in the order that they are received. Please limit your questions to one question, one follow-up question, and re-queue for any additional question. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. One moment please for our first question. Our first question is from Jason Brueschke with Citigroup.

[Katherine Lange:]

Hi. This is Katherine Lange speaking for Jason Brueschke. He’s marketing in Europe right now. First, we would like to congratulate you on a great quarter.

[Carol Yu:]

Thank you. Your sound is little bit soft. Would you mind speaking loud?

[Katherine Lange:]

This is Katherine Lange for Jason Brueschke.

[Charles Zhang:]

Okay; better.

[Katherine Lange:]

Yes, he is marketing in Europe right now. Is it better?

[Charles Zhang:]

Yes; it’s better.

[Katherine Lange:]

Okay. So, firstly congratulations on a great quarter. We just have a question on brand advertising. Firstly, could you update us on your agreements with Alibaba, is the contract is up for renewal, and if yes have you renewed it? If it’s not up for renewal, can you tell us if you’re looking for another exclusive agreement when you renew it?

[Carol Yu:]

The answer is yes. We have renewed it. It’s an annual contract; we renew it every year. And that has been factored into the guidance for 2006 that Charles just gave out.

[Katherine Lange:]

Okay. And, I just have a quick question on your customers. We noticed in your 10-Q that there has been a relatively large amount of churn in the advertisers, in terms of the new advertisers. And this is anticipated, obviously, given your guidance. Could you update us on whether this churn has moderated in the fourth quarter and whether the problems you mentioned in southern China have moderated as well?

[Carol Yu:]

The southern China problem has been sort of contained. And as you can see in the fourth quarter results, we actually are doing better than we originally expected for the entire brand advertising business as a whole. Turning to the churn, customer content goes in the because it’s a quarter-to-quarter thing so this customer may advertise this quarter and they may not do so in the next one. In terms of the total number of advertisers Q4 actually goes up by about 4%. So on the overall basis we are really happy with the customer base that we are having right now for brand advertising.

[Katherine Lange:]

So it's about the number of new advertisers, and a percentage of the total advertisers for the quarter is about around the same level as in the fourth quarter as in the previous third quarter?

[Carol Yu:]

Yes, it's up 4%.

[Katherine Lange:]

Okay, alright. Thank you.

[Carol Yu:]

Thanks.

[Operator:]

Thank you. Our next question is from Safa Rashtchy with Piper Jaffray.

[Carol Yu:]

Hi Safa.

[Safa Rashtchy:]

Good Charles, Carol. How are you?

[Carol Yu:]

Good.

[Safa Rashtchy:]

Congratulations on the good quarter. Couple of questions, mostly online search and advertising, and then a follow-up on wireless if I could. I belive if we take your guidance for Q1 on advertising, it suggests an acceleration of growth rate to over 30%. First of all, can you confirm if my calculations is correct? Are you expecting an acceleration that means that all organic? And overall, Charles, how do you view the advertising environment in '06 compared with '05?

[Carol Yu:]

Let me clarify the numbers. Yes, you're talking about year-on-year, for Q1 we are giving out the guidance I suggest, that it would grow by around 30%. So that's the guidance that we give out. And our belief is, what's your next question?

[Safa Rashtchy:]

Yes, just on acceleration of growth. And I want to a) first see if that is all organic and b) if you try to expect an acceleration of growth in advertising in '06 compared to '05?

[Carol Yu:]

Okay. In '05 we achieved a year-on-year growth of 27%. Your next question, and we gave our guidance for '06 to be 25% for advertising growth. And yes, the growth that we gave out for Q1 is all organic. We are not making any acquisitions in Q1, not factored in.

[Safa Rashtchy:]

Okay. So are you expecting growth to decelerate beyond Q1, because you said you are giving a 25% for '06, did I hear you correctly?

[Carol Yu:]

We are giving out an overall guidance for '06 to be 25%. We are comfortable with that number. We did say that we would grow by 20 to 25% last year, we did achieve 27 though. So we are comfortable with this 25% number for now in 2006. But you are right; the guidance that we gave out suggested around 30% growth for Q1 year-on-year.

[Safa Rashtchy:]

Okay, and second question on the wireless segment. Your wireless segment is doing well and the margins are expected to be better than – they hasn’t yet given their increasing cost, as you indicated that you maybe increasing your focus on wireless, especially as 3G licenses are getting closer, what kind of investment should we expect you will do in wireless, and what kind of expenses can we see added to that segment if at all in 2006?

[Charles Zhang:]

Yeah, I think we will achieve a recovery and regular growth without additional major investment in promotional expenses, and for our WAP development, it's already utilized the resources, the total, the PC based internet content that some of the content are quite accepted by mobile users, and some of the community product and also the Sogou search and also the Go2Map, and all these product the portal content can we developed used on a mobile phone without additional expenses.

[Safa Rashtchy:]

Great. Thank you, Charles, thank you, Carol. Good quarter.

[Carol Yu:]

Thank you.

[Charles Zhang:]

Thank you.

[Operator:]

Thank you. Our next question is from Frank Shi with CLSA.

[Frank Shi:]

Hi, good morning guys.

[Carol Yu:]

Hi Frank.

[Frank Shi:]

The question on online advertising. In terms of resources of online branding, which industry do you think will go fast, and which industry do you think will grow going slower? And the second question, in terms of your growth in page search, how many percent is driven by a number of customers, how many percent is driven by price changes? Thank you.

[Carol Yu:]

In terms of brand advertising, we saw going in 2006 as we mentioned will be primarily financial services and FMCG, the fast moving consumer goods. Slowing down we don’t expect much growth from online games due to the uncertainty in the overall game industry. And as well as like what we have - the industry that we typically that we exceeding from problems last year such as local mobile headsets, but other than that we see everything going fine and well.

[Operator:]

Ladies and gentlemen please continue to standby, we are having technical difficulties, please standby for one moment please. Many apologies for the delay, please continue with your answer.

[Carol Yu:]

Yes. Frank, did you get it?

[Frank Shi:]

Yeah.

[Carol Yu:]

In terms of the brand advertising question?

[Frank Shi:]

Yeah.

[Carol Yu:]

And in terms of search, the growth mainly comes from the shift from pay inclusion to bid listing. So it's not really relating to the increase in number of customers or in terms of price increase. So it's mainly coming from the shift in terms of the source of the revenue.

[Charles Zhang:]

And that was related to the traffic growth.

[Carol Yu:]

Right.

[Frank Shi:]

Okay. Thank you. My last question is also on the search. On the given Google’s push into the China market and Alibaba, I guess push I mean at the business itself. Clearly you guys compete on traffic, but do you also see increase in competition in terms of channels and in terms of human resources? Thank you.

[Charles Zhang:]

Yeah, in the fourth quarter we have seen our traffic grow by 40%. And after the Sogou 2.5 version launch in December and we have seen in the past few weeks, the traffic grow even faster. So we are, we are actually growing Sogou traffic faster than our competitors. There is a clear competition over talents and personnel and technologies and also on the marketing fronts. But on the marketing trends we have been, we do innovate marketing contents like the Supergirl contest, and also very lucky to have the year of the Dog and we have the search Dog contest. So it's a fierce competition, but we think that we are in a very good position.

[Frank Shi:]

Okay. Thank you.

[Carol Yu:]

Thanks.

[Operator:]

Thank you. Our next question is from Dick Wei with JP Morgan.

[Carol Yu:]

Hi Dick.

[Dick Wei:]

Hi, good morning Charles, and Carol. My question is on the marketing expense side. In the first quarter, selling marketing expense was up about 3.1 million from third quarter, and out of 1.4 million due to the advertising transition, marketing expense is up 1.7 million quarter-on-quarter, I was wondering, how much does it goes to the Olympics, and how much of this go to the some of Sogou or on to the wireless emphasis?

[Carol Yu:]

We didn’t' actually give up the specific number relating to the Olympics sponsorship as you know, but all the marketing expenses relating to the Olympics sponsorship plus our whole one-time marketing expenses relating to the event, such as the big launch ceremony and the light is around $1 million for Q4. So we will break that down that to how much is actually relating to the cost of the sponsorship. So and, so that is just typical seasonal, because the fourth quarter, we usually incur a little bit more than the other quarters. So when do you have, at the end of the year, thank you events to your clients and the like so. That's a seasonally high.

[Dick Wei:]

And so that one million related to Olympics some one-time, and some…

[Carol Yu:]

Recurring, yes.

[Dick Wei:]

Recurring. I have a question on, just on the August revenues, it has grown up some quite healthily by about to indicate, when do, does it really come from online games, and how we see it online to that? Thanks

[Carol Yu:]

Yes. The growth actually comes from mostly online games, actually e-commerce and the others are free flat, or down a little bit. And the role in online games comes from both online with games, and then in terms of - it's coming mostly from games online.

[Dick Wei:]

The last question is that, do you have the PCU numbers, and actually can you give the numbers available? Thanks.

[Carol Yu:]

It is very low, all the general its less than $30 PCU so, and I won't even care about it so.

[Dick Wei:]

Okay, thank you.

[Operator:]

Our next question is from Ming Zhao with SIG.

[Carol Yu:]

Hi Ming.

[Ming Zhao:]

Hi, congratulations Carol and Charles. I have a question on the advertising side. In your guidance for the 2006, you know 25% year-on-year growth. Have you factored in the stronger local currency, which is about 2.4% year-on-year, is that excluding that or including that?

[Carol Yu:]

We assume everything, so the year-on-year that you talk about will be starting from July, is only half of the year so. And the timing people just, we just already convert that into currency so.

[Ming Zhao:]

Okay. And also related to this brand advertising, just a followup question on the, you know, where the growth is coming from for the Q4 and for guidance in Q1. Because I have noted that you rate the cards, with your brand advertising has increased a lot on the homepage and those hot channels. Have you also taken consideration that price increase?

[Carol Yu:]

Yes, we have taken everything into consideration.

[Ming Zhao:]

So, on average how much is the increase upon the price increase?

[Carol Yu:]

Again, it will be on the hot resources, its around 17% to 25%.

[Ming Zhao:]

Okay, alright. Thank you.

[Carol Yu:]

Thank you.

[Operator:]

Thank you. Our next question is from Lu Sun with Lehman Brothers.

[Lu Sun:]

Hi Charles and Carol. I actually just want to ask two questions. One is about the treasure of the Olympics contract that you are signing with major companies. Again it's flying a little bit higher than, you know, from now going to 2008?

[Carol Yu:]

It's case by case, it's different from one to another. But mostly it would be called marketing activities, for example, surrounding a certain theme which is related to Olympics obviously, we just do marketing activities together. So it varies from company to company and deals from deals and deals to deals.

[Lu Sun:]

Does that help you a lot in those customers for two to three year periods with incremental spending every year?

[Carol Yu:]

If it’s relating to Olympics, yes. When you say margin, it's not, we would not have a long-term contract with these guys sacrificing how much they spend this year, the next year and the year after. But assuming that these guys are spending money to obtain the sponsorship and they will spend even more amount to promote the sponsorship that they got. They would have to do marketing to promote their own sponsorship, and that’s when that we would have an opportunity to work this up.

[Charles Zhang:]

The Olympics deal also includes the Winter Olympics in Turin. And actually Lenovo and the big marketing activities around this event, so and SOHU will have a reporting team to heavily report the Turin Winter Olympics.

[Carol Yu:]

It's just one of these examples.

[Lu Sun:]

I see. And my second question is on the rationale of changes in the commission schemes that you pay out to your salespeople. It looks like it’s counterintuitive in the sense that you actually encourage people to sign more contracts, but actually in the advertising world, isn’t receivable always a problem and you want to pay them only after you collect the cash?

[Carol Yu:]

Good question, Lu Sun. I’m glad you asked that. No change in terms of actual payment to the salespeople that we will only pay them after the collection of receivables from customers. But, in terms of the timing when I accrue this expense, I moved the recording point to an earlier time instead of recording that only upon collection of receivable, I now record it upon the recognition of revenue. So, it’s only the timing of the accrual change; it’s not the actual payment nor the scheme itself.

[Lu Sun:]

I see. Thank you.

[Carol Yu:]

And that’s why I specified that it is an accounting adjustment. It is not an actual change in the bonus plan or the commission plan.

[Lu Sun:]

And that applies to both the internal salespeople and also the outside agents, right?

[Carol Yu:]

We have always recognized a rebate to sales agents upon recognition of sales revenue. But, for internal, because it’s discretionary, in the past we’ve recorded upon the collection of receivables. Now we changed the timing of the recording.

[Lu Sun:]

I see. One last question. Do you think that paid search will outgrow brand advertising in 2006?

[Carol Yu:]

We believe that the product is most important for us on the search side. So we’ll continue to work on that. And once traffic grows, I think monetization will follow. We do not give out specific guidance as to the relative growth rates between these two advertising business lines.

[Lu Sun:]

Thank you very much.

[Operator:]

Thank you. Our next question is from Wallace Chung with Credit Suisse First Boston.

[Wallace Chung:]

Hello.

[Carol Yu:]

Hi, Wallace.

[Wallace Chung:]

Hi. Good morning, Charles and Carol. Good quarter. Two questions. First of all regarding gross margin, we see pretty impressive improvement. Should we expect for the gross margin increase in the first quarter and even in 2006, and can you explain a little bit the reason behind on the gross margin in terms of the particular in the brand advertising side? Second question regarding, again, on the expenses. Can you elaborate a little bit more on the potential incremental expenses regarding the Olympic deals in 2006 as well as any incremental marketing expenses on some of the key events Charles has mentioned about, say, Supergirl or other things that may happen in the first quarter? Thank you.

[Carol Yu:]

Let me talk about our expenses side first. The Olympic deals, I think we would not have much incremental expenses because as I have explained, certain of the expenses that we spoke in Q4 are one-time. And going into 2006, I think, I did explain on the last call and with a number of meetings that the expenses would be, as far as the cash portion is concerned it would be flattish. The one-time marketing expenses that we spend in Q4 would not be recurring, although we do have some recurring marketing expenses. The marketing events that Charles mentioned, like the Supergirl and the search dog that is what we do day in and day out. So these are just specific events that we highlight for investors and analysts to better understand what we’re doing in terms of promoting our Sogou product. It’s not because we are spending a lot of money on them. And what’s your first question, Wallace? Sorry.

[Wallace Chung:]

Again on the gross margin side because…

[Carol Yu:]

Oh, gross margin side. I think it would be pretty flattish going forward. And as we mentioned, except for the bandwidth and the server costs on the brand advertising side, most of it is pretty, are all fixed costs. It would just grow or change with our revenue so most of the costs are fixed.

[Wallace Chung:]

Okay. But that will be also observed the decline in gross margin in the paid search side. The reasons behind?

[Carol Yu:]

The reason is because of the shift in the revenue mix. We are growing from more, growing into more bid listings, which has a revenue sharing with all the web alliances and the like.

[Wallace Chung:]

Okay, great. Thank you.

[Operator:]

Thank you. Our next question is from Michael Zhang with INC Equity Partners.

[Michael Zhang:]

Hey. Good morning. Congratulations on the quarter. My questions are focused on the wireless side of business. I think Beijing Time yesterday, the Ministry of Information Industry was reportedly saying it’s going to clean up the fraudulent and inappropriate building practice in the telecommunications market, including the wireless value-added service.

[Carol Yu:]

Right.

[Michael Zhang:]

It looks like long-term positive news for the market, but what do you think the short-term impact will be on the industry in general and on SOHU’s business?

[Carol Yu:]

Let’s talk about SOHU specific first. I think, SOHU has underwent a rather painful cycle last year in terms of cleaning up all these inactive users and the like. And I think as far as we are concerned, we have already cut all the dead bushes around. And I think we’re already there. So I don’t think that would be very much affected if at all by this new policy. In terms of the industry, I think I mean maybe a better qualified candidate to answer this question is to ask the bigger players be our core business is now advertising, and we are not anything close to representative of major players in this market.

[Michael Zhang:]

Okay. That’s fair enough. The second question is as you mentioned, the core business right now is advertising, which is 67% of your revenue. And the non-advertising is also in the recovery mode. So, can you briefly address your outlook for 2006 and your strategies to achieve what you have envisioned?

[Carol Yu:]

Strategy?

[Michael Zhang:]

Yes. Outlook for 2006.

[Charles Zhang:]

Oh, continued focus on advertising.

[Michael Zhang:]

Yes.

[Charles Zhang:]

And brand advertising to, first of all, make sure that our information base to portal and also the community web 2.0 products continue to grow in terms of traffic and usage so that SOHU will become the default premium portal in China. With traffic growth, we’ll have leverage over our advertisers and attract more advertisers and also build. We already have a very good structure in terms of advertising sales force. And the build up of the team will continue. And, for the search side, our focus is to grow traffic. As demonstrated by the past quarter, the traffic already has been growing faster than our competitors. And through continued investment in research and development, make sure that our technologies stay up in the best. So, for the search side, it’s really the year of dog, it’s the year of the search dog traffic growth.

[Michael Zhang:]

What about the wireless side of business?

[Charles Zhang:]

We will maintain a continued rapid recovery.

[Carol Yu:]

We will continue to maintain a stable investment in this business. We would not invest aggressively, we would not be doing aggressive promotions or what not. And on that basis, we hopefully can grow the business on a cautious manner. This is our plan and our hope but as we have mentioned many times because this particular industry, the payment gateway is controlled by the two operators. If they do something drastic, there’s not much we can do but, and that’s what our strategy is to stay low and keep just continue to recover the business.

[Charles Zhang:]

And grow our WAP business, which is 3G era, preparing us for the 3G time.

[Operator:]

Thank you. Our next question is from Jason Brueschke with Citigroup.

[Katherine Lange:]

It’s still me, Catherine. I just have a follow-up question on the technology of the search, Sogou. From a technology point of view, could you comment on how the technology as of today compares with, the algorithm compares with Google and Yahoo’s algorithms? And when you fully monetize Sogou, how do you expect the technology to compare?

[Charles Zhang:]

With the Sogou version 2.5, we have a new set of, a new version spider, which are crawling and collecting pages at a much faster speed. And also, a new versatile coding, which are giving a more accurate and updated pages with a dozen links. Also, in specialized the search with the, we have a better technology in the music search and also with our Go2Map, combine the Sogou technology and the Go2Map information database in providing a better local search. We will launch our local search in a few months. So, the Sogou technology basic web page search site, web page side, a better spider and a better, a new coding that are just better, more efficient input/output retrieving technology to provide an accurate and relevant direct of the content, basic itself.

[Katherine Lange:]

Okay.

[Operator:]

Thank you. At this time, I’d like to turn the call back to management for additional remarks.

[Ingrid Shea:]

We would like to thank everyone for participating in today’s call. Please feel free to contact us should you have any additional questions. Thank you, and have a nice day.

[Carol Yu:]

Thank you.

[Operator:]

Thank you. Ladies and gentlemen, this does conclude SOHU’s fourth quarter and 2005 fiscal year earnings conference call. If you would like to listen to a replay of today’s conference, please dial 1-800-406-7325 or internationally at 303-590-3030 with pass code number 3460509, followed by the pound sign. Again, if you would like to listen to a replay of today’s call, please dial 1-800-406-7325 or 303-590-3030 with access number 3460509, followed by the pound sign. Again, thank you for your participation today, and you may now disconnect.