Sohu.com Limited
Q4 2006 Earnings Call Transcript

Published: 6 Feb 2007

[Operator:]

Thanks so much for holding everyone and welcome to the Sohu fourth quarter 2006 earnings conference call. Just a reminder, today’s conference is being recorded. And now, for opening remarks and introductions, I would like to turn the conference over to Brandi Piacente with the investor relations group at Sohu. Brandi, please go ahead.

[Brandi Piacente:]

Thank you for joining Sohu.com to discuss our 2006 fourth quarter and fiscal 2006 results. On the call today are Dr. Charles Zhang, Chairman of the Board and CEO; and Ms. Carol Yu, Co-President and 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 here-in, 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 statement. 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 online advertising sales, mobile phone related wireless revenue, and online games for its revenues. Further information regarding these and other risks are 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, let me turn the call over to Dr. Charles Zhang, Chairman and CEO. Charles.

[Dr. Charles Zhang:]

Thank you, Brandi. Hello, everyone. Welcome to Sohu's 2006 fourth quarter financial results call. First, I would like to begin today by announcing some key executive management promotions. Effective February 5th

[Carol Yu:]

Thank you, Charles. Hello, everyone. I would like now to take the opportunity to discuss some key financials for the fourth quarter and fiscal 2006. One, revenues. We are pleased to report total revenues of $34.4 million for the fourth quarter, which is in range with our guidance. Advertising

[Operator:]

(Operator Instructions) We will go first today to Jason Brueschke at Citigroup.

[Jason Brueschke:]

Thank you, and first of all, let me say congratulations, Carol, on your promotion to Co-President.

[Carol Yu:]

Thank you, Jason.

[Jason Brueschke:]

Let me just give three quick questions and then I will get off. The first one is, could you give us some more color on what exactly happened to the gross margins for advertising in the fourth quarter? The second one is regarding the wireless value-added services. What happened in the quarter that you guys did not anticipate when you gave us the guidance for the fourth quarter? Then the final, the third question is regarding the online video advertising. It seems like there is a tremendous amount of interest that is growing in China, as well as the rest of the world. Do you see ’07 really as a year where traffic and interest will happen, and then advertising revenues maybe follow more in 2008, or should we expect significant advertising revenues around the online video more in 2007? Thanks.

[Carol Yu:]

Let me answer your second question first. What we didn’t expect when we gave out the guidance is really the actual implementation of the wireless, the regulations of the rules on the wireless side when we actually gave out the guidance. You remember last quarter, the rules actually hit us a lot less than we originally expected, so we are a little bit on the optimistic side and continue to expect a flat quarter for the fourth quarter, after looking at our Q3 results. Unfortunately, the actual detailed implementation rules became more and more stringent as time went by, as the MII become very, very serious about those rules and operators implement those rules on a very stringent side. So that is what we did not anticipate. That is your question number two. On the advertising gross margins, what we actually do is we actually continue to launch more and more video products, as Charles explained in his script. That actually brings us more -- we have hired more editors on both the sports side and the entertainment side, and also although with our streaming technology, peer-to-peer streaming technology, there is some savings in terms of the bandwidth and server depreciation costs, but nonetheless, that is an entirely new business for us, so that actually increased the content cost as well. Sorry, what was your third question?

[Dr. Charles Zhang:]

I think the first question is about the gross margin on advertising. You talked about that, gross margin on advertising.

[Carol Yu:]

Yes, I just talked about it.

[Dr. Charles Zhang:]

The gross margin, why it is lower?

[Carol Yu:]

Yes, I --

[Dr. Charles Zhang:]

You didn’t talk about the wireless, but the advertising side.

[Jason Brueschke:]

It was on the rich media. Is ’07 going to be the year to really monetize rich media in a really mature way, or will we see that more in ’08?

[Dr. Charles Zhang:]

I think the defining moment is really 2006, the World Cup and later, the NBA broadcast that basically announced the coming of age of the video media on the Internet space in China. I think maybe the traffic popularity on a much larger scale will happen in the middle of 2007, maybe in six months of accumulation because we already see a lot of traffic for our B-Channel and S-Channel. And then, I think the advertising will follow not too late.

[Carol Yu:]

So the full year impact of these increasing advertising revenue on the video side, you will see a much more vivid impact in 2008.

[Jason Brueschke:]

Okay, great. Thank you.

[Operator:]

We will take our next question now from Dick Wei at JP Morgan.

[Dick Wei:]

Hi, good morning, Charles and Carol. I just have a quick question on the top line guidance for first quarter. Basically, it looks like for brand advertising, the guidance is going to be up 37% year over year, or sequentially up about 4%, which is quite strong compared with typical negative seasonality in Q1. Also, in addition, the Chinese New Year is late this year, so that typically causes advertising growth to be slower in Q1. I wonder, your strong guidance, does it suggest some one-time contribution to first quarter when I compare this with your full-year guidance of only 30% year-over-year growth? Could you provide some more color on the guidance?

[Carol Yu:]

We have better visibility for Q1 as we are already in it. Two factors leading to the relatively strong quarter, especially on the advertising side. One is, well, that’s the two factors that we keep talking about like parrots. One is the Olympics. The Olympics heat up, so we are seeing more and more activities between ourselves and other sponsors, and two is the video side. NBA was launched, the season started in November. Revenues started coming in thereafter, and so we are seeing a full quarter impact of NBA advertising in Q1.

[Dick Wei:]

Are you able to break down in Q1 Olympics-related advertising or video site-related advertising, roughly?

[Carol Yu:]

No.

[Dick Wei:]

All right. I will let someone else ask a question. Thank you.

[Carol Yu:]

Thank you.

[Operator:]

Ladies and gentlemen, we politely ask that you please try to keep your initial questions to one, and we go next now to James Mitchell at Goldman Sachs.

[James Mitchell:]

Hi, congratulations on your promotion. The G&A costs looked very low in the fourth quarter of ’06. I know in the MD&A, you stated that was due to lower bad debt and professional fees than in prior quarters, but was there any kind of contra items that reduced the G&A? Or should we expect the G&A to start again from that base level as we move into ’07?

[Carol Yu:]

We will continue to increase, or we will continue our investment, like what Charles has said, both premier content as well as on the R&D, so we will step up those investments starting 2007 as well. It is very seasonal, so it’s not like it’s flat from here or there. A lot of the expenses, for example, [sell-through] marketing, are very optional, so we may want to do it once more here or there.

[James Mitchell:]

Okay, but the G&A line item was down I think 40% Q-on-Q, and it was actually down year on year as well, ex stock-based compensation. So I am just wondering whether G&A will be closer to $2 million a quarter.

[Carol Yu:]

Oh, you are talking about just that line item?

[James Mitchell:]

Yes.

[Carol Yu:]

I will get Jackie to get back to you.

[James Mitchell:]

Okay. Thank you.

[Carol Yu:]

Thanks.

[Operator:]

We will take our next question now from Wallace Cheung at Credit Suisse.

[Wallace Cheung:]

Good morning, and congratulations on Carol’s promotion. Just one quick question, a follow-up on James’ question. Do you expect the brand advertising market growing at a similar rate as what you project on your annual growth guidance?

[Carol Yu:]

Say that again, sorry?

[Wallace Cheung:]

I’m sorry. Do you expect your brand advertising revenue growth at [inaudible] for the year, may be, from my perspective, a little conservative. Do you expect the overall market to grow the same?

[Carol Yu:]

What we are seeing right now is we have been in talks with the 40 sponsors and partners for the Olympics. I think this is the group of people who are going to spend the bulk of their money, or the most significant portion of their budget during 2007 and ’08. When we talk to this group of people, what we are hearing from them is they want to spend money they have in marketing budgets but what they are waiting to see is to pick and choose which activities they would like to invest in. They would like to see some cross-media integration, for example, between Internet and TV and traditional text media. So they are more like planning right now. So while I would say that the guidance right now is reflective of what we are seeing today, but as time goes by, they may decide to spend more on this front.

[Wallace Cheung:]

Okay, great. Just a clarification, Carol

[Carol Yu:]

Yes.

[Dr. Charles Zhang:]

We will update our guidance as the Olympic picture becomes clearer.

[Carol Yu:]

James, just to get back to your question, yes, you can take it as the base line, the G&A expense in Q4, as the base line going forward.

[Wallace Cheung:]

Thank you very much, both Charles and Carol. Thank you.

[Operator:]

We will take our next question now from Ming Zhao at SIG.

[Ming Zhao:]

Good morning, everyone. Just one question

[Carol Yu:]

We can provide that list to you, because real estate and game advertisers are mostly local companies, so I do not have that list ready for you.

[Ming Zhao:]

No, I am not asking for a list. I am asking do you see any trend in the real estate business? How is the trend of them spending online? Do you see an increase or a deceleration, or do you see in FM CG sector growing faster? Any comments on that?

[Dr. Charles Zhang:]

Yes, I think the FM CG sector is definitely picking up, accelerating, and also financial services is also an area that is getting very popular as the Chinese stock market continues getting very hot, and also Sohu's business channel is getting a lot of traffic. That is why we think because of the up rise of FM CG, we have been immersed and developed a very strong and powerful entertainment channel which is targeting to all this younger generation, and where a lot of FM CG products like to advertise on those channels. For real estate, I think that --

[Carol Yu:]

Well, real estate is kind of flattish, but one point I would like to make is that out of the big sectors, which traditionally are automobiles, real estate, and IT, automobiles actually we are seeing very, very impressive growth, so that will be one of the key factors for us in 2007.

[Ming Zhao:]

Great, thank you.

[Dr. Charles Zhang:]

Adding 1,000 cars per day in Beijing.

[Operator:]

We will take our next question now from Safa Rashtchy with Piper Jaffray.

[Nat Schindler:]

Hi, this is actually Nat Schindler calling in for Safa. Quickly, I just wanted to know if you can give us any sort of metrics or data that you have seen since the launch of Sogou 3.0 that would give us some indication of how well you are being able to keep up with your rather entrenched competition in the search market. Additionally, any new things you have been doing on the sales and marketing side to compete with the aggressiveness of SINA on its marketing on the sales side of it, the business in branded.

[Dr. Charles Zhang:]

In branded, okay. So first of all, on the search side, we have seen, after the launch of 3.0, Sogou 3.0, we have seen the traffic grow 20%. Also, on one hand, we are going to launch some marketing campaign as we did in 2005 and 2006, and now with a much better product. Also, online we have a network of websites, Sohu.com and other China websites to integrate the Sogou search intrinsically at a user level, at a registered user level, on every website pages of the Sohu site, Sohu websites, so that using that leverage of the Sohu websites to let users to readily use the search all over the Sohu websites. Also, to use the Sogou search engine to power the Sohu website so that to use the Sogou search engine for organizing Sohu news retrieval and delivery better. So this is the advantage we have as a portal over our competitors. Of course, there is also a very powerful Sogou technology-related product, which I just described, which is the Sogou Pinyin input method, which is getting extremely popular and it is actually a new direction for input method, and its input method is used anywhere, for when people are chatting and typing blogs and writing e-mails and writing Word documents, everywhere. So it is a very -- it needed the boost of the Sogou brand name. Some small mistake was made in our marketing of Sogou last year as the toolbar was considered to be intrusive, so that is why traffic suffered a little bit. Now the Sogou Pinyin input method is getting Sogou a very good brand name now. People really love it, so this will be another very powerful helping hand for the Sogou traffic. On the branded side --

[Carol Yu:]

Again, like what I said, how do we --

[Dr. Charles Zhang:]

Olympics and --

[Carol Yu:]

Yes, so it is how do we react to our competitors’ aggressive sales efforts. Again, it is something that is like the most important differentiating factor between ourselves and our competitors, and all of our competitors, is the Olympics opportunity that we are having right in front of us.

[Dr. Charles Zhang:]

Also, as I described, Sohu is now very technology and product focused, so that Sohu is much more innovative than our competitors, so that we are leading in the video content, which our competitor does not have, or does not have the technology to deliver the kind of content, so this will differentiate ourselves so that there will be more traffic and more users and also advertisers. Also, even in the blogs, Sohu Blog is very different. It is not only reading some journals written by users, but also it is really a personal space, so the Sohu Blogs user accumulation is much faster. That will get a lot of traffic to the blogs and to add registered users. And these users will, at the same time because the blogs are integrated so well with Sohu's different common channels, the blogs will bring a lot of new users to the different channels, like our business channel, our entertainment channel, and other channels. All of these are basically content marketing, with better content, better technology, so that -- actually, over the last few years, the technology focus now has come to its fruition, and shows up in all these Sohu content delivery. These are the, besides the Olympic opportunity, the technology-driven products, innovative products in blogs, interactive products and also in the video content are the powerful marketing tools marketing measure for users as well as for advertisers. Advertisers want to see the effect. Now, advertisers really want to look at the effectiveness of their advertising, so with traffic and the click-through increase and then they will continue to advertise with us.

[Nat Schindler:]

Charles, just to follow-up on that, have you increased your sales force size recently to get this message out?

[Dr. Charles Zhang:]

Well, on the sales side, no. It was basically gradually grow as -- it is really the PR and the marketing side to broadcast to the world about our new product, like we did in September at the Sohu Blog conference with 5,000 bloggers to attend and write articles, write journals about the event. This spring, we are going to launch some other content and product-related marketing. On the sales force side, no, we have not significantly increased the headcount.

[Nat Schindler:]

Okay. Thank you.

[Operator:]

We will go next now to William Bean at Deutsche Bank.

[William Bao Bean:]

Could you dig down a little bit deeper for me into the rich media and video? Maybe give us a sense of some numbers or metrics we should think about, like percentage of ad sales from those areas now and in the future?

[Dr. Charles Zhang:]

On the metrics, first of all, I can tell you about the traffic side. After we launched the B-Channel, basically the entertainment channel for video, and the S-Channel, we have now regularly every day we have over 1 million viewers per day, either broadcast or video on demand. That will add up to 30 million per month of viewers. So this page view is a high-quality page view because each view represents let’s say three or five minutes of viewing, much more valuable than the traditional text-based page. Within this -- before the video, there will be a 15-second TV like advertising. Also, on that video page, there will be surrounding text and some other. So as I said in the previous remarks, the video advertising has increased 150% quarter on quarter, and this rich media will -- now rich media appearing on other text-based pages, but you will see more and more of the 15-second TV commercials of advertising on our B-Channel and S-Channel.

[Carol Yu:]

William, on the dollar amount side, it is still off a very low base. We just want to give investors and analysts a sense of the trend that we are heading towards. Right now, it is still a relatively small amount, so when it gets to like say 10% of our total brand advertising revenue, I will report that, okay?

[William Bao Bean:]

Okay, and could you just talk a little bit about the regulatory risk? I think the government recently used the word purify and that kind of makes me nervous. Could you give some color there on your thoughts, especially on the user-generated side?

[Dr. Charles Zhang:]

Well, I think it has always -- well, you should not be terrified because it has been a gradual interactive process over the years. I think what the government is doing is right, because there are so many websites and so many individuals that now have the right to write anything. I think the company should be responsible. A corporate citizen has a responsibility to make sure the youngsters do not get exposed to problematic, pornographic content. That is one area where it is really for -- I think on the political side, it is not much area that we cannot -- so we already have a very good mechanism, have an interactive process with the corresponding government agencies to make sure that our sites are good and responsible.

[William Bao Bean:]

Great, so no problem so far, then, great. Then, just last quick --

[Dr. Charles Zhang:]

I think what the government is doing is right. I think it needs some cleaning.

[William Bao Bean:]

Then just the last thing, a clarification on Sogou 3.0. You said up 20% since launch. Is that month on month or year on year?

[Dr. Charles Zhang:]

It is only the first month.

[Carol Yu:]

Month on month.

[Dr. Charles Zhang:]

Yes, the first month.

[William Bao Bean:]

Okay, thanks.

[Dr. Charles Zhang:]

We have also seen the Sogou-related products, not only Sogou version 3.0 is a webpage search but based on that search, there is also some other progress on the Sogou-related products, as I mentioned the Pinyin input method and also we have seen the Sogou maps also gaining additional traffic. Also, we have seen -- you remember, the Sogou map is really the company we acquired two years ago, the Go to Map, and they really integrated the Sogou technology to make the Go to Map now become a consumer-based map service. Also, we have the Sogou-related message boards are also gaining much more traffic. Also, the Sogou Music Box that is well-integrated into the blogs, and others. So there is a variety of Sogou-related products.

[William Bao Bean:]

Thanks a lot. I’ve taken enough time. Congratulations again. Thanks, bye.

[Operator:]

We will go next now to Lin Chi with Lehman Brothers.

[Lin Chi:]

Hi, thanks for taking my questions. A question on search. Your Q1 guidance seems to suggest that search revenue probably have to decline Q-on-Q, but Q-on-Q and year on year. I just wonder how should we look at the monetization of your search effort? I should also mention, you have changed the revenue sharing arrangement with the -- are you seeing that as a defective measure? What other measures are you taking to promote the monetization side of Sogou? Thank you.

[Dr. Charles Zhang:]

I think, as I said, it is because the traffic is still small compared to our major competitor, so the first and most important thing now is to increase traffic, to get traffic, and then monetization later. So it takes, for Sogou’s technology to mature, we use three years. With version 1.0, 2.0 and now 2.5 and now 3.0, and finally the market, we had a blind test and the market is telling that finally Sogou 3.0 actually is better than our main competitor by the blind test. So now, we still view 2007 as the year of traffic growth, because with a small traffic, then the monetization really does not, it is not -- it is very hard. For the monetization side, we now re-write our software that manages our channels. Also, we are reorganizing the department to build a more effective organization. So 2007, we still see a year of traffic growth and not much on the monetization side as we had expected before.

[Lin Chi:]

Okay, understood. As for Sogou, the brand building, and besides that Sogou Pinyin and other related services, would you carry out anything nationwide, a brand-building campaign, et cetera, to build up the brand name?

[Dr. Charles Zhang:]

Yes, previously we had the Sogou mountain climbing activity in 2005 and in 2006, we had the Sogou Supergirl Contest. In 2007, we will have the 2007 Supergirl contest as well. Also, other marketing campaigns -- as we announce, you will see it. In 2005 and 2006, it was basically much more towards the brand building side, but in 2007, you will see the marketing will be integrated with the product more tightly to really drive traffic. As I mentioned, in 2006, the Sogou traffic suffered some set-backs because the toolbar was considered to be intrusive client-end software that allowed virus killing -- I mean, it was considered to be spam, which the strategy was some problem. Now we terminated that strategy and continually think in terms of the users’ experience.

[Lin Chi:]

Great, one last question, if I may. For the non-advertising revenue, it seems like we are expecting a weak quarter for Q1. Can you comment a little bit on in which particular business line are you seeing the weakest performance? Is it online game, SMS, or MMS, et cetera?

[Carol Yu:]

We talked about the wireless side. The bulk of the decrease on a quarter-to-quarter basis comes from the wireless side. We expect the wireless to be lower in Q1, go further down from the existing Q4 level. Also, we expect games, because we have now terminated one of our two online games back in Q4, towards the end of Q4, which is Knight Online, due to the maturity of that game. Also, we turned Blade Online from a time-charged basis to an item-charged basis starting the end of December. So those two impacts would also draw online games revenue to be lower as well. We expect the online games side would probably be, the impact of that would between $0.5 million, around that. The rest would be relating to wireless.

[Lin Chi:]

Okay, that is very helpful. Thank you.

[Carol Yu:]

Thank you.

[Operator:]

We will go next now to Richard Ji at Morgan Stanley.

[Richard Ji:]

Hi, Charles and Carol. I have some questions. First is regarding advertising rate increase. When do we expect the next round of advertising rate increase and by what magnitude?

[Carol Yu:]

We are now processing our pricing strategy going forward, and again, for us, the bulk, the key revenue driver would be what we have said to draw more budget allocation and to expand our advertiser base, rather than price increase. But we do expect to have another round of price increase probably early second quarter. The rate would be similar to what we are seeing in past years. It would be 15%, 20%.

[Richard Ji:]

The second question regarding your mobile service. When do you think the mobile service operation will stabilize?

[Carol Yu:]

I really don’t know, Richard. You will have to ask the MII when they will stop coming out with new and negative policies.

[Richard Ji:]

Or the operators.

[Carol Yu:]

Yes, so it is -- I mean, we have been preaching to the street that this is a very volatile business, subject to regulatory risk and unfortunately, we are correct.

[Richard Ji:]

Okay, thank you.

[Carol Yu:]

Thanks.

[Operator:]

At this time, Brandi, I would like to turn the conference back over to you.

[Brandi Piacente:]

Great. We would like to thank everyone for participating in today’s call. Please feel free to contact us with any additional questions that you may have. Thank you very much.

[Carol Yu:]

Thank you.

[Operator:]

Again, that will conclude our conference. Thank you all for joining us and we wish you all a great day. Good-bye.