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Youku Tudou, Inc. (NYSE:YOKU)

Q3 2012 Earnings Call

November 30, 2012 10:00 AM ET

Executives

Ryan Cheung - Corporate Finance Director

Victor Koo - Chairman and CEO

Dele Liu - President

Michael Xu - Chief Financial Officer, SVP

Analysts

Alicia Yap - Barclays Capital

Muzhi Li - Citigroup

Jin Yoon - Nomura Holdings

Gene Munster - Piper Jaffray

Piyush Mubayi - Goldman Sachs

Tian Hou - T. H. Capital

Ming Zhao - 86Research

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Youku Tudou Q3 2012 earnings conference call. (Operator Instructions). I must advise you that this conference is being recorded today, Friday, 30 November, 2012.

I'd now like to hand the conference over to your first speaker today, Mr. Mr. Ryan Cheung, Youku Corporate Finance Director. Thank you, sir, please go ahead.

Ryan Cheung

Thank you, operator, and welcome to our third quarter 2012 earnings conference call. Let me introduce the management team on the call today. They are Chairman and CEO, Victor Koo; our Board Director and President, Dele Liu; and Michael Xu, our Chief Financial Officer and Senior Vice President.

For today's agenda, Victor will kick off with an overview of our performance in Q2, key updates on sales and outlook. Dele will discuss about our target performance and contact strategy and Michael will discuss the second quarter financials and then we'll open the floor for questions.

As a reminder, the financial results and webcast of this conference call are all available at the Investor Relations section of the Youku Tudou website. A replay of the call will be available on our website in a few hours.

I refer you to our Safe Harbor Statement in our earnings press release which applies to this call as we will make forward-looking statements. Our earnings press release and this call is include discussion of certain unaudited non-GAAP financial measures, our press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures and is available on our IR website at ir.yoku.com.

Before we continue, I would like to inform you that on August 23rd 2012, the company and Tudou's Holdings Limited, announced the completion of the merger between Youku and Tudou. Following the completion of the merger, Youku's name was changed from Youku, Inc. to Youku Tudou, Inc. And Tudou's financial results were consolidated in Tudou company from the date of the completion of the merger.

Due to the fact that the sales activities of Youku and Tudou were separately operated until the end of the third quarter 2012, the financial results of Youku and Tudou are separately disclosed to reflect the Company's actual operational results and performance.

In addition, comparison of Tudou's financial results with previous periods cannot be provided because the cut-off date of previous periods would not reflect a consistent basis of comparison. From the fourth quarter 2012 onwards, consolidated financials of Youku Tudou for the full periods will only be presented on a consolidated basis.

Finally, please note that unless otherwise stated all figures mentioned during this conference call are in renminbi.

Let me now turn the call over to our Chairman and CEO, Victor Koo, please proceed.

Victor Koo

Thank you, Ryan. Good morning, and good evening everyone. Thank you for joining us. I'm pleased with our solid financial and operational performance in the third quarter the overall integration process with Tudou. Youku's standalone revenue growth exceeded the high end of our guidance. Despite challenging macro economic conditions, and diversion of our sales management resources, due to the merger with Tudou.

On the traffic front we are seeing robust growth in our traffic, especially from mobile devices. I'm also pleased to report that Youku standalone is profitable at the operational level, for the first time our company's history.

Let me first share some third quarter financial highlights with you. Youku's standalone revenue in the third quarter has achieved 84% year-on-year growth, exceeding the high-end of our previously provided guidance. The solid growth again shows how we continue to broaden and deepen our relationship with advertisers, coupled with Youku's strengthening monetization capability, by increase of sale-through rate and the effective CPM price.

New advertising clients came on board in the third quarter from sectors such as beverages, pharmaceuticals and retail and we see increasing number of local advertisers in the pipeline to shift their budget to online video. Pointing to our unrivaled ability of our sales team's execution and undisputed leadership, we are well-positioned to capture growing advertising budget to online video sector. More importantly, Youku has achieved profitability at the operational level for the first time in our company's history with a non-GAAP profit of RMB25.3 million. This is an important milestone for our company.

Youku's non-GAAP profitability is driven by increasing budget allocations from brand advertising due to our platform's proven advertising effectiveness and improving cost structure, particularly bandwidth and personnel related expenses. For example we have already seen bandwidth cost savings in the third quarter despite strong traffic growth, particularly from mobile devices which was largely contributed by the optimization of bandwidth infrastructure and the launch of our flash p2p technology platform.

Only about 3 months ago, we have also successfully completed the merger with Tudou on August 23rd. The combination of the number 1 and number 2 online video companies in China, is a milestone development for the future of China's internet industry and will allow us to create a scalable online video echo system, that will provide unrivaled value for advertising clients, content partners and internet users. The combined entity Youku Tudou Inc. represents a dominant leader in online video sector in China with the largest user base, most comprehensive content library, most advanced bandwidth infrastructure and most effective, monetization capability.

This merger, will further accelerate our virtuous cycle, speed up online video industry rationalization and increase our scalability, we believe that the result of this combination would maximize our shareholder value in the long-term. The management team is working hard on the integration with Tudou and I'm pleased with the overall progress and decisive actions made.

As we have mentioned in previous calls, Youku Tudou is continuing to develop Youku and Tudou as separate distinct platforms sharing a unified advertising client support system and integrated sales team. After much careful planning, and [general] training and extensive outreach to advertising partners, we have reorganized Youku and Tudou's sales operations, in order to create long term advertising value, so that the combined entity could maximize our revenue scale.

Decisive moves have been made to unlock these value, but short-term and temporary fluctuations are anticipated during this transition period. To give you a sense of this, reorganization has been made in our sales function and then we have reshuffled advertising accounts between Youku and Tudou's sales teams. Historically, Youku allocated it's advertiser accounts by industry, while Tudou allocated by region only, post merger closing, sales team are now combined and our advertising accounts were reallocated by industry segment based on sales people's performance and capabilities, in addition, both company's advertising delivery systems have been integrated and we reconfigured our advertising products for the two platforms.

The enhanced features of our ad products would require sufficient understanding from our sales force, advertisers, and agencies. To facilitate this we have held multiple training sessions, internally and road show events externally. These changes in sales operations have affected our sales progress to a certain extent as this requires time for them to understand the effectiveness and efficiency of our new advertising solutions.

Also with an intention to improve Tudou's user experience, we have eliminated selective ad formats for example the [frame wraparound ad] of Tudou's video players which was about 20% of Tudou's revenue. In addition, we have changed Tudou's advertiser mix, with the purpose to strengthen its overall advertising environment. As a result of these actions taken, the sale through rate for Tudou has been impacted in the short term, however we have already seen actions taken increased Tudou's appeal to advertisers as well as strengthening Tudou's monetization capability with quality brand advertisers starting to engage back with Tudou in November.

We are pleased that the overall sales integration is well underway and while we're excited by Tudou's monetization opportunities ahead we also understand well the challenges that any integration of this scale inevitably bring. But I also want to make it clear, that we are implementing the right actions and heading towards the right direction to lift those monetization capabilities and to scale economics.

The advertising market in China is big, and is still growing at a considerable pace, while online video is emerging as a mainstream advertising solution, it still represents a relatively small portion of advertising budget in China. The combined platform has now transformed into a unique one-stop advertising solution for brand advertisers, with a combined reach of more than 310 million on a weekly basis and over 400 million on a monthly basis covering 80% of Chinese online video audience, in terms of user time spent, Youku Tudou is ranked number 2 of all Chinese website in our reach for the two platforms are consistently ranked to top five web properties in China, according to iResearch.

The unparalleled reach of our platforms is comparable to mainstream TV stations in China, but more cost effective more, more engaging and more viral, also based on site-wide traffic audit by iResearch, the overlap of daily and weekly unique visitors of the two websites is only 14% and 18% respectively. Our advertising offering de-duplicates user base which decreases advertising wastage and maximizes efficiency and effectiveness in ad buys. This would also lead to increased opportunity cost for advertisers to place their budget to our peers due to insufficient reach and increase advertising wastage, all these incremental advertising benefits will be a focal point of communication from our sales team to advertising partners and as such we expect to see increased contributions of advertising dollars to Youku Tudou.

I would now turn the call over to Dele to go through our traffic performance and content strategy.

Dele Liu

Thank you, Victor. Hello, everyone. Let me first, briefly talk about the traffic scale for the two platforms separately. Youku is now not only the leader in online video across all metrics but also one of the largest internet properties in China. The growth in our entire traffic was very solid in the third quarter with total videos viewed increased 16% quarter-over-quarter, to over 24 billion according to our internal traffic data.

We're also encouraged by Tudou's traffic growth, as a result of the optimization in its operation, post the completion of the transaction. According to our recent internal traffic data, Tudou's daily unique visitors were over 38 million within its URL in addition Tudou has 8 million daily unique visitors watching Tudou videos outside of its URL. Average daily videos viewed were 135 million in November which grew from an average of 114 million in October. According to recent iResearch data, Tudou's daily and weekly number of unique visitors ranked solid number 2, higher than all other website who claim to be number 2. Tudou has an unparalleled UGC assets and Youku's content library now open to Tudou, Tudou will have an increasingly stronger position. After the launch of our original Tudou program, Tudou is clearly among the fastest growing Video websites in China.

We are extremely excited about the progress that we've made in Mobile internet. There's tremendous potential of internet users in China being tapped because smartphones increasingly commoditized. These mobile devices are now penetrating into lower tier cities where penetration of PCs is low. Smartphones and tablets are also helping people in the first tier and second tier cities use their fragmented time to watch more videos.

According to our internal tracking, Youku's daily unique visitors from mobile devices between apps and web in the latest week have already reached – exceeded 12 million, up from 1.4 million in Q4 2011. Now over 20% of our unique visitors and videos viewed are coming from mobile devices and a growing momentum will persist as mobile devices are increasingly penetrating in China. While some of our peers have already started to place commercials on their mobile traffic we still haven't launched any monetization initiatives on this front. So the mobile traffic comes as pure cost to our P&L, we're planning move monetize this traffic some time in 2013 and we believe the growing scale in mobile traffic will significantly improve our content economics, we're also making certain change in both platforms to better reflect each brand's characteristics and personalities, through original content community products and user interface.

Right after the completion of the merger we have kicked off, original Tudou differentiation campaigns revamping to Tudou's homepage and introducing new social features and original programming to Tudou. Original Tudou will further distinguish between the Youku and Tudou brands operated under a dual platform strategy. A new social product on Tudou - (Inaudible) makes it easier for viewers to discuss videos in real time as we see Tudou's users are more socially interactive. Three channels of Tudou's specific content were significantly strengthened, Tudou Original, Music and Animation. Tudou also announced three new self-produced programs under its youth-focused Tudou Original brand.

The first of these, Yif Magic, a weekly show premiered on Tudou in conjunction with the re-ramped website. This program has already received tremendous traction from our viewers, Tudou Surfing and Tudou Grooving series would present regular magazine style updates on global pop music, celebrities and the entertainment industry. All these efforts are to reflect the brand of Tudou which is young fashion forward and edgy.

Youku Original, would remain in the same direction to preserve the taste and styles we have built throughout the years, Legendary Me, an online talent show which was debuted in May is entering its second season with the goal of promoting grass roots talent from China's creative commons.

Other self-produced talk-shows such as Morning Call and Friend also received positive receptions and accumulatively generated 100 million videos viewed since premier. All these initiatives are to built up our self-produced content franchises going forward and balance of our content offerings across different sources of content. We are confident that we can leverage our unparalleled distribution scale to move up the video content value chain by developing and building proprietary content brand franchises.

In regards to user generated content, the addition of Tudou's content library would facilitate the combined company to have their largest user generated content library in China and we would have a stronger position - even stronger position in social video function, among all vide companies. As you can see how efforts are made in building up, a one-stop shop for users to watch and video content, Youku Tudou would continue to develop its paid services, in early November Youku Tudous signed agreements with Sony pictures to bring more than 300 new and classic Sony Picture titles to the Youku premium platform, coupled with the [collaboration] previously signed with Warner Brothers 20th Century Fox, Disney, Paramount, NBC, Universal, DreamWorks and Lions Gate, now all major Hollywood studios have licensed their content to Youku Tudou.

To conclude the Youku Tudou combination has lead online video in China into a new phase and our goal remains the same, to become the leading video source on any internet enabled devices in China. We have just completed the transaction not long ago, in late August, and this upcoming fourth quarter will be the first full quarter the management merged and started to reorganize and optimize the combined entities operations.

Our integration priority is to focus on maximizing Youku Tudou's traffic brands and revenue. While we are excited by the opportunities ahead of us, we did not underestimate the challenges that may arise from these unprecedented large scale merger in China's internet industry. We did anticipate short-term fluctuations that arising from our decisive moves to improve user experience and advertising environment in order to unlock the intrinsic value of Tudou, however, I believe we will cross-over the most difficult terrain soon, this is not the first time our management has gone through many challenges, and now we have successfully turned Youku into profitability at the operational level. Our experience, focus, and capabilities in online videos, makes us very confident to create shareholder value over the long-term.

With that I would like to pass the floor to Michael our CFO, to go over the financial results with you.

Michael Xu

Thank you, Dele. Now let's look at financial highlights for the quarter. The amount mentioned here are in RMB unless otherwise noted.

For the third quarter, consolidated net revenue were RMB502.2 million of which Youku's net revenue were RMB484 million in the third quarter of 2012 representing a 84% increase from the same period in 2011. The increase exceeds the high end of the revenue guidance previously announced by Youku, Inc. The growth was primarily attributable to the increased average spending per advertiser from RMB1 million to RMB1.7 million, and increased number of advertisers from 296 to 316, representing an increase of 70% and 7% respectively from the corresponding period in 2011.

Consolidated bandwidth costs as a component of cost of revenues were RMB136.6 million of which Youku's bandwidth costs were RMB112.9 million in the third quarter of 2012, representing 23% of Youku's net revenues, as compared to 35% in the corresponding period in 2011.

Consolidated content costs as a component of cost of revenues were RMB182.0 million in the third quarter of 2012, of which Youku's content costs as a component of cost of revenues were RMB136.4 million in the third quarter of 2012, representing 28% of Youku's net revenues, as compared to 26% in the third quarter of 2011. The increase was primarily due to content price increase during 2011, which we amortized using accelerated method, broadening of our content portfolio and increase in salaries and benefits for our content team with [headcount] increased by 91% year-on-year.

Consolidated in-house content production cost was RMB 9.5 million in the third quarter of 2012, of which Youku's in-house content production cost was RMB8 million in the third quarter of 2012, as compared to RMB8.6 million in the corresponding period in 2011. Consolidated gross profit was RMB125.4 million of which Youku's gross profit was RMB181.4 million an increase of 168% compared to RMB67.8 million for the same period in 2011.

Consolidated non-GAAP gross profit, was RMB147.2 million of which Youku's non-GAAP gross profit, was RMB185 million in the third quarter of 2012, an increase of 167% compared to RMB69.2 million in the same period in 2011 due to strong operating leverage.

Consolidated operating expenses were RMB227.6 million in the third quarter of 2012, of which Youku's operating expenses were RMB198.4 million in the third quarter of 2012 as compared to RMB120 million in the same period in 2011. Consolidated non-GAAP operating expenses, were RMB195.7 million of which Youku's non-GAAP operating expenses were RMB168.2 million in the third quarter of 2012, an increase of 64% compared to RMB102.3 million in the third quarter of 2011. The increase was primarily due to increase in sales and marketing expenses, product development expenses and general and administrative expenses as a result of the substantial growth of our business. Detailed discussion of each component of operating expenses is as follows:

Consolidated sales and marketing expenses were RMB109.3 million in the third quarter of 2012, of which Youku's sales and marketing expenses were RMB93.3 million in the third quarter, as compared to RMB74.2 million in the same period in 2011 of which Youku's non-GAAP sales and marketing expenses were RMB86.1 million in the third quarter of 2012, an increase of 26% compared to RMB68.2 million in the same period in 2011. This increase was primarily due to increase in marketing expenses and commission expenses paid to our sales force in line with our revenue growth.

Consolidated product development expenses were RMB45 million in the third quarter of 2012, of which Youku's product development expenses were RMB38 million in the third quarter of 2012 as compared with 2011. Consolidated non-GAAP product development expenses was RMB38.1 million in the third quarter of 2012 of which Youku's non-GAAP product development expenses were RMB32 million in the third quarter of 2012, an increase of 70% compared with RMB19 million in the corresponding period in 2011. This increase was primarily due to increases in salaries and benefits for our product development personnel in mobile, in search, in social and the paid services which the total [headcount] increased by 65% year-on-year.

Consolidated general and administrative expenses were RMB73.4 million in the third quarter of 2012, of which Youku's portion accounted for RMB67 million in the third quarter of 2012, as compared to RMB22 million in the corresponding period in 2011. Consolidated non-GAAP G&A expenses, were RMB57 million in the third quarter of 2012, of which Youku's were RMB51 million in the third quarter of 2012 representing an increase of 225% compared to RMB15.6 million in the same period in 2011. The increase was primarily due to an increase in personnel related expenses, with related [high count] increase by 40% year-on-year one-time tax charges.

Consolidated net loss was RMB92 million of which Youku's net loss was RMB92 million as compared to a net loss of RMB48 million for the same period in 2011.This increase was primarily due to Youku as the holding company consolidated Tudou's incurred loss after the completion of the merger.

Consolidated non-GAAP net loss was RMB37.7 million in the third quarter of 2012 of which Youku's non-GAAP net profit was RMB25 million in the third quarter of 2012, as compared to the non-GAAP net loss of RMB28 million in the third quarter of 2011. The change to profitability at the operational level of Youku standalone basis was due to a strong revenue growth and a cost savings from bandwidth and personnel-related expenses.

Turning to the cash flow items, as of September 30, 2012 consolidated cash, cash equivalents, restricted cash and short-term investments totaled RMB3.8 billion. Consolidated acquisition of the intangible assets for the third quarter of 2012 was RMB148.9 million of which Youku's acquisition of intangible assets for the third quarter of 2012 was RMB122.6 million as compared to RMB190 million for the corresponding period in 2011.

Corresponding related to consolidated financial commitment to [accounting] by the end of third quarter was RMB391 million. By the way the consolidated non-GAAP adjusted EBITDA loss was RMB26.8 million in the third quarter of 2012 of which Youku's non-GAAP adjusted EBITDA profit was RMB34 million in the third quarter of 2012 as compared to non-GAAP adjusted EBITDA loss of RMB22 million in the same period in 2011.

So looking out to the fourth quarter of 2012, we expect net revenue for Youku Tudou will be between RMB600 million and RMB630 million, of which RMB560 million to RMB585 million is attributable to our advertising services.

Before the start of Q&A session, I would like to take a few more minutes to talk about our Q4 guidance. Based on 2012 rebate range - rebate rates which you can easily figure out from both company's earnings release for Q1 and Q2. The both advertising revenue for Q4 corresponding to the high-end of our guidance, should be around RMB740 million to RMB720 million, representing 40% year-to-year growth on a pro forma basis. Though we can no longer accurately account for exact amount attributable to Youku or Tudou, because of most of sales team accounts are reshuffled and a single ad contract might be delivered on both platform. We can still make a ballpark estimate, by looking at performance of a small part of Original Tudou's sales team.

This team's personnel haven't changed much since August 23rd, the team can only sell Tudou inventories and their accounts, it's the team covers accounts for a minor portion of Tudou's pre-merger revenue. Based on what we have observed so far on this team, we estimate Original Tudou's sales team, may generate roughly RMB180 million to RMB200 million gross ad revenue in Q4. Youku's team contribute roughly RMB540 million to RMB520 million gross ad revenue in Q4. With these numbers Tudou's year-to-year growth in gross ad revenue will be around 9% and Youku will be around 55%.

While net ad revenue gross for Tudou will be around 5% and Youku will be around 44%, my interpretation to this data are, Tudou is recovering, though we hope the pace of recovery faster if we reach the high end of the guidance, Tudou's gross ad revenue should be either at par or slightly higher than its historical ad revenue peak which is our RMB189 million in Q2 2012. The demand for online video though affect - the second point I want to make is, the demand for online video though affected by economic headwind is still relatively healthy the growth of Youku's gross advertising revenue on a standalone basis, if reaching high end of guidance should be still about 50%, though compared with Q2's 19% this is a significant deceleration.

Now we'll open to the floor to questions. Operator, please go ahead.

Question-and-Answer Session

(Operator Instructions) Your first question comes from the line of Dick Wei, please ask your question. Your next question comes from the line of Alicia Yap from Barclays. Please ask your question.

Alicia Yap - Barclays Capital

Hi, good morning, everyone. Thanks for taking my questions. My first question is that is that possible in order to help us get a better sense on the consolidated basis, would you be able to provide us the Tudou nine month standalone revenues, if you have not combined with your financials?

Michael Xu

Well, I think it will be pretty difficult. Because for the Q3, we can only from accounting perspective, we can only do – we can only account for the revenue generated from August 23 to September 30, so basically what – nine months cumulative revenue – you can see will be – actually will be just 8 months, little bit less than 8 months. So I think the simplest way is to using that one month revenue we've already booked as a run rate, and then multiplied it by 2.5 you'll pretty much get Q3 revenue for Tudou on a – if Tudou standalone as independent company.

Alicia Yap - Barclays Capital

I see, that's helpful. And second question is, I understand it might be still early but according to your recent discussion with advertisers, can you share with us what are the current sentiment and the tone for the potential budget range for next year? And on a consolidated basis, should be expect the company to achieve breakeven or profitability next year?

Dele Liu

Thank you, Alicia. I think overall if we look at the results of all the Chinese internet industry players, on the advertising side, Q4 is relatively modest or difficult for a lot of players, but looking forward in terms of 2003, especially with the change in government leadership, as well as what we see on the macroeconomic environment we are cautiously optimistic about our next year. Especially what we're seeing is from the local account side, while most of the clients we have right now is on the – international as well as IT and auto industry, we're seeing more and more demand as online video becoming a more mainstream media.

And as the leading advertisers want each industry is basically adopting online video and increasing their average revenue per client, a lot of the local clients are showing increased interest. And this actually really corresponds to our overall goal to raise the utilization in terms of second tier city inventory. While we're seeing a lot of demand from the first tier city and price, I guess, [power] is actually quite strong for first tier cities I think for both Youku Tudou this considerable amount of room to grow from a second third tier city standpoint and this is where we see the basis for the growth for 2013.

Alicia Yap - Barclays Capital

I see and then if I may, one last question, is that – when you start to monetize your mobile device next year, will you sell separately to advertiser or will you see, will we see the same ads, for the same episode for example regardless of the PC or mobile devices or will you sell it separately according to maybe the local regions where the mobile device coming from.

Victor Koo

Well I think the solutions we provide on the mobile side will depend on our clients' requirements. We have certain fast moving consumer goods clients that wants the broadest reach for example, food and beverages and HVA category, that are interested in penetrating to first, second, third tier cities, and the ability to expand the reach beyond PC is actually highly attractive for them. On the other hand with also other clients are on the premium side who is looking to target, for example IOS devices like iPad or the high-end Android devices as well, and we will be able to provide those kinds of solutions for them.

In addition, just like our PC solutions, to an extent that clients want to [pass] it on geographical cities we should be able to deliver those kinds of solutions to them as well. So whether from a geographical standpoint from a content standpoint as well as from a demographic standpoint we'll be able to provide separate solutions for our clients across the Youku Tudou platform.

Alicia Yap - Barclays Capital

I see, great. Thank you. I will get back to the queue.

Operator

Your next question comes from the line of Muzhi Li from Citigroup. Please ask your question.

Muzhi Li - Citigroup

Hi, good morning, thanks for taking my questions. I want to follow-up with the mobile monetizations, do you see currently as of the traffic - do you see the mobile cannibalizations, and also when you start to monetize the mobile traffic would you be selling at a different price schemes or you're going to charge on the same across the board? Thank you.

Dele Liu

I will answer the question this way, from a user standpoint, you probably see three things happening, one is certain uses that are coming on mobile that do not have PC. Then you have existing PC users extending their time amount of time they watch on online video because they are in the world of multiple screens. But of course there's a portion of users that switching part of their time from PC to mobile as well, so that from user side that's three different aspects.

Now from the advertising side what we anticipate is again based on what the different categories of advertising is. For those advertisers that are looking for nationwide reach, the ability to increase the current reach of Youku Tudou on weekly basis of over 310 million and over 400 million on a monthly basis to a much wider scale makes the combined platform a lot more attractive to both international and local clients across the board as you go to a wider reach that gets closer and closer to television. But on the same time I think for the high-end devices actually we have a much better ability to segment your users because on PCs basically just on geographical basis but on mobiles can actually segment by on a device basis where you can actually target a high-end devices which we've actually had a lot of queries as well as interest from the certain [HBA] and certain premium brands. So for that aspect we think that we'll be able to charge a premium and that's what we intend to do. But from the broad base standpoint for the widest reach we'll probably charge similar rates as we do now.

Victor Koo

Also in terms of traffic we think we anticipate our PC traffic will continue to grow. PC [communications] is also growing in China. In addition, some of the small website are actually getting more and more marginalized, actually given out some of their traffic to major players, particularly those pirated website are now being less and less popular given the government's policy to reinforce the copyright legislations.

Muzhi Li - Citigroup

I see, thank you very much. And the next question, can you provide some color on the traffic please, between the 3G and WiFi to access your mobile traffic?

Dele Liu

You asked a very good question. Because 3G cost is still relatively high for users, what we are seeing is that more than half of the users are using a WiFi, but at the same time we also starting to see operators offering packages that are providing cap grades on 3G in certain cities, and as that grows we will probably see more and more 3G penetration or a proportion of the overall mobile traffic.

Muzhi Li - Citigroup

Thank you very much. I'll jump back to the queue.

Operator

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

Jin Yoon - Nomura Holdings

Hey, good morning, everyone. Just on the Tudou business, it looks like the business has decelerated pretty significantly since the announcement of the merger. Now do we expect is that largely the function of the fact that the execution of combining the sales team and we should expect once that is fully integrated that we should see a re-acceleration in that business, or it's just a function of demand for that inventory on the Tudou side becoming just significantly a lot less. So could you just talk about, give us some color on that.

And second of all, on the mobile monetization - is it - should we expect anything different than on the PC where we should have a significant pre-rule and a post-rule or is there anything else to it on the mobile monetization aspects? I'll stop there, thanks guys.

Victor Koo

Thanks, let me first address the Tudou integration. I think we do anticipate a reacceleration on our revenue growth on that side. As you can anticipate a merger of the scale we are really wanted to make quick and decisive actions to make sure that we can get the sales team integration together as soon as possible. So since August 23 we've been able to merge two teams together. And restructured the team based on industry level and that will actually make sure that the sales team are lot more specialized in terms of how they can provide the different new solutions that we're providing to our advertisers and agencies.

And we've also made a lot of moves that impacts short-term for example, improved user experience and improving advertising environment that impact the short-term revenue of Tudou, but we'll actually be much better off in terms of ability to monetize it through and video advertisers rather than our picture advertising that may get you short term revenue, but actually impacts your advertising environment and your selection of our advertising. We also have selectively decided not to take advertisers from certain sectors low end e-commerce for example, which also has gotten good reviews from a lot of the bidding advertisers or brand advertisers as well.

The good sign we are seeing especially now that the advertising platform has been integrated and we've got a very good reception in the road show so far and big clients for example General Motors for example Yum or KFC and Pizza Hut, (inaudible) have also -- have all tried across different industry of the combined platform solutions across Youku Tudou and have already shown very positive results. And that is why we're seeing even in November the sell-through rate of Tudou reaccelerating already and we think that as on a combined basis on its own will see more and more growth.

And although regional programming and the content solutions we're providing on Tudou also recently launched, and since the media database is now well on its way of integration where a lot of the media [collaboration] content at Youku can now serviced in Tudou by the end of the year we anticipate the media database to be both the long form content to be integrated that will also create a lot more long form inventory for Tudou, which also is very, very compelling for advertisers.

I think in summary, we're making decisive of action both from a consolidation of the sales force from a front end both in the client basis and the agency basis, from the backend in terms of the advertising platform integration in terms of revamping the Tudou website from front page all the way down to different channels in terms of improving its user experience, eliminating certain advertising formats, eliminating certain brand advertisers will help to form very strong basis for the future.

The analogy I want to put is that we're really this is almost like a race where these companies are moving a very, very fast pace like F1 car stopping for pit stop to change its tires and re-gas and then it will reaccelerate again to really capitalize is full potential. Like Dele pointed out the traffic of Tudou is still strong, it is still the solid number two player and growing and this inventory with experience sales team will generate better and better results in the quarters to come.

I think on the mobile side in terms of monetization, we feel quite positive in the old role stand study expand the reach of the entire platform for both Youku and Tudou. And as Dele pointed out will also really help out and the overall content economics of the entire platform. Because again with the same or similar content price will be able to leverage a much bigger traffic base that can be monetized. And since we have been able to consolidated the advertising platform and also de-duplicate the reach across the two platforms, what that means is that we can reach 80% and increasingly as that base of PC and mobile increases that will also give us more ability to reach a wider audience as well as deliver the frequency needed for our clients. And that becomes a much more strong complementary solution to television.

As I've mentioned before, as we are moving more to second and third tier cities, where we are seeing more and more demand, where arguably two thirds of our inventory is while our utilization on the first tier cities is already higher we have pricing power on that. As the second, third tire city utilization goes up and because the ability to de-duplicate and increase the ROI for our client, our ability to have pricing power as our utilization goes up in these area will also be strong for both Youku and Tudou. So I hope that answers your questions.

Jin Yoon - Nomura Holdings

Great, hey, thanks guys.

Operator

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

Gene Munster - Piper Jaffray

Hey good morning, I guess then some ways it's follow up with the previous questions here. But as we look further down the road, as the two companies become one should we generally think about these businesses is tracking measurably ahead of the broader advertising growth just because the video segment? In other words just how should we think about the overall growth of the businesses as we try to model this out longer term, I know you're not giving guidance but sort of guidelines to it's going to trend more toward some of the other online advertising growth or should be kind of step function above that? Thanks.

Victor Koo

Well, thanks Gene, I think as the dominant platform before as Youku I think it's very clear that Youku, Tudou becomes even more dominant on the online video space. If Youku on its own can reach just over 50% of the online video audience before the merger now as a combined company we can reach 80% reach of the online video as because the fact that we can de-duplicate and reduce the wastage for advertisers when they as they want to achieve their region frequency goals, and this something that Youku Tudou can do as a combined platform which other peers cannot do.

And as you can imagine the other 20% reach the wastage of that would be much higher, as such people understand as we go through these communication sessions across different cities in China, both internally and externally that would mean that as a combined basis we have much more compelling solution.

Now besides the mid-year corporation content that contributes say two thirds of our traffic, they're still different content marketing solutions that we can now offer to especially the local clients that do this a lot on the satellite television station and since the two platforms are positioned one as more mainstream and inspiring, and the other one as more young and edgy the content we're offering tough for us to relay that in the call but if you see any of those videos say you'll find that to be entirely different content marketing solution that are target towards very different audience based on what the profile or target consumer profile of the different brand that we work with, which will also give us the ability to address a lot more brands both international and local.

So that's why we see that merger is very compelling both from a user standpoint and from a revenue standpoint, we're just going through this transition period and we'll reaccelerate our revenue and the potential is high.

Gene Munster - Piper Jaffray

And Victor what do you see the transition period - should we think that this is kind of a transition year or is that going to be more or like two quarters?

Victor Koo

Well, our goal is really about Chinese New Year, tomorrow is actually first 100 days and we've just sent out an internal note to the company and I was doing the summary last night and I realized how much progress we've made in the last 100 days. And while we have a very clear goals what to do in the next 100 days. I think on the revenue side that's what the primary focus on I think to the next period because the first period is really focusing on the product technology and the content and since the sales team are now doing a lot of communication across the country I think we'll start to see improvement quite soon.

Gene Munster - Piper Jaffray

Great, thank you.

Operator

Your next question comes from the line of Piyush Mubayi from Goldman Sachs. Please ask your question.

Piyush Mubayi - Goldman Sachs

Good morning, thank you for taking my question. I've got a few questions, first you talked about the 20% mobile traffic is that just to confirm that Youku plus Tudou or is it one of the or the other? And also is that average for the third quarter or a spot number as we exited the third quarter?

The second is I - you talked about competition monetizing mobile and you talked about yourself not doing it yet what is holding you back and when should we expect you to rollout pre-roll on mobiles? And third just to clarify does the mobile include tablets? Thank you?

Victor Koo

The mobile does include tablets. First of all the strategy for Youku and Tudou on the mobile side has historically been quite different. Youku really has been focusing on the handset device manufacturers and on the application side and as lot more capabilities on this front whereas Tudou has very strong capabilities working with the operators. And this is an area where we're also quite complementary to each other.

Going back to your question about traffic it is actually more than 20% on the combined basis and this is still growing very nicely. From a monetization standpoint I think just like I said in the PC side, I think at the end of 2007 you want to platform to reach certain scale and I really defined it as 100 million video views before it becomes a scalable platform. So you don't want to advertise it prematurely, shall we say, and as I've said actually just two days ago in our annual sales conference, we anticipate that we will be able to start proposing mobile advertising solutions, the first part of 2002 because we're seeing that traffic will exceed 100 million to be very soon. And I should address all your questions right,

Dele Liu

The number – this is not quite –

Victor Koo

Well the ad load for the mobile space will also increase a little time just like PC as well.

Dele Liu

(Inaudible) the number we quote is for actual peak, average (Inaudible).

Victor Koo

Oh, yeah, the other part of the questions, it's actually peak and traffic.

Piyush Mubayi - Goldman Sachs

So – sorry its peak for the end of the quarter right?

Victor Koo

Yeah, because it's consistently growing.

Piyush Mubayi - Goldman Sachs

Okay. Thank you.

Operator

Your next question comes from the line of Tian Hou from T. H. Capital. Please ask your question.

Tian Hou - T. H. Capital

Yeah, I have a couple questions. The first one is based on CCTV auction result, would you think your pricing strategy will be next year is that possible to raise price in tier 1– tier 2 cities. And also the second question is regarding the utilization rate, is that possible to give some color on your current utilization rate in Tier 1, 2, 3 cities and what is your - how do you envision those utilization would be toward the end of next year?

Victor Koo

Thank you. You referred to the CCTV auctions, I think it's probably at this point in time because the change in the dynamics of the TV industry to look at both CCTV as well as the top four or five satellite television stations in terms of advertising growth which actually as you probably see the CCTV was over 10% and the certainly for the [smart] TV even stronger.

So referring to your question about our pricing I think the pricing strategy will be as such one is the areas for example you mentioned first and second tier cities where the sell-through rate is high there's certainly a lot of pricing power there that we plan to adjust on annual basis. I think for part of the second and especially third tier cities where the sell through rate is less high that will probably grow that in a more market pace.

So that's probably the overall pricing strategy. In terms of the sell-through rate that really depends also on the ad load as we are growing ad load gradually as well. Recall right now that we are still at three pre-roll ads and then 15 second pre-roll ad comparing to who for example which does one minute pre-roll and one minute mid-rolls, I think we've seen some players in the market I have also tried mid roll at as well this will also of course based on demand but we'll gradually increase the ad load over time.

Tian Hou - T. H. Capital

What about the utilization, Victor?

Victor Koo

That's what I'm saying because the utilization that I provide you right now would not be – would be a rate that will change very quickly as we increase ad load. So even for example that the utilization across different regions would be between 30% to 70% but that will clearly change as you increase advertising.

Dele Liu

There's a lot of room for us to increase the ad load as example the maximum ad load we are talking about today is 45 second for long for measure long form shows. If we double that the sales rate be half yet.

Victor Koo

Yeah we plan to grow that gradually.

Tian Hou - T. H. Capital

Okay, good. The last question will be the copyright issue, some TV stations and they're really violate copyrights laws, so how are you going to deal with that?

Victor Koo

Well, I think we're very much pro copyright protection and we're working expressly with international film and television companies to help them (Inaudible) that locally and we work very closely with all the domestic stations on this issue Dele can probably add more color to that because he drives that mission.

Dele Liu

Yeah we're working very hard with the government to try to clean up and make sure the copyright environment gets improved because the example our VOD, our paid services business is largely it is small but growing fast forever if the copyright environment get improved we expect that to be very significant business. So also a lot pirated sites particularly those p2p websites, are still consuming a lot of user time spends which actually should be divided up by the major legitimate players.

Tian Hou - T. H. Capital

Yeah, good luck on that. That's all my question. Thank you.

Dele Liu

Thank you.

Operator

Your final question comes from the line of Ming Zhao from 86Research. Please ask your question.

Ming Zhao - 86Research

Thank you for taking my questions. So on the – again reaching profitability in the third quarter, my question is going forward what would be - what do you look at the same assumptions to make you profitable? In other words, can you comment on your content cost and bandwidth cost and operating expenses for the future quarters, so as we can understand the profitability outlook? Thank you.

Victor Koo

I think, Ming, you're really seeing a lot of scalability when it comes to our product technology spending especially on bandwidth and this is an area even with the growth of the mobile traffic and PC traffic that we've been able to contain this very well. And especially with the combination of Youku Tudou and as our media database getting and increasing integrated and our video content delivery platform increasingly integrated where you will see more synergies coming from the bandwidth side and let me refer to Dele on the content side.

Dele Liu

I mean the profitability timetable is also predicated on the competitive landscape in terms of content price that the price today we see is significantly lower than the price of the bubble period last year which peaked actually in Q3 last year. The market price right now has been declining since then and it appears to have stabilized for Q3 2012 Youku's content cost was up about 28% of net revenue compared to 26% for the same period last year and this is significant improvement of the from the 37% in Q2. So our content strategy is to still offer comprehensive and competitive content portfolio.

So our goal is to have a fair share to maintain our high quality content portfolio comparable to our leadership position. So going forward actually the content calls is still linked to the competitive dynamics of the video sector.

Victor Koo

But overall as the market consolidates Youku Tudou as a leader industry will stay disciplined in terms of how we think about content spending but since we have the broadest library and UGC content and the leadership and self produced content I think we have more leverage over at the scale platform.

Dele Liu

And in terms of there is another angle to look at profitability; mobile is growing exponentially and we have decided to make very proactive investment in mobile and the monetization mobile will be starting gradually. So between mobile and PC business, the mobile still constitute a major area of investment for future growth and that's a good cost for us

Ming Zhao - 86Research

All right, great, very helpful and thank you, gentlemen.

Victor Koo

Thank you.

Dele Liu

Thank you.

Operator

I would now like to hand the call back to today's presenters. Please continue.

Victor Koo

Thank you all for joining us on this call please feel to call us if you have any questions. Good bye.

Operator

Ladies and gentlemen, that does conclude our conference for today.

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