Good day, ladies and gentlemen, and welcome to the Sina first quarter 2006 Earnings conference call. At this time, all participants are in a listen-only mode. We will, however, be facilitating a question-and-answer session towards the end of the conference. I would now like to turn the presentation over to your host for today’s conference, Ms. Chen Fu, Investor Relations Manager. Please go ahead, madam.
Thank you, good morning. Welcome to Sina’s earnings release for the first quarter 2006. Joining me today are our vice-chairman of the board, Yan Wang, our President and new CEO, Charles Chao, and our acting Chief Financial Officer, Herman Yu.
This conference call is also being broadcast on the Internet and is available through the investor relations section of the Sina website. Before the management presentation, I would like to read you the safe harbor statement in connection with today’s conference call. During the course of this conference call, we may make forward-looking statements, statements that are not historical facts, including statements about our beliefs and expectations. Forward-looking statements involve potential risk and uncertainties. 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, Sina’s historical losses, limited operating history, the uncertain regulatory landscape in the People’s Republic of China, the effect of the [inaudible] issued by the Chinese State, administration of radio, film and television in late January, 2005, on the company’s revenue from usage-based SMS products promoted by direct advertising on radio and television, the company’s ability to develop other usage-based SMS products, fluctuations in quarterly operating results, the company’s reliance on mobile value-added services and online-advertising sales for the majority of its revenues. Further information regarding these and other risks are included in Sina’s annual report form 10K for the year ended December 31, 2005, and in recent quarterly reports on form 10Q, as well as with its other filings with the Securities and Exchange Commission.
Additionally, the non-GAAP and comparable GAAP information are contained in our earnings release, which can be found on our corporate website at http://corp.sina.com.
Following management’s prepared remarks, we will open the line for a brief q-and-a session. Now, our Vice Chairman, Yan Wang, will make some brief remarks and introduce the company’s new management team.
Thank you, Fu Chen. Good morning everyone in Asia, thanks for all those who are staying late in the U.S. to join our conference call today. As many of you already knew from our press release earlier, I have officially resigned from the management position at Sina. However, I will stay on the board to oversee the company’s future developments.
After 10 years with Sina, this has been a difficult and important decision to make. However, the time at Sina will always remain an important chapter of both my professional and personal milestones, as I was actively involved in each of the company’s critical growth stages in the past ten years.
My responsibility as the Vice Chairman of the board will allow me to continue to support the existing management team and oversee the future development of Sina.
At this point, I would like to introduce our new CEO, Charles Chao. I had the pleasure to work closely with Charles in my time at Sina and to know first-hand the caliber of his management capability. Charles brings a wealth of industry experience in the area of finance, accounting, media advertising, and Internet related transactions.
I trust Sina’s future with Charles, and I am very confident with his ability to lead and take the company to a new level of success. Without further ado, let me turn the call over to our President and the Chief Executive Officer, Charles Chao.
Thank you, Wang Yan, for your kind words. It has been a privilege working with Wang Yan the past six years. I am pleased to take over for Wang Yan, who founded our China website and has made great contributions to make Sina one of the greatest Internet brands in China.
Now let me talk about the business highlights for the first quarter of 2006. Our total revenue for the first quarter was $46.7 million, slightly above the range of original guidance of $44.5 million and $46.5 million. This presented a 2% increase year on year, and a decrease of 10% quarter over quarter.
I am very glad to report that we have started our fiscal year 2006 with solid growth in our advertising business.
Starting from year ’05, we began to refocus our efforts on expanding our leadership position in the Internet portal business by investing in branding, content partners, and interactive communities. Our efforts have paid off with strong growth in online advertising business throughout 2005, and it continued in the first quarter of 2006. We see this momentum continue throughout 2006.
Advertising revenues for the first quarter were $22.2 million, up 33% year over year, about the middle point of our original guidance, excluding international markets. Advertising revenue from our China operations grew 36% year over year.
This strong year over year increase in advertising revenue was mainly due to the rate-cut increase, as well as increase in the number of customers. Compared to the last quarter, advertising revenues declined 11% sequentially due to strong seasonality in the first quarter. Advertising revenues accounted for 47% of our total revenues for the first quarter, as compared to 36% in the same period last year.
[inaudible], information technology, and automobile industry continue to be the three largest contributors for online advertising revenues. Combined, these three categories accounted for approximately 50% of our total advertising revenue for this first quarter.
As I mentioned in the beginning, we are continuing to invest in content and other web programs to further solidify our status as the leading Internet portal in China. In March, 2006, we launched the 2006 World Cup website, with exclusive web content partners, such as Associated Press, AFP, DPA, and various Chinese media companies.
Historically, Sina has made its name from its comprehensive and up-to-the-minute coverage of major sports event, such as Olympic games and the World Cups. We fully expect that our coverage of the World Cup in June and July will help us to set a new traffic record, and further enhance Sina’s sports brand. We also expect handsome returns from our World Cup website, with lucrative advertising sponsorships.
In April, we became the web partner for the three most anticipated American Idol-type reality TV shows in China, including Supergirl, Superboy, and [Chin Zao]. As some of you probably know, Supergirl 2005 was a national phenomenon in China last year. As the official website for Supergirl 2005, we had the benefit greatly of the huge success of the TV show in terms of generating traffic and the brand awareness. We are hopeful that the three reality TV shows this coming summer will create another battlefield on our website that is equally as exciting as the World Cup.
In addition, Sina Blog service continued its phenomenal success in the first quarter with users and traffic doubled in the last three months. In the last week of April, Sina Blog attracted 1.7 million unique users and with 130,000 Blog postings on a daily basis. Our Blog service not only brought more traffic and increased the stickiness of our website, but it also became an important source for our web content. We have started to try out a few new advertising products in our Blog service, and so far the results have been encouraging.
For 2006, for the entire year, we are still targeting full-year advertising revenue to grow 25% to 30% year on year, and we believe we are on the right track.
Now let me move on to the mobile value-add service business. The mobile value-add service revenue declined 14% year over year and 9% quarter over quarter in the first quarter, to $22.7 million U.S. This was largely based in operating expectations. The sequential and the year over year decline was largely due to SMS revenues. Our mobile revenue for non-SMS service was largely flat from Q4 2005 to Q1 2006, with modest increases in MMS and IVR, and a modest decline in the WAP and ringback tones.
The gross margin for mobile revenue decreased from 62% in Q4 2005 to 59% in Q1 2006. The decline in mobile gross margins was largely due to an increase in transmission costs and the content costs. We continue to see the challenges in mobile business in the three areas we talked about before, including high content costs, less effective promotion distribution channels, and less differentiation in product offerings. Those three factors will continue to result in lower revenue and high costs for our mobile business in general.
To deal with these challenges, we will have to increasingly leverage our portal content and media power to provide unique content and cheap distribution channels for our mobile business. We are making good progress in this direction by introducing our web-blog service to China Mobile’s multi-net, and by working with Nokia for its music web portal.
We estimate our mobile service revenue will decline in high single digits in Q2 of 2006, with further sequential decline in gross margins. We don’t believe that the gross margins decline will be as severe as we have seen in the past two quarters -- probably in the range of 1% to 2%. We still hope that we will be able to see a more stabilized mobile service in the second half of 2006 for both revenues and the gross margins.
As we stated before, we firmly believe it is critical for Sina to maintain a strong presence in wireless business in anticipation of the launch of 3G mobile network in China. We have been operating a free portal, and the traffic doubled in the last three months. We have also launched our mobile search service in several provinces in China, and have seen strong traffic growth in the first quarter. Although there is uncertainty in terms of future mobile Internet operations in China, we remain positive that we will be able to leverage our portal expense in the mobile Internet era.
I think that is it for my business highlights. Now let me turn to Herman Yu, our Acting Chief Financial Officer for the financial highlights.
Thank you, Charles, and thank you all for joining our conference call today. I will now discuss Sina’s financial highlights for this quarter. For the first quarter of 2006, we reported total revenues of $46.7 million, which is slightly above our guidance range between $44.5 million and $46.5 million, and represents a year over year growth of 2% and a quarter over quarter decline of 10%.
Revenues from our online advertising business, which include mainly thread advertising, such as banners, pop-up ads, and rich media, but excludes search, totaled $22.2 million, above the mid-point of our guidance. This represents a 33% increase from the same quarter last year, and an 11% decrease sequentially. Our advertising business experienced strong growth in 2005, and so far we are seeing the momentum carry forward in 2006. The sequential decrease is mainly due to seasonality, as we have historically seen Q1 as our slowest quarter for advertising.
As a percentage of Sina’s total revenues, advertising this quarter is 47% compared to 36% in the same period last year, and 48% in the previous quarter.
Let me also give you some color on our China operations in advertising. Total advertising revenues in China for the quarter was $21.4 million, an increase of 36% year over year. The strong year over year growth can be attributed mostly to increasing customers as well as pricing. Total number of advertisers in China for the quarter was 394, compared to 333 in the first quarter of 2005, and 364 last quarter. Spending per advertiser averaged $54,000 this quarter compared to $47,000 last year, and $66,000 last quarter.
On the wireless side, we saw first quarter 2006 revenues decline 14% year over year and 9% sequentially to $22.7 million. Revenues from our 2G product, which includes SMS, IVR and ringback tones, was $19.3 million for the first quarter of 2006. This represents a decline of 15% year over year and 9% sequentially. The year over year decline in 2G revenues can be mainly attributed to the drop in SMS revenues, which declined 20% from the first quarter last year, and 11% from last quarter, to $16.2 million. SMS accounted for 71% of Sina’s total wireless revenues in the first quarter of 2006, compared to 76% last year and 73% last quarter.
IVR revenues grew 49% from the first quarter last year and 15% sequentially, primarily due to increased users as well as adding China Telecom to provide our services. Ringback tones, on the other hand, decline 14% from a year ago, and 25% sequentially.
Turning now to 2.5G products, which include MMS, WAP, and Java games. Revenues from 2.5G products was $3.4 million for the first quarter of 2006, representing a decline of 10% year over year and a slight decrease of 3% from last quarter. First quarter MMS revenues dropped 56% from a year ago but grew 28% sequentially to approximately $1 million. We are uncertain at this point on whether we can continue to grow MMS from the current levels.
WAP revenues increased 23% from a year ago but dropped 19% sequentially. Revenues from Java games in the first quarter grew slightly by 4% from the previous quarter.
Turning now to gross margins, Sina’s gross margins for the first quarter of 2006 was 61% compared to 67% last year, and 66% last quarter. Our average rate in gross margins in the first quarter was 63% compared to 65% last year, and 69% last quarter.
Pursuant to FAS 123R, stock compensation expenses are included in our cost of sales and operating expenses for the first quarter of 2006.
Excluding the $4.4 million in stock-based compensation, non-GAAP amortizing gross margins for the first quarter of 2006 would have been 64%. The year over year decrease in advertising gross margin from 69% was primarily due to Q1 being historically a lower revenue quarter while costs of advertising sales was relatively fixed, and did not decline in proportion to revenues.
Our gross margins for wireless business was approximately 59% in the first quarter, down from 67% last year and 62% in the previous quarter. The year over year and quarter over quarter declines were mainly due to increased transmission costs paid to mobile operators, and increased cost for content acquisition.
As we indicated previously, we anticipate continuing increase in operator and content cost, and this gradual erosion of wireless gross margins, although it may not be at the rate that we have seen recently.
Turning now to operating expenses, our operating expenses for the quarter totaled $22 million. Excluding stock-based compensation of $1.2 million and the amortization of intangible assets of $0.5 million, our non-GAAP operating expenses for the quarter would have been $20.4 million, an increase of 3% from the same period last year and a decrease of 11% from last quarter. The quarter over quarter decrease in non-GAAP operating expenses was primarily due to lower marketing expenditure of $2.2 million, almost evenly split between TV advertising for our wireless services and our other product marketing activities.
During a recent fixed assets inventory count, the Company noted that a significant portion of certain fully depreciated computer equipment were still in use. The Company changed the estimated useful life of certain computer equipment from three years to four years. This change in accounting estimate resulted in a reduction in depreciation expenses of $0.6 million in the first quarter of 2006. $0.2 are in the cost of advertising sales and $0.4 million in operating expenses.
Turning now to the balance sheet. As of March 31, 2006 cash, cash equivalent and investments in marketable securities balance was $304 million compared to $301 million last quarter and $283 million at the end of last year. Our DSOs for the first quarter was 66 days compared to 70 days for the same period last year, and 59 days last quarter. The sequential decline in DSO was mainly due to a strong Q4 revenue quarter.
Turning now to our Q2 business outlook. For the second quarter of 2006 we are guiding total revenues to be between $47.5 million and $49.5 million. We are expecting advertising revenues to come in between $26 million and $27 million. As Charles mentioned, based on the demand that we have seen for our brand and advertising so far this year, we are reaffirming our 2006 year-over-year advertising revenue growth target of between 25% to 30%.
On the non-advertising side, we are expecting revenues between $21.5 million and $22.5 million. As we mentioned on the last call, we anticipate a gradual decline in wireless revenues in the near future. We hope that we will be able to stabilize the wireless business in the second half of 2003 with our new initiatives.
Also as Charles mentioned earlier, we are in the practice of reassessing our corporate strategy. As such, we will not be giving guidance on our net income this quarter. Stock compensation for the second quarter is expected to be around $1.5 million which does not factor in any new options that may be granted.
Now I will turn the call to Fu Chen.
Thank you, Herman. I believe Charles has some more remarks to make before we take the Q&A session.
Yes, Fu Chen, thanks. I just want to say a few words to add on to Herman's point about our Q2 guidance. As many of you know, due to the changes of our management team, we will be in the process of reassessing our future corporate strategies and our current business lines, which may or may not result in significant charges.
So we believe it is most prudent for the Company to only provide revenue guidance for the second quarter. We may consider to reassume the profit guidance in the future after we have more certainties regarding our future plans. So I think that is all I want to say. This will be the end of our presentation and we are now ready for questions.
(Operator Instructions) Your first question comes from the line of Richard Ji with Morgan Stanley. Please proceed.
Hi Charles, Herman. I have two questions, all related to your content strategy. What we have noticed is that clearly you are working hard on user-generated content, especially blogging. Can you comment a little more? Give us a little more color on that.
In terms of your content and partnerships with external sources, such as [Water Cup], et cetera, can you also elaborate a little more on the content costs and how much you need to update or share with the content partners? Thank you.
Richard, this is Charles. With regard to the content I think we will probably have three different types of content. You are probably talking about the web content only, right? You are not talking about the wireless, right?
Web content, yes.
In terms of web content, we probably also have two areas. One is the content, we usually have partnered with the media companies, like a news company or entertainment company. Some of this company we have partnerships for free, or some of the content we get partnerships with them for a fee.
The other part of content is called user-generated content, for us mainly in the areas of blog services and also the web commentary and other media type of content.
In terms of the content partnership with media companies, historically we work with a lot of media companies and we continue to do that. We are now partnered with over 2,000 media companies in China to get content. Most of this content we get for free and we pay for premium content and for some exclusive content. That is the ones we talked about just now for the [Water Cup] content partnership with us, and very famous international media companies.
The content, I mean this type of content historically it is not a big part of our costs in terms of total costs. We talked about that point before that we are in the process and we have seen the market change quite a bit in the past several quarters, and it continues to be so in the future that we can increase these types of costs quite a bit in the future.
But as a percentage of revenues, we don't expect them to be very significant this year and probably will become more significant next year. So this is regarding the content partners with media companies.
For the user-generated content, I think DBS and this type of content we have talked about before. It is quite common, but what we are excited about is our blog service. We launched our service about nine months ago. We have seen very exciting results from our blog service. I talked about a few numbers in my presentation just now. In the last week of April, our blog service attracted 1.7 million unique users on a daily basis, and with 30,000 blogs posting with us on a daily basis. There is about 200,000 comments for these blog postings on a daily basis. So these numbers probably represent a 100% increase for the last three months or so. We are very excited about that.
You probably know that a lot of our blog service where actually the bloggers are some of the rich and famous people in China and they are not only doing a lot of good content and also a lot of attentions from their fans to view their blogs. This becomes a very important part of our web content, in general.
So going forward we are going to invest more in this type of interactive content communities so we have more good sources for content and also increased interactions for our web portals in China. I hope that answers your question.
Thank you, Charles.
Your next question comes from the line of Lu Sun - Lehman Brothers.
Lu Sun - Lehman Brothers
Hi Charles, good morning.
Lu Sun - Lehman Brothers
I have two questions. The first one is regarding your wireless satellite service strategies going forward. You mentioned that you are hoping for stabilization in the second half of the year, and you are actually working on several new initiatives. Can you comment on which product will be your major growth driver going into the second half of the year? And whether you will be changing some of the advertising strategy or distribution strategy for the old product. Thank you. Then I have a follow-up.
I think this is a good question, Lu. Yes, we have started different initiatives in the wireless areas, but still you are talking about the situation or the issues within the content, the distribution channel. For us, for content we obviously try to leverage more from our portal for our media aspect of the business, and to try to introduce some of the unique content in the mobile business. We tried to introduce blog service to the wireless service. We are talking with China Mobile and to introduce the service into the mobile area and so far it has been pretty well received. We also started to work on keeping our website to cooperate with TV and radio stations, so we can leverage our media power to give them content.
On the other hand, we can leverage their air time to do some wireless business. So there are a lot of different things. We also mentioned that we talked with different handset manufacturers to also try to integrate our service, our content service like a blog service, like a music service and others into their handset going forward.
So we try to put in more unique content and we try to leverage more different distribution channels. You probably know that we began to rely more on the partner channels, [inaudible] and also for operations, mobile operators, for other promotions in the past.
So we try to diversify right now to get into multiple channels. So it is different content and channels, and we try to become more unique and more diversified. But these assets will take time to pay off, so it is really difficult to quantify [inaudible] of these initiatives we are in now. We are seeing good starting points with some of our initiatives and our proposals were received by mobile operators and by handset manufacturers. Right now the scale is still pretty small at this stage. It is difficult to really quantify any kind of revenues from these initiatives.
So basically we are working on different things to improve our content in more channels.
Lu Sun - Lehman Brothers
Thank you. My second question is on the management structure. We are very happy to see that you are taking control of the leadership of Sina. However, what kind of changes will you make to the department or business line management of Sina? We would appreciate your comments relating to that. Thank you.
I think that is one of the points we need to discuss with our board and also with our management team in the second quarter. First of all, we need to form our new corporate strategies and as well as consider our different business lines. Once the strategy is determined, we will be in a much better position to determine the management structure.
I think the real change, if you can tell right now, was at the corporate level. Basically CEO, CFO, COO level. That part has been changed quite a bit in the last three or four months with Hurst Lin's departure and Wang's departure.
So basically I am now playing the role on an overall leadership basis and you can see Herman Yu is acting as CFO right now. The board will start a search for a CFO, but I mean obviously Herman will also be one of the candidates.
At this point I cannot really tell you too much about it, but I don't really believe there will be any significant changes to the management structure for different business units and business lines at this point. There will be some significant changes to our business lines in the future.
We may add new people, but I don't think that will have too much of an impact. It is just going to be adding new blood to the Company, but not really so much of an impact on the existing management team in these different business units. These are the people who have been working at the Company and have proven to be very, very successful; outstanding in the past. Most of them, as you probably know, have been with the Company for more than six years and I don't expect that will change significantly in the future.
Lu Sun - Lehman Brothers
Thank you very much, Charles.
Our next question comes from Safa Rashtchy - Piper Jaffray.
Paul Dever - Piper Jaffray
Good morning. This is Paul Dever for Safa Rashtchy. I have two quick questions.
Paul Dever - Piper Jaffray
Can you provide some color on the wireless sector growth? Which segments exceeded your expectations and which segments, other than SMS under performed?
My second question is basically on the depreciation reduction. Does that only impact the first quarter or is that an ongoing reduction in depreciation expense? Thank you.
Paul, in terms of wireless business, I cannot particularly point out any sector that is more, better than we expected or the areas that are worse than we expected. It is pretty much what we expected.
In this SMS, because a lot of revenues were generated from the monthly subscribers, and this has historically been a very big portion of the total wireless business accounting for anywhere between 70% to 80% of the total wireless business. So this area has a lot of challenge for recruiting new monthly subscribers or keeping the existing monthly subscribers.
So basically the cost of obtaining these monthly subscribers becomes higher. On the other hand, the churn rate for these monthly subscribers becomes worse because of the tightened mobile operating policy in terms of the user retention for these kind of monthly subscribers for SMS. For that part, we are continuing to see some decline quarter over quarter as we have seen in the last quarter.
The categories are basically mainly in the area of WAP, MMS, IVR and ringback tones, these are the four major categories for SMS. The performance has not been very consistent and it fluctuates quite a bit quarter over quarter. We certainly hope that WAP and also IVR will continue to grow a little bit in the remaining year. Obviously areas are more subject to mobile operators policy change, and it is also very difficult to predict right now. We do hope these areas will grow faster so they can offset some of the decline in SMS.
So to summarize, it is a mixed picture and it is very difficult to say which product will perform better in the future. The nature of this product and the business, they are all subject to the [problems] talked about in accounting and distribution areas. Those are the areas we really need to work on, basically to increase our unique content and to find a better, cheap distribution channel so we can be in a better position to compete in the marketplace. So that is about wireless revenue.
In terms of the depreciation, this is not a one-time effect. Basically, this is going to be a change of accounting going forward on a prospective basis, which means from January 2006 the depreciation estimate life for certain fixed assets, mainly I am talking about non-personal use of computer equipment, like servers, routers. Historically we used a three-year depreciation period and we found that most of the equipment was being used after three years, so we changed that to four years. So starting from January, all of the existing servers and routers and also all the new purchases in these areas will be depreciated over four years instead of three years that we have seen in the past.
So basically if you are talking about the same amount of equipment, depreciation expense will be lower based on four years depreciation versus three years depreciation going forward. I hope that answers your question.
Paul Dever - Piper Jaffray
And what was the depreciation in the quarter?
The depreciation expense is about $2.3 million.
Paul Dever - Piper Jaffray
Your next question comes from the line of Jason Brueschke - Citigroup.
Jason Brueschke - Citigroup
Thank you. First of all, congratulations, Charles on your promotion to CEO. I think that is fantastic. I also have a few questions. Let me start with a general one. You've talked a little bit about some of the strategic considerations you might have. Can you give us a little more color, maybe qualitatively about first of all the scope? Meaning, are you planning on doing a comprehensive review of all of Sina's current business lines?
Second of all, could you help us maybe just understand the benchmarks that you are going to apply to this analysis? Are you going to be looking at profitability? Revenue growth? Market share? Will you consider divestments as well as acquisitions to change your business mix going forward? And then I have one other question.
Thanks for your comment. Actually, it is a very difficult question. I apologize, I cannot elaborate too much at this stage since I just took over right now and we are in discussions with board members, obviously, to find the right benchmarks and right structure to do this analysis. It is probably too early for me to elaborate as to the benchmark or the scope of this strategic consideration.
I think probably at this stage you probably will be working on a very broad basis, I can just talk about it a little bit. It is basically looking at the existing business and also the market to see the strength and the weakness of the Company. Looking to the areas that we have potential to grow, and to look at areas that we don't have the potential to grow. Maybe given the current market situation we are probably already very late; or there are different factors and we are probably not very competitive in some of the markets we are in, some of the business lines we are in. We need to do restructuring or reconsideration for the business.
And also looking to the market opportunities in the future, like we talked about in the 3G, we talked about enhancing our content offerings and also portal strength and investing in the interactive communities. If these other areas which have the good market opportunities, where it makes sense for us to invest more money in these areas. So this kind of -- I just want to offer you some color in this area, but I really cannot get into too much detail at this point on this particular issue.
Jason Brueschke - Citigroup
Thanks, that is still very helpful. My other question involves the [WBAS] business. There purportedly was a meeting between China Mobile in Chengdu of the major record labels. I wanted to get your comments on two levels. First of all, could you just remind us what level of exposure that you have in your wireless business to music?
And then maybe comment in general on what do you think the impact and timing, and maybe even the ultimate goal of what China Mobile is doing with respect to appearing to reach out directly to a number of the big music labels. As well, they have set up a website that will allow you to directly download music, et cetera. What is the impact for your business, as well as the industry?
I think that is a good question. I think the meeting happened a few weeks ago in Chengdu talking about the music strategy of China Mobile for their mobile value-added service, and they invited a lot of SPs as well as music houses to the meeting.
This actually reflects a trend we have always talked about, that the value of SP in the entire value chain for the mobile value-added service, and before we were a content acquirer, a content aggregator and also the product distributor for the value chain, and we play a very important role at the early stage of mobile value-added service. So we've got a big chunk of the revenue share for the entire value provided for the mobile service.
I think inevitably that the original content provider will try to work with our mobile operators, to try to work with original content providers to increase their share of that in the value chain.
I don't believe that this is going to eliminate the room for SPs to perform in this area. It is only adds to the possibility that there is a chance that they can work together to provide service, but we can provide alternative service to distributors, mobile music products to the users. I think the real impact will be on the margin side that the revenue share with content provider and mobile operator. We are determining how much percentage of the total dollar we can share in this value chain.
We can still provide a service, but it is possible that as I always talked about, the margin will be further squeezed in this area. It is not going to have an immediate impact, I think it is going to be a gradual impact because it takes some time for them to work effectively together and in the future. So it is going to be a very gradual process, in my opinion for most SPs.
In terms of impact of music itself on our Company and the industry in general, we talked about the music products, how they account for at this point probably a little bit over 50% of the total mobile value-added service including ringtone, ringback tone and IVR service. This is the same situation for Sina, probably our percentage of revenue from the music product is around 50%, I think. Some of the companies in this industry rely more on the music, but some of them rely less. The average is probably a little bit over 50%.
So I think the impact will be across the board for the entire industry and for most of the companies in this area. Again, I think it is not like it will be immediate in terms of providing this service, but the impact will be on the margin. That would be my opinion.
Jason Brueschke - Citigroup
Great, thank you and congratulations again, Charles.
Thank you, Jason.
Our next question comes from James Mitchell - Goldman Sachs.
James Mitchell - Goldman Sachs
Thank you and congratulations, Charles. Two questions. Could you provide some guidance on the tax rate for '06? I think previously you had indicated it should be high single digits, it looks like the first quarter was around 10%.
Secondly, and it is kind of esoteric, but if I look at your other revenue line that is not advertising and not mobile, I think previously you had indicated that the majority of that other revenue was search revenue, and that there would be a big sequential decline in the first quarter due to you using your own search engine. It looks like it didn't decline that much, but you are guiding for a fairly sharp decline in the second quarter. So is that just a timing issue?
Related to that and the strategic issues, can you make a rough estimate as to how much you are losing at the moment on developing your own search engine? Thank you.
I am sorry, the first question was?
James Mitchell - Goldman Sachs
Tax rate guidance.
We guided in the high single digits effective tax rate for the entire year of 2006, and between 5% to 10% basic average, in the middle point 7.5%. I think it is more related to our China operations and we were talking about 7.5%. For the international and also our corporate headquarters location came in tax free. On the international sites we don't pay tax and we do not expect to pay tax in the international sites. So we are really talking about China operations.
The China operations, the effective rate right now is about 7.5% and we expect that rate for almost the entire year. You can see that because of stock-based compensation and also some losses on the international side, these losses and expenses do not have corresponding tax benefit. So actually, the real effective tax rate as you can see from this quarter, is a little higher than the 7.5% we indicated before.
That rate will fluctuate a little bit depending on the losses and other non-deductible items for international and corporate level. I don't expect that will be too much. I do expect that for China operations about 7.5% for this year and for the overall effective rate, it will deviate a little bit. It is not going to deviate that much. Probably in the high single digits for the entire year.
With respect to the revenue components for our other non-advertising revenues, still the same that the majority of the revenues for the quarter were coming from the search business, and we talked about the decline in search revenue because we switched our search engine at the beginning of the year to make our own developed search engine the primary search engine we promote. But we still for the existing search engines, the previous search engine we are still offering on our web site, but it is in a less obvious location.
So we are still expecting that there is going to be revenue generated on the older contract. You are right, it was not as severe as I expected at the beginning of the quarter when I first looked at the issue, but they are still going to be declining quarter over quarter in the next three quarters, unless we decide to start to charge for our new search engine, which also will take some time to generate revenue going forward, if we do decide to do that in the next couple of quarters.
So I still expect sequential decline in this area and it is probably very difficult to quantify, but I think it is safe to assume year-over-year the search revenue will decline by 50%. You can do it proportionally based on each quarter's proportion, basically. I hope that answers your question, James.
James Mitchell - Goldman Sachs
That's great. On the search revenue, did you have a rough estimate for the search costs? The costs of running BDIR?
The search costs, there are two parts. One is obviously the personnel costs in terms of engineering costs for people. That actually is not -- we have about 60 or 70 people working on search engine, and half of them are engineers, half of them are operations people. That is not a very significant part of the cost.
The other cost is obviously equipment costs. Equipment costs are becoming more significant as we begin to really try to put out more websites and try to get more indexes. The websites we can store right now is about 1.5 billion and we probably have over 500 million indexed pages right now, so it is a big process and requires a lot of equipment. That part is probably a little bit more significant than the personnel costs at this point.
Overall, you probably want to get at how much further costs we have in terms of operating the search engine. I cannot give you a number exactly, but I hope that the information I just provided will be helpful.
James Mitchell - Goldman Sachs
That is helpful, thank you.
Thank you, James.
Your next question comes from the line of Dick Wei - JP Morgan.
Dick Wei - JP Morgan
Hi Charles and congratulations on the new position. I have two questions. First is you mentioned earlier that you tried out a few new advertising products on the user community site. Can you tell us about what those are?
Secondly in your press release you mentioned for the wireless, one of the reasons for the margin decline is the increase in transmission costs. Is that due to China Mobile or other mobile operators? Can you give some color? Is that in terms of product mix or policy change at the operator level?
In terms of the costs -- let me answer the second question first. Regarding the increase of wireless costs and transmission costs, basically I think it is a mixed picture. On the one hand some of the operators, they changed their policy. On a small-scale basis, that has impact. Basically it is a policy regarding how many messages you have to send through the channel, their gateways, in order to keep monthly subscribers, so on and so forth. Different partners may have different policies. So the number of messages required to change deviates from product to product and partner to partner. That will have an impact.
Also our product mix, obviously if you charge people on an online usage basis, there is only one message that you need to send out in order to get the revenue. But on a monthly basis, depending. On a similar product you have to send many messages on a daily basis, adding up to a very high cost. So if you have a news product on a message subscription basis, your costs will be very high. Also ringtones on a monthly basis, that would be lower but you still have to meet the minimum requirements that they charge people RMB10 per month for that product. They probably have to send at least 10 messages during the month in order for us to charge.
So there is a lot of different aspects of it, but overall, what I am trying to point out is that it is the product mix and sometimes it is the mobile policy, and sometimes the other factors contribute to that.
This product’s cost, actually, I do not see that would change that much in the next couple of quarters, and we probably will see more content increase in the next couple of quarters for our general, overall mobile cost of revenue space.
With respect to the first question on the advertising side for our community-based product, I am kind of reluctant to talk about it in too much detail, because we are in an experimental period. More importantly, it is not like I cannot talk basically, I just do not want to release too much information for our product right now, for competition reasons.
One of the products, I can tell you, we introduced in the blog service. Basically we try to find some sponsors to sponsor some topics of discussion among the bloggers. For example, we have invited Intel to sponsor a typical, specific topic for discussion among bloggers and we have some marketing events and also other events associated with this service. It is very well-received by the users who blog. These are the kinds of things we are experimenting right now, kind of looks like it is [inaudible[, basically.
Dick Wei - JP Morgan
Great, thank you.
I think we have time for one more question.
Your final question comes from the line of Frank Shi with CLSA. Please proceed, sir.
Frank Shi - CLSA Limited
Just one quick question on cash flow. This quarter you generate about $12 million of cash flow from operating activities. Your cash balance increased about $4 million, so the difference, is that CapEx?
No, it is not just CapEx. I think CapEx obviously is one of the reasons, and the other is a payment out to an acquisition that was made a couple of years, it is another payment. I believe the cash part is in the range of about, correct me if I am wrong, $11 million or something?
Yes, the cash part is about $11.3 million of the payment.
Really a cash payout for the acquisition, so net, it is only $4 million for the next year cash increase.
Frank Shi - CLSA Limited
This concludes the question and answer session. At this time, I would like to turn the call over to Mr. Charles Chao. Please proceed, sir.
Thank you. I think that is the end of our conference call today. Hopefully we will see you next time. Thank you, goodbye.
Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.
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