Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Derek Mitchell - Ogilvy Financial

Dr. Charles Zhang - Chairman of the Board, Chief Executive Officer

Belinda Wang - Co-President, Chief Marketing Officer

Dr. Gong Yu - Chief Operating Officer

Carol Yu - Co-President, Chief Financial Officer

Analysts

Jason Brueschke - Citigroup

Dick Wei - J.P. Morgan

Jenny Wu - Morgan Stanley

C. Ming Zhao - Susquehanna Financial Group

Kathy Chen - Goldman Sachs

Gene Munster - Piper Jaffray

Eddie Leung - Banc of America Merrill Lynch

Sohu.com Inc. (SOHU) Q2 2009 Earnings Call July 27, 2009 8:00 AM ET

Operator

Good evening and thank you for standing by for Sohu's second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference, Mr. Derek Mitchell, Sohu's Investor Relations representative from Ogilvy Financial.

Derek Mitchell

Thank you for joining Sohu.com to discuss the company’s second quarter 2009 results. On the call today are Chairman and Chief Executive Officer, Dr. Charles Zhang; Co-President and Chief Marketing Officer, Belinda Wang; Co-President and Chief Financial Officer, Carol Yu; Chief Executive Officer of Changyou.com, Tao Wang; Chief Financial Officer of Changyou.com, Alex Ho; and Sohu's Senior Finance Director, James Doing.

Before management begins their prepared remarks, I would like to read you the Safe Harbor statement in connection with today’s conference call. Except for the historical information contained herein, the matters discussed in this conference call are forward-looking statements. These statements are based on current plans, estimates, and projections and therefore you should not place undue reliance on them.

Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements.

Potential risks and uncertainties include, but are not limited to, the current global financial and credit market crisis and its potential impact on the Chinese economy, the slower growth the Chinese economy experienced during the latter half of 2008 and the first half of 2009, which could continue through the remainder of 2009; the uncertain regulatory landscape in the People’s Republic of China, fluctuations in Sohu's quarterly operating results, EPS dilution resulting from Changyou’s initial public offering, Sohu's historical and possible future losses and its reliance on online advertising sales, online games, and wireless services for its revenues.

Further information regarding these and other risks is included in Sohu's annual report on Form 10-K for the year ended December 31, 2008, and other filings with the Securities and Exchange Commission.

Now let me turn the call over to Dr. Charles Zhang, Chairman and CEO. Charles.

Dr. Charles Zhang

Thank you, Derek. Hello, everyone. Welcome to the call. Today I am pleased to report that the second quarter of 2009 was another solid quarter across the board, rounding out a successful first half of 2009 for the Sohu Group.

During the quarter, we achieved a record total revenues of $127.1 million, exceeding the high-end of our guidance and translating into growth of 25% year-on-year. This quarter was the ninth out of the past 10 quarters we achieved record total revenues, a significant achievement given the challenging global economic backdrop over the past several months.

Brand advertising revenue increased 5% year-on-year to $43.6 million, within our guidance. We are particularly pleased with this achievement, given the difficult economic situation and the tough comparison to the second quarter of 2008, when advertisers started to spend heavily leading up to the Beijing 2008 Olympic Games.

Our online game business also posted record high total revenue of $66.6 million, exceeding the high-end of our guidance, representing an increase of 8% quarter-on-quarter and 39% year-on-year.

For comparison purposes, before deducting the share of net income pertaining to non-controlling interest in Changyou, non-GAAP net income was $49 million, also exceeding the high-end of guidance of $46 million, up 4% quarter-on-quarter and 16% year-on-year. After deducting the share of net income pertaining to the non-controlling interests in Changyou, non-GAAP net income attributable to Sohu.com was $35.2 million, or $0.90 per fully diluted share, exceeding the high-end of guidance of $0.85 by $0.05.

These achievements are the results of the robust performance of our unique combination of Sohu's two core businesses, our portal business and online game business. Even in this weak economic environment, our portal business continues to show modest growth and a strong ability to grab market share. Meanwhile, online games, a defensive play in the economic downturn, are proving an effective way to drive high growth and high profitability, as well as to generate strong cash flows. We continue to see ongoing synergies between our portal business and online game business to secure long-term and sustainable growth for Sohu.

Now let me discuss our portal business in detail. Our ongoing investment in branding, content offering, and technological products has continued to strengthen our leading position as one of the most powerful mainstream media platforms in China.

In terms of branding, our Browse Sohu, Know the World marketing campaign is generating positive results. Third quarter research shows that more than half of the people interviewed increased their visits to Sohu websites as a result of their exposure to Sohu's marketing campaign.

Since the commencement of this campaign, average unique visitors to Sohu's news channel grew by 13% in three months. Given the effectiveness of these efforts, we decided to expand the marketing campaign from the 42 cities last quarter to 61 cities. The additional cities are mostly third and fourth tier cities where the Internet penetration is low and the Internet population is growing rapidly.

Our second focus has been on executing our media strategy and investing in video content. Sohu TV Channel has successfully secured a large amount of authorized high definition content, video content and the real-time broadcast of more than 180 local TV stations. In addition, we are able to produce high quality video programs in-house. Our rich video content offering has another driver of recent traffic growth. The average number of daily unique visitors to Sohu's TV channel increased 29% sequentially in the second quarter. As user growth for Sohu's TV channel accelerates, some advertisers switched to Sohu's TV channel from other channels this year and are happy with the results.

Well, for 2009, the total marketing dollars to Sohu remains largely unchanged. In the coming years, we expect more advertisers will be attracted to this very valuable user base and allocate additional budgets to Sohu.

Finally, our persistence in executing our technology and product driven strategy starts to pay off. For example, after three years of continuous technological and marketing efforts, Sogo Pinyin method is not installed on more than 70%, or more than 100 million PCs in China. As these 100 million PC users type Chinese with Sogo Pinyin, our software collects their user behavior which in turn helps us increase the effectiveness of targeted marketing on the Sohu platform.

Our intense focus on branding, media content, and technology is resulting in robust traffic growth for the Sohu portal. In the first four months in 2009, unique visitors to Sohu portal increased approximately 50% year-on-year. Even with higher comparative numbers in 2008 surrounding the Sichuan earthquake and the run-up to the Olympic Games, unique visitors in May and June of 2009 increased by more than 20% year-on-year.

In a moment, Belinda will give a more detailed review of our brand advertising business but let me first briefly discuss our online game business.

For the second quarter of 2009, online games revenue grew 8% quarter-on-quarter to $66.6 million, making this eight out of the past nine quarters that we have exceeded guidance.

Our business does not only benefit from the overall strength of the online gaming industry in China and its status as a strong defensive play in difficult economic times, our focus on the user experience and creating games people want to play has also helped to generate these impressive results.

During the second quarter, we continued to operate two RPG games, Tian Long Ba Bu and Blade Online. For these MMORPGs, aggregated registered users jumped by 9% to 69.1 million, and aggregated active paying accounts, or APA, grew by 5% to 2.39 million. Aggregated peak concurrent users, or PCU, was approximately 950,000. We maintained average revenue per user, or ARPU, at an affordable level of RMB186, up slightly from RMB179 last quarter.

This set of strong operational metrics reflects the continued strength and growth potential of our games.

Regarding expansion packs for Tian Long Ba Bu at the end of March, we released our Legend of the Shadow expansion pack, which introduced a certain highly anticipated features, such as hidden weapons. This has succeeded in increasing user stickiness and maintaining growth momentum for Tian Long Ba Bu.

In early July, we launched another expansion pack, Xiao Ao Kun Lun, with new game features such as new maps, skills, and in-game activities. Our objective is to attract new users and retain existing users during the summer months.

Overseas markets -- in the second quarter we launched Tian Long Ba Bu in Malaysia and Singapore, adding to our existing markets of Hong Kong, Taiwan, and Vietnam. By the fourth quarter, we also expect to launch the game in Korea.

Even more exciting is that our new U.S. subsidiary is working on an English version of Tian Long Ba Bu which we plan to launch in North America by the end of the year. We believe our U.S. operations will provide us with valuable insight on world-class user production and customer service standards that we can introduce in China, thereby strengthening our reputation for quality and paving the way for the launch of more successful games in the future.

Now let me share with your our strategic vision and what we have done this quarter to further develop our business. As always, our long-term strategic goal is to make Changyou one of the leading developers and operators of online games. A major step in this direction was Changyou’s NASDAQ listing in April, which elevated public awareness and recognition of Changyou as a major player in the online gaming space in China. We plan to further develop this brand equity by focusing on the quality of our games.

As part of this focus, we ramped up our recruiting efforts this quarter and nearly doubled our number of engineers from the 220 we had before Changyou’s IPO in April to over 400 as of July. We also took steps to strengthen and improve our training process to help employees quickly assimilate into the Changyou culture and begin making valuable contributions.

We are looking to further strengthen our human capital to ensure a continual flow of new games and broaden the appeal and the depth of our game portfolio.

Our pipeline is made up of games with different game scenes and styles. Let me provide an update on each of them.

First, in the third quarter, we will launch Blade Hero 2, the sequel to Blade Online. This is a 2.5D martial arts style fighting game that will include popular features of Blade Online as well as new features, such as horse-riding system, new fighting techniques, and additional team combat functions to give players a more intense and realistic fighting experience.

The game also includes upgrades to some of our community features that we expect will increase the game’s stickiness.

Since this new feature significantly differentiated this sequel from the original, we plan to launch it as a new game.

Second, in the fourth quarter, we plan to launch a major expansion pack for Tian Long Ba Bu, with new game features that are as always developed based on the user feedback collected through our real-time feedback system. This expansion pack will contain more content than previous expansion packs.

Aside from new maps and missions, we have added a pack decoration function and additional channels where gamers can further upgrade their character weapons, skills, and abilities. We believe these additions will increase the game’s stickiness and help extent the lifespan of the games.

Third, in the first quarter of 2010, we plan to launch the licensed 2D game, Immortal Faith, which is based on the Chinese myth. The game will feature a celestial world filled with mythical characters and magical items, where users will need to battle and defend the territory and resources.

While development by the original third-party studio has been completed, our 30 in-house game developers will continue to upgrade the game play and enhance the game’s underlying technology over the next six to nine months.

Fourth, in the second quarter of 2010, we plan to launch Legend of the Ancient World, a fantasy themed 2.5D game licensed from a local independent studio.

And finally, for Duke of Mountain Deer, or DMD, our second in-house developed game, in April we entered into another round of technical closed beta testing. We’ve invited around 25,000 gamers to test the game and feedback so far has been quite positive. With a greater selection of online games available in the market now, gamers have become more selective of the games they play and are demanding for high quality games. We plan to devote more time and resources to the development of DMD to further enhance its appeal and innovation. Given the large number of characters and the unique storyline of the novel on which the game is based, we’ll develop even more innovative features that will broaden the audience of DMD.

We believe this will further increase the chance of success for DMD. We plan to begin open beta testing of DMD in the third quarter of 2010. This will bring the total development cycle of DMD to 35 months, which is comparable to Tian Long Ba Bu, which underwent 31 months of development.

In closing, I would just like to say that we are pleased with our achievements so far and believe that Changyou’s NASDAQ listing has been a big positive contributor toward the long-term success of our business. We are confident that our unique system of collecting and implementing game player feedback and our user-centric development model are resulting in a highly sustainable game development operation platform.

We see a bright future for the online gaming industry in China and we believe that Changyou will continue to play a leading role in its development.

Later one, Carol Yu, our Co-President and CFO, will share with you some of our results from our online game operations but now let me turn the call over to Belinda, who will break down the brand advertising business in more detail. Belinda.

Belinda Wang

Thank you, Charles. I am pleased to give more color on Sohu's advertising business front. For the second quarter, we are pleased to report brand advertising revenue of $43.6 million, representing 5% year-on-year growth and making for total brand advertising revenue of $82.7 million in the first half of the year, a 10% year-on-year growth. We believe these results are quite impressive, given the tough comps in 2008 and the economic environment in 2009. The top three industries for brand advertising revenues in the second quarter were automobile, online games, and real estate and such accounted for more than 50% of total brand advertising revenues.

Revenues from retail closing, consumer electronics, and automobile were the fastest growing sectors in the second quarter.

Giving you some additional color on the top three industries for the full year 2009, the first, the China Association of Automobile Manufacturers recently announced that sales of passenger cars in China for June grew almost 50% year-on-year, making China the world’s largest automobile market in the first half of the year. This has exceeded expectation of even the auto manufacturers who have been more willing to spend to promote their products. In addition, auto advertisers continue to shift from offline to online advertising and Sohu is a clear beneficiary.

Second, for online games, we expect reduced marketing spending from smaller game developers to be partly offset by increased spending from larger ones. This will still likely result in a slight revenue decrease for the full year.

And third, the real estate industry was impacted by the macro environment and the Chinese Government took measures to spur an increase in transaction volumes. We have noticed that the recovery in the industry starting from March; however, it may take time for this segment to fully recover. We expect full-year revenues for the real estate segment to decrease slightly.

And fourth, further revenues from FMCG continue to grow. Even in a weak economy, the industry has remained relatively untouched. FMCG advertisers will rely on advertising to quickly move products off their shelves by increasing marketing spend in Sohu to promote sales.

As Charles mentioned earlier, we have seen improving outlook for advertising spending in recent months; however, our year-on-year comparison will be very difficult, given the exceptionally strong Olympic related advertising revenue that we received in the third quarter of 2008. Therefore our current outlook for the third quarter of 2009 assumes year-on-year growth to be flattish. For the full year of 2009, we anticipate brand advertising revenue to grow by 5% to 8% year-on-year.

I would now like to turn the call over to our CFO, Carol Yu, who will take you through the quarterly -- our quarter’s financials. Carol.

Carol Yu

Thank you, Belinda. Now I would like to take you through the quarterly financials.

One, revenue -- starting with the top line results, total revenues were $127.1 million, representing an increase of 10% sequentially and an increase of 25% year-on-year.

Brand advertising revenues totaled $43.6 million, representing a sequential increase of 12% and a year-on-year increase of 5%.

Online game revenues for the second quarter of 2009 exceeded guidance, increasing 8% sequentially and 39% year-on-year to a record $66.6 million. Revenues from game operations increased 9% quarter-on-quarter and 42% year-on-year to $64.9 million. The increases were mainly due to user base expansion and higher APA, which reflect the growing popularity of our games. We also noted that the lottery based activities related revenue only accounted for around 1% of our revenues.

Overseas licensing revenues were $1.7 million, a decrease of 27% sequentially and 23% year-on-year. The decrease was largely the result of greater competition in mature overseas markets.

Wireless revenues were $15 million, a quarter on quarter increase of 12% and a year-on-year increase of 63%, attributable to effective promotions of our products through diversified channels, including a number of TV stations.

Most of the rest of the measures I’ll be discussing will be non-GAAP. Under SFAS-123R, our share based compensation expenses are charged to the quarter cost of revenue and operating expenses. Total share-based compensation expense for the second quarter was $6.6 million. We believe excluding the share-based compensation expense from our non-GAAP financial measure of net income makes a more meaningful comparison of Sohu's operational results and improves investors’ understanding of Sohu's performance, so we use non-GAAP measures in these discussions to explain margins, cost, and expense items.

Gross margin -- overall non-GAAP gross margin for the second quarter was 78%, increased from the 76% in the previous -- in both the previous quarter and the same period last year.

Brand advertising non-GAAP gross margin for the second quarter was 68%, increased from the 65% in the previous quarter and 67% in the same period last year.

Online game non-GAAP gross margin for the second quarter was 94%, the same as in the previous quarter and 67 in the same period of last year -- and edged up from the 93% in the same period of last year.

Wireless non-GAAP gross margin for the second quarter was 45%, an increase from the 43% in the previous quarter of 2009 and 40% in the same period of last year.

Operating expenses -- for the second quarter of 2009, Sohu's non-GAAP operating expenses totaled $43.5 million, up 21% from $36.1 million in the previous quarter and up 23% year-on-year. The year-on-year increase was mainly due to increase in headcount and related cost, as well as an increase in marketing expense as explained below.

The quarter on quarter increase reflects higher sales and marketing expenses related to the Browse Sohu Know the World campaign, where amounts recorded in the second quarter were $7.5 million compared to $2.8 million in the previous quarter. We plan to spend $6.2 million and $3.5 million on this marketing campaign in the third and fourth quarters of 2009 respectively.

Operating margin -- non-GAAP operating profit margin was 43% for the second quarter of 2009, down from 45% in the previous quarter and up from 41% in the second quarter of 2008.

Income tax expense - for the second quarter of 2009, income tax expense was $8 million, compared to $6.6 million in the previous quarter. In the second quarter of 2009, we recorded a one-time income tax adjustment of $1.2 million. Excluding such adjustment, the effective tax rate for the second quarter was 14%.

Six, net income -- before deducting the share of net income pertaining to the Non-Controlling Interest in Changyou, non-GAAP net income for the second quarter of 2009 was $49 million, exceeding the high-end of the company guidance of $46 million, up 4% quarter-on-quarter and 16% year-on-year.

After deducting the share of net income pertaining to the non-controlling interest in Changyou, non-GAAP net income for the second quarter of 2009 was $35.2 million, or $0.90 per fully diluted share, exceeding the high-end of the company guidance of $0.85 by $0.05.

Net margin -- before deducting the share of net income pertaining to the non-controlling interest in Changyou, non-GAAP net margin for the second quarter was 39%, compared with 40% in the previous quarter and 42% in the second quarter of 2008. Taking out the income tax adjustments of total $4.1 million in the second quarter of last year, the non-GAAP net margin for last year would have been 38%.

Balance sheet and cash flow position -- we continued to maintain a debt-free balance sheet. For the second quarter, our businesses generated $47 million in operating cash flow. As of June 30, 2009, our cash balance was $546.7 million. All of our cash is either on-demand or in time deposits with reputable banks.

As of June 30, 2009, our net accounts receivable balance was $53.3 million, an increase of $9.5 million from the previous quarter. Brand advertising DSO for the second quarter was 73 days, compared to 69 days in the previous quarter and 52 days in the second quarter of 2008.

As of June 30th, our bad debt provision totaled $1.1 million, with bad debt expense of $433,000 recorded for the second quarter of 2009.

As of June 30, 2009, receipts in advanced of deferred revenue of our online game business was $22.6 million, compared to $21.3 million as of March 31, 2009.

I will share below with you some of the selective game operational metrics. Aggregate registered accounts for both of our MMORPGs as of June 30, 2009 increased 9% sequentially and 53% year-on-year to 69.1 million.

Aggregate active paying accounts, or APA, for both MMORPGs increased 5% sequentially and 32% year-on-year to 2.39 million.

Average revenue per user, or ARPU, for both MMORPGs increased 4% sequentially and 6% year-on-year to RMB186.

Aggregate peak concurrent users, or PCUs, for both MMORPGs was flattish sequentially and increased 23% year-on-year to approximately $950,000.

Lastly, business outlook -- for the third quarter of 2009, Sohu expects total revenues to be between $133.5 million to $137.5 million, with advertising revenues of $49.5 million to $51.5 million.

Brand advertising revenues of $48 to $50 million. This implies a 10% to 15% quarter-on-quarter growth or a negative 3% to positive 1% year-on-year growth. This will bring our brand advertising growth for the first quarter -- for the first three quarters of 2009 to between 5% to 7% year-on-year.

Online games revenues of $67 million to $69 million. Before deducting the share of non-GAAP net income pertaining to the non-controlling interest in Changyou, we estimate our pro forma non-GAAP net income to be between $50 million to $52 million, as compared to $49 million for the second quarter as mentioned above. After deducting the share of non-GAAP net income pertaining to the non-controlling interest in Changyou, Sohu estimates non-GAAP net income attributable to Sohu for the third quarter of 2009 to be between $36 million to $38 million and non-GAAP fully diluted earnings per share for the third quarter of 2009 to be between $0.92 to $0.97.

Assuming no new grants of share-based awards, Sohu estimates share-based compensation expense for the third quarter of 2009 to be between $4 million and $5 million, which includes that for Changyou of $3.5 million to $4 million. Considering Sohu’s share in Changyou, the estimated impact of this expense is expected to reduce Sohu's fully diluted earnings per share under US GAAP by $0.07 to $0.09.

Our results from the quarter show that even in a tough economic situation, we can post impressive year-on-year growth on top of the high comps in 2008. We have also been able to continue our growth trajectory with Changyou, our now independent released MMORPG gaming business, which has consistently delivered solid results for Sohu and Changyou shareholders alike.

Thank you for joining the call today. This concludes our prepared remarks and we would now like to open the call up for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from Jason Brueschke with Citigroup.

Jason Brueschke - Citigroup

Thank you and good evening everyone in Hong Kong, and congratulations on the quarter. Charles, Carol, Belinda -- I have more of a strategic question. When I look at your business and I see that you guys enjoy a very high margin gaming business, which is very fast-growing, I also see that you have $550 million in cash and you’ve had very good success early on in your brand building campaign.

When I look out over the next year or two, can you maybe give us what your strategic -- either view what your strategy is with respect to being able to deploy your cash to grow your market share and your competitive position in both the portal space, as well as the wireless value-added services space and should we expect that you will continue to invest in your campaigns to strengthen your brand and your content? Thanks.

Dr. Charles Zhang

So you said eight years?

Jason Brueschke - Citigroup

No, just the next year or two.

Dr. Charles Zhang

Oh, next year or two. Okay. Basically continue to build a comprehensive media platform. I mean comprehensive means it’s not just the traditional concepts of media but a -- not only the -- called the media 1.0, just the reporting on news but also user generated content like content provided by blogs and message boards. And also the -- the type of content, not only text-based and pictures but also the video, which we believe that in China that the state-owned television stations are not as competitive so that leaves a lot of young people basically watching video online, so it’s a very important opportunity for a [inaudible] in China. So text-based content, video content, and user-generated content, and also social networks. So recently we launched our advanced SMS products, by.sogo.com, is part of our efforts. So to build up this comprehensive media platform with many things to do, so for people to come on to the Sohu matrix so people just stay here and do not need to go anywhere else, and also to broaden the channels to deliver this content. That means people may come not only by the Sohu domain name but also through the client software, through mobile phone and through these Sogo Pinyin clients and desktop applications and through browser, Sogo browser, and the search engine and through -- you know, searching [Sohu] and also our Sogo search engine.

So this is basically for people to come and stay and just consume enough -- spend enough time and consume as many pages as possible and at the same time, not all pages are financially equal but that’s what we are going to make it equal because that means that through a financial, a good monetization system so that provides -- you know, precision targeting advertising, so that provides a -- this is also another effort.

So these will basically investment in technology, in content purchase, and in building up a quality editorial team, and also brand building. So we’ll continue to spend money on brand building as evidenced by the success of our recent brand building.

So there’s many things to do and that will probably spend some of our cash. And we basically will grow by organically -- we will probably not look into too much of acquisition. Early days we did a lot of the smaller acquisitions. Now we believe that with our current technological and product capability, I think it’s better to develop in-house and that proved to be a very viable strategy.

Jason Brueschke - Citigroup

Just a quick follow-up would be as the gaming business continues to grow and throw off tremendous profits, does that give you a lot more latitude and flexibility to invest in all of these initiatives you’ve just outlined at a much higher level than say Sohu was able to do a few years ago before the successful launch of TLBB? And should we expect, I guess is the short of it, should we expect that you will maintain a higher level of investment because of the gaming division as we look forward?

Dr. Charles Zhang

Yes. So without the game success, we wouldn’t imagine the marketing campaign that we did in this year.

Jason Brueschke - Citigroup

Great, thanks.

Operator

Your next question comes from the line of Dick Wei with J.P. Morgan.

Dick Wei - J.P. Morgan

My question is regarding your video strategy -- obviously Sohu has a very good distribution platform and can reach larger [than most] users. Can you maybe discuss your expertise in the space in terms of selecting TVs or movie content, as well as the investment plans, like the cost, the bandwidth cost, as well as the revenue related to that strategy, that would be great. Thanks.

Dr. Charles Zhang

So for our video strategy, first of all, in China the -- as I said, the TV stations program is not as competitive and a lot of young people watching video and so we spend our -- we spend more money buying quality content, especially TV series, and provide viewers these quality stories, TV series, and our cost is really -- I think the bandwidth cost is still the larger amount compared with the content but the content is really ramping up. And there’s some other video sites are trying to imitate or copy the business model of YouTube. Actually, YouTube never served as a standalone business model. In China, I think -- actually a lot of them are showing pirated content, so on one hand, we buy content and on the other hand, we provide high definition content, copyrighted content; on the other hand, we are fighting piracy together with the Chinese government and make sure that intellectual properties are protected and artists and producers and all this good quality content can be -- you know, make enough money to help generate more good content.

So that’s our strategy -- basically we provide high definition video content and buy lots of content and fight piracy and those are basically to build up a -- I’ll call it video 1.0, instead of 2.0 and let people share video, which is not very popular in China because it’s basically -- piracy basically killed that kind of business model, or the non-business model, so we basically build up an alternative to the TVs for the young people, especially when you have an on-demand where you will miss some TV series or movies on the TV, then you can type on Sohu to watch it.

We’ve seen our traffic grow, as I said, it grows by 50% in the last few months. And also because of this video surge -- surge of traffic, we’ll attract some of our advertisers by trying to advertise, try this new format, this TV commercial on the video. Also we are also attracting, in the future attracting additional advertisers from -- you know, who never spend a lot on the Internet but used to spend on TV commercials with the television station.

Dick Wei - J.P. Morgan

Great. That was very helpful. Thanks a lot, Charles.

Operator

Your next question comes from the line of Jenny Wu with Morgan Stanley.

Jenny Wu - Morgan Stanley

Thank you for taking my question. My question is regarding the online advertising from real estate. And so how much revenue contribution from that sector so far, basically for the first half ’09 and what is your [inaudible] in ’08 and in the first half of ’09? And the reason for me to ask this question is because last time you mentioned Sohu is losing market share in this sector and I’m just wondering how much share you have lost.

And I heard there’s departure of key persons in this sector, like [inaudible], and I’m just wondering, is that the major region for the market share losing?

And I probably also heard of SINA’s merger with e-house, so how are you going to incorporate this internal and external [inaudible], and what are you going to do to [round up] the business in this sector? Thank you very much.

Carol Yu

Let me just give you some statistics -- the real estate vertical accounted for roughly about 15% in Q2, and the increase from -- in Q2 as over Q1 is actually over 100%, so there’s a very nice recovery. From there we can tell that the -- that overall the new team has now been in very nice operation under the leadership of Belinda. So I would say that it’s now back to our normal [inaudible].

And then I’ll just leave -- pass the question over to Belinda to talk about the impact on e-house.

Belinda Wang

Actually for Sohu I think the revenue, we expect a full year revenue for the real estate segment to be still decreased slightly. I think for the first quarter we see a heavy impact from the macroeconomic environment and actually starting from May, we saw a blooming market for the real estate industry; however, some real estate companies are still quite cautious about spending a budget on marketing, given that there will be limited inventory for them to sell.

Regarding your question about SINA and e-house deal, I think so far we didn’t see impact on the market share but we are keeping an eye on that, how things are going on there.

Jenny Wu - Morgan Stanley

Okay. You mean now it is like 15% of total revenues, on advertising revenue from --

Belinda Wang

Yeah, for the second quarter the real estate industry accounted for about 15% of the total revenue.

Jenny Wu - Morgan Stanley

How much in 2008 -- is it roughly the same level?

Belinda Wang

2008 -- roughly --

Carol Yu

It’s actually more than that. It was closer to 20 last year.

Jenny Wu - Morgan Stanley

Okay. Thank you very much.

Dr. Charles Zhang

But compared with Q1, it showed a strong pick-up, right?

Carol Yu

Yes.

Belinda Wang

Yes, Q1 was about 7%.

Jenny Wu - Morgan Stanley

Okay, got it. Thank you.

Dr. Charles Zhang

So it’s a strong pick-up not because of the -- not only because of the macroeconomic situation but also this new streamlining of management actually under Belinda, so it is really picking up nicely.

Jenny Wu - Morgan Stanley

Okay, great news. Thank you very much, guys.

Operator

Your next question comes from the line of Ming Zhao with SIG.

C. Ming Zhao - Susquehanna Financial Group

Thank you. Good evening. Good quarter. I have two questions -- the first question, Carol, can you specify again about the marketing expense for the campaign, Browse Sohu, Know the World -- what were the expenses for [inaudible] and what is your plan for next year?

Carol Yu

Sorry, Ming, can you speak up?

C. Ming Zhao - Susquehanna Financial Group

Okay. My first question is about your marketing expense on the campaign Browse Sohu, Know the World -- what are the expenses for 2Q through 4Q and what is the plan for next year?

And secondly, heading into the second half, on the advertising spending, do you think that advertisers will spend more just to finish their annual budget towards the 4Q and do you have any outlook for ad spending for next year? Thank you.

Carol Yu

I’ll take the question on the marketing spend and then I’ll defer the other two to Belinda. In Q1, we spent $2.8 million. Q2 is 7.5. Q3 we plan to spend 6.2 and then Q4 is 3.5.

Belinda Wang

Regarding your second question about the revenue picture for the year of 2010 -- right, next year?

Carol Yu

Second-half of the year first.

Belinda Wang

Oh, second half -- yes, we have given the color for the full year 2009 earlier; that is, we expect a 5% to 8% year-on-year growth for the year of 2009. For the next year, I think we are -- we cannot see a clear sign on the change of the macroeconomic environment. Although the Internet user base keeps growing, I think so far it’s still quite difficult to make any judgments on the revenue growth for the year of 2010.

C. Ming Zhao - Susquehanna Financial Group

Okay. Carol, just a follow-up -- what’s the plan for that campaign next year? Is that an ongoing campaign every year?

Dr. Charles Zhang

I think because Sohu is probably, in my words, basically we entered into the -- we are the finalist, one of the few Internet companies in China and it’s getting more and more competitive and to become basically the major league and in order to do that, I think we need to maintain a certain level of marketing campaign every year, so we will probably do it again next year.

C. Ming Zhao - Susquehanna Financial Group

Okay. Thank you very much.

Dr. Charles Zhang

And hopefully the [games are] generating cash for us. But I think we also -- I think our portal business will not only depend on brand advertising, I think brand advertising will also become more -- will evolve into more a kind of advertising rather than just a brand advertising. And also we -- I think the search advertising and precision marketing will make our advertising business more growth engine -- I mean, more a driver but that will depend on whether we can have a very good understanding of user behavior and the precision marketing technology system. And it also depends on how the Sogo traffic and Sogo search engine fare, [what they are doing].

C. Ming Zhao - Susquehanna Financial Group

Okay. Thank you.

Dr. Charles Zhang

And also, there’s also the wireless side, where there will be in addition to the traditional value-added service revenue, which is having a nice growth this quarter, as mobile phones become more sophisticated and bandwidth becomes broadened, and people use mobile phones to do more Internet browsing and Internet activities, I think there will be additional user acquisition and revenue opportunity I think will appear in -- I think in 2010, wireless side. Finally, the wireless Internet and the PC-based Internet are starting to merge in some way.

C. Ming Zhao - Susquehanna Financial Group

All right. Thank you.

Operator

Your next question comes from the line of Kathy Chen with Goldman Sachs.

Kathy Chen - Goldman Sachs

Thanks for the call. I have a question again on the advertising side -- if you could talk a little bit more about what you are seeing for the auto vertical, I didn’t hear earlier any guidance for the full year for auto advertising revenue. I’m just trying to get a sense of, for the full year, where the total advertising growth of 5% to 8% is coming from, given that real estate and online games are both expected to decrease slightly. Could you share how much other advertising contributed to the total revenues in the first half of this year, as well as for the full year last year? Thanks.

Carol Yu

We don’t want to give out really that specific numbers for each and every verticals. But in general, and you are right -- I mean, the bulk of the growth that we are seeing that we gave out for the 5% to 8% is coming from our auto verticals as well as from FMCGs.

Kathy Chen - Goldman Sachs

Okay, and then can you share how much it contributed so far, year-to-date?

Carol Yu

Well, like what we said, I mean, the three verticals contributed for over 50% of our total revenue, brand ad revenue.

Kathy Chen - Goldman Sachs

Okay, thanks.

Operator

Your next question comes from the line of Gene Munster with Piper Jaffray.

Gene Munster - Piper Jaffray

Good evening and congratulations. If you could talk just about the pricing side, how price has been trending. And second is you’ve obviously given some detailed guidance of branded growth in the quarter, what -- how we should think about branded growth in Q4, so how is pricing trending and branded growth for Q4, just some general thinking on that. Thank you.

Belinda Wang

I think for the third quarter, we will keep a flat pricing compared with the second quarter. So at [inaudible], we will adjust our pricing starting from the fourth quarter.

Gene Munster - Piper Jaffray

Okay, and then pricing will be adjusted in the fourth quarter, is that --

Belinda Wang

Yes, starting in early October.

Gene Munster - Piper Jaffray

Okay, so I assume that it goes up in the quarter?

Belinda Wang

Yes.

Gene Munster - Piper Jaffray

Okay. And up consistent with normally what it’s been changed in the past?

Belinda Wang

Yes, we keep it flat compared with the second quarter.

Carol Yu

Yes, we do the same thing every year, Gene.

Gene Munster - Piper Jaffray

Okay, great and then just [inaudible] branded in Q4?

Carol Yu

Yes, we raise prices in Q4 every year.

Operator

Your next question comes from the line of Eddie Leung with Banc of America Merrill Lynch.

Eddie Leung - Banc of America Merrill Lynch

Good evening, everyone. Just a couple of questions -- the first one is on the online video front. Longer term down the road, is it possible that we will see some in-house production from Sohu in terms of content, or some investments in movies or drama series?

Dr. Charles Zhang

No. Well, basically now we are basically like shopping around for good content when -- especially when this industry really starts booming and there’s so many producers and movie houses producing many, many movies and TV series and we just shop around and find the best and we find the most popular one, and so that’s the most effective way to do that.

As our traffic continues to grow and we have a huge user base for online video, then we may in the future to invest or to produce some stories or features, pictures our selves but that depends on -- that has to be -- there’s the assumption that we have a huge user base so that every picture we produce, then it has a return on investment that is enough but mostly we still -- we will in the foreseeable future, we will basically purchase content as our main strategy.

In the U.S., the TV industry -- the U.S. TV industry provides a good history and example, in the pre-Internet days where all these major media companies eventually end up purchasing some movie houses. That’s something that we could do in the future.

Eddie Leung - Banc of America Merrill Lynch

Yes. Charles, could you also talk a little bit about your strategies to compete with search engines? Because we have been hearing some changes in major advertisers’ budgets towards search engines. Can you talk a little bit about your thoughts on competition between portals and search engines?

Dr. Charles Zhang

I think our -- on two fronts; first of all, on the user side, we will broaden the channels of our content delivery. That means that for the Sohu content, the videos, the text, and the communities, the message boards, the blogs, all these activities are much richer applications than search engines, so we need to have more delivery channels for these activities on Sohu. That means people will browse, people will browse using our browser, people will use the Sogo Pinyin and people will use other means to reach Sohu pages rather than just typing in sohu.com -- www.sohu.com, so this is -- one, it’s basically to let our content to be delivered in many ways to as many people as possible.

Of course, we also have our own search engine that we have observed a surge in traffic in the first two quarters this year. And also a nice small -- still small but nice run-up of, growth of the search engine revenue.

So these are -- of course, the search engine, as I said, is one of the channels, the deliveries that I was talking about.

Secondly, I think we need to improve the monetization percentage or monetization level of all these rich content sites, the rich activities rather than search engine keyword. That’s what I was talking about, the precision marketing.

Eddie Leung - Banc of America Merrill Lynch

That’s very helpful. Thank you.

Operator

Ladies and gentlemen, we are now approaching the end of the conference call. I will now turn the call over to Sohu's investor relations representative from Ogilvy Financial, Mr. Derek Mitchell for the closing remarks.

Derek Mitchell

Once again, thank you all for joining us on today’s call. If you have any follow-up questions, please do not hesitate to contact Sohu at ir@contact.sohu.com. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a good day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Sohu Q2 2009 Earnings Call Transcript
This Transcript
All Transcripts