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Youku Tudou (NYSE:YOKU)

Q3 2013 Earnings Call

November 14, 2013 8:00 pm ET

Executives

Ryan Cheung - Corporate Finance Director

Cheung Koo Wing - Founder, Chairman and Chief Executive Officer

Dele Liu - President and Director

Ge Xu - Chief Financial Officer and Senior Vice President

Analysts

Muzhi Li - Citigroup Inc, Research Division

Alex Yao - Deutsche Bank AG, Research Division

Alicia Yap - Barclays Capital, Research Division

Alan Hellawell - Deutsche Bank AG, Research Division

Dick Wei - Crédit Suisse AG, Research Division

Eddie Leung - BofA Merrill Lynch, Research Division

Philip Wan - Morgan Stanley, Research Division

Jiong Shao - Macquarie Research

Yu-Heng Fan

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2013 Youku Tudou Inc. Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Friday, 15th of November 2013. I will now like to hand the conference over to your speaker today, Mr. Ryan Cheung, the Corporate Finance Director. Thank you, and please go ahead, sir.

Ryan Cheung

Thank you, operator, and welcome to our Third Quarter 2013 Earnings Conference Call. Let me introduce the management team on the call today. They are Chairman and CEO, Victor Koo; our Board Director and President, Dele Liu; and Michael Xu, our Chief Financial Officer and Senior Vice President. For today's agenda, Victor will kick off with a strategic overview of our multiscreen online video platform and sales performance in Q3. Dele will discuss our company's operations and content strategy, and Michael will discuss the third quarter 2013 unaudited financials. And then we'll open up the floor for questions.

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

I refer you to our Safe Harbor statement in our earnings press release, which applies to this call, as we will make forward-looking statements. In addition, please also refer to our Basis of Presentation sections on our press release. Finally, please note that, unless otherwise stated, all figures mentioned during this conference call are in renminbi.

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

Cheung Koo Wing

Thank you, Ryan. Good morning and good evening, everyone. Thank you for joining us. Highlights for the third quarter were in line, net revenues of RMB 858 million, up 14% quarter-on-quarter and 55% year-on-year on a pro forma basis, excellent growth in mobile traffic and further economies of scale for the group. We are solidly executing on plan this year, and we are well on track to achieve all financial and operational benchmarks for this year. Our business is moving rapidly ahead as online video becomes mainstream in China. Our leading position as the #1 multiscreen online video company in China remains strong and unchallenged. As the clear industry leader and in view of exciting opportunities in this sector, we continue to strengthen the foundation of our business model to further diversification in 3 areas: our traffic, our content and our revenue.

Let me discuss each of these in more detail. Let me first give you more color on the diversification that we see in our traffic growth. This is driven by wider availability of video on multiple screens, as well as our operation of 2 distinctly branded platforms for Youku and Tudou. In the third quarter, the spectacular growth in our mobile traffic that we enjoyed in the first half of the year continued for both Youku and Tudou mobile apps. Daily mobile video views for Youku reached over 300 million in November at an increase of more than 300% as compared to the beginning of this year. Importantly, close to 90%, 9-0 percent, on mobile video views came to our application. Our research data in September shows that Youku app daily reach and user engagement continue to be well ahead of our competitors. Meanwhile, Tudou's mobile video views grew rapidly in the third quarter, increasing more than 50% quarter-over-quarter, driven by Android and iOS product upgrades.

Let me take a long-term view performance regarding our traffic diversification. As video is a key function of the mobile Internet, we are excited about the rapid growth of our mobile traffic and success to date in capturing the majority of video views through our apps. Within these apps, we see more and more users come to our app directly to find, watch and share videos. According to our research, Youku app is in the top 10 most visited mobile apps in China on a monthly basis and the only online video app within the top 10. In addition, the iResearch data show Youku app is within the top 5 mobile apps in China, based on user time spent across all categories. Other apps within the top 5 include WeChat and QQ mobile. In short, we believe we are laying the foundation to become one of the major traffic gateways for the mobile Internet in the near future. As we rapidly grow our traffic from wider multiple screen use, a second point to make on our traffic numbers is that they reflect how well our approach of operating 2 differentiated brands within one company is working. Our clear strategy in favor of more additional and user-generated content versus head content, which I outlined last quarter, is making the Youku and Tudou brands stronger as they become more distinctive. We ensure that original content is produced to be a good fit for either Youku's more mainstream and positive culture or Tudou's young and edgy brand appeal. Particularly, I would like to emphasize how unique Tudou's positioning is as a youth brand. There is hardly any equivalent in China for the young and stylish yet daring image that is associated with Tudou, and we believe much of its branding potential is still untapped. In addition to this distinctive original content, we noticed that users of Youku and Tudou upload different types of user-generated content. This UGC, in turn, further reinforces the separate identity of the 2 brands and engagement by our users. This increased brand distinction of Youku and Tudou helps us grow our user base and widen our reach in China.

Let me now turn to the second major area of diversification, that of our content. Our vision of online video that allows people to watch anything, any time, anywhere on any screen is rapidly becoming a reality. As a result, we see user behavior rapidly changing. As I already mentioned last quarter, we see more video consumption spread out throughout the day, and users watch a larger variety of content genres now that they have become so evenly accessible on various screens. For example, the contribution from head license TV serial drama to our traffic is only less than 10% of our entire traffic. So we are notably less reliant on this content compared to our peers. We believe our strategy in devoting more on original content, UGC, partner-generated content, PGC, and our vast library was right. In addition, our latest initiative to attract partner-generated content is also well received. Dele will update you with more details on this revenue-sharing program with our content partners. The point I would like to make now is that Youku Tudou is at the forefront of bringing web-based, creative and professional content, targeting multiscreen Internet users as their tastes evolve, along with new technological possibilities.

And thirdly, the diversification of our traffic and content is helping us build more revenue streams. The overall brand advertising environment in China continues to show progress. During the quarter, we had 482 active brand advertisers, of which 128 were new clients, including Tudou China, Bentley Motors, Kunming Airlines, Huayi Brothers, Galant [ph] and Monichi [ph]. FMCG remains our largest ad category, but we saw rapid traction in the e-commerce category. Beyond the traditional brand advertising, we see new trends in the market and opportunities for us to diversify our advertising revenue. As mobile Internet takes center stage and advertising on multiple screens is gaining momentum, we see new categories of advertisers emerge with our multiscreen advertising package rollout. What, with such new category of advertisers, is mobile apps that are looking for ways to be branded and promoted on mobile phones. We see the mobile gaming and e-commerce sector presenting a larger advertising opportunity on mobile than on PC, and demand for our platform based on data-driven analytics is a potential new sales product that can help us sell our mobile inventories out to advertisers.

Our sales effort year-to-date to diversify our advertising revenues is showing results. We see more brands embracing mobile video advertising. We also launched performance-based advertising products on mobile in Q4, and the initial response from our advertising partners are positive. We anticipate to see good traction at the latter part of Q4. Our PC sell-through rates in lower-tier cities have increased significantly, and pricing power in the first- and second-tier cities remain strong, while agency rebates have been gradually decreased in the course of 2013. Meanwhile, we are making progress in selling our content marketing solutions. We won new brand sponsorships and product placement in the last quarter, notably Master Kong, Lenovo, Huang Yo, Nestlé, Wrigley's and Nabisco. Clients who bought our content marketing solutions in the first 3 quarters of this year more than doubled from the same period last year. Finally, we are offering new advertising opportunities through interactive ad formats.

On the user monetization front, we continue to enrich our content library with domestic and international movies under our paid services channel. We established payment gateways with multiple online payment services, including Alipay and WeChat payment to improve the payment experience for our users. We have also introduced a few original content under our paid services, for example, Hip Hop Trio and the talk show of, Fu Le Gan [ph], a famous comedian in China, and we see strong interest from our users to pay online. Along with these improvements for our consumers, we recorded a notable increase in new memberships and orders in the past quarter, which resulted in our paid services reaching breakeven point.

The diversification of our traffic, content and revenue continues to be a work in progress, and we will make adjustments when needed, as the market and technology changes, presenting new opportunities and challenges. But for now, our solid Q3 results show that we are on the right track and executing well on plan.

With that, I will now turn the call over to Dele to go over our content strategy.

Dele Liu

Thank you, Victor. Hello, everyone. As we continue to grow the top line and increase our multiscreen viewership, the scalability of our business model for the group has become more pronounced in the third quarter. Bandwidth cost grew 11% quarter-over-quarter, despite rapid growth in traffic driven by mobile. As a percentage of revenue, bandwidth cost decreased to 21%. We expect to see moderate increase in bandwidth cost in the fourth quarter. As we mentioned before, unit bandwidth cost will structurally continue to decrease due to technology innovations in data compression and network architecture. Personnel-related expenses saw a moderate increase quarter-over-quarter as we expected, with stable headcounts and some increase in cost and benefits following mid-year promotions and adjustment. In the fourth quarter, we also expect moderate growth in personnel-related expenses.

On content, our balanced approach in securing a reasonable share of head content, and strengthening our provision in self-produced content, saw notable progress in the third quarter. We are the clear leader in professional syndicated content, with the most comprehensive content portfolio in the industry. We are leveraging our scale to generate record traffic for the content we bought. For example, Little Daddy, a drama broadcasting simultaneously with [Chinese] dragon TV, recorded 100 million videos viewed in the first 3 days of broadcasting, and the total view count is over 1 billion to date. At the same time, we are relying less than before on premium licensed content to generate traffic. As a larger variety of content has become available, percentage-wise, our users generally are watching less of the highly-priced licensed content, specifically domestic TV drama series. To reflect the change of head content, our content consumption patterns for hot current content, we changed our accounting estimate and accelerated our content amortization schedule. All our licensed TV dramas and movies are now amortized under this new accelerated amortization schedule, and this new amortization schedule would need to apply prospectively to previous quarters' amortized content. Michael, later, will provide you more details on this.

Evidently, users increasingly favor the comprehensive library of contents we have built in the last few years. We are the dominant leader in user-generated content, original content and library content. Besides Hong Kong TV serial dramas, for which we have already established a long-term exclusive relationship with TVB, we are the leading online video destination for American, Korean and Taiwanese TV serial dramas and variety shows. Our original web comedy series, [Chinese], was launched in August and with a resounding success that has reached a record high of over 250 million videos viewed within only 3 episodes. Other popular original content productions, including [Chinese], constantly ranked as the top 10 show in its content category on our platforms. We made further progress in building our UGC ecosystem that differentiates Youku and Tudou from our peers, and that is the largest platform for UGC in China.

Last quarter, we talked about the launch of our content partner program to share advertising revenue with content partners for the content they upload. We launched the program to encourage China's creative grassroot video producers to share their work with the wider audience. This new revenue-sharing program is a salary [ph] team UGC growth in China, providing content creators with direct financial return. Since the launch in June, we have attracted 600 partners, and videos viewed of their production within this program have grown by 30% on a monthly basis. All these initiatives underscore that Youku Tudou is the go-to place for users, as well as creators of original content, making us the largest, most dynamic and innovative video content platform in China.

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

Ge Xu

Thank you, Dele. I'm going to walk you through our financial highlights for the quarter. The amount mentioned here are in RMB unless otherwise noted. Before we drill down to each line item, you should be aware that Tudou's financial statements of operation for the third quarter of 2012 consist of stand-alone historical financial information for the period from July 1, 2012 to August 12 -- 22, 2012, and the consolidated financials information with this adjustment for the period from August 23, 2012 to September 30, 2012. We don't believe that comparison of company's financial results with the corresponding period in 2012 can be provided on a consistent basis. For ease of reference only, we present comparison of our financial result for the third quarter of 2013 and the second quarter of 2013 in this press release only for this quarter.

For the third quarter, our net revenue were RMB 858 million, a 14% sequential increase, meeting the net revenue guidance previously announced by the company. Advertising net revenue were 748 -- RMB 745 million, also in line with our guidance.

Bandwidth costs were RMB 182 million, representing 21% of the net revenue, as compared RMB 164 million, representing 22% of the net revenue in Q2. As Dele has mentioned, our accumulated traffic data of TV series drama and movies reflected a new consumption pattern, and we have adjusted our accounting estimate on content cost amortization accordingly. This resulted in further accelerating both our content cost for the head content starting from the third quarter of 2013. If we had not adopted the newly adjusted amortization estimates, RMB 334 million would have been recorded in the third quarter of 2013, which is RMB 144 million lower than the reported figures

Non-GAAP gross profit was RMB 100 million. If we hadn't adopted the newly adjusted amortization estimate, a non-GAAP gross profit of RMB 245 million, a 20% sequential increase or 29% of the net revenue, would have been recorded in the third quarter of 2013, which is RMB 144 million higher than the reported figures.

Non-GAAP operating expenses were RMB 272 million, a 4% sequential increase. Detailed discussion of this component of operating expenses is as follows: Non-GAAP sales and marketing expenses were RMB 157 million, a 5% increase sequentially. Non-GAAP product development expenses were RMB 68 million, a 23% increase quarter-over-quarter. This increase was mainly due to a reclassification of a portion of expenses from G&A into product development. Non-GAAP general and administrative expenses were RMB 47 million, a decrease of 15% quarter-to-quarter. This is also because of reclassification of a portion of G&A expenses into product development expenses.

Non-GAAP net loss was RMB 159 million in the third quarter of 2013. If we have not adopted the newly adjusted amortization estimates, a non-GAAP net loss of RMB 15 million, a decrease of 65% sequentially, would have been recorded in the third quarter of 2013, which is RMB 144 million lower than the reporting figures.

Turning to the cash flow items. As of September 30, 2013, our cash, cash equivalent, restricted cash and short-term investments totaled RMB 3.2 billion. Our acquisition of intangible assets for the quarter of -- for the third quarter of 2013 was RMB 172 million.

Looking out to the fourth quarter of 2013, we expect that consolidated net revenue will be between RMB 860 million and RMB 900 million, which implies a 35% to 42% year-on-year increase, with consolidated advertising net revenue contributing between RMB 780 million to RMB 820 million, which implies a 36% to 43% year-on-year increase. Even though we don't give formal guidance on the bottom line, based on our projected gross momentum and the scalability, we expect to achieve non-GAAP profitability in the fourth quarter.

I will now turn -- open the call for the questions. Operator, please go ahead.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Muzhi Li from Citigroup.

Muzhi Li - Citigroup Inc, Research Division

I have 2 questions. The first one is about the content price, pricing trend in 2014. Would the management see the pricing trend will be normalized as if in 2013, or it could further move into a downward trend secularly? And the second question is about the content marketing solutions. Can you give us some example about how Youku will carry out the content marketing solutions? And what's the impact and the potential market size of this product?

Dele Liu

Great. This is Dele Liu. I will take up the content question. The price of the TV dramas stabilized at a high level since the beginning of this year as we had reported. The price -- actually, the current price is not making gross profit or any profit. However, we also saw a recently significant price inflation that has been in variety shows. As we have reported to investors since the first quarter this year, our content strategy is to re-differentiate our portfolio to offer more time-engaging, web-based content instead of relying on TV content, for which we have limited marketing power. TV content, on the other hand, are actually getting less and less -- through Internet offing in China, as the restrictions on TV shows are actually stronger. So today, as Michael mentioned, top domestic TV dramas accounts for less than 10% of our traffic. We will continue to build the common ecosystem so that our user-generated content, partner-generated content will contribute as the majority of our content, therefore achieving for us, top of the world.

Cheung Koo Wing

This is Victor here. Let me comment on the content marketing solutions, which is heavily tied to the original content and the PGC content strategy that we laid out before. As I mentioned also in the call, given the very strong brand differentiation of Youku and Tudou, we're producing differentiated original, as well as working with partners, PGC content, that are increasingly popular, as well as maintaining group brand over the last 4 to 5 years. And because of the distinct positioning, for example, mainstream brands versus young and edgy brands, different categories like to work with different programs in terms of sponsorships, product placements, targeted advertising and many different formats that are highly attractive, to the extent that we could only have hard advertising slots for TV content. With original content PGC programs, we have a lot more advertising inventory, shall we say, and actually can serve a variety of needs of our advertisers. Hard advertising is great for reach and frequency, and -- but it's not very good in terms of building brand engagement, as well as affinity. And that's why top lines, whether domestic and international, like working with Youku Tudou because of the video -- visual impact of video, as well as the storytelling capabilities of original content and PGC. Let me cite some examples. We mentioned before Tudou Groovin', which is a very hip midweek [ph] show, which works with, for example, the MTV equivalent of the Korean And Next [ph]. And because these young power brands are highly associated and actually, in all the stores around China, that they broadcast Tudou Groovin' show. Youku also has a very strong record in terms of talk shows, as well as web series, as well as micro movies. And this year, we've also had a very successful film marketing solution program, working with all of the top movie companies as well. We've got style review shows, as well as movie ranking shows that are increasingly popular with advertisers, as well as film companies.

Muzhi Li - Citigroup Inc, Research Division

I see. A follow-up -- a quick -- very quick follow-up is about what's the current revenue come -- generate from the PGC content?

Ge Xu

Actually, in terms of our legal content and -- I think it will be around maybe 4% to 5% currently, but it's growing very quickly.

Operator

Your next question comes from the line of Alex Yao from JPMorgan.

Alex Yao - Deutsche Bank AG, Research Division

I have 2 questions on the mobile video. Number one is on the traffic side. You guys obviously showed a very strong growth compared to the -- at the beginning of the year when you had a 1 million daily unique visitors. So what is driving such a strong growth momentum behind the mobile traffic? And how do you compare your competitive positioning to the peers? Secondly is on the mobile video advertising monetization. Can you give us an update on this initiative? What percentage of the revenue currently is from mobile? And you guys also talked about performance based -- the mobile apps product to be launched in the fourth quarter. Can you give us a little more update on this product?

Cheung Koo Wing

Sure. This is Victor here. Let me comment on mobile. We started working on mobile actually back in 2009. But for the entire video industry, because it's a data-intensive application, the traffic started really taking off after text and picture applications like social, and really, I would say, started in roughly second quarter of 2012, where we see a very quick acceleration of traffic in the last 5 to 6 quarters. And we reached 100 million video views at the end of last year, and we see increased acceleration. So the whole market basis is growing very strongly, but we are growing months -- faster than competition, I think, in a variety of reasons. First of all, I think in terms of a comprehensive library, the #1 brand, as well as cross-using screen experience. It makes us unchallenged in this area in terms of growth. Because what we found is that users actually, at different parts of the day, use different screens to watch videos. And because you have cloud-based -- cloud features that we have, basically, we can track the users in terms of giving them recommendations, in terms of giving them memory functions of what they've been watching, which episode they've been watching. The other interesting aspect is that they found that even on mobile screens, people are watching a variety of long and short programs. For example, a 40-minute show, they may be watching 20 minutes on their way to work and 20 minutes on the way back from -- to home. And then the fact that you're with the service, when in your different settings, with different screens, our advantage across screens is becoming increasingly network effects. So this is something that we feel very happy about, and you're seeing accelerating traffic because of network effect that you're seeing as well. Now in terms of monetization, I mentioned after we reach 100 million video views at the end of last year that this is the first year of mobile monetization, similar to what we said 2008 was the first year of PC monetization. And as you recall -- and there is 2 sides of this; there's the B2B side, and there's the B2C side. With B2B side, in terms of advertising, monetization on the mobile, there are quite a few things needs to happen. Of course, very similar to PC, training or in terms of education and communication with all the advertisers, the agencies, as well as our internal team working with third-party agencies in terms of establishing measurements, as well as standards. And also, on the mobile side, in fact, there are actually a lot more products that you can launch associated with monetization versus PC. Like this quarter, in Q3, we launched our in-house app center, and we expect to launch our in-house game center in Q4. And there are a lot of -- as the case, that we need to work with a lot of mobile advertising agencies. So there's multiple things that need to happen before revenue can take off. And we see high potential in this area but it takes time to execute. But we're on the right track. On the consumer side, you also see a lot of opportunities, too, as we are launching these services this and next quarter.

Operator

Your next question comes from the line of Alicia Yap from Barclays.

Alicia Yap - Barclays Capital, Research Division

My question is regarding the content amortization schedule change. So I wanted to clarify. That's only applied to your professional content that you acquire, right? And will not be applied to your in-house-produced content? And then with that, can we get a rough outlook on the upcoming TV drama or the movie content that will be released in the coming quarters, so we can have a better sense on how should we look at the content line impact on the P&L going forward? Will there be some volatility of the some content cost recognitions in the future?

Ge Xu

Okay. So yes, you are very right. That acceleration of amortization applied to professional content only. And for the PGC, UGC and in-house production, they follow a different rule. And in terms of -- to be more specific, the previous amortization rule is 70% for the first year, 20% for the second year and 10% for the third year. Under the new rule, the -- most of professional content will be amortized, 92%. The cost will be amortized into P&L by 92% in the first year and 8% for the second year. So this reflected kind of multiple reasons having this. One is -- so one of the key reason is, for example, the broadcasting cycle is getting shorter on a traditional TV station. It's from 2 series per -- 2 episodes per day to 3 episodes per day. So -- and also, a lot of the TV dramas may not be that successful, and they're getting -- the traffic is getting -- the long-tail traffic are kind of getting shorter in the TV dramas. So anyway, in terms of 2014 and the Q4 impact -- 2013 Q4 impact, I would say it will definitely making more -- causing more cost in -- amortized into P&L, if assuming everything else being equal. But just like Dele said, we are moving away from the head counting. As long as we keep the fair share and we are putting more focus on UGC, PGC and in-house production, that will not affect -- actually, it will not affect our long-term sustainability of our long-term profitability.

Cheung Koo Wing

Let me add a quick comment here. I think that our overall management and finance teams' philosophy is to make sure that our financials reflect the real economics of different categories of content for investors to fully understand different categories of content and what the basic economics are. We understand for any business that you should have some boss, leaders in your overall store -- or virtual stores, shall we say it. But having a fairly high concentration like our peers do, I think it's very problematic and can -- and we don't really see a path to profitability in any kind of time frame. And so I think we are moving away from this strategy 2, 3, 4 years ago, and so we want to make sure that all these economics are reflected to the investment community.

Alicia Yap - Barclays Capital, Research Division

I see. Can I just clarify a couple of things that Michael just explained? So first of all, is this additional RMB 144 million that we cannot recognize in 3Q, is this a little bit more one-off retrospective to some of the schedule that we have to counter for in the past quarter? And you mentioned also, I think, given there will be more new TV dramas will be coming out, so in 4Q and now that -- if I'm reading right, is it 4Q also will be a relatively high cost?

Ge Xu

Can you repeat your question?

Alicia Yap - Barclays Capital, Research Division

Sure. I didn't -- in the press release, you mentioned that if we would have kind of like amortized on the normal schedule, the -- I think the content cost would have been RMB 144 million lower. So I just wanted to clarify. Is this because we actually accelerated retrospective to some of the quarters that happened before to make it the same schedule, so that there was a onetime cost that's associated with that, that's recognized in 3Q?

Ge Xu

Yes, basically your understanding is right.

Alicia Yap - Barclays Capital, Research Division

I see. And then what happens for 4Q? I think if I hear it right, we will also have some new content that is releasing? And how should we look at these costs portions in 4Q?

Ge Xu

Just like I said, the new release will follow the same kind of amortization schedule, which is 92% for the first quarter -- first for the first year and 8% for the second year.

Alicia Yap - Barclays Capital, Research Division

Okay. And then my second question is on -- a follow-up on the mobile monetization. Because we do have a lot more -- the UGC and PGC type of content. Should we assume we actually are at a relatively better position than our peers to monetize the mobile video views?

Cheung Koo Wing

I think that's a fair point. The -- part of the reason that our mobile leadership is extending is the fact that users, one that -- comprehensive library in different times of the day, they're looking for different content at different times of the day. And the other fundamental difference, I think, is most of mobile application based for us, over 90%, versus what base, which means -- then defined, and search behavior actually helps -- actually happens natively within the app itself, and so whether it's find, interact or watch, it's all within the app itself. And that's why in terms of time spent, we're already the #4 app in all of China, all these apps in China.

Operator

The next question comes from the line of Alan Hellawell from Deutsche Bank.

Alan Hellawell - Deutsche Bank AG, Research Division

Really, I just wanted to get a sense from you what your house view might be around the feasible implementation of 4G in China. It's clearly going to present a nice step-up in usage and monetization. When you think that might happen, how we should think about the change in behavior and the monetization opportunity?

Cheung Koo Wing

Thank you, Alan. If we look at the media coverage, there's a lot of discussions about the about 4G licenses being issued late this year, and that the operators will start embracing it next year. So there's a projection indicating there -- it's anywhere between 400 million to 450 million new mobile phones coming in next year. So next year, we will continue to see very strong mobile growth. That will also help in the overall context of mobile monetization and -- which will actually bring multiscreen video to a much, much more mainstream basis. When you're looking at the mobile phone screen, the PC screen and the tablets, on a composite basis you get -- that's moving from 450 million, 500 million, 600 million, going up very, very quickly in terms of overall reach as a core native solution. And the other thing that's quite important, and we are dedicating a lot of energy working with our agencies and clients is for them to understand, especially for consumer products, that our daily use, as well as in-house items, the fact that mobile phones are close to -- at all -- close to where they shop, where they eat and drink and where they consume, and eventually, is actually quite significant. And we need to develop new marketing solutions that will help them achieve their marketing objectives.

Operator

The next question comes from the line of Dick Wei from Crédit Suisse.

Dick Wei - Crédit Suisse AG, Research Division

I've got 2 questions. The first question is that -- maybe if management comment a bit about the seasonality for next quarter. It looks like the fourth quarter may be a little bit softer in terms of seasonality. I'm not sure if that is on the back of market or on the back of more of the competition. And then like -- the second question is on this -- I guess on this lawsuit with Baidu. So I just want to get an update on that as well.

Cheung Koo Wing

Thanks, Dick. Let me comment on seasonality for the overall FMCG category, where -- which is our core category. Actually, it has been relatively soft, I think, over the last quarter or so. So I think that's reflected, and -- but as we move forward in 2014, I think the key part here is mobile monetization, how to develop local advertising clients, as well as content marketing solutions, and how that -- those fit together. On the second question, you're correct to point out that a group of leading video companies, including ourselves, Tencent and Soku video, MPAA, which represents all the Hollywood studios, as well as the leading film and television production companies, such as Alight [ph], Huayi, as well as Wanda [ph]. All these leading film companies have come together on an online video industry antipiracy alliance. And on Wednesday, we announced basically multiple lawsuits to Baidu video as well as QVOD, because we are seeing that rampant piracy on these services on both the mobile screens, as well as PC. On the overall copyright, as well as intellectual property, we've seen a lot of improvement, and I think with the industry working with the government authorities, where a lot of the smaller websites, as well as the DVDs on the street have been cleaned up a lot better, comparing years ago. But we're still seeing a smaller number of P2P-based services, like the one I mentioned, that still has a rampant piracy of content of video websites, as well as both domestic and U.S. movies. Quite a few of which are actually current movies being shown in the cinemas, as well as other inappropriate content on these P2P-based client software. And this has been a long-term problem for the industry, and this is something that a lot of people have had complaints about. And basically, the alliance came together pretty quickly, because we're seeing a lot more people working to push their intellectual property rights and then less and less services remaining that are still pushing this rampant piracy.

Dick Wei - Crédit Suisse AG, Research Division

Got it, great. Maybe if I can -- just to have it squeeze in like one small question. I think a lot of the market players in the space getting into more serious, into like smart TVs and set-top box. I wondered what is Youku's strategy in making sure that we are still going to be a market leader right in this smart TV as maybe, gradually, over the next couple of years, more users are going to enjoy their TV over the large screen TV?

Cheung Koo Wing

Thanks, Dick. It's very similar to mobile screen. We've actually -- when we worked on this a couple of years before the market really took off, we've had a team dedicated to the big screen, working on our HD app for a period of time, and we worked with industry players, the leading industry players pretty diversely. And the way that we think about it is, I guess, in the U.S. parallel, become a Netflix-like strategy. But I think, overall, this is an area, as most people know, that's highly regulated and a lot of sensitive topics. Having said that, we still see smaller players in our industry are launching products in this area, but also getting a lot of -- into problems with SARFT, as well as other license holders. So we wanted to make sure that we are pushing our strategy in association with license holders and in accordance with SARFT policy, and we're making very, very solid progress here.

Operator

The next question comes from the line of Eddie Leung from Merrill Lynch.

Eddie Leung - BofA Merrill Lynch, Research Division

I have 2 questions. The first one is about your revenue and traffic dependency on the top-tier cities. We have heard various industry players saying that the inventory in first-tier cities cover running out quite far. So could you give us an update on the utilization in the first-tier cities? And how you are going to address this problem? Are we going to see any raise in CPM price getting into next year? That's my first question. The second question is, I might have missed some of the metrics, could you remind us on your traffic and revenue mix from the professional content. As you mentioned that you guys probably would try to diversify away from this type of content?

Cheung Koo Wing

So let me take the first part here. It's Victor. In terms of sell-through rate for top -- first- and second-tier cities, it's significantly higher than the nationwide, as well as third and fourth cities. But from a business standpoint, we have -- actually, both are positive when you have high [indiscernible] your pricing power. And as you mentioned, on the first- and second-tier cities, basically, a lot of the inventory for most of the video websites are very high utilization, shall we say. And since we are the market leader with the most inventory, also with high utilization, we continue to have very solid pricing power in this area. And as we push and work more towards local advertisers, we are also seeing the utilization and sell-through rate for second and third cities, as well as nationwide buy improving over time. And this is an area that is growing and will continue to see progress.

Ge Xu

So as for the revenue contribution and traffic contribution from professional content, to put this way. You -- within the professional content, we -- you have both head content and body and tail. So what really matters in terms of cost is head content. We define head content as the TV dramas broadcasted simultaneously with the traditional TV station. And I don't think that we can give very specific figure on this conference call because of commercial reasons, but what I can tell you is in terms of traffic contribution, in terms of revenue contribution, the so-called top TV drama accounts for either low-double digit or single -- high-single digits in terms of revenue and the traffic. And in terms of budget, of course, they account for a majority of the contract valuers from each year in -- before -- for 2013 and 2012.

Operator

The next question comes from the line of Philip Wan from Morgan Stanley.

Philip Wan - Morgan Stanley, Research Division

I have 2. Number one, I just want to clarify, for your guidance of breaking even in 4Q. Are you talking about the -- also taking into consideration of accelerated content cost amortization? And then my second question is, could you share with us the current challenge of getting the local advertising budget and how Youku is going to address them going forward?

Ge Xu

Great. So the fourth quarter guidance, we said in Q4, we expect to see profitability on a non-GAAP basis. Yes, it is under the new amortization rules. We expect to see breakeven for Q4 on a non-GAAP basis. I'll leave the second question to Victor.

Cheung Koo Wing

Sure. On the mobile client side, this is merely a focus for this year, and there are a couple of initiatives to help with that. One is in terms of really complementing our current team with local talent from local television, as well as agencies. We've seen improvements here, and then that will continue. The other area is with localization because unlike in central clients, they are spread throughout the country, and that's an area that will -- that takes also time to develop, and that's moving forward. Thirdly, in terms of providing different marketing solutions, both in terms of TV satellite [ph] solutions, as well as content marketing solutions, and that partly why we think that original content marketing solutions is important. Because if you look at the satellite television stations, a lot of sponsorships and product placement are actually being done by our local advertisers across the board.

Operator

The next question comes from the line of Jiong Shao from Macquarie.

Jiong Shao - Macquarie Research

I have 3 quick questions, then I'm asking one long. Your Q4 guidance is suggesting about 6% to 10% quarter-over-quarter growth, which is pretty good in my view. How much of that was contribution from the new mobile monetization in gaming and e-commerce? I was wondering. Second question is about your multiscreen strategy, could you please give us an update on the set-top box side, as many of your peers are already making set-top box and even are making TVs altogether? So I was hoping you can give us an update there. And lastly, about your original content...

Cheung Koo Wing

All right, sorry, you have to repeat the second part of the question. I think there's something -- the signal on your phone is not very good.

Jiong Shao - Macquarie Research

Okay. Sorry, where did I lose you?

Cheung Koo Wing

Maybe Michael should take the first part first because we're having trouble hearing you.

Ge Xu

Yes, sure. For -- Jiong, your question actually is what percentage of our Q4 revenue is for mobile? Is that right?

Jiong Shao - Macquarie Research

Yes.

Ge Xu

Okay. So in -- I would say roughly...

Jiong Shao - Macquarie Research

Growth.

Ge Xu

Yes. We've going to see -- yes, so the mobile contribution in Q3 is roughly 3%, and I think that's the percentage, well, for the increase in Q4, because we have -- because the performance-based advertising on mobile had also more advertisers adapting more mobile platform. But on the other hand, from -- just like what Victor had said, for the performance-based advertising on mobile and also some other mobile format, it means that there is -- there are problems -- there are still a few operational issues that needs to be solved. So Jiong, you shouldn't expect to see an explosive growth on the mobile in terms of mobile contribution in Q4, but we are on the right track. The -- actually, we didn't hear your second question.

Cheung Koo Wing

Can you repeat the second question again because we couldn't really here it?

[Technical Difficulty]

Operator

The next question comes from the line of Yu-Heng Fan from China Renaissance.

Yu-Heng Fan

I just had a follow-up on the game center you are going to launch in Q4. Can you elaborate more about the potential opportunity in the mobile game publishing, given your very large reach on the mobile phone and also the enhancement in the mobile payment you just mentioned?

Cheung Koo Wing

Sure. This is relatively new, actually, because we focused really this year, on the mobile team, really working towards product improvement and user experience especially at the first half of the year. Of course, we have seen rapid growth of the mobile game industry this year. And as we keep expanding our traffic, we see a good potential here. Like I mentioned, we are launching our app center this quarter and specifically our game center next year. And we're also starting work with mobile advertising agencies that specialize in mobile games and also working directly with leading mobile games. So this is -- and we're seeing positive early results, but it's still early days.

Operator

I will now like to hand the conference back to today's presenter. Please continue.

Ryan Cheung

Thank you, all, for joining us on this call. Please feel free to contact us if you have any questions. Goodbye.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

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