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Sohu.com Inc. (NASDAQ:SOHU)

Q4 2009 Earnings Call Transcript

February 1, 2010 8:30 am ET

Executives

Derek Mitchell – IR, Ogilvy Financial

Charles Zhang – Chairman and CEO

Carol Yu – Co-President and CFO

Analysts

Catherine Leung – Citigroup

Dick Wei – JP Morgan

Eddie Leung – Banc of America/Merrill Lynch

Kathy Chen – Goldman Sachs

Jenny Wu – Morgan Stanley

Steve Weinstein – Pacific Crest

Eric Quinn [ph] – MAR Securities [ph]

Wendy Huang – RBS

Operator

Ladies and gentlemen, thank you for standing by. Good evening, and thank you for standing by for Sohu’s fourth quarter and full-year 2009 earnings conference call. At this time, all participants are in a listen-only mode. After the management’s prepared remarks, there will be a Q&A session. Today’s conference call is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the conference over to your host for today’s conference call, Mr. Derek Mitchell, Sohu’s Investor Relations Representative from Ogilvy Financial. Please go ahead, sir.

Derek Mitchell

Thank you. Thank you for joining us today to discuss Sohu.com’s fourth quarter and 2009 year-end results. On the call today are Chairman and Chief Executive Officer, Dr. Charles Zhang; 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 Finance Director, James Deng.

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 in 2009, which may continue through 2010; 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, noting that most wireless revenues are collected from a few mobile network operations for the company’s 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, please proceed.

Charles Zhang

Thank you Derek. Hello everyone, welcome to the call. Today, I am pleased to report another quarter of strong results, with record revenues for the full-year 2009. During the fourth quarter, we achieved a total revenue of $135.8 million, in line with our guidance and translating into growth of 12% year-over-year.

Brand advertising revenues for the fourth quarter were $45.9 million, in line with our guidance and up 2% year-over-year. Our online game business posted record high revenues of $70.7 million for the fourth quarter, also in line with our guidance and translating into growth of 3% quarter-over-quarter and 21% year-over-year.

Before deducting the shares of net income pertaining to the non-controlling interest in Changyou, non-GAAP net income for the fourth quarter was $50.3 million, in line with our guidance. After deducting the share of net income pertaining to the non-controlling Interest in Changyou, on a fully diluted basis, non-GAAP net income was $35.8 million, or $0.92 per fully diluted share, in line with our guidance.

For the full year of 2009, total revenues were $515.2 million, up 20% compared to 2008. Brand advertising revenues were $177.1 million, up 5% compared to 2008. Online game revenues were $267.6 million, up 33% compared to 2008. Non-GAAP net income before deducting the share of net income pertaining to the non-controlling interest in Changyou was $197.7 million, up 17% compared to 2008. After deducting the share of net income pertaining to the non-controlling interest in Changyou, on a fully diluted basis, non-GAAP net income for the full-year 2009 was $155.3 million, or $3.98 per fully diluted share.

Our strong fourth quarter and full-year results are testaments to the successful execution of our business strategies across our core business segments, mainly portal and online game business. We believe our emphasis on securing and developing leading Internet video content and technologies will drive impressive growth in both users and advertising revenues in 2010. Our persistent efforts in fighting online video piracy have started to bear fruit and have made Sohu the partner of choice for leading global and local media companies. Our online game business also continues to deliver impressive results and progress. While our three healthy and growing existing games continue to deliver solid revenues, our highly anticipated and diverse 2010 pipeline of five games will bring us increasing momentum in the coming quarters. Our second in-house developed game, Duke of Mount Deer, one of the most anticipated online games in China, is progressing smoothly.

Before discussing the quarter in more detail, I would like to take time to congratulate Belinda Wang and Xiaochuan Wang on the promotions to Chief Operating Officer and Chief Technology Officer respectively. Both have exceptional track records with years of experience. We are confident in their abilities to perform well in their new roles and are excited to see their new contributions to Sohu. I would also like to take a moment to congratulate Dewen Chen, Changyou’s Chief Operating Officer on his recent promotion to the President of Changyou, a role which he will serve in addition to as Chief Operating Officer of Changyou. Dewen is one of the Changyou’s founders and has been instrumental to the strategic rudiments of Changyou. We look forward to further contributions from him in his expanded role.

Now, let me discuss our portal business in more detail. During the fourth quarter, we continued to invest in our content technologies and branding to further strengthen our leading media platform. First, we continued to execute on our media strategy. Our diligent efforts to fight privacy through the China Online Video Anti-Piracy Alliance, have begun to generate positive results for the industry as well as for Sohu. We are pleased to see that many local video sites have increasingly been pressured to remove their pirated content. Our efforts in fighting online video piracy and our leading media platform have made Sohu the partner of choice for many leading global and local media companies. The force increased our domestic content offerings and one example was Sohu’s exclusive broadcasting of the premium, The Qin Empire, a popular TV drama in China before it aired on TV stations.

Viewership for the premium was very strong and based on the considerable amount of user feedback we received, we have been encouraged to continue exploring new opportunities upon this approach. The trend of the establishing authorized video content libraries in place of pirate content have encouraged Tudou [ph], Ku6, one of the leading video sharing sites in China to set up a joint fund for the procurement of licenses for international movies and television programs together with Sohu. The fund will be used to buy licenses from leading global media companies to show Hollywood movies and TV shows on our video Websites.

Our recent moves are helping to advance the industry’s efforts to combat online video piracy, while reaching hurdles some of the existing online video sites engaged in this practice. As the amount of pirated content among private companies decreases, we believe our proactive assess will provide ample opportunities for Sohu to increase both users and advertising revenues. For the fourth quarter, average number of daily video views increased approximately 30% sequentially and revenue generated from TV channels, from Sohu TV channel increased 27% quarter-on-quarter.

Second, our technological advancement are improving the user experience and providing cross-marketing opportunities through various institution channels. Continuous upgrades to Sogou Pinyin have helped secure its market leadership position while increasing user stickiness. We have also started to leverage Sogou Pinyin search engine [ph] market share to cross-market our other leading products such as video and news sites.

Additionally, the mobile version of Sogou Pinyin continues to grow in popularity and well facilitates Sogou’s users to watch online videos through their mobile handsets to the future of widespread implementation of 3G technology. Last, we also continued to execute on our marketing campaigns throughout Sohu Know the World. Based on third-party feedback research, the number of people who frequently served Sohu increased to 10% compared to the third quarter. For the full-year 2009, average daily unique visitors to our news channels has increased approximately 20% compared to 2008.

Traffic growth on our news channels for the third and the fourth tier cities grow at even faster rate than the first and second tier cities, after we expanded the campaigns to third and fourth tier cities in the second quarter of 2009.

Going forward in 2010, we plan to implement several marketing activities that will further promote our products that are high-definition video content. Overall, and in fact in combination of improved content technological advancement and the efficient branding, has allowed our online portal to survive, meeting and often exceeding the desires of Internet users.

Now, I would like to discuss brand advertising business in more details. For the fourth quarter, brand advertising revenues were $45.9 million, up 2% year-on-year. For full-year 2009, brand advertising revenues were $177.1 million, up 5% compared to 2008. Gross brand advertising revenues before business tax for the fourth quarter and full year of 2009 were $50.2 million and $193.8 million respectively.

Auto, real estate, and online gaming contributed most to brand advertising revenues for the fourth quarter. In total, we accounted for more than half of brand advertising revenues. Our fastest growing sector in the fourth quarter were consumer electronics, retail clothing and auto industries. The fourth quarter of 2009 was a quiet quarter for online advertising business with moderate revenues and stable margins.

We expect the advertising market to rebound in 2010 and are currently in negotiations with advertisers for their 2010 contracts. We should have greater full-year 2010 visibility over the next coming months.

Looking at our top three industries for 2010 in more detail. China auto industry, which became the largest in the world in last year continued to expand. As the government encouraged auto sales in low-tier cities, we believe auto companies will be more inclined to advertise online for greater nationalized reach. Additionally, we expect more marketing activities in the coming year, particularly surrounding the World Cup, Asian Games, and World Expo. As such, we expect revenues from auto industry to grow modestly in 2010.

Real estate, in regard to 2010, although we cannot be certain about the exact impact of government’s moves to curb speculation and cool down the market, we maintained a positive view on the long-term value of the property markets and the moderate growth of marketing spending.

Online games, as the economy continues to grow, we expect operators and developers to increase their marketing spending accordingly on 17173.com, China’s leading online game portal and the depot marketing platform for most online games. The first quarter is typically a slow quarter. In 2010, the Chinese New Year is two weeks later than the previous year, which also negatively affects our brand advertising revenues. Based on execution orders we receive, our outlook for the brand advertising revenues for the first quarter of 2010 is between $38 million and $40 million.

Now, I would like to discuss our online game business. Our fourth quarter operational results reflect the solid momentum of our existing games and it demonstrate the strengths of our game operation and product development capabilities. The strategic releases of engaging gaming features developed based on our user feedbacks throughout the year are existing games had boosted our user base, resulting in first, aggregate registered users reaching 80.9 million in the fourth quarter from 75 million last quarter, an increase of 8% quarter-on-quarter and 41% year-on-year.

Second, aggregate peak concurrent users, PCU, growing to 990,000 in the fourth quarter, from 910,000 last quarter, up 9% quarter-on-quarter and 19% year-on-year. And thirdly, aggregate active paying accounts, or APA, reaching a high level of 2.4 million, flattish with last quarter and representing an increase of 21% year-over-year.

We achieved these results while making concerted efforts to keep average revenue per active paying accounts up at an affordable level of 196 RMB, up by 3% from a 190 RMB in the third quarter and 1% year-over-year. We are also pleased to report that Tian Long Ba Bu continues to be one of the most popular games in China. During the quarter, we saw Tian Long Ba Bu’s PCU reach a high of 870,000 [ph], reflecting an increase in both new and old users to the game after the successful launch of our major expansion pack, former addition in late September 2009.

In order to assimilate gamers into the virtual community, we followed up in December with a release of our Christmas and New Year’s pack, which contained enhancement’s to the in-game community and tab platform and Flash virtual items of holiday season. Introduced the game, Cha-Ching in January with new writing animals, virtual pads and other activities in advance of our New Year holiday.

These and other strategic releases of new games content throughout the year have continued to expand Tian Long Ba Bu’s lifecycle, forming a solid revenue base for funding growth in our existing and pipeline games. We will continue to provide game content updates for Tian Long Ba Bu with the next one planned for release in April. For our Blade Online series, we saw growth in the fourth quarter, as Blade Hero 2 continues to gain traction amongst users. During the quarter, we conducted in-game marketing events and released new virtual items for both games in the series.

As part of our ongoing commitment to broaden our user base and differentiate our game offerings, we recently separated the R&D team for these two games in Blade Online series. We expect this will lead to distinct differences in game development and offer a variety of game play that will attract additional users. The solid operations of our existing games affirm our belief that game development should be user-oriented and based on user feedback. It is with this principle in mind that our R&D team develops the games in our 2010 pipeline.

Now, let me provide you with an update of our current development in progress. First, game development on our second in-house developed game Duke of Mount Deer or DMD is progressing smoothly as we test out new boundaries and weapons in the closed beta version. A team of over 160 game engineers are currently working on the game, providing updates on a weekly basis to enrich game content in improved user experience. Gamers have so far responded positively to the ticks we have made to various in-game functions, and the game is on track for an open data test, data launch in the third quarter of 2010.

Second, with converted (inaudible) our Thailand-licensed market RPG game and the first venture into the 3D segment into simplified Chinese. Also localization of the game for the Chinese market has more or less been completed. The game will enter technical closed beta testing tomorrow and we expect to commence open beta testing in the second quarter of 2010.

Third, we licensed a new 2D turn-based cartoon style, MMORPG, Dahua Shuihu. The game features a suite of community-based game play that takes humorous twist on the characters and the scenes from the Chinese clinical novel, Outlaws of the Marsh. The game entered closed beta testing in early January and we plan to begin open data testing as early as March 2010. In light of the upcoming release of Dahua Shuihu, management is currently evaluating other super time slots in 2010 for the open data of Immortal Faith and Legend of Ancient World. Both games continue to undergo closed beta testing and the game development is progressing as planned.

2009 was an exceptional year for Changyou and in closing, I would like to say that we were very pleased with the progress we made. Our successful IPO of Changyou in April enhanced Changyou’s brand recognition, well providing us the platform and the resources to further expand Changyou’s businesses. Leading on the consistent growth of Changyou’s existing games, we are able to generate record returns and make additional investments and advancements in our new game pipeline, while delivering significant value for our shareholders.

Looking forward, we are optimistic heading into 2010. We have a full slate of games preparing for release during the year. Our user-centric games development platform and a diverse portfolio of new and existing high quality games will allow Changyou to establish significant presence in the key market sub segments that will serve as the catalyst for a growth in the years to come.

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

Carol Yu

Thank you Charles, and hello everybody. I would like to walk you through our financials for the fourth quarter. One, revenue. Starting with topline results, total revenues of $135.8 million, representing a 1% decrease sequentially and a 12% increase year-on-year. Brand advertising revenues totaled $45.9 million, representing a sequential decrease of 5% and a year-over-year increase of 2%. Online games revenues for the fourth quarter of 2009 grew to $70.7 million, at the high end of our guidance, an increase of 3% sequentially and 21% year-over-year. Revenues from game operations increased 3% sequentially and 22% year-over-year to $68.6 million. Increases were mainly due to increased popularity of our flagship game, TLBB. Overseas licensing revenues were $2.1 million, an increase of 15% sequentially and 5% year-over-year. Wireless revenues were $15.7 million, a sequential decrease of 7% and a year-over-year increase of 6%.

The quarter-over-quarter decrease was mainly attributable to China Mobile discontinuing the billing for WAP services in late November. For the first quarter of 2010, we expect wireless revenues to decrease around 20% to 30% quarter-over-quarter due to operators tightening controls over subscription and mobile phones coupled with the WAP policy. Our focus for the wireless business remains the capitalization on upcoming 3G opportunities.

Most of the remaining figures I will be discussing will be non-GAAP. Impact of share-based awards, including share-based compensation expense and related non-cash income tax expense are charged to the quarter’s cost of revenue, operating expenses and income tax expense. For the fourth quarter, each of the total share-based compensation expense and non-cash income tax expense was $3.9 million. We believe excluding the impacts of share-based compensation awards from our non-GAAP financial measures of net income makes a more meaningful comparison of Sohu’s operational results and improves investors’ understanding of Sohu’s performance. Sohu will use non-GAAP measures in this discussion to explain margins, cost, and expense items.

Two, gross margins. Overall, non-GAAP gross margin for the fourth quarter was 75%, slightly down from 76% last quarter and the same during the fourth quarter of last year. Brand advertising non-GAAP gross margin for the fourth quarter was 65%, down from 69% in previous quarter and 67% in the same period of last year. The decline of gross margin was a result of additional bandwidth costs and amortized purchasing costs of high definition video content relating to our video strategy.

Online game non-GAAP gross margin was 92% for the fourth quarter compared to 93% in the last quarter and in the fourth quarter of last year. Wireless non-GAAP gross margin for the fourth quarter was 44%, increase from the 43% in the previous quarter and decrease from the 46% in the same period of last year.

Four, operating expenses. For the fourth quarter of 2009, Sohu’s non-GAAP operating expenses totaled $45 million, down 4% from the $46 million in the previous quarter and up 14% year-on-year. The year-on-year increase primarily reflects an increase in marketing expenses. Four, operating margin, Non-GAAP operating profit margin was 42%, the same as the previous quarter and down slightly from the 43% in the fourth quarter of last year.

Five, income tax expense. For the fourth quarter of 2009, non-GAAP income tax expense was $8.2 million as compared with $7.0 million in the previous quarter. Under US GAAP, we also recorded non-cash income tax expense of $3.9 million related to share-based compensation awards for the fourth quarter. Six, net income. Before deducting the share of net income pertaining to the non-controlling interest in Changyou, non-GAAP net income for the fourth quarter of 2009 was $50.3 million, in line with Group’s guidance, down 2% quarter-over-quarter and 15% year-on-year. After deducting the share of net income pertaining to the non-controlling interest in Changyou, non-GAAP net income for the fourth quarter of 2009 was $35.8 million, or $0.92 per fully diluted share, also in line with Group’s guidance.

Seven, net margin. Before deducting the share of net income pertaining to the non-controlling interest in Changyou, non-GAAP net margin for the fourth quarter was 37% compared with 38% in the previous quarter and 49% in the fourth quarter of 2008. Eight, balance sheet and cash flow position; we continue to maintain a debt-free balance sheet. For the fourth quarter, our businesses generated $71.1 million in operating cash flow. As of December 31st, 2009, our cash balance was $563.8 million. As of December 31st, 2009, our nets accounts receivable balance was $46.6 million, a decrease of $13.5 million from the previous quarter. Brand advertising DSO for the fourth quarter was 57 days, compared to 73 days in the previous quarter and 45 days in the fourth quarter of 2008.

As of December 31st, 2009, our bad debt provision totaled $1.4 million, with bad debt expense of $765,000 recorded for the fourth quarter of 2009. As of December 31st, 2009, receipts in advance and deferred revenue of our online game business was $30.2 million, compared to $29.2 million as of September 30th, 2009.

Nine, status of share repurchase program. During the fourth quarter of 2009, under the stock repurchase program approved by the Board in the third quarter of 2008, we repurchased 751,224 shares of common stock at an average price of $53.26, for a total consideration of $40 million. As of December 31st, 2009, we have purchased in total 1,252,910 Sohu shares in the open market, at an average price of $47.89 for a total consideration of $60 million. The buyback program announced in October 2008 has expired by the end of 2009.

Regarding our business outlook for the first quarter of 2010, Sohu expects total revenues to be between $123 million to $128 million, with advertising revenues of $40 million to $42 million; brand advertising revenues of $38 million to $40 million. This implies a 17% to 13% quarter-over-quarter decline or a negative 3% to positive 2% year-on-year growth; online game revenues of between $70 million to $73 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 $45.0 [ph] million to $47.5 million as compared to $50.3 million for the fourth quarter of 2009. After deducting the share of non-GAAP net income pertaining to the non-controlling interest in Changyou, Sohu estimates non-GAAP net income for the first quarter of 2010 to be between $30 million to $33 million and non-GAAP fully diluted earnings per share for the first quarter of 2010 to be between $0.78 and $0.83.

Taking into consideration the impact of the recent new grants of share-based awards, Sohu estimates compensation expense and income tax expense relating to share-based awards for the first quarter of 2010 to be $6.5 million to $7.5 million, which includes that for Changyou of $3.0 million to $3.5 million. Considering Sohu’s share in Changyou, the estimated impact of this expense is expected to reduce Sohu's fully diluted earnings per share for the first quarter of 2010 under US GAAP by $0.14 to $0.16.

In conclusion, including in our fourth quarter results, Sohu has generated an impressive accomplishment considering the challenging economic environment of 2009. We are very pleased with our results in 2009 as we consistently achieved balanced growth across our key businesses. Going forward into 2010, we are confident in our ability to leverage our strong balance sheet and sound business strategies to achieve sustainable growth that will deliver long-term value to our shareholders.

Thank you for joining the call today. This concludes our prepared remarks. I will now like to open the call up to questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) First question comes from Catherine Leung from Citigroup. Please go ahead with your question.

Catherine Leung – Citigroup

My question is how should we reconcile the company’s optimistic quality of comment for a rebound in the advertising market, which the first quarter guidance, is this I believe due to first quarter still being seasonally weak and not fully reflecting the market improvement, or are there also some nuances with the company’s major advertiser industry category? Thank you.

Charles Zhang

I think one of the reason is really the seasonal reason. It’s really a slow quarter, we have got spring festival in the middle of the quarter, and approaching the spring festival, you know, is the advertisers just become lazy and are working out hard, and after the spring festival, it’s already, the quarter already ends. So, this is one of the reasons. But looking at 2010, I think there is this general trend that online video become very popular and advertisers from – advertising industry, advertising motion picture and motion picture videos on television are the bulk part of and then some of them are moving into online. So, that will be one of the drivers and Sohu has already a leading position in this copyrighted content and this model. So, we are optimistic for 2010.

Catherine Leung – Citigroup

Okay, thank you.

Operator

Next question is coming from Dick Wei from JP Morgan. Please go ahead with your question.

Dick Wei – JP Morgan

And my question, a follow-up on the prior question, any particular industry segment that you see more negative decline QoverQ for Q1, and also as far as 2Q and 3Q is kind of maybe, yes, 2Q and rest of the years concerned, do you expect to see a pretty strong pickup in Q2 and Q3, particularly if you look at like the guidance for first quarter, it should be one of the – of Q1 that, that (inaudible), so I wonder any stronger-than-usual for the rest of the year? Thanks.

Carol Yu

Dick, this is Carol. No, we didn’t see any particular weakness in any one of the sector. Traditionally, (inaudible) it is very slow during the first quarter and then in light of the recent various governmental regulations that come out each and every day. So, it’s slightly declined more than the rest of the other industries, but on a whole, it’s still pretty much a decline on overall basis if you are talking about quarter-over-quarter. And just like what Charles had said, we would remain pretty bullish for the entire 2010. It’s just that we believe that the growth would kick in, in the following three quarters instead of the first one.

Dick Wei – JP Morgan

And any thoughts from your conversation with advertisers about this distributed growth would be like (inaudible) any color would be helpful? Thanks.

Carol Yu

I am sure it would be a lot better than 2009.

Dick Wei – JP Morgan

Okay, that’s great. Thanks a lot Carol and Charles.

Operator

And next question is coming from Eddie Leung from Banc of America/Merrill Lynch. Please go ahead.

Eddie Leung – Banc of America/Merrill Lynch

Good everyone. I have a question on the fourth quarter number of brand advertisers. Carol, could you give us the number of brand advertisers? And also, a follow-up question on the online video side. When we could see from a period contribution from online video, are we talking about a timeframe of one to two years or longer than that? Thanks.

Carol Yu

I will answer the first part of the question first. It’s around 700.

Eddie Leung – Banc of America/Merrill Lynch

Thank you.

Charles Zhang

You mean, a timeframe for online video pickup?

Carol Yu

For the revenue that become meaningful.

Charles Zhang

Meaningful? I think in two years. You will see in 2010, it will become kind of meaningful, but in 2011, it will be pretty meaningful.

Carol Yu

I think let me put it this way. Given our current strategy of putting a lot of emphasis in online video and de-emphasizing for example, the DSP businesses for wireless, I am sure, pretty sure that unless something drastically happens, we probably should be seeing that, the revenues from online videos surpassing our wireless business or making up the loss in the wireless business in two or three years.

Charles Zhang

For online video business, our success also depends on the industry shift, which Sohu is actually the driver for this. The driving basically is fighting online piracy, so that enable companies like Sohu who have authorized content enable to compete. Over the year 2009, I think our efforts in fighting piracy has resulted in some very good progress that (inaudible) been pressured to delete some of their pirated content and this trend will continue as more and more sites are starting to pick the site of justice, rather than, you know, against the trend of history. So, this is one trend that Sohu is leading. And also on other hand, fighting piracy at the same time, spending to buy content. So, these two efforts that we have been doing and will result in user growth and other timing model follows.

Operator

(Operator instructions) Next question comes from Kathy Chen from Goldman Sachs. Please go ahead.

Kathy Chen – Goldman Sachs

Questions, I have a couple of questions on the advertising side. Firstly, just a follow-up again on the first quarter advertising guidance, is it possible to quantify how much the impact is from the later Chinese New Year this year? If we have historically in the first quarter, you advertising revenue trends are usually more stable or flattish quarter-on-quarter. So, is the quarter-on-quarter decline you are guiding for this here primarily due to the later Chinese New Year? And then secondly, if I could ask a follow-up of another question regarding the second quarter outlook, I think usually you raise the rate cards in April every year, is there any indication here on how much Japan should raise the rate card side this April? Thank you.

Carol Yu

It’s really difficult to quantify the timing, but we probably lose, I would say roughly another two weeks because of the Chinese New Year, the after timing of the Chinese New Year. So, that would be probably two weeks out of six weeks or seven weeks. So, I mean, if you really need to do that quantification, this is probably some ballpark numbers. And in terms of rate card increase, we always do that every year. So, I don’t see why we should change that, or I haven’t heard that we would change – we have any plans to change that yet.

Kathy Chen – Goldman Sachs

Is there any thoughts here on how much you would raise the rate card by?

Carol Yu

A commercial secret.

Kathy Chen – Goldman Sachs

Okay, thank you.

Operator

Next question is coming from Jenny Wu from Morgan Stanley. Please go ahead with your question.

Jenny Wu – Morgan Stanley

Hi. Thank you for taking my questions. Hi Carol, my question is regarding your margin. Giving your spending on content, especially radio content and your marketing campaigns for 2010. So, what’s your budget disposal for content costs and your marketing costs, and what’s the impact on your margin in or maybe shortly, what expectations for your margin trends? Thank you.

Carol Yu

I think the margin would top for – you are talking about advertising side, right, gross margin?

Jenny Wu – Morgan Stanley

Yes, yes, sure.

Carol Yu

Okay, I will start with that. I think on the gross margin side, I would expect that to be – what we found in Q2 and after, Q2 that we found in advertising revenue because the sharp dip in Q1, the bulk of it relates to the smaller revenue base as well as a lot of costs are fixed in nature. I would believe that it’s probably on the year-on-year basis, would probably rebound to 2 basis points below that of 2009 Q4 for the whole year, at least that’s what I am working to it. In terms of marketing expenses, we probably just would rise in mind with revenue growth from last year. So, based on the revenue base, so that’s what I have in mind.

Jenny Wu – Morgan Stanley

Okay, sure. Thanks.

Operator

Next question is coming from Steve Weinstein from Pacific Crest. Please go ahead with your question.

Steve Weinstein – Pacific Crest

I was hoping if you could update us a little bit more in terms of the communication you are having with the carriers regarding your wireless businesses. What are some of the issues they are trying to address, and you know, what change you may think or you may need to make to your different products, I mean going forward, and when you can take some resolutions?

Charles Zhang

Because of the government’s crackdown on, you know, pornography and others, so the operators stopped the WAP dealing. That’s one of the major policy change that impacted our wireless business. And as moving forward, I think the wireless business already, I think will be evolving in nature. While the traditional value-added services has been always been on a declining trend, the mobile handsets has its computing power and its sophistication, it’s approaching a PC, so that the mobile Internet strategy is more like, you know, another battlefield for the general products. So, we are now focused more on research and development of the product with mobile handset. For example, the Sogou Pinyin, we will make sure that we will repeat the success with the PC base.

Steve Weinstein – Pacific Crest

Okay, thanks.

Operator

Thank you. Next question is coming from Eric Quinn [ph] from MAR Securities [ph]. Please go ahead with your question. Mr. Eric Quinn from MAR Securities, your line is open. Please ask your question.

Eric Quinn – MAR Securities

Hi, Thanks for taking my question. I have two questions if I may. Number one is, can management outline the licensing fee structure for Chinese Hero, if it’s not commercial? And the second, I have a follow-up question regarding percentage of revenue, advertising revenue from video and how does the management fees driving the growth going forward? Thanks.

Charles Zhang

The license fee for Chinese Hero is two parts. One is the initial licensing fee plus the revenue sharing. For the initial licensing fee, that has been paid and has already been effected in the balance sheet of Changyou as intangible asset. For the licensing revenue sharing, typically, for licensing deal in China, the revenue sharing is of the range of 20% to 30% sharing.

Eric Quinn – MAR Securities

Thanks. And is there any minimum guarantees in the licensee you see at part?

Charles Zhang

That’s a bit too detailed for disclosing a commercial transaction.

Eric Quinn – MAR Securities

Okay, I understand. Thanks. So, second question is on the video ad, did I say correct that, Charles, you said it has increased 27% quarter-on-quarter in the fourth quarter?

Charles Zhang

Correct.

Eric Quinn – MAR Securities

Well, how much is that? Is it immaterial at this point or can you disclose the percentage of total advertising that comes from video?

Charles Zhang

No, no. As I said, it’s going to be somewhat meaningful in 2010 and then it will be pretty meaningful in 2011.

Eric Quinn – MAR Securities

Okay.

Charles Zhang

I cannot disclose the percentage.

Carol Yu

Actual amount.

Charles Zhang

Actual amount.

Eric Quinn – MAR Securities

Okay. Thank you.

Operator

(Operator instructions) Next question is coming from Wendy Huang from RBS. Please go ahead with your question.

Wendy Huang – RBS

Thanks for taking my question. Regarding your wireless guidance, you guide 2.7 million revenue decline in Q1 2010, actually even if we wipe out all the WAP revenue for Q1, it’s just less than 1 million. So, I wonder whether are there any policies coming from the China Mobile or MMIC [ph] that affect your other wireless services such as SMS?

Charles Zhang

There is a stricter policy on the embedded.

Wendy Huang – RBS

Yes.

Charles Zhang

Also, there is, you know, a stricter policy out for restricting the embedded product that deal some SMS wireless value-added services products.

Wendy Huang – RBS

So, that’s mainly on SMS, and you didn’t see any impact on the MMS, the others?

Charles Zhang

No, it’s just this practice is not being allowed in the future, to embed some function in the mobile handset that induce some service.

Wendy Huang – RBS

I see. And also regarding the seasonality you mentioned about ad business, actually in 2007, the Chinese New Year is February 18th; in 2008, the Chinese New Year is February 6th. They are very similar to this year, but in those two years, you actually still see the slight sequential growth in Q1 for two years. Why did you guide it, such a dramatic decline this year?

Carol Yu

In 2007, we had the run-up to Olympics. So, advertisers start to do some of the advertising then.

Wendy Huang – RBS

Okay, that’s fair. Thank you.

Operator

We are now approaching the end of the conference call. I will now turn the conference over to Sohu’s Investor Relations Representative from Ogilvy Financial, Mr. Derek Mitchell for closing remarks. Thank you, sir.

Derek Mitchell

Once again, I would like to thank all of you 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. Thanks for your participation in today’s conference call. This concludes the presentation. You may now disconnect. Have a great day. Thank you.

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Source: Sohu.com Inc. Q4 2009 Earnings Call Transcript

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