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Sohu.com Inc. (NASDAQ:SOHU)

Q2 2011 Earnings Call

August 1, 2011 8:30 AM ET

Executives

Jenny Wu – IR

Charles Zhang – Chairman and CEO

Belinda Wang – Co-President and COO

Carol Yu – Co-President and CFO

Analysts

Dick Wei – JP Morgan

Ming Zhao – Standard Chartered

Ming Zhao – Susquehanna Financial Group

Wallace Cheung – Credit Suisse

Julian Cheung – Morgan Stanley

Catherine Leung – Goldman Sachs

Gary Ngan – UBS

Wendy Huang – RBS Capital Markets

Muzhi Li – Mizuho Securities

Jiong Shao – Macquarie Capital Securities

Eddie Leung – Merrill Lynch

Operator

Ladies and gentlemen, thank you for standing by and good evening. Thank you for joining Sohu’s Second Quarter 2011 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, Jenny Wu from Christensen. Please go ahead, madam.

Jenny Wu

Thank you, operator, and thank you for joining us today to discuss Sohu.com’s second quarter 2011 results. On the call today are Chairman and Chief Executive Officer, Dr. Charles Zhang; Co-President and Chief Operating Officer, Belinda Wang; Co-President and Chief Financial Officer, Carol Yu; Chief Technology Officer of Sohu and CEO of Sogou, Xiaochuan Wang; Vice President of Sohu and CEO of Sohu Video, Ye Deng. Also with us from Changyou are Chief Executive Officer, Tao Wang; President and Chief Operating Officer, Dewen Chen; and Chief Financial Officer, Alex Ho.

Before management begins their prepared remarks, I would like to remind you of the company’s 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. For more information about the potential risks and uncertainties, please refer to the company’s filings with the Securities and Exchange Commission, including its registration statements and most recent Annual Report on Form 10-K.

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

Charles Zhang

Thank you. Today I would like to start off with my congratulations to our online gaming subsidiary, Changyou. And both excited and for report that on July 22nd, Changyou launched Duke of Mount Deer or DMD, its second in-house developed game. The unique technological innovations brought by the four years of development have been well received by players. Since its launch, the games user base has grown steadily and we have already had to add more servers for the game.

Now with our flagship game Tian Long Ba Bu, and the acquisition of the 7Road, a web-based game company in China, and the newly launched DMD Changyou has successfully transformed itself into a diversified gaming company and escalated its leading position in China’s online gaming industry. I’ll go into more details later on this call. For the second quarter, I am pleased to report strong financial results as we’ve set a new record for total revenue which was supported by our record high revenues in three of our core business lines, brand ads, Sogou, and Changyou.

In addition to Changyou, both our online video and the Sogou businesses also posted solid results. Sohu Video, outperformed its large competitors and expanding its audience rich while Sogou accelerated its growth with over 250% top line growth driven by a strong improvement in search traffic and in monetization. I’d like to start with some quarterly highlights. Total revenue were US$199 million in the second quarter, up 36% year-over-year and 14% quarter-over-quarter. Growth on brand ad revenue before tax were US$74 million.

Net online brand advertising revenues were US$68 million, up 27% year-over-year and 19% quarter-over-quarter exceeding the high-end of our expectations. SoGou’s revenues were at US$13.6 million, up 252% year-over-year and 71% quarter-over-quarter, this compared with the US$11 million that we provided in our guidance. Online gaming revenues reached US$102 million surpassing the US$100 million mark, up 31% year-over-year and 7% quarter-over-quarter, exceeding the high-end of our expectations.

Non-GAAP diluted EPS were $1.21, compared with $0.96 in the second quarter of 2010, which is also ahead of our expectations. Now I would like to discuss our online video business in more detail. In the second quarter, we saw over 150% increase in revenue from online video, making it as the fastest growing area in our brand ad business. It continued to broaden our viewer coverage and to solidify our position as one of the top three players in the market, as we further narrowed the gap against our larger competitors.

According to iResearch, our monthly unique visitors reached a 161 million in June, up to 11% from March, representing a penetration rate of 48.4%, up 7.3 percentage points from the previous quarter. I’d like to point out that our market penetration rate rose twice as fast as that of our current market leader. Our robust user growth is the direct result of our content strategy, which I’d like to provide a bit more color. First in China, industry practice is that the content is put out to the market six to 10 months prior to launch.

We tried ourselves on our ability to select and to secure arguably the most sought after content available. For example, in late 2010, we secured exclusive rights to the Qing Princess; in Chinese, Huan Zhu Gege which is well known TV drama and has become the hottest TV series on both the TV and the internet. The ability to secure such content requires extensive market expertise and experience that might be difficult for our competitors to replicate in a short period of time.

Second, Sohu’s strong balance sheet and high cash balance, give us our video business the financial fire power and the flexibility to present the best content in a manner that is as aggressive as we need to be. Third, as we already viewed is sizable user base and the reputable brand, are now a lot less dependent on exclusive content to attract new viewers. So we are now at liberty to sublicense the rights to our industry players of our choice to other industry player of our choice. For example, we have sublicensed the Qing Princess, Huan Zhu Gege to other video sites. And we are happy to see our viewership on this popular show remain strong and in line with our expectations.

And lastly to enrich and differentiated our content offering, we are investing more resources in short-term programs and in-house product content. We planned to extend our efforts to various forms of the original content, including film, TV drama, documentaries and other TV shows.

For example, in June, Sohu Video announced the 7 Film Project, a project that is partnered with the China Film Group Corporation, the largest filmmaker and distributor in China and the Nokia. We’ve already signed seven very popular actors to the cast. This initiative will help further build the local video brand and attract both users and advertisers.

Now moving onto our Sogou business. During the second quarter, Sogou continued its strong momentum. Revenue rose 252% year-over-year and 71% sequentially which exceeded our expectations. This was achieved by improvements in search traffic and monetization. And also demonstrated our highly effective strategy of leveraging Sogou Pinyin 300 million plus user base to promote the Sogou web browser and direct traffic to our Sogou search engine.

We’re increasingly seeing the benefit of jointly leveraging our three core products, Sogou Pinyin, Sogou browser and the Sogou search. In the second quarter, our Sogou browser again ranked third in the market, but we continued to pick up market share. According to iResearch in June, the monthly active users reached 93.6 million and a user penetration hit 23% compared with 81 million and a 20% in March respectively. Search traffic as measured by daily page views increased rapidly by approximately 25% quarter-over-quarter.

SoGou’s success is built on our strong technological focus where we constantly seek to improve product quality and developing new functionalities. For example, our newly launched Sogou browser version 3.0 includes an innovative web-page update notification function, that allows users to receive alerts whenever updates are available for various personalized pages and applications that we have selected. The latest version of Sogou Pinyin has a flash supported skin function which will allow users to choose embedded applications such as listening to online audio books and video or reading a daily horoscope without the use of external applications.

All these features and more have been well received by internet users. Moving on and before I pass the call to Belinda, I would like to take a moment to come back to Changyou. I’ll go through the three key gains in Changyou’s portfolio launch. First, on July 22nd Changyou launched the Duke of Mount Deer with 64 realms of servers and has added 46 realms of servers in the past 10 days bringing the total to 110. The initial buzz as well as the continued momentum has convinced the Changyou team that their four years of development of DMD is well paid off.

Second, our four year old game Tian Long Ba Bu, once again demonstrated its long lasting popularity and the continued growth. The release of its extension packs in mid-March and in early July added new dungeons and the team based missions and we saw a pickup in the number of gamers after each release. A major extension pack TLBB 3 is scheduled for release to be released in the latter half of this year. Importantly there is no material impact on the usage of Tian Long Ba Bu following DMD’s launch.

Third, with the acquisition of 7Road, Changyou quickly established a leading position in the fast growing web-based gaming segment which is an important part of its strategy to diversity beyond MMORPG games. In the second quarter, 7Road hit game DDTank continued to be one of the China’s top five web-based games according to Baidu search ranking.

Now I’d like to turn the call to our Co-president and Chief Operating Officer, Belinda Wang, who will update you on our online brand advertising business, Belinda.

Belinda Wang

Thank you, Charles. Second quarter revenue for our online brand advertisement business reached a new high. We witnessed steady growth of advertising demand for auto, real estate and IT sectors and particularly strong demand from E-commerce and FMCG companies.

Net Online brand advertising revenues for the second quarter were US$68 million, up 27% year-over-year and gross online brand advertising revenues before business tax was US$74 million. As Charles mentioned earlier, online video was the fastest growing area with over 150% growth in revenues and nearly 50% increase in the number of advertisers on a year-over-year basis. We are optimistic about the prospect of online video growth as more advertisers including a lot of traditional TV advertisers are expected to allocate a portion of their marketing budget to this area over time.

Looking forward for the third quarter of 2011, we expect gross online brand advertising revenues before business tax to be between US$82 and $84 million, and we expect net online brand advertising revenues to be between US$75 million and US$77 million. This would represent a year-over-year increase of between 27% and 30%.

Now I will turn the call over to our Co-President and CFO, Carol Yu, who will walk you through the quarter’s financials. Carol.

Carol Yu

Thank you, Belinda, and hello, everyone. I would now take you through our financials for the second quarter. First revenues; total revenues were US$199 million, up 36% year-over-year and 14% quarter-over-quarter. This is a new record and came in ahead of our expectations.

Online brand advertising revenues also came ahead of our expectations at US$68 million, up 27% year-on-year and 19% quarter-over-quarter. The increases were mainly due to increased number of brand advertising customers and strong advertising demand coming from the IT sector including E-commerce companies. Sogou revenues were at US$13.6 million, up 252% year-over-year and 71% quarter-over-quarter. Sogou revenues include search and start-up page revenues. The increases were mainly due to increased search traffic and improved monetization.

Online games revenues were at US$102 million, up 31% year-over-year and 7% quarter-over-quarter. Wireless revenues were at US$11.6 million, a year-over-year increase of 5% and quarter-over-quarter decrease of 1%.

Now, let me provide some more details of our financials. For now on, most of the figures discussed will be non-GAAP. The impact of share-based awards include share-based compensation expense and its related non-cash income tax expense that are charged to the quarter’s cost of revenue, operating expenses and income tax expense.

For the second quarter, the total share-based compensation expense was US$4.4 million. We believe, excluding the impact of share-based compensation awards from our non-GAAP financial measures and net income makes a more meaningful comparison of Sohu’s operational results and improves investors’ understandings of our performance. So we will use non-GAAP measures in this discussion to explain margin, cost and expense items.

Two, gross margins. Non-GAAP gross margin in the second quarter was 74%, which was unchanged from the previous quarter and the same period of last year. Online brand advertising non-GAAP gross margin in the second quarter was 63% which compares with 62% previous quarter and 60% in the same period of last year. Sogou non-GAAP gross margin in the second quarter was 55% compared with 39% in the previous quarter and 14% in the same period of last year.

Online games non-GAAP gross margin was 90% for the second quarter, which compares with 91% last quarter and 91% in the same period of last year. Wireless non-GAAP gross margin for the second quarter was 39%, which compares with 41% in the previous quarter and 48% in the same period of last year.

Three, operating expenses. Non-GAAP operating expenses for the second quarter of 2011 totaled US$73 million, which were an increase of 20% from the previous quarter and an increase of 43% from the same period last year. The year-over-year increase and quarter-over-quarter increases were mainly due to increases in both headcount and average compensation and higher expenses associated with marketing activities in the second quarter of 2011.

Fourth, operating margins. Non-GAAP operating margin was 37%, which was down from 39% last quarter and 39% from the same period of last year.

Five, income tax expense. For the second quarter, excluding a non-cash income tax expense of US$1 million recorded for tax benefits from the share-based awards, non-GAAP income tax expense was US$9 million compared with US$11 million last quarter.

Six, net income. Before deducting the share of net income pertaining to non-controlling interest, non-GAAP net income was US$67 million, up 10% compared with the previous quarter and up 27% compared with the second quarter of last year. Non-GAAP net attributable to Sohu.com Inc. was US$47 million, or $1.21 per fully diluted share, which was ahead of our expectations, and represented an increase of 8% compared with the previous quarter and an increase of 27% compared with the second quarter of last year.

Seven, net margin. Non-GAAP net margin before deducting the share of net income pertaining to the non-controlling interest was 34% comparing with 35% last quarter and 36% in the same period of last year.

Eight, moving onto the balance sheet and cash flow statement, for the second quarter, we generated close to US$84 million in operating cash flow bringing our cash balance to US$718 million as of June 30, 2011. As of June 30, our net accounts receivable was US$86 million, compared with US$69 million as of the end of the first quarter. Our online brand advertising DSO for the second quarter was 64 days compared with 63 days in the previous quarter and 70 days in the second quarter of 2010.

Nine, our outlook for the third quarter of 2011 is as follows. We expect total revenues to be between US$225 million and US$230 million. Online brand advertising revenues to be between US$75 million and US$77 million, which implies a sequential increase of 11% to 14% or 27% to 30% year-over-year. Sogou revenues to be around US$16 million, total revenues from Changyou to be between US$115 million to US$118 million, including online games revenues of US$112 million to US$114 million.

Before deducting the share of non-GAAP net income pertaining to the non-controlling interest, non-GAAP net income to be between US$64.5 million to US$67 million. Non-GAAP income attributable to Sohu.com Inc. to be between US$47 million to US$49 million and non-GAAP fully diluted earnings per share to be between $1.20 and $1.25. Assuming no new grants of share-based awards, we estimate that compensation expenses and income tax expenses relating to share-based awards to be around US$4 million to US$4.8 million. The estimated impact of this expense is expected to reduce Sohu’s fully diluted earnings per share for the third quarter of 2011 under U.S. GAAP by $0.10 to $0.12.

In conclusion, we are pleased with our strong second quarter results. Our key online games, online video and Sogou business units are all expanding rapidly, as a result of years of steady investment and hard work. We have demonstrated a consistent ability to cultivate new businesses from the incubation stage to the point where they can prosper as a separately listed company. We will continue to proactively support all of our underlying businesses as we strive to create value for our shareholders over the long-term.

This concludes our prepared remarks. Thank you for joining the call today. Operator, we’ll now like to open the call to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Dick Wei. Please proceed.

Dick Wei – JP Morgan

Hi, thanks for taking my call. My first question is on the video expenses. I wondered how much cash outflow is going to come from video and other content expenditure. Thank you.

Carol Yu

We purchased the content upfront and then we amortize it over two years over on a straight line basis. So cash flow doesn’t correlate to the net income. We’re looking probably the 2011 cash run rate is around $25 million to $30 million.

Dick Wei – JP Morgan

Okay, so that’s on the cash flow side, and how about on the P&L side?

Carol Yu

We don’t disclose that.

Dick Wei – JP Morgan

Okay, great. And then also is there any revenue related to sublicensing of the video, and where is it booked?

Carol Yu

Up to second quarter of this year, sublicensing revenue hasn’t been very material, until – because we have been pursuing the exclusive content strategy in the past, but starting from the Princess Qing, which will only hit our P&L in July, or third quarter onwards, we’re coming to see some – a little bit more sublicensing revenues, a couple of million dollars per quarter.

Dick Wei – JP Morgan

Okay, great. And my last question is just on Sogou, Belinda [ph] on a standalone basis, how much cash and net income do we expect to see this year and any financing needs on the Sogou front?

Belinda Wang

Sogou still has enough cash to sustain its operations until it gets breakeven which will be very soon.

Dick Wei – JP Morgan

Great, thank you very much.

Operator

Your next question comes from the line of Ming Zhao. Please proceed.

Ming Zhao – Standard Chartered

Total revenue on the portal side, what was the growth rate in the second quarter, I think you gave us the number for the video advertising, so for non-video advertising, could you give us that number?

Carol Yu

[Foreign Language – Chinese]. We gave you the overall one, so you should be able to sort of work that out.

Ming Zhao – Standard Chartered

Well I don’t know the breakdown of video versus non-video.

Carol Yu

I’ll give it to you later. We didn’t break that out either.

Ming Zhao – Standard Chartered

Okay. All right, my second question is on your guidance, I looked at your guidance for the first quarter, it implies that your wireless revenue and other revenue excluding the (inaudible) that’s up $7 million quarter-over-quarter in third quarter. Just wonder why – what is the reason behind that growth?

Carol Yu

The sublicensing revenue also goes into that line.

Ming Zhao – Standard Chartered

Which one sorry?

Carol Yu

The sublicensing revenue for the video business also goes into that line.

Ming Zhao – Susquehanna Financial Group

I don’t understand that, can you – what revenue for the video? The sublicensing, right?

Charles Zhang

Sublicensing, yes. We resell the content to other websites.

Ming Zhao – Susquehanna Financial Group

Okay, so that’s roughly $3 million, $4 million, right?

Carol Yu

Yes. So others would account for another couple of million dollars.

Ming Zhao – Susquehanna Financial Group

And is this booked to one time or is it – do we expect the third quarter – fourth quarter to have similar amount?

Carol Yu

It really depends on whether there are new dramas coming up. It would not as steady as the advertising income obviously. It really depends on whether we have the content on hand and whether we’ve sublicensed it.

Charles Zhang

Right, it depends on whether…

Ming Zhao – Susquehanna Financial Group

Okay.

Charles Zhang

We seek the exclusivity or not?

Ming Zhao – Susquehanna Financial Group

Okay, so mainly the third quarter increase for that part is from financial growth, all right?

Carol Yu

Yes.

Ming Zhao – Susquehanna Financial Group

Okay, all right. Thank you.

Operator

Your next question comes from the line of Wallace Cheung with Credit Suisse. Please proceed.

Wallace Cheung – Credit Suisse

Hi, congratulations on a good quarter. Also questions following up on the online video part, and as we have seen some of your competitor has recently came out to claim they are getting more exclusive contents potentially without sublicensing to the peers, but Sohu it seems to be going the other way around. Can you give us a bit more color that whether the market right now is pretty much like the content will be concentrated into a fewer players hand or there is sort of licensing and this sublicensing activities would keep going on, I have a follow-up questions on the Sogou part. Thank you.

Charles Zhang

Until recently we’ve been seeking an exclusive content strategy onto recently the price of per episode has sky high, very high. And so we are looking to this sublicensing strategy because of Sohu video’s brand and the user base and also our own housing self-developed content, we are confident that even by sublicensing to other websites, we still can we remain to be competitive and while at the same time to reduce the cost of our content cost.

Carol Yu

And I think one important factor is that we not only – we do not only sublicense our contents in return for money. We also trade with our other competitors. So if they – if we like what they have, we’ll be able to trade. We’ll have a lot more bargaining power in that respect.

Wallace Cheung – Credit Suisse

Okay, great. Just also one sort of on the online video part, that as Sogou video have been building up quite strongly, what type of content are you more interested to develop in-house. And then my next question on Sogou, can you split up the revenue between the pay-per-performance search and start-up page revenue? Thank you.

Charles Zhang

In our content purchase, we – most popular content purchase is really the TV episode, the drama because it is one of the most popular programs on the Chinese satellite TV system. So that we on the just – on the internet broadcast that to get the share of the eyeballs. Similarly, in our in-house developed content, we also co-invest or co-develop, co-produce a similar type of TV drama targeting the younger generation about the modern city life or those kinds of TV drama series. In addition, we will also – we may produce some documentaries and also enhance our programs in celebrity, current affair and those kinds of programs, we’ve been doing for many years.

So mostly in drama and then with also with some talk show, celebrity interviews and also documentaries.

Carol Yu

And sorry Wallace, what’s your second question on Sogou?

Wallace Cheung – Credit Suisse

Yes, would you mind to split up the revenue between the pay-per-performance search and the start-up page advertisement revenue please? Thank you.

Carol Yu

Start-up page is roughly about 10% to 15%.

Wallace Cheung – Credit Suisse

And is growing fast.

Carol Yu

It’s growing, yes. And overall revenue is growing fast.

Wallace Cheung – Credit Suisse

Okay, thanks very much for very detailed answer. Thank you.

Operator

Your next question is from the line of Julian Cheung [ph] of Morgan Stanley. Please proceed.

Julian Cheung – Morgan Stanley

Thank you taking my questions. For brand advertising, can you share with us your advertising outlook for second half of this year? And in your prepared remarks, you mentioned that you saw strong advertising demand from the internet sector. Can you share with us the growth rate for this sector, and do you expect a strong growth from this sector to continue into second half. And can you also provide us some insights on the sales trends for auto and real estate verticals as well as the pricing trends in second half. And then I have another question after this.

Carol Yu

It’s a long question.

Belinda Wang

Actually we have given the guidance for the third quarter, so I think the second half year’s growth rate will be in line with what we performed in first half of 2011. And regarding to your second question, on the vertical side, right?

Charles Zhang

On the internet.

Belinda Wang

Yes, in terms of the internet sector, we have achieved great rapid growth from E-commerce. I think this is because – we may continue to see the faster growing revenue from this industry in the substantial quarters because of the sharp competition in this industry and because of the industry markets are robust.

Charles Zhang

And also on the auto…

Belinda Wang

Yes, also in terms of the auto and real estate vertical industry sectors, I think we will see a steady growth rate for these sectors in the third quarter and the fourth quarter. And especially for the real estate sector, we don’t see the regulation impact on our revenue yet.

Charles Zhang

We mean the restricted purchase of housing and auto impacting...

Belinda Wang

Yes, we didn’t do the regulation impact. And also we would like to give some color on the auto industry. I think based on the Sohu auto is a well-established media in place. Starting from this year, our auto have implemented its vertical industry strategy which includes expanding a low cost Sohu auto website in over 40 cities and we also provide the uploading information software for the car dealers and providing online auto communication and e-business service for the auto users. So I think in the year of 2011, this strategical power will strengthen our user influence and help our auto advertising revenue growth.

Julian Cheung – Morgan Stanley

Great. Thanks for the detailed answer. I just wonder if the trend is quite stable in the second half, then should we expect the pricing trend also similar to the first half.

Belinda Wang

Yes, I think so.

Julian Cheung – Morgan Stanley

Okay, great.

Operator

Your next question comes from the line of Catherine Leung with Goldman Sachs. Please proceed.

Catherine Leung – Goldman Sachs

Hi, I have two questions. My first question is around your brand advertising growth margins. How much of the approximately $4 million cost increasing on a year-on-year basis is related to video content and bandwidth? And from your line of commentarial towards the World Cup related costs, (inaudible) would you please elaborate on how much.

Carol Yu

Sorry Catherine, we can’t hear you at all.

Charles Zhang

Gross margin.

Catherine Leung – Goldman Sachs

Can you hear me better?

Carol Yu

Yes, this is better. Can you repeat your question? We just heard that you asked something about gross margin on advertising.

Catherine Leung – Goldman Sachs

Yes, so on the gross margins for your brand advertising business, I was just wondering, approximately how much of the $4 million cost increase on a year-on-year basis is related to video content and bandwidth costs? And how material were the non-recurring World Cup related costs? And secondly is whether you would be able to elaborate on how much of your SoGou’s search traffic is via the Sogo browser? Thank you.

Carol Yu

Okay. The bulk of the increase in cost would come from – would be coming content costs and bandwidth costs of the video side, primarily the bandwidth cost would be costing more, because of the sharp increase in the viewership. And what’s your second question again?

Charles Zhang

The search traffic coming from browser or...

Carol Yu

Coming from the browser. [Foreign Language – Chinese]. About 80% of the growth in the search traffic will be sourcing from the browser – from the growth of the browser. Hello?

Operator

Your next question comes from the line of Gary Ngan of UBS. Please proceed.

Gary Ngan – UBS

Thanks for taking my question. I have two questions. One is related to the video sublicensing. Could you share with us approximately on a normalized basis, how much of cost or cash cost would you recoup by sublicensing and your expectation?

Charles Zhang

In terms of, for example the Qing Princess, we recouped all of the cost of the purchase of Huan Zhu Gege basically. But we won’t expect these kind of things to happen again because it’s so popular and so much competition for this.

Operator

The number you have reached is temporarily unavailable, please try again later.

Charles Zhang

Hello?

Gary Ngan – UBS

Sorry, the line was cut just now.

Carol Yu

Yes, but could you hear us?

Gary Ngan – UBS

Yes.

Charles Zhang

Okay.

Gary Ngan – UBS

Sorry, you said, it’s not going to continue…

Charles Zhang

So this is a TV drama, we did it good.

Gary Ngan – UBS

Right.

Charles Zhang

In the future, as the competition for good quality content continues, I think the sublicensing will definitely reduce our cost significantly if we decide to, but sometimes the exclusivity will continue – part of our content is exclusivity will be our competitive strategy, so we will only chose to.

Gary Ngan – UBS

Right. Actually that brings us to the second question, I remember you said something on the internet a bit earlier, about you think that the competition for content might actually be more or less ridiculous in the future, could you share with us why do you think that’s the case because it seems to me like a lot of the smaller video websites – video companies are getting funding either by IPO or private equity or venture capital or whatever, it seems that everyone has a lot of firepower to just drive the content cost upwards, and I guess there is a debate about whether these TV drama – that the cost for drama will actually exceed TV – the cost for TV station to acquire these drama at some point. What do you think about that?

Charles Zhang

I think the cost of the Chinese TV series per episode already surpassed that of the America Hollywood production. So it is too high, it is high, it’s sometime not quite reasonable considering the investment to introducing the TV dramas. So it’s too high because part of the reason is because Wall Street, you guys now really care for market share and for not caring for profit. So if I think when really there is a fight, battlefield for market share started to cool a little bit and then when investors care for profits, I think these funded companies well – when they start buying content, they will be more reasonable. By that time I think – I don’t know when it will happen but by that time it will – it will be that a really quality production will deserve that kind of the price while the bad production or anything that’s not very good will not have that kind of price.

Gary Ngan – UBS

I see, thank you very much for your detailed answer.

Operator

Your next question comes from the line of Wendy Huang with RBS. Please proceed.

Wendy Huang – RBS Capital Markets

Thanks for taking my questions. I actually have several housekeeping questions. Belinda, you mentioned earlier that you expect the second half brand advertising growth rate to be similar in the first half. So when I look at your first half growth, it’s roughly 35%. So are you implying that the full-year brand advertising growth will be at similar level to 35%?

Belinda Wang

Between 30% to 35%, yes.

Wendy Huang – RBS Capital Markets

Okay. And also Carol, you had mentioned earlier that you expect search advertising to breakeven very soon. So can you maybe clarify how soon that will be, because previously I think it will be likely 2012 but even the recent strong top line growth in the search, do you think you guys actually can breakeven at bottom line in 2011?

Carol Yu

Your line is breaking up, so I can’t hear the question very clearly, but yes, we expect to breakeven soon, in the next probably two to four quarters.

Wendy Huang – RBS Capital Markets

I see, and also can you remind me what’s your brand advertising exposure to the auto, i.e., what’s the percentage of the brand advertising come from the auto advertisers right now?

Carol Yu

We do not disclose that.

Wendy Huang – RBS Capital Markets

Okay. And also can you give some color on your budget for the microblog for this year and next year maybe?

Carol Yu

It’s very difficult for us to segregate on particular projects like this. So it’s all reflected in our financials.

Wendy Huang – RBS Capital Markets

Okay. My final question is regarding your online video business. So if we look at the current online video marketing in China, we don’t lack off big players with huge traffic, we also don’t lack off big players have a lot of cash on the balance. So what’s the real entry barrier or the edge or key exchange for the big players in the current market in your view is it content, technology or cash position?

Charles Zhang

I think it’s everything. It’s the brand, its traffic, user base and its technology and product and user experience and also it’s the cash power that provides the flexibility to buy content. So I think it’s these four area, the brand, traffic, content, technology and product are all important. It’s really – its overall combined efforts combined. You have to be strong in all these areas. So it’s really a competition of the whether you have the right organization and also the resources to compete.

Wendy Huang – RBS Capital Markets

Okay. Maybe a follow-up on that, you guys mentioned earlier that, one of the reasons. Hello.

Carol Yu

Yes, can you make it your last question please.

Wendy Huang – RBS Capital Markets

Yes, sure, sorry. I mean the bandwidth cost you mentioned earlier that’s the one of the most important reasons for your cost increase. So can you elaborate a little bit on the video technology you are using and do you expect it to adopt some newer technology to reduce the bandwidth cost or to have a relatively low cost relative to your peers? Thank you.

Charles Zhang

Right now, we have a choice, a decision to make. Every website has a decision, because when we introduce any peer-to-peer technology, you need either a client software or a plug-in. So it actually takes away – takes something from the users that actually – that brought up they are doing some – established some user – area for users to user to login to use. So in this fierce battle for market share, we want to have the minimize – we want to minimize that, so that most of these online video companies does not require users to have any plug-ins or software – client software to accelerate or to share bandwidth. But as maybe our browser or as people care for profits and really want to proactively decide that we want to reduce cost may be P2P technology maybe available. That can significantly reduce cost.

So right now it’s basically – but we still hope that the telecom operators will reduce the bandwidth costs. And or we will more at the same – if the bandwidth cost remain the same, we have first of all, advertising also more better efficient advertising or sublicensing or certain product content becomes paid per view for the first maybe combine with advertising on paid per view may be some hot TV dramas – the paid per view for the first month of the release, as we are doing some purchase from Hollywood content. Then I think we will have a business model that can be profitable. So it depends on several factors. So right now we’re not many plug-ins to provide the P2P technology to share bandwidth right now.

Wendy Huang – RBS Capital Markets

Thanks for the answers and I appreciate your patience.

Operator

(Operator Instructions) Your next question comes from the line of Muzhi Li with Mizuho Securities. Please proceed.

Muzhi Li – Mizuho Securities

Thank you for taking my questions and congratulations for a great quarter. Would you please briefly review the current year’s content budget for acquiring the online video programs or the TV dramas and I have a follow-up from that? Thank you.

Carol Yu

[Foreign Language – Chinese] US$30 million for the whole year for purchase.

Charles Zhang

It’s amortized actually.

Carol Yu

Yes, spending, it’s in the P&L.

Muzhi Li – Mizuho Securities

Okay, great, thank you. And regarding the $10 million of the Sohu’s investment in Xunlei, since Xunlei’s IPO gets postponed or cancelled. Does that mean that your $10 million investment gets refunded back?

Carol Yu

We did – that’s actually an investment conditional upon the successful IPO of Xunlei.

Muzhi Li – Mizuho Securities

I see.

Carol Yu

So that did happen.

Muzhi Li – Mizuho Securities

Okay, and finally.

Carol Yu

But you’re asking three, four questions. Go ahead.

Muzhi Li – Mizuho Securities

Sorry about that, just really quick, I am reading the earnings per share summaries and, I realize that Sohu’s non-controlling interest is only about US$69,000 loss, does that mean that Sohu is on the verge of breaking even or did I missed something?

Carol Yu

Yes, it is like what I said, it’s on its way to breakeven.

Muzhi Li – Mizuho Securities

Okay, great. Thank you very much, and congratulations again.

Charles Zhang

We get a multiple top line growth in the market share.

Muzhi Li – Mizuho Securities

Excellent, thank you.

Operator

Your next question comes from the line of Jiong Shao with Macquarie. Please proceed.

Jiong Shao – Macquarie Capital Securities

Thank you very much, thank you for taking my questions. I have one question but two parts. The first part is on the search business, could you tell the number of customers for Sogou, and could you also remind us the current market share in queries? That’s my first part of the question.

Carol Yu

Say that again, the number of…

Jiong Shao – Macquarie Capital Securities

The number of your customers for the Sogou.

Carol Yu

Okay.

Charles Zhang

And the queries.

Jiong Shao – Macquarie Capital Securities

And also your market share in customers search queries?

Carol Yu

Search query is about 5%. Number of advertisers, I’ll get back to you. What’s your second part? Make it quick.

Jiong Shao – Macquarie Capital Securities

All right. So for the video business, could you talk about the content cost increase rate right now year-over-year for your video business, also do you have the number of customer for your video business handy as well?

Carol Yu

We do not disclose the number of advertisers for the video business, but going back to your first part of your question, the number of customers, advertisers for the search business is about between 20,000 to 25,000.

Jiong Shao – Macquarie Capital Securities

Okay, and the content cost increase right now, the increasing rate, apple-to-apple basis?

Belinda Wang

You mean per episode rate or…

Jiong Shao – Macquarie Capital Securities

Yes, just roughly speaking per episode rate, and how much more you need to pay this year versus last year?

Belinda Wang

[Foreign Language – Chinese].

Charles Zhang

It will depend on – whether you’re talking about exclusive rights or non-exclusive rights?

Belinda Wang

Increased by 200%. If you’re talking about exclusive first tier content, sorry, the top tier ones.

Jiong Shao – Macquarie Capital Securities

Okay. And there is a lot of new reports related about the IPOs of your search business and also your video business, I don’t know if anything you can share with us?

Carol Yu

No, next question please.

Charles Zhang

Last question.

Operator

(Operator Instructions) Your next question comes from the line of Eddie Leung with Merrill Lynch. Please proceed.

Eddie Leung – Merrill Lynch

Good evening guys. Just one question on your browser business. Could you share with us the market share of your browser business and how you plan to grow in that browser business? Thanks.

Carol Yu

Like what we said, the browser right now ranks number three in the market. User penetration rate hits 23%. And we’ll continue to grow the browser through technological innovations as well as increased or expanded distribution network.

Operator

Thank you and that concludes today’s question-and-answer session. At this time, I’d like to turn the call back over to Ms. Jenny Wu for any closing comments.

Jenny Wu

Thank you everyone for joining the call today. If you have any further questions, please do not hesitate to contact us or the company directly. Thank you.

Operator

Thank you. Ladies and gentlemen, and that concludes today’s second quarter 2011 Sohu earnings conference call. Thank you for your participation. You may now disconnect.

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