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SINA Corporation (NASDAQ:SINA)

Q2 2007 Earnings Call

August 6, 2007 9:00 pm ET

Executives

Cathy Peng - Investor Relations

Charles Chao - President, Chief Executive Officer

Herman Yu - Chief Financial Officer, Vice President

Analysts

James Mitchell - Goldman Sachs

Richard Ji - Morgan Stanley

Alicia Yap – Citigroup

Wallace Cheung - Credit Suisse

Gene Munster - Piper Jaffray

Eddie Leung - Deutsche Bank

Dick Wei - JP Morgan

James Lee - WR Hambrecht

Presentation

Operator

Good day, ladies and gentlemen and welcome to the second quarter 2007 earnings conference call. (Operator Instructions) I would now like to turn the call over to Cathy Peng. Please proceed, ma'am.

Cathy Peng

Thank you. Good morning. Welcome to SINA's earnings release for the second quarter of 2007. Joining me today are our President and CEO, Charles Chao; and our Chief Financial Officer, Herman Yu. This conference call is also being broadcast on the Internet and is available through the Investor Relations section of the SINA website.

Before the management presentation, I would like to read the Safe Harbor statement in connection with today's conference call. During the course of this conference call, we may make forward-looking statements; statements that are not historical facts, including statements about beliefs and expectations. Forward-looking statements involve inherent risks and uncertainties, and a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements. Further information regarding these and other risks is included in SINA's annual report on Form 10-K for the year ended December 31, 2006 and its other filings with the Securities and Exchange Commission.

Additionally, the non-GAAP and comparable GAAP information are contained in our earnings release, which can be found at our corporate website at http://corp.sina.com. Following management's prepared remarks, we will open the lines for a brief Q&A session.

With this, I would like to turn the call over to our President and CEO, Charles Chao.

Charles Chao

Thank you, Cathy. Good morning, everyone and welcome to our second quarter 2007 earnings conference call. I'm pleased to report another strong quarter with advertising revenues exceeding the high end of our original guidance, despite our high revenue base comparison with the same period of last year, where we had a huge success in our FIFA World Cup coverage and related outstanding advertising results. This marked the fifth consecutive quarter that we were able to grow our online advertising revenues by 40% or more on a year-over-year basis. Our advertising revenue growth was supported by a favorable advertising market in China with strong GDP growth and our continued strong traffic growth, particularly from our interactive community products including blogs and podcasting.

During the second quarter, we added more interactive products and tools to our user-generated content communities to facilitate in-community communication and interactions. These initiatives have significantly increased activities within the communities and enhanced the stickiness of the communities. As a result, we saw significant traffic growth in our interactive communities in the last week of July. The average daily unique visitors for our blog service increased by 27% to 5.8 million from the same period three months ago, while average daily page views increased by 51% in the same period to 189 million. More recently, our blog traffic surpassed 200 million page views per day, which allowed us to hit our yearly target five months earlier.

Also in the month of July, the cumulative hits on the blog for Xu Jinglei, a famous actress and movie director in China, surpassed the 100 million mark, arguably the first in the world to reach that mark. The event has received heavy coverage on news media in China.

Equally encouraging was the progress we made on our video platform, SINA podcasting. In the last week of July, the daily unique visitors for our video-sharing program reached 2.8 million, more than doubling the number three months ago. The number of video items viewed by users on a daily basis also increased by 75% during the same period, to 13 million. Our strategic partnership with China telecom on our video platform really helped us to improve our video service quality, while the cost of providing such service has been under control.

Our continued success in our blog and the video offerings helped us to increase our brand recognition, our overall traffic and the user base which in turn, helped to drive our advertising revenue growth. On the advertising side, we are pleased to see another strong growth quarter with quarter-to-quarter increase of 13% and a year-over-year increase of 14%. As I mentioned in the previous conference call, the second quarter was going to be a hard quarter to compare on a year-over-year basis due to our outstanding performance during the FIFA World Cup last year. We generated $8 million advertising in last year’s World Cup and approximately 60% of that amount was recorded in the second quarter last year. We are obviously very happy to see our strong growth off this very high revenue base in the current quarter.

Automobiles, fast-moving consumer goods and the financial services were the major drivers for the growth in the second quarter, and all had triple-digit growth year over year. Although revenues from real estate and IT still remain the top revenue contribution categories, we are particularly excited about our advertising revenue growth in the financial services area, which grew by more than 230% from the same period last year. This means our investment in the financial content and products are beginning to pay off and we expect continued strong growth in this sector going forward.

Tomorrow is an important day in China, as the country begins to count down one year before the 2008 Beijing Olympic Games, and SINA is ready to take advantage of this great opportunity; so are our advertisers. We are seeing more and more Olympic partners and sponsors who have come up with their Olympic marketing plans and are starting to place more of their budget on Internet. As I mentioned before, most of the Olympic marketing partner sponsors or suppliers have traditionally been SINA’s customers and we are in a good position to take advantage of this wave of spending in the next 12 months.

We recently formed an Olympic Coverage Alliance with two other leading Chinese Internet media companies, Tencent and Netease. This alliance has been expanded to include scores of other web sites in China, including 20 state-owned news sites. The mission of this alliance is to provide our audience with the best coverage of the Olympic Games, as well as Olympic-related activities and events. The alliance is also aiming at providing our advertisers with the highest reach and coverage for their marketing campaigns.

Now let me spend some time talking about our strategic partnership with Google. We are excited about this relationship, as it provides SINA users with a high quality search service, while SINA will benefit financially from the arrangement. Under the agreement, SINA will use web search service and will be paid based on the traffic diverted to Google.cn from SINA’s website. In addition, SINA will deploy Google’s AdSense for Content product on SINA’s content pages, and will share revenue with Google for advertising dollars generated from the ad placements.

The revenues from this arrangement were minor in the second quarter as we need to go through a two to three months testing period for AdSense while the traffic ramp up for the web search will take some time. For the same reason, we will not see the full impact from the deal in the third quarter either, as the arrangement started in the middle of June.

Before I turn to Herman for the financial highlights, I would like to take this opportunity to congratulate Herman for his promotion to the position of Chief Financial Officer of the company. Herman has been the Acting CFO of the company since May last year, and has done a great job for the company in the areas of financial management, as well as investor relations. I trust that he will do an even better job for the company and shareholders in the future.

With that, I'm now turning to Herman for financial highlights for the quarter.

Herman Yu

Thank you, Charles and thank you all for joining our conference call today. I will now take you through the key financial highlights. Total revenues for the second quarter of 2007 came in at $59.8 million, which is at the high end of our guidance range between $58 million and $60 million, and represented an 11% growth year over year and a 17% growth sequentially.

Our advertising revenues, which exclude search revenues for the second quarter of 2007, were $41.2 million, representing a 40% growth year over year and a 30% growth quarter over quarter. Despite a large advertising revenue base in Q2 of last year, which included our record-breaking coverage of the FIFA World Cup event, our advertising revenues in China again grew 40% year over year for the fifth consecutive quarter.

As Charles alluded, automobile, real estate and IT sectors still make up over half of our advertising revenues in the second quarter; however, our robust advertising revenue growth is coming from sectors like automobile, financial and fast-moving consumer goods, where we experienced triple-digit increases year over year. Compared to the same period last year, the number of advertising customers in China increased 11% while advertising revenues per customer grew 26%.

For the second quarter of 2007, online advertising revenues represent 69% of SINA's total revenues compared to 55% for the same period last year and 62% for the previous quarter. We expect this trend to continue in the near future.

Turning to our non-advertising business, for the second quarter of 2007 our mobile business generated revenues of $17 million, which represents a decline of 24% year over year and 7% quarter over quarter. IVR revenues declined 39% quarter over quarter to $2.1 million, which explains most of the quarter-over-quarter declines in mobile revenues.

SMS revenues declined 1% quarter over quarter to $10.5 million, or 62% of our mobile revenues. Revenues from 2.5G, which include MMS, WAP and Kajima remained sequentially flat at $3.2 million. All in all, our mobile business continued to be impacted by operator policy changes. As such, we have adjusted our cost model, particularly marketing activities, in an attempt to maximize profitability as opposed to revenue growth.

For the second quarter of 2007, our other non-advertising revenues, mainly search and other fee-based revenues, were $1.6 million, representing a decline of 10% year over year and an increase of 27% quarter over quarter. The roughly $300,000 quarter over quarter increase mainly came from search revenues, of which only a small portion relates to the search portion of the Google partnership.

Before I turn the discussion to gross margins, I'd like to remind everyone that our discussion today includes non-GAAP measures which exclude stock-based compensation as well as other items. We use non-GAAP measures to exclude certain items that are not expected to result in future cash payments that are non-recurring or that may not be indicative of our core operating results. For a further explanation of our non-GAAP measures and a detailed reconciliation between our GAAP and non-GAAP results please refer to our earnings release.

Our non-GAAP gross margin for the second quarter of 2007 was 63% compared to 64% in the same period last year and 60% last quarter. Our non-GAAP advertising gross margin for the second quarter was 63% compared to 66% in 2Q06 and 59% last quarter. The year-over-year decline in gross margin was mainly due to higher content bandwidth and infrastructure-related costs. On a sequential basis, advertising gross margin expanded as advertising revenues grew faster than associated costs. Non-GAAP gross margin for our wireless business was 61% in the second quarter, compared to 60% for the same period last year and last quarter.

Turning to operating expenses, our non-GAAP operating expenses for the second quarter of 2007 was $22.6 million compared to $23.2 million for the same period last year and $20.8 million last quarter. The 3% year-over-year decrease in operating expenses was mainly due to decreased marketing activities, particularly related to mass promotions, partially offset by higher expenses related to payroll, depreciation and bad debt, as well as the impact of RMB appreciation on spending in China.

The 9% quarter-over-quarter increase in operating expenses was primarily due to higher commissions and other payroll-related costs and higher travel and entertainment expenses. Our non-GAAP operating margin for the quarter was 25% compared to 21% in the same period last year and 20% last quarter.

Before I turn to net income, I should briefly mention that our non-operating income for the second quarter of 2007 includes a one-time gain of $800,000 from an investment divestiture.

Now turning to net income, non-GAAP net income for the quarter, which excludes stock-based compensation and other items, was $16.1 million, an increase of 31% from the same period last year and an increase of 42% from last quarter. Non-GAAP net margin for the second quarter was 27% compared to 23% in 2Q06 and 22% last quarter. Non-GAAP diluted EPS for the quarter was $0.27 compared to $0.21 in the same period last year and $0.19 last quarter.

Turning to balance sheet and cash flows, as of June 30th, 2007 our cash, cash equivalent and marketable securities were $415.2 million compared to $312.5 million at the end of 2Q06 and $382.7 million at the end of last quarter. Cash flow from operations for the quarter was $20.9 million compared to $8.1 million for the same period last year and $16.6 million last quarter. Capital expenditure for the quarter was approximately $3 million.

Let me now turn to our guidance for the third quarter of 2007. We are targeting total revenues of $63 million to $65 million. For online advertising, we're targeting $45 million to $46 million and for non-advertising business, we're targeting $18 million to $19 million. Excluding any shares that might be granted, we expected stock-based compensation to be approximately $1.7 million for the third quarter.

This concludes the written portion of our call. We are now ready to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from James Mitchell - Goldman Sachs.

James Mitchell - Goldman Sachs

Thank you very much for taking my question. Just in terms of the other revenue business line, which I guess is search plus email plus casual games. Could you talk a little bit about why the gross margin dipped in the second quarter? Also for the third quarter, could you talk about how you see the revenue split between mobile, VAS, and other within the $18 million to $19 million you've guided for the two cumulatively? Thank you.

Herman Yu

With regard to the cost of sales, some of that relates to additional server depreciation and associated costs. With regard to the split between mobile and net, we think that the mobile will probably be flat to a little bit of upside.

James Mitchell - Goldman Sachs

You say the mobile is flat to upside and then everything else is flat, implicitly?

Herman Yu

Yes.

Operator

Your next question comes from the line of Richard Ji - Morgan Stanley.

Richard Ji - Morgan Stanley

I have two questions. The first one is regarding your 3Q outlook. You guided for an 11% sequential increase from your brand advertising, which is below the outlook for your closest rivals, Sohu. Just help us understand a little bit how much of the incremental growth comes from price increase for your advertising rate, and how much of that comes from Olympics-related volume pick up?

Charles Chao

In terms of the revenue guidance for Q3, I think this is a very typical pattern we have seen in the past whatever years we have been in this business. If you look at the growth rate between Q2 to Q3, normally it has been about 10% in the last two or three years. So I think this is very normal.

In terms of growth, and obviously there will be some benefit from increased Olympics-related activity in Q3, but I think it's more like a normal growth from all sectors. Nothing in particular will drive this growth, we do not really actually have the price increase in Q3; as you recall that we typically raise our price in Q2 and Q4, not in Q1 and Q3. But if there's some Olympics-related activities and other non-standardized advertising format, then there will be some price that's maybe different from what we previously offered. But in general, there was no price increase, basically.

Richard Ji - Morgan Stanley

My follow-up question is regarding two of your new revenue drivers. One is the blogs, especially celebrity-sponsored blogs. My observation is literally 90% of the blogs in China are very hard to monetize, yet celebrity-sponsored blogs indeed have advertising value. Can you help us understand it better? How much revenue, what is the current status, what are your future plans to monetize your blog site?

Plus a follow-up question regarding your Google search initiative. When do you foresee the revenue of that starting, and by what magnitude?

Charles Chao

Regarding the monetization of blogs, actually we've just seen some very good progress in our blog monetization in Q2. We started to place more advertising on the blog pages, not in the personal blog but on the front page of blogs. I don't know if you have had a chance to look at our website. We only had a front page for our general blog entry point but also we have the front page for a lot blog aggregation pages like in every content channel and in different circles; if you look at our weather channel and technology channel and entertainment channel, sports channel and so on and so forth you will see that there is always a front page for that.

So we started to generate a lot more revenues in these areas in Q2. I think the total amount was probably around $1 million US in Q2. More importantly, as we've said before, that blogs have been an important factor and a weapon for us to get more advertising dollars from our advertisers, because a lot of advertisers like the idea of the user participation in a lot of marketing campaigns. Particularly we saw a trend in dealing with Olympic sponsors these days that we saw a lot of demand for our blogs, I mean participation in the Olympics campaign.

As you know, Olympics is about participation by people in the country. They would like to have audience involvement, participation in their Olympic campaign. For example Lenovo had a big deal with the passing the torch relay, and immediately a blog started. There's a lot of these examples. So we're actually getting more and more benefit from this blog service. In the future, as I mentioned before, we are actually beginning to develop the system to try to place the ads in the personal blog page but we just want to do that more cautiously. While we're already starting to benefit from the blog service in terms of monetization and we want to move our steps more cautiously going forward, at the right pace basically, so we can have the best system for blog monetization going forward.

You are right, that 90% of blog service, it's very hard to monetize in China. This is true for not only in China but in other countries too. I think we have a lot of ways to monetize it and we began to see that impact and benefit, and we will see more of these things in the future.

Regarding your question about the Google deal financial impact, I think we're not going to see the full impact in Q3, as I just discussed in my opening remarks here. For AdSense, we'll probably have to go through two to three months of a testing period so they'll be testing different pages to see the effectiveness in entirely different locations, different pages. This is a starting point that's more like a transitional point for AdSense. We are going to see the full impact of AdSense probably in the month of September. For the web search, it will take some time to ramp the traffic so I would say that for that portion probably we'll see a nominal impact beginning early next year. I hope that answered your question.

Richard Ji - Morgan Stanley

Yes, great. Thanks Charles.

Charles Chao

No problem, Richard.

Operator

Your next question comes from Alicia Yap – Citigroup.

Alicia Yap – Citigroup

On the Google deal, can you share with us a little bit more detail on the partnership agreement? For example, is there any minimum payment people will pay you each year and will these payments change over time?

My second question is on the recent Olympic Alliance. Do you see the success of this alliance as an important strategy to compete with Sohu and though it may be still early, have you seen a pick up on your Olympic-related ads since the announcement of the alliance? Thank you.

Charles Chao

Regarding the Google contract, I already said a little bit in my opening remarks. There was basically no specific or minimum guarantee, but somehow it was implied in the contract because there was a very low bar for getting some minimum benefit from the agreement. I could not really spell out the details very specifically given the confidential treatment of this agreement, as Google is also doing business in China with other partners here. So this is something that we cannot really specify too much. But I think it's somehow that there is some guaranteed amount implied, but not really specifically said in the agreement.

I think once you passed the minimum point, then with the traffic growth it is more for the web search and with more revenue generated from AdSense you obviously will see more and more benefit from the deal going forward.

With respect to the question for the Olympic Alliance, I think the purpose of the alliance as I said earlier, was to basically form an alliance here so we can have a better content service offering, and to reach the widest audience base in China. We can partly share some costs of the content also. On the other hand, together we can do a lot of campaigns to promote Olympic games.

I think the Olympic games in China is not just about sports; I mean it's not just about the commercial benefit of the advertising. More importantly, it's more like a national event here and everybody is participating in the event, so we want to be a part of it; as a very influential Internet media company in China, we want to be part of it and be able to contribute in this process. I think together we can do it much more effectively, instead of compete on the resources of content and allow other things drive up a lot of costs without the benefit for the users and for ourselves.

I think this is just the beginning of the Alliance, and it is also possible that we will be able to team together with the companies within this Alliance to provide a more complete or complementary product and service and to reach the widest audience for our advertisers. As you can see the trend for online advertising in China as well as in other countries, that people would like to utilize a lot of new forms, new products, especially the interactive product and format in their advertising campaign. Each company has their strength and weakness in areas in their service for providing the best quality service for the advertisers. So together, it could be much more of a complete package for advertisers to reach the audience base they want to reach.

I think this is very encouraging, and of course there are a lot of details that we need to work out.

Operator

Your next question comes from Wallace Cheung - Credit Suisse.

Wallace Cheung - Credit Suisse

Good morning, Charles and Herman, and congratulations to Herman.

Herman Yu

Thank you.

Wallace Cheung - Credit Suisse

Just two questions related to the Olympics. Charles, can you share more of your thoughts and insights about the visibility right now regarding overall spending in 2008? How we are going to see major spending to come, is there a timeframe and the market share that you are targeting.

Secondly on the FMCG side, it is good to hear that FMCG is contributing more. Can you share a bit more of thoughts in terms of the percentage of brand advertising revenue, how is the percentage? Do you have any specific strategies to try expanding the FMCG on SINA? Thank you.

Charles Chao

Wallace, I did not quite exactly get your first question. You are talking about our prediction for the Olympics spending for 2008 and our predicted market share for the Olympic Games? Is that the question?

Wallace Cheung - Credit Suisse

My question is maybe too general. To narrow it down, can you explain a little bit more about the Olympic spending in 2008, because there is some third-party research saying that the overall advertising spending is going to be increased by 25% in 2008, then what is the potential increase of the Olympics spending on the Internet segment in 2008?

Charles Chao

I think that is a very difficult question to answer, because always you will see people spending a lot more money from now to the Olympic Games, and during the Olympic Games, including the sponsors and the partners for Olympic Games. They will increase their budgets for the Olympic events, activities, campaigns and so on and so forth.

On the other hand, these people will spend money anyway for their normal advertising, and they probably will choose to spend more money on the Olympic-related activities and campaigns.

So like I said before, most of these sponsors and partners, I would say 80% to 90%, probably 80% or so of these companies have been our long-time customers. A company like China Mobile and Lenovo have always been some of our top customers. We are seeing them actually doing more Olympic campaigns.

On the other hand, this is not like an entire extra budget for the company. It's not like they were spending $100 million last year and they are still spending $100 million this year for their normal advertising and spending another $100 million for Olympic Games. I think in general, they increase their budget but it is not like entirely extra here.

It's really difficult to say how they increase their budget for the Olympics, but in general we are seeing them spending more money right now on the web site on general advertising and the marketing campaigns, and also on offline media. So I will say that, you will gradually see the ramp up for the Olympic-related advertising campaigns from now until August of next year and we will do our best to get more market share in this process. We are confident that we will get a lot of budget from these campaigns going forward, one being that they have always been our big customers; and secondly, we believe that SINA is in a very good position to take a large chunk of these budgets from the advertisers.

If you want me to give you a specific number for Olympic-related, I don't think anybody can give that number.

Wallace Cheung - Credit Suisse

Sorry about the confusing question. My second question is on the FMCG side.

Charles Chao

Herman, can you take the question?

Herman Yu

Can you repeat that question again?

Wallace Cheung - Credit Suisse

My question is actually in two parts. First is what's the percentage of brand advertising revenue from the FMCG segment? Second will be any specific strategy to improve FMCG spending on SINA?

Herman Yu

With regards to percentage of revenue, FMCG is about 7% or 8% roughly. Your second part is what the strategy is?

Charles Chao

I will take the second part of the question. Regarding FMCG, traditionally FMCG has been spending most of their budget on TV, on Outdoor LED, these kind of media. Our strategy is to really develop our video offerings and the platforms in China has a lot to do with the potential of the FMCG opportunities. Being the largest category for the advertising dollars in the market, TV typically has about 60% to 70%, around 70% of the total advertising market share in China. If we can grab a piece of it from the TV advertising, TV media than it could be very significant. So that is part of our strategy is if we can develop a very good and powerful video platform and be able to deliver that, I mean with the right technology, right systems and to be more precise in terms of targeting then there will be good opportunities for the growth of FMCG advertising on the Internet going forward.

But I want to caution you that this takes some time because traditionally this media budget most of the times are located in the so-called TV department, in the marketing department. For our customers this is very typical among the Chinese advertisers. So they have a group of people dealing with TV advertising, another group dealing with so-called new media or Internet advertising. So it takes some time for these organizations for their structure to change.

Actually, we are seeing this kind of trend for some of our customers. They see the importance of how the overall packaging for the cross-media promotions not only on TV but also across the board between the traditional media TV and Outdoor as well as Internet media and new media. We see some of these trends coming but it will take some time. As I said before we'll probably see more media advertising in '08 and not in '07.

Wallace Cheung - Credit Suisse

Thank you. Good to hear the trends as well. Thank you, Charles and Herman.

Charles Chao

Thank you, Wallace.

Herman Yu

Thank you.

Operator

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

Gene Munster - Piper Jaffray

One more try on the Google question: you're basically saying don't expect much until 2008. Is it going to be measurable in 2008? Is this going to be something where it will be measurable?

Charles Chao

I think it will be measurable. It’s very hard for me to give you that number because somehow it would be implying the deal structure of the agreement so I'm reluctant to give you a number prediction. But I think AdSense especially is very much measurable and web search I think partly will depend on how we are going to be able to grow traffic for Google web search, but we have a good feeling that we will be able to get to that point somewhere in '08.

Gene Munster - Piper Jaffray

One last question is, if I'm an advertiser and I want to advertise on SINA and I'm an official Olympic sponsor, can I use the Olympic logo in my advertising campaign on SINA?

Charles Chao

Well I think there has been some confusion in this area. Our understanding from our communication with IOC directly is that there will be no restrictions in terms of using logos on the website and going forward in China. I think there was a lot of complicated history on this particular issue, but part of the objective of this Olympic Alliance is to send a statement to the market and to the audience here in China that there will be no such thing called exclusivity on the reporting of Olympic Games and there will be no such thing called exclusivity on advertising on a website in China for Olympic Games.

Gene Munster - Piper Jaffray

That’s very helpful. Thank you.

Operator

Your next question comes from the line of Eddie Leung - Deutsche Bank.

Eddie Leung - Deutsche Bank

Could you talk a little bit about your strategy on the audience with competition from verticals? The second question is on your music as well as e-magazine platforms. Can you talk about your business plans on these two platforms? Thank you.

Charles Chao

The first question regarding our strategy in terms of our dealing with the competition from the vertical websites, we have been talking about this trend for some time now that just like other countries, China also begins to see this trend, more obviously that a lot of the vertical websites becomes more and more strong in the marketplace, just because the Internet audience base has been growing very fast. I think this model has become more mature in some categories such as automobiles, real estate, job hunting, travel and finance, and IT and so on and so forth. So the market becomes big enough to accommodate some of these vertical websites to make them profitable and grow at a reasonable pace in the market now.

Obviously, I mean SINA has always been very strong in many, many verticals like finance, sports, entertainment, IT, automobiles, and so on and so forth. So our strategy, basically part of it we want to go deep in terms of a lot of verticals with a lot of advertising potential. For example, we talked about finance. I mean, we talked about sports and automobiles, for example. If you take these vertical websites out, it clearly is the leader in the market and much bigger than a lot of vertical sites. So we want to build on this advantage for our leadership position or rating in these areas, and to invest more in personal content as well as the technology related to these products, to make them much more competitive. I think these verticals have a lot of potential in advertising dollars.

Having said that, it’s not possible that we can compete effectively or to keep a leadership position in every category for the verticals and we have to choose the areas we compete. SINA is probably is more famous and known for it’s high-quality audience and entrenched audience base in China; the website for the white collar people. We probably have a priority here to spend more money and investment in those areas where we are good at it, and have the potential to generate more marketing dollars in those areas.

Another strategy probably will be, part of it will be in the future we might consider to cooperate with some of these vertical websites, so we can help them to develop the market together in terms of advertising. Meanwhile, they can help us enhance the product offerings for these verticals. A lot of areas may require a lot of investment in personnel and also in the product development of a particular vertical. For example, there might be ecommerce opportunities in vertical areas where we may choose to cooperate instead of doing it ourselves, so we will be able to take advantage of our branding power and our advertising sales ability; and on the other hand somebody else will be able to help us develop ecommerce in those verticals. So these are some of the strategies we are implementing and could be effective in the future.

The second question about our offering on music and e-magazine. On the music, as you recall we launched our music platform at the end of January and so far on this platform it has been pretty well received with pretty good traffic increase in our music platform. We are still in the process of developing an online community for music here within that platform, and so we will probably introduce that in fourth quarter. I think once we have this community up, this community will obviously be integrated to our other communities like blog and podcasting, and so we expect significant user and traffic growth once this community is built up. On the other hand, we are hopeful that right now that the business model is primarily for advertising, but going forward and we actually see a better and better legal environment in China for offering legal music with the legal copyrights, and this trend obviously will take some time, but we obviously have seen some encouraging development recently and we are hopeful that in the future we will be able to get into the business of offering a fee-based service for the music service going forward.

E-magazine is one channel we just launched recently with the publisher of another small company here in China. Our strategy and idea about e-magazine is, its just part of our overall content strategy where we want to be multimedia and also multiple offerings for our content. These products can be integrated together to offer the best content service for our customers and audience.

If you look at the website, obviously we have a lot of content from a traditional media company. We're also developing other content ourselves and from the content perspective we have blog and podcasting, we have the book channel and we also have a lot of other channels like music, we also have a music platform. So e-magazine is part of it. Not just e-magazine, but we've also recently launched a SINA photo platform. So together, these are adding up being somewhat a very comprehensive content offerings for our users that's just one part of our strategy.

Operator

Your next question comes from Dick Wei - JP Morgan.

Dick Wei - JP Morgan

Hi Charles and Herman. Congrats on the promotion. I've got a couple of questions. The first question is on the gross margin trend, if you can give us some visibility over the next couple of quarters particularly related to the China Telecom partnerships? You mentioned in the prepared remarks that we can see some cost savings in that area?

Charles Chao

Well I think the gross margin, our best estimate right now is that in the second half of the year the gross margin will be similar to the gross margin we saw in Q2. There could be a possibility it will improve slightly. It really depends on our initiatives on some of the content acquisition area.

You mentioned about a partnership with China Telecom. This particular partnership did not really save our costs vis-à-vis the costs we had before. I mean it was not like something we can cut down the costs we had before. It was something that really helped us to increase our costs for our video platform going forward as we increased the traffic. So don't get that wrong. It was not like a reduction of costs. It's just it will cut down our incremental costs in the future with the increase of video traffic, basically. So I don't think that's a factor that will impact our gross margin so much in the future.

More likely the impact will be coming from our content acquisition as well as server depreciation increase in the future. As you can see, we actually increase our traffic pretty significantly recently and we also predict there will be a good traffic increase in the media area and also in the community areas; all require a lot of hardware investment that in turn will increase our depreciation expenses.

Dick Wei - JP Morgan

I see but potentially in the future you're able to see some more advertising revenue from the video podcasting service and you may be able to see some leverage on that, is it fair to say that?

Charles Chao

Yes I think that in the long term definitely.

Dick Wei - JP Morgan

Another question I have is on the advertising rates, I guess the rates charged for 2008, have you settled on a rate card? Or will you wait for the City TV in November, the primetime auction, before you set the card? If you can comment on the sale rate for 2008 that would be great.

Charles Chao

We don't look up to City TV for our rate adjustment. We look at our own system to see the demand and supply relationship on the inventory offerings we have on our website. And so as you recall, we do a price adjustment every two quarters and we did one in Q2. There will be another one in Q4. In terms of how much we're going to adjust the two factors, obviously we'll look at the market in terms of what other players in this space are offering for similar inventory, and also look at the demand and supply issue within our system to see what's the best way to adjust our price rate card going forward. But going forward definitely in '08 we're working to increase the price, but it's too early to say how much we're going to increase.

Dick Wei - JP Morgan

When do you think you will decide on the rate card? Can advertisers now place ads for 2008 already?

Charles Chao

Oh I see. No typically we do not -- when we sign a contract it's a campaign, it's very difficult to last for the entire year so the advertisers, typically we sign, if you recall the frame contract with the customers. If it's on an annual basis, that contract would determine the discount rate for that particular contract for that particular customer. But when they actually sign the execution contract for a particular campaign, the price will be based on the price rate card, basically. So we can sign a contract with the amount with the discount rate but may necessarily have the price rate for a particular campaign basically.

Operator

Your next question comes from James Lee - WR Hambrecht.

James Lee - WR Hambrecht

Charles, can you provide a little bit of clarity to Gene’s question before? You were saying that IOC has given you a clear mandate allowing you to have advertisers using the joint logo. Do you expect them to maybe give a clear definition soon to market? Apparently there's confusion.

Charles Chao

What do you mean by joint logo?

James Lee - WR Hambrecht

Joint logo having the Olympic sponsor logo along with the Olympic logo on a same banner ad.

Charles Chao

Sponsor logo?

James Lee - WR Hambrecht

For example, Lenovo would put their logo on the banner ad and also along with the Olympics logo on the banner ad.

Charles Chao

Not like two sponsors put their logo together, it is like Lenovo has their logo and the Beijing Olympics logo is also in the same banner? Right. It's not like where we get a mandate from the IOC, it was really the clarification we got from IOC when they told us there was no such restriction here. Actually you have seen a lot of these logos on our website and other people's websites in China, if you check the website for a lot of Chinese customers here. This is something is based on our understanding communication with IOC but you're right there is a lot of confusion in the market and that is why I wanted to clarify that.

James Lee - WR Hambrecht

Do you expect IOC to come out and give a formal definition to the marketplace to alleviate this confusion? Clearly this is a diversion of opinion between BOCO and IOC in that respect. I was curious from speaking with advertisers, especially with the Olympic sponsor, how do they feel about this situation? Are they in the situation say okay, maybe I'll wait until the situation clears a little bit before allocating more dollars on Olympic spending, or do you think they are indifferent at this point? Just curious when you talk to advertisers, especially Olympic advertisers, what their responses are due to the confusing marketplace?

Charles Chao

Well in the past we have seen some different situations, one is that some people just don't put the logos on the website. They do advertising anyway for Olympic-related activities. We're seeing more and more people actually put the logo in their banner. This is an issue that a lot of people are confused about, and I agree some advertisers are also confused, so we need to get the clarification and we are in the process of getting a written clarification from IOC but that's our understanding now from the oral communication with the IOC.

James Lee - WR Hambrecht

Do your advertisers, Olympic sponsor advertisers, push that on BOCO i.e. putting a joint logo on your website, a banner on your website? Do they get a letter or any kind of notification from BOCO as a result sort of pushing them or encouraging them to take the Olympic logo on banner or you haven't seen that kind of reaction from the Olympic advertising community?

Charles Chao

Well as I said, in the past we saw some of these situations where the advertiser did get some confusion here but going forward I hope that confusion will be clarified and be clear.

Operator

There are no further questions in queue. I would now like to turn the call back over the management for closing remarks.

Charles Chao

We thank you for your participation and we will see you next quarter. Thanks.

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