Ladies and gentlemen, thank you for standing by and welcome to the SOHU's Third Quarter 2005 Results Conference Call. At this time all participants are in a listen-only mode. Operator Instructions As a reminder this call is being recorded today, Tuesday, November 08, 2005.
I would now like to turn the call over to Ms. Ingrid Shea (ph). Please go ahead ma'am.
Ingrid Shea, Investor Relations
Thank you. Thank you everyone for joining SOHU.com to discuss our third quarter 2005 results. On the call today are Charles Zhang, Chairman of the Board and CEO and Carol Yu, Chief Financial Officer.
Before the management presentations, 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 SOHU's historical and possible future losses, limited operating history, uncertain regulatory landscape in the People's Republic of China, fluctuations in quarterly operating results and the Company's reliance on on-line advertising sales, mobile phone related wireless revenues, on-line games and e-commerce for its revenues. Further information regarding these and other risks is included in SOHU's Annual Report on Form 10-K and other filings with the Securities and Exchange Commission.
Thank you all for your patience. Now let me turn the call to Charles Zhang, Chairman and CEO. Charles?
Charles Zhang, Chairman of the Board and Chief Executive Officer
Thank you all for joining our conference call today.
First, I'd like to highlight one of the most significant events in our Company's history. We at SOHU are all very excited in the first official Internet content sponsor for the 2008 Olympics. This will provide SOHU exclusive access to the 2008 Olympics official Web site content and also give the Company exclusive cross marketing and cross selling opportunities with the other Fortune 1000 corporate partners and sponsors such as Coca Cola, GE, McDonalds, Adidas, Lenovo, China Mobile and Air China.
The magnitude of what this means for SOHU is enormous for the future of our on-line advertising business. This was a heavily sought after project in China and the environment in which we won was highly competitive and the one that we view as a testament to the strength of SOHU brand. Our reasons for this investment are simple. As we move closer to the 2008 Olympics we believe we will see accelerated growth opportunities in leveraging the sponsorship program and drive more advertising revenue through customers looking to capitalize on the 2008 Olympic event. We believe it will serve as a platform to showcase our superior technology and a brand presence.
There are two core messages that I want to emphasize on our call today. First, we firmly believe that having been chosen as official Internet content sponsor for the Olympics Web sites puts us at the head of the pack amongst our peers. This endorsement is one of the most exclusive events that can happen in the Chinese Internet market. With the full support of the Beijing Organizing Committee of the Olympic games and the Chinese government we are now well positioned to lead our Company down the path of strong success through seamless execution of the Olympic Web site launch.
Second, we will continue to drive our business through continued development and the roll out of our own innovative products and services to drive increased traffic and the usage of our sites. We believe the combination of these two events will not only shape the way SOHU sells to its customers, but that it will have a large impact on the Chinese Internet market as a whole.
Now I would like to discuss the other highlights for the quarter. First, we reported revenue of $28.3 million growing 9% sequentially and coming in again at the high end of the Company guidance. Now let me discuss the progress of each of our business lines. Advertising revenue was $18.8 million and exceeded our prior Company guidance. Brand advertising revenue was $15.6 million and sponsored search accounted for $3.2 million, an increase of 13% and 2% respectively. Overall we have seen a strong quarter in advertising business.
For the first nine months of 2005 we have grown 27% year-over-year similar to our closest competitor. In brand advertising the 13% sequential revenue growth was mainly driven by heavy spending sectors such as real estate, information technology and automobiles. Number of advertisers in the quarter grew from 420 to 450. Our fastest growing sectors were on-line games, financial services and FMCG, fast moving consumer goods companies. On-line games came back stronger than expected mainly due to World of Warcraft having a lesser than expected impact on the launch of other games enhanced our business.
On the product side we will continue to launch new products that will drive new users to our sites. For example, we have successfully built the largest community of users in the Chinese Internet space such as PBS (ph), the number one message boards in china and the China Alumni Club and the China message boards. We also launched several new products including our Picture Bar, which allows users to download pictures through various content on our Web site and SOHU's blog. All of these new products are contributing to increased traffic. The goal is to continue to provide more targeted marketing through this platform and to sell our products and services into that user base.
Overall, we remain confident that we will be strong, there will be strong growth for our advertising business over the next few years. Branding effect from the Olympic sponsorship will have a significant impact on our ability to drive our advertising business. Our reach will be much broader, especially in areas such as sports, news and in many other channels. We also strongly believe our leadership position allows us to continue to provide clients with unique branding advertising opportunity reaching both the mass population and the targeting communities via our numerous sector specific on-line channels.
Turning now to the outlook for advertising for the remainder of the year. Year-to-date our advertising revenue are up 27% growth over the same nine months of 2004. We see continued healthy growth in brand advertising and, as you can see from our guidance, we expect to meet our overall advertising revenue growth target for the full year of 2005, which is 25%.
In sponsored search we saw modest sequential growth, which was largely due to several reasons, first, an increasingly competitive search environment, 2) an adjustment to our distributor structure as we strive to position sogou more competitively by using multi-distributors rather than relying on sole distributors. To our satisfaction our own internal beta shows the sogou traffic has grown 50% from Q2 to Q3. Developing a successful search business is based on getting the right technology and the products to increase penetration.
Our efforts toward strengthening our search business are heavily focused on these areas. A good example is our recent upgrade of the sogou version 2.0 to sogou version 2.5, which is targeted to be launched later this month. This enhancement will lead to increased traffic over time. We are confident that our investment in developing the right technology and getting the necessary products, the right and necessary products to make sogou a leading search engine for the Chinese language are focused in the right direction.
Finally, turning to our largest business where our focus remains on our core advertising business we are very happy to see a continuing cautious recovery in our wireless business with a 6% sequential growth to $6.8 million. We are particularly pleased that the exchange on our 6% growth we did not have to spend heavily on advertisements or other marketing efforts to achieve that growth.
We are pleased that our wireless business, although small, has become very stable. Additionally, our Olympic sponsorship should also have a positive impact on our wireless business. China Mobile is also a member of the Olympics Sponsorship program and we view this as a potential catalyst for enhanced cooperation in the future, particularly around the coverage and the related program services of the 2008 Beijing Olympics.
Now, I would like to give the floor to our CFO, Carol Yu, for our financial review. Carol?
Carol Yu, Chief Financial Officer
Thank you, Charles. I would like to take this opportunity to discuss some key financials to enhance your understanding of our business operations. 1) Revenues, we are pleased to report strong revenues of 28.3 million for the third quarter, which came in at the high end of our guidance.
1) advertising, with advertising revenues of 18.8 million we experienced a healthy 11% sequential and 21% year-on-year improvement. Year-to-date we're on track to meet our target advertising revenue growth of 25% for the full year of 2005.
2) Wireless, we are very pleased to note that our wireless business is continuing to show healthy signs of recovery. Let me give you a breakdown of the third quarter wireless revenue.
Our SMS service grew 23% quarter-on-quarter to 4.2 million. Our wire services declined a marginal 2% to 2.1 million. Our MMS, IBR and ring back tone services contribute only very small amounts at this stage. Going forward we believe we will continue to see modest recovery for this business line.
Other revenues, our on-line game revenues grew 8% sequentially to 1.4 million with flat on-line revenues growing 11% sequentially.
2) Turning to our gross margins overall gross margin for the third quarter was 65%, down from 67% in the previous quarter and 68% in the third quarter of 2004. Advertising gross margin was 74% in the third quarter down from 76 in the second quarter and 79% in the same period last year but still higher than that of our closest competitor. Both advertising profit increased to 13.9 million from 12.9 million in the previous quarter.
Non-advertising gross margin was 47% for the third quarter compared to 51% in the prior quarter and 52% in the third quarter of last year. The decrease was mainly due to an alleged penalty of $241,000 charged by Unicom as a result of Unicom's investigation carried out at the previous quarter and such was recorded as a cost of revenue in the third quarter. Although we do not believe SOHU had mistakenly charged users that did not prescribe to our services, the possibility of this penalty being reversed is remote and we would like to prefer to move forward with our business relationship with Unicom and put this behind us.
3) Operating expenses for the third quarter of 2005 SOHU's operating expenses totaled 11.1 million increasing a modest 3% quarter-on-quarter and 15% year-on-year. The year-on-year increase in operating expenses was mostly due to investment in long-term growth opportunity, primarily in the area of research and development.
4) Operating profit margin, operating profit margin in the third quarter was 26%, largely unchanged from the previous quarter but down from 31% in the same period last year.
5) Balance sheet, let me now make a few comments on the balance sheet. Our DSO for Q3 is 82 days compared to 81 days in Q2. Advertising DSO for Q3 is 105 days, up from 89 days in Q2. The increase was due to our biannual payment settlement as agreed with advertising agencies coming in at the end of June, which made the June quarter DSO shorter than the September quarter. Our September 30th net accounts receivable balance was 23.3 million compared to 21.5 million in Q2 including 17.5 million related to our advertising business and 4.5 million to our wireless business.
As of September 30th our bad debt provision amounted to 1.7 million as compared to the 1.6 million provision as of June 30th. While we consider this level of bad debt provision to be relatively low as compared to our overall level of advertising sales, we continue to pay close attention in remaining prudent in our credit extension policy. We also continue to strengthen our credit extension and revenue recognition policy.
6) Stock buyback program, SOHU today announced its Board of Directors has approved a stock repurchase program and wish the Company to purchase up to $15 million of its outstanding shares in the open market. During previous stock repurchase program from May 2004 to February 2005 the Company purchased a total of $37.8 million worth of stock or roughly 6% of the shares outstanding. Further, since May of 2004 Charles purchased 550,000 shares in the open market totaling approximately 9.8 million and exercised 566,000 options. Also in February this year I purchased 15,000 shares too. We are firm believers in our Company's future and worked hard to drive value to our shareholders.
7) And finally our business outlook. You will find detailed guidance for the fourth quarter in our Earnings Release but I would like to highlight 1) we are on track to meet our full-year advertising revenue growth target of 25%, 2) for the fourth quarter we expect advertising revenues to be in the $19 to $20 million range and non-advertising revenues to be in the $9 million to $10 million range. 3) We will start advertising the sponsorship cash fee paid for the 2008 Olympic games and recording expenses relating to the construction, operation and hosting of the official Olympic Web site starting in the fourth quarter of 2005. We also expect to incur one-time marketing and promotional expenses in relation to the announcement and launch of this event. Our fourth quarter EPS guidance of $0.19 to $0.22 has already taken the above into consideration.
In summary, we are pleased with our overall results and believe we are well positioned for growth in 2006. Our multi dimensional strategy of increasing advertising revenue while growing a strong and steady search business is one we believe will have a lasting effect on development as a company. We view the Olympic sponsorship as a strong growth catalyst that will accelerate our current business model. We are very confident that our positioning and go forward strategy is the right mix of what is needed to do to drive results and increase shareholder value. That concludes my presentation. Thank you for your attention.
I would like to now open the floor for questions. Operator?
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