Good day, ladies and gentlemen. Welcome to the Sina Third Quarter 2005 Earnings Conference Call. At this time, all participants are in a listen-only mode. We will, however, be facilitating a question and answer session towards the end of the conference.
I would now like to turn the presentation over to your host for today's conference, Ms. Chen Fu, Investor Relations Manager. Please go ahead, ma'am.
Chen Fu, Investor Relations Manager
Thank you. Good morning. Welcome to Sina's earnings release for the third quarter 2005. Joining me today are CEO Wang Yan, our President and CFO, Charles Chao, and our COO, Hurst Lin.
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 you 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 fact, including statements about our beliefs and expectations. Forward-looking statements involve certain risks and uncertainties. A number of important factors could cause actual results to differ materially from those contained in any forward-looking statement.
Potential risks and uncertainties include, but are not limited to, Sina's historical losses, its limited operating history, the uncertain regulatory landscape in the People's Republic of China, the effect of the notice issued by the Chinese State Administration of Radio, Film and Television in late January 2005, on the Company's revenues from usage-based SMS products promoted via direct advertisement on radio and television, the Company's ability to develop and market other usage-based SMS products, fluctuations in quarterly operating results, the Company's reliance on mobile value-added services and online advertising sales for the majority of its revenues, the Company's reliance on mobile operators in China to provide mobile value-added services, the change in January 2005 by China Mobile to its billing process for undelivered MMS services and the effect of those changes on the Company's MMS revenues, the migration by China Mobile of MMS onto MISC platforms and the effect of such migration on the Company's MMS revenues, any failure to successfully develop and introduce new products, and failure to successfully integrate acquired businesses.
Further information regarding these and other risks is included in Sina's Annual Report on Form 10-K for the period ended December 31, 2004 and its quarterly report on form 10-Q for the quarter ended June 30, 2005, as well as in 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 on our corporate website at http://corp.sina.com.
Following management's prepared results, we will open the lines for a brief Q&A session. Now let me turn the call over to the CEO, Wang Yan.
Wang Yan, Chief Executive Officer
Hello. Good morning to those of you in Asia and good evening to those of you in the U.S., and a warm welcome to all of you to our September quarter 2005 earnings conference call.
September has been both a rewarding and a challenging quarter. We reached our revenue target of $49.6 million, which was an increase of 8% over the previous quarter. This performance was achieved mainly by the fact that our core advertising business continuing to perform strongly. The advertising revenue of the September quarter was $23 million, which is a 24% increase over the same period last year and a 13% increase over last quarter. Advertising revenue now represents 46% of our total revenue, compared with last quarter's 44%.
On the Mobile front, unfortunately we had to make some difficult decisions regarding the usage of television advertising for a few of our key SMS monthly subscription products. Due to this marketing decision, we ended up spending much higher advertising dollars than what we had originally anticipated. While this may have caused a temporary setback in Sina's profitability, I personally believe that this decision should bring future benefits to our Wireless business.
I will now turn it over to Charles to give you more colors regarding the impact from the advertising decision that we made regarding our Wireless business.
Charles Chao, Chief Financial Officer
Thank you, Wang Yan, and good morning, everyone. As Wang just said, we have closed a rewarding and challenging third quarter.
Let me talk about the challenging part of our business. The Wireless business first.
At the beginning of the quarter, we told investors that we cautiously believed that we would have some modest growth in our Wireless business, primarily because we had seen some encouraging results from our TV campaign starting from the end of the second quarter, for a couple of our newly introduced monthly subscription based SMS products. We carried out an extensive TV campaign throughout the third quarter.
Our total advertising expenses relating to this campaign amounted to $6.7 million in the third quarter, significantly higher than the $1.2 million similar expenses we had incurred in the second quarter. We acquired many new subscribers for our new monthly subscription based SMS product service through the TV campaigns during the third quarter. And each subscriber paid approximately 10 IOV which translates into about $1.25 per month for the subscription. As a result, our SMS revenues for the third quarter increased by 11% from the second quarter, to $17.4 million.
During the third quarter, however, we faced a tough decision as to whether to continually invest in direct advertising activities, since we put even more costs in advertising than the revenue benefit we would receive within a quarter. We have maintained a sophisticated live monitoring system on the effectiveness of the TV campaign and we are confident that over the latter period of the subscriptions for the part users we will generate positive returns.
Our experience has been that a subscriber on average will continue a subscription for a few months. As a result, we decided to continue to increase our TV advertising spending as long as the spend will generate reasonable returns over the long term, and we ended up spending $6.7 million in TV campaign in the third quarter. This amount was obviously higher than our original projection at the beginning of the quarter.
This was a tough decision as we could have cut back advertising to include the bottom line for the current quarter, but we believe that our decision makes sense from the business point of view.
We generated approximately $5.5 million revenues from these advertisings in the third quarter. In October, 2.5 million of monthly subscribers we acquired from the TV campaign in the third quarter should remain Sina customers, and we certainly believe that these subscribers will generate more revenues in the future period.
Hence the amount of TV advertising expenses for subscription based MMS products became so material for the third quarter, and the nature of these advertising expenses was such, the nature of these advertising expenses was acquiring subscribers and the probable future revenue benefit from these subscribers acquired, the Company is required to consider the Statement of Position 93-7 or SOP 93-7 on how you report advertising costs to determine whether such advertising costs meet the requirements to be treated as direct response advertising under SOP 93-7.
If we determine this is direct response advertising and meets the specific requirements under SOP 93-7, then according to this pronouncement we should capitalize a portion of the $6.7 million and defer the expense provision to future periods, when we receive the benefit for these costs. We estimate that between $3 million to $4 million of the $6.7 million should be deferred to future periods, if we meet the requirement for capitalization.
If that happens, our operating expenses for the third quarter will be decreased by the same amount and our net income for the quarter will be increased.
Unfortunately, the requirements under SOP 93-7 for capitalization of advertising costs are very complex. Not only does it require companies to prove there is a direct linkage between advertising costs incurred with revenue received, it also requires the Company to have reliable historical data to accurately estimate the future revenues that will be generated from the initial advertising costs incurred. The specific guidance for the SOP 93-7 actually gets more complicated and requires significant investment. As a result the amount of work involved to demonstrate the Board's conclusion is very time consuming.
Based on the work so far, we are not able to reach a conclusion as to whether we can capitalize advertising costs incurred in the third quarter and we are not certain when we can reach that conclusion. As we're approaching our 10-Q filing date for the quarter, and given that we are not sure when we can reach the conclusion, and given that the issues involved only relate to the timing of the recognition of these advertising expenses but not impacting the overall economic benefits over the longer term, it has been explained to the investors that we have chosen to announce our preliminary third quarter results assuming we will not be able to meet the requirement for capitalization under SOP 93-7.
We certainly hope that we can reach a conclusion before our 10-Q filing date on November 9, but there is no guarantee that we can do that.
I guess we have talked enough about this topic. Coming back to the business, since we'll receive recurring revenues from users we acquired in the third quarter, our SMS revenues was 80 in the fourth quarter, although the growth could be modest in single digits.
Let me talk about our other parts of business in the third quarter.
Our MMS revenue decreased by 37% from the second quarter to $1.3 million. This was primarily due to the continuing impact from the billing platform transition that began at the end of the first quarter. We do not expect that we can grow our MMS revenue in the future quarters, as we are not seeing a pick-up in MMS usage in the market.
Our revenues for our WAT service grew $1.4 million, up 10% from the previous quarter. We saw some relatively strong pick-up in WAT revenues in the months of September and October, so we are expecting meaningful growth in WAT revenues in the fourth quarter.
Revenues from IVR were about $1.9m and revenues from Ring Back Tone were about $1.3 million for the third quarter. Both on track from the previous quarter. We believe we'll see some growth in revenues in the fourth quarter, as we begin to offer IVR service on more platforms, such as fixed line platforms. But our impact on revenues in the fourth quarter will realize the impact from the third quarter.
Our revenues from Sina Games jumped more than 100% in the third quarter from second quarter, to $800,000, due to the introduction of more games. While we continue to see growth in games in Q4, the growth rate will come down significantly.
Now let me turn to our online advertising business. During this past quarter, our online advertising which included mainly brand advertising such as Bennet Equine (ph) and rich media, but excluding pay search listings, totaled $23 million for the quarter representing a 24% increase from $18.5 million reported in the same period in 2004 and a 13% increase from $20.4 million reported in the previous quarter.
Advertising revenues now accounted for 46% of our total revenues, as compared to 44% in the previous quarter and 35% in the third quarter last year. This strong growth came off an increasingly high advertising revenue base and in an increasingly competitive online advertising market in China. This again confirms that we are continuing to maintain our leadership position in China internet product space.
Total number of advertisers has reached 571 in the third quarter as compared to 515 in the second quarter. Spending for advertising also increased slightly, from $39,600 in the second quarter to $39,900 in the third quarter.
During the third quarter we saw continuing strong demand in the factors like webhosting, webcast and IT industry. And these three factors continue to be the three largest contributors of our advertising revenues in the third quarter. Combined, these three accounted for 47% of our total compound revenues for this quarter, as compared to 50% in the previous quarter. In addition, we saw more revenues contribution from vertical websites such as our own channel including our payment company, as we began to receive full quarter benefits from multiple year contract from China HR and eLong.
Revenues from advertisers of fast-moving consumer goods, or FMCG, continue to grow, although we intend our out through dollar amount it is do not material to the total recovering revenues. During the quarter, Coca-Cola and the Pepsi started a rich media fighting advertising war on our website, which was widely reported on Chinese press as advertising war between red and blue and green. We believe that this kind of media attention has evicted growing interest from other FMCG customers, with a very good foundation for the take-up of large-scale media trends in the Internet by FMCG customers next year.
Despite increased competition in online advertising market in China, we are not seeing a slowdown in demand for this advertising business. And in fact we have adjusted the rate popup, starting in the fourth quarter, for some of our product inventory, without probably much negative impact on demand.
Overall, our general sense is that the Internet is taking market share away from traditional media, especially newspapers, for certain advertising categories in China and we believe this trend will continue.
We launched a few new products in the third quarter. In August we successfully launched our Blog 2.0 version and have since attracted over 1 million users to our new fast service. We intend two Blog versions, one for China’s elite group, such as famous writers and celebrities, and one for ordinary net users. Each day we have approximately 9,000 new Blog ads and estimate good growth. By that standard, we believe that we’re already one of the largest Blog service in China.
Now let me to turn to Hurst for instruction of some more new products and specialist areas.
Hurst Lin, Chief Operating Officer
Thank you, Charles. I will now provide some updates regarding some of our key products.
First is Search. During the third quarter we continued to improve our search offering. In addition to a traditional webpage search engine, we add a global search with detailed maps for ten of the top cities in China. We also add a mobile search to allow users to search on their cell phone through WAP. Lastly, our knowledge base community search has been, has begun to attract corporate sponsors, such as Hewlett Packard, who use this platform to provide extra answers to users regarding IT products.
Looking ahead to this quarter, we’re again ready for another major upgrade to our search, with a much more expanded document library and improved user interface.
Another major product, instant messaging. Our UC brand instant messaging has made major progress in the September quarter by achieving 500,000 max daily concurrent users, up on 300,000 in June quarter. As this is a major project for SINA, in the upcoming quarters we will continue to invest to capitalize on the progress that we have made so far during this quarter.
On the Online Game front, we experienced a summer peak of close to 700,000 active users during the quarter for iGame and we’ll continue to develop upgrades to digital casual games to make the experience ever richer, even richer for our game players.
On the SINA front managed to continue to suffer from user based erosion. The average concurrent users for September quarter was roughly 50,000, down from 70,000 recorded in the June quarter, with roughly $110,000 of loss from our shares in a joint venture with NCSoft during the quarter.
Regarding our option platform, 1pai, as many of you know, in August Yahoo announced its investment in Alibaba. As part of this investment, Yahoo intended to transfer its shares in 1pai to Alibaba. SINA owns 33% of this joint venture and we’re in negotiations with Yahoo and Alibaba as to the settlement of our investment in the joint venture, but as yet no agreement has been reached.
In summary, during this quarter we continue to focus our energy on our core business in Internet, with both telephony product launches and product upgrades. Looking ahead, we plan to continue to invest in key areas such as Search, Blog, as Charles mentioned, and broadband streaming to further cement our position as the number one portal in China.
I will now hand back to Charles to go over some of the financial highlights.
Charles Chao, President and Chief Financial Officer
Okay. Thanks, Hurst. We have already talked about revenues in detail, so I’ll just talk on a few more financial items briefly, then we’ll switch to Q&A.
First, let me talk about gross margins. Our advertising gross margin remained flat at 68% in the third quarter compared to the second quarter, despite an increase in advertising revenues. This is largely due to an increase in our content costs, especially in the content costs for the video content and our bandwidth costs. We expect that our gross margin will remain the same in Q4 for general.
Our gross margin for Wireless business was approximately 56% in the third quarter, down from 57% in the previous quarter. That means another 2 percentage point drop in Wireless gross margin in the fourth quarter, as we continue to increase our content costs and transmission costs for our Wireless business.
Our accounts receivable balance at September 30 was $32.9 million, slightly increased from $32.4 million at June 30. This was mainly due to an increase in revenues, offset by our head paper collection in the receivables for the advertising revenues. Our DSO for the quarter is 61 days for the third quarter, improved from 64 days in the second quarter.
During the third quarter, we accrued a loss of approximately $708,000 on auction joint venture with Yahoo. As Hurst just mentioned, because Alibaba subsidiary is also involved in online auctions in China, we’re in negotiation with Yahoo and Alibaba concerning our shareholding in this joint venture and we think we can reach an agreement in the fourth quarter.
We also recorded a heavy loss by our games joint venture with NCSoft. The amount of loss was approximately $110,000. We expect to incur similar or slightly higher losses from JD in the fourth quarter.
During the quarter we also reported a gain in the amount of $1.5 million for the sale of Fortune Trip to eLong. And this is offset by a similar loss for the other investment in Tidetime Sun, previously known as Sue Media Group, for the same amount.
I guess this is, that that’s all of our presentation today and we are now ready for the questions.
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