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Sohu.com Inc. (SOHU)
Q3 2007 Earnings Call
October 29, 2007 8:00 pm ET
Executives
Brandi Piacente - The Piacente Group
Dr. Charles Zhang - Chairman of the Board, Chief ExecutiveOfficer
Carol Yu - Co-President, Chief Financial Officer
Dr. Gong Yu - Chief Operating Officer
Wang Tao - Head of Online Game Business
Analysts
Jason Brueschke - Citigroup
Dick Wei - J.P. Morgan
Jenny Wu - Morgan Stanley
Eddie Leung - Merrill Lynch
Wallace Cheung - Credit Suisse
James Mitchell - Goldman Sachs
Tian Hou - Pali Capital
C. Ming Zhao - Susquehanna Financial Group
Paul Keung - CIBC World Markets
Operator
Ladies and gentlemen, thank you for standing by. At thistime, I would like to welcome everyone to Sohu’s third quarter 2007 earningsconference call. (Operator Instructions) I would now like to turn theconference over to Brandi Piacente, Investor Relations, please go ahead.
Brandi Piacente
Thank you for joining Sohu.com to discuss our third quarter2007 results. On the call today are Dr. Charles Zhang, Chairman and ChiefExecutive Officer; Ms. Carol Yu, Co-President and Chief Financial Officer; Dr.Gong Yu, Chief Operating Officer; and Mr. [Wang Tao], Head of Online GameBusiness.
Before management begins their prepared remarks, I wouldlike to read you the Safe Harbor statement in connection with today’sconference call. Except for the historical information contained herein, thatmatters discussed in this conference call are forward-looking statements. Thesestatements are based on current plans, estimates, and projections and thereforeyou should not place undue reliance on them.
Forward-looking statements involve inherent risks anduncertainties. We caution you that a number of important factors could causeactual results to differ materially from those contained in any forward-lookingstatements.
Potential risks and uncertainties include, but are notlimited to, Sohu's historical and possible future losses, limited operatinghistory, uncertain regulatory landscape in the People’s Republic of China,fluctuations in quarterly operating results, and the company’s reliance ononline advertising sales, online game revenue, and mobile phone relatedwireless revenue for its revenues.
Further information regarding these and other risks areincluded in Sohu's annual report on Form 10-K and other filings with theSecurities and Exchange Commission.
Now, let me turn the call over to Dr. Charles Zhang,Chairman and CEO. Charles.
Dr. Charles Zhang
Thank you, Brandi. Hello, everyone. Welcome to Sohu's thirdquarter 2007 financial results conference call. I am very pleased to reportanother outstanding quarter with record total revenues and non-GAAP earnings.
We have exceeded all of our guidance for each of our revenuecategories, as well as earnings. This set of results are made possible onlybecause of our focus on technology and our long-term vision, such asinvestments in our first in-house developed online game, Tian Long Ba Bu, andour Beijing 2008 Olympics sponsorship.
I will begin by discussing Sohu's major achievements for thethird quarter. First, brand advertising -- Sohu delivered record high brandadvertising revenue of $29.8 million, exceeding the high end of our guidance,representing 42% year-on-year growth. For the first nine months of 2007, brandadvertising revenue grew by 40% year-on-year, despite a challenging comparisonto 2006 with the FIFA World Cup.
And here I would like to extend special thanks to BelindaWang, our Chief Marketing Officer and Co-President, for her diligent effortsand accomplishments, even during her maternity leave over the last few months.Belinda will officially report to duty next month and will join us in our nextcall.
Fueled by the fast growth of the Chinese economy and thecontinued migration of advertisers from offline to online, our brandadvertising continues to ride the tide of a robust market, especially with theBeijing 2008 Olympic Games now less than 10 months away.
For the third quarter, revenues continued to be driven byheavy spending sectors such as auto, real estate, and online games. Sectorsthat showed the highest year-on-year growth were online games, fast-movingconsumer goods, and the financial services. Online games increased more than120% year on year, driven by the launch of many new titles and IPO marketingactivities by some online game companies.
Fast-moving consumer goods grew by 108% year on year, astraditionally heavy offline advertisers, fast-moving consumer goods advertisersare accelerating their conversation to online platforms.
Financial services increased by 98% year on year, primarilydue to the robust Chinese stock market.
Our outlook for brand advertising for the rest of the yearremains strong, looking to achieve 2007 full year brand advertising revenuegrowth of between 38% to 40%, as compared to our previous target of 35%.
In addition, our dominant advantages surrounding the Beijing2008 Olympic Games continue to differentiate and distance us from the rest ofthe crowd, of the competition. We are the portal of choice for the Olympics,for both Internet users and advertisers in China.
A solid, undisputed example is our reporting on the one-yearcountdown to the Olympics on August 8, 2007. Sohu was able to conduct videointerviews with more than 200 famous Chinese athletes from among all of the 55national sports teams. This is in stark contrast to 40 video clips for all ourmajor competitors combined.
In cooperation with CCTV, we conducted an online survey andreceived over 10 million responses, compared to 6,000 responses of a competitorfor a similar survey.
Sohu secured 10 Olympic partners, sponsors, and suppliers,as well as one non-sponsor to advertise with us on this event. But none of ourmajor peers have any advertisement on the same event.
In addition, in early October, to prepare for the OlympicTorch relay across Mount Everest, I myself personally led a team of engineersand reporters to climb the Yuzhu Mountain with an altitude of about 6,200 meters. By applying Sohu'sstate-of-the-art technology for the first time in the remote Yuzhu Mountainarea, we have successfully overcome the difficulties caused by the lack of atelecommunication network. We succeeded in setting up a broadband data transmissionnetwork in the extremely remote and difficult environment, and dry run areporting plant on site.
This event aroused a lot of interest from Internet users,and further reinforced our unchallenged position as the portal of choice forthe Olympics.
Secondly, our technology co-initiatives, which include agood example of success brought by our focus of technology, is Tian Long Ba Bu,the online game success. Back in 2004, we started our investment in Tian LongBa Bu as our first in-house massive multi-player online roleplaying game. Itwas launched in May of this year.
Here in the third quarter, we continued to focus onimproving Tian Long Ba Bu’s in-game quality and launch of new features. OnAugust 15th, we launched our first expansion pack. We also carried outsuccessful marketing campaigns, especially leveraging on our own leading gameinformation portal, 17173.
All these efforts contributed to make Tian Long Ba Bu becomeone of the top RPG games in China. We continue to see increased user numbers, growinggame loyalty and higher monetization.
For the third quarter, registered users climbed to 18million from 10 million, an increase of 80%. Quarterly active paying accountsincreased to 690,000 from 209,000, an increase of 230%. Peak concurrent usersremained at a stable level of around 400,000.
Quarterly average revenue per active paying accounts valueincreased to RMB118 from the previously RMB82 an increase of 44%. Revenueincreased by 384% to $10.9 million from the previous $2.3 million.
Our success of Tian Long Ba Bu in China enables us tolicense the game overseas. In August, we licensed Tian Long Ba Bu to anoperator in Vietnam and now, Tian Long Ba Bu is one of the top three gamesthere with peak concurrent users of 30,000 in Vietnam. Earlier this month, we licensed Tian Long BaBu to leading operators in Taiwan with an expected launch early next year.Although we do not expect substantial revenue from these arrangements, theyprovide incentives for us to explore other oversea markets going forward.
We expect to see Tian Long Ba Bu getting more matured herein the coming two months, with revenue of this game kind of starting the firstquarter of next year, maybe with a maximum of 5% to 10% quarter-on-quartergrowth going from there.
Looking ahead to Sohu's next game, I am very happy toannounce that Sohu has obtained the rights for The Duke of Mount Deer, anotherfamous novel by Mr. Louis Cha, author of Tian Long Ba Bu. This is already underdevelopment as a 2.5D cartoon style RPG game with an expected launch by the endof next year.
Our technological initiatives also include Sohu 3.0, whichhas been tracking well and is positively received by Internet users. In lateJuly, we launched Sohu 3.0, which integrates all of Sohu's products and communitieswithin the Sohu matrix through Sohu Blogs, Sohu Passport, and Sohu web-basedmessengers. Since its launch, Sohu 3.0 has been successful in cross-selling 7million accounts of products for our users. For example, an e-mail user isattracted to also become a user of China Alumni Club through 3.0.
Video blogs are getting to be very popular among users whoare increasingly adopting their blogs as a personalized portal. This hassuccessfully attracted new users to Sohu. For the third quarter, Sohu's uniquevisitors has increased by 21% quarter on quarter.
We believe the strength of Sohu 3.0 will continue to surfacein the coming months, which will bring long-term growth to Sohu's users,traffic, and advertising revenue.
Another technological achievement is our premier clientdesktop product, Sogo Pinyin, a Chinese character input method software whichcontinues to expand its market presence. Sogo Pinyin’s vocabulary database istied to the search queries database of Sogo search engine, thus it can capturethe latest trend of words used by Internet users.
Since its launch in mid-2006, Sogo Pinyin has beenwell-received by users. During the third quarter, weekly active PCs using SogoPinyin has expanded by 48% over the second quarter.
Lastly, let me review the major investments made. I wouldlike to reiterate our long-term vision in managing our business and in makinginvestments to create and enhance shareholder value.
I am pleased to recap such investments made during the pastfew years. First, development of Tian Long Ba Bu in-house since 2004. As of theend of the third quarter, we had already recouped all of our investment in TianLong Ba Bu, including game development costs, CapEx for servers and marketingexpenditures.
Second, Olympic Sponsorship; for the first nine months of2007, just counting the increased ad revenue from our sports and Olympicchannel over the corresponding period last year, we have more than recouped allcash fees paid to [inaudible] for Olympic sponsorship. For the entire Sohumatrix, we are even more pleased to report that Olympic partners and sponsorshave increased their advertising spending on Sohu by around 70%, as compared tothe same period in 2006.
Third, stock purchase program -- since 2004, we haverepurchased 2.9 million Sohu shares, or 7% of the company, at an average priceof $18.20, utilizing a total of $62.7 million. Using the closing market priceat October 26th for Sohu stock of $49.92, market value of these stocks is now$144.8 million, or a $92.1 million above our cost.
These examples should help demonstrate management’slong-term vision and successful track record in our strategic initiatives. Westrongly believe investments we are making today, such as Sohu 3.0, SogoSearch, Sogo Pinyin input method, and other technological initiatives willbring similar successes in the future.
With that, I would now like to turn the call of Gong Yu,Chief Operating Officer, for an update of our Sohu website operation and videoachievements.
Dr. Gong Yu
We have achieved 21% user growth in unique visitors for thethird quarter. We are also pleased to report healthy traffic growth for theSohu matrix of websites over the last third quarter. Channels such as blog,entertainment, news and sports enjoyed the highest traffic growth.
Now I would like to discuss more about our video strategy.With increased broadband penetration and the continuous improvement ofpeer-to-peer streaming technology, online video content is now in even higherdemand from Internet users. In 2006, we launched our S and V channels, twoonline 24-hour video channels on sports and entertainment, respectively. Bothchannels have been well received. During the third quarter, page views for Sand V channels increased by 32% and 21% respectively.
In order to expand our video services, in the third quarterwe launched a new TV channel through strategic partnerships with 49 televisionstations, including 14 provincial TV stations that have national coverage. Programsfrom these TV stations are now streamed on Sohu on both live and on-demandservice. Such TV clips are nicely integrated into our text-based news and havebeen well received by our users.
With that, I would like to turn the call to Carol,Co-President and Chief Financial Officer, from an update of our third quarterfinancial performance.
Carol Yu
Thank you, Gong Yu. Hello, everyone. I will now provide areview of our financial results for the third quarter ended September 30, 2007.
One, revenues -- as mentioned by Charles, for the thirdquarter total revenues hit a record of $51.5 million, exceeding the high end ofour guidance by $4.5 million, representing an increase of 32% sequentially and46% year on year. Not only does each of the revenue categories exceed ourprevious guidance, some by a rather wide margin, but each of them also hittheir all-time highs as well.
With total advertising revenues of $31.5 million, weachieved a sequential increase of 11% and a year-on-year increase of 32%. Brandadvertising revenues were $29.8 million, representing a sequential increase of12% and year-on-year increase of 42%. Sponsored search revenues were $1.7million, flat from the second quarter and declined by 39% year-on-year. Theyear-on-year decline was mainly due to the strengthening of our anti-fraudulentclick policy based on more sophisticated algorithms starting mid-2006.
In the third quarter, through better integration with theSohu Portal and fine-tuning of featured search product, such as picture and [favorites],traffic of Sogo has increased by 94% sequentially.
Non-advertising revenues were $20 million, exceeding thehigh-end of our guidance by close to $4 million, an increase of 88%sequentially and 74% year-on-year. Online games revenue were $12.7 million, anincrease of 232% sequentially and 473% year-on-year, due to the strong resultsof Tian Long Ba Bu.
For the third quarter, revenues from Tian Long Ba Bu andBlade Online were $10.9 million and $1.8 million respectively. Wirelessrevenues were at $6.8 million, a sequential increase of 4% quarter on quarterand down 23% year-on-year. Sohu is well-positioned to minimize risks associatedwith the wireless sector as they now only represent 13% of our total revenue.
Gross margin -- under SFAS-123R, share-based compensationexpenses are charged to quarter revenues and operating expenses. Totalshare-based compensation expense for the third quarter of 2007 was $2 million.As we believe excluding the share-based compensation expense from our non-GAAPfinancial measure of net income makes a more meaningful comparison of Sohu'soperating results and improves users’ understanding of Sohu's performance, weuse non-GAAP measures in this discussion to explain margin cost and expenseitems.
Non-GAAP gross margin for the third quarter was 67% comparedwith 62% in the previous quarter and 65% in the third quarter of 2006. Grossmargin expansion was primarily due to the contribution from Tian Long Ba Bu.
Non-GAAP advertising gross margin was 64% in the thirdquarter, same as the previous quarter, and a decrease of 71% from the sameperiod last year. Brand advertising non-GAAP gross margin for the third quarterwas 67%, same as the previous quarter and down from 73% in the same quarterlast year. The year-on-year decrease was primarily due to the increased contentcosts, bandwidth, and server depreciation expenses.
Sponsored search non-GAAP gross margin for the third quarterwas 24%, up from the 22% in the previous quarter but down from 58% in the sameperiod last year. The year-on-year decrease was primarily due to higher serverdepreciation expense in relation to the launch of Sogo 3.0 in late 2006.
Non-advertising non-GAAP gross margin was 72% for the thirdquarter, up from 56% for the previous quarter and 54% in the third quarter oflast year. Online games non-GAAP gross margin for the third quarter was 84%, upfrom 64% in the previous quarter and 55% from the same period last year. Theincrease correlates to an increase in revenue from Tian Long Ba Bu.
Wireless non-GAAP gross margin for the third quarter was52%, same as the previous quarter but down from 54% in the same period lastyear. The year-on-year decrease was mainly caused by the negative impact ofpolicy changes put in place by mobile network operators since July 2006.
Operating expenses -- for the third quarter, Sohu's non-GAAPoperating expenses totaled $23.9 million, up 43% from $16.7 million from theprevious quarter and up 58% year-on-year. The increase was primarily due to ourcontinued investment in product development and Sohu's branding, marketingexpenses for Tian Long Ba Bu and Sohu 3.0, as well as an increase in bonuses toreward employees for their contribution to this quarter’s good results.
Operating margin -- non-GAAP operating profit margin was 21%for the third quarter, compared with 19% for the previous quarter and 23% forthe same period last year.
Other income -- in the third quarter, we disposed of ourequity interest in an associated company resulting in a gain of $0.6 million.
Income tax expense in the third quarter was $0.3 million,compared to $0.2 million in the previous quarter.
Net income -- non-GAAP net income for the third quarterreached a record high of $11.7 million, or $0.30 per fully diluted share.Non-GAAP net income increased by 44% sequentially and 37% year-on-year. GAAPnet income for the third quarter was $9.7 million, or $0.25 per fully dilutedshare. This increased 70% sequentially and 47% year-on-year.
Net margin -- non-GAAP net margin for the third quarter was23% as compared to 21% in the previous quarter and 24% in the third quarter of2006.
Cash position and balance sheet -- now I will make a fewcomments on our cash position and balance sheet. As of September 30, 2007,subsequent to the repayment of our convertible notes of $58.5 million in July,our balance of cash, cash equivalents, and investments in marketable debtsecurities remains at a very comfortable level of $76.9 million. This comparesto the balance of $113 million as of June 30th and $129.7 million as of the endof last year.
Cash inflow from operating activities for this quarter wasabout $23 million. With our current cash position and strong operating cashflow at present, we do not expect any immediate needs to raise financing.
As of September 30, 2007, our net accounts receivable balancewas $34.9 million, an increase of $5.9 million as compared to $29 million lastquarter. Our DSO for the third quarter was 58 days compared to 63 days for theprevious quarter and 72 days for the third quarter of 2006.
Third quarter brand advertising DSO was 75 days, compared to70 days for the previous quarter and 66 days for the same quarter last year. Weare continuing to monitor our accounts receivable and are pleased with theoutcome.
As of September 30, 2007, our bad debt provision total $1.7million, compared to $1.4 million as of June 30, 2007, reflecting our stringentrevenue recognition and credit extension policies.
Finally, turning to our business outlook, for the fourthquarter ending December 31, 2007, Sohu expects: one, total revenues to bebetween $53.5 million to $55.5 million with advertising revenues of $31 millionto $32 million and non-advertising revenues of $22.5 million to $23.5 million.Brand advertising revenues of $29.5 million to $30.5 million; two, we estimatenon-GAAP fully diluted earnings per share to be between $0.33 and $0.35; andthree, assuming no grants of new share-based awards, we estimate share-basedcompensation expense to be between $1.8 million to $1.9 million. The estimatedimpact of this expense is expected to reduce fully diluted earnings per shareunder U.S. GAAP by $0.05.
In conclusion, we are very pleased to have reported anotherrecord quarter. To repeat what Charles has said at the start of the call, thisset of results are made possible only because of our focus on technology andour long-term vision. We will continue to invest for the long-term benefit ofthe company and to further enhance shareholder value.
This concludes our prepared remarks for today. We will nowopen the floor for questions. Operator, please go ahead.
Question-and-AnswerSession
Operator
(Operator Instructions) Our first question comes from Jason Brueschkewith Citigroup. Please go ahead.
Jason Brueschke -Citigroup
Thank you. Good morning, everyone, and congratulations on a reallyfantastic quarter. Let me ask two questions, if I can; first of all, on theonline gaming, you’ve had tremendous success so far from TLBB and it seems likewe have at least another solid quarter of growth ahead of us. If I can lookahead to the new game that you announced, I think it was Duke of Mount Deer,could you maybe give us some additional color on some of the similarities thatyou see that that game represents? You indicated it’s by the same author. Maybegive us some indication of how popular this novel was versus TLBB and thingslike that, just so we can have a context for understanding what some of thepotential is for the next game, and then I have a follow-up question.
Dr. Charles Zhang
Let me describe a little bit and then I will ask [Wang Tao]to say things and maybe I can translate, or you can. I think Duke of Mount Deer is as popular interms of the novel and the story and the movie is as popular as Tian Long BaBu. It is very, very well-known and actually now, there is a television seriesthat is being filmed now about Duke of Mount Deer.
The game is a 2.5D cartoon style. Maybe Wang Tao canelaborate.
Wang Tao (Translation)
Okay. Similarities between Tian Long Ba Bu and Lù Dǐng Jì isas follows; when we first developed Tian Long Ba Bu, we followed two key themesor strategic direction. One is community-based. Tian Long Ba Bu iscommunity-based, and the second is we followed the strong features ofsuccessful Korean games in China.
We are now in the process of developing Lù Dǐng Jì. When wedo that, we not only put equal emphasis on the two successful features fromTian Long Ba Bu, but at the same time, we also increased the in-game featuresthat are actually success factors for other games in China, but also we also 3Dfeatures as well -- 3D engine.
The target market for Lù Dǐng Jì is more of the cartoonfeatured market for the game.
Carol Yu
Jason, you got a clue? Hello?
Operator
Our next question will come from the line of Dick Wei withJ.P. Morgan. Please go ahead.
Dick Wei - J.P.Morgan
Congrats on the strong quarter, and two questions; firstquestion is can you tell us more about what you see on advertisers plan for theOlympics -- where are they spending, in terms of timing of the spending, and isthere any hints on the amount? That would be great. Because I’ve been hearingthat some advertisers are holding back some of the ad spending in Q3 for theupcoming quarters.
And the second question is on Tian Long Ba Bu, just quicklyabout the revenue expectation for Q4 on the game.
Carol Yu
For advertising revenue coming from Olympics, we are seeingvery encouraging signs. Our current efforts focused on marketing our OlympicGames package to the advertisers and so far, results have been encouraging. Wewill give out our full 2008 year guidance when we report our Q1 or Q4 resultsin the coming quarters.
The second question regarding Tian Long Ba Bu, our revenueguidance for Q4 for total, for games in total, is $15 million to $16 million.So for Tian Long Ba Bu, it would be about $14 million.
Dick Wei - J.P.Morgan
Great. Thanks.
Operator
Thank you. Our next question comes from Jenny Wu with MorganStanley.
Jenny Wu - MorganStanley
Hi, guys. Congratulations on a very good quarter. I have twoquestions. First one, would you please elaborate more on your advertisingpricing change? I remember last quarter, you guys increased the price change by37%. How about the trend going forward? Thank you.
Carol Yu
On the pricing change, we haven’t had any price increasesince last quarter, but based on the current package that we offer to ourclients for the Olympic Games times, it would be at a premium of at least 20%to existing inventory.
Jenny Wu - MorganStanley
Thank you. And the second one is regarding your new TVchannel. Is there any revenue sharing plan with those 49 TV stations?
Dr. Charles Zhang
Not yet. Our first goal is to increase the traffic. When wehave a sizable traffic, then we will definitely in the future, there will beadvertising opportunities for these streaming video and TV channels, becauseadvertisers have been used to advertise on television. So now, advertise withthe video-on-demand or streaming, it’s a natural conversion, so we expect that thefuture is very good. But right now, we are focused on developing traffic andactually, the launch of the TV channel -- it’s only for less than a month andwe’ve seen a pretty good result in terms of page views, and the page views areactually higher quality because each view represents a few minutes of viewing,so it’s actually better, more high quality numbers than a text-based page view.
Jenny Wu - MorganStanley
Thank you.
Operator
Thank you. We have a follow-up coming from the line of JasonBrueschke. Please go ahead.
Jason Brueschke -Citigroup
Thank you. Sorry about that. That was a glitch on my end. Myfollow-up question now is a follow-up basically to what Dick had asked. Andwhat I’m interested in is with respect to the Olympic advertising, could youmaybe just qualitatively comment on the linearity of the ramp? You gave anindication that some of your advertisers have increased their spending 70% yearover year and we are less than a year away now. Should we expect that to be alinear ramp, that Q4 gets stronger and then Q1 is stronger and Q2 is strongeras we get closer to the games? Or is there something peculiar going on thatmight say it accelerates faster and plateaus, or will it just kind of likelinear ride into August of next year? That would be helpful. Thanks.
Carol Yu
Well, obviously we can divide the coming 300 days intobasically I think three phases. The first phase will be from now on until Marchof next year, which will pretty much -- I will use the word stable to talkabout advertiser spending. Starting from March next year, when the torch relaystarts, we would actually be really entering into the Olympic time zonestarting there, especially with a big ramp-up of mass interest starting fromMay when the torch actually enters into China’s soil.
And then with the teams, national teams from around theworld getting set up and the list of athletes who got into the Olympics and whois not got announced, everybody’s attention will be drawn towards the Olympics.I think that will reach another high ground.
And then obviously the third phase would be starting maybethe first of August, a week before opening ceremony. I think the whole world’sattention will be on that.
So I think the advertising revenue will follow that threephases as well.
Jason Brueschke -Citigroup
Thank you. That’s very helpful.
Dr. Charles Zhang
In our interaction with our advertisers, since it is alreadythe end of the year, they actually set out some good chunk of advertisingspending for the Olympics, but how they will spend it really depends on thephases that Carol just described. So it is important to design the differentmarketing activities that attract mass attention and with good quality contentthat reporting all these activities and events, so that help our advertisers toplan their spending accordingly.
Now they are -- they always think they are going to spendreally good money for the Olympics but now they have the chunk of money set up,but how to spend it, it really depends on our interaction with them in the next10 months.
Operator
Thank you. Our next question comes from Eddie Leung withMerrill Lynch. Please go ahead.
Eddie Leung - MerrillLynch
Good morning. I have two questions. One is kind of ahousekeeping question. Can you guys talk about how many brand advertisers inthis quarter and how the number has changed from the previous quarter? And thenI have a follow-up.
Carol Yu
In terms of number of advertisers, it’s actually prettylevel. We have 652 advertisers in Q3 and 639 in Q2.
Eddie Leung - MerrillLynch
And also a question on brand advertising; can you talk alittle bit about the demand from non-Olympic sponsors? I would imagine thoseadvertisers would represent a majority of your branded advertisers. And forthose advertisers, what’s the impact you see from you guys getting the Olympicsponsorship?
Carol Yu
Well, we see equally good demand from sponsors andnon-sponsors. I think what Charles has just described both during the script orin his script or when he answered earlier questions is that number one, during,for example, using the one-year countdown as an example, we have 10 Olympicpartners and one non-partner coming to sponsor our reporting for that event, sothat’s number one.
And number two, I think a lot of advertisers, irrespectiveof whether they are partners or not, they are actually very anxious to seeproposals from ourselves for how to do sports marketing or marketingsurrounding the Olympics. I think we stand in a much better position versus ourcompetitors and even some of the media, because of resources that we havesecured on our media platform. So I think that actually -- I mean, Charlesquoted two examples and I think that [factors all].
Eddie Leung - MerrillLynch
Thank you.
Operator
Thank you. Our next question comes from Wallace Cheung withCredit Suisse. Please go ahead.
Wallace Cheung -Credit Suisse
Good morning. Congratulations on the very great results. Ihave questions related to the brand advertising side. Firstly, it seems to methe guidance of the brand advertising seems to be a bit low, because if youcompared the year-on-year growth in the first quarter, it is actually around42%. And if you take a look at the fourth quarter guidance, it is actually only34% to 49%. I understand the management team has been very conservative inproviding guidance, but can you give a little more color why the guidance, theyear-on-year growth is actually lower than the first quarter, besides the RMBappreciation impact? And I also have a follow-up on brand advertising revenue.Thank you.
Carol Yu
Well, this is how we look at the business at the present, aswe speak. Like what you have said, I think we are already seeing very goodgrowth for the past three quarters and I think an annual projection of close to40% is already something that we are very pleased with.
Wallace Cheung -Credit Suisse
Okay, I think one follow-up question is actually again onbrand advertising side. It seems to be the, as what management have said, thesports channel has been doing very well, I think according to Alexa figures.The traffic was close to double from the year before, so from an advertiserperspective, how do they see this like reflection on this kinds of changes ofthe traffic mix? Do they think it is actually more valuable? Do they --[inaudible] on this? Thank you.
Dr. Charles Zhang
I think first of all, we don’t look at it -- well, we don’tlook at -- I think there’s a lot of some manipulation or whatever to the Alexanumber that reflects, so we have our own internal account of our trafficgrowth. It’s quit a balanced growth, with traffic for our content channelsacross the board to grow, especially in sports and entertainment and also theimprovement of the news media.
And especially, because of the Sohu 3.0 and blogs and newfeatures of blogs and the video content, the Sohu matrix 3.0 stickiness aresignificantly improved. So the average time spent for a user on the Sohu matrixis longer than before. That translates, so although blogs, standalone blogs wehaven’t developed any methods to monetize, it’s all a free product, but becauseall these products are so inter-connected and you can move around soseamlessly, so that the stickiness improves, so that the click-throughs aregetting better. Advertisers are feeling that effect that the advertising onSohu has improved, so that helps advertisers to continue to sign biggercontracts with us. That’s why -- that’s the underlying force behind theever-increasing strong brand advertising growth.
Because people don’t see the connection. You invest in thetechnology, bandwidth, servers and all these software engineers to developproducts that are free, like blogs and like Sohu 3.0. Actually, it’s indirectlyfundamentally making our platform more attractive to advertisers, so in thelong-term, you will see the effect of our technological initiatives in terms ofbrand advertising.
For online games, it’s an immediate reflection of revenueand earnings, but for brand advertising, it’s a slow but fundamental and reallyirreversible path toward a largest Internet portal in China and the largest,most attractive advertising platform in China.
Wallace Cheung -Credit Suisse
Thanks for that, Charles. Just a final question is I believeTLBB is actually providing a lot of incremental user base for Sohu as a whole.Any plan to convert the TLBB incremental user base into your portal or into theSohu matrix? Thank you.
Dr. Charles Zhang
You got it right. I mean, that’s also my concern andinitiative. It’s very important because Tian Long Ba Bu actually attracts --it’s very sticky. I think among all the Internet products, RPG games are themost stickiest applications and communities. So we definitely have plans tointegrate Tian Long Ba Bu players with our Sohu 3.0 and our Passport and otherproducts.
Actually, it’s already -- some of the process has alreadybeen going on and so it is - we are doing that.
Wallace Cheung -Credit Suisse
Thank you very much.
Operator
Thank you. Our next question comes from James Mitchell withGoldman Sachs. Please go ahead.
James Mitchell -Goldman Sachs
Congratulations, Team Sohu. Two quick questions, first onyour fourth quarter guidance. It looks like you are guiding for earnings growthfaster than revenue in the fourth quarter, which is all good from ourperspective. I’m curious whether --
Carol Yu
Sorry, James. I lost you towards the tail end of thequestion. Can you repeat that?
James Mitchell -Goldman Sachs
First question on guidance for the fourth quarter, it lookslike you are guiding for faster earnings growth than revenue growth, which isgood. I’m wondering whether the cost in the fourth quarter will be more stablebecause of less sales and marketing spending on Tian Long Ba Bu, or whether thecosts will be more stable because of our bonus accrual being more usual? Ithink you mentioned in the prepared remarks the bonus accrual was high duringthe third quarter and I was wondering if you could talk about how that works.And then I have a question on a separate topic. Thank you.
Carol Yu
I think the Q4 results, the Q4 guidance include -- you arecorrect, that a lower amount on sales and marketing for Tian Long Ba Bu becausethe game will enter into a more matured phase. Employee bonuses, it would bemore or less the same because they would be as a function of our profitability.
James Mitchell -Goldman Sachs
So you accrue bonuses fairly evenly through the year --
Carol Yu
For the -- well, I would say for the back half of the year,the second half of the year.
James Mitchell - GoldmanSachs
Okay, great. And then my second question on the computergames, I think you gave an implied revenue growth for the fourth quarter to $14million. I wonder if you’d see that revenue growth coming more from a greaternumber of paying accounts, or more from ARPU improvement? And comparing thegames of peers, it seems like you have a relatively good conversion rate offree accounts into paying accounts.
Dr. Charles Zhang
If I guess, I think we are seeing good user growth. [WangTao], do you agree?
Carol Yu
We are growing -- we are actually -- we’ll work hard for thefourth quarter, we’ll work hard to grow the active paying accounts, hopefullywith a very stable ARPU.
James Mitchell -Goldman Sachs
Okay, great. Thank you.
Operator
Thank you. Our next question comes from Tian Hou with PaliCapital. Please go ahead.
Tian Hou - PaliCapital
Congratulations on the good quarter. Regarding your game,Tian Long Ba Bu, I just wonder, how do you position this game? Is this like agame similar to Westward Journey II or is the game much similar to [inaudible]?How do you position them?
Carol Yu
It’s more like Fantasy Westward Journey and The Legend fromShanda.
Tian Hou - PaliCapital
How long do you expect this game’s life cycle will be?
Wang Tao (Translation)
Over five years.
Tian Hou - PaliCapital
Okay, the last question will be regarding the onlineadvertising. I guess someone’s already asked this question, your Q4 brandadvertising is quite flat compared with Q3. Is there any particular reason forthis flat projection?
Carol Yu
No particular reason. It’s just how we see businesses.
Dr. Charles Zhang
Seasonality. That’s normal seasonality.
Tian Hou - PaliCapital
Thank you.
Operator
Thank you. The next question comes from Ming Zhao with SIG.Please go ahead.
C. Ming Zhao -Susquehanna Financial Group
Thank you. Thank you for taking my questions. I have twoquestions. My first question, maybe following James Mitchell’s question; in thethird quarter, you just mentioned there was some bonus for the employees, whichI believe they deserve. Do we see that as a continuous payment incentive it thefollowing quarters, so that your margin will actually improve in the fourthquarter?
And a related question is, is the marketing spending for thegame in the Q3, I believe you said it has increased by $1 million from Q2. Howdo you budget your marketing expense in the fourth quarter and quarters beyond?
Carol Yu
It’s pretty much level.
C. Ming Zhao -Susquehanna Financial Group
You mean the marketing expense, right?
Carol Yu
No, I’m talking about the bonus level.
C. Ming Zhao -Susquehanna Financial Group
How about the marketing expense?
Carol Yu
It would be, because we see a growing revenue, but theabsolute dollars for the marketing expense will remain pretty stable, so thatcircles back to James’ question. If we expressed it as a percentage of revenue,actually that would go down.
C. Ming Zhao -Susquehanna Financial Group
I guess previously, looking at the non-GAAP operating marginfrom a low 20s to mid-20s, with game accounting for more revenue in the topline and it’s more profitable, what’s the long-term operating margin that wewill be looking at?
Carol Yu
I am still looking at that level because like Charles and Iand Gong Yu have all emphasized, I mean, we invest in the long-term of thecompany so we now have the “luxury” of contribution from Tian Long Ba Bu, so wewould actually put that back into the business and invest in othertechnological investments and the like.
C. Ming Zhao -Susquehanna Financial Group
Last question is on the mobile side, I guess not many peopleasked this question today, the question is actually how do we see thisbusiness? If I think rightly, your Sogo Pinyin, if you can put that into themobile phones, I think it would be a great product. Is that something you aregoing to explore in the future?
Dr. Charles Zhang
You mean the Sogo Pinyin on mobile phones?
C. Ming Zhao -Susquehanna Financial Group
Yeah, because I think the Pinyin input on the mobile phoneis still very --
Dr. Charles Zhang
Yes, well, sure, definitely we have plans. But it’s becauseof the product or the type -- so many types of mobile phones, so the task willbe a very big one. We have plans to do that but not immediately. It’s in ourplan.
C. Ming Zhao -Susquehanna Financial Group
So how do you see this mobile business? Are you just goingto make it a stable revenue stream going forward?
Dr. Charles Zhang
Well, the wireless -- you mean the wireless business, right?
C. Ming Zhao -Susquehanna Financial Group
Yes.
Dr. Charles Zhang
Yes, I think it really depends on operators’ policies andthe general trend before any new business model emerged that’s independent ofoperators. I think the trend is generally going down gradually, but we managedwell so that it gradually become a less and a less part of the Sohu overallrevenue mix.
C. Ming Zhao -Susquehanna Financial Group
Okay. Thank you. Great quarter.
Operator
Thank you. The next question comes from Paul Keung with CIBCWorld Markets. Please go ahead.
Paul Keung - CIBCWorld Markets
Hello. This is [Mahresh] calling for Paul. Good quarter.Considering the strength in the gaming revenue, could you talk a little bitabout what we could expect going forward for ARPU growth as well as activepaying account growth? And also, in terms of your games pipeline, do you have aplan for a certain number of games to be launched every year and do you seethis ever becoming even a bigger part of revenue than advertising?
Carol Yu
As far as -- like we talked about, our objective is to growactive paying accounts during the fourth quarter while maintaining a relativelystable ARPU. We do have plans to launch another game next year, as we mentionedbefore, but taking into consideration that our games business, our real gamesbusiness only has -- like is still in its infancy stage, which is like twoquarters old, even if we count up to now, I mean, it’s only six months out. Wewould be very carefully articulating our overall game strategy where we seemore quarters of success.
Hello?
Operator
Does that answer your question?
Paul Keung - CIBCWorld Markets
Yes, it does. Thank you.
Operator
Thank you. At this time, I will turn the call back to BrandiPiacente for closing comments. Please go ahead.
Brandi Piacente
We would like to thank everyone for participating in today’scall. Please feel free to contact us if you have any additional questions.Thank you.
Operator
Ladies and gentlemen, that will conclude today’steleconference. We do thank you again for your participation and at this time,you may disconnect.
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