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eLong, Inc. (NASDAQ:LONG)

Q3 2007 Earnings Call

November 13, 2007 7:00 pm ET

Executives

Effie Han - IR

Henrik Kjellberg - Chairman

Guangfu Cui - CEO

Chris Chan - CFO

Analysts

Catherine Liu - Citigroup

Jason Johnson – Aurora Investments

Chun Ming Zhao - Susquehanna International Group

Reid Abden – Brendon Madoff

Vik Mehta - J Goldman

TRANSCRIPT SPONSOR

Operator

Welcome to the eLong conference call. (Operator Instructions) Now I would like to hand the call over to Miss. Effie Han. Ms. Han, please go ahead.

Effie Han

Hello everyone. Thank you for joining eLong's third quarter 2007 conference call. Today Henrik Kjellberg, Chairman of the Board, will make some remarks about the quarter followed by Chris Chan, our CFO, who will provide greater details on our financial results. Henrik will also introduce our new CEO, Guangfu Cui, who will make some brief comments. Following their prepared remarks, Henrik and Chris will be available to take your questions.

Before the management presentations, please allow me to read our Safe Harbor statement. During this conference call, representatives of the company will make forward-looking statements. These statements are based upon management's current views and expectations with respect to future events and are not a guarantee of future performance.

Furthermore these statements are, by their nature, subject to a number of risks and uncertainties that could cause actual performance and results to differ materially from those discussed in the forward-looking statements, as a result of a number of factors. eLong undertakes no obligation to publicly update any forward-looking statements whether as a result of new information, future events or otherwise.

Please refer to eLong's filings with the SEC including its Form 20-F as well as the risk factors described in our Form 6-K, which will be filed with the SEC in connection with our press release and this conference call for a discussion of the important factors that could affect future results.

I will now turn the call over to Chairman of the Board Henrik Kjellberg.

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Henrik Kjellberg

M goi, and thank you for being on this call. For those of you who follow these calls, it will feel a bit like a repeat of last quarter's call, although if you listen carefully you will trace more optimism in my tone than in the previous two quarters.

Since we last spoke, our team has been hard at work and while the results have not improved this quarter, we see much room for improvement to turn eLong around. We realize this will take some time as there are no quick fixes to the various challenges that we face, but we're committed to the task and I believe we are right on track.

I do believe, however, that we have made some improvements after a review of our company and that we are laying a new foundation at eLong, one that will yield great results over the long term.

I would like to update you on our progress in our key areas of focus. First, the management team. We are delighted to have hired our new CEO, Guangfu Cui, who has extensive experience of operating consumer businesses for multinational corporations in China, including Proctor & Gamble and FedEx Kinko's. I have had the pleasure of working with Guangfu over the past weeks and I have been increasingly impressed with his ability to grasp the business. He has already had a big impact on the team and on the business and it's with a lot of confidence that I have handed the business over to him.

We are also very pleased to have added a new CTO, Ken Liao, who joins us from Cisco and a new VP of Operations, Jenny Watson, who joins us from Expedia and Hotels.com and brings extensive experience in call center operations to the team.

Secondly, our back end platform. We have concluded a review of our systems and will start introducing new technology during the course of 2008. Importantly, we'll continue to implement enhancements to the existing platform to continue improving the user experience in the interim and we hope to tell you more about our infrastructure developments in the next quarter.

Thirdly, we are relentless in elevating our call center performance. We have introduced peak season planning to better match our contact center staffing with expected call volumes and are implementing a number of other very basic but extremely meaningful improvements to the call center. We believe that over the next six to 12 months we will see significant difference in terms of quality and efficiency on our call center.

Lastly, we continue to refine our sales and marketing strategy.

Going forward, I believe these four themes will remain our key improvement areas and we look forward to updating you on our progress. Now, it is with great pleasure I introduce you to our new CEO Guangfu Cui for some brief remarks.

Guangfu Cui

Thank you, Henrik. Hello, everyone. Thank you for attending today. I am very delighted to be part of the eLong team. I would like to take a moment to share my thoughts on the business and the priorities I have identified over the past month.

First things first -- I believe in building a culture based on people, service and purpose which is based on taking care of our people so that they can take better care of our customers; a philosophy that will generate returns over the long term.

Second, we will continue our effort to build our management team, not only at the VP level but also at the director and manager levels.

Third, we will focus on enhancing our customers’ experiences. We will focus on the fundamentals. We will fix the base business first with a heavy emphasis on execution and platform enhancements, especially in the call center.

Our sales and marketing approach will more proactively target our current customer base where we have emphasized our efforts on acquiring new customers, an important strategy with the rapid growth of China's travel market. It is also critical that we earn the loyalty of our existing customers. As Henrik has mentioned, sales and marketing investment is a main area of focus for us and we intend to be creative in giving our customers compelling reasons to continue to transact with us. We have a lot of work ahead of us but I am confident that with a continuous and relentless focus on execution, we will see improved results.

Thank you very much. Now I would like to hand it to Chris.

Chris Chan

Thank you, Guangfu. Let me give you an overview of our third quarter results starting with our statement of operations, followed by our balance sheet. Our third quarter total gross revenues were RMB 83.9 million, an increase of 12% year over year. The mix of revenue from our core travel business declined slightly over the prior year to 96% of total revenue. Gross revenue from hotel commissions totaled RMB 64.4 million, a year-over-year increase of 12% mainly due to higher room volumes. Hotel room nights booked through eLong totaled 1.009 million in the third quarter, up 13% from 893,000 in the corresponding period a year ago.

Hotel commissions per room night were RMB 63.8, which is slightly lower than the same period last year of RMB 64.3. Our hotel commission rate of 15% remains unchanged from the same period a year ago. Our third quarter 2007 average daily rate of RMB 416 was slightly lower than RMB 421 in the same period last year.

Gross revenue from air ticketing during the third quarter was RMB 15.6 million, a year-over-year increase of 41%. The air segment was 370,000 an increase of 36% over the prior year period. Commissions earned per air ticket in the third quarter were RMB 42, up slightly from RMB 41 in the third quarter last year. The average ticket price was RMB 891 as compared to RMB 867 in the third quarter of 2006 while the average commission rate in the third quarter was unchanged year on year at 4.7%.

Other travel revenue in the third quarter of 2007 was RMB 0.9 million, a year-over-year decrease of 77% from RMB 3.9 million. The year-over-year decrease was mostly due to the full quarterly effect of the vacation package suspension and a one-time adjustment of shared revenue from Expedia last year. Non-travel revenue accounted for 4% of total revenue in the third quarter and consisted mainly of non-travel online advertising on our website.

Let me point out that we start from this quarter onwards to report revenues net of business tax and surcharges. We have adjusted the statement of operations accordingly. The effect is a reclassification of business tax and surcharges from operating expenses to a reduction of gross revenues. There will be restated statements of operations on eLong's investor relations website after the earnings call, for your convenience.

Gross margin in the third quarter was 74%, down over 200 basis points from 76% in the same quarter last year, due to a higher mix of lower margin air revenue.

Service development, sales and marketing and general and administrative expenses together were RMB 67.3 million, a year-over-year increase of 31% from RMB 51.4 million, mainly because of higher sales and marketing and consulting expenses. The increased expense in sales and marketing was due to a higher advertising and promotions spending, as well as increased sales commissions.

In the third quarter, we also incurred approximately RMB 7 million in consulting expense as part of our effort to improve operations and customer service. Without this one-time expense, the Q3 general and administrative expense would have been RMB 11.3 million, or 14% of net revenue.

Let me now make a few comments on our balance sheet. As of September 30th, 2007 the company's cash and cash equivalents balance was $158 million. We intend to continue to use our cash balance to enhance our organic growth and consider strategic acquisitions in the future.

During the third quarter, we had capital expenditures of RMB 4.8 million compared with RMB 5.7 million in 2006. This amount mainly paid for technology and infrastructure investments, including increased server capacity and other hardware and software purchases.

Finally, let me share with you our business outlook for the fourth quarter of 2007. eLong expects total net revenues for the fourth quarter of 2007 to be within the range of RMB 73 million to RMB 80 million, an increase of 12% to 22% from the fourth quarter of 2006.

This concludes the financial review. Henrik and I will look forward to any questions you may have. Operator, if you would now open the call for questions.

Question-and-Answer Session

Operator

Your first question comes from Catherine Liu - Citigroup.

Catherine Liu - Citigroup

On last quarter's call you mentioned that the review phase of the turnaround plan would conclude at the end of August and that some changes will be implemented thereafter. Now that the consulting review phase has been completed, can you please share with us some of the findings from this consultation and what, if any, changes have been implemented?

My second question is on your sales and marketing strategy. You mentioned on the call that you would refine your strategy and more proactively target your existing customers. Could you elaborate on what the strategy will be going forward? Thank you.

Chris Chan

Catherine, this is Chris. Could you repeat your first question please?

Catherine Liu - Citigroup

My first question is on some of the findings of the consultation that I understand was completed at the end of August. What were some of the findings and what, if any, changes have been implemented so far?

Henrik Kjellberg

Hi, Catherine. Given that I started the work I will start the question and then I will hand it over to Guangfu. The findings were largely in line with let's call it our suspicions, which was that the call center needs a fundamental upgrade both in terms of how we recruit, retain and train people and also the systems that would support that call center. So those were the main findings of the company and we asked the consultancy companies to very much focus on the operational side. That's also what they did.

They have given us a detailed plan, which we are following and implementing a number of changes on, which include the planning, as I mentioned earlier, but also will include things going forward which we are now evaluating which relate to the systems, the back end that supports the call center going forward.

I think with Guangfu coming on board I would like to have him comment on some of the things that he has seen as well, which I believe are very much in line with the findings of the consultancy group.

Guangfu Cui

Yes I would like to just elaborate on what Henrik has said. The findings are pretty similar and now it is really about the actions we are going to take going forward. There are several actions we are taking to really make sure that we have a balanced approach toward the new customer acquisition and the loyalty of existing customers.

One thing we have adopted is to make a triple points award to the existing customers if they book online for our hotel rooms. This is an effort that we are going to support our existing customers for more loyalty points.

Secondly, we are really working on the fundamentals, basically back to the point of we've taken an initiative we call know who I am and save my time. Basically we want to know who the customer is and how to save their time when they transact with our call centers and websites.

Just give you a concrete sense of it, we have worked to shorten our call center scripts from 900 words to 470 and it's been implemented. The customers should see the immediate change in call center efficiency and in how eLong makes it easy for them to do business with us.

Thank you.

Operator

Your next question comes from Jason Johnson - Aurora Investments.

Jason Johnson - Aurora Investments

Chris, could you break down your accounts receivable? I noticed that you have a $40 million accounts receivable. What is the source of this accounts receivable?

Chris Chan

It's mostly an account settlement receivable with hotels so I think it's between 70% to 75% from hotels and the rest are mainly from credit card settlements with banks and some air ticketing receivables. We do use some ticketing agents and we use a separate delivery company to collect our cash, so those would be the main components.

Jason Johnson - Aurora Investments

Do you have a percentage of how much is from the hotel commissions?

Chris Chan

I just said 70% to 75% is for hotel.

Jason Johnson - Aurora Investments

75 okay. Well, last week at Ctrip had said at the analyst conference call -- I asked the same question. They have about $290 million of accounts receivable and I asked the same question. They told me that some of the credit card payments for airline ticketing is booked as accounts receivable. Do you do that in eLong?

Chris Chan

I think it would not be receivable from the airlines. It would be receivable from banks because there is some lead time settlement, settling the credit card payment.

Operator

Your next question comes from Chun Ming Zhao - Susquehanna International Group.

Chun Ming Zhao - Susquehanna International Group

We saw there is an increase in your sales and marketing in the G&A expense. May we know more details and will this trend continue going forward in the next quarters?

The second question is, would you please give us more color on your upcoming quarters like revenue and the competition figures? Thank you.

Henrik Kjellberg

I'll take it and then I'll also hand over to Guangfu on the forward-looking statements. On the sales and marketing, we did see an increase in spend. A large part of this relates to the fact that we wanted to be more aggressive and try new channels of marketing whilst we still had some of the old channels that we've been relying upon in the past working for us. So we have seen a spike in sales and marketing and we are aware of this.

We do think that spike is likely to continue over the next, I would say let's call it the short to medium term, but over time we do expect that to decrease by a bit but we haven't quantified that number yet. The reason for that, as Guangfu will explain later, is that we are trying to very much re-charter the way we do sales and marketing, which has for a long time been reliant upon handing out cards in physical places in China.

On the G&A, that's a one-time event. We recruited a consultancy firm to help us out, which brought the costs up. We were in a state where the company was in a drastic need for a turnaround and we judged it to be a judicious use of funds to help the company get kick started on a new process to really turn eLong around, so that is a one-time expense.

I've given you some indication on the sales and marketing going forward, but I would like Guangfu also to share his view on really what our plans on the sales and marketing are because I do believe those are of some interest to the investors at large.

Guangfu Cui

As I have mentioned, my strategy is to take a balanced approach toward the existing customer base and acquiring new customers. In the past, we have been relying on the traditional channel of handing out the cards in the airports, the railway stations and bus stations, for example, to acquire new customers which is very costly and it starts to reach a point that the customers actually are annoyed to be receiving these cards.

However, there is quite a percentage of business of new customers coming from that traditional channel. So my strategy is to gradually get out of that channel. However, that will take us a couple of quarters, moving out of that traditional channel. So right now what we are doing is we are optimizing the channels. We really reduced the channel from-- well, when I said channels it's really the bus station, airports etcetera, etcetera. So we are trying to reduce quite a number of traditional channels and shifting our expenditures to the customer loyalty program.

For example, the triple points program we just launched it in November for hotels and we also are going to continue that program for a while to really reward customers who continue to shop with us. Right now, because we have experimented in the past quarter with a different approach, for example, online marketing we have now gradually increased the efficiency of the online marketing.

Also in other areas of sales and marketing, we start to see that by geography, optimizing, that we could also better utilize our salesforce in the field and also make a better constructed deal with the websites business, that we also look at how to optimize that channel also.

So going forward is really a balanced approach of acquiring new customers and also how to gain the loyalty of our existing customers. Thank you.

Operator

Your next question comes from [Reid Abden – Brendon Madoff].

Reid Abden – Brendon Madoff

Can you talk about how long it's going to take to implement the new software platform? Can you talk about headcount for call centers, what it was last quarter, what it was this quarter and what do you expect it going to?

Henrik Kjellberg

On the platforms, we think there are different components to it. Some things we think we think can be implemented relatively quickly, which should have a consumer facing element to it, but there are some items which we think are going to take probably in the sort of 12 to 18 months to really and get the back end infrastructure as solid as we would like it to be. It doesn't mean that all changes are going to happen at the end of an 18 month period, but I think before we conclude it we're looking at a year, year-and-a-half.

In terms of the headcount, Chris, can you just go through where we were on headcount last quarter? I'm not sure we do predict headcount on a forecasting basis.

Chris Chan

No. We don't forecast on headcount. Our cost on headcount stayed pretty much the same as Q2 at around 950 people.

Operator

Your next question comes from Vik Mehta - J Goldman.

Vik Mehta - J Goldman

First, with regard to your change in how you're going to be reporting revenues, if I understand correctly your guidance is 12% to 22%. Is that based on last year's net revenues as well?

Chris Chan

Correct. It's apples-to-apples net revenue basis.

Vik Mehta - J Goldman

And then the Q3 that you're reporting right now, I haven't been able to go through the exact press release right now, but the Q3 that you're reporting right now that's on gross revenue?

Chris Chan

If you look at the financial statements it's been restated to report on a net basis, but we do have two exhibits on the back to show you the previous two quarter presentations using the net method and later on after the call we will be posting a 12-month basis restated statement for your convenience.

Vik Mehta - J Goldman

Therefore then in Q4 your gross margins will automatically be moving up, assuming that the business stays the same as in Q3?

Chris Chan

Yes, correct. So this is all apples-to-apples basis.

Vik Mehta - J Goldman

Can you give an apples-to-apples comparison of --I guess apples to apples is wrong -- but can you give us a sense of what your gross margins might look like in Q4 assuming you were to have a 74% gross margin the way you reported in Q3?

Chris Chan

Well, we don't comment on margin. So we only give revenue guidance and for this quarter the guidance will be on net revenue basis and the growth rate is also year-on-year on net revenue.

Vik Mehta - J Goldman

Okay, but it's safe to assume that gross margins will move up in this transition? I'm just clarifying that.

Chris Chan

Once the number has been quantified we can pretty much tell the effect on the percent just from the formula. I think that would be a slight improvement to the percent because of the lower denominator number.

Vik Mehta - J Goldman

The next question is with regard to your cash that presently sits in U.S. dollars. If I understand correctly with regards to acquisitions, you would be looking in China or other parts of Asia. Why would you keep the cash sitting in U.S. dollars, which appear to be depreciating on a daily basis?

Henrik Kjellberg

That's a good question and one that we discuss intensely at the board level and at the management level. We are reviewing options of where we want to keep the cash. I think we're getting refined in terms of our strategy where that cash will be needed. At this point we've concluded that we need to investigate a little bit further to determine what the best use of it is; but again, we're no strangers to the realities of the market and following the trajectory of the dollar. So we expect in the future to have a better answer as to where to actually place it.

I think at this point also we have judged it as a management team that we have more pressing matters than to focus solely on the cash. Although it is a financial impact on the company, we don't think it is of -- let's call it critical importance -- at this very quarter, given some of the other challenges we have. So all of the team right now is focused on improving customer service and are really getting the company back on track, so that's why it hasn't been at the forefront of our agenda.

As we get a lot of these things fixed and we are starting to make very good progress in some of these areas, the cash question will rise in terms of priority and by that time we expect to get back to investors with an answer on how that cash will be used.

Vik Mehta - J Goldman

Okay, are there any other alternatives for cash besides acquisitions and share repurchase?

Henrik Kjellberg

Sure. I mean you could put it in currency baskets and there's a number of different hedging funds and hedging strategies that are out there in the market; but again, as you investigate these some are good and they all have pros and cons. So, yes, there are other options for the cash.

Vik Mehta - J Goldman

Okay, my last question is with regard to your top line growth. Being that you're not burning cash, I mean there is an economic change in your cash position due to the remedy of the measure, but being that you're not burning cash why not accelerate even further your sales and marketing to then help drive your revenues even faster?

Henrik Kjellberg

Again, a good question. I think one of the things we did in Q3 was we started to accelerate some of the spend in sales and marketing, but we've also found that unless you match this with the customer experience in the call center that is as good as we would like it to be we're not creating the lasting impact on the consumers that we are really trying to do in this market, so we wanted to work in conjunction. As we see some of the improvements that we believe will happen in the consumer experience side as we upgrade the call center, then I think that's a very viable question. I'd like Guangfu to comment on that as well.

Guangfu Cui

I think Henrik has said it well. Basically, unless you earn the loyalty of the customers in China because in China the competition is really centered in a few players in the market, so consumers really look for the customer service to satisfy their choice of travel. So our focus right now will be the fundamentals, meaning that we will focus on know who the customer is and save their time so that we can really improve the experience of the customers. That's our current focus. Thank you.

Vik Mehta - J Goldman

The guidance, if I take the midpoint of your guidance for the next quarter at 17% year-over-year growth, should we use that as a benchmark for improvement from then on forward, as you are going to be increasing and keeping the sales and marketing figure up where it is?

Henrik Kjellberg

Let me comment on that. In the long term, is we believe the current growth rates and that's certainly one that we are not growing anywhere near to the potential of the company. In the immediate term we do think as we make some improvements we do expect that to have an impact on consumers, so that would sort of lead growth rates over time to up. However, as we're changing strategy I would also like to caution investors that there are some risks associated with our strategy. So the sort of the short-term I would say is probably less certain; it's harder to give an accurate guidance.

We're moving into new areas of marketing and as we're doing that, we're upgrading the call center. How quickly consumers will realize that this is happening it's hard to predict. There's no empirical data we can look back and model this on.

The long term we're very confident. Short to medium term I think the guidance number we've given gives an indication of where we think it is for Q4 and I don't want to at this point, I think as we give out the Q4 results we'll be in a better position and we'll also give guidance on '08. Correct, Chris?

Chris Chan

Yes. Correct.

Operator

Your next question comes from Jason Johnson – Aurora Investments.

Jason Johnson - Aurora Investments

Going forward, as you look at the competitive landscape, could you comment what the vertical travel search engines have on those traditional travel online travel service like Ctrip and eLong? There is a travel search engine called [Qnar.com]. this is a new player on the landscape. What impact should we see down the road?

Henrik Kjellberg

That's a good question. I mean I worked on the Expedia side as well, so we've seen a number of these vertical search engines that are appearing in a number of markets. The general consensus across the globe if you wish is that these players are sort of niche players, that they certainly fill a role in the market.

As we look to China more specifically, there are a couple of players out there. However, in China the number of players such as ourselves are quite few, so it makes a vertical search engine I would say possibly less interesting than in a market where you have a large. You also have in China much less supplier direct at this point than you have in some of the more established markets.

So at this point, we think they probably fill a niche sort of function. We don't necessarily think they're material to our trajectory of where we're going or where we're not going. So they're a niche player. I think at this stage in China they probably fill less of a role than in some more mature markets where you have more players in the field we're in and also more supplier direct.

Jason Johnson - Aurora Investments

But I noted that all the major players like all the big three China airlines -- Air China, China Southern, China Eastern -- they all put their products on [Qnar] and all the hotels like Marriot, Super 8, they sell their products online. They go direct. Will that impact your business down the road?

Henrik Kjellberg

Of course supplier direct in China will come and of course they are already selling their product direct. That's not news to me. I would say the quality of the product that is supplier direct and the incentives used by the supplier direct in China with in the U.S. or in the UK for example, I think there is still a gap. We're certain that the supplier direct element will increase in China. I mean these companies are very clever, very smart and it will come.

I think for us, which is one of the reasons we're really building on what Guangfu mentioned on creating a superb relationship with our consumers, have a really good customer call center. We need to build this up because over time competition in China is going to increase, not decrease. Certainly supplier direct will become a much more tangible element in the market.

How fast this will happen? We don't know yet. So yes, fully agree. I mean it's happening today and they're putting their product on. I don't know all of these players that they're using, but the question is how much is actually booked via them? That I would guess, I haven't seen any numbers but I would guess if you looked at the Air China report it's going to be less than for example a VA which in a short haul business is probably selling 60% to 70% of its business direct and not via travel agents.

Jason Johnson - Aurora Investments

My second question is about the Olympic impact. You know we have in China we'll host the Olympics next year. How much impact will that boost your revenue?

Henrik Kjellberg

On the Olympics we don't know what the impact will be. That might sound strange, but I've been through two other Olympics with Expedia and it's very hard to predict. Here's why. All the hotels are extremely bullish at this point, as they typically are eight or nine months ahead of the event on what's going to happen. What we've seen in other Olympics is as you get closer some of the rooms aren't actually filled and then they get more flexible and they want to work with you.

So it can work both in our favor because ADRs will be up during this month, but it can also work not in our favor if they're sold out. That very much depends on the level of demand that China is able to generate from across the globe with people coming to Beijing and then Hong Kong for the Olympics.

We do have plans in place and we're working already with hotels to establish how we can promote the Olympics and also finding cities around Beijing where we can host people as they come into the Olympics, but we don't have an actual number. We've assumed Olympics are neutral for us next year in order to be conservative.

Operator

There seem to be no more questions at the moment.

Henrik Kjellberg

Operator, I would then ask that we conclude the call.

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