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SINA Corporation (SINA)
Q3 2007 Earnings Call
November 14, 2007 8:00 pm ET
Executives
Cathy Peng - Investor Relations Manager
Charles Chao - President and Chief Executive Officer
Herman Yu - Chief Financial Officer
Analysts
Jason Brueschke - Citigroup
Richard Ji - Morgan Stanley
Analyst for Eddie Leung - Merrill Lynch
James Mitchell - Goldman Sachs
Gene Munster - Piper Jaffray
George Chu - UBS
Wendy Huang - Bear Stearns
Analyst for C. Ming Zhao - SIG
Steve Weinstein - Pacific Crest
Dick Wei - JP Morgan
Operator
Good day, ladies and gentlemen, and welcome to the SINACorporation third quarter earnings conference call. (Operator Instructions) Iwould now like to turn the presentation over to your host for today’sconference, Ms. Cathy Peng, Investor Relations Manager. Please go ahead, Madam.
Cathy Peng
Thank you. Good morning. Welcome to SINA’s earnings releasefor the third quarter 2007. Joining me today are our President and CEO, CharlesChao, and our Chief Financial Officer, Herman Yu. This conference call is alsobeing broadcast on the Internet and is available through the investor relationssection of the SINA website.
Before the management presentation, I would like to read youthe Safe Harbor statement in connection with today’s conference call. Duringthe course of this conference call, we may make forward-looking statements,statements that are not historical fact, including statements about our beliefsand expectations. Forward-looking statements involve inherent risks anduncertainties. A number of important factors could cause actual results todiffer materially from those contained in any forward-looking statements.
Further information regarding these and other risks isincluded in SINA’s annual report on Form 10-K for the year ended December 31,2006, and its other filings with the Securities and Exchange Commission.
Additionally, I would like to remind you that our discussiontoday includes non-GAAP measures which exclude stock-based compensation, aswell as other items. We use non-GAAP measures to exclude certain items that arenot expected to result in future cash payments that are non-recurring or thatmay not be indicative of our core operating results.
For further explanation of our non-GAAP measures anddetailed reconciliations between our GAAP and non-GAAP results, please refer toour earnings [release].
Following management’s prepared remarks, we will open thelines for a brief Q&A session.
With that, I would like to turn the call over to ourPresident and CEO, Charles Chao.
Charles Chao
Thank you, Cathy. Good morning, everyone and welcome to ourthird quarter 2007 earnings conference call. I am pleased to report anotherstrong quarter with record total revenues and non-GAAP net income. This markedthe sixth consecutive quarter that we were able to grow our online advertisingrevenues by 40% or more on a year-over-year basis.
Advertising revenues now account for over 70% of our totalrevenues. We started to see overall operating margin expansion with rapidgrowth in advertising revenues. Our mobile value-added service business,although continued to decline in the third quarter, we have seen some signs ofstabilization for the near-term.
During the third quarter, we continued to see great momentumfor the general advertising market in China. SINA’s traditional strongholds inautomobile, IT, and [inaudible] remain the largest contributors. For our totaladvertising revenues, these three sectors combined accounted for 48% of totaladvertising revenues. In particular, ad revenues from automobile industry grewstrongly in the third quarter with over 60% year-over-year increase.
The best performing sector for SINA in terms ofyear-over-year growth came from the financial sector, which grew over 220% fromthe same quarter last year and advertising revenues from financial services nowaccount for 9% of our total advertising revenue in the third quarter.
It proves that our investments in the finance sector arereally starting to pay off. Over the past 12 months, we have managed to secureexclusive content relationships with a large number of major financial printmedia and have rolled out a significant number of new products in our financechannel, including live stock quotes, stock messaging board, and a web-basedchat program.
These initiatives have enabled us to attract a large numberof users to our finance channel. We believe this sector will continue to growfaster for SINA as the financial services sector is still in the early stagesof Internet adoption for marketing.
Our strong performance in all those four sectors mentionedabove further demonstrate SINA’s strong position as the premium website forhigh-end product and services with its desirable user demographic and strongbrand recognition in China.We intend to further enhance our brand recognition and make SINA thedestination site for high-end users in China.
In the month of September, we formally announced our Olympicstrategies in China. In conjunction with that, we have announced our exclusivecontent relationship with major international news agencies and local mediaalliance with newspapers and TV stations for the Olympic coverage. We have alsoannounced the acquisition of the live score input for the Olympic Games and theformation of our dedicated Olympic reporting team with hundreds of professionalstaff.
At the same time, we launched our integrated marketingcampaign named “My 2008: The World Opens Its Eyes”. The year-long campaign isaiming at encouraging our users to participate and record the events andchanges in China in the period leading up to and as well as during the OlympicGames, by fully utilizing our increasingly popular blog and forecastingplatforms.
The campaign is also designed to help increase userinteractions among all our interactive communities and the communicationproducts. Within the two months of the campaign launch, more than 23 millionpeople have thus far participated in the campaign. Over the next 10 months, wewill gradually roll out new themes and events for the campaign and to push thecampaign to the climax before the Olympic Games.
My 2008 campaign has not only attracted users participationbut also caught the attention among our major advertisers and so far, six ofour major customers have become the partners of our My 2008 campaign and thatnumber is still growing.
In order to best position SINA for the Olympic opportunitiesin 2008, we have also taken initiatives to further enhance our leadership inonline sports area by creating more exclusive content. During the quarter, webecame the exclusive Internet portal partner in Chinafor English Premier League and Italian Series A League for live broadcast footballmatches for all matches. We have also renewed our contract to continue tobroadcast all matches for the European Championship Cup.
In addition, we have exclusively acquired all video clipsfor the English Premier League games for the next three years. Our investmentin sports content will help us to solidify our strong leadership in the area inthis increasingly competitive market for the online sports in China.
Now let me spend some time to talk about our strategicpartnership with Google. As we discussed before, this partnership includes bothweb search and Adsense for content products. During the third quarter, therevenues generated from this arrangement were approximately $800,000, whichwere not significant to the total revenues. As we explained before, we need twoto three months testing period for Adsense while the traffic ramp-up for theweb search will take some time.
Our team has been working closely with Google China toimprove the search experience for our users and to optimize the keywordplacement for the Adsense product on a webpage.
Now let me talk a bit about our mobile service. Although wesee some continuing decline in our mobile revenues in the third quarter, basedon the current trends, we believe our total mobile revenues may be stabilizedfor the near term. Having said that, operating margin for the mobile businesscontinue to be under pressure, given the increase in marketing costs fortraditional media.
We are exploring new channels for our mobile productpromotions and hope to improve our overall margin for the mobile business inthe coming quarters.
On a more bright side for the mobile service, we continue tosee strong growth in our free WAP portal traffic with daily unique visitorsgrowing by 30% quarter to quarter to reach $1.3 million at the end of thirdquarter. We continue to believe that mobile Internet will offer great businessopportunities in China and we intend to further invest in this area.
Before I turn to Herman for the financial review, I wouldlike to talk briefly about our new initiatives in the online gaming. There isno doubt that online gaming has been one of the hottest sports in ChinaInternet market, with strong growth potential. Historically, SINA hasmaintained a popular game channel on our portal and has been generating revenues,primarily through online advertising.
In our attempt to take advantage of more businessopportunities in this sector, we have recently formed SINA Gaming BusinessUnit, which integrates our game channel, our casual game platform, and ourpopular audio-based instant messaging platform, You Talk, for the game.
The newly created gaming unit will be aimed at exploring newbusiness opportunities by offering platform service to game operators and byjointly running online game operations. We have just got started on thisinitiative and we’ll provide more update on our game efforts in the futurequarters.
With that, I will now turn to Herman for the financialhighlights for the quarter.
Herman Yu
Thank you, Charles, and thank you all for joining ourconference call. I will now take you through the key financial highlights.
Total revenues for the third quarter of 2007 came in at$64.3 million, which is within our guidance range between $63 million and $65million, and represents a 15% growth year over year and an 8% growthsequentially.
Our advertising revenues, which exclude search revenues forthe third quarter of 2007 were $45.8 million, representing a 40% year-over-yeargrowth.
Advertising revenues from China grew 41% year over year and11% quarter over quarter to $44.9 million. This is very strong performance,considering that we also had a 40% plus year-over-year growth last year, partlyarising from our record-breaking coverage of FIFA World Cup.
The growth of our advertising revenues this quarter wassupported by new customer additions, as well as increased average spending peradvertiser. Compared to the same period last year, the number of advertisingcustomers in China increased 11% while spending per advertising customer grew27%.
Online advertising revenue now accounts for 71% of SINA’stotal revenues, compared to 58% for the same period last year and 69% lastquarter. We expect this trend to continue in the near future.
Turning to our non-advertising business, for the third quarterof 2007, our mobile business generated revenues of $16.6 million, whichrepresents a decline of 24% year over year and 2% quarter over quarter. As aresult of changes in operating environments, such as stricter controls ontelevision promotion, during the quarter we shifted our direct advertisingefforts away from certain SMS products to IVR products. Consequently, SMSrevenues declined 20% quarter over quarter to $8.4 million, partially offset byan 82% increase in IVR revenues quarter over quarter to $3.9 million.
For the third quarter of 2007, SMS accounted for 51% oftotal MVAS revenues while IVR made up 23% of total MVAS revenues. Revenues from2.5G products, which include MMS, WAP, and [Kajiva], increased 5% quarter overquarter to $3.3 million.
Our non-GAAP gross margin for the third quarter of 2007 was63% compared to 65% in the same period last year and 63% in the last quarter.Our non-GAAP advertising gross margin for the third quarter was 65% compared to67% in Q306 and 63% last quarter.
The year-over-year decline in gross margin was mainly due tohigher content, bandwidth, and infrastructure related costs. On a sequentialbasis, advertising gross margin improved as advertising revenues grew fasterthan associated costs.
Non-GAAP gross margin for our wireless business was 56% inthe third quarter of 2007 compared to 62% in the same period last year and 61%last quarter. The decline in non-GAAP wireless gross margin was mainly due tohigher content and channel costs.
Turning to operating expenses, our non-GAAP operatingexpenses for the third quarter 2007 was $23.1 million, compared to $23 millionin the same period last year and $22.6 million last quarter. Compared to thesame period last year, product development increased 24%, arising primarilyfrom additional IT spending and associated depreciation, while general andadministrative expenses decreased 20% year over year, due primarily to baddebt, personnel related expenses, and professional fees.
Our non-GAAP operating margin for the quarter was 27%compared to 24% in the same period last year and 25% last quarter. Interest andother income for the quarter included a $0.9 million foreign currency gainarising from an inter-company dividend payout.
Now turning to net income, non-GAAP net income for thequarter, which excludes stock-based compensation and other items, was $19.1million, an increase of 31% from the same period last year and an increase of19% from last quarter.
Non-GAAP net margin for the third quarter 2007 was 30% comparedto 26% in Q306 and 27% last quarter. Non-GAAP diluted EPS for the quarter was$0.32 compared to $0.25 in the same period last year and $0.27 last quarter.
Turning to our balance sheets and cash flow, as of September30, 2007, our cash, cash equivalent, and marketable securities, short-termsecurities, were $439.4 million compared to $345.3 million at the end of Q306,and $415.2 million at the end of last quarter.
Cash flow from operations for the quarter was $19.6 million,compared to $27.7 million for the same period last year and $20.9 million lastquarter. Cash spent on capital expenditure for the quarter was approximately$2.3 million.
Let me now turn to our guidance for the fourth quarter of2007. We are targeting total revenues of $68 million to $70 million. For onlineadvertising, we are targeting $49 million to $50 million. We are targetingbetween $19 million to $20 million for our non-advertising business. Excludingany new shares that may be granted, we expect stock-based compensation to beapproximately $1.6 million for the fourth quarter of 2007.
This concludes the written portion of our call. Operator, weare now ready for questions.
Question-and-AnswerSession
Operator
(Operator Instructions) Your first question comes from the lineof Jason Brueschke from Citigroup.Please proceed.
Jason Brueschke -Citigroup
Thank you. Good morning, Charles and Herman. Can I begin bytalking about some of the monetization opportunities you have around your Web2.0 properties? I know that earlier in the third quarter, you had announcedsome preliminary efforts to do monetization of the blogs and you have a lot of,as you said in the prepared remarks, a lot of very interesting and I thinkprobably compelling different ways of attracting traffic.
But as we look into 2008, can you just give us a sense ofwhen the monetization of these products will become material and how we shouldthink about maybe the ramp-up in the monetization of these new services? Andthen I have a follow-up question as well.
Charles Chao
On the monetization for the web 2.0 product, I think I’lljust make a correction here. We actually never officially announced anyinitiative for the web 2.0 monetization on the press. I think there’s somelocal media report on some initiatives on our experiment for the revenuesharing program on our blog platform. And indeed, we have started theexperiment in the late part of Q3 and what we did was selecting about 20, 30celebrity blogs and to place advertising on their personal blog and we aretrying to adopt a revenue share program with these bloggers.
Basically, the results so far have been pretty encouragingand we have received some advertising results effectiveness in these blogs havebeen very similar to the results we have seen in some of our prime channels, inthe front page of prime channels -- I mean, the page views and theclick-through rates.
But in terms of our place for rolling out this particularblog sharing program, revenue program, we are still I think in the experimentalstage and our plan is to roll out the entire platform in Q1 2008. At thisstage, I mean, it is too early to tell the magnitude and the revenuecontribution we may have on this particular product going forward and our hopeobviously is to ramp up the scaleable revenues by the second half of next year.But at this stage, I think there are a lot of logistic problems we have toovercome and I think it is too early to tell.
At the current stage, as we’ve discussed before, we arestill trying to monetize our blog through our traditional advertising format byplacing branded advertising on the main page, front page and front page, a lotof channels for blog and also using the user participation for a lot of ouroverall integrated campaigns for our customers using the blog as a platform.
And to give some sense, I mean, we talked about last quarterwe generated -- in Q2, we generate about $1 million from this particular blogplatform and in Q3, we probably did about $1.6 million, so there was aquarter-to-quarter increase of 60% and we fully expect that -- I mean, thatportion of revenue would continue to grow pretty significantly quarter overquarter and in the next few quarters, basically. I hope that answers yourquestion.
Jason Brueschke -Citigroup
Yes, thank you, Charles. The follow-up question is more of amacro question. When we look at the competitive landscape, Tencent’s actuallydone extremely well, admittedly off a low base but the base that these guyshave is now getting higher. They are probably about 40% your size, maybetwo-thirds the size of Sohu by my calculations, and their growth is reallyhigh.
Can you maybe look out over the next two years and see whatthe momentum that Tencent has and some of the strengths relative to what youhave? And then maybe the same type of question with Baidu and how search, whichin other markets around the world, seems to be impacting a little bit more --branded advertising hasn’t really seen like we’ve seen that affect at all inChina. But between those two companies, which I would include you as theleaders in different segments of that, could you just give us your views of howyou think this evolves as we go forward over the next few years? I appreciateit. Thanks.
Charles Chao
I think on a macro basis, obviously the overall advertisingmarket is growing very fast in China and the Internet as a whole is growingfaster. The question is really talking about the market share within theInternet players in this market. I think it’s difficult for me to commentexactly what Tencent will do, how they are going to perform in the next twoyears. But overall, I think Tencent’s advertising revenue, my understandingcoming from both their IM platform as well as portal and IM platform obviouslyhas a tremendous amount of traffic, and also the portal site also has a lot oftraffic.
And the difference between us and them is basically weprobably have very different user demographics and brand recognition among theusers and advertisers in China. We are more aimed at high-end users and are thesite, the destination site for a lot of more well-educated and high-end usersfor the China market. And as a result, we are grabbing a lot of shares in termsof, as I mentioned earlier on the conference call, a lot of shares in terms ofthe high-end products and industry sectors and services, basically, in likeautomobiles, like digital products, like housing, like financial services.
I think we will continue to do very well in these sectors interms of both total revenue and market share, and obviously the Internetadoption for marketing becomes more widely accepted in the market, so therewill be more industries coming online for their marketing campaign anddifferent companies will have different strengths. And for Tencent, forexample, they probably will be doing very well in terms of a lot of consumerproduct, FMCG, and so on and so forth.
I think there is a lot of room for different companies togrow but each company will have their own strengths in terms of their growth.
With respect to the question on the search, and searchdefinitely is also taking off in China,but again I think we are aiming at a very different customer base. Searchprobably is more, at this stage more for the small and medium companies, forproduct and services and for brand advertising. We are more focused uponserving the big clients in their brand advertising needs. So I think that weare in a very different category. I mean, the only question is which sectorwill grow faster and only the market can tell, basically.
Jason Brueschke -Citigroup
Thank you, Charles. I appreciate it.
Operator
And your next question comes from the line of Richard Jifrom Morgan Stanley. Please proceed, sir.
Richard Ji - MorganStanley
Good morning. I have two questions. Let’s start with theOlympics, and clearly we know this is going to be the single largest event fornext year and the demand, advertising demand is very robust. Do you plan tocreate additional Olympics channel associated with additional advertisinginventory? That’s part of the question.
Secondly, do we also expect to raise advertising rates by amuch larger magnitude than before in the early part of next year? And also,last but not least, so far based on your rough calculation, what percentage ofOlympic sponsors have already committed their budget with you?
Charles Chao
Let’s see, you have three questions. On the first one,Olympic inventories, we actually have already started our Olympic channel. Ithink it was at the end of last year in ’06, the fourth quarter ’06. So it hasbeen there for almost a year. So the question really is how much stuff we canadd to these Olympic channels.
I think the Olympics is not just about the Olympic coverage.There are a lot of activities and events associated with that particularopportunity in China, so our strategy is not only create more content in thesports area, more offerings in the Olympic channel, but rather we want toutilize the entire strength of the SINA website, basically our total content strengthin the news area for the web 1.0 product, like our news, finance, technology,entertainment channels, to create marketing opportunities in the contents foranything associated with Olympic Games.
For example, in our finance channel, we have created asub-channel for the Olympic related economic opportunities events for China andin our technology channel, we have created a sub-channel for the technology,new products associated with the Olympic Games. For the [inaudible] relatedstuff, we also have a lot of activities associated with Olympic Games.
We also try to utilize our web 2.0 products, our blog andforecasting platform to encourage users to participate, as I mentioned in theconference call earlier, basically encourage people to participate, to recordanything that changes and events happening leading up to the Olympic Games, sowe have this huge marketing campaign not only to attract user participation butalso try to create a lot of content and events from now until the Olympic Gamesto really warm up our offerings and coverage for the Olympic Games.
So there are a lot of things we are doing to create Olympicinventories and the marketing opportunities for our customers, basically.
In terms of advertising rates, and there is no question nextyear will be a big year for advertising and all the major media companies aretalking about a rate hike for next year. And we are actually waiting for themarket, how they respond to the CCTV’s, you know, the annual bidding for nextyear’s advertising slots. Basically it’s going to happen probably either thisweek or next week. I’m not sure of the exact day.
So that usually serves as a basic benchmark for theadvertising rates for next year, and there is no question we are going to raisethe rate. It’s a matter of how much we are going to raise and I think anythingrelated to Olympics coverage and marketing will be expensive in Chinaand SINA obviously is in a good position to command a premium price over themarket, given our strong position in the areas of total online advertising, aswell in the sports area.
And in terms of Olympic sponsors, we have thus far, I justbriefly checked the numbers of advertisers we have in Q3 and Q4 and thus far Ithink more than 50% of sponsors have already spent money on us for Q3 and Q4for Olympic related promotions. That means they put the Olympic logos inconjunction with their advertisement or promotion, and I think there is a -- Ithink more than 60% or 70% of Beijing local sponsors and partners have placed advertisingon websites with logos in Q3 and Q4. I think that number will gradually go upand total dollar amount from these customers will also ramp up.
In terms of next year’s budget, we are still talking to our majorcustomers. At this point, I don’t think there are too many who have set theirexact budget for next year. There is probably 10% of these customers have abetter idea in terms of how much they are going to spend with us next year, butI think a majority of them are in the stage of negotiations, basically.
Richard Ji - MorganStanley
Thank you, Charles. And my last question is again regardingyour content alliance. Obviously you guys have been doing a great job insecuring some scarce and premium content, including English Premier League soccergames as well as Italian Super League games, plus the financial content. Canyou enlighten us about the revenue sharing arrangement or the payment streamyou have secured thus far, and what you expect some margin pressure, furthermargin pressure due to content payment going forward? Thank you.
Charles Chao
I think our content, there is no question in the last coupleof years the content costs have increased significantly. But we have been in avery conscious effort to control the content costs in line with our revenueincrease in advertising, so if you look at gross margin, it has been heldpretty steadily over the last several quarters. I think our strategy basicallyis to control the content costs to the extent that we’ll be able to generate astable gross margin for advertising business, basically, and there might besome content hike in terms of the spending during the Olympic Games. Obviouslywe are expecting a lot more revenues from that coverage, basically.
There is no question the content costs will go up in termsof absolute dollar amount but in terms of content as a percentage of totalrevenues, we’ll be able to control at a certain percentage so it is not goingto impact gross margin going forward.
Richard Ji - MorganStanley
Thank you, Charles.
Operator
Your next question comes from the line of Eddie Leung fromMerrill Lynch. Please proceed.
Analyst for EddieLeung - Merrill Lynch
I’m Thomas asking questions on behalf of Eddie Leung.Congratulations on the good results. My question is can you talk about theplans for the music business? Are there any strategies for developing fee-basedmusic downloads in the future? Thanks.
Charles Chao
I’m sorry, the fee-based -- I did not hear the firstquestion.
Analyst for EddieLeung - Merrill Lynch
My question is can you talk about your music business andare there any strategies for developing fee-based music downloads in thefuture?
Charles Chao
Yes, in terms of our music strategy, basically we talkedabout -- I mean, we have set up a platform for the online music listening withfour or five major music record companies and so far, I think we have beenreceiving very good results in terms of our traffic and number of users.
We have also developed a time-based product for music product,music platform, and there is a lot of downloads for our products for the music.Obviously our long-term initiative will be -- I mean, hopefully we will be ableto have the download on a fee-based basis, but I think in China it’s still tooearly, as the entire environment is probably not very suitable for the legaldownloads, I mean with a fee-based model.
We are in discussions with these music companies right nowto try to implement some fee-based service next year. It’s still in thenegotiation stage and we probably will have a better idea next quarter when wereport earnings. Obviously right now, we are generating advertising revenuesfrom our music platform, but over the longer term when the legal environmentimproves in China, given our established platform, we have a strong hope thatwe’ll be able to charge for the downloads, either to MP3 or to the mobile phonegoing forward.
Analyst for EddieLeung - Merrill Lynch
Thank you.
Operator
Your next question comes from the line of James Mitchell.
James Mitchell -Goldman Sachs
Thank you from taking my questions. In terms of the $800,000Google related revenue for the quarter, was that mostly Adsense revenue withinthe advertising revenue line? Or was that mostly search revenue within the otherrevenue line?
And then a follow-up, consequential question; in terms ofyour non-advertising revenue guidance for the fourth quarter, it looks like youare guiding for about an extra $1 million in revenue. Is that up-lift comingmostly from the mobile VAS business or mostly from the other business? Thankyou.
Charles Chao
The answer to your question, both questions, half and half.I mean, for the Google related revenues for Q3, a little bit over 50% isrecorded under other revenues for search, and a little bit under 50% isrecorded in the advertising revenues for Adsense.
And in terms of the increase of non-advertising revenues inQ4, I think 50% will come from mobile and 50% will come from the increase ofsearch related products coming from Google, basically.
James Mitchell -Goldman Sachs
And looking forward, would you expect it to remain just over50% of the Google revenue from search and just under 50% from brandedadvertising from Adsense, or would you expect it to change over time?
Charles Chao
Our current results, for next year, I mean, we probablyexpect more revenues from Adsense product than from the web search product. Wehave done a lot of optimizations recently and have really seen some improvedresults for Adsense product. I think initially, I don’t think we were veryhappy with the results, so we have worked very closely with Google, optimizingthe Adsense product on the website in terms of the placement and key words andeverything -- I mean, in terms of the locations where they put these key words,so on and so forth.
And I think we have developed some very good experience andnot really seen in Q4, we really see a big improvement in the results forAdsense products, and so going forward next year, we probably will see morerevenues from Adsense than from web search.
James Mitchell -Goldman Sachs
Great. Thank you.
Operator
Your next question comes from the line of Gene Munster fromPiper Jaffray.
Gene Munster - PiperJaffray
Good morning. There was I guess mid-quarter a lot of talk ofthe running man controversy, and I know that Herman, you were very explicitthat a lot of your advertisers are currently using running man. Do you thinkthat some of the confusion in the marketplace had an impact on your business?
Charles Chao
Running man, you are saying?
Gene Munster - PiperJaffray
Right. The whole logo controversy.
Charles Chao
Yeah. I don’t think there’s a -- I know the market has beenconfused on this particular topic, but when I was answering the question from RichardJi from Morgan Stanley, I already said that more than 60%, 70% of localpartners for the Beijing Olympic Games, which [supposed to be grouped], I mean,people got confused whether they will be able to place the logos on websites ornot.
I can tell you, I mean, if you look at websites, almost allof them have placed logos on their advertisements with us, so 70% of theselocal partners have already done that. I don’t think there is any restrictionon that particular issue. In fact, nobody has been talking about that in thelast couple of months anymore.
Gene Munster - PiperJaffray
Okay, so the issue, it was something that people weretalking about and now they are not talking about it?
Charles Chao
I don’t see anymore talking on this particular topic inChina.
Gene Munster - PiperJaffray
Okay, excellent. And second is on the gaming side, can youjust recap exactly what -- obviously you have a gaming -- advertisers gaminginitiative now, a portal. I assume this is all [inaudible] -- you guys don’thave any ambitions to make games, do you?
Charles Chao
I think it’s a very new initiatives we are taking right nowand given the size of the gaming market, obviously that offers a lot ofbusiness opportunities. Our current strategy probably will try to takeadvantage of our current product and platform and combine them as one unit.
Historically, these different products and platforms havebeen different, different departments like the game channel is in the contentdepartment and our casual games in the platform is in another department andour IM, audio-based IM product, You Talk, is in a third department. So we arecombining these products into one business unit called the online gamingbusiness unit, and try to take advantage of the strengths we have in theseareas.
For example, our game channel has always been very, verypopular in Chinafor a lot of gamers to get information and to participate in the gamecommunities in China. Also, our audio-based IM product UTalk hasbeen the primary IM product for a lot of gamers in China.On a daily basis, the concurrent users have actually reached 300,000 peak usersconcurrently.
So it’s a very good platform for people for playing thegames. Our initial initiative to combine these departments and these unitstogether to create an overall platform for serving our customers and users.We’re also doing some joint operations for some online games in China. Over the course of the next couple ofquarters, we will probably roll out our new initiatives in the online gaming,but at this stage we do not have a plan to develop our own games, basically.
Operator
Your next question comes from George Chu - UBS.
George Chu - UBS
On the cost of video content delivery; you mentioned thegross margin is improving on a sequential basis. Would you say the impact from the cost of thevideo content delivery going forward will be lessening? Thank you.
Charles Chao
We’re not saying it’s less. I think the cost of video delivery has not been a significant portion ofour total cost of advertising revenues for us. If you recall, we have formeda strategic relationship with ChinaTelecom for our video platform. China Telecom has been providing the bandwidthand IDC for our video platform, and this is for the majority of the market in China.
This partnership will help us to really reduce the costs forall of our video delivery in China,in the last couple of quarters. Goingforward, obviously, we intend also to increase some of the costs ourselvesbecause there are areas China Telecom has no coverage or has limited coverageand so we still have to buy a lot of the IDC and the bandwidth for our videodelivery.
Overall comparing to other companies, video delivery costswill not be significant, the total costs for us, given our relationship withChina Telecom. But the overall cost forvideo delivery will go up, but it will not be very significant as a percentageof total revenues.
Operator
Your next question comes from Wendy Huang - BearStearns.
Wendy Huang - Bear Stearns
Could you comment on the pricing trend in the onlineadvertising post-Olympics? Will it goback to the 20% historical level or will it maybe moderate after the rate hikeduring the Olympics? Thanks.
Charles Chao
I think we can just talk briefly on that particular topic.We do expect the rate hike for next year, but at this stage we have not decidedhow much higher it will go, what percentage we’re going to increase. Historically, obviously you’re right, on anannual basis we would probably do a 20% increase in the advertising rate. I think that’s probably minimum for nextyear.
For some premier inventories related to the Olympic Games,or Olympic campaigns, some we would call probably non-standardized inventorywith probably high rates given the market demand for those inventories. So it’s going to be a mixed picture, but I dobelieve that next year the overall rate hike, if you are talking on an overallbasis for next year, will be more than 20%.
Wendy Huang - BearStearns
What kind of a pricing trend do you perceive post-Olympics,in 4Q next year?
Charles Chao
It’s just too early to tell if you’re talking post-OlympicGames. I think the inventoryspecifically related to the Olympic Games obviously will be gone but for thenon-Olympic-related inventories I do not think there will be a decline. They will further go up in ‘09. That’s probably the marketing trend, in China,basically.
Wendy Huang - BearStearns
Could you maybe compare your game channel with Sohu’s gamingportal 17173.com?
Charles Chao
It’s difficult to draw a comparison here. I don’t have a lotof statistics in front of me, so I don’t exactly their traffic, their products;I know ours probably better. But overall, I think the difference is our gamechannel is a channel within a website and Sohu’s 17173.com is a verticalwebsite itself and so it has a full dedicated staff working for the gamingportal versus us; it’s a unit of our content department.
So we are beefing up our effort to create more offerings forour users for our gaming, given the optimism in this area. So in other words,we’re going to increase our investment for our game channel to make it morecomprehensive to serve our users and our customers, basically.
Wendy Huang - BearStearns
So in terms of the gaming information provided to the usersand gamer demographics you are targeting at, there is no big difference?
Charles Chao
Obviously I cannot answer this question very precisely giventhe information I have right now.
Wendy Huang - BearStearns
You expect the wireless revenue to stabilize going forward.Could you give us some sense about wireless gross margin going forward? Becauseyou mention that this quarter’s decline is due to the higher content and thechannel costs. So does this mean that the content provider has strongerbargaining power against you? What kind of margin should we expect goingforward?
Charles Chao
We’re not talking margin, we’re talking overall operatingmargin for the wireless business. The true portion of the cost we are dealingwith, that’s very typical in the mobile business. One is the cost of revenueswhich relate to the content and also the channel costs associated with themobile operators.
The other is the marketing costs associated with promotingthe products for wireless. On the accounting area, I don’t think there has beentoo much change in terms of the content revenue share with the contentproviders. It’s more related to our strategies in terms of promoting differentproducts.
For example, the SMS product probably will have high grossmargin but for IVR, we probably will have more in revenue but on the other handthe gross margin could be less because we are actually paying higher channelcosts for IVR, given our revenue share with operators on the IVR product.
When we talk about overall margin pressure, at this point itprobably more relates to the marketing side of our promotions, basically. Some of the channels we are using for thewireless promotion like TV advertising, for example, the rate has been going up recently and soprobably it will go up again in ‘08 given overall advertising demand in themarket. This is the margin pressure we are talking about.
But over on the revenue side I think at least on the currenttrend we are seeing for this quarter and also some initiatives we’re going totake next quarter, we believe it stabilized in the short term but over the longterm, it’s still very early yet. It isdifficult for us to tell, basically.
Operator
Your next question comes from C. Ming Zhao- SIG..
Analyst for C. MingZhao - SIG
On your convertible debt, it looks like on your balancesheet it is now classified as current liability. Will you chose to this pay off? What are your plans?
Herman Yu
We’re actually required to classify them as currentliabilities since it’s callable within 12 months under U.S. GAAP.
In terms of our ability to pay off, we don’t have thatoption to pay off until a few years later.
Analyst for C. MingZhao - SIG
The second question is given the market situation, do yousee any potential weakening from real estate and the financial sectors in theupcoming quarters?
Charles Chao
Well these two sectors people have been talking a lot interms of the volatility in both sectors in the overall market. Let me talk tothese two separately.
The U.S.market is not something that people think that if the real estate market isgetting weaker that the advertising market is getting weaker. I mean there’s no direct relationship,sometimes, between that advertising market versus the real estate marketitself.
For example, if the real estate market is really hot, peopleactually are spending less advertising on the media, because they don’t worryabout sales. People line up and they tryto get whatever apartment unit they can get. Sometimes there is actually less need for advertising. But when the realestate market is weaker, sometimes they have more incentive to spend more moneyon the advertising side. So sometimesit’s a very different situation than people thought.
So really, I mean the entire real estate market in China,although there is a lot of volatility in the pricing, but there is no questionthere is a lot of demand for the entire real estate in the next few years andso the total advertising opportunity is still great. It’s a matter of which media can grab a goodshare of the market for real estate and for advertising.
For financial sectors, it’s true that a lot of trafficassociated with financial-related websites has been associated with the stock boomingin the last year. Accordingly there’s asignificant increase in advertising spending for financial-relatedwebsites.
But I think the stock market itself, although it has a lotof volatility, it does not necessarily impact the overall marketing spending onthe financial sector going forward because when we talk about financial serviceadvertising, it’s not just the stock market. There are a lot of areas we could potentially tackle.
For example, there’s a lot of commercial banks have beengoing public in Chinaand there’s a very great need for the marketing campaign and advertising forthese commercial banks. There’s a lot ofdemand for personal finance products like insurance, the investment fund and alot of different areas. There’s a great needfor these kinds of products and also there are a lot of service providerstrying to push their product in to the market. Also, with a lot of competition in Chinafor credit card business, that also gives rise to a lot of marketingopportunities in the market.
So it’s not about just the stock market, it’s about thedemand for the overall finance service as well as the need for a lot offinancial players to push their product into the market.
As I said, the Internet adoption for the financial servicessector is still in a very early stage and this particular sector for theadvertising is going to grow very strongly over the next few years, andobviously we’re in a very good position to take advantage of that.
Operator
Your next question comes from Steve Weinstein - PacificCrest.
Steve Weinstein -Pacific Crest
You already spoke about it substantially, but a few morequestions on the gaming initiatives that you have going forward. What is going to be the mandate for that teamas far as acquiring new content and new games? How aggressive would they be in trying to get developers to use yourplatform to promote a new vehicle?
Charles Chao
Well as I said, it’s too early for me to talk about a lot ofdetails. First of all, we’re notplanning to develop our own games and we probably will not in the nearfuture run a game independently throughlicense agreements. Rather, we want touse this platform to provide better service for the gamers and for the gamedevelopers promoting their products, as well as jointly running some operationsfor the game that the operators are running right now.
That means they can have their games offering on our websitealso so we can have a revenue share model with these developers. Again, too early for me to tell a lot ofdetails but I will probably give you more of an update next quarter.
Operator
Your final question comes from Dick Wei - JP Morgan.
Dick Wei - JP Morgan
The G&A expense is down quarter over quarter andadvertising and marketing spend was relatively flattish. Can you tell me the reason for that?
Charles Chao
You’re talking about G&A quarter over quarter?
Dick Wei - JP Morgan
Right, and sales and marketing?
Charles Chao
For quarter over quarter G&A mainly is related to baddebt, personnel-related expenses and so forth.
With regards to sales and marketing I think it’s actually upquarter over quarter and the reason it’s up is mainly marketing activities.
Dick Wei - JP Morgan
I guess the growth is slower than the overall top line growth. Do we expect to see more leverage going intonext year or the next couple of quarters?
Charles Chao
I think that’s exactly what we’re talking about. On the gross margin basis, we are seeing morestabilized gross margin but for the operating expenses we’ll probably see moreleverage going into next year, basically.
Dick Wei - JP Morgan
Next question is, you’ve talked quite a lot about thefinancial services sector. I’m quiteinterested in, for example, the number of advertisers in the financial sectorcurrently. If you can break it out byinsurance companies or banks or hedge fund that would be great. Also, do you expect them to become one ofyour top three in the next one or two quarters in 2008/2009?
Charles Chao
We don’t have that detailed information in front of us,Dick. Maybe we can talk offline after the call.
For your second question, I think financial service willgrow faster so it’s very likely it will become in the top 3 for our totaladvertising categories in ‘08 basically
Dick Wei - JP Morgan
Can you give us some data on the page views or unique usergrowth for the quarter?
Charles Chao
We never actually give the actual amount, a number for thepage views and unique users for the overall website. Again, this is due to lack of a commonlyaccepted measurement in China. We’re ready to do that once there is a thirdparty that is widely recognized as the common, fair third party measurementgoing forward, basically.
Dick Wei - JP Morgan
I think before you were able to give some of the trafficgrowth; slightly more upside traffic growth or the medium sized trafficgrowth. I don’t know if you have thedata?
Charles Chao
It’s probably one that on a semi-annual basis, we’re goingto talk about that next quarter, on a semi-annual basis.
Dick Wei - JP Morgan
When we ask how much of the revenue in ‘08 will be comingout of the Olympics channel, I waswondering if you could give more details on that?
Charles Chao
I don’t know, Dick.
Dick Wei - JP Morgan
That’s quite integrated into the finance channel, as yousaid.
Charles Chao
Pardon?
Dick Wei - JP Morgan
I understand it is quite integrated into those variouschannels.
Charles Chao
Yes, exactly. It is not just the Olympic channel. I thinkthe Olympic channels probably will be the most prominent channel for revenuegeneration during the Olympic Games, but I think before that it’s going to bethe revenue generated from across the board from all related channels, and alsofrom our user-generated content, basically.
Operator
At this time we have exhausted the time allotted forQ&A. I would now like to turn the call back over to Ms. Cathy Peng forclosing remarks.
Cathy Peng
Thanks, everyone for joining us today. If you have anyadditional questions please feel free to contact us. Thank you.
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