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SOHU.com (NASDAQ:SOHU)

Q4 2005 Earnings Conference Call

February 6th 2006, 8:00 PM.

Executives:

Ingrid Shea, Investor Relations

Charles Zhang, Chairman of the Board and Chief Executive Officer

Carol Yu, Chief Financial Officer

Analysts:

Katherine Lange, Citigroup

Safa Rashtchy, Piper Jaffray

Frank Shi, CLSA

Dick Wei, JP Morgan

Ming Zhao, SIG

Lu Sun, Lehman Brothers

Wallace Chung, Credit Suisse First Boston

Michael Zhang, INC Equity Partners

Operator

Good day ladies and gentlemen, and welcome to SOHU's First Quarter and 2005 Fiscal Year Earnings Conference Call. At this time, all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs assistance at anytime during the conference, please press the star followed by the zero. As a reminder this conference is being recorded today, Monday, February 6, 2006. I would now like to turn the conference over to Ms. Ingrid Shea, Investor Relations. Please go ahead ma'am.

Ingrid Shea, Investor Relations

Thank you for joining SOHU.com to discuss our Fourth Quarter and Fiscal 2005 Results. On the call today are Charles Zhang, Chairman of the Board and Chief Executive Officer, and Carol Yu, Chief Financial Officer.

Before the management presentations I would like to read you the Safe Harbor statement in connection with today's conference call. Except for the historical information contained herein, the matters discussed in this conference call are forward-looking statements. These statements are based on current plans, estimates and projections, and therefore, you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements. Potential risks and uncertainties include but are not limited to SOHU's historical and possible future losses, limited operating history, uncertain regulatory landscape in the People's Republic of China, fluctuations in quarterly operating results and the company's reliance on on-line advertising sales, mobile phone related wireless revenues, online games and e-commerce for its revenues. Further information regarding these and other risks is included in SOHU's Annual Report on Form 10-K and other filings with the Securities and Exchange Commission. Thank you for your patience.

Now I would like to the call over to Charles Zhang, Chairman and CEO. Charles?

Charles Zhang, Chairman of the Board and Chief Executive Officer

Thank you all for joining our conference call today. To start there is one key message that I want to emphasize on our call today. And that is our commitment for our core advertising business. SOHU's brand and research, we managed firm and the growth that we have seen this past quarter and throughout 2005 is representative of our growing strength in China's online advertising market. We look to further drive our business through continue development and the rollout of our own innovative products and the services to drive increased traffic and the usage on our sites.

Now I'd like to discuss highlights for the quarter. We reported record total revenue of $30.5 million growing 8% sequentially and 27% year-on-year exceeding company guidance. Let me discuss the progress of our main business line. Advertising, overall we have seen a healthy fourth quarter and 2005 fiscal year in the advertising business. Advertising revenues for the fourth quarter were $20.3 million, up 8% quarter-over-quarter, which exceeded our guidance. For the full fiscal year 2005, Advertising revenue grew 27% year-over-year also exceeding our guidance of 20% to 25% year-over-year growth.

Brand advertising revenue were $16.9 million, and the sponsored search accounted for $3.4 million, a sequential increase of 8% and 7% respectively in a traditionally weak quarter, and a year-on-year increase of 28% and 27% respectively. I'd like to give an overview of brand advertising first. In brand advertising, the 8% of sequential revenue growth was primarily due to heavy advertising spending sectors such as information technology, automobiles and real estate. On the other hand sectors that have experienced the fastest growth for the quarter has been financial services, travel and healthcare. More specifically, there are two very important and underling sectors which are as a core of our brand advertising strength and the strong future growth outlook.

First, SOHU's Olympic sponsorship growth is a near-term and long-term growth catalyst for our brand advertising business. The fourth quarter was the first quarter of our constructing operating and hosting official Beijing 2008 Olympics website. The website www.beijing2008.com is now up in running in three languages: Chinese, English and the French. We are very excited about our role in the Olympics and this has been felt throughout the entire organization at SOHU. This is the point of extreme pride for myself and also for the entire unit. Our Olympics sponsorship role is also an important recognition by the Chinese Government that SOHU is the premium internet portal company and has enhanced our overall relationship with government agencies. The overall impact is the increased SOHU brand awareness and we have already seen the impact SOHU branding power coming through from 14,100 advertisers. In Q4 2005, we already beginning signing new Olympics related deals with 14,100 advertisers such as Lenovo and Audi China. We expect in fact to become even more magnified as the Beijing 2008 Olympics approaches.

Second, SOHU's family of sites and innovative products continued to attract more traffic, increased strictness and lead to more effective monetization for its brand advertisers. SOHU's has more than 1,000 corporate partners and has unique products such as Chinaren, Alumni Club, and new products such as message boards, picture galleries and the blogs. Traffic of our community products, example message boards and picture galleries are increasing at a monthly rate of over 10% during Q4 2005. As a result, SOHU's combined family website has achieved the number one ranking of page views among Chinese internet companies according to Alexa, and SOHU has widened its lead against its major competitors. Based on Alexa as of mid-January of 2006, SOHU's family of website traffic have increased with more than 120% of our major competitors in terms of page views.

Turning to portal site, SOHU.com, we have narrowed the GAAP quite significantly compared for our major competitors, just in the past few months with SOHU traffic on the rise from representing 72% of that of our major competitors at the end of September of 2005 to 87% as of mid-January 2006. We're also making pleased kind of higher thickness with it to certain pages per user versus our competitor 10 to 11. I would like to again emphasize despite above payoff in investment, SOHU has been able to maintain a higher gross margins of 74% versus our competitors 68%.

In addition, we've also seen increased monetization of our new products, in Q4 2005 revenue from Chinaren and its old new products such as message boards and the Picture Bar increased by over 60% sequentially. Although, this was off relatively small base, we expect retailers continue to gain momentum going forward. In sponsored search, the 7% sequential growth was driven by a significant increase in bid listing revenues, which accommodated for 30% of our total sponsored search revenues, compared with the 23% in the third quarter. This shift is revenue mix of managed utility expansion of our website client networks and the growing acceptance of the pay-per-click concept in China.

In late November 2005, we also successfully launched sogou version 2.5, which increased the search database to 2 billion retrieved pages and 800 million index pages. In addition, sogou 2.5 is the more intelligence version in terms of crawling, selecting and ranking for search results, thus providing users with more relevant, accurate and up-to-date web pages. Sogou 2.5 improves analysis capability to more effectively minimize dead links and repetitive links.

According to our internal data SOHU's traffic in the fourth quarter will close to 40% compared with the third quarter and we believe this does not yet fully reflect the sogou 2.5 upgrade, as the new product did not fully ramp-up on to the end of December. In addition, we will continue to look for new and innovative ways to promote sogou brand via our Sogou Supergirl contest and National Dog Search. The Dog search has sparked great interest especially given that this year 2006 is a Year of the Dog. It is important for us to brand Sogou and the search engine's choice customer tailored to the needs of entire community.

We remain confident that there will be strong growth for our advertising business over the next few years. The brand impact from the Olympics sponsorship will continue to have a significant impact on our ability to drive our advertising business going forward. We will also continue to focus on developing and fine-tuning our search products given the increasingly competitive search environments in order to position Sogou as one of the leading search engines in China. For 2006, we're targeting full-year advertising revenue to grow 25% year-on-year as we see continued healthy growth in brand advertising and more significant contributions from sponsored search advertising.

Turning to our wireless business. Though our focus remains on our core advertising business, we happened to see a continuous steady recovery in our route wireless business with 7% sequential growth and 65% year-on-year growth in the fourth quarter to $7.2 million. In addition, the growth of our wireless business was achieved with no substantial increase in promotional expenses or revenue sharing percent exchange.

We are pleased that our wireless business has become increasingly stable in fiscal year of 2005. We certainly believe it is important for SOHU to maintain a presence on the wireless side, and the more specifically in WAP in anticipation of the eminent launch of the 3G mobile network in China and the burdening market that it will bring. 3G license is expected to be awarded this year and the commercialization of the technology by 2007.

With this in mind we recently launched our WAP Portal, now WAP version of our existing portal in a simplified format in December 2005. And we have been seeing fabulous increase, 80% in the subsequent to two months. We have been able to capitalize on the SOHU’s broad content strength from our portal and the family of website. We belive that we will be able to continue to leverage our content strength strategy in this area. Now I'd like to turn the call over to our Chief Financial Officer, Carol Yu for financial review. Carol?

Carol Yu, Chief Financial Officer

Thank you, Charles. I would like to take this opportunity to discuss some key financials for the fourth quarter and 2005 fiscal year. One, Revenues: We are pleased to report strong revenues of 30.5 million for the fourth quarter, which exceeded our guidance. Revenues for fiscal 2005 were 108.3 million, a record in SOHU's corporate history. One, Advertising. With advertising revenues of 20.3 million, we experienced a healthy 8% sequential and 28 year-on-year improvement. In fiscal 2005, total advertising revenues of 70.9 million grew 27% year-on-year. Two, Wireless. For the fourth quarter, wireless revenues were 7.2 million, up 7% quarter-on-quarter and 55% year-on-year. In fiscal 2005, total wireless revenue were 26.3 million, declining 28% year-on-year, reflected those strategy of shifting revenue mix to the core advertising business.

Let me give you a breakdown of the fourth quarter wireless revenues. SMS revenues declined 3% to 4.2 million, which was a result of technical problems with one of the operator's network. These issues have already been result by the end of the fourth quarter. WAP revenues were up 8% despitely impacted by China Mobile's new policy. In late November, soliciting all askings from remoting paid services or any WAP networks except on China Mobile's mode in that platform. MMS, IBR and ring back tone services accounted for 0.9 million in total, that’s compared to 0.5 million in the previous quarter. Despite certain challenges, wireless revenues has experienced full consecutive quarter of cautious recovery. Three, other revenues. Our other revenues mainly include online game revenues which grew 19% sequentially and 42% year-on-year to 1.7 million.

Two, turning to our gross market. Overall gross margin for the fourth quarter was 66%, up from 65% in the previous quarter and down from 68% in the fourth quarter of 2004. In fiscal 2005, overall gross margin was 66%, down slightly from 67% in fiscal 2004. Advertising gross margin was 74% in the fourth quarter, relatively flat from the previous quarter, and down from 81% in the same period last year. In fiscal 2005, advertising gross margin was 75% compared with 78% in fiscal 2004. Non-advertising gross margin was 50% for the fourth quarter, an improvement from 47% from prior quarter and 42% in the fourth quarter of last year. In fiscal 2005, non-advertising gross margin was 50% compared with 54% in fiscal 2004.

Three, operating expenses. For the fourth quarter, SOHU's operating expenses totaled 40.2 million, increasing 25% from the previous quarter and 37% year-on-year. The increase in expenses quarter-on-quarter primarily relates to cost associated with SOHU's exclusive Olympic sponsorship role and additional advertising sales commission payable to our sales team totaling 1.4 million.

More specifically, the increase of 1.4 sales commission can be attributed to two factors. First, consistent with SOHU's previous policy, commission expenses payable to our sales team will recorded upon actual cash collection of advertising revenue. During the fourth quarter, actual cash collections was much higher than that of last quarter. Related sales commission increased by 0.7 million. Second, as of December 31, 2005, in view of the company’s implementation of tighter credit control and an increase in overall credit worthiness of its customers, the company determined that sales commissions should be recorded upon recognizing advertising revenue. As a result, we recorded an additional accounting adjustment of $0.7 million of sales commission relating to revenue recorded but not yet collected as of December 31, 2005.

Four, operating profit margins. Operating profit margins in the fourth quarter was 19%, down from 25% in the previous quarter and 25% down in the same period last year. Operating profit margin in 2005 was 23%, down from 33% in fiscal 2004, before the inclusion of the newly required stock-based compensation expense we estimate operating profit margin will resume back to the mid-20s level for the first quarter of 2006.

Five, other income. For the fourth quarter, SOHU’s other income totaled $2.4 million. This included a gain of $1.2 million arising from the repurchase of convertible notes with face value of $15.22 million as a discount. In addition, due to an exception regarding payment of certain taxes, and receipts of tax refunds by our China subsidiaries, we have also recorded approximately $1.2 million gain of other income.

Six, net income. Net income for the fourth quarter was $8.9 million or $0.23 per fully diluted share. This compares to net income of $8 million or $0.21 per fully diluted share for the previous quarter and $6.5 million or $0.17 per fully diluted share for the fourth quarter of 2004. For fiscal 2005, net income was $29.8 million, or $0.77 per fully diluted share, compared to net income of $35.6 million, or $0.89 per fully diluted share in fiscal 2004.

Seven, balance sheet. Let me now make a few comments on the balance sheet. As of December 31, 2005, SOHU’s cash, cash equivalents and investments in marketable debt securities was $134 million compared to $132 million as of end of last quarter, and $141 million as of December 31, 2004. During the year, the company completed a $13.8 million stock repurchase program and the above-mentioned repurchase of convertible notes. As of December 31, 2005, our net accounts receivable balance was $19.3 million, reduced by $4 million as compared to last quarter. This includes $14.3 million relating to our advertising business and $3.5 million related to our wireless business. During the fourth quarter, we managed to collect sales proceeds totaling $23.3 million for our advertising business. Such collections resulted in a drop in our DSO for the fourth quarter to 62 days, compared to 82 days in the previous quarter.

Fourth quarter advertising DSO was also reduced to 77 days, significantly down from 105 days for the third quarter. This demonstrates our efforts in closely monitoring our accounts receivable are paying off. As of December 31, 2005, our bad debt provision amounted to $1.2 million, compared to $1.7 million as of September 30, 2005. While we consider this level of bad debt provision to be still relatively low as compared to our level of advertising sales, we continue to remain prudent in our revenue recognition policy and strengthening of our credit extension.

Eight, and finally, our business outlook. You will find detailed guidance for the first quarter 2006 in our earnings release, but I would like to highlight. One, SOHU estimates total revenues to be $28 to $30 million, with advertising revenues of $19 to $20 million and non-advertising revenues of $9 to $10 million. Two, SOHU estimates first-time stock-based compensation expense to be $1.7 to $1.8 million. In addition, starting from January 1, 2006, the applicable PRC income tax rate of SOHU has increased from 0% to 7.5%. SOHU estimates PRC income tax expense to be between $0.5 to $0.7 million for the first quarter. The total impact of these two expenses is expected to reduce SOHU’s fully diluted earnings per share by $0.05 to $0.06. And, third, after deducting the above-mentioned stock-based compensation and PRC income tax expense, SOHU estimates fully diluted earnings per share for the first quarter of 2006 under US Generally Accepted Accounting Principles to be between $0.14 to $0.16.

In summary, we are pleased with our fourth quarter and fiscal 2005 results and believe we are well positioned for growth in 2006. Our healthy brand advertising business combined with the steadily improving search product further supplemented by cautious recovery on the wireless side are all positive factors as we look ahead into 2006 and beyond. We view the Olympic sponsorship as a strong growth catalyst, and affirmation of SOHU’s long-term leadership in this dynamic online environment. We remain confident that our positioning and forward strategy contains the optimal mix of what is needed to drive results and increase shareholders value.

That concludes my presentation. Thank you for your attention. I would now like to open the floor for questions. Operator?

Questions-and-Answer Session

Operator

Thank you. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press the '*' followed by “1”on your pushbutton phone. Again that's '*' '1' to ask a question. If you would like to decline from the polling process, press the ‘*’ followed by ‘2’. You will hear a three tone prompt acknowledging your selection, and the questions will be pulled in the order that they are received. Please limit your questions to one question, one follow-up question, and re-queue for any additional question. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. One moment please for our first question. Our first question is from Jason Brueschke with Citigroup.

Q - Katherine Lange

Hi. This is Katherine Lange speaking for Jason Brueschke. He’s marketing in Europe right now. First, we would like to congratulate you on a great quarter.

A - Carol Yu

Thank you. Your sound is little bit soft. Would you mind speaking loud?

Q - Katherine Lange

This is Katherine Lange for Jason Brueschke.

A - Charles Zhang

Okay; better.

Q - Katherine Lange

Yes, he is marketing in Europe right now. Is it better?

A - Charles Zhang

Yes; it’s better.

Q - Katherine Lange

Okay. So, firstly congratulations on a great quarter. We just have a question on brand advertising. Firstly, could you update us on your agreements with Alibaba, is the contract is up for renewal, and if yes have you renewed it? If it’s not up for renewal, can you tell us if you’re looking for another exclusive agreement when you renew it?

A - Carol Yu

The answer is yes. We have renewed it. It’s an annual contract; we renew it every year. And that has been factored into the guidance for 2006 that Charles just gave out.

Q - Katherine Lange

Okay. And, I just have a quick question on your customers. We noticed in your 10-Q that there has been a relatively large amount of churn in the advertisers, in terms of the new advertisers. And this is anticipated, obviously, given your guidance. Could you update us on whether this churn has moderated in the fourth quarter and whether the problems you mentioned in southern China have moderated as well?

A - Carol Yu

The southern China problem has been sort of contained. And as you can see in the fourth quarter results, we actually are doing better than we originally expected for the entire brand advertising business as a whole. Turning to the churn, customer content goes in the because it’s a quarter-to-quarter thing so this customer may advertise this quarter and they may not do so in the next one. In terms of the total number of advertisers Q4 actually goes up by about 4%. So on the overall basis we are really happy with the customer base that we are having right now for brand advertising.

Q - Katherine Lange

So it's about the number of new advertisers, and a percentage of the total advertisers for the quarter is about around the same level as in the fourth quarter as in the previous third quarter?

A - Carol Yu

Yes, it's up 4%.

Q - Katherine Lange

Okay, alright. Thank you.

A - Carol Yu

Thanks.

Operator

Thank you. Our next question is from Safa Rashtchy with Piper Jaffray.

A - Carol Yu

Hi Safa.

Q - Safa Rashtchy

Good Charles, Carol. How are you?

A - Carol Yu

Good.

Q - Safa Rashtchy

Congratulations on the good quarter. Couple of questions, mostly online search and advertising, and then a follow-up on wireless if I could. I belive if we take your guidance for Q1 on advertising, it suggests an acceleration of growth rate to over 30%. First of all, can you confirm if my calculations is correct? Are you expecting an acceleration that means that all organic? And overall, Charles, how do you view the advertising environment in '06 compared with '05?

A - Carol Yu

Let me clarify the numbers. Yes, you're talking about year-on-year, for Q1 we are giving out the guidance I suggest, that it would grow by around 30%. So that's the guidance that we give out. And our belief is, what's your next question?

Q - Safa Rashtchy

Yes, just on acceleration of growth. And I want to a) first see if that is all organic and b) if you try to expect an acceleration of growth in advertising in '06 compared to '05?

A - Carol Yu

Okay. In '05 we achieved a year-on-year growth of 27%. Your next question, and we gave our guidance for '06 to be 25% for advertising growth. And yes, the growth that we gave out for Q1 is all organic. We are not making any acquisitions in Q1, not factored in.

Q - Safa Rashtchy

Okay. So are you expecting growth to decelerate beyond Q1, because you said you are giving a 25% for '06, did I hear you correctly?

A - Carol Yu

We are giving out an overall guidance for '06 to be 25%. We are comfortable with that number. We did say that we would grow by 20 to 25% last year, we did achieve 27 though. So we are comfortable with this 25% number for now in 2006. But you are right; the guidance that we gave out suggested around 30% growth for Q1 year-on-year.

Q - Safa Rashtchy

Okay, and second question on the wireless segment. Your wireless segment is doing well and the margins are expected to be better than – they hasn’t yet given their increasing cost, as you indicated that you maybe increasing your focus on wireless, especially as 3G licenses are getting closer, what kind of investment should we expect you will do in wireless, and what kind of expenses can we see added to that segment if at all in 2006?

A - Charles Zhang

Yeah, I think we will achieve a recovery and regular growth without additional major investment in promotional expenses, and for our WAP development, it's already utilized the resources, the total, the PC based internet content that some of the content are quite accepted by mobile users, and some of the community product and also the Sogou search and also the Go2Map, and all these product the portal content can we developed used on a mobile phone without additional expenses.

Q - Safa Rashtchy

Great. Thank you, Charles, thank you, Carol. Good quarter.

A - Carol Yu

Thank you.

A - Charles Zhang

Thank you.

Operator

Thank you. Our next question is from Frank Shi with CLSA.

Q - Frank Shi

Hi, good morning guys.

A - Carol Yu

Hi Frank.

Q - Frank Shi

The question on online advertising. In terms of resources of online branding, which industry do you think will go fast, and which industry do you think will grow going slower? And the second question, in terms of your growth in page search, how many percent is driven by a number of customers, how many percent is driven by price changes? Thank you.

A - Carol Yu

In terms of brand advertising, we saw going in 2006 as we mentioned will be primarily financial services and FMCG, the fast moving consumer goods. Slowing down we don’t expect much growth from online games due to the uncertainty in the overall game industry. And as well as like what we have - the industry that we typically that we exceeding from problems last year such as local mobile headsets, but other than that we see everything going fine and well.

Operator

Ladies and gentlemen please continue to standby, we are having technical difficulties, please standby for one moment please. Many apologies for the delay, please continue with your answer.

A - Carol Yu

Yes. Frank, did you get it?

Q - Frank Shi

Yeah.

A - Carol Yu

In terms of the brand advertising question?

Q - Frank Shi

Yeah.

A - Carol Yu

And in terms of search, the growth mainly comes from the shift from pay inclusion to bid listing. So it's not really relating to the increase in number of customers or in terms of price increase. So it's mainly coming from the shift in terms of the source of the revenue.

A - Charles Zhang

And that was related to the traffic growth.

A - Carol Yu

Right.

Q - Frank Shi

Okay. Thank you. My last question is also on the search. On the given Google’s push into the China market and Alibaba, I guess push I mean at the business itself. Clearly you guys compete on traffic, but do you also see increase in competition in terms of channels and in terms of human resources? Thank you.

A - Charles Zhang

Yeah, in the fourth quarter we have seen our traffic grow by 40%. And after the Sogou 2.5 version launch in December and we have seen in the past few weeks, the traffic grow even faster. So we are, we are actually growing Sogou traffic faster than our competitors. There is a clear competition over talents and personnel and technologies and also on the marketing fronts. But on the marketing trends we have been, we do innovate marketing contents like the Supergirl contest, and also very lucky to have the year of the Dog and we have the search Dog contest. So it's a fierce competition, but we think that we are in a very good position.

Q - Frank Shi

Okay. Thank you.

A - Carol Yu

Thanks.

Operator

Thank you. Our next question is from Dick Wei with JP Morgan.

A - Carol Yu

Hi Dick.

Q - Dick Wei

Hi, good morning Charles, and Carol. My question is on the marketing expense side. In the first quarter, selling marketing expense was up about 3.1 million from third quarter, and out of 1.4 million due to the advertising transition, marketing expense is up 1.7 million quarter-on-quarter, I was wondering, how much does it goes to the Olympics, and how much of this go to the some of Sogou or on to the wireless emphasis?

A - Carol Yu

We didn’t' actually give up the specific number relating to the Olympics sponsorship as you know, but all the marketing expenses relating to the Olympics sponsorship plus our whole one-time marketing expenses relating to the event, such as the big launch ceremony and the light is around $1 million for Q4. So we will break that down that to how much is actually relating to the cost of the sponsorship. So and, so that is just typical seasonal, because the fourth quarter, we usually incur a little bit more than the other quarters. So when do you have, at the end of the year, thank you events to your clients and the like so. That's a seasonally high.

Q - Dick Wei

And so that one million related to Olympics some one-time, and some…

A - Carol Yu

Recurring, yes.

Q - Dick Wei

Recurring. I have a question on, just on the August revenues, it has grown up some quite healthily by about to indicate, when do, does it really come from online games, and how we see it online to that? Thanks

A - Carol Yu

Yes. The growth actually comes from mostly online games, actually e-commerce and the others are free flat, or down a little bit. And the role in online games comes from both online with games, and then in terms of - it's coming mostly from games online.

Q - Dick Wei

The last question is that, do you have the PCU numbers, and actually can you give the numbers available? Thanks.

A - Carol Yu

It is very low, all the general its less than $30 PCU so, and I won't even care about it so.

Q - Dick Wei

Okay, thank you.

Operator

Our next question is from Ming Zhao with SIG.

A - Carol Yu

Hi Ming.

Q - Ming Zhao

Hi, congratulations Carol and Charles. I have a question on the advertising side. In your guidance for the 2006, you know 25% year-on-year growth. Have you factored in the stronger local currency, which is about 2.4% year-on-year, is that excluding that or including that?

A - Carol Yu

We assume everything, so the year-on-year that you talk about will be starting from July, is only half of the year so. And the timing people just, we just already convert that into currency so.

Q - Ming Zhao

Okay. And also related to this brand advertising, just a followup question on the, you know, where the growth is coming from for the Q4 and for guidance in Q1. Because I have noted that you rate the cards, with your brand advertising has increased a lot on the homepage and those hot channels. Have you also taken consideration that price increase?

A - Carol Yu

Yes, we have taken everything into consideration.

Q - Ming Zhao

So, on average how much is the increase upon the price increase?

A - Carol Yu

Again, it will be on the hot resources, its around 17% to 25%.

Q - Ming Zhao

Okay, alright. Thank you.

A - Carol Yu

Thank you.

Operator

Thank you. Our next question is from Lu Sun with Lehman Brothers.

Q - Lu Sun

Hi Charles and Carol. I actually just want to ask two questions. One is about the treasure of the Olympics contract that you are signing with major companies. Again it's flying a little bit higher than, you know, from now going to 2008?

A - Carol Yu

It's case by case, it's different from one to another. But mostly it would be called marketing activities, for example, surrounding a certain theme which is related to Olympics obviously, we just do marketing activities together. So it varies from company to company and deals from deals and deals to deals.

Q - Lu Sun

Does that help you a lot in those customers for two to three year periods with incremental spending every year?

A - Carol Yu

If it’s relating to Olympics, yes. When you say margin, it's not, we would not have a long-term contract with these guys sacrificing how much they spend this year, the next year and the year after. But assuming that these guys are spending money to obtain the sponsorship and they will spend even more amount to promote the sponsorship that they got. They would have to do marketing to promote their own sponsorship, and that’s when that we would have an opportunity to work this up.

A - Charles Zhang

The Olympics deal also includes the Winter Olympics in Turin. And actually Lenovo and the big marketing activities around this event, so and SOHU will have a reporting team to heavily report the Turin Winter Olympics.

A - Carol Yu

It's just one of these examples.

Q - Lu Sun

I see. And my second question is on the rationale of changes in the commission schemes that you pay out to your salespeople. It looks like it’s counterintuitive in the sense that you actually encourage people to sign more contracts, but actually in the advertising world, isn’t receivable always a problem and you want to pay them only after you collect the cash?

A - Carol Yu

Good question, Lu Sun. I’m glad you asked that. No change in terms of actual payment to the salespeople that we will only pay them after the collection of receivables from customers. But, in terms of the timing when I accrue this expense, I moved the recording point to an earlier time instead of recording that only upon collection of receivable, I now record it upon the recognition of revenue. So, it’s only the timing of the accrual change; it’s not the actual payment nor the scheme itself.

Q - Lu Sun

I see. Thank you.

A - Carol Yu

And that’s why I specified that it is an accounting adjustment. It is not an actual change in the bonus plan or the commission plan.

Q - Lu Sun

And that applies to both the internal salespeople and also the outside agents, right?

A - Carol Yu

We have always recognized a rebate to sales agents upon recognition of sales revenue. But, for internal, because it’s discretionary, in the past we’ve recorded upon the collection of receivables. Now we changed the timing of the recording.

Q - Lu Sun

I see. One last question. Do you think that paid search will outgrow brand advertising in 2006?

A - Carol Yu

We believe that the product is most important for us on the search side. So we’ll continue to work on that. And once traffic grows, I think monetization will follow. We do not give out specific guidance as to the relative growth rates between these two advertising business lines.

Q - Lu Sun

Thank you very much.

Operator

Thank you. Our next question is from Wallace Chung with Credit Suisse First Boston.

Q - Wallace Chung

Hello.

A - Carol Yu

Hi, Wallace.

Q - Wallace Chung

Hi. Good morning, Charles and Carol. Good quarter. Two questions. First of all regarding gross margin, we see pretty impressive improvement. Should we expect for the gross margin increase in the first quarter and even in 2006, and can you explain a little bit the reason behind on the gross margin in terms of the particular in the brand advertising side? Second question regarding, again, on the expenses. Can you elaborate a little bit more on the potential incremental expenses regarding the Olympic deals in 2006 as well as any incremental marketing expenses on some of the key events Charles has mentioned about, say, Supergirl or other things that may happen in the first quarter? Thank you.

A - Carol Yu

Let me talk about our expenses side first. The Olympic deals, I think we would not have much incremental expenses because as I have explained, certain of the expenses that we spoke in Q4 are one-time. And going into 2006, I think, I did explain on the last call and with a number of meetings that the expenses would be, as far as the cash portion is concerned it would be flattish. The one-time marketing expenses that we spend in Q4 would not be recurring, although we do have some recurring marketing expenses. The marketing events that Charles mentioned, like the Supergirl and the search dog that is what we do day in and day out. So these are just specific events that we highlight for investors and analysts to better understand what we’re doing in terms of promoting our Sogou product. It’s not because we are spending a lot of money on them. And what’s your first question, Wallace? Sorry.

Q - Wallace Chung

Again on the gross margin side because…

A - Carol Yu

Oh, gross margin side. I think it would be pretty flattish going forward. And as we mentioned, except for the bandwidth and the server costs on the brand advertising side, most of it is pretty, are all fixed costs. It would just grow or change with our revenue so most of the costs are fixed.

Q - Wallace Chung

Okay. But that will be also observed the decline in gross margin in the paid search side. The reasons behind?

A - Carol Yu

The reason is because of the shift in the revenue mix. We are growing from more, growing into more bid listings, which has a revenue sharing with all the web alliances and the like.

Q - Wallace Chung

Okay, great. Thank you.

Operator

Thank you. Our next question is from Michael Zhang with INC Equity Partners.

Q - Michael Zhang

Hey. Good morning. Congratulations on the quarter. My questions are focused on the wireless side of business. I think Beijing Time yesterday, the Ministry of Information Industry was reportedly saying it’s going to clean up the fraudulent and inappropriate building practice in the telecommunications market, including the wireless value-added service.

A - Carol Yu

Right.

Q - Michael Zhang

It looks like long-term positive news for the market, but what do you think the short-term impact will be on the industry in general and on SOHU’s business?

A - Carol Yu

Let’s talk about SOHU specific first. I think, SOHU has underwent a rather painful cycle last year in terms of cleaning up all these inactive users and the like. And I think as far as we are concerned, we have already cut all the dead bushes around. And I think we’re already there. So I don’t think that would be very much affected if at all by this new policy. In terms of the industry, I think I mean maybe a better qualified candidate to answer this question is to ask the bigger players be our core business is now advertising, and we are not anything close to representative of major players in this market.

Q - Michael Zhang

Okay. That’s fair enough. The second question is as you mentioned, the core business right now is advertising, which is 67% of your revenue. And the non-advertising is also in the recovery mode. So, can you briefly address your outlook for 2006 and your strategies to achieve what you have envisioned?

A - Carol Yu

Strategy?

Q - Michael Zhang

Yes. Outlook for 2006.

A - Charles Zhang

Oh, continued focus on advertising.

Q - Michael Zhang

Yes.

A - Charles Zhang

And brand advertising to, first of all, make sure that our information base to portal and also the community web 2.0 products continue to grow in terms of traffic and usage so that SOHU will become the default premium portal in China. With traffic growth, we’ll have leverage over our advertisers and attract more advertisers and also build. We already have a very good structure in terms of advertising sales force. And the build up of the team will continue. And, for the search side, our focus is to grow traffic. As demonstrated by the past quarter, the traffic already has been growing faster than our competitors. And through continued investment in research and development, make sure that our technologies stay up in the best. So, for the search side, it’s really the year of dog, it’s the year of the search dog traffic growth.

Q - Michael Zhang

What about the wireless side of business?

A - Charles Zhang

We will maintain a continued rapid recovery.

A - Carol Yu

We will continue to maintain a stable investment in this business. We would not invest aggressively, we would not be doing aggressive promotions or what not. And on that basis, we hopefully can grow the business on a cautious manner. This is our plan and our hope but as we have mentioned many times because this particular industry, the payment gateway is controlled by the two operators. If they do something drastic, there’s not much we can do but, and that’s what our strategy is to stay low and keep just continue to recover the business.

A - Charles Zhang

And grow our WAP business, which is 3G era, preparing us for the 3G time.

Operator

Thank you. Our next question is from Jason Brueschke with Citigroup.

Q - Katherine Lange

It’s still me, Catherine. I just have a follow-up question on the technology of the search, Sogou. From a technology point of view, could you comment on how the technology as of today compares with, the algorithm compares with Google and Yahoo’s algorithms? And when you fully monetize Sogou, how do you expect the technology to compare?

A - Charles Zhang

With the Sogou version 2.5, we have a new set of, a new version spider, which are crawling and collecting pages at a much faster speed. And also, a new versatile coding, which are giving a more accurate and updated pages with a dozen links. Also, in specialized the search with the, we have a better technology in the music search and also with our Go2Map, combine the Sogou technology and the Go2Map information database in providing a better local search. We will launch our local search in a few months. So, the Sogou technology basic web page search site, web page side, a better spider and a better, a new coding that are just better, more efficient input/output retrieving technology to provide an accurate and relevant direct of the content, basic itself.

Q - Katherine Lange

Okay.

Operator

Thank you. At this time, I’d like to turn the call back to management for additional remarks.

Ingrid Shea, Investor Relations

We would like to thank everyone for participating in today’s call. Please feel free to contact us should you have any additional questions. Thank you, and have a nice day.

Carol Yu, Chief Financial Officer

Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude SOHU’s fourth quarter and 2005 fiscal year earnings conference call. If you would like to listen to a replay of today’s conference, please dial 1-800-406-7325 or internationally at 303-590-3030 with pass code number 3460509, followed by the pound sign. Again, if you would like to listen to a replay of today’s call, please dial 1-800-406-7325 or 303-590-3030 with access number 3460509, followed by the pound sign. Again, thank you for your participation today, and you may now disconnect.

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