Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Sohu.com Inc. (NASDAQ:SOHU)

Q1 2008 Earnings Call

April 28, 2008 8:00 am ET

Executives

Brandi Piacente - The Piacente Group

Dr. Charles Zhang - Chairman of the Board, Chief Executive Officer

Belinda Wang - Co-President, Chief Marketing Officer

Dr. Gong Yu - Chief Operating Officer

Carol Yu - Co-President, Chief Financial Officer

Analysts

Catherine Leung - Citigroup

Jenny Wu - Morgan Stanley

Dick Wei - J.P. Morgan

Wallace Chung - Credit Suisse

Wendy Huang - Bear Stearns

Eddie Leung - Merrill Lynch

Leah Hao - Goldman Sachs

C. Ming Zhao - Susquehanna Financial Group

Operator

Good evening, ladies and gentlemen. Thank you for standing by. Welcome to the Sohu first quarter 2008 earnings conference call. (Operator Instructions) I would like to turn the conference over to Miss Brandi Piacente. Please go ahead, Madam.

Brandi Piacente

Thank you for joining Sohu.com to discuss our first quarter results. On the call today are Chairman and Chief Executive Officer, Dr. Charles Zhang; Co-President and Chief Marketing Officer, Belinda Wang; Co-President and Chief Financial Officer, Carol Yu; Chief Operating Officer, Gong Yu; and Vice President of Online Game Business, Wang Tao.

Before management begins their prepared remarks, 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 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 online advertising sales, online game revenues, and mobile phone related wireless revenue for its revenues.

Further information regarding these and other risks are included in Sohu's annual report on Form 10-K and other filings with the Securities and Exchange Commission.

Now, let me turn the call over to Dr. Charles Zhang, Chairman and CEO. Charles.

Dr. Charles Zhang

Thank you, Brandi. Hello, everyone. Welcome to Sohu's first quarter financial results conference call. I am right now actually at the base camp of Mount Everest at 5100 meters high, participating and leading a team reporting about the torch relay on the Mount Everest area, so I will speak really slowly because of having 60% of the oxygen of ground level.

We are thrilled to report another excellent quarter, the first quarter of 2008, with the third consecutive in which we reported record total revenue, record revenues in each category, as well as record non-GAAP net income. Let me first begin by giving you some highlights of our financial results.

For the first quarter of 2008, our total revenue grew by 30% quarter-on-quarter, reaching $84.8 million. Brand advertising revenue once again excelled, reaching $33.2 million, representing a 3% quarter-on-quarter growth and 41% year-on-year increase. Online game revenue reached $41 million, up 71% quarter-on-quarter. Non-GAAP net income increased by 48% quarter-on-quarter to $25.1 million.

All of those milestones exceeded our first quarter guidance and most of them exceeded our expectations by a rather wide margin. We believe that these results are made possible only by our long-term strategic vision on the Chinese Internet space, such as our elite position at the official Internet content sponsor of Beijing 2008 Olympic Games and by our continued cutting edge advantage in our technological development, such as our in-house developed online game Tian Long Ba Bu.

Now I will begin by discussing Sohu's major achievement. First, Beijing 2008 Olympic Games -- as the Olympic torch was lit in Athens on March 24th, momentum of Chinese Internet users and advertisers reached a new peak. As the sole official Internet content sponsor of the Beijing 2008 Olympic Games, Sohu continued to provide first-hand and authoritative Olympic reporting, which has further distanced us from the rest of the competition. Sohu has been further solidifying its position as the portal of choice for the Olympics for both the Internet users and advertisers in China.

Using the Olympic Torch Relay as an example, by invitation from the Greek Olympic Committee, which is a huge honor, I personally led a team of 25 editors and reporters to Athens, the largest team among all the Chinese, to attend and report on the torch lighting ceremony and handover of the Olympic Games.

With Sohu's privileged role, we were able to conduct various exclusive video interviews with famous torchbearers and the prominent government officials and as the only Internet media allowed to travel on the same private aircraft worldwide with the Olympic Flame, we were able to have a distinct advantage and provide a first-hand coverage of the torch relay, which put us in the leadership position reporting on a high profile international event.

When [inaudible] from the commencement of the torch relay 370 Sohu produced articles and pictures have been referenced in 140 publications and our pictures and video clips were used extensively by 40 television stations, including CCTV, Beijing TV, and Shanghai Media Group. We expect to further demonstrate and expand our leadership position with the upcoming torch relay at Mount Everest.

After kicking off the relay, average daily page views of our Olympic channel tripled from previous levels. In addition, we are pleased to see the acceleration of advertisers starting from the Olympic torch relay, as reflected in our second quarter guidance. In a few moments, Belinda will provide you with more color on this.

We believe that the opportunities surrounding the Olympics, coupled with Sohu's Olympic strategy, will enable us to gain market share of Internet users, further enhance Sohu's value, and become the destination for advertisers to carry out their online marketing campaigns.

During the run-up to the Olympic Games, we will invest about $14.5 million to carry our a massive branding and marketing program, including TVs and outdoors, in 27 major cities in China that will host the torch relay, as well as hospitality programs for our VIP advertisers and partners. We believe this will further broaden people’s awareness of Sohu as the portal of choice for the Olympic Games.

Among such expenses, approximately $4.5 million and $10 million will be charged to income statements in the second and third quarter, respectively. None of them will become recurring in 2009.

Secondly -- hold on just one second. Belinda will provide you a business review of our brand advertising business in a few moments but first, let me briefly discuss our online game business and technology initiatives.

Online game revenues increased by 71% quarter-on-quarter and reached $41 million in the first quarter of 2008. Tian Long Ba Bu continues to outperform and reach a new high as we saw first quarter revenues grow by 77% quarter-on-quarter, reaching $39 million, once again above our expectations.

In the first quarter, due to our effective marketing campaigns and the launch of a new expansion pack on January 16th, we managed to grow Tian Long Ba Bu registered accounts by 22% sequentially from $23 million to $28 million, despite the first quarter being a seasonally weak quarter for Internet usage and the fact that Tian Long Ba Bu had entered into its fourth quarter of operations.

We’ve also been successful in converting non-paying accounts into paying accounts through in-game activities. For the first quarter, quarterly active paying accounts increased by 26% quarter-on-quarter from 1.1 million to 1.39 million.

While maintaining the stability of our in-game ecosystem, we launched certain virtual items to further enhance user stickiness and game effectiveness. These items were well-accepted by our users. Hence, quarterly average revenue per account increased by 35% quarter-on-quarter from RMB147 to RMB199. We are also glad to report that peak concurrent users, PCU, to Tian Long Ba Bu has exceeded 600,000 since early April and we plan to launch our next expansion pack around late June.

Despite the first quarter’s strong revenue growth, we are still targeting 5% to 10% sequential revenue growth for the second quarter of 2008, given our planned promotional efforts during the quarter. We expect that growth to come from both increasing users and [op] value.

Development progress on our second in-house developed RPG game, Duke of Mountain Deer, is on track. Overall, we are pleased with the development quality thus far and continue to target closed beta testing by the end of 2008.

I wish to emphasize the substantial synergies between our portal and the online game business. On one hand, our game business brings to Sohu revenues, profitability, and most importantly, new users. On the other hand, Sohu websites matrix, in particular 17173.com, the number one online game information portal in China, is a significant advertising resource. Most importantly, 17173.com provides valuable insight for games development by utilizing the comprehensive gamer experience. We have been able to leverage their advice during the development stage of our online games, which largely enhances our success potential. This is an unmatched advantage in the industry.

My third topic pertains to Sohu's innovative products, which continued to demonstrate our thought leadership and attract users and have allowed us to achieve great success in the development of major and groundbreaking technology products and initiatives. For example, with Sohu blogs, we have been continuously upgrading our blogs to [gear up] a community based [inaudible] space. In March, Sohu launched a new function named [inaudible]. This new functionality allows the Sohu blog users to receive real-time updates to his or her space friends, as friends make changes to their blogs.

A traditional blogs user could write articles, uploading pictures and videos but essentially operating on a standalone basis. On the upgraded Sohu blogs, users become automatically connected to their friends through their blogs, where users can get timely updates about their friends’ movement.

Our continuous enhancement of Sohu blogs has been well-received by our users, especially by the young [consuming] generation, and we believe more and more bloggers are converting their Sohu blogs into their personalized portal space.

Thank you for your attention. Now I would like to turn the call to Belinda Wang, Co-President and Chief Marketing Officer of Sohu.com, for a brief discussion of progress in the brand advertising business. Belinda.

Belinda Wang

Thank you, Charles. We continue to be excited about the robust trend driving the strong momentum of the Chinese online advertising market. Despite a generally weak season in the industry for the first quarter of the year, we were able to achieve yet another record in terms of brand advertising revenues. We can squarely attribute this result to the continued shifting of advertising from offline to online and robust momentum in the advertiser spending as the 2008 Beijing Olympic Games are only about 100 days away.

For the first quarter, the top three industries in brand advertising were automobile, online games, and the real estate, the same as in the previous quarter. The fastest growing sectors during the first quarter was online games, which continued to experience strong momentum, posting 170% increase over last year’s levels due to strong trends of the online game business in China.

With the Olympic Games drawing close, as Charles mentioned, we are pleased with the acceleration on the advertiser spending starting from the torch relay as reflected in our second quarter guidance. Based on the signed [inaudible] contracts and the deals in final negotiations in 2008 for Olympic partners, sponsors, and suppliers, we expect that they will increase their spending by 50% to 100% year-on-year with Sohu. This is even more impressive considering that those partners, sponsors, and suppliers had already extended their ad spending with Sohu by 74% year-on-year in 2007.

Historically, we normally adjust the price semi-annually and our last price increase was in October 2007. Starting in April 2008, we increased our average prices by 38% sequentially from the last price increase, which will be effective for three months to June, 2008. We have not seen much push-back from clients so far.

Looking ahead at the full year of 2008, we expect brand advertising revenue to grow by 40% to 45% year-on-year.

With that, I would now like to turn the call to Gong Yu, Chief Operating Officer, for the review of website operations.

Dr. Gong Yu

Thank you, Belinda. As Sohu continues to leverage opportunities surrounding the Olympics our premier content offerings and the news reporting capabilities have been highly recognized by many well-known entrepreneurs and thought leaders in China. The impact and the reach of our online reporting capabilities across China are well-respected by the industry and have further positioned Sohu as one of the most powerful online media sources in China.

We have worked continuously to provide premier content and innovative products to our users. As a result, during the quarter we saw unique visitors increase 41% year-on-year, which again represents the strong attraction we have to Internet users. We are confident that with our continuous efforts, we will further attract users to Sohu, especially during the 2008 Beijing Olympic Games on the [kipson] and Sohu platform.

With that, I would like to turn the call to Carol, Co-President and Chief Financial Officer, for a review of Sohu's financial results. Carol.

Carol Yu

Thank you, Gong Yu and hello, everyone. I will now provide the review of the financial results for the first quarter of 2008.

One, revenues -- starting with top line results, total revenues hit a record of $84.8 million, representing an increase of 30% sequentially and 156% year-on-year. Not only did each of the revenue categories exceed our expectations but also passed all-time records.

One, advertising -- total advertising revenues reached $34.8 million, as we achieved a sequential increase of 3% and a year-on-year increase of 36%.

Brand advertising -- brand advertising revenues totaled $33.2 million, representing 3% sequential increase and a year-on-year increase of 41%.

Sponsored search revenues were $1.6 million, representing a 5% sequential increase and a 23% decline year-on-year. The year-on-year decline was mainly due to the strengthening of the anti-fraudulent click policy, based on more sophisticated algorithms.

Two, non-advertising revenues -- non-ad revenues totaled $50.1 million, representing an increase of 58% sequentially and a five-fold increase year-on-year. Online games revenues were $41 million, an increase of 71% quarter-on-quarter and 24 times year-on-year, due to the strong performance of TLBB. For the first quarter, revenues from TLBB and Blade Online were $38.9 million and $2.1 million respectively.

Wireless revenues were $8.6 million, a quarter-on-quarter increase of 17% and year-on-year increase of 54%. Sohu is well-positioned to minimize risk associated with the wireless sector, as it now represents only 10% of our total revenue.

Two, gross margins -- as you may know, under SFAS-123R, share-based compensation expenses are charged to the quarter’s revenue and operating expenses. Total share-based compensation expense for the first quarter of 2008 was $3.5 million. As we believe excluding the share-based compensation expense from our non-GAAP financial measure of net income makes a more meaningful comparison of Sohu operation results and improves investors’ understanding of Sohu's performance, we use non-GAAP measures in this discussion to explain margin, comp, and expense items.

Non-GAAP gross margin for the first quarter was 76%, compared with 72% in the previous quarter and 61% in the first quarter of 2007. Gross margin expansion was primarily due to contribution from TLBB.

Non-GAAP advertising gross margin was 64% in the first quarter, flat with the previous quarter and with the same period last year. Brand advertising non-GAAP gross margin for the first quarter was 67%, flat with the previous quarter and the same period last year.

Sponsored search non-GAAP gross margin for the first quarter was 6%, down from 12% in the previous quarter and 25% in the same period last year. The year-on-year decrease was primarily due to higher bandwidth costs to support the increased traffic and the smaller scale of search revenue.

Non-advertising non-GAAP gross margin was 85% for the first quarter, up from 79% from the previous quarter and 52% in the first quarter of last year. Online games non-GAAP gross margin for the first quarter was 92%, up from 88% in the previous quarter and 47% in the same period last year. The increase correlates to the increase in revenue from TLBB.

Wireless non-GAAP gross margin for the first quarter was 54%, down from 56% in the previous quarter and up from 53% in the same period last year.

Three, operating expenses -- for the first quarter, Sohu's non-GAAP operating expenses totaled $30.8 million, up 3% from the $30 million for the previous quarter and 125% year-on-year. The year-on-year increase was primarily due to continued investments in product development, marketing expenses for Sohu branding and on TLBB, and as well as an increase in bonuses to reward employees for their contribution to the good results.

Four, operating margin -- non-GAAP operating profit margin was 40% for the first quarter, up from 26% in the previous quarter and 20% in the same period last year.

Five, income tax expense -- income tax expense for the first quarter was $9.2 million, compared to $0.7 million in the previous quarter and $0.3 million for the same period last year.

On January 1, 2008, the newly introduce corporate income tax laws, which unifies the statutory income tax rate of enterprises in China to 25%, became effective. On April 14, 2008, relevant government regulatory authorities released qualification criteria application procedures and assessment processes for new technology enterprises which will be entitled to a favorable statutory tax rate of 15%. Solicitation of actual application has not yet commenced, however. In addition, there are still divergent views as to whether there will be any pre-conditions for allowing grandfather treatment for the unexpired tax holiday of new technology enterprises previously qualified under the old laws as of December 31, 2007.

Due to uncertainties on A, whether any of Sohu's major operating entities in China will eventually be approved for new technology enterprise status and B, whether these entities will be able to enjoy grandfather treatment for their unexpired tax holidays unconditionally, hence for the first quarter of 2008 Sohu has accounted for its income tax based on the statutory tax rate of 25%, assuming that it will not enjoy any of the preferential tax treatment mentioned above.

Sohu will account for lower tax charges in future quarters even when confirmation is received from the Chinese Tax Authority that any of these operating entities is entitled to be taxed at preferential rates.

Six, net income -- non-GAAP net income for the first quarter reached a record high of $25.1 million, or $0.64 per fully diluted share. Non-GAAP net income increased by 48% sequentially and 261% year-on-year.

Seven, net margin -- non-GAAP net margin for the first quarter was 30%. Compared with 26% in the previous quarter and 21% in the first quarter of 2007.

Eight, balance sheet -- as of March 31, 2008, our net accounts receivable balance was $36.2 million, an increase of $9.1 million as compared to $27.1 million last quarter. Our DSO for the first quarter was 37 days compared to 37 days for the previous quarter. First quarter brand advertising DSO was 69 days compared to 53 days for the previous quarter. As of March 31, 2008, our bad debt provision totaled $2 million, compared to $2.1 million as of December 31, 2007, reflecting our stringent revenue recognition and credit extension policies.

Finally, turning to our business outlook, for the second quarter of 2008 Sohu expects: one, total revenues to be between $93 million to $96 million, with advertising revenues of $40 million to $41 million and non-ad revenues of $53 million to $55 million; two, brand advertising revenues of $38.5 million to $39.5 million; three, online games revenues of $43 million to $45 million; four, we estimate non-GAAP fully diluted earnings per share to be between $0.72 and $0.75, assuming statutory income tax rate for our major operating entities in China to be 25%; and lastly, assuming no new grants of share-based awards, we estimate share-based compensation expense to be between $2 million to $2.5 million. The impact of this expense is expected to reduce fully diluted earnings per share under U.S. GAAP by about $0.05 to $0.06.

In conclusion, Sohu's outstanding results for the first quarter were driven largely by our focus on innovation, the execution of strategic deals, and our desire to grow our market share and to be the leading Internet company in China.

With the Olympic Games just around the corner, there are many exciting developments we hope to be sharing with you over the near-term.

This concludes our prepared remarks for today. We will now open the floor for questions. Operator, please go ahead.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Catherine Leung at Citigroup.

Catherine Leung - Citigroup

Good evening and congratulations on a very strong set of results. I have two questions. The first question is that it is our belief that the costs associated with being the Olympic sponsor are quite significant and these costs will likely come to an end when the Olympics are done. Could you give us some sense of the magnitude of the likely cost savings in 2009 versus 2006 -- I’m sorry, 7, 8, and where the cost savings will come from? And I have a follow-up question.

Carol Yu

To answer your first question, we have always emphasized the costs of the Olympic sponsorship is not as big an amount as the market has widely rumored, so that is false news.

Second is we do give out -- in Charles’ script, we do give out a number today saying that the marketing expense relating to current year that is surrounding our Olympic marketing efforts done by Sohu ourselves, that will be around $14.5 million. Those are non-recurring in 2009.

Catherine Leung - Citigroup

And are there any significant content costs in terms of you’re building a new portal for the Olympics and obviously building a very strong editorial and reporting team for the Olympics.

Carol Yu

I think for those part, yes, we are actually having a very strong focus on our Olympic reporting but we do not -- we have not hired massively for that effort. We are basically reallocating our internal resources to make that effort, so you will not see a big decline in terms of our content or HR related costs in that respect for next year.

Catherine Leung - Citigroup

Thanks. My second question is regarding your online gaming business. Charles had already discussed in his presentation that one of the real strengths and differentiators of your gaming business is that you have the 17173 website and that you have the ability to better tailor your games to the needs and the wants of the gaming community. Could you please elaborate a little further on how exactly that works and how much of a strength that is for Sohu and significantly why that set-up really makes your company less dependent on superstar developers than might be the case at some other gaming companies? Thank you.

Carol Yu

Well, we do have superstar game developers, to start with. But yes, you are right -- the fact that we own 17173, which is not only a very powerful marketing platform for our games but is also a very reliable product development or product definition tool for us. Effectively is -- our game and our games developer will work closely with our 173 team to make sure that whatever they come up with -- the expansion packs and the new games and the games that we licensed would all match to the appetite of the potential game players. So that would ensure success of the games that we are going to launch.

Catherine Leung - Citigroup

Okay, great. Thank you.

Operator

Thank you. Our next question is from the line of Jenny Wu with Morgan Stanley.

Jenny Wu - Morgan Stanley

Congratulations on a very great quarter. I have two questions. The first one regarding your online games; would you please update us about your online game pipeline and the related game launch timetable? Thank you.

Carol Yu

Well, the pipeline remains unchanged. We have two games in operation. Everybody knows Tian Long Ba Bu. The second game will be [inaudible], which is on track, very much so, launched fourth quarter of the year. And then the third game being a licensed game, which will be the middle of next year.

Jenny Wu - Morgan Stanley

Okay, thank you. And my second question is regarding your online advertising. Firstly, following the April advertising rate hike, are you going to have another rate hike approaching the Olympic Games?

Belinda Wang

Well, actually yeah. As I introduced in my presentation, we have adjusted our price. The last time it was around October 2007 and starting in April 2008, we [fix] our price by 38% from the last price increase. And actually, we are trying to increase the price on our Olympic channel during the Olympic Games [inaudible], and in the meantime we are going to increase our advertising capacity on the front page and the news channel at that time.

Jenny Wu - Morgan Stanley

Okay, thank you. And the company guided a very strong quarter for online advertising in the second quarter of ’08. So based on the company’s visibility so far, would you please guide us -- is that growth largely coming from the increased disbanding from the existing advertisers or mainly from the new advertisers?

Belinda Wang

I think both. We are getting the increased investment from our traditional clients, especially those who had invested in the Olympic Games, those Olympic partners, sponsors, and suppliers. And in the meantime, also invite the investment from the non-sponsors as part of the new clients for Sohu.

Jenny Wu - Morgan Stanley

Okay. Thank you very much.

Operator

Thank you. Our next question is from the line of Dick Wei with J.P. Morgan.

Dick Wei - J.P. Morgan

Congrats on a very good quarter. The first question is can you give us -- you mentioned about full year advertising guidance of 40% to 45%. I wonder if you can roughly break out the seasonality we expect to see in 3Q and 4Q this year.

Carol Yu

Well, we give out guidance for the second Q already, so -- I mean, you can work that out. So for the latter half of the year, you can imagine that -- I mean, you will see probably some sort of a spike in Q3 and then tail off a little bit in Q4, but at the present moment, we don’t give that out.

Dick Wei - J.P. Morgan

Okay. Tails off a bit meaning maybe a single digit decline or [inaudible] have that visibility yet on the --

Carol Yu

Well, I think it would be -- obviously decline as compared to Q3.

Dick Wei - J.P. Morgan

Okay and the second question I have is regarding your margin. As you mentioned, Carol, that the non-GAAP net margin is very strong, like 21% last year to 30% this year. And I guess if you didn’t use the 25% tax rate, you would probably see like a high net margin as well. I understand I guess the shift is mainly due to you get higher revenue contribution from online games, but can you give out the roughly net margin breakdown between games and on the advertising? And also, in the longer term how do we see the gross margins for both businesses? I know like games at 92% and what is it, the brand advertising now is at 67 or so. Do you see this increase or decrease in the next couple of quarters or next year? Thanks.

Carol Yu

In terms of margins, if you look back in Sohu's numbers prior to having the big ramp-up in the game revenue, I think if you compare margins then and our margins today, if we take out the games business it is actually relatively stable in terms of both of the growth at the net level. But if you add in games, then obviously the picture changes a lot. The games business, as we have just mentioned, it would be between like in the 80s in terms of gross. In terms of net, it would be 50. So depending on the mix of those revenues, the net margin number will change. But if you split the two businesses, that is probably what you are looking at.

Dick Wei - J.P. Morgan

Great. Thanks a lot.

Operator

Thank you. Our next question is from the line of Wallace Chung with Credit Suisse.

Wallace Chung - Credit Suisse

Congratulations on the great results. Two quick questions -- my first one is do we expect any -- again, incremental pressure related to the Olympics, do we expect any incremental bandwidth and server costs during the Olympics?

And the second question, again also related to the Olympics is assuming you are going to spend like $14.5 million incremental marketing spending and percent and perhaps other incremental costs as well, should we expect that like during first quarter, we are going to see quite a substantial amount of advertising revenue, given the fact that management should try to create some incremental returns from all this spending? Thank you.

Carol Yu

Wallace, exactly what’s the question?

Wallace Chung - Credit Suisse

I think my question would be -- actually, I’m not asking for specific guidance but points because you indicate that in the second quarter, first quarter, all the marketing expenses that will be accounted for around $14.5 million and potentially there could be other incremental costs as well, that assuming you may generate incremental advertising revenue to cover the costs, that could be one of the indication of the first quarter revenue.

Carol Yu

Yes, we do. We will generate incremental advertising revenues during the third quarter.

Wallace Chung - Credit Suisse

And assuming there will be quite a certain kind of margin that you are assuming that you can generate?

Carol Yu

No.

Wallace Chung - Credit Suisse

Okay.

Carol Yu

We don’t manage the business that way. If you look at -- it’s actually the flip side of the coin, Wallace. Our advertisers advertise with us during the Olympics, during the third quarter because of the Olympics because that generates the best results for them. So we do the same thing. In this end, we are the advertisers so we want to spend money when it generates the best returns and that’s the third quarter. So that’s how you look at it.

Wallace Chung - Credit Suisse

All right, thank you. And just the first question regarding incremental bandwidth and server costs, please?

Carol Yu

Yes, we do. We will. We have already lined all of those up. But if you compare that to the $10 million that we are going to book in Q3 in terms of marketing expenses, bandwidth and server costs are relatively cheap.

Wallace Chung - Credit Suisse

Okay. Thank you. Thanks a lot and again, congratulations on the great results.

Operator

Thank you. Our next question is from the line of Wendy Huang with Bear Stearns.

Wendy Huang - Bear Stearns

Good evening, everyone. Thanks for taking my question. First, could you just comment on gaming’s gross margin in this quarter? The gross margin further increased by 4%. Is this 92% gross margin sustainable or should we be more optimistic, maybe expect some further expansion from the current level?

Carol Yu

I think it is sustainable but it is not expandable. 92% is already very high. I mean, we still have to pay certain bandwidth costs and servers for that, so --

Wendy Huang - Bear Stearns

Okay. Secondly is about your wireless gross margin in this quarter declined by 2%, despite that revenue increased very strong this quarter. So could you give us some color on that? Your wireless gross margin declined by 2% despite the strong revenue growth.

Carol Yu

None of us really studied into the wireless gross margin, so my apologies. We’ll find that out and send you by e-mail.

Wendy Huang - Bear Stearns

Okay, thank you. And in your guidance, it seems that you guided 15% to 16% wireless revenue growth. Could you maybe give us some color whether as many from the SMS or from other wireless business segments? Because in the first quarter, SMS --

Carol Yu

We believe there is a better market, so it is due to improved market conditions. And also with the Olympics ramping up, our special role as a very rich resources owner of a lot of Olympic-related resources, I mean, we are also -- we will capitalize on those and turn that into revenue on the run-up to the Olympics, so that’s also part of the reason.

Wendy Huang - Bear Stearns

So basically the Olympics benefits the wireless business overall?

Carol Yu

Yes, and to us in particular.

Wendy Huang - Bear Stearns

Thanks, Carol. Thank you.

Operator

Thank you. Our next question is from the line of Eddie Leung with Merrill Lynch.

Eddie Leung - Merrill Lynch

Good evening, everyone. Congratulations on a great quarter. I have two questions. Firstly, I apologize if I have missed the data, but can I get the number of brand advertisers in the first quarter and how many of them are Olympic sponsors, suppliers, and partners?

Carol Yu

Wait a second. We’re checking our notes. The number of the advertisers in the first quarter is 602. How many of those are Olympic sponsors we’ll find out and we’ll get back to you.

Eddie Leung - Merrill Lynch

Thank you. And my second question is could you talk a little bit about your M&A strategy related to portals and number two, whether you guys are also thinking about investing in some of these smaller game studios in order to boost your pipeline, or you guys are basically happy with your in-house development team right now? Thanks.

Carol Yu

We do not preclude any M&A opportunities in the games development side. We will be very open-minded in terms of acquiring development teams, should there be -- we’ll be opportunistic, basically.

Eddie Leung - Merrill Lynch

But how about regarding speculation on a potential merger with another portal?

Carol Yu

Well, that’s speculation. We don’t comment on that.

Eddie Leung - Merrill Lynch

Okay. Thank you. Thank you very much, guys.

Operator

Thank you. Our next question is from the line of Leah Hao with Goldman Sachs. Please go ahead.

Leah Hao - Goldman Sachs

Good evening. Nice quarter, guys. Just two questions; with TLBB going very strong this quarter and probably very strong for the next couple of quarters, I was wondering if you have any updated outlook on the potential game cycle for this particular game?

Carol Yu

We are very confident that this will be a long life game. We are not anxious to milk the game the game and like make it short-lived. We are doing everything to preserve the life. We have no reason to believe that it would not be as good as the other games that have reached to this scale, which has been like -- I mean, other games with this size in the market has been there for five or six years, so there is no reason for us to believe why this would not be a similar game.

Leah Hao - Goldman Sachs

That’s great. And the second question is a little bit kind of a follow-up; with the game revenue sort of surpassing your advertising revenue from this quarter already and it looks like that way for the next couple of quarters as well, and with another game in your pipeline, I understand strategically you probably still see yourself mainly as an advertising company but at what point, with gaming revenue sites up so quickly that you sort of see yourself tilting a little bit towards more of a game operator or developer/operator instead of just a pure branded advertising company?

Carol Yu

We view ourselves as an Internet company, so we have different lines. We have a search business, we have our portal business, we have our games. So it’s not that we are now from a media company to a games company. It’s not like that. We are an Internet company that offers users a range of services that they welcome.

Leah Hao - Goldman Sachs

Thank you very much.

Operator

Thank you. Our next question is from the line of Ming Zhao with SIG.

C. Ming Zhao - Susquehanna Financial Group

Thank you. Good evening and congratulations again. Two questions; first question is on TLBB; if I remember correctly, you guys said the ARPU level, you are looking at about 170 to 180. This quarter, you already surpassed that. But if I look at the top game in the market, their PCU was three times yours and the ARPU is 1.5 times yours. How should we look at TLBB scores in the future, in the next couple of years? Do you think we can get there? That’s the first question.

Carol Yu

Well, TLBB is only one year old, so we are looking to -- like what we said in the past, I mean, we still maintain revenue growth to be between 5% to 10% quarter on quarter, and then a piece of good news is that PCU now just surpassed 600,000 as compared to 500 that we last announced. So we are just slowly working up. I mean, we’re not in a hurry. We know there is room to grow the game but we’re in no hurry.

C. Ming Zhao - Susquehanna Financial Group

Okay, great. The second question is just a broad question -- if we look at the next couple of years, can we say -- let’s say what will be the next TLBB and have you had any plans for the World Cup and the next Olympics -- not this one, but the next Olympics?

Carol Yu

I don’t really get you, Ming.

C. Ming Zhao - Susquehanna Financial Group

I just want to get a sense about your long-term strategy and my question is what other revenue segment can we expect to be the next gold mine? And have you had any plans for the next World Cup games and the next Olympic Games?

Carol Yu

Ming, we’d rather to it than say it, so just hang in there. We’ll deliver. We’d rather do it than say it.

C. Ming Zhao - Susquehanna Financial Group

Great. Thank you.

Brandi Piacente

Thank you. We would like to thank everyone for participating in today’s call. Please feel free to contact us with any additional questions that you may have. Thanks and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Sohu Q1 2008 Earnings Call Transcript
This Transcript
All Transcripts