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Executives

Ryan Cheung – Corporate Finance Director

Victor Koo – Chairman and CEO

Dele Liu – President, Board Director

Michael Xu – CFO, SVP

Analysts

Jin Yoon – Nomura Holdings

Jiong Shao – Macquarie

Gene Munster – Piper Jaffray

Dick Wei – J.P. Morgan

Alicia Yap – Barclays Capital

Henry Guo – ThinkEquity

Long Lin – Brean Murray, Carret & Co.

Youku.com, Inc. (YOKU) Q2 2012 Earnings Call August 6, 2012 9:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2012 Youku, Inc. earnings conference call.

[Operator Instructions]. I must advise you that this conference is being recorded today, August 6, 2012.

I would now like to hand the conference over to your speaker for today, Youku Corporate Finance Director, Mr. Ryan Cheung. Sir, please go ahead.

Ryan Cheung

Thank you, operator, and welcome to our second quarter 2012 earnings conference call. Let me introduce the management team on the call tonight. They are Chairman and CEO, Victor Koo; our Board Director and President, Dele Liu; and Michael Xu, our Chief Financial Officer and Senior Vice President.

For today's agenda, Victor will kick off with an overview of our performance in Q2, key updates and outlook. Dele will walk you through the planning and transition process relating to the pending merger with Tudou. Michael will discuss the second quarter financials and then we'll open the floor for questions.

As a reminder, the financial results and webcast of this conference call are all available at the Investor Relations section of the Youku website. A replay of the call will be available on our website in a few hours.

Before we continue, I refer you to our Safe Harbor Statement in our earnings press release which applies to this call as we will make forward-looking statements. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in renminbi.

Let me now turn the call over to our Chairman and CEO, Victor Koo. Please proceed.

Victor Koo

Thank you, Ryan. Good morning and good evening, everyone. Thank you for joining us.

First of all, congratulations to both Dele and Michael on their promotions.

Now let me give you our highlights for the second quarter. During the second quarter of 2012, we recorded another quarter of solid growth in our operation and financial results. Youku continues to be the number one online video platform in China across unique visitors, user time spent and video views, and the recognition of this undisputed leadership from brand advertisers [built a] solid top-line increase with close to triple-digit year-on-year growth in the second quarter despite challenging macroeconomic conditions.

Online video industry continues to experience a high growth rate and we are determined to nourish this space with proactive investment in our content, brand, product and technology innovation to continue to drive the scale of our platform. The pending merger with Tudou and the smooth transition period to date will position us on the number one and number two online websites and brands in China, which will further accelerate our virtuous cycle online video industry rationalization, and increase our scalability that will lead to profitable growth as we believe scale is central to the success of our business model.

Broadening and deepening the relationship with our users and advertisers have always been our strategic priority. And in Q2 2012, we continue to make solid progress on these fronts. This points to our unrivaled execution ability and understanding of our users and advertisers' demand to further grow our traffic and revenue.

On the user front, the total internet population in China is now 538 million while watching video on internet has become the most used functionality, with the broadest coverage and longest user time spent by Chinese internet users ahead of search according to iResearch. There are strong functionality for users to watch online video in China and we see there's room for our traffic to further grow, driven by the overall increase in Chinese internet users, easier accessibility for users with more internet-enabled devices, improved products and network infrastructure, as well as enriching our content library to fulfill users' increasing demand of video content.

By focusing on our user experience and continue to elevate our brand as the one-stop shop for internet users to find and watch videos for any internet-enabled devices, we will always benefit from capturing growth areas from the online video sector. Youku continues to be the number one in online video platform across all matrices and is ranked the third largest internet property in China currently and will rank the second after the pending combination of Tudou in terms of user time spent according to iResearch.

In addition, the coverage of Chinese internet users by our platform is already ranked as one of the top five amongst all the Chinese internet properties according to iResearch. The breadth of our coverage will be further strengthened and the combined traffic lead over our competitors will be further widened with the pending merger with Tudou.

Youku's traffic growth in the second quarter remains solid with user time spent increased 28% as compared to the corresponding period in 2011, according to iResearch. This does not include traffic growth from installed applications on mobile devices, internet café and videos viewed outside Youku URL. According to internal traffic data, our installed iOS and Android applications increased more than two times when compared with the beginning of this year, while our total video views from mobile devices in the second quarter increased about 77% when compared with the first quarter. Counting these traffic from both inside and outside Youku URL, we continue to have solid traffic growth above industry average. Starting into the second half of 2012, we anticipate to see solid traffic growth as we are starting to see the benefits of the pending merger starting to materialize, as well as several high-quality content we purchased last year, are scheduled to be shown on our platform later this year.

On the monetization front, our strengthening leadership in internet user base and broadening reach of our platform have already positioned us as a must-buy platform in online video for brand advertisers to reach a nationwide audience within China. Our revenue continues to experience a high growth at 96% year on year in the second quarter, largely credited to our improvement in monetization ability through our sales team execution.

As online video becomes a mainstream advertising solution in China, enhanced demand and awareness among brand advertisers continues to drive our growth in average revenue per advertiser and number of advertisers. To optimize the growing demand from brand advertisers in online vide, especially in the first and second-tier cities, we are streamlining our effective CPM and utilization of our inventory to ensure sustainable revenue growth in the long term.

The pending merger with Tudou will further supplement our monetization capability based on the increased scale of the two platforms. With growing demand from advertisers on brand development, favorable regulatory environment that incentivize them to use online video advertising, and our increased capability to absorb these demands, brand advertisers appreciate the value we create for them, and as a result, we are confident the broadening of our advertisers' base and deepening relationship would persist.

I would also like to touch on our revenue outlook for the second half of 2012. We are seeing softening signals in macroeconomic conditions which affect the overall sentiment for advertising in China. Despite challenging advertising demand and the lack of visibility from advertisers' commitment for the upcoming quarter, online video advertising demand is relatively more resilient than other traditional and new media as majority of our revenues are generated from FMCG which tends to be less impacted.

As we are shaping a new advertising landscape for our clients, we are also adding new advertisers and larger budget allocations that offset the weakening sentiment. Thus, the growth is meeting our expectation when we first entered into this year. In fact, we can also take this opportunity to crystallize our current amortizing relationship and highlight to the market the attractiveness of the advertising solutions we offer as it is much more cost-effective, more engaging and more viral than other video advertising platforms, and further grow our revenue scale in China.

Our management team strongly believes that the key opportunity of our business does not only come from just the increase in terms of number of users but also how we continue to enhance the value of our platform for our users. To further elaborate Youku's goal, which is to become the leading platform for users to watch videos on any internet-enabled devices in China, our services need to be more and more relevant to our users so that we can increased our breadth and depth of our relationships with them. We also believe that as the value and relationship with our users continue to expand, users and advertisers would appreciate the usefulness of Youku and would compensate us for such value.

All the initiatives we have been rolling out are to make ourselves increasingly relevant to users and create value that they recognize. Through our investment in content, brand, product and technology innovation, we believe we are moving forward in a solid way to foster our ecosystem to create meaningful value to users and advertisers.

One of the value that we create for our users is to provide comprehensive selection of video content combined with fast and convenient access. We have strong conviction in the durability of these needs from internet users. We have already envisioned in advance that our competitive edge is our excellence in services to providing users different genres and variety of content with best-in-class technology, editorial recommendation, social feedback and products to keep our users engaged in our online video ecosystem, rather than content exclusivity as other online video companies have previously pursued, which led to content price escalation during last year.

We are pleased to see the entire industry is rationalizing its underlying economics and heading towards a more healthy development. We have seen content price continues to go down as a result of rationalized behavior in our industry. In addition, online video companies are swapping their exclusive content actively with each other, also with the consensus to reduce the content price given the fragmentation of content production environment in China. We will continue our partnership with other online video companies to jointly promote the healthy development of this sector. With the scale of our traffic, content library and monetization ability, we are confident to see profitable growth in the future.

To position Youku for the future, we continued to maintain our proactive investment in three key areas: mobile platforms, original content, and premium services. In regards to our mobile platforms, we have invested in product and technology innovation across internet-enabled devices, as users access Youku through their personal computers, smartphones, tablets or internet televisions. Our early investment in iOS and Android applications have led to exciting traffic growth from mobile devices.

Secondly, we have launched the biggest upgrade on our client-based software, iKu, in recent years with a new interface that supports users to watch, upload, download, search and recommend Youku's videos, and also allow users to watch our videos on their TV through Airplay for Apple TV.

Thirdly, the next version of Apple OSX desktop operating system and iOS mobile operating system will integrate with services from Youku and Tudou to enable users to quickly and easily share videos on the web. As users are increasingly relying on their smartphones and tablets other than their desktops to watch videos, the cooperation with Apple enable our platform to be more iOS-friendly on these devices.

All these product innovations we invested lay a solid foundation for further growth in any internet-enabled devices and make our platform more relevant to users. We are confident that all this technology innovation will be synergistic with each other and add incremental value to our platform.

Let's now turn to our development in original content. We are proactively investing in content library through adding content selection and deepening in each genre to further our appeal to internet users. Youku is also devoting significant resources in generating more web-based content to differentiate our content library and to reduce our reliance on popular TV serial dramas.

We have debuted Legendary Me, an online music talent show in May in partnership with China's top satellite TV stations and music labels with the goal of highlighting and promoting grassroots talent from among the site's user base. Video views of this show have already reached close to 130 million.

Another self-produced talk show, Morning Call, received positive receptions and generated close to 3 million video views per episode. All these initiatives are to build up our self-owned content franchises going forward and balance our content offering across the platform. We are confident that we can leverage our unparalleled distribution scale to move up the video content value chain by developing and building proprietary content, brand, channels and franchises.

In addition, we continue to have the largest user-generated content library in China, and with the pending addition of Tudou's user-generated content library, our traffic in social media and mobile where user-generated content is predominantly watched would continue to lead among our peers.

In addition, we have continued our investment in our paid service platform, Youku Premium. We're continuously increasing our cooperation with international media companies to further enrich the content offering on Youku Movie Channel. Youku has signed deals to license content from a number of major international studios including Warner Brothers, DreamWorks, Paramount, Disney, Fox, Lions Gate and CBS. In July we've entered into a multiyear agreement with NBC Universal for the video-on-demand right in China to a broad selection of current library and upcoming NBC Universal feature films.

I would like to briefly talk about our announcement on the pending combination with Tudou Holdings Inc. Limited before I turn the call to Dele and Michael for an update on our transition period with Tudou and review of financial results.

The pending combined entities, Youku Tudou Inc. will form a group company which will own the number one and number two online video platforms both being household online video brands in China, with the largest user base, most comprehensive content library, most advanced bandwidth infrastructure, and most effective monetization capability. The pending combination of both entities is expected to established the strong leader in the online video sector and become one of the largest internet properties in China. Both companies' board of directors are fully supportive of this pending combination with Tudou as this deal will lead to healthy development of the online video industry in China and generate the scale and traffic and revenue that will maximize our shareholder value in the long run.

On behalf of our Board of Directors, we recommend that Youku shareholders vote for the resolutions to authorize and approve this pending combination with Tudou.

With that, I would like to pass the floor to Dele, our President, to go over the transition status in regard to the pending merger with Tudou.

Dele Liu

Thank you, Victor. Hello, everyone, and thank you all for joining our conference call today. Let me update you on our transition management status with Tudou since the announcement of the pending merger.

The transition management process is proceeding very smoothly, with both companies fully committed to this transaction to deliver long-term shareholder value. The SEC declared Effective on our proxy statement on July 17 in relation to this transaction, and shareholders have 30 days to vote on this deal from July 17. Our AGM will be held in Hong Kong on August 20 and the results of the shareholders' votes will be announced on or after August 20. After the shareholders approve this combination, customary closing procedures will be performed. And it's targeted to complete before end of August.

As we have mentioned in previous calls, a transition management committee comprised of top teams from Youku and Tudou was formed to lead the overall transition process and to drive synergies. Our transition planning process is ahead of our original schedule. We are pleased to report that we have completed the integration plan and have agreed on the new organizational structure with Tudou management team, which will be announced upon closing.

We have also reached decisions on the roles and responsibilities of the core executives of the combined company. The new organizational structure will be implemented immediately upon closing and the integrated team of the combined company will be fully effective in Q4 2012, which we're starting to see the benefits of the combination kicking to see.

As we work closely on the integration planning with our Tudou colleagues, we become more optimistic about the potential synergy than when we entered into the merger agreement. The Tudou property is more valuable than we expected.

First, based on iResearch traffic audit, which is still ongoing, the overlap of daily unique visitors of the two websites is less than expected. With Youku and Tudou combined, the total reach is over 300 million users every week. This represents a one-stop-shop solution for online video advertisers.

Secondly, Tudou traffic is understated by third-party matrix because of its significant videos view outside Tudou URL given its strong UGC content. Tudou's total user time spent in August this year is about 56% of Youku's.

Thirdly, by leveraging Youku's content management database to empower Tudou's content operation, we expect to significantly improve Tudou's user experience of long form content and therefore increase their user time spent.

We maintain our strategy that there will be two separate platforms and two differentiated brands to maximize traffic and revenue. All backend functions will be fully integrated including advertising system, product and technology, search content procurement, CEN, HR, finance, and marketing.

The integrated advertising system will be launched upon closing and will effectively unify the two platforms' advertising solutions to address any overlapping of user coverage. Our integrated advertising management system will eliminate advertising wastage and generate cost savings for brand advertisers which no competitors can do. With less-than-expected overlapping of user base and the 300 million weekly coverage between the two platforms, we are confident that we will be providing high ROI solution to advertisers which are the value of our advertising delivery effectiveness, which will be compensated by brand advertisers over time.

We have also decided to integrate our sales operation that provides TV commercial solutions such as our pre-roll and post-roll app, because these brand advertisers -- because brand advertisers' focus is on the reach and frequency of their commercials in China. For content for event-based marketing solutions such as in-house production, we will keep the sales function separate to the extent that the solutions are driven by uniqueness of the two brands and differentiated audience base.

By means of these active integration steps, we anticipate temporary fluctuations in Tudou's near-term revenue. However, we anticipate our integrate sales force to be fully effective in Q4 this year. By offering an unparalleled reach to our clients and solutions which [deduplicate] the user base, we will be providing high ROI solutions than peers to our advertisers. As a result, we expect to realize strong monetization efficiency and synergy in next year.

We have also targeted content sharing and cooperation on content syndication and media cooperation between the two companies since the announcement of our pending merger, and we have seen positive results in content pricing. With the purchased content shared by the two platforms, we will significantly improve the content economics. We expect our content costs to increase at a material rate, lower rate, than revenue growth in 2013.

We have also started to share the best practices in bandwidth management. The bandwidth cost as a percentage of revenue has dropped significantly in Q2. With the content delivery network at a much bigger scale of the two companies combined, we expect the bandwidth cost as a percentage of revenue will also materially decrease in 2013.

Now I would like to turn the call to Michael who will walk you through the quarterly financial results.

Michael Xu

Thank you, Dele. Hello, everyone, and thank you all for joining our conference call today. I'm pleased to report another solid top-line growth in the second quarter of 2012. Now let's look at financial highlights for the quarter. The amounts mentioned here are in RMB unless otherwise noted.

For the second quarter, total net revenue was RMB387.4 million, representing a 96% increase year over year, on top of base growth of 178% year on year in 2011, meeting our previously provided guidance.

During the second quarter 2012, Youku had 283 clients, a 9% increase from the same period in 2011, while gross revenue per advertiser was RMB1.7 million, which is up 89% over the same period in 2011. This was attributable to the broadening of our client base and the deepening relationship with them.

Bandwidth costs were RMB111.9 million in the second quarter, representing 29% of net revenues compared to 33% in the same period in 2011. Content costs were RMB144 million in the second quarter, representing 37% of net revenues, compared to 25% in the corresponding period in 2011. The increase was primarily due to content that was bought at a higher cost in 2011 started in the -- started the amortization schedule in 2012.

In addition, we have broadened our content portfolio including investing additional resource in the in-house content production in order to maintain our content offering appeal as well as to establish unique brand identity in user's mind. Our headcount in our content team has also increased significantly by 93%, which also increased our salaries and benefits expenses [under our content] expenses.

As Victor has already mentioned in this call, the escalated content cost is temporary as we are seeing significant decline in recent months as competition in online video is rationalizing. As a result, we expect to see significant operating leverage resulting from declining trends in content costs going forward.

Non-GAAP gross profit, which is gross profit excluding share-based compensation expenses, has returned to positive, and was standing at RMB9.5 million in the second quarter of 2012 as compared to RMB53.6 million in the corresponding period in 2011.

Non-GAAP operating expenses, which is operating expenses excluding share-based compensation expenses and the business combination related expenses, were RMB127.4 million in the second quarter of 2012, an increase of 72% compared to RMB74.1 million in the corresponding period in 2011. The increase was primarily due to increase in number of employees as a result of rapid growth of the business and our continuous and expanded investment in product development in mobile, search, social and paid services.

The breakdown of our operating expenses are as follows. Non-GAAP sales and marketing expenses, which is the sales and marketing expenses excluding share-based compensation expenses and the non-recurring business combination related expenses, were RMB74.3 million in the second quarter of 2012, an increase of 50% compared to RMB49.7 million in the corresponding period in 2011. This increase was primarily due to increase in marketing expenses and commission expenses paid to our sales force in line with our revenue growth.

Non-GAAP product development expenses, which is product development expenses, excluding share-based compensation expenses and non-recurring business combination related expenses, were RMB28.6 million in the second quarter, an increase of 130% compared to RMB12.5 million in the corresponding period in 2011. This increase was primarily due to an increase in salaries and benefits of our product development personnel in mobile, search, social and paid services.

During the past year, we have expanded our R&D talent pool as we want to maintain our focus in improving our offering to users, providing additional product offerings as well as network infrastructure to foster our ecosystem. As such, there was headcount increase of 66% in product and development coupled with average salary increase, and has therefore increased our salary and benefit expenses under this line item. We believe human capital is the backbone of our success and the investment in this area is essential to generate long-term growth of the company.

Non-GAAP general and administrative expenses, which is general and administrative expenses excluding share-based compensation expenses and non-recurring business combination related expenses, were RMB24.5 million in the second quarter of 2012, representing an increase of 104% compared to 12% -- RMB12 million in the corresponding period in 2011. This increase was primarily due to the increase in professional fees, personnel related expenses as our back-office team has increased 40% headcount in the past year, as well as tax surcharges.

As a result, non-GAAP net loss, which is net loss excluding share-based compensation expenses, and non-recurring business combination related expenses was RMB29.3 million in the second quarter of 2012 as compared to RMB20.8 million in the same period 2011. During the past year, we have made significant investment to build a solid online video platform and a strong ecosystem surrounding it to support larger user base and increase user engagement. We believe this investment should generate high return in the future and expecting significant operating leverage of business model in future quarters.

Turning to cash flow item as of June 30, 2012, cash, cash equivalent and short-term investments totaled RMB3.5 billion as of June 30, 2012. Acquisition of the intangible assets for the second quarter was RMB52 million as compared to RMB144 million for the same period in 2011. Correspondingly, we have already secured a solid pipeline of content offering to 2012 in advance and the financial commitment by the end of second quarter 2012 for this content was RMB208 million.

Looking out to the third quarter of 2012, we expect our net revenue to increase by 70% to 80% year on year.

Now, we'll open to questions. Operator, please go ahead.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions].

Your first question comes from the line of Mr. Jin Yoon from Nomura. Please ask your question.

Jin Yoon – Nomura Holdings

Hey. Good morning, everyone, just -- or good evening, everyone. Just a couple of questions. First of all, on your guidance, first of all, how much of your guidance is impacted by the actual merger? I mean, do you see like clients or customers or advertisers, I should say, kind of holding on, on the side [inaudible] pending merger and there could be a different pricing structure that comes with it or different sales force that could have a different makeup of the sales force after the merger?

And second of all, on the visibility aspect, you mentioned in your prepared remarks that visibility is a lot [more clear] today than three, six months ago. Where is that visibility coming from? Is it the pricing aspect? Is it, you know, are we seeing a bigger pricing discrepancy between TV and video in tier 1 cities? Can you give me a little bit more visibility on both of those things? Thanks.

Victor Koo

Thanks, Jin. Let me take this one. First of all, I think from a revenue guidance standpoint, we are taking into consideration that the transaction will close around the end of August and then the integration will actually happen right after. So that is actually in part the consideration.

In terms of the overall macroeconomic remarks, I think I mentioned that online video, because of the high exposure to fast-moving consumer goods, in that aspect, I think there's less impact versus other categories within traditional and new media.

Also in kind of an uncertain economic environment, what you also see is that advertisers are looking for higher ROI solutions where online video clearly has the advantage on. And also we're seeing that there's a flight to quality as well on each category that advertisers are really picking the top sites in each category when -- during times that are uncertain. So I think those factors actually benefit I think Youku Tudou.

Jin Yoon – Nomura Holdings

A longer visibility aspect, I mean where are you seeing the lack of visibility? Is it like the pricing aspect or is there any major discrepancy in terms of visibility in tier cities versus tier 2? Can you give me a little bit more color on how we should be looking at not only in the third quarter but going into Q4 and Q1?

Victor Koo

Well, like I mentioned, I think the impact or the visibility actually varies across different sectors. I think for those fast-moving consumer goods, especially on the international side, a lot of the [inaudible] as well as the budget has been decided on annual basis, and we see that visibility actually quite clearly. I think on the other side, if you look at areas like automobiles or white goods, financial services, that's an area where I think a lot of the clients will revisit their budget and make adjustments in the second half of the year. So it really differs across the different sectors.

Jin Yoon – Nomura Holdings

Good. And one final question, on kind of your breakeven outlook, I think you mentioned before that as a Youku standalone entity, that breakeven was a possibility in Q4. As a combined entity, do you have any kind of guidelines in terms of internally what you're looking forward to in terms of breaking even as a combined entity?

Victor Koo

Well, I think we're seeing a lot of operating leverage across the board, especially the comment that -- both the line I made on the content and bandwidth, we don't really comment on specific [profitability] timing, but especially given the adjustment on the content landscape and the rationalized costs, those leverage we will clearly see in 2013. And so from a content bandwidth standpoint, those will actually be very, very important for profitability in our sector.

Jin Yoon – Nomura Holdings

Great. That's it for me. Thanks, guys.

Operator

Thank you, sir. Your next question comes from the line of Jiong Shao from Macquarie. Please ask your question.

Jiong Shao – Macquarie

Hi. Thank you very much for taking my questions. Firstly, congratulations to both Dele and Michael for their new roles.

I have a couple of questions. Firstly, on the sales force integration, I thought I heard you said before that you're going to keep the sales force separate, at least for the initial stage, but then I also heard I think Dele mention earlier that integrated sales force. I just want to clarify what's your plan for working with two different sales forces in the coming months when you consolidate the two platforms.

Victor Koo

Well, the important thing to note was within the online video there are two major categories of solutions. One is in terms of TVC and TV-like solutions where the feedback from clients and agencies are clearly that scale in terms of reach and frequency is what they're looking for. And especially since we are integrating the element and system, improving the productivity of the Tudou delivery plus the ability to eliminate kind of the overlap users, I think it's much more effective to have combined initiatives when we are dealing with TV-like solutions.

But as Dele also pointed out, both Youku and Tudou have differentiated brands and websites with different demographics, and content marketing solutions and event marketing solutions will -- clients will still look for different solutions on the two platforms and they can still decide to have different solutions on both websites.

Jiong Shao – Macquarie

Okay. Great, thanks. My second question is just following on the macro advertising trend. Clearly the macro is a bit weaker than we thought a few months back. I think your revenue growth is still down a little bit. I was just wondering, could you talk about, are you seeing your advertisers reducing their budget a little bit or are they just delaying their budget given the uncertainty in the environment?

Victor Koo

As I mentioned before, I think it really varies across the different sectors. I think from what you're seeing on the fast-moving consumer goods standpoint, I think those orders are still ongoing and so forth. Certain other sectors like auto or financial institutions, we are seeing in some cases delays, yes.

Jiong Shao – Macquarie

Okay. My last question before I hand over the floor is on the pending merger with Tudou. Earlier you talked about the -- Victor, that you are encouraging your shareholders to approve the deal. I was just wondering whether or not you have already sort of secured certain amounts of votes or had a lot of conversation with the shareholders, and how confident you are right now for sort of executing on this merger given the market on and off has these different chatters about maybe some potential challenges. So I was hoping you can clarify the situation for everybody on the call. Thank you very much.

Victor Koo

Sure. In terms of shareholder approval, as I mentioned in my script, basically both board of directors are fully in support of this, which constitute a very large proportion of the shareholders. And throughout the process, we're also communicating with the key shareholders of both companies and we've observed really overwhelming approval as well as support for this transaction. And especially in light of a lot of the new potentials that we've identified that Dele has pointed out.

Jiong Shao – Macquarie

All right. Thank you very much, guys.

Operator

Thank you for the question. Your next question comes from the line of Gene Munster from Piper Jaffray. Please ask your question.

Gene Munster – Piper Jaffray

Hey, good afternoon. And Victor, maybe -- I know you talked a lot about the macro, can you put it into, maybe, into context with 2009, how this feels versus 2009? And then I have a follow-up question.

Victor Koo

Well, I think starting from really Q2, in comparison, I think we're really seeing, at this point, we think it's a short-term transition, especially with the 18th National Party Congress coming in Q4, I think from a macroeconomic standpoint we are optimistic that there are probably going to be macroeconomic adjustments post the National Party Congress.

Gene Munster – Piper Jaffray

Is it safe to say it doesn’t feel as desperate as 2009 then?

Victor Koo

I think that's fair.

Gene Munster – Piper Jaffray

Okay. And --

Victor Koo

I think there are already economic indicators that are suggesting that this is a temporary phenomena.

Gene Munster – Piper Jaffray

Okay. And then separately, I know you talked a lot about the synergies and increased reach with the acquisition. Is there anything you've seen changed competitively on how your competitors are approaching the market since the deal has been announced, since you're moving forward? Thanks.

Victor Koo

Well, we're certainly seeing a market with fewer players and more consolidated field plus a lot more cooperation and rationality across the board. I think there's direct communication with a small number of players in the market, especially on related content, and that has really improved overall economics I think from the content side, that has come back to a rational rate, including the [P content] that was really an issue for last year.

And I think in the other areas such as bandwidth, it's really within our control and the scalability of the platforms combined together, we should see that operating leverage directly.

Gene Munster – Piper Jaffray

Great. Thank you.

Operator

Thank you for the question. Your next question comes from the line of Mr. Dick Wei from J.P. Morgan. Please ask your question.

Dick Wei – J.P. Morgan

Hi. Thank you for taking my questions. First question is on the content cost. Wondering, if I look at the content cost for 2Q, is flattish quarter over quarter. Wondering what is the driver for that. Is that mainly because of some of the lower content has been reflected into amortization, or it is more because of least number of big content being release in Q2? And related to that, maybe we can get an update on maybe the expense, content expense for the rest of the year as well for 2013. Thank you.

Michael Xu

Okay. In terms of 2012, the content cost booked in the P&L has to do with the shows, the timing of the shows, the schedule of the shows. So -- but relative to -- what's more important to look at the cash spending this year versus last year on content, this year Q2 we spent RMB52 million versus RMB144 million last year, partially driven by the price drops. If we compare apple to apple the content price [inaudible] has dropped something around one-third to 50%. And in addition, as Victor mentioned, we are also entering into group buy kind of [inaudible] with [Tencent], [GE], et cetera. And we're also active in swap content with them. So as a result, we expect content cost as a percentage of revenue will drop materially in 2012 -- 2013, sorry.

Victor Koo

Yeah. Most of the delay impact, about three to four quarters. When you're making these purchase decisions, you really -- those shows most likely broadcasted in about three to four quarters when they start amortizing.

Michael Xu

But this year, yeah, the number, because of -- because we are amortizing a high price buy terms this year, so it won't be -- the price drop won't directly impact this year's P&L.

Dick Wei – J.P. Morgan

Great. If you can also update maybe the next year spending plan at the combined entity.

Michael Xu

For competitive reasons, we don't disclose next year's concrete budget -- concrete purchasing strategy at this point in time. We will report of course as time goes by to investors.

Dick Wei – J.P. Morgan

Okay, great. Maybe last question is that, if you can give out the advertising category breakdown by industry, that will be great.

Victor Koo

Sure. As I mentioned before, FMCG is about 55% to 60%. For us, transportation and finance is actually under 15%. And the other area where we feel the overall economic indicators are still good are actually IT and internet services which together are above between 10% to 15%. So, those are the big categories.

Dick Wei – J.P. Morgan

Okay, great. Thank you very much.

Operator

Thank you very much. Your next question comes from the line of Ms. Alicia Yap from Barclays. Please ask your question.

Alicia Yap – Barclays Capital

Hi, good evening, Victor, Dele, Michael and Ryan. Thanks for taking my questions. My first question is that, can you update us, are you still on track to achieve the annual cost saving of RMB50 million to RMB60 million post the merger? And do you have an update on the timeline for the synergies achieved?

Dele Liu

Okay. First of all, we would like reiterate what we have already told the investment community about the RMB50 million to RMB60 million synergies we identified on cost side. Yes, we are very much on track over this. And by the way, I think we, in the conference call we talked about less overlap than we expected in terms of user -- in terms of reach, I think that's another kind of synergy we haven't quantified and informed the investors before this quarter. So I think we are very satisfied with this merger, and I think we are -- everything is on track.

Alicia Yap – Barclays Capital

So, can --

Dele Liu

We are integrating the TV commercial kind of app solutions into [one team]. We are also -- for those CPM price, will be also capped at the same level with Youku.

Victor Koo

And as I mentioned, the deduplication as well as the productivity of combining the management systems is actually quite solid based on the planning that we've done to date.

Alicia Yap – Barclays Capital

I see. So, can I clarify if that's going to be achieved within the 12 months post the merger complete?

Dele Liu

That's right, yeah.

Victor Koo

Correct.

Alicia Yap – Barclays Capital

Okay, great. And my second question is that, can you share with us roughly the percentage of revenue coming from your professional content versus those coming from your self-produced content? And how will that change going forward? Thank you.

Michael Xu

It remains largely the same with previous quarters, which is something around 80% coming from professional content and about 20% coming from user-uploaded content.

Victor Koo

And original content?

Michael Xu

Yeah.

Alicia Yap – Barclays Capital

Okay. Great. Thank you.

Operator

Thank you very much. Your next question comes from the line of Mr. Henry Guo from ThinkEquity. Please ask your question.

Henry Guo – ThinkEquity

Hi. Thank for taking my question. A quick one, I noticed the sales and marketing expense is kind of lower than we expected, so, can you guys explain how the company achieved this and the company expect this trend to continue? Thanks.

Michael Xu

Actually we, in terms of sales and marketing, we have two parts. One part is salary and the other is commission. Basic commission will grow going up and down in line with the revenue growth up and down. And I think the percentage, the kind of percentage drop you have observed in Q4 -- Q2 is mostly due to our bigger revenue base which make -- which reflect the operating leverage we have on this area.

Victor Koo

Yes.

Michael Xu

And the commission rate will increase as the monetization scale go up year on year -- decrease, sorry.

Henry Guo – ThinkEquity

Thank you.

Operator

Thank you for the question, sir. Your next question comes from the line of Mr. [Ming Zhao] from [86 Research]. Please ask your question.

Hello, Mr. [Ming Zhao]? Your line is now open.

Sorry, he has -- Mr. [Ming Zhao's] line has disconnected. I'll move on to the next question.

Your next question comes from the line of Long Lin from Brean Murray. Please ask your question.

Long Lin – Brean Murray, Carret & Co.

Hello? Hi. Thank you for taking my questions. I have a follow-up question on the 2012 outlook. So, with this growth, 3Q growth outlook, can you talk about your overall outlook for the year 2012?

Victor Koo

Can you be more specific? When you're talking about outlook, talking about cost, talking about revenue, or something else?

Long Lin – Brean Murray, Carret & Co.

-- 3Q growth outlook, can you talk about your overall outlook for the year 2012?

Victor Koo

Well --

Long Lin – Brean Murray, Carret & Co.

Hello?

Victor Koo

Yeah. Can you be more specific in terms of what you're asking for from the outlook standpoint?

Long Lin – Brean Murray, Carret & Co.

Hello? I can't hear.

Victor Koo

Are you looking for revenue or cost outlook? What specifically are you asking for?

Unidentified Company Representative

Bad connection.

Long Lin – Brean Murray, Carret & Co.

Oh yeah. So, like, you know, for the 3Q you guided like 70% to 80% year over year, so, what about the overall 2012, like basically for the second half of the 2012?

Victor Koo

Yeah. We generally don't provide guidance beyond the quarter. As we mentioned for Q3, there is a transition process for the integration, and we expect the team integration to be well in its place for Q4. So we're not providing any specific guidance in Q4.

Long Lin – Brean Murray, Carret & Co.

Okay. Thank you. My second question is regarding the, like, the new regulatory -- the new regulation from the State Administration of Radio, Film and Television, because for the limitation on the TV drama series production. What do you -- can you talk about the impact from this new limitation?

Victor Koo

There are several regulation that came from SARFT, one about original content production and the fact that video [app sites] can actually be authorized to produce this content with its own approval, with the right license which Youku does.

The other area that I think you're commenting is related to the dramas in terms of the [instructions], so that will impact really the nature of the genres of the content that will be broadcasted on television I think in the coming six to 12 months. But in general, since Youku has a very broad diversified platform, change in terms of genre of content does not really have a material impact on our traffic or revenue.

Long Lin – Brean Murray, Carret & Co.

Okay. Thank you. That's all my questions.

Victor Koo

Thank you.

Operator

Thank you very much. [Operator Instructions].

Sir, there are no further questions at this time. Please continue.

Ryan Cheung

Operator. Thank you all for joining us on this call. Please feel free to contact us if you have any questions. Goodbye.

Victor Koo

Thank you.

Dele Liu

Thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may now all disconnect.

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