Sohu.com Q3 2007 Earnings Call Transcript

| About: Sohu.com Inc. (SOHU)
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Sohu.com Inc. (NASDAQ:SOHU)

Q3 2007 Earnings Call

October 29, 2007 8:00 pm ET

Executives

Brandi Piacente - The Piacente Group

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

Carol Yu - Co-President, Chief Financial Officer

Dr. Gong Yu - Chief Operating Officer

Wang Tao - Head of Online Game Business

Analysts

Jason Brueschke - Citigroup

Dick Wei - J.P. Morgan

Jenny Wu - Morgan Stanley

Eddie Leung - Merrill Lynch

Wallace Cheung - Credit Suisse

James Mitchell - Goldman Sachs

Tian Hou - Pali Capital

C. Ming Zhao - Susquehanna Financial Group

Paul Keung - CIBC World Markets

Operator

Ladies and gentlemen, thank you for standing by. At this time, I would like to welcome everyone to Sohu’s third quarter 2007 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Brandi Piacente, Investor Relations, please go ahead.

Brandi Piacente

Thank you for joining Sohu.com to discuss our third quarter 2007 results. On the call today are Dr. Charles Zhang, Chairman and Chief Executive Officer; Ms. Carol Yu, Co-President and Chief Financial Officer; Dr. Gong Yu, Chief Operating Officer; and Mr. [Wang Tao], Head of Online Game Business.

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, that 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 online advertising sales, online game revenue, 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.

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Dr. Charles Zhang

Thank you, Brandi. Hello, everyone. Welcome to Sohu's third quarter 2007 financial results conference call. I am very pleased to report another outstanding quarter with record total revenues and non-GAAP earnings.

We have exceeded all of our guidance for each of our revenue categories, as well as earnings. This set of results are made possible only because of our focus on technology and our long-term vision, such as investments in our first in-house developed online game, Tian Long Ba Bu, and our Beijing 2008 Olympics sponsorship.

I will begin by discussing Sohu's major achievements for the third quarter. First, brand advertising -- Sohu delivered record high brand advertising revenue of $29.8 million, exceeding the high end of our guidance, representing 42% year-on-year growth. For the first nine months of 2007, brand advertising revenue grew by 40% year-on-year, despite a challenging comparison to 2006 with the FIFA World Cup.

And here I would like to extend special thanks to Belinda Wang, our Chief Marketing Officer and Co-President, for her diligent efforts and accomplishments, even during her maternity leave over the last few months. Belinda will officially report to duty next month and will join us in our next call.

Fueled by the fast growth of the Chinese economy and the continued migration of advertisers from offline to online, our brand advertising continues to ride the tide of a robust market, especially with the Beijing 2008 Olympic Games now less than 10 months away.

For the third quarter, revenues continued to be driven by heavy spending sectors such as auto, real estate, and online games. Sectors that showed the highest year-on-year growth were online games, fast-moving consumer goods, and the financial services. Online games increased more than 120% year on year, driven by the launch of many new titles and IPO marketing activities by some online game companies.

Fast-moving consumer goods grew by 108% year on year, as traditionally heavy offline advertisers, fast-moving consumer goods advertisers are accelerating their conversation to online platforms.

Financial services increased by 98% year on year, primarily due to the robust Chinese stock market.

Our outlook for brand advertising for the rest of the year remains strong, looking to achieve 2007 full year brand advertising revenue growth of between 38% to 40%, as compared to our previous target of 35%.

In addition, our dominant advantages surrounding the Beijing 2008 Olympic Games continue to differentiate and distance us from the rest of the crowd, of the competition. We are the portal of choice for the Olympics, for both Internet users and advertisers in China.

A solid, undisputed example is our reporting on the one-year countdown to the Olympics on August 8, 2007. Sohu was able to conduct video interviews with more than 200 famous Chinese athletes from among all of the 55 national sports teams. This is in stark contrast to 40 video clips for all our major competitors combined.

In cooperation with CCTV, we conducted an online survey and received over 10 million responses, compared to 6,000 responses of a competitor for a similar survey.

Sohu secured 10 Olympic partners, sponsors, and suppliers, as well as one non-sponsor to advertise with us on this event. But none of our major peers have any advertisement on the same event.

In addition, in early October, to prepare for the Olympic Torch relay across Mount Everest, I myself personally led a team of engineers and reporters to climb the Yuzhu Mountain with an altitude of about 6,200 meters. By applying Sohu's state-of-the-art technology for the first time in the remote Yuzhu Mountain area, we have successfully overcome the difficulties caused by the lack of a telecommunication network. We succeeded in setting up a broadband data transmission network in the extremely remote and difficult environment, and dry run a reporting plant on site.

This event aroused a lot of interest from Internet users, and further reinforced our unchallenged position as the portal of choice for the Olympics.

Secondly, our technology co-initiatives, which include a good example of success brought by our focus of technology, is Tian Long Ba Bu, the online game success. Back in 2004, we started our investment in Tian Long Ba Bu as our first in-house massive multi-player online roleplaying game. It was launched in May of this year.

Here in the third quarter, we continued to focus on improving Tian Long Ba Bu’s in-game quality and launch of new features. On August 15th, we launched our first expansion pack. We also carried out successful marketing campaigns, especially leveraging on our own leading game information portal, 17173.

All these efforts contributed to make Tian Long Ba Bu become one of the top RPG games in China. We continue to see increased user numbers, growing game loyalty and higher monetization.

For the third quarter, registered users climbed to 18 million from 10 million, an increase of 80%. Quarterly active paying accounts increased to 690,000 from 209,000, an increase of 230%. Peak concurrent users remained at a stable level of around 400,000.

Quarterly average revenue per active paying accounts value increased to RMB118 from the previously RMB82 an increase of 44%. Revenue increased by 384% to $10.9 million from the previous $2.3 million.

Our success of Tian Long Ba Bu in China enables us to license the game overseas. In August, we licensed Tian Long Ba Bu to an operator in Vietnam and now, Tian Long Ba Bu is one of the top three games there with peak concurrent users of 30,000 in Vietnam. Earlier this month, we licensed Tian Long Ba Bu to leading operators in Taiwan with an expected launch early next year. Although we do not expect substantial revenue from these arrangements, they provide incentives for us to explore other oversea markets going forward.

We expect to see Tian Long Ba Bu getting more matured here in the coming two months, with revenue of this game kind of starting the first quarter of next year, maybe with a maximum of 5% to 10% quarter-on-quarter growth going from there.

Looking ahead to Sohu's next game, I am very happy to announce that Sohu has obtained the rights for The Duke of Mount Deer, another famous novel by Mr. Louis Cha, author of Tian Long Ba Bu. This is already under development as a 2.5D cartoon style RPG game with an expected launch by the end of next year.

Our technological initiatives also include Sohu 3.0, which has been tracking well and is positively received by Internet users. In late July, we launched Sohu 3.0, which integrates all of Sohu's products and communities within the Sohu matrix through Sohu Blogs, Sohu Passport, and Sohu web-based messengers. Since its launch, Sohu 3.0 has been successful in cross-selling 7 million accounts of products for our users. For example, an e-mail user is attracted to also become a user of China Alumni Club through 3.0.

Video blogs are getting to be very popular among users who are increasingly adopting their blogs as a personalized portal. This has successfully attracted new users to Sohu. For the third quarter, Sohu's unique visitors has increased by 21% quarter on quarter.

We believe the strength of Sohu 3.0 will continue to surface in the coming months, which will bring long-term growth to Sohu's users, traffic, and advertising revenue.

Another technological achievement is our premier client desktop product, Sogo Pinyin, a Chinese character input method software which continues to expand its market presence. Sogo Pinyin’s vocabulary database is tied to the search queries database of Sogo search engine, thus it can capture the latest trend of words used by Internet users.

Since its launch in mid-2006, Sogo Pinyin has been well-received by users. During the third quarter, weekly active PCs using Sogo Pinyin has expanded by 48% over the second quarter.

Lastly, let me review the major investments made. I would like to reiterate our long-term vision in managing our business and in making investments to create and enhance shareholder value.

I am pleased to recap such investments made during the past few years. First, development of Tian Long Ba Bu in-house since 2004. As of the end of the third quarter, we had already recouped all of our investment in Tian Long Ba Bu, including game development costs, CapEx for servers and marketing expenditures.

Second, Olympic Sponsorship; for the first nine months of 2007, just counting the increased ad revenue from our sports and Olympic channel over the corresponding period last year, we have more than recouped all cash fees paid to [inaudible] for Olympic sponsorship. For the entire Sohu matrix, we are even more pleased to report that Olympic partners and sponsors have increased their advertising spending on Sohu by around 70%, as compared to the same period in 2006.

Third, stock purchase program -- since 2004, we have repurchased 2.9 million Sohu shares, or 7% of the company, at an average price of $18.20, utilizing a total of $62.7 million. Using the closing market price at October 26th for Sohu stock of $49.92, market value of these stocks is now $144.8 million, or a $92.1 million above our cost.

These examples should help demonstrate management’s long-term vision and successful track record in our strategic initiatives. We strongly believe investments we are making today, such as Sohu 3.0, Sogo Search, Sogo Pinyin input method, and other technological initiatives will bring similar successes in the future.

With that, I would now like to turn the call of Gong Yu, Chief Operating Officer, for an update of our Sohu website operation and video achievements.

Dr. Gong Yu

We have achieved 21% user growth in unique visitors for the third quarter. We are also pleased to report healthy traffic growth for the Sohu matrix of websites over the last third quarter. Channels such as blog, entertainment, news and sports enjoyed the highest traffic growth.

Now I would like to discuss more about our video strategy. With increased broadband penetration and the continuous improvement of peer-to-peer streaming technology, online video content is now in even higher demand from Internet users. In 2006, we launched our S and V channels, two online 24-hour video channels on sports and entertainment, respectively. Both channels have been well received. During the third quarter, page views for S and V channels increased by 32% and 21% respectively.

In order to expand our video services, in the third quarter we launched a new TV channel through strategic partnerships with 49 television stations, including 14 provincial TV stations that have national coverage. Programs from these TV stations are now streamed on Sohu on both live and on-demand service. Such TV clips are nicely integrated into our text-based news and have been well received by our users.

With that, I would like to turn the call to Carol, Co-President and Chief Financial Officer, from an update of our third quarter financial performance.

Carol Yu

Thank you, Gong Yu. Hello, everyone. I will now provide a review of our financial results for the third quarter ended September 30, 2007.

One, revenues -- as mentioned by Charles, for the third quarter total revenues hit a record of $51.5 million, exceeding the high end of our guidance by $4.5 million, representing an increase of 32% sequentially and 46% year on year. Not only does each of the revenue categories exceed our previous guidance, some by a rather wide margin, but each of them also hit their all-time highs as well.

With total advertising revenues of $31.5 million, we achieved a sequential increase of 11% and a year-on-year increase of 32%. Brand advertising revenues were $29.8 million, representing a sequential increase of 12% and year-on-year increase of 42%. Sponsored search revenues were $1.7 million, flat from the second quarter and declined by 39% year-on-year. The year-on-year decline was mainly due to the strengthening of our anti-fraudulent click policy based on more sophisticated algorithms starting mid-2006.

In the third quarter, through better integration with the Sohu Portal and fine-tuning of featured search product, such as picture and [favorites], traffic of Sogo has increased by 94% sequentially.

Non-advertising revenues were $20 million, exceeding the high-end of our guidance by close to $4 million, an increase of 88% sequentially and 74% year-on-year. Online games revenue were $12.7 million, an increase of 232% sequentially and 473% year-on-year, due to the strong results of Tian Long Ba Bu.

For the third quarter, revenues from Tian Long Ba Bu and Blade Online were $10.9 million and $1.8 million respectively. Wireless revenues were at $6.8 million, a sequential increase of 4% quarter on quarter and down 23% year-on-year. Sohu is well-positioned to minimize risks associated with the wireless sector as they now only represent 13% of our total revenue.

Gross margin -- under SFAS-123R, share-based compensation expenses are charged to quarter revenues and operating expenses. Total share-based compensation expense for the third quarter of 2007 was $2 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's operating results and improves users’ understanding of Sohu's performance, we use non-GAAP measures in this discussion to explain margin cost and expense items.

Non-GAAP gross margin for the third quarter was 67% compared with 62% in the previous quarter and 65% in the third quarter of 2006. Gross margin expansion was primarily due to the contribution from Tian Long Ba Bu.

Non-GAAP advertising gross margin was 64% in the third quarter, same as the previous quarter, and a decrease of 71% from the same period last year. Brand advertising non-GAAP gross margin for the third quarter was 67%, same as the previous quarter and down from 73% in the same quarter last year. The year-on-year decrease was primarily due to the increased content costs, bandwidth, and server depreciation expenses.

Sponsored search non-GAAP gross margin for the third quarter was 24%, up from the 22% in the previous quarter but down from 58% in the same period last year. The year-on-year decrease was primarily due to higher server depreciation expense in relation to the launch of Sogo 3.0 in late 2006.

Non-advertising non-GAAP gross margin was 72% for the third quarter, up from 56% for the previous quarter and 54% in the third quarter of last year. Online games non-GAAP gross margin for the third quarter was 84%, up from 64% in the previous quarter and 55% from the same period last year. The increase correlates to an increase in revenue from Tian Long Ba Bu.

Wireless non-GAAP gross margin for the third quarter was 52%, same as the previous quarter but down from 54% in the same period last year. The year-on-year decrease was mainly caused by the negative impact of policy changes put in place by mobile network operators since July 2006.

Operating expenses -- for the third quarter, Sohu's non-GAAP operating expenses totaled $23.9 million, up 43% from $16.7 million from the previous quarter and up 58% year-on-year. The increase was primarily due to our continued investment in product development and Sohu's branding, marketing expenses for Tian Long Ba Bu and Sohu 3.0, as well as an increase in bonuses to reward employees for their contribution to this quarter’s good results.

Operating margin -- non-GAAP operating profit margin was 21% for the third quarter, compared with 19% for the previous quarter and 23% for the same period last year.

Other income -- in the third quarter, we disposed of our equity interest in an associated company resulting in a gain of $0.6 million.

Income tax expense in the third quarter was $0.3 million, compared to $0.2 million in the previous quarter.

Net income -- non-GAAP net income for the third quarter reached a record high of $11.7 million, or $0.30 per fully diluted share. Non-GAAP net income increased by 44% sequentially and 37% year-on-year. GAAP net income for the third quarter was $9.7 million, or $0.25 per fully diluted share. This increased 70% sequentially and 47% year-on-year.

Net margin -- non-GAAP net margin for the third quarter was 23% as compared to 21% in the previous quarter and 24% in the third quarter of 2006.

Cash position and balance sheet -- now I will make a few comments on our cash position and balance sheet. As of September 30, 2007, subsequent to the repayment of our convertible notes of $58.5 million in July, our balance of cash, cash equivalents, and investments in marketable debt securities remains at a very comfortable level of $76.9 million. This compares to the balance of $113 million as of June 30th and $129.7 million as of the end of last year.

Cash inflow from operating activities for this quarter was about $23 million. With our current cash position and strong operating cash flow at present, we do not expect any immediate needs to raise financing.

As of September 30, 2007, our net accounts receivable balance was $34.9 million, an increase of $5.9 million as compared to $29 million last quarter. Our DSO for the third quarter was 58 days compared to 63 days for the previous quarter and 72 days for the third quarter of 2006.

Third quarter brand advertising DSO was 75 days, compared to 70 days for the previous quarter and 66 days for the same quarter last year. We are continuing to monitor our accounts receivable and are pleased with the outcome.

As of September 30, 2007, our bad debt provision total $1.7 million, compared to $1.4 million as of June 30, 2007, reflecting our stringent revenue recognition and credit extension policies.

Finally, turning to our business outlook, for the fourth quarter ending December 31, 2007, Sohu expects: one, total revenues to be between $53.5 million to $55.5 million with advertising revenues of $31 million to $32 million and non-advertising revenues of $22.5 million to $23.5 million. Brand advertising revenues of $29.5 million to $30.5 million; two, we estimate non-GAAP fully diluted earnings per share to be between $0.33 and $0.35; and three, assuming no grants of new share-based awards, we estimate share-based compensation expense to be between $1.8 million to $1.9 million. The estimated impact of this expense is expected to reduce fully diluted earnings per share under U.S. GAAP by $0.05.

In conclusion, we are very pleased to have reported another record quarter. To repeat what Charles has said at the start of the call, this set of results are made possible only because of our focus on technology and our long-term vision. We will continue to invest for the long-term benefit of the company and to further enhance shareholder value.

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 comes from Jason Brueschke with Citigroup. Please go ahead.

Jason Brueschke - Citigroup

Thank you. Good morning, everyone, and congratulations on a really fantastic quarter. Let me ask two questions, if I can; first of all, on the online gaming, you’ve had tremendous success so far from TLBB and it seems like we have at least another solid quarter of growth ahead of us. If I can look ahead to the new game that you announced, I think it was Duke of Mount Deer, could you maybe give us some additional color on some of the similarities that you see that that game represents? You indicated it’s by the same author. Maybe give us some indication of how popular this novel was versus TLBB and things like that, just so we can have a context for understanding what some of the potential is for the next game, and then I have a follow-up question.

Dr. Charles Zhang

Let me describe a little bit and then I will ask [Wang Tao] to say things and maybe I can translate, or you can. I think Duke of Mount Deer is as popular in terms of the novel and the story and the movie is as popular as Tian Long Ba Bu. It is very, very well-known and actually now, there is a television series that is being filmed now about Duke of Mount Deer.

The game is a 2.5D cartoon style. Maybe Wang Tao can elaborate.

Wang Tao (Translation)

Okay. Similarities between Tian Long Ba Bu and Lù Dǐng Jì is as follows; when we first developed Tian Long Ba Bu, we followed two key themes or strategic direction. One is community-based. Tian Long Ba Bu is community-based, and the second is we followed the strong features of successful Korean games in China.

We are now in the process of developing Lù Dǐng Jì. When we do that, we not only put equal emphasis on the two successful features from Tian Long Ba Bu, but at the same time, we also increased the in-game features that are actually success factors for other games in China, but also we also 3D features as well -- 3D engine.

The target market for Lù Dǐng Jì is more of the cartoon featured market for the game.

Carol Yu

Jason, you got a clue? Hello?

Operator

Our next question will come from the line of Dick Wei with J.P. Morgan. Please go ahead.

Dick Wei - J.P. Morgan

Congrats on the strong quarter, and two questions; first question is can you tell us more about what you see on advertisers plan for the Olympics -- where are they spending, in terms of timing of the spending, and is there any hints on the amount? That would be great. Because I’ve been hearing that some advertisers are holding back some of the ad spending in Q3 for the upcoming quarters.

And the second question is on Tian Long Ba Bu, just quickly about the revenue expectation for Q4 on the game.

Carol Yu

For advertising revenue coming from Olympics, we are seeing very encouraging signs. Our current efforts focused on marketing our Olympic Games package to the advertisers and so far, results have been encouraging. We will give out our full 2008 year guidance when we report our Q1 or Q4 results in the coming quarters.

The second question regarding Tian Long Ba Bu, our revenue guidance for Q4 for total, for games in total, is $15 million to $16 million. So for Tian Long Ba Bu, it would be about $14 million.

Dick Wei - J.P. Morgan

Great. Thanks.

Operator

Thank you. Our next question comes from Jenny Wu with Morgan Stanley.

Jenny Wu - Morgan Stanley

Hi, guys. Congratulations on a very good quarter. I have two questions. First one, would you please elaborate more on your advertising pricing change? I remember last quarter, you guys increased the price change by 37%. How about the trend going forward? Thank you.

Carol Yu

On the pricing change, we haven’t had any price increase since last quarter, but based on the current package that we offer to our clients for the Olympic Games times, it would be at a premium of at least 20% to existing inventory.

Jenny Wu - Morgan Stanley

Thank you. And the second one is regarding your new TV channel. Is there any revenue sharing plan with those 49 TV stations?

Dr. Charles Zhang

Not yet. Our first goal is to increase the traffic. When we have a sizable traffic, then we will definitely in the future, there will be advertising opportunities for these streaming video and TV channels, because advertisers have been used to advertise on television. So now, advertise with the video-on-demand or streaming, it’s a natural conversion, so we expect that the future is very good. But right now, we are focused on developing traffic and actually, the launch of the TV channel -- it’s only for less than a month and we’ve seen a pretty good result in terms of page views, and the page views are actually higher quality because each view represents a few minutes of viewing, so it’s actually better, more high quality numbers than a text-based page view.

Jenny Wu - Morgan Stanley

Thank you.

Operator

Thank you. We have a follow-up coming from the line of Jason Brueschke. Please go ahead.

Jason Brueschke - Citigroup

Thank you. Sorry about that. That was a glitch on my end. My follow-up question now is a follow-up basically to what Dick had asked. And what I’m interested in is with respect to the Olympic advertising, could you maybe just qualitatively comment on the linearity of the ramp? You gave an indication that some of your advertisers have increased their spending 70% year over year and we are less than a year away now. Should we expect that to be a linear ramp, that Q4 gets stronger and then Q1 is stronger and Q2 is stronger as we get closer to the games? Or is there something peculiar going on that might say it accelerates faster and plateaus, or will it just kind of like linear ride into August of next year? That would be helpful. Thanks.

Carol Yu

Well, obviously we can divide the coming 300 days into basically I think three phases. The first phase will be from now on until March of next year, which will pretty much -- I will use the word stable to talk about advertiser spending. Starting from March next year, when the torch relay starts, we would actually be really entering into the Olympic time zone starting there, especially with a big ramp-up of mass interest starting from May when the torch actually enters into China’s soil.

And then with the teams, national teams from around the world getting set up and the list of athletes who got into the Olympics and who is not got announced, everybody’s attention will be drawn towards the Olympics. I think that will reach another high ground.

And then obviously the third phase would be starting maybe the first of August, a week before opening ceremony. I think the whole world’s attention will be on that.

So I think the advertising revenue will follow that three phases as well.

Jason Brueschke - Citigroup

Thank you. That’s very helpful.

Dr. Charles Zhang

In our interaction with our advertisers, since it is already the end of the year, they actually set out some good chunk of advertising spending for the Olympics, but how they will spend it really depends on the phases that Carol just described. So it is important to design the different marketing activities that attract mass attention and with good quality content that reporting all these activities and events, so that help our advertisers to plan their spending accordingly.

Now they are -- they always think they are going to spend really good money for the Olympics but now they have the chunk of money set up, but how to spend it, it really depends on our interaction with them in the next 10 months.

Operator

Thank you. Our next question comes from Eddie Leung with Merrill Lynch. Please go ahead.

Eddie Leung - Merrill Lynch

Good morning. I have two questions. One is kind of a housekeeping question. Can you guys talk about how many brand advertisers in this quarter and how the number has changed from the previous quarter? And then I have a follow-up.

Carol Yu

In terms of number of advertisers, it’s actually pretty level. We have 652 advertisers in Q3 and 639 in Q2.

Eddie Leung - Merrill Lynch

And also a question on brand advertising; can you talk a little bit about the demand from non-Olympic sponsors? I would imagine those advertisers would represent a majority of your branded advertisers. And for those advertisers, what’s the impact you see from you guys getting the Olympic sponsorship?

Carol Yu

Well, we see equally good demand from sponsors and non-sponsors. I think what Charles has just described both during the script or in his script or when he answered earlier questions is that number one, during, for example, using the one-year countdown as an example, we have 10 Olympic partners and one non-partner coming to sponsor our reporting for that event, so that’s number one.

And number two, I think a lot of advertisers, irrespective of whether they are partners or not, they are actually very anxious to see proposals from ourselves for how to do sports marketing or marketing surrounding the Olympics. I think we stand in a much better position versus our competitors and even some of the media, because of resources that we have secured on our media platform. So I think that actually -- I mean, Charles quoted two examples and I think that [factors all].

Eddie Leung - Merrill Lynch

Thank you.

Operator

Thank you. Our next question comes from Wallace Cheung with Credit Suisse. Please go ahead.

Wallace Cheung - Credit Suisse

Good morning. Congratulations on the very great results. I have questions related to the brand advertising side. Firstly, it seems to me the guidance of the brand advertising seems to be a bit low, because if you compared the year-on-year growth in the first quarter, it is actually around 42%. And if you take a look at the fourth quarter guidance, it is actually only 34% to 49%. I understand the management team has been very conservative in providing guidance, but can you give a little more color why the guidance, the year-on-year growth is actually lower than the first quarter, besides the RMB appreciation impact? And I also have a follow-up on brand advertising revenue. Thank you.

Carol Yu

Well, this is how we look at the business at the present, as we speak. Like what you have said, I think we are already seeing very good growth for the past three quarters and I think an annual projection of close to 40% is already something that we are very pleased with.

Wallace Cheung - Credit Suisse

Okay, I think one follow-up question is actually again on brand advertising side. It seems to be the, as what management have said, the sports channel has been doing very well, I think according to Alexa figures. The traffic was close to double from the year before, so from an advertiser perspective, how do they see this like reflection on this kinds of changes of the traffic mix? Do they think it is actually more valuable? Do they -- [inaudible] on this? Thank you.

Dr. Charles Zhang

I think first of all, we don’t look at it -- well, we don’t look at -- I think there’s a lot of some manipulation or whatever to the Alexa number that reflects, so we have our own internal account of our traffic growth. It’s quit a balanced growth, with traffic for our content channels across the board to grow, especially in sports and entertainment and also the improvement of the news media.

And especially, because of the Sohu 3.0 and blogs and new features of blogs and the video content, the Sohu matrix 3.0 stickiness are significantly improved. So the average time spent for a user on the Sohu matrix is longer than before. That translates, so although blogs, standalone blogs we haven’t developed any methods to monetize, it’s all a free product, but because all these products are so inter-connected and you can move around so seamlessly, so that the stickiness improves, so that the click-throughs are getting better. Advertisers are feeling that effect that the advertising on Sohu has improved, so that helps advertisers to continue to sign bigger contracts with us. That’s why -- that’s the underlying force behind the ever-increasing strong brand advertising growth.

Because people don’t see the connection. You invest in the technology, bandwidth, servers and all these software engineers to develop products that are free, like blogs and like Sohu 3.0. Actually, it’s indirectly fundamentally making our platform more attractive to advertisers, so in the long-term, you will see the effect of our technological initiatives in terms of brand advertising.

For online games, it’s an immediate reflection of revenue and earnings, but for brand advertising, it’s a slow but fundamental and really irreversible path toward a largest Internet portal in China and the largest, most attractive advertising platform in China.

Wallace Cheung - Credit Suisse

Thanks for that, Charles. Just a final question is I believe TLBB is actually providing a lot of incremental user base for Sohu as a whole. Any plan to convert the TLBB incremental user base into your portal or into the Sohu matrix? Thank you.

Dr. Charles Zhang

You got it right. I mean, that’s also my concern and initiative. It’s very important because Tian Long Ba Bu actually attracts -- it’s very sticky. I think among all the Internet products, RPG games are the most stickiest applications and communities. So we definitely have plans to integrate Tian Long Ba Bu players with our Sohu 3.0 and our Passport and other products.

Actually, it’s already -- some of the process has already been going on and so it is - we are doing that.

Wallace Cheung - Credit Suisse

Thank you very much.

Operator

Thank you. Our next question comes from James Mitchell with Goldman Sachs. Please go ahead.

James Mitchell - Goldman Sachs

Congratulations, Team Sohu. Two quick questions, first on your fourth quarter guidance. It looks like you are guiding for earnings growth faster than revenue in the fourth quarter, which is all good from our perspective. I’m curious whether --

Carol Yu

Sorry, James. I lost you towards the tail end of the question. Can you repeat that?

James Mitchell - Goldman Sachs

First question on guidance for the fourth quarter, it looks like you are guiding for faster earnings growth than revenue growth, which is good. I’m wondering whether the cost in the fourth quarter will be more stable because of less sales and marketing spending on Tian Long Ba Bu, or whether the costs will be more stable because of our bonus accrual being more usual? I think you mentioned in the prepared remarks the bonus accrual was high during the third quarter and I was wondering if you could talk about how that works. And then I have a question on a separate topic. Thank you.

Carol Yu

I think the Q4 results, the Q4 guidance include -- you are correct, that a lower amount on sales and marketing for Tian Long Ba Bu because the game will enter into a more matured phase. Employee bonuses, it would be more or less the same because they would be as a function of our profitability.

James Mitchell - Goldman Sachs

So you accrue bonuses fairly evenly through the year --

Carol Yu

For the -- well, I would say for the back half of the year, the second half of the year.

James Mitchell - Goldman Sachs

Okay, great. And then my second question on the computer games, I think you gave an implied revenue growth for the fourth quarter to $14 million. I wonder if you’d see that revenue growth coming more from a greater number of paying accounts, or more from ARPU improvement? And comparing the games of peers, it seems like you have a relatively good conversion rate of free accounts into paying accounts.

Dr. Charles Zhang

If I guess, I think we are seeing good user growth. [Wang Tao], do you agree?

Carol Yu

We are growing -- we are actually -- we’ll work hard for the fourth quarter, we’ll work hard to grow the active paying accounts, hopefully with a very stable ARPU.

James Mitchell - Goldman Sachs

Okay, great. Thank you.

Operator

Thank you. Our next question comes from Tian Hou with Pali Capital. Please go ahead.

Tian Hou - Pali Capital

Congratulations on the good quarter. Regarding your game, Tian Long Ba Bu, I just wonder, how do you position this game? Is this like a game similar to Westward Journey II or is the game much similar to [inaudible]? How do you position them?

Carol Yu

It’s more like Fantasy Westward Journey and The Legend from Shanda.

Tian Hou - Pali Capital

How long do you expect this game’s life cycle will be?

Wang Tao (Translation)

Over five years.

Tian Hou - Pali Capital

Okay, the last question will be regarding the online advertising. I guess someone’s already asked this question, your Q4 brand advertising is quite flat compared with Q3. Is there any particular reason for this flat projection?

Carol Yu

No particular reason. It’s just how we see businesses.

Dr. Charles Zhang

Seasonality. That’s normal seasonality.

Tian Hou - Pali Capital

Thank you.

Operator

Thank you. The next question comes from Ming Zhao with SIG. Please go ahead.

C. Ming Zhao - Susquehanna Financial Group

Thank you. Thank you for taking my questions. I have two questions. My first question, maybe following James Mitchell’s question; in the third quarter, you just mentioned there was some bonus for the employees, which I believe they deserve. Do we see that as a continuous payment incentive it the following quarters, so that your margin will actually improve in the fourth quarter?

And a related question is, is the marketing spending for the game in the Q3, I believe you said it has increased by $1 million from Q2. How do you budget your marketing expense in the fourth quarter and quarters beyond?

Carol Yu

It’s pretty much level.

C. Ming Zhao - Susquehanna Financial Group

You mean the marketing expense, right?

Carol Yu

No, I’m talking about the bonus level.

C. Ming Zhao - Susquehanna Financial Group

How about the marketing expense?

Carol Yu

It would be, because we see a growing revenue, but the absolute dollars for the marketing expense will remain pretty stable, so that circles back to James’ question. If we expressed it as a percentage of revenue, actually that would go down.

C. Ming Zhao - Susquehanna Financial Group

I guess previously, looking at the non-GAAP operating margin from a low 20s to mid-20s, with game accounting for more revenue in the top line and it’s more profitable, what’s the long-term operating margin that we will be looking at?

Carol Yu

I am still looking at that level because like Charles and I and Gong Yu have all emphasized, I mean, we invest in the long-term of the company so we now have the “luxury” of contribution from Tian Long Ba Bu, so we would actually put that back into the business and invest in other technological investments and the like.

C. Ming Zhao - Susquehanna Financial Group

Last question is on the mobile side, I guess not many people asked this question today, the question is actually how do we see this business? If I think rightly, your Sogo Pinyin, if you can put that into the mobile phones, I think it would be a great product. Is that something you are going to explore in the future?

Dr. Charles Zhang

You mean the Sogo Pinyin on mobile phones?

C. Ming Zhao - Susquehanna Financial Group

Yeah, because I think the Pinyin input on the mobile phone is still very --

Dr. Charles Zhang

Yes, well, sure, definitely we have plans. But it’s because of the product or the type -- so many types of mobile phones, so the task will be a very big one. We have plans to do that but not immediately. It’s in our plan.

C. Ming Zhao - Susquehanna Financial Group

So how do you see this mobile business? Are you just going to make it a stable revenue stream going forward?

Dr. Charles Zhang

Well, the wireless -- you mean the wireless business, right?

C. Ming Zhao - Susquehanna Financial Group

Yes.

Dr. Charles Zhang

Yes, I think it really depends on operators’ policies and the general trend before any new business model emerged that’s independent of operators. I think the trend is generally going down gradually, but we managed well so that it gradually become a less and a less part of the Sohu overall revenue mix.

C. Ming Zhao - Susquehanna Financial Group

Okay. Thank you. Great quarter.

Operator

Thank you. The next question comes from Paul Keung with CIBC World Markets. Please go ahead.

Paul Keung - CIBC World Markets

Hello. This is [Mahresh] calling for Paul. Good quarter. Considering the strength in the gaming revenue, could you talk a little bit about what we could expect going forward for ARPU growth as well as active paying account growth? And also, in terms of your games pipeline, do you have a plan for a certain number of games to be launched every year and do you see this ever becoming even a bigger part of revenue than advertising?

Carol Yu

As far as -- like we talked about, our objective is to grow active paying accounts during the fourth quarter while maintaining a relatively stable ARPU. We do have plans to launch another game next year, as we mentioned before, but taking into consideration that our games business, our real games business only has -- like is still in its infancy stage, which is like two quarters old, even if we count up to now, I mean, it’s only six months out. We would be very carefully articulating our overall game strategy where we see more quarters of success.

Hello?

Operator

Does that answer your question?

Paul Keung - CIBC World Markets

Yes, it does. Thank you.

Operator

Thank you. At this time, I will turn the call back to Brandi Piacente for closing comments. Please go ahead.

Brandi Piacente

We would like to thank everyone for participating in today’s call. Please feel free to contact us if you have any additional questions. Thank you.

Operator

Ladies and gentlemen, that will conclude today’s teleconference. We do thank you again for your participation and at this time, you may disconnect.

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