Sohu.com Ltd (SOHU) 2018 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and good evening. Thank you for joining Sohu's Third Quarter 2018 Earnings Conference Call. (Operator Instructions) Today's conference call is being recorded. If you have any objections, you may disconnect at this time.

I will now turn the conference over to your host for today, Eric Yuan, Investor Relations Director of Sohu. Please go ahead, sir.

Thanks, operator. Thank you for joining us today to discuss Sohu's third quarter 2018 results. On the call are Chairman and CEO, Dr. Charles Zhang; CFO, Joanna Lv. Also with us today are Changyou's CEO, Dewen Chen; and CFO, Yaobin Wang; and Sogou's CEO, Xiaochuan Wang; and CFO, Joe Zhou.

Before management begins their prepared remarks, I would like to remind you of the company's safe harbor statement in connection with today's conference call. Except for the historical information contained herein, the matters discussed during 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. Please refer to the company's filings with the Securities and Exchange Commission, including its registration statement and the most recent annual form on Form 10-K.

With that, I will now turn the call over to Dr. Charles Zhang. Charles, please proceed.

Thanks Eric, and thanks to everyone for joining our call. For the third quarter, well, our total revenues were partly in line with prior guidance, the bottom line performance, excluding nonoperating items, came in better than we expected, mainly driven by the cost saving of Sohu Video and solid results of our online game business.

For the media portal, we focused our efforts on upgrading the content as well as optimizing our recommendations' engine algorithms. And our key mobile application -- apps gained momentum in terms of daily active user DAU and the time spent by users.

For video, we remain on track to reduce content costs, while develop new original programs, which tend to generate better ROI. And this helped us narrow this segment's -- the video segment's loss by more than 50% year-over-year.

And Sogou continuously integrated more innovative AI features into its search and mobile keyboard products, strengthening its market competitiveness.

Lastly, Changyou games comfortably beat expectations on both revenues and targets, supported by the healthy performance of its TLBB PC and mobile games.

Before I give more details about our key businesses, let me summarize the financial results for the third quarter. Total revenues of $460 million, down 11% year-over-year and 5% quarter-over-quarter. On a constant currency basis, total revenues would have been $9 million higher than the reported revenues and down 9% year-over-year instead of 11%.

Net brand advertising revenue of $57 million, down 24% year-over-year and 7% quarter-over-quarter. Search and search-related advertising revenues were $255 million, up 13% year-over-year and down 6% quarter-over-quarter. Online games revenue $96 million, down 28% year-over-year and up 2% quarter-over-quarter. Non-GAAP net loss attributable to Sohu.com Limited was $32 million compared with a net loss of $93 million in the third quarter last year. Operating loss for Sohu Video $27 million compared with the loss of $60 million in the third quarter of 2017.

So let me go through some of our key businesses. First, the Sohu Media Portal business. For the third quarter, we continued to concentrate our efforts on expanding the user base of our key mobile products. To further improve the user experience, we worked hard to elevate the quality of our content, especially content brought by third-party authors on Sohu Hub. In the meantime, we refined our recommendation engine using machine learning technology to provide more personalized stories for -- to users.

On the product interface front, we upgraded the design of our Sohu News App, in particular a new column called The Moment. It's highlighted at the center position of the front page. We are pleased to see that, collectively, in September, daily active users of our mobile apps increased about 20%. And of total revenues for Sohu Media Portal, mobile revenues now accounted over 80% in the third quarter compared with 70% in the second quarter of this year.

During our third quarter, inevitably, we felt the impact of the economic slowdown in China, which led to budget cuts from large brand advertisers. This impact is likely to last for some quarters. To revive revenue growth for Sohu Media Portal, we must rely more on small media enterprises, customers that tend to be more resilient in this kind of environment. In addition, to improve monetization on our platform, we are upgrading our advertising system to better match the click-based ads with our users to increase click-through. With the support of stronger user traffic, we look forward to seeing positive trend of revenues in 2019.

Now moving over to Sohu Video. In the third quarter, we remained on track in our implementation of a revamped content strategy that focuses on self-development content and short-form video programs. We saw encouraging progress from the move. During the quarter, video content costs 60% lower than the same period last year and the operating loss of Sohu Video had been halved year-over-year.

For the original content, we have been able to consistently launch a number of good quality dramas and shows each quarter, while keeping our production budgets under control.

In the third quarter, we released 3 original dramas, including a very popular one, (foreign language), which achieved certifying performance. We also rolled out the second season of a variety show (foreign language) and originally -- an original reality show that has since become one of the best rated shows on (foreign language) which is a premium cultural website ranking the popularity of shows.

Looking ahead, we plan to continue developing original titles at our own pace with a particular focus on quality over quantity. In addition, we are exploring opportunities to acquire more inexpensive TV programs that -- to complement our content library. We believe with solid execution, Sohu Video's losses will further narrow over the next few quarters.

Now turning to Sogou. In the third quarter, Sogou made solid progress to upgrade its search and mobile keyboard products by applying innovative AI technologies.

Sogou Search is processing more and more Q&A format queries, while providing comprehensive video- and image-based search results to users. Sogou also upgraded the speech recognition model for Sogou Mobile Keyboard, one of the top mobile apps in China. The upgrade reduced the error rate and helped increase the usage of voice input function for the app.

Lastly, Changyou. Driven by solid performance of our flagship TLBB franchise gains, Changyou's quarterly revenues and profit were both ahead of our expectations. TLBB PC games revenue saw modest increase quarter-over-quarter upon the launch of promotional events in the summer expansion pack.

For the new mobile games in the pipeline, the MMORPG game will still be the key genre we focus on. Meanwhile, the potential opportunities with advanced casual games and SLG games are also in our sight. We will continuously seek to make breakthroughs in important areas such as graphics and game play as we look to rollout new hit games and adapt to the continually changing gaming market.

Now let me turn the call over to Joanna, our CFO, who will walk you through financial results.

Thank you, Charles. I will walk you through the key financials of our 4 major segments. For the third quarter of 2018, all of the numbers that I will mention are all on a non-GAAP basis. You can find a reconciliation of non-GAAP to GAAP measures on our IR website.

For Sohu Media Portal, revenues were $31 million, down 17% year-over-year. The quarterly loss was $38 million, which compares with a net loss of $70 million in the third quarter of 2017.

For Sohu Video, revenues were $26 million, down 40% from a year ago. Of this, advertising revenues were $30 million. The quarterly loss was $27 million, which compares with a net loss of $60 million in the same quarter last year.

For Sogou, total revenues were $277 million, up 7% year-over-year and is down 8% quarter-over-quarter. Net income was $28 million, down from $31 million in the same quarter last year.

For Changyou, total revenue, including 17173, were $180 million, down 29% year-over-year and up 5% quarter-over-quarter. Changyou posted net income of $54 million compared with a net loss of $5 million in the same quarter last year.

For the fourth quarter of 2018, we expect total revenues to be between $465 million and $495 million; Brand advertising revenues to be between $55 million and $60 million. This implies annual decrease of 16% to 23% and a sequential decrease of 3% to a sequential increase of 5%; Sogou revenues to be between $292 million and $307 million. This implies annual increase of 5% to 11% and a sequential increase of 6% to 11%; online game revenues to be between $85 million and $95 million. This implies annual decrease of 13% to 22% and a sequential decrease of 1% to 11%.

Before deducting the share of non-GAAP net income pertaining to noncontrolling interest, non-GAAP net loss to be between $23 million and $33 million. Assuming no new grants of share-based awards and that the market price of our share is unchanged, we estimate that compensation expense relating to share-based awards will be around $3 million. Including the impact of this share-based award, GAAP net loss before noncontrolling interest to be between $26 million and $36 million, non-GAAP net loss attributable to Sohu.com Limited to be between $45 million and $55 million and non-GAAP loss per fully diluted ADS to be between $1.15 and $1.40, including the impact of aforementioned share-based award and netting of around $2 million of Sohu's economic interest in Changyou and Sogou. GAAP net loss attributable to Sohu.com Limited to be between $46 million and $56 million and GAAP loss per fully diluted ADS to be between $1.20 and $1.45.

For the fourth quarter of 2018 guidance, we used a presumed exchange rate of RMB 7 to $1, which compares with the actual exchange rate of around RMB 6.8 to $1 for the third quarter of 2018 and RMB 6.61 to $1 for the fourth quarter of 2017.

With that, this concludes our prepared remarks. Operator, we would now like to open the call to questions.

(Operator Instructions) Our first question comes from the line of Eddie Leung from Merrill Lynch.

I'm wondering how perhaps, Charles, you think about the potential synergy between news feed as well as Sogou? So that's the first question. And then secondly, could you guys also give us some update or any color about your video subscription business? Any metrics or growth trend would be great.

Yes, there is some synergy between the Sogou news feed and Sogou because Sogou's broader and Sogou Search APP both actually providing some news feed under the search box. Sohu is also developing that, so Sohu can actually provide quality content actually directly through the company internal system instead of a robot or kind of a crawler. So -- and also -- so that's the content side. And also definitely can share some user click-through information. So that's -- definitely, there is some synergy there. And so we still need to work on it. As Sogou moving more toward information streamed business. And Video, I think we're not disclosing the children numbers, but since we have mostly the original content, the drama side, well, the variety show side is mostly based on advertising, but the drama side is mostly through subscription. So that -- and also it's Sohu exclusive only -- only Sohu Video, so that actually drives disposition. So it's our experience user base basically is growing steadily -- even slowly steadily, but we are not disclosing the numbers. And we are looking at future quarters with the improvement of the daily active users of our app -- the video app and also the introduction of newer -- the short forms of video content. And also the information streaming -- stream advertising besides the preload, we expect the video revenues to actually grow in the coming quarters.

Our next question comes from the line of Thomas Chong from Crédit Suisse.

I have a question about the macro headwinds and maturations. You just talked about that it may take several quarters for macro headwinds to last. I just wonder about the key verticals in portal and video, how we should think about the trend as we go into 2019? And my second question is about mini programs. Given the fact that the customer acquisition cost is very high these days, do we have any strategies about mini programs?

Mini programs, (foreign language) Mini programs. All right. So yes -- from the macro -- you mean the macro downturn -- not macroeconomic downturn, right? (foreign language). Yes, that -- yes, there is -- as far as economic downturn, [America constitutes]-- Brand advertising both on media portal and on video will be negatively impacted. But by innovatively having a kind of events and creative marketing events for our advertisers, we are trying to hold ground on the brand side. But we expect the SME side actually grow because those are more resilient to market condition -- macroeconomics situation because we have so many people in China who will continue to consume, right? So you have -- so the SMEs. There's hundreds or thousands advertisers that -- some are not spending money, but others are spending. So actually -- and also by now, up to this -- Sohu still have a small -- relatively very small market share of the SME market. So we expect that by better execution and innovation, we can grow our SME revenue faster than the negative impact of the macroeconomic condition on the SME.

(foreign language)

Not really. Not really, yes. I think the application put them in, yes. Okay.

Our next question comes from the line of Shi, Jialong from Nomura.

My question is about your video -- about the video business. Recently, we noticed there are some regulations being issued by Chinese authority to cap the compensations for actors. In addition, the Chinese tax authorities decided to more strictly levy tax on those actors. So I just wonder how these regulations may impact the Online Video industry as a whole. Should we expect to see a potential drop in the average cost of your self-produced video content as a result of potentially lower expenses for the cast? And also just wonder when do you expect your video business to hit breakeven?

Yes, actually, it should -- I think the recent regulation, the cap on actor/actress is have -- definitely have a positive impact, definitely -- especially, the head content will have lower cost. Actually, it will be a positively impact, low cost for the head content. But the effect on Sogou is less compared with other video companies that are still buying those head content very expensive one. We have been -- especially with our own original content, we are already using basically new -- I mean, relatively -- we -- actually, we sign our own talent and use our own actors and actresses, who sign -- with relatively new and at basically low cost. So it's not that big saving for Sohu, but we do have still buying some kind of low-cost TV programs. And that cost could be -- will be even lower in the future. So it is good. It's a good thing for the video business. The profitability timeline. So if you look at Q1, we are losing $48 million and in Q2 are losing $35 million. And this Q3, we are losing $27 million. So we are looking at -- so maybe Q3 next year or latest, will be -- in Q4, Sohu Video will reach profitability.

May I ask another question about your search business, about Sogou? So for -- I just wonder how does [changing] of the regulatory environment toward the healthcare apps? Did you see any tightening on this category? The reason I ask -- I wanted to ask this question was because your competitor Baidu decided to host all the lending pages for those healthcare apps on its own servers. So I just wonder if Sogou may follow suit.

(foreign language)

So as referring, we launched live doctor platform in fact in 2016. And we intend to offer users with reliable and trustworthy content from authority resources. We do not want to increase advertising for the healthcare sector. We believe with a differentiated initiative, we will reboot the brand over time and increase the overall competitiveness of Sogou Search.

Our next question comes from the line of Alicia Yap with Citigroup.

Actually, I have a follow-up with a couple of the questions earlier. One is that regarding salary control for the celebrity. I wonder if Charles have any comments or view about how much roughly do you think the overall professional content costs could come down? And even though, I think, Sohu will benefit less, but then for our self-produced content on the relatively term if those more high-profile salary -- celebrity salary come down, the Sohu self-produced talent could -- may also save some of the costs, right? So if you can just maybe quantify or share with us how much you think overall industry content costs could actually come down by? And then second is, I just have follow-up questions regarding your comment regarding SME could be a little bit more resilient compared to the big brands. Given we thought the weaker macro could also result to more credit tightening, right, for some of the SME. Isn't that could also affect the SME cash flow and the appetite, which could also affect potentially the SME advertising revenue? So any color you can further elaborate, that would be helpful.

Okay. The first question, let's say for -- generally speaking, there's a lot of big celebrities -- actually, a lot of them stop accepting roles because they don't want to accept a salary that does not match their status. So a lot of the head content program -- I mean, the dramas are also starting to use relatively, I would say, not the A-List, of the B or C List people now. So A-List people basically stopped. They don't want to lose their status or -- the face by accepting a lower budget salary. I mean, low salary. So it's -- so for us, as I said earlier, yes, we are less impacted or less saving for Sohu because we are not actually using those big celebrities in the first place. For our original dramas and some of our variety shows, we probably have -- we probably can use one of the relatively well known or famous actors or actresses, so savings is insignificant for us. But definitely, I would say, if those top talents or top actors or actresses do accepting -- accept roles, I think there should be about 1/2, right, or 1/3 of their previous -- I don't know. So about the SME resilience in this -- amid this weaker macro situation, resilience comes from -- it's -- there is many, like thousands or even -- for some other company like Baidu and others, they have hundreds of thousands of these kind of small ME advertisers. Then some have lower budgeting because their business -- either they went out of business or they are just [credit turning]. But there's always newcomers, new companies, new small companies emerging to serve. So there's a kind of -- you are not looking at the same number of -- same group of companies. You are looking at different companies. So there's always -- because as in -- as there is 1.4 billion people in China, people will always need to have some kind of consuming, right? So actually, even people asking less than those companies who provide the low -- cheap products or low spending products are actually making money. So they are spending money advertising. That's where the resilience comes -- how the resilience is built into the structure.

Can I just follow-up? Is it fair to say maybe -- talking about maybe some of the emerging industry, for example, the e-commerce platform that may be targeting those lower end user or...

Yes, like [indoor] like -- yes.

I see. And then some low-cost services companies could be more active?

Yes, low-cost services. Yes, because let's say -- probably the travel company would spend less because people don't have the money, right? Or people going abroad are those kinds of things are less, but there's other companies that are providing all kind of low-budget services -- low-cost services, yes.

Our next question comes from the line of [Greg Stanhill] from [Sunrose Capital].

Two questions. Number one, does the company intend to initiate a stock buyback with the shares trading near generation modes for Sohu? And two, management was very aggressive buyers in the mid-30s, yet I've seen no activity in the 17s, 16s, 18s. Just curious to hear, why?

No. We don't have a stock buyback because we're actually -- our cash need to be used to -- right? We don't have the actual cash to buyback. And as -- actually myself, I think -- I bought -- when the stock went to the teens, right, the window for the management is still closed. So I cannot buy. Does that answer your question?

Sure.

The window open by tomorrow. No -- yes, tomorrow.

There are no further questions at this time. I'll now hand the call back over to the speaker, Mr. Eric Yuan.

Yes. Okay. Thank you for joining our call, and have a good evening, and a good day. Bye-bye.

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