Sohu.com Inc. (NASDAQ:SOHU) Q4 2018 Earnings Conference Call February 1, 2019 8:30 AM ET

Company Participants

Eric Yuan - Investor Relations Director
Dr. Charles Zhang - Chairman and CEO
Joanna Lv - CFO
Dewen Chen - Changyou's CEO
Yaobin Wang - Changyou's CFO
Xiaochuan Wang - Sogou's CEO
Joe Zhou - Sogou's CFO

Conference Call Participants

Thomas Chong - Credit Suisse
Alicia Yap - Citigroup
Shi Jialong - Nomura

Operator

Ladies and gentlemen, thank you for standing by, and good evening. Thank you for joining Sohu's Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's prepared remarks, there will be a Q-and-Answer session. Today's conference call is being recorded. If you have any objections, you may disconnect at this time.

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

Eric Yuan

Thanks, operator. Thank you for joining us today to discuss Sohu's fourth 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; 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 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 with that a number of important factors could cause actual results to differ materially from those presenting, any forward looking statements. For many information about the potential risks and uncertainties, please refer to the company's filings with the Securities and Exchange Commission, including its registration statements and most recent annual report on Form 10-K.

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

Dr. Charles Zhang

Thanks, Eric, and thanks to everyone for joining our call. During 2018, as we faced a challenging macroeconomic environment, we focused our resources on key mobile products and worked hard to improve operating efficiencies. While annual revenues were largely flat compared with 2017, our bottom-line performance was meaningfully improved, thanks to a variety of cost saving efforts.

For Sohu Media Portal, daily active users of Sohu News app, our flagship mobile product, outpaced the industry's growth benefiting from superior content and continued upgrades of the recommendation engine. For Sohu Video, we focused on original program production, providing users unique and high quality dramas and shows. In the meantime, we significantly cut spending our traditional TV programs and successfully lowered the segment's loss over 60% compared to 2017.

In 2018 Sogou mobile search and mobile keyboard continued to gain user traction over its leading AI capabilities have now been -- and have been not only recognized in the international context but also applied to new commercial use cases.

Lastly, Changyou delivered in line financial results supported by solid performance of TLBB PC and mobile games like TLBB and other more mobile games. For 2019 Changyou will strengthen its research and development capabilities to launch more hit games.

Before I go into more details of our key business let me summarize our financial results for the fourth quarter. So for the fourth quarter, total revenues $482 million, down 5% year-over-year, up 5% quarter-over-quarter. If on the constant currency basis, total revenue would have been $22 million higher than our reported revenues and down 1% year-over-year.

Net brand advertising revenue is $57 million, down 20% year-over-year and flat quarter-over-quarter. Search and search related advertising revenues $277 million, up 12% year-over-year and 8% quarter-over-quarter.

Online games revenue $94 million, down 14% year-over-year and 2% quarter-over-quarter. Operating loss for Sohu Video was $30 million compared with a loss of $69 million in the fourth quarter of 2017.

GAAP net income attributable to Sohu.com Limited was $15 million compared with a net loss of $295 million in the fourth quarter of 2017. Non-GAAP net loss attributable to Sohu.com Limited was loss of $59 million compared with a net loss of $78 million in the fourth quarter of 2017. But in the fourth quarter of 2018, Changyou recognized a $60 million charge for goodwill impairment related to the one time announcement of industry website. Excluding the effect of this goodwill impairment charge non-GAAP net loss attributable to sohu.com would have been $48 million instead of $59 million. So $48 million compared with the $78 million in the fourth quarter of 2017.

So now let me look at full year 2018. Total revenue is $1.8 billion, up 1% from 2017. Net brand advertising revenue is $232 million, down 26% from 2017. Search and search related advertising revenue is $1.1 billion, up 28% from 2017. Online games revenues were $298 million, down 13% from 2017. Operating loss for Sohu Video was $140 million compared with a loss of $302 million in 2017 [indiscernible] reduction -- 100% reduction -- more than a 100% reduction.

So GAAP net loss attributable to Sohu.com Limited was $161 million compared with a net loss of $556 million in 2017. Non-GAAP net loss attributable to Sohu.com Limited was $237 million compared with a net loss of $210 million in 2017.

So now let me go through some of our key businesses. First of all, the Media Portal business. As one of the leading online media platform in China was declined EBIT growth as a main priority for Sohu media business in 2018. Our [indiscernible] will continue to elevate the quality of our content including our [indiscernible] as well as the third-party content in media of Sohu. On the other hand we strengthened the product, upgraded the design of our flagship mobile news product, the Sohu News app. And especially continually refining the algorithm that drives the recognition engine behind the apps and make it more intelligent, basically applied AI technology, machine learning.

We can now send more relevant stories to users, to smartphones more quickly and accurately. In addition, we accurately invested in expanding the distribution of Sohu News app through pre-installations on Meizu mobile phones brand. And as a result of these efforts, all user metrics surpass industry's growth over the past year, actually significantly. In December 2018, the daily active users of Sohu News app doubled, while the leading page view tripled from year ago. The solid performance should help lay the groundwork for stronger monetization in 2019, first, year-to-date then the monetization.

In 2018, the slowdown in China's economy growth negatively impacted our advertising revenues as some of the most important sectors such as Auto and IT experienced the difficulties. The industry-wide budget cuts that we saw last year may last for few more quarters in 2019. To adjust this challenging situation, we plan to increase content marketing efforts to seek promotional budgets from key clients. At the same time we’re upgrading our advertising system to improve conversions so that we can get more budget allocation from SME customers. So despite the macro headwinds, the strong ease of traction and execution, I'm confident that Sohu Media will achieve positive growth in 2019.

Now moving to the Sohu Video. In 2018, our content strategy was to provide users with the balanced mix of in-house developed drama and shows, and low-cost nonexclusive TV program as well as in rich short-form -- short video clips. We are pleased to see that as we give up some most -- some of the most expensive license content, the overall content ROI improved substantially. At the same time, we seriously reviewed our options -- reviewed our operations and terminated a number of the noncore and profitable projects. The affect was quite clear. Sohu Video's financial loss in 2018 saw a 55% drop from a year ago.

In terms of our original content in 2018, we released a total of 12 dramas and 5 daily variety shows. For dramas, leveraging our industry knowledge, and also we have a team of talented producers and unique insights about new trend. So our teams has developed a series of popular dramas such as [Indiscernible] and Medical Examiner Dr. Qin and [indiscernible] and also the Sogou like the X-Files TV drama episode. Such high quality content helped us retained a largely group of reviewers who are willing to pay for our dramas. Therefore, even though we reduced our budget for originals -- the expensive license drama, significantly, the subscription revenue in 2018 actually was stable compared to 2017. And for the reality shows, variety shows, we've launched a number of differentiated projects to target certain demographic groups such as one of the very successful one, [Indiscernible] white-collar woman theme reality show, which drew a positive view for its two seasons, Season 1 and 2.

We also approached a potential advertising client at the early stage of the development of our projects in order secure $100 million. Because it's self made program and we are able to do that. This move helped to increase the likelihood that we can make profit from the projects.

So for this year -- for 2019, we planned to keep up the pace of our original common production focusing on quality over quantity. We're also acquiring more inexpensive low-cost TV programs to compliment our content library. For short video clips, we planned to enhance the personalization features in Sohu Video app to better match users with content we want. In short, with the healthier and more sustainable business model and the content mix, I believe Sohu Video is on track to continue improving its bottom-line in 2019.

Now, next turning to Sogou. In 2018, we have increasingly targeted and integrated AI technologies into our products and services. At Sogou Search, we made dedicated efforts to improve the quality of search results, enriched our differentiated content and continued to upgrade such services to the question-and-answer-based search. And also, with Sogou Mobile Keyboard, its user base continued to expand. By the end of year Sohu Mobile Keyboard daily active users reached 430 million users a day, an increase of 28% from prior year.

In the [indiscernible] we also made track skill in language centric technologies. We explore ways to use our AI technology in track skill connect applications. For instance, in November 2018, at the Fifth World International Conference in Weixin, we debuted the world's first AI news anchor in partnership with Weixin Agency, leaving Sogou's vacational avatars solution with virtue anchor create a lifelike resemblance of a professional human anchor. The success has then generated, while interest among media and featuring other industries.

Lastly, for Changyou, in 2018, Changyou's Flex TLBB PC and the Legacy TLBB mobile game both performed well driven by content launch of a new extension pack -- both performed well driven by content launch of new extension packs. The common features -- the content features introduced into games effectively drew many gamers back and improved the user engagement. Changyou will continue to contribute healthy free cash flow to our Group. For the full year, its total revenue reached $486 million, and excluding certain one-off items, non-GAAP net income was $141 million.

Looking ahead Changyou's priority is to develop top level quality games. MMORPG mobile games will continue to be its strategic focus where we’re also exploring the opportunities with schedule and strategy games. Its management had spent a significant time to review the game in pipeline and set higher standard in the game development process. And these efforts should help us lay a solid foundation for producing high quality games in the future.

I would like now to turn the call to Joanna, our CFO, who will walk you through our financial results. Joanna?

Joanna Lv

Thank you, Charles. I will walk you through the key financials of our four major segments for the first quarter and full year of 2018. All the numbers that I will mention are all under non-GAAP basis.

For Sohu Media Portal, quarterly revenues were $33 million, down 10% year-over-year. Quarterly loss was $36 million, which compares with a net loss of $25 million in the fourth quarter of 2017. For full year 2018, Sohu Media Portal revenues were $128 million, down 16% from 2017. Its full year net loss was $141 million compared with net loss of $67 million in 2017.

For Sohu Video, quarterly revenues were $26 million, down 34% from a year ago, of which advertising revenues were $13 million. Quarterly loss was $13 million, which compares with a net loss of $69 million in the same quarter last year.

For full year 2018, Sohu Video's total revenues were $150 million, down 29% from a year ago, of which advertising revenue was $64 million. Sohu Video's full year loss was $113 million compared with a net loss of $302 million in 2017. For Sogou, quarterly revenues were $298 million, up 7% year-over-year and 8% quarter-over-quarter. Net income was $27 million compared with net income of $38 million in the same quarter last year. For full year 2018, its total revenues were $1.12 billion, up 24% compared with 2017. Net income was $113 million compared with net income of $106 million in 2017.

For Changyou, quarterly revenues, including 17173 were $180 million, down 18% year-over-year and flat quarter-over-quarter. Changyou posted net income of $11 million compared with net income of $34 million in the same quarter last year. For full year 2018, Sohu revenues were $486 million, down 16% compared with 2017. Changyou posted net income of $78 million compared with net income of $126 million in 2017. For the first quarter of 2019, we expect total revenues to be between $390 million and $450 million, from advertising revenues to be between $45 million and $50 million. This implies annual decrease of 11% to 20% and a sequential decrease of 13% to 21%. Sohu revenues to be between $231 million and $241 million. This implies annual decrease of 3% to 7%, and a sequential decrease of 19% to 22%.

Online game revenues to be between $80 million and $90 million. This implies an annual decrease of 16% to 24%, and a sequential decrease of 12% to 15%, non-GAAP net loss attributable to Sohu.com Limited to be between $50 million and $60 million and non-GAAP loss per fully diluted EDS to be between $1.30 and $1.55, GAAP net loss attributable to Sohu.com Limited to be between $55 million and $65 million, and GAAP loss for fully diluted EDS to be between $1.40 and $1.55. For the first quarter 2019 guidance, we used a presumed exchange rate of RMB 6.9 to $1, which compares with the actual exchange rate of RMB 6.36 to $1 for the first quarter of 2018, and RMB 6.9 to $1 for the fourth quarter of 2018.

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

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer session [Operator Instructions] The first question comes from the line of Thomas Chong from Credit Suisse. Please ask your question.

Thomas Chong

I've got a question on our brand advertising. When I'm looking at the Q1 guidance, can management talk about how much is coming from negative seasonality? And any impacts do we see from macro headwinds? Thank you.

Dr. Charles Zhang

So Thomas your question is how much is from the [indiscernible] account?

Thomas Chong

Yes. Basically, for brand advertising, our sequential metrics decline is about, somewhere around 15% to 21% on a sequential basis. So I just wanted to get a sense about how much is actually for macro headwinds and how much is coming from negative seasonality, because historically, when we're looking at the brand advertising business, typically [indiscernible] developing someway along that range. So just want to get a sense about -- do we actually see any impact on the macro headwinds.

Dr. Charles Zhang

I think it's more of seasonality. We have Chinese New Year, the fourth quarter. So the macroeconomic situations definitely have an impact, but since Sohu's having brand advertising market share is still relatively small. The headwinds or the impact is less -- secondary to the seasonality of the Chinese New Year.

Operator

Our next question comes from the line of Alicia Yap from Citigroup. Please ask your question.

Alicia Yap

I have a question about macro impact. How is this year macro softness compared to previous down cycle? And what are the industry vertical that we will be most impacted? Thank you.

Dr. Charles Zhang

Yes. So -- it is -- we're looking at -- we're seeing the some of the traditional factors are that our advertisers like auto and IT sectors are actually have -- [indiscernible] but we just need to develop new clients, new customers to have a just broader range or mix of customers because there is one point for one billion people in China, and we need to consume things. So there's always companies have need to advertise something. So we just need to have better spread of advertisers. And also as I said earlier, since the Sohu's advertising market share is relatively small, so the -- we just need to have -- although the overall price shrinking some expense, we just need to work harder and do a better job to have a larger allocation of the price. So that's why we're looking at the growth in this year.

Operator

Thank you. Our next question comes from the line of Shi Jialong from Nomura. Please ask you question.

Shi Jialong

I have two questions both about your video business. And we saw the net loss -- the operating loss for your video business narrowed quite meaningfully in Q4. So I just wondered if you can update us where your video business can hit breakeven based on the latest progress they made? And also what do you think is a long-term sustainable option margin for your online video business? So this is question number one. And question number two is about your regulation. Online video business or industry in China used to enjoy less regulation than TV in content productions as well as in the types of contents that were allowed to air. And however, we saw regulations on video contents were tightening quite rapidly, in particular, in the past two years. So I just wonder where we are now in terms of the video regulation that you -- I just wonder if you guys do enjoy relatively less regulations than TV? Thank you.

Dr. Charles Zhang

For the first question, we already established a trend of cost cutting. So we -- compared with, so we are -- so the Q4 loss is $30 million. And actually there is kind of a -- it's a new number because of some kind of [indiscernible] effect

Joanna Lv

Impairment …

Dr. Charles Zhang

Impairment of some of the American TV dramas -- there is like $6 million of goodwill. Actually the real loss is actually $24 million. That means a reduction -- a significant reduction compared with a year ago. Actually we've already established this trend of narrowing the loss. And we’re looking at, I feel -- I am still looking at a quarter in this year that we -- the Sohu Video will reach profitability. As I've just said in our -- in my talk that we already -- we found the way toward the future because a mix of house produced -- in-house produced dramas and [indiscernible] and also variety shows were advertising and also low cost-cutting TV programs instead of the very high expensive ones and also short videos. So with the good video mix and a better monetization, we are looking at a path to profitability a quarter -- some quarter in this year. Your second question, about regulations, yes, it's tightening the -- both the long clips, I mean, the video, the dramas or the variety show of the long clips or the short clips, they're tightening. But actually I would say the impact is less on the video compared with actually on the news side, so -- on the media side. So, and since -- especially was -- it affect everyone, because as we all know about when an economic downturn, people mostly stay home and don’t go out and spend money, and people order things and keep things and people just to play online games and watching video. That’s why that’s a good time to produce a lot of good video programs for people to watch. So it's actually an online activity. And we all know that actually in the last 1930s Hollywood got really [indiscernible] recession, right. So we’re looking at opportunities.

Operator

Thank you. [Operator Instructions] There are no more questions. That does conclude our conference for today. Thank you for your participating. You may all disconnect.