Sohu.com Limited (SOHU) Q3 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and good evening. Thank you for joining Sohu's third-quarter 2015 earnings conference call. [Operator Instructions]. 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's conference call, Mr. 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 2015 results. On the call are our Chairman and Chief Executive Officer, Dr. Charles Zhang; President and Chief Financial Officer, Carol Yu. Also with us from Changyou are CEO Dewen Chan; CFO Jasmine Zhou; as well as CEO of Sogou, Xiaochuan Wang; Vice President of Sogou and COO Video, Ye Deng; Vice President Finance of Sohu, Steven Sim. 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 you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. For more information about the potential risks and uncertainties, please refer to the Company's filings with the Securities and Exchange Commission, including its [indiscernible] statement 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.

Thank you. Thanks to everyone for joining our call. I'm pleased with our quarterly results amid a sluggish economy and considerable RMB depreciation. This past quarter recorded Chinese economy growth at the slowest rate since 2009. The soft macroeconomic economy had a major impact on traditional brand advertisers, who shrank their marketing budgets. In addition, the depreciation of RMB against the US dollar had an adverse effect to our reported numbers. Despite these factors and excluding certain non-recurring items, we still managed to deliver in-line revenue performance and operating profit well exceeded our prior expectations. Now for the different business lines. For Sohu Media Portal, in the third quarter we continued to refine mobile news app interface to improve user experience. In the meantime, we strived to enhance our content offering, providing users high-quality news and reliable information. For Sohu Video, while we took a cautious approach to acquiring head content, we have been more aggressively investing in original content and the PGC, professionally generated content. Sogou continued to deliver strong top-line and bottom-line performance while it prepared to ramp up investment in promoting its search brand. Changyou continued to deliver strong revenue and cash flow, and with its strong R&D capabilities as well as a vast user base from the legacy TLBB game, Changyou is well positioned to bring new hit games to the market. Before I give more details about our key businesses, let me summarize our financial results for the third quarter of 2015. Total revenues $520 million, up 21% year-over-year and 6% quarter over quarter. Should we have excluded the effect of the depreciation of RMB against the US dollar, the total revenue would have been $14 million higher, with a growth rate of 25% year-over-year and 9% quarter over quarter. Net brand advertising revenue, $152 million, up 2% year-over-year and flat quarter-over quarter. Excluding exchange rate effects, brand ad revenue would have been 5% year-over-year and 4% quarter-over-quarter growth. Amongst the reported number of $152 million, revenues from Sohu Media Portal or Sohu.com [Video] $51 million, down 6% year over year. Sohu Video revenues of $57 million, up 9% year over year. Sogou revenues are $162 million, up 53% year over year and 10% quarter over quarter. Before non-controlling interest, Sogou posted net income of $34 million. Had Sohu Group included Sogou's net income based on its 40% equity stake in Sogou, Sohu Group would have been able to recognize an additional $40 million in profit, which is not included in our earnings yet. Online game revenues $153 million, flat year over year and then down 12% quarter over quarter. No-GAAP net income attributable to Sohu.com was $49 million or $1.27 per fully diluted share. Now let me go through some of our key businesses. First of all our media business. For Sohu Media Portal, in the third quarter we focused our efforts in enhancing features with our leading mobile news app and improving our overall content quality. For content, we have adopted a hybrid approach to produce high-quality and diversified content. Our lean by highly efficient [advertising] team now mainly focused on reporting general and business news and major events. For example, during the quarter we fully covered Xi Jinping's visit to US and accidental explosion in Tianjin in the meantime, for example. So in the meantime the -- for leisure and service-oriented topics, such as travel and fashion, we invited a vast number of outside contributors and bloggers who generated hundreds of articles on a daily basis. We also rolled out unique channels that target the younger generation, such as we launched a very popular jogging running channel and also a channel of horoscopes. Moving to Sohu Video, over the past few quarters China online video industry has been increasingly competitive and we've been seeing continuous price escalation following its license for content. The return on investment for traditional dramas and variety shows have further deteriorated. To get out of this dilemma, our strategy is to shift the focus to the creation of native web content, online content, namely original content and PGC. Therefore while we still secured a good number of premium dramas and variety shows with a more rational budget, we intend to divert more resource to original content and PGC. For original content, we unveiled one popular drama after another. In the third quarter, for example, [indiscernible], the [Master] Killer, a suspense-themed drama, set a new record among all of our original dramas for video view, reaching 800 million video views during the broadcast period. More recently another drama called Love Me If You Dare, Ta Lai Le, Qing Bi Yan, has received a large number of favorable reviews on social networking sites since its debut and has ranked as one of the top dramas on Baidu search index. For these two dramas we will continue to derive long-term benefits, including producing sequels, and we have secured multi-year deals with the IP owner. For other shows like Diors Man series, which Sohu Video has full IP rights, we can develop the commercial value in even broader scope. Diors Man is one of the most successful web series in our industry, with its widespread popularity, helping us enter into the movie production business for the first time. In the third quarter Sohu invested movie [indiscernible], which is the movie version of Diors Man, was released and became an instant blockbuster, collecting more than $160 million at the box office. This single project generated $29 million in net revenue and $23 million in net profit for Sohu. We look forward to building on this innovative model in the future. Now paid subscription business is another area where there is tremendous opportunity. This year we saw a fast growth in the number of subscribers across the industry, where the economics of the business is healthier than the traditional business -- ad business. Last quarter a Korean drama called [The Producer] [indiscernible] was exclusively broadcast on our platform. We allow the viewers to watch the entire series without waiting for the weekly updates when they subscribe to our monthly service. This proved to be a very effective marketing tool with our paid subscribers nearly doubled in the first month since we activated this service. Looking ahead, we plan to replicate such models by making more exclusive content available on our paid channels. Lastly, I'd like to share some updates about our video ad sales. Similar to our media portal, we feel the pressure amid the economic slowdown. Big advertisers will be becoming more conservative as they tend to prioritize their reduced budgets to the best known traditional programs, a category in which we have consciously scaled down the investment given the irrational price tag. As a result, for the third quarter video ad revenue decelerated to a growth rate of 9% year on year. And revenues from mobile account for 42% of total revenue. Now about Sogou, in the third quarter Sogou mobile search traffic for the first time surpassed PC traffic. With the solid new product offerings we are now prepared to launch major brand campaigns for Sogou to expand its presence in mobile search market. Xiaochuan will update you more details after my remarks. Lastly about Changyou. Changyou's management team has repositioned itself once again as a game-centric company and focused on enhancing its R&D capabilities. Our proven R&D team with extensive experience in MMO PC games is now realigning to the development of hard-core mobile games. In addition, Changyou enjoys a strong portfolio of IP that enables itself to develop new hit games going forward. Now let me pass the call over to Wang Xiaochuan for an overview of Sogou business. Xiaochuan?

[Foreign Language] Thank you, Charles. For the third quarter, Sogou once again posted record revenue and profit. We continue to accelerate the penetration of mobile products. Mobile search traffic maintained faster growth and surpassed PC traffic for the first time. Our leading mobile [info tasks], such as mobile keyboard, further expanded its user base. According to our research, Sogou mobile keyboard remained the third largest mobile application in China in terms of daily active users. On the product front, with the focus on differentiating our mobile search service by adding more unique and high-quality content and services, as an example, we recently established exclusive search-based access to several hundred thousand of Tencent's QQ interest tribes. The posts, photo albums and activities within this tribe now can be discovered by Sogou search users. Sogou [Win-Win], our question-and-answer-based platform, has also been deeply integrated with QQ groups. As an in-group function it can have users send questions and review answers from other members within each group. We're also stepping up our O2O local services by launching an open platform which covers popular services, such as movie tickets, restaurants and a courier service. Users can be directed to third party platforms to complete orders via Sogou search. For Sogou mobile keyboard, building our clear leadership position, we are relentless in product innovation, with the most recent innovations being around voice and image recognition features. For voice recognition, our adoption of deep learning technology improves the accuracy substantially. This in turn helps bring usage of voice input functions within Sogou mobile keyboard to almost 100 million times a day, making Sogou the top player in terms of voice input among all mobile applications in China. For image recognition, we also launched a new feature, where Chinese characters embedded in a picture can be identified by Sogou mobile keyboard and automatically converted into text. This can help increase input speed and is quite useful given the complexity of typing Chinese characters. During the past quarter, leveraging the various resources of our two major shareholders, Sohu and Tencent, we strive to enhance the Sogou brand. For example, in conjunction with the release of Sohu Video's blockbuster movie, Jianbin Man, posters featuring Sogou search were placed in the cinemas in 40 major cities in China. Given that a range of good Sogou products have been well lined up and some of the best technology in place, we will be more aggressive in brand promotion for new users. Financially, for the third quarter Sogou's total revenues reached $162 million, up 53% year over year. Taking out the impact of the depreciating RMB against the US dollar, revenues would have been 56% higher. Mobile monetization shows good progress, with mobile search revenues contributing 30% of total search revenue, up from 14% a year ago. Non-GAAP net income was $34 million, more than 5 times the level from a year ago. I would now like to turn the call over to our Vice President of Finance, Steven, who will walk you through the Group's financial results.

Thank you, Xiaochuan. I'll walk you through the key financials for the third quarter. The profit and loss numbers mentioned below are all on a non-GAAP basis. For brand ad business, in the third quarter net brand advertising revenues were $152 million, up 2% year over year and flat quarter over quarter. Of this, revenues of Sohu Media Portal were $51 million, down 6% year over year. The business posted a net income of $7 million as compared to net income of $3 million in the prior year. Revenues of Sohu Video were $57 million, up 9% year over year. Sohu Video posted net loss of $15 million as compared to a net loss of $28 million in the prior year. Excluding the $23 million net income recognized from the movie Jianbin Man, net loss for the third quarter would have been $38 million. For Sogou for the third quarter, total revenues were $162 million, up 53% year over year and 10% quarter over quarter. Of this, search-related revenues were $148 million, up [50%] year over year and 9% quarter over quarter. Before non-controlling interests, Sogou posted net income of $34 million as compared to $7 million in the prior year. Under Sohu's Group income statement, Sogou profit in the third quarter was recorded as non-controlling interest to reflect the interest in Sogou held by Sogou's non-controlling shareholders, reflecting the allocation of Sogou profits based on investment terms and terms of the [costs] of shares held by non-controlling shareholders in Sogou. Should Sohu Group include a share of Sogou profit based on its 40% shareholding percentage on a fully diluted basis, which better reflects our economic rights, Sohu Group would have been able to recognize an additional $40 million in profits. For Changyou for the third quarter, total revenues, including 17173, were $189 million, up 4% year over year and down 7% quarter over quarter. Before non-controlling interest, Changyou posted a net income of $78 million versus net income of $4 million in the prior year. For the Group, in the third quarter total revenues were $522 million, up 21% year over year and 6% quarter over quarter. Non-GAAP net income attributable to Sohu.com Inc. was $49 million or $1.27 per fully -- sorry, $1.27 per fully diluted share. Now let me provide our outlook for the fourth quarter of 2015. We're expecting total revenues to be between $435 million and $465 million. Brand advertising revenues to be between $135 million and $145 million. This implies a sequential decrease of 4% to 11% and an annual decrease of 2% to 9%. Sohu Media Portal revenues to be between 34% and 36% of total brand advertising revenue. Sohu Video revenues to be between 35% and 38% of total brand advertising revenues. Sogou revenues to be between $165 million and $175 million. This implies a sequential increase of 2% to 8% and an annual growth of 38% to 47%. Online game revenues to be between $115 million and $125 million. This implies a sequential decrease of 18% to 25% and an annual decrease of 32% to 38%. Before deducting the share of non-GAAP net income pertaining to non-controlling interest, non-GAAP net income to be between $10 million and $20 million. Non-GAAP net loss attributable to Sohu.com Inc. to be between $15 million and $25 million. And non-GAAP loss per fully diluted share to be between $0.40 and $0.65. Assuming no new grants of share-based awards, we estimate that compensation expense relating to share-based awards will be around $30 million to $40 million. GAAP net loss attributable to Sohu.com Inc. to be between $25 million and $35 million, and GAAP loss per fully diluted share to be between $0.65 and $0.90. Now, I turn over the call to Carol to make her concluding remarks.

Thank you, Steven. Two of our Group subsidiaries. Sogou and Changyou have continued to contribute sizable revenues and profits. Sohu Video continues its rational spending on [hard] content and strives for better, more cost-efficient original and PGC. These developments, together with a strong balance sheet, enabled our Group to maintain competitiveness in the China Internet's market. This concludes our concluding remarks. This does conclude our prepared remarks. Operator, we would now like to open the call to questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions]. Your first question comes from the line of Eddie Leung from Merrill Lynch. Please go ahead.

Good evening. Thank you for taking my questions. Two questions about Sogou. You mentioned that there has been some negative impact from macro on brand advertising, so just wondering if you could also talk a little bit about your search outlook and any potential impact from macro. And then, a housekeeping question about the advertisers of Sogou -- could you give us the number of advertisers for Sogou in the third quarter? Thank you.

[Foreign Language]. Okay, for the search business, we do feel some pressure from the macro headwinds and sectors, like finance, gaming and e-commerce, more or less impacted. And in terms of the outlook, I think we are still evaluating the negative implications from macro, and we have some more visibility over time. In terms of the number of advertisers, from the third quarter, we have 64,000 advertisers for the search business, which remains flattish quarter on quarter, and about 14% growth year on year.

Thank you for the questions. I’ll now move on to the next questions from the line of Gregory Zhao from Barclays. Please go ahead.

Hi, management. Thanks for taking my question. I have two questions. The first tone is about our video content. I think regarding the big box office sharing from [gaming in China], we made good success in movie market, so just wanted to know the Company's future plans in moving production and distribution. This is my first question.

Yes, we are planning to look into this business, but at this time, it's just a one off. And our strategy to move into movie production aggressively or not depends on our online subscriptions, because movies -- our online strategy has to be -- our offline box office strategy has to be aligned with our online strategy, which is basically a subscription paid service. So if we achieve a sizable user base of a paid user base, we probably will be -- move more aggressively to movie production. Looking at year 2016, we probably -- maybe one or two movies.

Thank you. My second question is about our advertising services. It's our mobile advertising services. I just wanted to get some update of our key advertising categories or the [inventories] of our advertisers on our mobile portal and our mobile video services and what's the difference of the advertising mix there. Thank you.

We are able to achieve a flattish or basically in-line advertising for our media portal because we have a much higher percentage of mobile advertising, which basically the inventories are -- because the default user behaviors are moving to mobile. So we are actually -- the business model is basically shifting toward a business that's in an upward trajectory in terms of user behavior. So compared between the mobile media portal and the video, those two are mostly the growth really happened on the mobile side. But for the news and text-based media portal, we see, besides the traditional advertisers -- we see some small-medium enterprises coming along to appear in our -- people's news feeding lines. These new formats actually fit these small-medium enterprises. In terms of the head advertisers, the sector is still as usual, right? Basically, it's led by auto and e-commerce, IT and fast-moving consumer goods, so it's -- but it's really the smaller companies or smaller amount of payments per company. Those are really coming along strong, which we believe these are more resilient in an economic downturn. For the video business, we are looking at -- we are seeing a shifting of the television advertisers. People who advertise on the television now find the Internet more cost efficient.

Thank you for the questions. Our next question comes from the line of Chi Tsang from HSBC. Please go ahead.

Good evening. Thank you for taking my question. So I have two questions regarding video. So, firstly, when I look at your video revenues, up 9% year on year, then I'm looking at your guidance. I'm wondering how much of the slowdown is really coming from you're losing market share versus actually just the weaker budget environments, so that's my first question.

I think it's due to the weaker budgets -- elements. We are actually the first company that reports quarterly, so I think what we are saying about the softer macroeconomic situation, macroeconomic situation, you just wait and see, to see other companies' results. But we are -- in terms of user traffic, we are not losing market share.

Okay, so my second question is, I was wondering if you can comment on the Alibaba acquiring Youku. So in your mind, does that make the industry more or less rational? Thank you.

I think in terms of content price competition, it makes it probably less irrational -- I mean, more irrational -- less rational. So the price will probably deteriorate, continue. But we believe that the video business is really -- needs innovation, so I think in terms of innovation, new business model emerging, these are actually -- give us more opportunity to explore. Because for the video business to actually have a sustainable and money-making business, it's got to really move into more creative business models, instead of just competing head on on these -- have very expensive content, [head] content.

So if you think the market is getting -- industry is getting more irrational, do you think that you guys have the scales to continue to operate independently, or do you think you might have to find another partner to be more successful in video? Thanks.

What I'm saying, that the irrationality only happens in this very traditional [head] content competition, but that's not a whole picture of the video business. For the Internet companies, the money is not the only elements in competing, so there's other factors that are much more important than money, so that's why we are not -- we are going to compete independently, and we believe we will be more competitive.

Thank you for the questions. Next question comes from the line of Henry Guo from Summit Research. Please go ahead.

Thanks for taking my question, so two very quick ones. So the first is the online video contents. Have you guys disclosed how much content costs you guys spent in Q3?

Actually, in Q3, actually, we actually had a smaller spending, right, compared with Q2, right? So it's $41 million.

Great, thank you.

Compared with $49 million in Q2.

Hello. It's $41 million, right, in Q3?

Yes, right.

Okay, great. Thank you. And then my second question is regarding [for your] trends is about Sogou Search. I think that's [now] you mentioned the economic impact to the Sogou business, so can you just disclose the breakout of revenue contribution (technical difficulty).

The last sentence we cannot hear.

The revenue breakout between large advertisers and SMEs for Sogou business, for Sogou Search?

I think there is no larger advertisers for Sogou, right? Mostly are SMEs, so I think it's more resilient.

So the -- but I think [indiscernible] just mentioned that the economy had some impact on the business, so pretty much that impact is really from the SME customers so far. Okay, great. Thank you.

Definitely. It definitely will influence -- impact it, but not as large as to -- the head advertisers, large advertisers.

Thank you for your questions. Next question is comes from the line of Hillman Chen from Macquarie. Please ask your question.

Thank you, management, for taking my question. Regarding your search business, could you talk about the traffic, the search traffic breakdown among some of your key sources, including QQ Browser, [Rechat], your Sogou Mobile Search app and others and what contributed to the most incremental traffic?

[Foreign Language] So in terms of mobile search traffic, I think over half of that comes from Tencent's QQ Mobile Browser, and we also see incremental traffic from search apps and other organic sources.

So which sources contributed to the most increment in terms of the mobile search traffic?

[Foreign Language].

And my -- another question is about the paid user subscriptions for the video businesses. Could you talk about some data point around your paid user subscriptions, and also your strategy to drive subscriptions higher? Thank you.

So the paid subscription, we started from a low base, small base, but we do see a jump of users, subscribers after we launched the Korean TV series, Producer. So we believe that in 2016, our paid services will have a meaningful part of our overall revenue. So our strategy is to have more TV series and content that we have the right to charge for the whole series and also movies and in conjunction with our own produced movies. So the paid service will be a very central strategy for 2016.

Okay, just one follow-up question on that. I think some time ago, like for Sohu Video, US TV drama used to be the key [to traction], and now we are definitely shifting towards the PGC and [indiscernible]. So going forwards, how are you positioning Sohu video to attract paid users? And compare a little bit about the pricing -- I think for now, if we look at the monthly subscription price, Sohu Video is among the lowest, but if we look at the yearly subscription price, it's roughly the same. So what's our content strategy and pricing strategy and how we're positioning ourselves to drive that piece going forward. Thank you.

Yes, I think the US TV dramas, because of the regulation reasons, so it is -- I think it's past its golden time, but still, it's going to be continuing a long-term necessity for Chinese users. But actually, the ballpark -- the large majority is really the mainstream TV dramas that will continue to compete on this traditional TV drama head content business. Through also our budget, you can see that Q3 is actually lower than Q2, but because of our traditional genetically smart, in terms of entertainment and content, we actually had a very higher rate of good bidding -- betting on the best quality content of the domestic TV dramas. So we'll stay in the game and continue to compete in this advertising-based head content. For example, we -- all these major hit shows in China, Sohu all have it, like [Widrangua], like [Xinfash], [Liadang] and [Wachenbu]. All these most popular hit TV series, talk of the town TV series, Sohu -- and even under limited budget, we have them. So we are not backing off. We are not -- we are still competing in this traditional head content advertising business, but we're definitely aggressively moving into paid services and also PGC. And for the PGC now, we started from a low point, and the price is still now quite competitive, but definitely, when we have larger offerings, we definitely will adjust the price next year, and also PGC, those are -- it's through technology innovation. So we are going to -- looking into the future, our video business competitive strategy hardly shifted to not only -- basically not just depend on the -- the money-dependent, heavy-investment head content advertising competition, but new routes. A new path has already emerged.

Thank you for the questions. Next question comes from the line of Alvin Jiang from Morgan Stanley. Please go ahead.

Hi, management. Thank you for taking my questions. It's Ben Lin calling on behalf of Alvin. I have two questions. My first question is regarding your -- sorry, regarding the macro influence of traditional ad business. In terms of verticals, which vertical are we seeing most influenced by the macro? That's the first question. My second question is related to your video strategy. So we are currently switching to a more PGC-related strategy, but we also see that in 2015, we are seeing some professional content providers, like [indiscernible]. They actually have -- seems to be growing stronger and have a stronger [budgeting] power. So is it possible that in the very short time, the cost of PGC will actually achieve the same level as those acquired dramas? So, yes, that is my two questions. Thank you.

Well, verticals, [we saw] verticals appear and disappear. Impact. Yes, the impact that the winter that felt first by the two verticals are really auto and IT sector. And in the smaller -- many smaller verticals related to people's daily needs, and those things are impacted less. That's actually we're -- our advertisers, really proliferation of those kind of advertisers, if you check our Sohu News app, you can see all kind of advertisers, much more variety than compared with the before. So we believe those kind of smaller advertisers are more economically -- more economic depression resilient. In terms of your second question, I think there's -- I need to clarify about this PGC, the P. It stands for professional. We mean professional. It's a word that we not invented, but we just adopted. It doesn't mean a company like you mentioned, [indiscernible]. It doesn't mean those kind of professional, large studios. It's actually anyone who really has good ideas and really focused -- it may be one person or a few persons, to produce a very -- a video clips that's worth watching and really providing knowledge and useful and fun to people. We consider it to be professionally produced. So that means that we don't buy -- we don't buy those content. They update their content, and we really have advertising in front of it. We share revenue with them, so there is no cost -- there is issue here. There is a cost issue, but it's not really upfront, big buying.