Sohu.com Limited (SOHU) Q4 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and good evening. Thank you for joining Sohu's Fourth Quarter and Fiscal Year 2017 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 for Sohu. Please go ahead, sir.

Thanks, operator. Thank you for joining us today to discuss Sohu's fourth quarter 2017 results. On the call are Chairman and Chief Executive Officer, 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 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 registration statement and the 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, Eric. And thanks to everyone for joining our call. We ended 2017 with an eventful quarter. After 14 years of great effort, our search subsidiary, Sogou, finally completed a successful U.S. IPO in November. The IPO has strengthened Sogou's brand and the balance sheet, and should help us to further expand our market share in China's search industry while developing advanced AI technology capabilities. For Sohu Media Portal, we have built a stronger product development team and seen encouraging user metrics for Sohu News App. For Sohu Video, 2017 was a transformative year, when we shifted our focus to original content and began to significantly cut spending on traditional TV dramas programs. The initiative should generate meaningful cost savings and narrow the losses in our video businesses in 2018 this year. On the online game side, 2017 Changyou benefited from the launch of mobile game, Legacy TLBB, and achieved solid year-over-year growth in revenue and adjusted net profit. At the same time, the business has not stopped its effort in developing multiple new mobile games and diversifying its game portfolio. Before I give more details about our key businesses, let me summarize the overall financial results for the fourth quarter. Total revenues, $510 million, up 24% year-over-year and down 1% quarter-over-quarter. Net Brand Advertising revenues, $72 million, down 27% year-over-year and 4% quarter-over-quarter. Search and search-related advertising revenues, $247 million, up 62% year-over-year and 10% quarter-over-quarter. Online game revenues, $109 million, up 15% year-over-year and down 17% quarter-over-quarter. For the whole year of 2017, total revenues reached $1.86 billion, up 13% compared with '16. Net Brand Advertising revenues, $314 million, down 30% compared with 2016. Search and search-related advertising revenues, $801 million, up 34% compared with 2016. Online game revenues, $450 million, up 14% compared with 2016. Now let me go through some of our key businesses. First, the Media Portal business. In 2017, competition in the online media industry among the various mobile new applications and other distribution platforms got intense. All major players invested heavily in content and promotions to acquire new users. With so many choices for users, the bar is being raised as users want to immediately get them stories that are interesting to them, as soon as we opened the app. To remain as top-tier player, we must continuously refine our flagship mobile product, Sohu News App, and expand its penetration as fast as we can. To do that, in the fourth quarter, we added a few new key technology leaders to our product team. So that has been able to significantly enhance the algorithm of the recommendation stream and the app -- understand our user much better -- users' profiles, importantly what they like to read or watch. We've seen some initial success with this enhancement and we've seen the channel of recommended stream, News APP, the reading page view grow by 80%. So we intend to quickly apply this new algorithm to all our main channels. Over the past few months, we've also made important progress on development of new advertising system. The new system can help advertisers easily produce and distribute their ad materials across our mobile and PC products. More importantly, this system will help us to better match ads with users, precision targeting. We've been encouraged to see that click-through rates of ads have been improving a lot recently. Financially, revenue was soft in 2017, as the contribution from large advertisers was not at settlement for us, not satisfying. But as I mentioned earlier, we have been seeing some encouraging signs and we're mapping out a more effective promotion plan for Sohu News App. With upward trajectory that we're seeing in our user base and with page view, I'm confident that the revenue for Sohu Media Portal will return to growth in 2018, this year. Moving over to Sohu Video. In 2017, we adjusted our content acquisition strategy and shifted majority of our resources to in-house developed dramas. For projects, we are not pursuing some of the most expensive IP names, instead we're looking for high-quality stories that can capture our audience attention. And we're looking to groom young actors and talent who are willing to sign talent management contracts with Sohu. These moves are helping us to build a solid pipeline of original dramas, while keeping costs within a reasonable budget. In fourth quarter 2017, we collectively launched 6 original dramas. One of the most popular one is Your Highness, [Foreign Language], a story that was inspired by our most popular mobile game, Legacy TLBB. The show quickly became a trending topic in China's social networks. And it became especially among young audiences, who like the so called ACGN, animation, comics, games and novel culture. Animation, comics, games and novel culture [Foreign Language]. We'll continue to utilize social networks to promote our new shows. For 2018, we plan to launch over 20 original dramas, including some highly anticipated ones such as Medical Examiner Season 2 and Liar Hunter x and The Big Bug, the [indiscernible] and many more like [indiscernible], etcetera. In 2017, benefiting from our original shows, we saw steady -- in the last year, we saw steady growth in our subscription base, the business in terms of playing -- paying users and the revenues. Our advertising sales team is also working closely with content team to offer clients more ad formats, such as product placements and to bring incremental revenues. For 2018, with substantial cost savings from traditional TV dramas and with new revenue initiatives, we expect the overall loss in our Sohu Video business to narrow. Next moving to Sogou. In 2017, Sogou's core search and input method products continued to gain user traction. By December, its mobile search traffic grew 31% year-over-year. According to iResearch Sogou's search market share by mobile queries increased to 18.2%, up 3 percentage points from March 2017. In December, daily active users for Sogou Mobile Keyboard input method reached 330 million, up 46% from a year ago. Driven by solid mobile search traffic and improved monetization, Sogou delivered strong financial performance. In the fourth quarter, total revenues $270 million -- $280 million increase of 62% year-over-year. Non-GAAP net income was $38 million, up 80% year-over-year. Lastly, for Changyou, in March 2017, a successful launch of the hit mobile game, Legacy TLBB provided new growth momentum for Changyou. For the full year, Changyou's total revenue reached $580 million, a 10% increase year-over-year. Excluding some onetime items, non-GAAP net income for 2017 was $187 million, an increase of 22% from the previous year, 2016. While we see the problem of user attention of existing games -- user attrition of the existing games, we are exploring ways to expand the life cycles of them. In the meantime, we are committed to developing more high-quality mobile games. MMORPG games will continue to be our strategic focus. Advanced casual games and SLG games also be added in our pipeline of -- and to diversify our portfolios. Now let me turn to Joanna, who will walk you through financial results. Joanna?

Thank you, Charles. I will walk you through the key financials of our 4 major segments for the first quarter and the full year of 2017. 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 $36 million, down 15% year-over-year. The quarterly loss was $25 million compared with net loss of $10 million in the fourth quarter of 2016. For full year 2017, Sohu Media quarterly revenues were $153 million, down 17% from 2016. It's full year net loss was $67 million compared with net loss of $30 million in 2016. For Sohu Video, revenues were $39 million, down 10% from a year ago. Of this, advertising revenues were $80 million. The quarterly loss was $69 million compared with a net loss of $82 million in the same quarter last year. For full year 2017, Sohu Video's total revenue were $163 million, down 5% from a year ago. Of this, advertising revenue was $81 million. Sohu Video full year loss was $302 million compared with a net loss of $272 million in 2016. For Sogou, total revenues were $278 million, up 62% year-over-year and 8% quarter-over-quarter. Net income was $38 million compared with net income of $21 million in the same quarter last year. For full year 2017, total revenues were $908 million, up 38% compared with last year. Net income was $106 million compared with net income of $69 million in 2016. For Changyou, total revenues, including 17173, were $144 million, up 11% year-over-year and down 13% quarter-over-quarter. Changyou posted a net income of $34 million compared with net income of $40 million in the same quarter last year. For full year 2017, total revenues were $580 million, up 10% compared with 2016. Changyou posted net income of $126 million compared with net income of $153 million in 2016. For the first quarter of 2018, we expect total revenues to be between $410 million and $435 million; Brand Advertising revenues to be between $55 million and $60 million. This implies an annual decrease of 26% to 32%, and a sequential decrease of 16% to 23%. Sogou revenues to be between $218 million and $228 million. This implies an annual increase of 35% to 41% and a sequential decrease of 18% to 22%. Online game revenues to be between $90 million and $100 million. This implies an annual increase of 5% to 17% and a sequential decrease of 9% to 18%. Before deducting the share of non-GAAP net income pertaining to noncontrolling interest, non-GAAP net loss to be between $45 million and $55 million. Assuming no new grants of share-based awards and that the market price of our shares is unchanged, we estimate that compensation expense relating to share-based awards will be around $6 million. Including the impact of these share-based awards, GAAP net loss before noncontrolling interest to be between $51 million and $61 million. Non-GAAP net loss attributable to Sohu.com Inc. to be between $65 million and $75 million. And the non-GAAP loss per fully diluted share to be between $1.65 and $1.90. Including the impact of aforementioned share-based awards and netting off around $3 million of Sohu's economic interest in Changyou and Sogou, GAAP net loss attributable to Sohu.com Inc. to be between $68 million and $78 million. And GAAP loss per fully diluted share to be between $1.75 and $2. For the first quarter 2018 guidance, the company has adopted a presumed exchange rate of RMB 6.6 to $1 as compared with the actual exchange rate of around RMB 6.88 to $1 for the first quarter of 2017; and RMB 6.61 to $1 for the fourth quarter of 2017. Lastly, please be reminded that we won't take questions regarding the Changyou's privatization proposals in Q&A session. And this concludes our prepared remarks. Operator, we would now like to open the call to questions.

[Operator Instructions]. The first question comes from the line of Thomas Chong from Crédit Suisse.

I have a couple of questions. The first question is about the competitive landscape for online media as well as how we budget our content cost for this year. And my second question is about the competition in News APP. How should we think about the competition that we see, for example, like [indiscernible] Baidu news feed how do we differentiate on best trend?

In terms of the video budget, 2018 will see quite a significant, basically, reduction of the common cost. Because we basically are not buying the traditional TV dramas and mostly rely on our in-house produced dramas, which will produce between 20 and 30 dramas, at much lower cost. And also to generate exclusive broadcasting on Sohu so that we can generate subscription base. So we're looking at, I would say, reduction, right? We're looking at about 40% reduction of the cost for the video. And because of a lot of creativity needed -- so that sometimes it's not that the most expensive TV dramas that are the most popular. So for this content business so we can maintain a user traffic and also grow our subscription base with a lower budget for the content. And for the News APP, yes, it's an competition intensifying. And it's really the technology and algorithm, the smart design of the product and the user profile and understanding of the users. And so it's all competition, basically, for talents and for team and for smarts and as we've been in the first quarter, we've been ramp up or improve our team, our sophistication and the smart so that we've been able to -- for the new algorithm that improved the traffic for the recommendation channel by 80% with a -- so we are confident in 2018, we will be able to grow the user base and also the overall business of the media business back to growth.

May I just ask a very quick follow-up? It's about the breakeven timing for our online media business. Should we expect to break even sometime in the second half this year?

The video business, as I promised before, that actually we're going to be breakeven in 2019 as the schedule is like that. So we're definitely seeing narrowing of our loss of the video business this year.

The next question comes from the line of Eddie Leung from Merrill Lynch.

I'm wondering if Charles could talk about the development in the video subscription and what's the outlook in 2018 from this revenue source. And then secondly, could you also comment on your thought about the growth of short-form video? Would that affect the current spend and potentially user engagement in long-form video? And then finally, perhaps a question to Joanna, could you give us a bit of guidance on your tax rate in 2018, given the tax reform in the U.S.?

The current subscription base, we're looking at -- so this year, the video advertising has been kind of coming down slowly but it's going to be a turning point because -- so with the subscription, I would say this year, we'll see the subscription business revenue probably will surpass or probably will catch up with advertising revenue at midpoint of this year. But the advertising revenue also will continue to grow because even for the paid subscribers, there's a lot of new formats of advertising like in Chinese called [Foreign Language], it's embedded, right, embedded revenue. So we're looking at both -- actually we have a new team leader for the advertising team. We're looking at the growth from the advertising with new formats, common content marketing of common sales, basically it would be more -- especially with our house -- with our in-house produced or our own produced TV dramas, we have kind of a quality control from the beginning so that we can actually incorporate some of the TV stories with some of the advertising and embedded advertising and also we are promoting on social media of our dramas so that basically subscription [Technical Difficulty] and by midpoint of the year probably will half by half advertising and half subscription.

Yes, short-form ads. We've been dealing a kind of the like the five minutes kind of video formats for the last few years. And now we also launched into some shorter, like one minute or like -- video. And like one of the success is our with these clips, like only 1 minute for all the breaking news or breaking scene or some kind of happenings that filmed by our local representatives somewhere. So that's called a [Foreign Language], which become quite popular. So yes, we are generating more shorter forms like 1-minute videos through our Sohu Video team but also some other teams are doing that. But the consumption of those videos will be mostly on our Sohu News App, where because it's -- we need to -- for the algorithm -- for the machine to understand the content of the short forms so that -- and also with the titles so that the algorithms can recommend a precision of the short forms to users. So the short forms will consume the not only on the Sohu Video app but mostly on our news information stream with similar algorithm recommendation but you just need to understand better -- have the better technology to substract the content, the text nature content of the video. I hope I answered your question?

Got that. The tax rate?

Yes, tax rate...

So the U.S. tax in 2018, we'll pay the subtracted income, the tax rate will be 21%. The subtracted income mainly include the interest income. And we'll also need to pay the global intangible low tax rated income. This will start from December 2018. The tax rate will also be 21%.

The next question comes from the line of Alicia Yap from Citigroup.

I have a couple of quick ones. Number one is, can we get a sense of what are the plans that Sohu plans to participate or leverage the upcoming Winter Olympics? And also if we have any early thoughts about the overall advertising sentiment for 2018? And the second question is related to the Sogou -- on the news feed and also on the Sohu News APP. It seems Sogou is also launching the news feed content. Would that be any kind of conflict or competition between the Sogou news feed versus the Sohu News App? And how you'll internally reduce these conflicts and also attract advertiser budget allocation?

Yes. First of all your first question about advertising. This year 2018 is, I would say, a big year for sports events, we have PyeongChang Olympics and also we have World Cup in the summer. Yes, advertising this year looks good. We just need to capture these opportunities by applying the newest forum like news app and with the news feed, and most importantly, with video like our -- the PGC video, basically five minutes long video and also short-form video. And also we have the [Foreign Language] live broadcast platform with -- especially for the World Cup, we're going to produce several programs, especially one of them is really a live broadcast with anchor just report or comment or talk about the games real-time. So we have lot of tools basically now with the application and the video and live, to report these events and provide the advertisers with many more type of formats. In terms of news feed, yes, there is Sogou news feed and Sogou's news feed search app and also it's the mobile browser. So this is the trend, but I don't think there is any conflict of interest. Actually, because of this different news feed enhance the application of that different APPs and with the Sohu family of products, they're actually getting users from our competitors like [indiscernible] and other browser-related news feeds. So there is no conflict of interest here. Actually, we share some of the content and also the user profiles. And basically, when people initially have a different intention to let's say, open up or dial up, call up the Sogou's search app, people have the intention of looking for something but then they are greeted with -- they are met with some very interesting news feeds, which is different from the Sogou news feed, which is more news focused. And Sogou Search app the news feed is more information-based -- broader targeted information based. So it's going to enhance the stickiness of each app.

The next question comes from the line of Wendy Huang from Macquarie.

Actually, my question is a follow-up question on the search business. In previous call, I think Sogou management mentioned the monetization gap with the builder against Baidu has narrowed. So can you give more color as to the CPC or CPM difference between Sogou and the Baidu search? And also as to your collaboration with the Tencent Weixin, that there was a [indiscernible] since October. Can you clarify, is it just the weixin.sogou.com or it also covers the [indiscernible] feature we recently actually noticed from Weixin?

Okay. I'll answer the monetization comparison with respect to [indiscernible] will talk about the Weixin collaboration. So in Q3 comparing to Baidu, mobile side before the discount to agents, so on gross revenue we're about 70% of Baidu's monetization. So in first quarter, we further narrowed the gap so it's quite close to 80% of Baidu's monetization on mobile side.

Actually, we have two areas of corporation with Tencent first. On sogou.com, you can have exclusive access to the content of Weixin official accounts. And second, within the Weixin app, Sogou general search function is integrated within that app, which allows users of Weixin to accept other information over the Internet. So it's two differences, but it's all related to Weixin.

Okay. Further clarify it. So when you say fully integrated with the Weixin, does that mean you cover not just the Weixin moment content but also the chatting but also the video, the conference information created on Weixin?

No, no. In the Weixin search function 1 party is in-app search that's provided by Tencent by Weixin itself. And the other function is general search. This integrated -- that's a part that Sogou general search is integrated as part of the search result, including the in app search results. So this party is provided by Sogou. So it's integrated search results including Weixin's in-app and Sogou's general search results.

Our next question comes from the line of Han Kim from Deutsche Bank.

Just a few housekeeping questions. Your other revenue had been on a progressive climb over the past few years. And then I kind of noticed from your guidance for 1Q, it's starting to take a little bit of a dip. So can you just remind us what had been growing and why we're seeing maybe a stunted level of growth into the 2018? And then the second issue is on the tax and the adjustment that we've made. I'm just wondering why we haven't seen that at your affiliate level but we're seeing kind of a large tax provisioning on the Sohu level. And what kind of marks the difference between the different affiliates within the organization?

So other revenue...

Our other revenue, including the [indiscernible].

The [indiscernible] Yes. Other revenue include the [indiscernible] the live broadcast platform.

And sublicensing...

And sublicensing some of our video content. Right. So Han Joon, you talked about Sohu Group. So overall other revenue, right? Not just for Sohu video?

Correct.

So, it's a big basket of other items, right?

Yes.

So we just talked about the video side, other revenue includes the live broadcast [indiscernible] sublicensing but with other. So basically the other revenue line includes several items some of them are from Changyou and some of them are from Sogou and Sohu as well. So it will take a lot of time. So maybe we can explain that and the trend to you off-line. Is that okay to you?

Sure, sure. Appreciate that. And then, just on the tax rate.

Could you repeat your questions on tax?

Yes. Correct me if I'm wrong, but I really haven't seen a lot of tax adjustment on the Sogou side of the Changyou side, but I'm noticing a large chunk on the Sohu side. So I'm just wondering why we, as Sohu, have to take a large chunky tax adjustment.

Yes. Because Sohu.com is a Delaware incorporated company and you may act as U.S. tax reform -- I think it only impacted the companies incorporated in the U.S. And obviously, Sogou and Changyou is -- they are not U.S. incorporated companies. I think that's the reason.

Yes. Cayman companies, good question.

The next question comes from the line of Figaro Chen [ph] from CICC.

We noticed that your R&D cost [indiscernible] significantly in 4Q and it is about 4% more compared to the 3Q. So we'd like to know that what's the reason behind this change. Is it reflecting the investment on the fees content [indiscernible] as well as [indiscernible] recruiting?

[Foreign Language]

Actually it is the percentages of revenue.

For the overall, right?

Yes, yes. Overall revenue. It is about 24% in 4Q, but is just 21% in 3Q?

[Foreign Language]

Shall we move to next question?

Yes, next question. Just the 4% is not big -- yes, go ahead.

The next question comes from the line of Juan Lin from 86Research.

I have one question on Sohu Media Portal. You mentioned that revenue from Sohu Video is expected to resume growth in 2018. I wonder whether the Media Portal is also expected to start growing. And also, which advertising verticals do you expect to demonstrate strong demand? Between brand ad and SME, which one is the major driver and contributor to the Media Portal business this year? Also a small question on the video side. Last year, the online video platforms and the live broadcasting platforms were under regulatory pressure due to major litigal events. Do you think there will be less regulatory pressure on the media sector this year? Or whether the 40th anniversary of economic reforms and opening up may potentially bring more stringent censorship?

So in the 2018, yes, our media portal will restart basically growth. And it will happen in both the brand advertising and the small media advertising. It's really because we see some of the upward trend of our user base or the consumption page views or consumption of our content [indiscernible] a growth of inventory. And also as I just said, the advertising system just improved so that our inventory can be utilized more effectively and also provide more value to the advertisers and because it's also user profile and the targeting. And so that's the 2 reasons that we are confident that in 2018, we'll start to grow again the media businesses, especially with the news app and also other apps. In terms of industry, I think, it certainly is a small media enterprises, I think it shifted all the time. Now it will move towards e-commerce is one, the travel and game right, -- gaming, travel, e-commerce, some kind of -and some other Internet services and some of the traditional advertisers start to pick up like the...

Liquor, home appliances, yes, so I think the three reasons, one is there is a user base, the traffic. And secondly, the improvement [indiscernible] some of those industries start to advertise the news feed. About the censorship, your question is about video or media?

Video.

Video. I think that...

I think it's media in general. But last year video and the live broadcasting saw the biggest hit from the change of regulatory environment. But I think the question in general on the whole media sector and if video will be -- continue to be under pressure, also would like to understand whether that is going to be the case?

The video, since our -- I think the live broadcast the [indiscernible] is not that much affected. We are actually [indiscernible], not only with those anchor those -- but more value provision, education, and some knowledge-based live broadcast and those kind of things. So it's not much impacted by the regulatory change. And also the video side is -- since we're all producing in-house dramas so that it's -- we -- our production team and producers know very well where the line is so make sure that we are complying. Like in the last Q4, we launched the six dramas and with no problems with any regulatory issues. So that's not a problem. I think the most -- if you talk about the impact or -- it's really on the media side. The media side where probably there will be more requirement for editorial content, which is actually, in terms of competition is -- we actually can benefit that because Sohu has been traditionally been strong at editorial content. And yes. So Sohu will be less impacted compared with our competitors.

[Operator Instructions]. There are no further questions at this time. I would like to hand the conference back to the management. Please go ahead, sir.

Okay, thank you for joining our call, and goodbye.