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Sohu.com Inc  (NASDAQ:SOHU)
Q3 2018 Earnings Conference Call
Nov. 05, 2018, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and good evening. Thank you for joining Sohu's Third 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&A session. 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.

Eric Yuan -- Investor Relations Director

Thanks, operator. Thank you for joining us today to discuss Sohu's third quarter 2018 results. On the call are Chairman and the 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 most recent annual form on Form 10-K.

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

Charles Zhang -- Chairman and Chief Executive Officer

Thanks, Eric. And thanks to everyone for joining our call. For the third quarter, well, our total revenues were largely in line with the prior guidance. The bottom line performance, excluding non-operating 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 recommendation engine algorithms. And our key mobile application -- apps gained momentum in terms of daily active users, 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 the 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 profits, supported by the healthy performance of its TLBB PC and mobile games.

Before I give more details about our key businesses, let me summarize our financial results for the third quarter. Total revenues are $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, $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 a 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 Sohuaut (ph). In the mean time, we refined our recommendation engine using machine learning technology. It provides more personalized stories to users.

On the product interface front, we upgraded the design of our Sohu News App, in particular, a new column called The Moment is highlighted at a central position in the front page. We're 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 the 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 provide 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 a click-based ad 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 ramp-up -- event 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've been able to consistently launch a number of good quality dramas and shows each quarter, while keeping our production slightly under control. In the third quarter, we released the three original dramas, including a very popular one (inaudible), which achieved satisfying performance. We also rolled out the second season of a variety show, (inaudible) a original reality show that has since become one of the best-rated shows on Douban, which is a premium culture 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 (technical difficulty) 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 reduces the error rate and helps increase the usage of voice improvement 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 roll out 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 the financial results.

Joanna Lv -- Chief Financial Officer

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

For Sohu Media Portal, revenues were $31 million, down 17% a year-over-year. The quarterly loss was $38 million, which compares with a net loss of $17 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 $13 million. The quarterly loss was $27 million, which compares with a net loss of $16 million in the same quarter last year. For Sogou, total revenues were $277 million, up 7% year-over-year and down (ph) 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 $118 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 revenue 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 non-controlling 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 the compensation expense relating to share-based awards will be around the $3 million. Including the impact of this share-based award, GAAP net loss before non-controlling 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 off around $2 million of Sohu's economic interests 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 2018 guidance, we used a presumed exchange rate of RMB7 to $1, which compares with the actual exchange rate of around RMB6.8 to $1 for the third quarter of 2018, and RMB6.61 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.

Questions and Answers:

Operator

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

Eddie Leung -- Merrill Lynch -- Analyst

Hi, good morning guys. I'm wondering how -- perhaps you Charles, you think about the potential synergy between news feed as far 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 basis, any metrics or growth trend will be great? Thank you.

Charles Zhang -- Chairman and Chief Executive Officer

Yeah, there is some synergy between the Sohu news feed and Sogou, because Sogou is broader and Sogou Search app, both actually providing some news feed under the search box. So it's 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 caller. And also -- so that's the content side. And also definitely can share some user click-through information. And so that's definitely -- there is some synergy there (inaudible) as Sogou are moving more toward an information stream business.

And Video, I think we are not disclosing the subscription 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 on that -- and also it's Sohu exclusive-only -- Sohu Video only. So that actually drives the subscription (ph). So our subscription user base basically is growing steadily, even slowly steadily, but we are not disclosing the number and we are looking at in 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 the video content and also the information streaming, stream advertising, besides the pre-load, we expect the Video revenues to actually grow in the coming quarters.

Eddie Leung -- Merrill Lynch -- Analyst

Thank you very much.

Operator

Thank you. Our next question comes from the line of Thomas Chong from Credit Suisse. Please ask your question.

Thomas Chong -- Credit Suisse -- Analyst

Hi, management for taking my questions. I have a question about the macro headwinds and vectorations. We just talk 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? Thank you.

Charles Zhang -- Chairman and Chief Executive Officer

Mini programs (multiple speakers) Yes, from the macro -- you mean the macro downturn, not macroeconomic downturn (multiple speakers). Yes, there is -- for economic downturn, and that constitutes (ph) our brand advertising both on Media Portal and/or Video, will be negatively impacted. But by innovatively having kind of events and new creative marketing events for our advertisers, we are trying to hold ground on the brand side. But we expect the SME side to actually grow, because those are more resilient to market conditions -- macroeconomics situations, because we have so many people in China who will continue to consume, right. So you have -- so this SMEs, there is hundreds or (ph) thousands advertisers that some are not spending money, but others are spending, so we actually -- and also by now, up to this -- now the Sohu still has 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. (Multiple speakers) Not really, not really. Alright, yes. I think (technical difficulty)

Operator

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

Jialong Shi -- Nomura Capital -- Analyst

Hi. Good evening, management. Thanks for taking my question. My question is about your Video -- about the Video business. Recent 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. And should we expect to see a potential drop in the average cost for 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? Thank you.

Charles Zhang -- Chairman and Chief Executive Officer

Yes. Actually it should -- I think the recent regulation, the cap on the actor/actress have a -- definitely have a positive impact, definitely, especially the head content will have lower cost. So actually it will be positively impacted, lower cost for the head content. But the effect on Sohu is less compared with other media companies that are still buying those head content, very expensive. We have been -- especially with our own original content, we are already using basically new -- I mean, relatively -- we actually are -- we sign our own talent and use our own actors and actress who sign the -- 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 thing for the video business.

The profitability timeline. So if you look at Q1, we are losing $48 million and in Q2 we're losing $35 million and this Q3 we're losing $27 million. So we're looking at -- so maybe Q3 next year or latest will be -- will be in Q4 where Sohu Video will reach profitability.

Jialong Shi -- Nomura Capital -- Analyst

Thank you. May I ask another question about your search business, about Sogou? So I just wonder how does -- Charles, I'm trying to think of the regulatory environment toward the healthcare ads. 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 landing pages for those healthcare ads on its own servers. So I just wonder if Sogou may follow suit. Thank you.

Joanna Lv -- Chief Financial Officer

(Foreign Language) So, as you're referring now, we launched Wise Doctor platform back in 2016. And we intended to offer users with reliable and trustworthy content from (inaudible) we do not want to increase advertising for the healthcare sector. We believe with a differentiated initiative we will build those brands over time and increase the overall competitveness of Sogou Search.

Jialong Shi -- Nomura Capital -- Analyst

Thanks Charles and Joanna.

Charles Zhang -- Chairman and Chief Executive Officer

Okay, thank you.

Operator

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

Alicia Yap -- Citigroup -- Analyst

Hi, Charles and management team. Thanks for taking my questions. Good evening. Actually a follow-up with a couple of the questions earlier. One is that regarding the salary control for the celebrity. Wonder if Charles has 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 relative return, if those more high-profile celebrity salary comes down, the Sohu self-produced talents could -- may also face 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 for some of the SME, isn't that could also affect the SME cash flow and the ad budget, which could also affect potentially the SME advertising revenues? So, any color you can further elaborate that would be helpful. Thank you.

Charles Zhang -- Chairman and Chief Executive Officer

Okay. On the first question, let's see, for -- generally speaking, there is lot of the big celebrities, we actually -- a lot of them stopped accepting roles, because they don't want accept a salary that is not -- 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. The A list people have basically stopped. They don't want to lose their status or the face by accepting a lower budget salar -- I mean, low salary. So it's -- so for us, as I said earlier that, yes, we are less impacted or less saving for Sohu, because we are not -- actually not using those big celebrities in the first place. For our dramas and some of our variety shows, we probably have -- we probably can use one of this relatively well known or famous actors or actress. So the saving is insignificant for us. But, definitely, I would say if those top talents or top actors or actresses do -- accepting -- accept the roles, I think there should be half right or a third of their previous -- I don't know.

So about the SME resilience amid this weaker macroeconomic situation, the resilience comes from -- there is many, like thousands or even a -- for some other companies like Baidu and others, they have hundreds of thousands of this kind of small ME advertisers. Then some have lower budgeting, because their business -- either they went out of business or they are just (inaudible). But there's always newcomers -- new companies, new small companies emerging to serve. So there is a kind of -- you are not looking at the same number -- same number of -- same group of companies you're looking at different companies. So there's always -- because, as I said, there's 1.4 billion people in China, people will always need to have some kind of consuming, right. So actually, even people are spending less than those companies who provide the low -- cheap products or low spending products are actually making money. So they are spending money on advertising. That's where the resilience -- how the resilience is built in this sort of structure.

Alicia Yap -- Citigroup -- Analyst

So, can I just follow up, is it fair to say maybe you are talking about maybe some of the emerging industry, for example, the e-commerce platform that may be targeting those lower end user or --

Charles Zhang -- Chairman and Chief Executive Officer

Yes, like (multiple speakers)

Alicia Yap -- Citigroup -- Analyst

Okay. And then some low-cost services companies --

Charles Zhang -- Chairman and Chief Executive Officer

Yes, low cost services .

Alicia Yap -- Citigroup -- Analyst

Being more active. I see. Okay. Alright it's very helpful.

Charles Zhang -- Chairman and Chief Executive Officer

These are, let's say -- people in probably the travel company will spend less, because those people don't have the money, right, or people going abroad or those kind of things are less. But there is other companies, they are providing all kind of low-budget services, low cost services, yes.

Alicia Yap -- Citigroup -- Analyst

I see, OK. Thank you, Charles.

Charles Zhang -- Chairman and Chief Executive Officer

Welcome.

Operator

Thank you. Our next question comes from line of (inaudible).

Unidentified Participant -- -- Analyst

Good evening. Good morning from California. And thank you taking my questions. Two questions. Number one, does the Company intend to initiate a stock buyback with the shares trading in their generation lows 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 as to why? Thank you.

Charles Zhang -- Chairman and Chief Executive Officer

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 buy back. 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 you question?

Unidentified Participant -- -- Analyst

Sure. Thank you.

Charles Zhang -- Chairman and Chief Executive Officer

The window will open by tomorrow. Yes tomorrow.

Unidentified Participant -- -- Analyst

Okay, great. Thanks so much.

Operator

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

Eric Yuan -- Investor Relations Director

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

Operator

Thank you. Ladies and gentlemen, that does (technical difficulty) Thank you for participating, you may all disconnect.

Duration: 36 minutes

Call participants:

Eric Yuan -- Investor Relations Director

Charles Zhang -- Chairman and Chief Executive Officer

Joanna Lv -- Chief Financial Officer

Eddie Leung -- Merrill Lynch -- Analyst

Thomas Chong -- Credit Suisse -- Analyst

Jialong Shi -- Nomura Capital -- Analyst

Alicia Yap -- Citigroup -- Analyst

Unidentified Participant -- -- Analyst

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