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Changyou.com Limited (NASDAQ:CYOU)
Q3 2019 Earnings Call
Nov 4, 2019, 6:30 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. Welcome to Changyou's Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded. If you have any objections, you may disconnect at this time.

I would like to turn the conference over to your host for today's call, Changyou's IR Head, Mr. Zhao Yujia. Please go ahead, Yujia.

Zhao Yujia -- Head of Investor Relations

Thank you, operator and thanks everyone for joining us. On the call today are Mr. Chen Dewen, CEO; Mr. Hong Xiaojian, COO; Mr. Wang Yaobin, CFO; and Mr. Wei Qing, Chief Games Development Officer.

For today's agenda, management will discuss highlights for the third quarter 2019. This will be followed by a question-and-answer session.

Before we continue, please allow me to read you Changyou's Safe Harbor statements. Statements that are not historical facts, including statements about the company's beliefs and expectations 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 SEC, including its most recent Annual Report on Form 20-F.

I will now turn the call over to our CEO, Mr. Chen Dewen.

Dewen Chen -- Chief Executive Officer

[Foreign Speech] For the third quarter of 2019, our total revenue was $111 million. Online games performed well with revenue reaching $108 million. Our non-GAAP net income was $34 million, which exceeded the high-end of our guidance.

[Foreign Speech] For PC games, we launched a new expansion pack for TLBB PC during the quarter to sustain user entries. In addition, we rolled out this year's second promotional event, which ranked and rewarded our highest paying users. We were happy to see that. It not only helped to sustain player engagement, but it also effectively stabilized the in-game spending of players. Overall, TLBB PC revenue in the third quarter was flat on a sequential basis.

[Foreign Speech] For the fourth quarter of 2019, we will launch another expansion pack for TLBB PC that features the addition of new plan. We will also further improve our payment system and launch new holiday events that are specifically designed to promote engagement among mid-tier paying players. Given the uncertainties due to the National Day holidays and fewer promotions during the fourth quarter, we expect TLBB PC revenue to decrease by about 7% on a sequential basis. We will continue to focus on our core strategy to maintain user-engagement and maximize the longevity of our legacy PC games such as TLBB.

[Foreign Speech] For mobile games, revenue from Legacy TLBB Mobile increased slightly in the third quarter on a sequential basis, which was actually better than we expected, many thanks to new content that we introduced during the quarter. Mr. Wei Qing, our Chief Games Development Officer will give you an update later on our latest progress with this game.

[Foreign Speech] During the quarter, we launched a new MMORPG mobile game, TLBB Honor, which adopts the core game play of other passive games from our TLBB franchise and features an innovative portrait screen-mode, leveraging the influences of the TLBB franchise among highly active mobile game players. The game has performed quite well since its launch. However, since the game content is not particularly extensive, its revenue contribution and the profitability are not comparable with Legacy TLBB Mobile.

[Foreign Speech] Going forward, MMORPG mobile games will continue to be our strategic focus and we will continue to work on improving the quality of the key games that we are developing, so that we can give them the best possible chance to become hits. In the meantime, we are also developing some casual and the strategy games to make sure that we maintain a diversified product portfolio.

[Foreign Speech] With that, let me turn the call over to Mr. Wei Qing, our Chief Games Development Officer to give you an update on the latest progress of Legacy TLBB Mobile.

Qing Wei -- Chief Games Development Officer

[Foreign Speech] During the quarter, we launched an expansion pack with an underwater world map and new challenging dungeons, all of which helped to drive higher player involvement. In addition, we were pleased to see that the newly introduced clan has been well received by players. So overall, we have been able to maintain stable user engagement during the quarter and achieve solid player spending.

[Foreign Speech] During the fourth quarter of 2019, we will launch more expanded content that includes casual gameplay, featuring some additional elements of day-to-day life. In addition, we will do a preliminary review of the skill system of all clans in order to be prepared to further enhance the PvP experience in the future. For Legacy TLBB Mobile, we will continue to focus on long-term orientated operational strategies and introduce new content in order to provide a better experience for players.

[Foreign Speech] Now I will turn the call over to our CFO, Mr. Wang Yaobin to discuss the financial highlights.

Yaobin Wang -- Chief Financial Officer

[Foreign Speech] Before I walk you through our financial highlights for the third quarter, I would like to remind you that the Company's wholly owned subsidiary Shanghai Jingmao Culture Communication Company Limited, Shanghai Jingmao in short, which operated the Company's cinema advertising business ceased operations and wound down the business during the third quarter of 2019, as a result of a Chinese court having granted a petition by Shanghai Jingmao for bankruptcy relief. Accordingly, the results of operations for the Company's cinema advertising business have been excluded from the Company's results from continuing operations in the condensed consolidated statements of operations for the third quarter and are presented in separate line items as discontinued operations. Retrospective adjustments to the historical statements have been made in order to provide a consistent basis for comparison. Unless indicated otherwise, results presented in this release are related to continuing operations only and exclude results from the Cinema Advertising business.

[Foreign Speech] Total revenue was $111 million, an increase of 9% year-over-year and 4% quarter-over-quarter, exceeding our guidance.

[Foreign Speech] Online game revenue was $108 million, an increase of 13% year-over-year and 6% quarter-over-quarter, exceeding our guidance. The year-over-year increase was due to the revenue contribution from new games launched during the quarter.

[Foreign Speech] Online advertising revenue was $3 million, a decrease of 42% year-over-year and 30% quarter-over-quarter. The year-over-year and quarter-over-quarter decreases were mainly due to fewer games being marketed on the 17173.com website.

[Foreign Speech] Now let me provide some more details about our other financials. From now on, most of the figures discussed will be on a non-GAAP basis. As a reminder, you can find a reconciliation of these non-GAAP measures in our published earnings release.

[Foreign Speech] Gross margin was 78% compared with 83% in the third quarter of 2018 and 82% in the second quarter of 2019.

[Foreign Speech] Gross margin of the online game business was 78% compared with 84% in the third quarter of 2018 and 82% in the second quarter of 2019.

[Foreign Speech] Operating profit was $35 million compared with an operating profit of $40 million in the third quarter of 2018 and an operating profit of $38 million in the second quarter of 2019.

[Foreign Speech] Net income from continuing operations attributable to Changyou.com Limited was $34 million compared with net income of $67 million in the third quarter of 2018 and net income of $41 million in the second quarter of 2019.

[Foreign Speech] Fully diluted net income from continuing operations attributable to Changyou.com Limited per ADS was $0.64 compared with net income of $1.25 in the third quarter of 2018 and net income of $0.77 in the second quarter of 2019.

[Foreign Speech] Next, moving on to the balance sheet and cash flow statement.

[Foreign Speech] As of September 30th 2019, we had net cash of $250 million compared with $671 million as of December 31st, 2018. The decrease was mainly due to the distribution of a special cash dividend of about $503 million in the second quarter of 2019.

[Foreign Speech] For the third quarter, we had net operating cash inflow of $56 million.

[Foreign Speech] Finally, for the fourth quarter 2019 guidance, we expect;

[Foreign Speech] Total revenue to be between $100 million and $110 million. This implies a sequential decrease of 10% to 1%.

[Foreign Speech] Within total revenue, online game revenue to be between $95 million and $105 million. This implies a sequential decrease of 12% [Phonetic] to 3%.

[Foreign Speech] Non-GAAP net income attributable to Changyou.com Limited to be between $27 million and $32 million.

[Foreign Speech] Non-GAAP fully diluted net income attributable to Changyou.com Limited per ADS to be between $0.50 and $0.60.

[Foreign Speech] Share-based compensation expense to be around $3 million, reflecting grants to certain key employees of share-based awards approved by the Company's Board of Directors under a newly adopted share incentive plan as well as remaining share-based awards under 2014 Share Incentive Plan and assuming no other grants of share-based awards in the fourth quarter of 2019.

[Foreign Speech] In our guidance, we have adopted a presumed exchange rate of RMB7.1 to $1 as compared with the actual exchange rate of about RMB6.99 to $1 for the third quarter of 2019.

[Foreign Speech] Like last quarter, we won't take any questions regarding the ongoing private proposal in the Q&A session of this call.

[Foreign Speech] This concludes our prepared remarks. Thank you. Operator, we would now like to open the call to questions.

Questions and Answers:

Operator

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

Ribery Gu -- Credit Suisse AG -- Analyst

[Foreign Speech] I will translate myself. We have noticed that the -- a trial company has already received several new monetization approvals for online games. Could management kindly comment on the potential pipeline and the financial contribution from the new games that are going to be launched? Thanks.

Qing Wei -- Chief Games Development Officer

[Foreign Speech] From fourth quarter of this year to until to the end of next year, we will launch some new games and the most recent could be DMD, Duke of Mount Deer, we may launch it in the fourth quarter or first quarter next year.

Yaobin Wang -- Chief Financial Officer

[Foreign Speech] It's hard to predict the revenue performance of those new games. So we need further support from testing results. Thank you.

Ribery Gu -- Credit Suisse AG -- Analyst

Thanks, management.

Operator

Your next question comes from the line of Eddie Leung from BoAML. Please ask your question.

Eddie Leung -- Bank of America Merrill Lynch -- Analyst

[Foreign Speech] So I have three questions. The first question is about the potential impact of our cloud games to the online game industry and we keep hearing [Phonetic] for the new changes in the industry when we prepared our new games? And then secondly, I'm just wondering why there was a sequential decline in the deferred revenue in the third quarter, given some new games. And finally, how many engineers we have right now? Thank you.

Dewen Chen -- Chief Executive Officer

[Foreign Speech] We are studying the cloud-based game actually. In the future, the user scale will be large enough, but for the provider side, there will be still content provider and operator [Indecipherable].

[Foreign Speech] For us like a game developer no matter it's cloud based era or current market, it won't be large difference between games.

[Foreign Speech] So from our perspective as a content provider or game developer, it won't impact us in the future.

[Foreign Speech] From the limits from bandwidth and the very high cost of the Internet connection speed, we believe the current revenue mode is not high enough to cover those kind of cost.

[Foreign Speech] So now only those several very big players are trying in this very new market and to establish new platform and to operate cloud-based games.

Yaobin Wang -- Chief Financial Officer

[Foreign Speech] Yeah. To answer the second and third question, now we have been maintaining 1,100 R&D workforce scale. And as we have been reviewing our game projects under development periodically, so we will close or shut-down some other projects without enough creative ideas, so we will have some loss in R&D workforce. But in the meantime, we will also have new recruitment from new projects established, so we will -- overall speaking, we will maintain the similar scale of R&D workforce.

Eddie Leung -- Bank of America Merrill Lynch -- Analyst

Thank you very much.

Yaobin Wang -- Chief Financial Officer

Thank you, Eddie.

Operator

Your next question comes from the line of Nelson Cheung from Citi. Please ask your question.

Nelson Cheung -- Citi Research -- Analyst

[Foreign Speech] I will translate the questions myself. My first question is on the marketing dollars. Can management share what would be your marketing strategies going into next quarter? Should we expect more aggressive spending in order to lengthen the life-cycle of the new games? And my second question is on the revenue mix between PC and mobile games. And can management share the current revenue mix between TV and mobile in terms of reported numbers in closing? Thank you.

Dewen Chen -- Chief Executive Officer

[Foreign Speech] The increase of marketing fees in the third quarter was mainly due to our new game launch in the market, TLBB Honor, because we had a different publishing mode at this time. In the past, we took distribution channels plus advertising, but at this time, we used a method of -- in Chinese it's [Foreign Speech] and we buy user traffic.

[Foreign Speech] So in terms of buying user traffic, you need to consider the cost of buying traffic and the lifetime value from the buying traffic method.

[Foreign Speech] So the future cost and the marketing fees will be dependent on the rate of return.

[Foreign Speech] And for next quarter, we expect in fact lower investment on buying traffic.

[Foreign Speech] For cash receipts or gross billing, the PC games accounted for 38% and mobile game accounted for 62%.

[Foreign Speech] In terms of revenue, PC games accounted for 60% and the mobile game 40%. Thank you, Nelson.

Operator

[Operator Instructions]. Your next question comes from the line of Thomas Chong from Jefferies. Please ask your question.

Thomas Chong -- Jefferies -- Analyst

Hi management, thanks for taking my questions. I have two quick questions. The first one is about Duke of Mount Deer, the DMD Mobile that we are going to launch. Can you share how we should think about the PC version that we launched many, many years ago. Is there any lessons that we learned from 10 years ago about the challenge faced by DMD at that time?

And my second question is about the 2020 outlook. In particular, can we get some color about TLBB PC version and Legacy TLBB in terms of the growth momentum or should we expect stabilization versus 2019? [Foreign Speech]

Qing Wei -- Chief Games Development Officer

[Foreign Speech] In terms of the game content, actually DMD Mobile will be very differentiated from DMD PC 10 years ago.

[Foreign Speech] With a very different R&D team, so our game content, gameplay and the story slots will be totally different.

[Foreign Speech] Because they are -- both are older games from the company, so from our expectations, they will decrease for the next year. What we can do is to further extensive their lifespan and we will also have some more promotional event in the future, but the core strategy will be maintaining user engagement in the first place. So it's hard to say how much it will be decreased for the next like one-year period.

[Foreign Speech] Roughly speaking, will be at the end of this year or early next year, but specific timing will be dependent on further testing results.

Thomas Chong -- Jefferies -- Analyst

Thank you.

Dewen Chen -- Chief Executive Officer

Thank you.

Qing Wei -- Chief Games Development Officer

Thank you, Thomas.

Operator

[Operator Instructions] As there are no further questions, we will now begin closing comments. Please go ahead, Yujia.

Zhao Yujia -- Head of Investor Relations

Once again, I would like to thank you for joining today's call. If you have further questions, please don't hesitate to contact us. Thank you.

Operator

[Operator Closing Remarks]

Duration: 39 minutes

Call participants:

Zhao Yujia -- Head of Investor Relations

Dewen Chen -- Chief Executive Officer

Qing Wei -- Chief Games Development Officer

Yaobin Wang -- Chief Financial Officer

Ribery Gu -- Credit Suisse AG -- Analyst

Eddie Leung -- Bank of America Merrill Lynch -- Analyst

Nelson Cheung -- Citi Research -- Analyst

Thomas Chong -- Jefferies -- Analyst

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