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ChangYou.com  (NASDAQ:CYOU)
Q4 2018 Earnings Conference Call
Feb. 01, 2019, 12:30 p.m. ET

Contents:

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and good evening. Welcome to Changyou's Fourth Quarter and Fiscal-Year 2018 Earnings Conference Call. At this time, all participants are in listen-only mode. After the management 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 would now like to turn the conference over to your host for today's conference call, Changyou's IR Head, Mr. Yujia Zhao. Please go ahead, Yujia.

Yujia Zhao -- Head of Investor Relations

Thank you, operator. And thanks, everyone, for joining us today. On the call today are Mr. Dewen Chen, CEO; Mr. Xiaojian Hong, COO; Mr. Yaobin Wang, CFO; and Mr. Wei Qing, Chief Games Development Officer. For today's agenda, management will discuss highlights for the fourth quarter and fiscal year 2018. This will be followed by a question-and-answer session.

Before we continue, please allow me to read you Changyou's Safe Harbor statement. 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 statements. 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. Dewen Chen.

Dewen Chen -- Chief Executive Officer & Director

(Foreign Language)

In 2018, we stayed focused on our strategy of developing high-end mobile games. As a part of this, we took significant time to reveal and think deeply about our previous experience in mobile game development, especially the games that we currency have under development, and our overall development process. As we emerged from this constructive process, we implemented a number of changes that should help us lay a more solid foundation for producing high-quality games in the future.

A few of the biggest changes were that we streamlined our development processes and we've set higher standards in terms of overall game quality when it comes to approving and advancing gains within our pipeline.

In the meantime, we also continued to adjust the in-game environment and optimize the operational strategy of our existing games. As a result, we were able to maintain decent revenue contribution from our core existing games and achieve stable performance amid the rapidly changing industry environment in 2018.

(Foreign Language)

For the full-year 2018, our total revenue was $486 million and non-GAAP net income was $78 million. Excluding one-off items including the accrual of additional income tax withholdings in the fourth quarter and impairment charges in the fourth quarter, non-GAAP net income for 2018 was $141 million.

(Foreign Language)

For the fourth quarter of 2018, total revenue was $118 million. Online gaming revenue was $94 million. Both were in line with our expectations. Excluding the impairment charges in the fourth quarter, non-GAAP net income was $28 million, which was at the top end of our guidance.

(Foreign Language)

For PC games, TLBB PC delivered solid performance in the fourth quarter. As expected, revenue declined slightly quarter-over-quarter due to the impact of national holidays. During the quarter, we introduced a new eagerly anticipated feature that allowed players to switch clans mid-game. At the same time, we also provided more benefit to players through daily in-game promotional events, which effectively stimulated payers' willingness to pay.

(Foreign Language)

In the first quarter of the 2019, we plan to launch a new expansion pack for the Spring Festival, and we will also host a variety of related online and offline events to maintain user engagement and retention. However, we expect revenue from TLBB PC to decline in the first quarter of 2019 on a sequential basis, mainly due to the impact of the Spring Festival holidays.

Going forward, we plan to leverage the rich experience we have accumulated from operating PC games over the year, continue to meet the needs of players, promote player engagement, and maximize the longevity of our legacy PC games such as TLBB.

(Foreign Language)

For mobile games, Legacy TLBB Mobile's revenues increased slightly in the fourth quarter on a sequential basis, which exceeded our expectations. For TLBB Mobile, we have always taken a long-term view and looked at it as an important franchise in our portfolio.

With this in mind, we have continued to invest in the game, not just on ongoing content updates, but also on overall game play. Mr. Wei Qing, our Chief Games Development Officer, will give you an update later on our latest progress with this game.

(Foreign Language)

For TLBB 3D, revenue was flat quarter-over-quarter. The game has now been in operation for more than four years. We will keep improving (ph) the game and experiment with creative R&D ideas that we can apply for other games.

(Foreign Language)

Looking out at 2019, we will continue to execute our strategy of top games by greatly improving our capabilities in game design, game technology and graphics (inaudible), enhancing project management over the development process, improving development efficiencies, as well as further investing in talent acquisition and development.

MMORPG mobile games will continue to be our strategic focus, but we are also developing some casual games and strategy games, leveraging our accumulated experience and ongoing innovations. We believe we are well positioned to roll out new blockbusters and create value for our shareholders over the (inaudible).

(Foreign Language)

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 Language)

During the quarter, we were happy to see that Legacy TLBB Mobile's revenue increased on a sequential basis. As Dewen mentioned, this was mainly due to the continued updates that we have been making to the game content and design as we look to keep maximizing the longevity of the game.

During the quarter, we launched a new expansion pack and introduced a new clan called Shaolin, which effectively, to many former players, back to the game, and improved player engagement. Meanwhile, we also introduced a new crossover clan war, which is similar to the game play of a strategy game. So far, it has received very positive feedback from players due to the creative freedom it provides.

(Foreign Language)

For the first quarter of 2019, we plan to launch a variety of events for the Spring Festival and upgrade some of the popular game play to ensure player retention. We expect revenue to decline in the first quarter of 2019 on a sequential basis, mainly because of the Spring Festival.

Going forward, we will continue to update the in-game content and make further optimizations based on player feedback. Ultimately, we are confident that we can continue to maximize the lifecycle of the game through such long-term oriented operational strategies.

(Foreign Language) Now, let me turn the call over to our CFO, Mr. Yaobin Wang, to discuss the financial highlights.

Yaobin Wang -- Chief Financial Officer

(Foreign Language)

Thank you, Wei Qing.

Qing Wei -- Chief Games Development Officer

(Foreign Language)

Now, let me walk you through our financial highlights for the fourth quarter.

(Foreign Language)

Total revenue was $180 million, a decrease of 18% year-over-year and flat quarter-over-quarter, in line with our guidance.

(Foreign Language)

Online game revenue was $94 million, a decrease of 14% year-over-year and 2% quarter-over-quarter, in line with our guidance. The year-over-year decrease was due to the natural decline in revenue from our other games, including Legacy TLBB Mobile.

(Foreign Language)

Online advertising revenue was $4 million, a decrease of 32% year-over-year and 14% quarter-over-quarter. The year-over-year and quarter-over-quarter decreases were mainly due to fewer PC and Web games being marketed on the 17173 website.

(Foreign Language)

Cinema advertising revenue was $18 million, a decrease of 30% year-over-year and an increase of 13% quarter-over-quarter. The year-over-year decrease reflected the impact of a strategy adjustment in the second quarter of 2018 related to the acquisition and sale of advertising resources. The quarter-over-quarter increase reflected a recovery in the revenue following the strategy adjustments.

(Foreign Language)

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 Language).

Yaobin Wang -- Chief Financial Officer

(Foreign Language)

Gross margin was 66% compared with 68% in the fourth quarter of 2017 and 67% in the third quarter of 2018.

(Foreign Language)

Gross margin of the online games business was 85% compared with 84% in both the fourth quarter of 2017 and the third quarter of 2018.

(Foreign Language)

Operating profit was $9 million compared with an operating profit of $35 million in the fourth quarter of 2017 and an operating profit of $28 million in the third quarter of 2018.

(Foreign Language)

Net income attributable to Changyou.com Limited was $11 million compared with net income of $34 million in the fourth quarter of 2017 and net income of $54 million in the third quarter of 2018.

(Foreign Language)

Fully diluted net income attributable to Changyou.com Limited per ADS was $0.21 compared with net income of $0.64 in the third quarter of 2017 and net income of $1.01 in the third quarter of 2018.

(Foreign Language)

During this past quarter, we recognized a goodwill impairment of $16 million. The impairment was mainly related to the 17173.com website business, which was acquired in 2011. In the fourth quarter of 2018, due to more stringent regulations, there was a significant decline in the number of new game launches in the market. So, the number of games marketed on 17173.com also fell.

In addition, the profit outlook of its new initiatives remain uncertain. As a result, the Company determined that the future performance of 17173.com would likely fall short of expectations and that impairment charges were required.

(Foreign Language)

Excluding the impairment charges in the fourth quarter, net income was $28 million, which was at the top end of our guidance.

(Foreign Language)

Next, moving on to the balance sheet and cash flow statement.

(Foreign Language)

As of December 31, 2018, excluding $220 million we obtained from a loan agreement in the fourth quarter of 2018, we had net cash of $673 million compared with $978 million as of December 31, 2017.

(Foreign Language)

For the fourth quarter, we had net operating cash inflow of $47 million.

(Foreign Language)

Now, let me walk you through our 2018 full-year financials very briefly.

(Foreign Language)

Total revenue was $486 million, representing a decrease of 16% year-over-year.

(Foreign Language)

Gross margin was 67%, which compares to 72% in 2017.

(Foreign Language)

Operating profit was $94 million compared with $108 million in 2017.

(Foreign Language)

Net income attributable to Changyou.com Limited was $78 million compared with $126 million in 2017.

(Foreign Language)

Fully diluted net income attributable to Changyou.com Limited per ADS was $1.45 compared with $2.36 in 2017.

(Foreign Language)

Finally, for the first quarter 2019 guidance, we expect --

(Foreign Language)

-- total revenue to be between $105 million and $115 million. This implies a sequential decrease of 11% to 3%.

(Foreign Language)

Within total revenue, online game revenues will be between $80 million and $90 million. This implies a sequential decrease of 15% to 4%.

(Foreign Language)

Non-GAAP net income attributable to Changyou.com Limited to be between $23 million and the $28 million.

(Foreign Language)

Non-GAAP fully diluted net income attributable to Changyou.com Limited per ADS to be between $0.43 and the $0.52.

(Foreign Language)

Share-based composition expense to be around $1 million, assuming no new grants of share-based awards.

(Foreign Language)

In our guidance, we have adopted a presumed exchange rate of RMB6.9 to $1 as compared with the actual exchange rate of about RMB6.91 to $1 for the fourth quarter 2018.

(Foreign Language)

Like previous quarter, we won't take questions regarding the going-private proposal in the Q&A session of this call.

(Foreign Language)

This concludes our prepared remarks. Thank you. Operator, we would like to open the call for questions now.

Questions and Answers:

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) The first question comes from the line of Alex Xie from Credit Suisse. Please ask your question.

Alex Xie -- Credit Suisse -- Analyst

Hi, management. Thank you for taking my question. So, I have three questions. First one, I would like to ask about the breakdown of the online games revenue. How much is from mobile? How much is from PC?

And, secondly, I would like to ask about the company's new game pipeline. So, how many games are in the pipeline? And among them, how many have obtained the new game license? And how many people were put into these -- or resources were put into these new games? And what kind of new games are there? And thirdly, I would like to ask about -- do management have any plan for another round of special dividends, like we did in 2018?

Unidentified Speaker --

(Foreign Language)

For the first question, Alex, in terms of revenue, PC game accounted for around 60% and mobile game accounted for 40%. In terms of gross billing, PC game accounted for 40% and the mobile game accounted for 60%.

(Foreign Language)

Now, we have no more than 20 games under development. We're considering to decrease some number of the games under development because we hope to deploy more resources to more promising games. So far, we only have two games that have got the license approval, but we don't worry about that because, in 2019, actually, we won't launch too many games. So, we are confident that we can get enough license approval in the year.

(Foreign Language)

Other than the games under development, we also licensed in some games for both domestic and overseas markets.

(Foreign Language)

We have 800 to 900 employees working on mobile game development.

(Foreign Language)

Currently, we don't have that plan.

Alex Xie -- Credit Suisse -- Analyst

Thank you, management. For the new game pipeline, may I ask a follow-up question? So, what kind of games or what kind of genres are there among the games that we think there is a high chance of -- higher chance of success?

Unidentified Speaker --

(Foreign Language)

We have MMO games, strategy games and also casual games. But we believe MMORPG games will be mostly successful ones for Changyou in the future.

Alex Xie -- Credit Suisse -- Analyst

Thank you, management.

Yujia Zhao -- Head of Investor Relations

Thank you.

Operator

(Operator Instructions). Next, we have the questions -- comes from the line of Alicia Yap from Citigroup. Please ask your question.

Alicia Yap -- Citi Research -- Analyst

Hi. Good evening, management. Thanks for taking my questions. I have two questions. Number one is that, could you share with us some data points on your gamers' commitments and time spent. For example, for the PC TLBB, what are the typical hours of playing time from your hardcore gamers now? And similarly, for the TLBB Legacy Mobile, how long are the core users spending time on playing that game these days?

Second, I just wanted to follow-up on the games approval. I guess, you mentioned you have two games that already got the approval. But then, out of that 10 plus games in the pipeline, have all of the rest of the games you already submitted to the authority? Or is it you haven't submitted? And just curious if you know any criteria about how they are using it for approving the game? is that by the timing of the submission? Thank you.

Yujia Zhao -- Head of Investor Relations

Okay. Thank you.

Unidentified Speaker --

(Foreign Language)

(inaudible) the time players spent in our PC game is longer than the play time of mobile game. In 2018, our MAU -- in other words, user engagement -- has been very stable because we actually have been trying to decrease the pressure or (ph) the time play within the game for players.

(Foreign Language)

Take PC game, for example, player take, on average, 10 hours per day in the game. And for mobile game, players takes about 4 to 5 hours per day.

(Foreign Language)

For 10 hours in PC games, typically, players just sitting there for selling things or the person is not actually sitting in front of the desk. So, it's longer than mobile games.

(Foreign Language)

We actually have submitted some materials for some of the games, but for others, it depends on their development progress. This year, so far, they have approved five batches of games. So, we don't worry about the program this year.

(Foreign Language)

Same question that we don't worry about this because TLBB PC has been awarded many times by the government for its topics. And this year, we don't see any specific criteria that government is paying attention to any genre of the game.

(Foreign Language)

So far, we see that the license approval given by chronological order.

(Foreign Language)

Thank you, Alicia.

Alicia Yap -- Citi Research -- Analyst

Thank you so much.

Operator

(Operator Instructions) We have the follow-up questions from the line of Alex Xie from Credit Suisse, Please proceed.

Alex Xie -- Credit Suisse -- Analyst

Hi, management. Thank you for taking the questions again. So, I would like to ask about the bank loan arrangement we made in this quarter because we have a very solid balance sheet and I think we have most of the cash balance in offshore. So, why do we still need the $220 million loans for the refinancing? And also, I would like to ask about the management loan status. So, how much we have drawn down from Sohu and how much Sohu has drawn down from us?

Unidentified Speaker --

(Foreign Language)

As for the management loan, actually, we had two times of special cash dividend in previous years. One is $500 million and the other one was $200 million. And also, we had expenditures on a overseas business. So, for the management loan, we had a net balance of $630 million we've drawn down from Sohu. So, this number is not enough for our special cash dividend and also the overseas business expenditure. And in the past, we had a financing facility, which is not a bank loan, just a similar one, and it won't be showed up in our balance sheet. And this time, we used a offshore bridge loan to financing this amount of money.

(Foreign Language)

So, after the mature of the old financing facility, we had to find a new agreement bank loan offshore, a bridge loan to repay -- to roll over the old one.

(Foreign Language)

The bridge -- the offshore bridge loan has a relatively high capital cost. So, if we can get other methods of financing, we will repay that. Actually, at the end of January, we have another financing facility. So, we have repaid $80 million (ph) of these offshore bridge loans.

Unidentified Participant -- -- Analyst

Okay thank you, yeah, thank you, may I have just one last follow up about our cash and short-term investments, how much is in offshore and how much is in onshore?

Unidentified Speaker --

(Foreign Language)

Including cash, cash equivalent short-term investments, restricted cash and restricted time deposit, our offshore and onshore cash we have a one-to-one ratio.

(Foreign Language)

Unidentified Participant -- -- Analyst

Thank you management. It's very clear.

Unidentified Speaker --

Thank you, Alex (ph).

Operator

(Operator Instructions).

Alex Xie -- Credit Suisse -- Analyst

Okay, thank you. Yeah. Thank you, management. May I have just one last follow-up. For our cash and short-term investments, how much is in offshore and how much is in onshore?

Unidentified Participant -- -- Analyst

(Foreign Language)

Including cash, cash equivalents, short-term investments, restricted cash and restricted time deposit, our offshore and onshore cash will have 1 to 1 ratio.

Alex Xie -- Credit Suisse -- Analyst

Thank you, management. It's very clear.

Yujia Zhao -- Head of Investor Relations

Thank you, Alex.

Operator

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

Yujia Zhao -- Head of Investor Relations

Thank you. Once again, I would like to thank you for joining us today. If you have any follow-up questions, please don't hesitate to contact us and we wish you a happy Chinese New Year. Thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

Duration: 45 minutes

Call participants:

Yujia Zhao -- Head of Investor Relations

Dewen Chen -- Chief Executive Officer & Director

Qing Wei -- Chief Games Development Officer

Yaobin Wang -- Chief Financial Officer

Alex Xie -- Credit Suisse -- Analyst

Unidentified Speaker --

Alicia Yap -- Citi Research -- Analyst

Unidentified Participant -- -- Analyst

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