Eric Yuan - IR Director Charles Zhang - Chairman and CEO Joanna Lv - CFO

Eddie Leung - Merrill Lynch Thomas Chong - Credit Suisse Alicia Yap - Citigroup

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.

Thanks, operator. Thank you for joining us today to discuss Sohu's third quarter 2018 results. On the call are Chairman and 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 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. Please refer to the company's filings with the Securities and Exchange Commission, including its registration statement and most recent annual report on Form 10-K. With that, I will now turn the call over to Dr. Charles Zhang. Charles, please proceed.

Thanks, Eric and thanks to everyone for joining our call. For the third quarter, while 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 savings of Sohu Video and solid results of our online game business. For the Media Portal, we've focused on our efforts on upgrading the content as well as optimizing our recommendation engine algorithm. In our key mobile application gained momentum in terms of daily active users DAU and the time spend by users. Sohu Video, we remained on track to reduce content costs while develop new original programs, which tend to generate better ROI. This helped us narrow 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 competiveness. Lastly, Changyou game comfortably beat expectations on both revenues and profit, supported by the healthy performance of its TLBB PC and mobile games. Before I give more details about our key businesses, let me summarize the financial results for the third quarter. Total revenues $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 revenue 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 revenue 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 $16 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 continue 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 are Sohu heart [ph]. In the meantime, we find our recommendation engine using machine learning technology will provide more personalized storage for users. On a product interface front we upgraded the design of our Sohu News app, in particular a new column called The Moment, is highlight at a center position on the front page. We're pleased to see that collectively in September daily active users of our mobile apps increased about 20% and our 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 advisors. This impact is likely to last for some quarters. To revive 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 the click based ads with our customers to increase click through, with the support of stronger user traffic, we look forward to seeing positive trends 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 program. We saw encouraging progress from the move. During the quarter, video content cost 60% lower than the same period last year and operating loss of Sohu Video have been halved year-over-year. For the original content, we've been able to consistently launch number of good quality dramas and shows this quarter, while keep our production budget under control. In the third quarter, we released three original dramas including a very popular one the [indiscernible], which achieved a satisfying performance. We also rolled out the second season of a variety show [indiscernible], an original reality show that has since become one of the best rated shows on [indiscernible] which is a premium culture website in ranking the popularity of shows. Local ads, 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 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 reduced the error rate and helped increase the usage of voice input into 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 site. We'll continuously seek to make breakthroughs in important areas such as graphics and game play, as we look to roll out new hit game and adapt the continually changing gaming market. Now, let me turn the call over to Joanna, our CFO who will walk you through financial results.

Thank you, Charles. I will walk you through the key financials of our four major segments. For third quarter 2018, all of the numbers that I will mention are all under non-GAAP basis, you can find a reconfiguration of non-GAAP to GAAP measures on our IR website. For Sohu Media Portal, revenues were $31 million, down 17% year-over-year. The quarterly loss was $48 million, which compares with a net loss of $17 million in the first quarter of 2017. For Sohu Video, revenues was $26 million, down 40% from a year ago. Of this, advertising revenues were $30 million. The quarterly loss was $27 million, which compares with a net loss of $60 million in the same quarter last year. For Sogou, total revenues were $277 million, up 7% of year-over-year and was down 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 revenue 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 revenues 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 shares is unchanged, we estimate that compensation expense relating to share-based awards will be around $3 million. Including the impact of these share-based awards, 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 the aforementioned share-based awards, 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 of 2018 guidance, we use 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 an RMB6.61 to $1 for the third quarter of 2017. With that, this concludes our prepared remarks. Operator, we would now like to open call for questions.

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.

Hey. Good morning, guys. I'm wondering how perhaps, you Charles, you think about the potential synergy between news feed as well as Sogou. So that's the question. And then secondly, could you guys also give us some update or any color about your Video subscription business? Any metrics or growth trend will be great. Thank you.

Yes. There is some synergy between the Sohu news feed and Sogou. Because Sogou is the broader and Sogou search app both actually providing some news feed under the first box. So it's also developing that. So Sohu can actually provide quality content actually directly through the company internal system instead of a robust or kind of caller. So and also - so that's content side. And also definitely we can share some user click through information. So that's definitely there is some synergy there, so we see it forthcoming. And Sogou moving more toward information stream business. And video, I think we're not disclosing the attrition 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 that - and also its Sohu excluding only. Only Sohu video only, so that actually drive the position. So it's our subscription user base basically growing steadily, slowly steady, but we're not disclosing the numbers. And we're looking at future quarters with the improvement of the daily active users of our approximately, the video app. And also the introduction of our short forms of video content and also the information streaming - stream advertising besides the preload, we expect the video revenues to actually grow in the coming quarters.

Thank you very much.

Okay.

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

Hi. Hi management for taking my questions. I have a question about the macro headwinds and recreations. 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.

Mini program - so yes, from the macro economic downturn is that - yes - that - yes there is for economic downturn micro economic issues, brand advertising both on Media Portal and 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 actually grow because those are more resilient to market condition - macro-economic situation, because we have so many people in China, who will continue to consume, right. So you have for those SMEs there is hundreds or thousands advertisers that some are not spending money, but others are spending, so actually - we actually. And also by now up to this now the Sohu still have a small - relatively very small market share of the SME market. So we expect that by better executive and innovation so we can grow our SME revenue faster than the negative impact of the macroeconomic condition on the SME. Not really, yeah I think that I have to speak the - more, yeah, okay.

Thank you. Our next question comes from the line of Sujay Long [ph] from Nomura. Please ask the question.

Hi. Good evening, management. Thanks for taking my question. My question is about your video - about the video business. Recently we noticed there are some regulations being issued by Chinese authority to kept 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 job in the average costs of those produced video contents 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.

Yes, actually it should - I think the recent regulation cap kept on actor, actress is definitely have a positive impact definitely especially the head content will have lower costs. So actually it will be a positively impact lower cost for the head content. But the effect on Sohu is less compared with others - other video companies that still buying those headcount very extensively. We have been especially with our own original content, we already using basically new - I mean relatively we actually - we sign our own talent and use our own actors and actress who signs with relatively new and at basically low costs. So it's not that bit 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, it's a good thing for the video business. So if you look at Q1, we are losing $48 million and Q2 losing $35 million and Q3 we're losing $27 million. So we are looking at - so maybe Q3 next year or latest will be Q4, Sohu Video will reach the profitability.

Thank you. May I ask another question about your search business about Sogou? So for - I just wonder how is the impact of the regulatory environment towards the healthcare ads. Did you see any tightening on this category? The reason I asked - I wanted to ask this question was because your competitor Byju decided to host all the lending pages for those healthcare ads is on service. So I just wonder if Sogou may follow it. Thank you.

So at the point we now launched live doctor platform I think in 2016. And we intend to offer users with reliable and trustworthy content from our [indiscernible]. We do not want to increase advertising for the healthcare sector. We believe this differentiated initiative will viewed service brand overtime and increase the overall competitiveness of our Sogou Search.

Thanks. And I will turn it back.

Okay, thank you.

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

Hi, Charles and management team. Thanks for taking my questions, good evening. As you have follow up with couple of the questions earlier. One is that regarding the salary control for the celebrities. Wonder if Charles have any comments or view about how much roughly do you think the overall professional content cost could come down? And even though I think Sogou will benefit less, but then for our self-produced content, on the relatively term it goes more high profile celebrity salary come down the Sohu self-produced talent could may also save some of the cost, right? So if you can just maybe quantify or share with us how much you think overall industry content cost could actually come down by? And then second is, I just have follow up questions regarding your comment regarding the SME could be a little bit more resilient compared to the big brand. Given we thought the weaker macro could also results to more credit tightening right for some of the SME. Isn't that could also affect the SME cash flow and the app budget, which could also affect potentially the SME advertising revenue. So any color you can further elaborate that will be helpful? Thank you.

Okay. The first question let's say, for generally speaking there is lot of the big celebrities, the actually a lot of them stop accepting roles. Because they don't want to accept a salary that is 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 A list of the B or C list people now. A list people is basically stopped, they don't lose their status or the face by accepting a lower budget, salary, I mean, low salary. So it's - so for us, as I said earlier, 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 drama 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 saving is insignificant for us, but definitely, I would say if those top talents or top actors or actress, do accepting roles, I think there should be half right or a third of their previous - I don't know. So about the SME resilience in a weaker micro situation the resilience comes from its - there is many like thousands or even for some other company like Byju and others and they have hundreds of thousands this kind of small and medium advertisers then some are have lower budget because their business either they went out of business or they're just - can you tell me, but there's always new companies, new small companies emerging to serve. So, there is a kind of - you're not looking at the same number of - same group of companies, you're looking at different companies. So there's always because as there is 1.4 billion people in China, people 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 this will are spending money on advertising. That's where the resilience - how resilience is built in the sort of structure.

I see. So, can I just follow-up? Is it fair to say maybe you're talking about maybe some of the emerging industry, for example the e-commerce platform that maybe targeting those lower end user or...

Yes.

Okay. And then some local services companies looking more active…

Yes, local services.

I see. Okay, that is helpful.

Let's say people probably the travel company will spend less, because people don't have the money, right. Or people going abroad and those kind of things are less. But there's other companies that providing all kind of low budget service - low costs services. Yes.

I see. Okay. Thank you, Charles.

Welcome.

Thank you. Our next question from the line of Greg Samuels [ph] from Samuels Capital. Please ask your question.

Good evening. Good morning from California and thank you for taking my question. Two questions. Number one, does the company intent to initiate a stock buyback with shares trading their generation lows for Sohu? And two, management was very aggressive buyers in the mid-30s yet actually no activity in the 17, 16, 18, just curious why? Thank you.

No. We don't have a stock buyback, because actually, our cash need to be used to right, we don't have the extra 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 your question?

Sure. Thank you.

The window open by tomorrow. No. Yes. Tomorrow.

Okay. Great. Thanks so much.

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

Yes. Okay. Thank you for joining on our call. And have a good evening or good day. Bye-bye.

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