Sogou Inc.
Q1 2019 Earnings Call Transcript

Published: 29 Apr 2019

[Operator:]

Ladies and gentlemen thank you for standing by, and welcome to Sogou's First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After managements' prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded and if you have any objections, you may disconnect at this time. I would now like to turn the call over to your host today, Jessie Zheng, Investor Relations, Director of Sogou. Please go ahead.

[Jessie Zheng:]

Hello, everyone, and thank you for joining Sogou's first quarter and 2019 earnings conference call. On the call, our CEO, Xiaochuan Wang; and our CFO, Joe Zhou, will give an overview of operations and the financial results. In line with our practise on the previous earnings conference call, Xiaochuan's prepared remarks will be made in his voice using personalized the speech synthesis and the style transfer learning technology, which is developed by the Sogou Voice Interaction Technology Center. Xiaochuan will join a Q&A portion of the call in person. 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 here, the matters discussed in this conference call are forward-looking statements. These statements are based on current plans, estimates and the 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 Securities and Exchange Commission. With that, I will now turn the call over to our CEO, Xiaochuan Wang.

[Xiaochuan Wang:]

Thank you, Jessie. During the first quarter of 2019, our core business recorded steady growth as we continued to execute our three engine strategy supported by Sogou Search and Sogou Mobile Keyboard. We also remain committed to leveraging our AI technologies to bolster innovation and enhance competitiveness across all business segments. In search, we further differentiated our content offerings, while driving ongoing upgrade of our services to intelligent Q&A based research. As China's second largest search engine, our core search revenue maintained positive faster growth than industry average in the first quarter. On Mobile Keyboard, we were pleased to see solid user traction in the first quarter. With increasing synergies with Sogou Search, the Mobile Keyboard now has stronger content and service distribution capabilities. At the end of March 2019, Sogou Mobile Keyboard has 443 million DAUs, an increase of 23% year-over-year. This positions as this third largest Chinese mobile app in terms of DAU according to iResearch. Now, let me walk you through each of our core businesses, starting with Search. As part of our strategy to build up more efficient and knowledgeable search platform that provides high-quality content, we focused our search efforts on the health care vertical and the intelligence to unveil capabilities. In terms of health care search, in the first quarter, we further increased our content ecosystem by integrating more interactive digital content to better address our user service. We recently formed exclusive partnerships with several trusted institutions in the health care industry, which enabled us to provide more accurate search results and practical guidelines in multiple medical categories, including disease and the maternal and infant care, driven by this initiative, self-reviewed content accounted for much higher proportion of our health care search results compared to other industry players in the first quarter. At the same time, we further strengthened our intelligent Q&A capabilities to deliver a more efficient search experience to users. During the first quarter, we continued to lead the industry in both the fulfillment and the accuracy of our results direct answer results. Turning to Mobile Keyboard. We are constantly integrating our latest AI technologies to launch more innovative product feature. Our technologies in voice translation and dialogue have not only enabled more intelligent user interaction, but also facilitated more personalized user expression, contributing to the solid growth of our user base. By the end of March 2019, average daily voice requests made by of our Sogou Mobile Keyboard have increased by 69% year-over-year, result to 600 million requests per day, making Sogou Mobile Keyboard the largest voice as in China. In addition, Sogou Mobile Keyboard has continuously strengthened its content and the service distribution capabilities. Since driving best [ph] understanding of user intent across multiple user cases, Sogou Mobile Keyboard now offers more targeted content recommendations in user chat. This has resulted in an increase in the click through rate of the content as, well as the rate that this content is shared between users. Moving to smart hardware. In the first quarter, we leveraged our core AI capabilities to drive ongoing upgrades of this business segment. We have now established the three major product lines, children, translation and voice. We also accelerated the product development process for our AI enabled hardware product. In March, we launched our new smart recorder CI, integrating our ratings to AI and competencies, the CI has redefined the traditional micro-recorder with a variety of innovating functions, including real time transcription and simultaneous translation, into multiple languages. We believe it will transform the work style of a diverse group of users such as journalist, students and businessmen and significantly improve work efficiency. To date, the C1 has been very positively received in the market. In addition, we have set up or R&D of new products in the children and the translation categories and are exploring the integration of multiple AI capabilities. Second, intelligent Q&A and the Vocational Avatars, which will increase the competitiveness of our product. Finally, turning to our AI strategy. We are committed to developing language centric AI technologies that build our leadership position in voice, computer vision, machine translation and Q&A. In the first quarter, we launched our new generation of Sogou Vocational Avatars that leverages our upgraded voice and computer vision technologies. Instead of a seated broadcaster, the new AI news anchor is able to stand and gesture as a human broadcaster will, making its broadcast more natural and lifelike. Following our launch of the world’s first AI news anchor with Xinhua News Agency, we introduced a new female AI news anchor named Xin Xiaomeng, who made her debut during the Two Sessions. We also launched another AI anchor jointly with CCTV finance channel to host the preview show for the March 15 consumer day gala. Moreover, we just announced a partnership with Abu Dhabi Media, company in the United Arab Emirates to provide a comprehensive AI news anchor solution. This marks the first time that our AI news anchor will be leveraged by an international media platform. And we look forward to introducing our solution to an even more global audience. Now, I will turn the call to Joe, who will walk you through our financials.

[Joe Zhou:]

Thank you, Xiaochuan. Hello everyone. We are pleased to report that our total revenues exceeded the top end of our guidance in the first quarter of 2019. This result was primarily driven by the better than expected performance in our core Search business, with search and a search related revenues increasing by 13% percent year-over-year in RMB terms, a faster pace than the industry average. We will return to solid profitability in the second quarter with seasonal recovery and continuous growth of our organic traffic and improvement monetization capability combined with our greater focus on execution and efficiency. Now, I'll walk you through our financials in greater detail. Please note that unless otherwise noted, all monetary amounts that I discussed are in U.S. dollars. Also note that, I will refer to some non-GAAP numbers which exclude share-based compensation expenses. You can find our reconciliation of non-GAAP to GAAP measures in our earnings release. Total revenues in the first quarter were $253 million. On a constant currency basis. Total revenues in the first quarter would have been $268 eight million, an 8% increase year-over-year. Search and as such related revenues were $234 million. On a constant currency basis, search and the search related revenues would have booked 13% increase year-over-year. The increase was primarily due to the growth in auction based pay-for-click services. Auction-based pay-for-click services accounted for 87% of search and search-related revenues, compared to 83% in the corresponding period in 2018. The number of advertisers for our auction-based pay-for-click service was approximately 79,400, up 7% year-over-year. The average revenue per advertiser for auction-based pay-for-click services was $2,600, up 7% year-over-year. Other revenues were $90 million, a 34% decrease year-over-year. The decrease was primarily due to lower sales of smart hardware products, as we continue to upgrade the smart hardware strategy and phase out certain legacy models of existing products. With new models to be launched and increasing contribution from the newly launched smart recorder, we expect hardware sales to bottom out in the second quarter and return to growth in the second half of 2019. Cost of revenues were $185 million, a 20% increase year-over-year. Traffic acquisition cost, a primary driver of cost of revenues was $143 million, a 28% increase year-over-year, representing 57% of total revenues compared to 45% in the corresponding period in 2018. The year-over-year increase was driven by price inflation which has clearly moderated from a year ago. As we become more selective with traffic acquisition and benefit from expected increase in the contribution from organic traffic, we expect this type of growth to be contained for the remaining quarters of 2019. Both GAAP and non-GAAP gross profit was $68 million compared to $94 million in the corresponding period in 2018. Both GAAP and non-GAAP gross margin were 27% compared to 38% a year ago. The decrease primarily resulted from the growth of traffic acquisition cost outpacing that of revenues. Total operating expenses were $80 million, largely flat year-over-year. Research and development expenses were $41 million, a 12% decrease year-over-year, representing 16% of total revenues compared to 19% in the corresponding period in 2018. The decrease was primarily due to a decrease in personnel-related expenses. Sales and marketing expenses were $29 million, a 8% increase year-over-year, representing 12% of total revenues, compared to 11% in the corresponding period in 2018. The increase was primarily attributable to an increase in personnel-related expenses. G&A expenses were $10 million, a 53% increase year-over-year, representing 4% of total revenues, compared to a 3% in the corresponding period in 2018. Operating loss was $12 million, compared to operating income of $14 million in the corresponding period in 2018. Non-GAAP operating loss was $11 million, compared to non-GAAP operating income of $19 million in the corresponding period in 2018. Other income, net was $9 million, compared to $4 million in the corresponding period in 2018. The increase was primarily due to an increase in gain from short-term investments. Income tax benefit was $0.2 million, compared to income tax expense of $2 million in the corresponding period in 2018. Net loss attributable to Sogou was $4 million, compared to net income of $15 million in the corresponding period in 2018. Non-GAAP net loss attributable to Sogou was $3 million, compared to net income of $20 million in the corresponding period in 2018. Basic and diluted loss per ADS were $0.01. Non-GAAP basic and diluted loss per ADS were $0.01. As of December 31, 2019, we had cash and cash equivalents and short-term investments of $1.1 billion, compared with $1 billion as of December 31, 2018. Net operating cash inflow for the first quarter of 2019 was $92 million. Capital expenditures for the first quarter of 2019 were $9 million. And finally turning to guidance. For the second quarter 2019 Sogou expects total revenues to be in the range of $303 million to $313 million, representing a 1% to 4% increase year-over-year, or a 7 % to 11% increase year-over-year in RMB terms. Please note that for the second quarter 2019 guidance, we have assumed the exchange rate of RMB 6.80 to the dollar, as compared with the actual exchange rate of approximately RMB6.38 to the dollar for the second quarter of 2018, and RMB6.74 to the dollar for the first quarter of 2019. That concludes our prepared remarks.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Elsie Cheng of Goldman Sachs. Please go ahead.

[Elsie Cheng:]

Thank you, management for taking my question. I have a question to Xiaochuan on the industry trend, so over the last two to three years we actually have observed the seed platforms, whether it's new seed or short-video seeds, have added a lot of incremental ad inventory to the P4P advertising space, which results in a supply demand dynamic change and that's probably adding pricing pressure to the overall industry. So I'd like to hear your insights on maybe first, what are your observations in the space and how it has impacted the search vertical segment? And second, how do you think this dynamic will play out this year and also for the next few years? And finally, what’s Sogou’s strategy under the changing competitive dynamic? Thank you. [Foreign Language]

[Xiaochuan Wang:]

[Foreign Language] So first, apparently seed is growing very fast and I think it has a very big impact on advertising dollars. And admittedly, Sogou's share of that advertising budget is on the decline. [Foreign Language] However it seems Sogou is a relatively smaller player and has roughly a smaller share of the market. We do you have a lot of room for growth, whether it be seed or leveraging big data capabilities, we believe we will continue to outperform the search industry in terms of revenue growth.

[Operator:]

[Operator Instructions] Our next question comes from Gregory Zhu of Credit Suisse. Please go ahead.

[Gregory Zhu:]

[Foreign Language] Now, I will translate my question to English. Thanks, management for taking my question. As we noted that the company has remarkably ramp up the monetization pace compared to the traffics. Can we know what are the triggers contribute to this significant increase and more specifically can we understand how should we put AI technology into this development? Our second question is regarding the smart hardware, can management further explaining what is the synergy between AI smart hardware with the current Search and Keyboard business? Thanks.

[Joe Zhou:]

[Foreign Language] Okay. So, I'll take the first one. First I'll give you more detail on the basic data. So for Q1 if in RMB terms our total revenue increased to 8% percent and on that search related revenue increased to 13%. So amount of 13% growth is roughly close to 10% is from improvement on monetization and for rest go to the growth in traffic. So why we can have better improvement on monetization than the industry average? So basically there are two factors. Number one, so comparing to the industry leader in terms of RPM, we still have certain gap with them, so - especially on the mobile side. So that's why we still have a lot of room to improve. And the second reason is that, last year due to the year spent in the [indiscernible] in the third quarter, that caused the management team, especially the monetization team, a lot of efforts and time to cope with the instance. After that, I mean, in the Q4 last year and this Q1 they shifted their focus on the improvement on monetization. That's why we see much faster improvement on monetization in Q1 and this trend will continue into the second quarter and second half of 2019.

[Joe Zhou:]

[Foreign Language] Okay. Regarding your second question on synergies, on search keyboard and hardware, we viewed our business in search and keyboard based on language-centric capabilities and with the era of artificial intelligence, we've developed a road map of natural interaction and knowledge computing and we used such technologies into our search and mobile cable keyboard - for example using natural interaction we enabled and our mobile keyboard to become the intelligent Q&A based search. And also in terms of hardware, we are trying to leverage a language-centric capabilities into the developmental process of our hardware business to help users to better input, express themselves and get information. For example in our latest launch of the smart recorder C1, we've leverage a lot of language capabilities and make it a – make it a very efficient experience for a diverse group of users. And in the future we plan to launch a few more new AI enabled hardware products that would more closely integrate our language-centric AI capabilities.

[Gregory Zhu:]

Thank you, management.

[Operator:]

Our next question comes from Xueru Zhang of 86 Research. Please go ahead.

[Xueru Zhang:]

[Foreign Language] I'll now translate my questions. The first question is can management comment about how we see the advertising sentiment changing from Q1 to Q2 if any? And how should we think about the trend for our key advertising categories as we head into 2019? And again, a follow up question on AI related exploration. I'm wondering besides the smart hardware business and the other monetization opportunities here which could leverage your core competency - competence in particular your speech and translation and that we should pay attention to? Thank you.

[Xiaochuan Wang:]

[Foreign Language] So regarding your first question on advertising sentiment, we believe Sogou has a relatively small base of advertisers and that we may not be the best representative to speak for the industry. Having said that, you may notice that our advertising revenues grew by a 13% in the first quarter and actually we are in the process of signing up a framework contract with key accounts, and we currently see a 15% to 20% growth. So that shows that our search - core search business is having a solid growth.

[Xiaochuan Wang:]

[Foreign Language] The top five - top five sectors as to healthcare, e-commerce, gaming, merchant services and business services in the first quarter we haven't seen much change from, the advertisers spend it varies according different sectors, but not so much, more or less affected by the macro softness. And some specific industries like gaming is more impacted by regulatory risks.

[Xiaochuan Wang:]

[Foreign Language] In addition to leveraging our AI capabilities in smart hardware business, I just mentioned we've been able to applying such competencies in our keyboard and which help users to communicate and get information. We believe with, refinement of our language-centric capabilities, such as the voice interaction, computer vision and the Q&A technologies, I think keyboard has greater room for growth.

[Xiaochuan Wang:]

[Foreign Language] On the 2B [ph] side we've also noticed some opportunities, although we would not take full swing into that. But we - our AI news anchor actually has been well received in the market and actually in different sectors it has the potential applications such as education, insurance, news reporting, which allows us to you know, leverage such AI news anchor solutions to help them better communicate with their target audience.

[Operator:]

[Operator Instructions] Apologies, please go ahead.

[Xiaochuan Wang:]

I guess that's very helpful. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Alicia Yap of Citigroup. Please go ahead.

[Alicia Yap:]

Thank you. Good evening, management. [Operator Instructions] I had two quick questions. Number one is that, given Sogou recently had some progress on the news feed, whether management could you elaborate a little bit some of the achievement and also any plans to enter the short videos content? And then second question is that, given there is a lot more step-up or a little bit sensitive year this year, so have you seen any step-up content control from the regulatory side. If so any potential impact that you foresee that it could affect the search industry and also Sogou? Thank you.

[Xiaochuan Wang:]

[Foreign Language] On the short video I think we are trying to develop our own content ecosystem, including Sogou Hao [ph] similar to Tudou Hao [ph] and these have been driving the growth of seed and search content. We are not going to enter in the market of YouTube content on the short video front, but we have been working with some short video companies like Kuaishou to increase the coverage of short video content, our search platform, the regulatory control, we've seen that since the second half of last year our regulators have stepped up their regulation on the Internet industry and we are coping well with the related agencies to meet their demand, but we haven't seen a further step up of their regulator control. We don't expect any more regulatory risks of going forward.

[Alicia Yap:]

Okay. Thank you.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Jessie Zheng for any closing remarks.

[Jessie Zheng:]

Okay. Thank you all for attending Sogou’s first quarter earnings conference call. We look forward to speaking to you next time.

[Operator:]

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.