Sogou Inc.
Q4 2019 Earnings Call Transcript

Published: 9 Mar 2020

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to Sogou's Fourth Quarter and Full-Year 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 fourth quarter and full-year 2019 earnings conference call. On the call, are our CEO, Xiaochuan Wang; and our CFO, Joe Zhou will give an overview of the operations and financial results. In line with our practice on the previous earnings conference calls, Xiaochuan prepared remarks will be made in Xiaochuan's voice using personalized speech synthesis and style transfer learning technology which was developed by the Sogou Voice Interaction Technology Center. Xiaochuan will join the 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 herein. The matters discussed in this conference call are forward-looking statements. These statements are based on the current plans, estimates and projections and therefore you should not place undue reliance on them. Forward-looking statements [technical difficulty] Securities and Exchange Commission.With that, I'd now turn the call over to our CEO, Xiaochuan Wang.

[Xiaochuan Wang:]

Thank you, Jessie and hello, everyone. We maintained steady progress in 2019. Despite headwinds in the macro environment and online advertising industry in China, our cost of revenues increased 9% year-over-year to over RMB8 billion and net income surpassed RMB730 million for the year. This was primarily driven by our dedication to continuously drive organic traffic growth and unlock the monetization potential of our core user assets, while at the same time further improving operational efficiencies.By the end of 2019, Sogou Search remain China's second largest search engine. And now Search revenue continued to grow faster than the industry average. Sogou Mobile Keyboard increased its user base to 464 million DAUs reinforcing its position as the third largest Chinese mobile app in terms of DAUs according to iResearch.With respect to our recommendation service that leverages Mobile Keyboard, its revenue continues to experience robust growth. In addition, our Smart Hardware business maintained healthy momentum. Thanks to ongoing upgrades to our AI offerings.Now let me walk you through each of our core businesses, including Search, Mobile Keyboard and Smart Hardware. In Search, on top of ongoing efforts to improve the quality of search services, we also strengthened our content and service ecosystem during 2019.On the content front, we made solid progress in building a more professional search platform. For example, healthcare related contents on Sogou Search continued to be perceived as more reliable. Our intelligent Q&A provided users wider access to high quality content, including that on reach as official accounts and Sogou Health also further optimized its content ecosystem.On the services front, we enhanced our offering, starting with healthcare to explore opportunities in Smart Triage [ph]. Throughout the year, we significantly improved user experience in healthcare search and both average click-through volume and click-through rate per person recorded solid increases. Our top direct answer fulfilled a significant portion of our overall search results with a high level of accuracy. These initiatives have effectively boosted our organic traffic growth.Turning to Mobile Keyboard. Over the past year, we launched a comprehensive set of upgrades, defining user perception of AI input with our smarter AI enabled solutions that allow a more efficient and accurate input. In particular, we released a number of product innovations which differentiate us from other players and expand our user base.For example, Smart Wanzai an AI enabled communication assistant within Mobile Keyboard that was launched in the third quarter of 2019 recommends to users a large variety of the emoticons [indiscernible] reply and comments to use in chat and online shopping. The recommended content has been used hundreds of millions of times per day on average, and the daily usage number keeps climbing. Another good example is our AI enabled voice functions such as voice conversion and personalized voice recognition, which effectively strengthens our user [indiscernible].By the end of December 2019, Sogou Mobile Keyboard process 54% more daily voice requests on average year-over-year with up to 800 million requests per day, retaining our position as the largest voice recognition app in China. On top of product upgrades, we have also strengthened our recommendation service that leverages Mobile Keyboard to further allow its commercial value. In 2019, revenue generated from our recommendation service increased nearly 90%. Going forward, we intend to tap into additional use cases for recommendations that are fulfilling users various needs for information discovery, while they are typing.On Smart Hardware, we leveraged our AI technologies to further drive business upgrades. In 2019, we successfully launched a new compelling product category, AI Smart Recorder C1 and C1 Pro, which led an AI driven upgrade in all across the recording industry. The two products also top the best selling on several mainstream e-commerce platforms.At the same time, we proactively established an AI innovation alliance with leading recorder players in China, under which we have been able to capture an increasing number of users through opening up our Sogou Transcription service. These also allows us to drive the AI evolution of traditional recorders and to explore a service based business model in the future. Going forward, we will set up R&D efforts to diversify our product matrix and strengthen the pipeline.Moving on to AI. In 2019, we made great advances across our core language centric AI technology, including voice, computer vision, machine translation and Q&A. In addition to empowering our Mobile Keyboard and Smart Hardware businesses, we also integrated the technologies into the industry leading solutions, including vocational avatars and AI powered simultaneous interpretation.In particular, with further advanced Sogou Vocational Avatars with real time human interaction features. Moreover, we expanded the application of this into multiple sectors, including AI News Anchor for News Broadcasting, AI Virtual Judge for Legal Services, AI host for Literature and Entertainment events, and AI Customer Service Avatar for financial services. Our proprietary Vocational Avatar Yanny has successfully hosted multiple conferences recently and gained broad recognition among the industry.In terms of Sogou Simultaneous Interpretation Solution, we made substantial progress in utilizing our proprietary contact engine, computer vision as well as AI self-learning capabilities in the latest upgrade. This means our solution is stable to not only listen, but also to see and think in real time during the interpretation process. This is the first of its kind in the market. As a result, the accuracy of interpretation results have increased 40%.In 2019, Sogou Simultaneous Interpretation Solution supported nearly 50 conferences in the areas of technology, finance, sports and more.Next, I'd like to talk about the impact of the recent COVID-19 outbreak. Before I begin, I want to say that our thoughts go out to those who have been impacted by the situation, our users, employees, business partners and the general public. When the outbreak started we donated RMB13 million worth of cash and materials to aid the frontline medical staff in regions that have been severely impacted. We also pledged RMB50 million to set up a special purpose fund, which will be used to help primary level public health institutions to tackle the critical issues faced with an emphasis on AI applications.The Internet technologies have played an important role in resolving various difficulties during the outbreak. This has also created emerging opportunities for Sogou, which we can leverage to accumulate and cultivate additional users during the outbreak benefiting from users surging requests for finding reliable information and high efficiency. Sogou Search traffic reached a record high level. Of that, healthcare search traffic increased as much as 100% year-over-year and online consultation volume grow a very substantial 400% year-over-year.Sogo Mobile Keyboard DAUs also booked a record high of 480 million with organic users growing significantly. The increases also resulted from our efforts as a major industry player to quickly mobilize our R&D and technological advantages to address the situation. We are pleased that this has enabled us to make constructive contributions at this challenging time, as well as to boost our development in search, feed and AI healthcare.Let me give a few examples of our initiatives in relation to the outbreak. Sogou Search launched a series of functions, which allow users to have quick, convenient and effective access to epidemic information functions like diagnose patient's travel history search were the first among our users and the industry. Meanwhile, we also facilitated the development of AI healthcare to serve our users during the outbreak [technical difficulty] at partnering with authorities, including China's National Health Commission, we launched an AI enabled [indiscernible] checker robot as well as an intelligent Q&A robot to alleviate the threat faced by primary level health institutions, particularly in handling massive and repetitive queries about the epidemic.Looking forward, the epidemic so far has caused significant interruption to businesses and economic activities across many industries in China, including online advertising industry. Sogou is now immune to the impact and there will be a one-off short-term dampening impact on our results in the first quarter of 2020. Nevertheless, from a long-term perspective, the epidemic has increased users reliance on the Internet, fostered more online behaviors and generated new demands from both users and businesses, which we believe will drive the ongoing development of the internet industry.Looking at 2020 [technical difficulty] increase the revenue contribution. While it is difficult to take how the year will unfold with this set of strategies implemented and once things return to normal, post the epidemic. We currently expect our business to accelerate in the second half of 2020. We will, however, keep the investment community well-informed on this moving forward.With that, I will now turn the call to Joe to go through our financial.

[Joe Zhou:]

Thank you, Xiaochuan. Hello, everyone. In the first part of 2019, we recorded total revenues of $301 million as Search remained resilient despite the pressure from external challenges and recommendation service and smart hardware continue to deliver solid growth. Moreover, we again witnessed across the board market expansion, and our non-GAAP net income increased to 44% year-over-year to $39 million. The solid visibility primarily resulted from our stringent control in traffic acquisition costs and expenses as well as improved operating efficiency.Please note that unless otherwise noted, all monetary amounts that I discuss 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 a reconciliation of non-GAAP to GAAP measures in our earnings release.Total revenues in the fourth quarter were $301 million. On a constant currency basis, total revenues in the fourth quarter would have been $306 million, a 3% increase year-over-year. Search and Search related revenues were $275 million. On a constant currency basis, Search and a Search related revenues would have looked at 1% increase year-over-year. The increase was primarily due to growth in auction-based pay-for-click services.Auction-based pay-for-click services accounted for 88% of Search and Search related revenues, compared to 85% in the corresponding period in 2018. Other revenues were $26 million, a 26% increase year-over-year. The increase was primarily due to increased revenues from sales of Smart Hardware product.Cost of revenues was $169 million, a 9% decrease year-over-year. Traffic acquisition cost, our primary driver of cost of revenues was $129 million, a 14% decrease year-over-year, representing 43% of total revenues compared to 50% in the corresponding period in 2018. As we continue to benefit from the increasing contribution from organic traffic and industry competition for external traffic has proved moderated. We expect TAC growth to be well contained in 2020.Gross profit was $132 million, an 18% increase year-over-year. Non-GAAP gross profit was $133 million, a 19% increase year-over-year. Both GAAP and non-GAAP gross margin increased to 44% compared to 38% a year-ago. The increase primarily resulted from our efforts to control traffic acquisition cost.Total operating expenses were $95 million, a 4% decrease year-over-year. Research and development expenses were $49 million, a 100% increase year-over-year, representing 16% of total revenues, largely flat compared to the corresponding period in 2018.Sales and marketing expenses were $35 million, a 16% decrease year-over-year, representing 12% of total revenues compared to 14% in the corresponding period in 2018. The decrease was primarily attributable to our decrease in marketing and promotional spending. G&A expenses were $11 million, a 21% increase year-over-year, representing 4% of total revenues compared to 3% in the corresponding period in 2018. The increase was primarily due to an increase in professional fees.Operating income was $37 million, a 202% increase year-over-year compared to $12 million in the corresponding period in 2018. Non-GAAP operating income was $41 million, a 216% increase year-over-year compared to $30 million in the corresponding period in 2018. Other income net was $0.5 million compared to $9.6 million in the corresponding period in 2018. The increase was primarily due to a $9.1 million impairment loss on the company's equity investments in 2019.Income tax expense was $2 million compared to income tax benefit of $4 million in the corresponding period in 2018. Net income attributable to Sogou was $35 million, a 33% increase year-over-year compared to net income of $26 million in the corresponding period in 2018. Non-GAAP net income attributable to Sogou was $39 million, a 44% increase year-over-year compared to a net income of $27 million in the corresponding period in 2018.Basic and diluted earnings per ADS were $0.09. non-GAAP basic and diluted earnings per ADS were $0.10. As of December 31, 2019 we had cash and cash equivalents and short-term investments of $1.1 billion compared to $1 billion as of December 31, 2018. Net operating cash inflow for the first quarter was $52 million. Capital expenditures for the first quarter were $9 million.Now I will briefly walk through the highlights of our full-year results. Total revenues were $1.2 billion, a 4%. increased from 2018 or a 9% increase on a constant currency basis. Search and Search related revenue [technical difficulty] were 88% of Search and Search related revenues compared to 84% in 2018. Other revenues were $99 million compared to $101 million in 2018.Net income was $89 million compared to $99 million in 2018. Non-GAAP net income was $105 million compared to $130 million in 2018. Basic and diluted earnings per ADS were $0.23. Non-GAAP basic and diluted earnings per ADS were $0.27.And finally, turning to our outlook. For the first quarter of 2020, we expect total revenues to be in the range of $240 million to $260 million, representing a 5% decrease to 3% increase year-over-year or a 1% decrease to 7% increase year-over-year in RMB terms. This near-term guidance takes into account the impact of the coronavirus outbreak as well as other [technical difficulty].We currently expect to get back on track post the epidemic and accelerate development in the second half of 2020. Please note that for the first quarter 2020 guidance, we have presumed an exchange rate of RMB7 to $1 as compared with the actual exchange rate of approximately RMB6.74 to $1 for the first quarter of 2019 and RMB7.03 to $1 for the first quarter of 2019.That concludes our prepared remarks.

[Jessie Zheng:]

Thank you, Joe. Operator [technical difficulty].

[Operator:]

[Operator Instructions] The first question today comes from Thomas Chong of Jefferies. Please go ahead.

[Thomas Chong:]

[Technical difficulty] good health and safe. My question is about the advertising trend across different industry. Can management share about how different categories allocate their spending in Q1, and how we should think about the trend in Q2 and second half? And my second question is about our Smart Hardware initiative. Can management share the KPI for this year and about the timing that we expect to achieve profitability? Thank you.

[Joe Zhou:]

Okay. First question. So for Q1 during the outbreak, we are benefiting from users surging requests for finding reliable information and high efficiency. So our search traffic reached a record high. But the outbreak has caused significant interruptions to China's economy and the businesses, which has negative short-term impact on online advertising. So therefore, despite this strong increase in traffic, our search related revenues will face more [technical difficulty].

[Xiaochuan Wang:]

So in terms of the hardware question, Sogou launched mainstream hardware product within this year, targeting a larger population of consumers with faster development space, And we expect to achieve mid to high single-digit revenue contribution from our hardware business, and we expect to achieve profitability in 2021.

[Joe Zhou:]

And let me add more color on the second quarter and second half. So, basically we expect the advertising revenue will largely recover from the Q1, I mean, the coronavirus outbreak. So the growth rate will accelerate in Q2, and with our -- we continue to unlock the value of our mobile keyboard and accelerate the AI Smart Hardware in the second half that the revenue will be -- will accelerate further, I mean, quarter-over-quarter comparing to Q2.

[Thomas Chong:]

Got it. Thank you.

[Operator:]

The next question comes from Daniel Chen of JPMorgan. Please go ahead.

[Daniel Chen:]

[Indiscernible] myself wish everybody in good health. My first question is regarding the advertising business. Could management give us an update on how the business recover in the last two weeks? And also some preliminary view on what do we expect our advertising -- when do we expect our advertising business to back to a normal status? Second question is on Mobile Keyboard. So we have done pretty well in terms of revenue growth for the keyboard in 2019. So what is our main strategy to further monetize and further grows our Mobile Keyboard in 2020? Thank you.

[Unidentified Company Representative:]

So [indiscernible] will answer that.

[Joe Zhou:]

Okay. So over the past two weeks, we see the advertising revenue recovery with little bit visibility where we still take time to look at revenue. Basically it will recover quarter-over-quarter. So in Q2 it will largely recover, but of course not 100% to normal situation. Now for the second half, we expect it will fully recover to a normal situation. So as I mentioned, with which we unlock the value of our mobile keyboard and smart hardware, so that's why in the second half, we expect revenue growth to accelerate.

[Xiaochuan Wang:]

Okay. In response to our mobile keyboard question, I think you have noticed that in 2019 we further grown our user base and we’ve launched very innovative function called Smart Wanzai, which basically transforms mobile keyboard to intelligent communication assistant that we can leverage to do all kinds of recommendations. And in 2020, we'll step up our efforts to strengthen users mindshare and in terms of commercialization we'll steadily drive forward recommendations service with more targeted recommendations of both information and services. And we are also further unlock the commercial value of mobile keyboards user assets such as the rollout of paid-to-see value added services, including personalizing graphic skins, emoticons, etcetera. Recommendation surveys has grown by nearly 19% year-over-year in 2019, and we expect it will maintain robust growth in 2020. As a percent of our total revenues, it's going to be like mid to high single-digit contribution in 2020, and we -- we will continue to grow to a meaningful level going forward.

[Operator:]

The next question comes from Natalie Wu of CICC. Please go ahead.

[Natalie Wu:]

So thank you [technical difficulty] so can management update us your up to date advertiser sector distribution? And what would you expect that distribution to equal by the end of this year? And my second question is regarding the recent variations in investments into [indiscernible]. I noticed that in this [indiscernible] investment into the online medical treatment platform [indiscernible] just wondering what kind of the strategic collaboration do we anticipate in future? Thank you.

[Joe Zhou:]

Okay, I'll take the first question. So for Q1 guidance, so if you look at midline [indiscernible] basically it means 3% increase year-over-year. That's better than industry average. That's primarily because

[Xiaochuan Wang:]

Okay. In response to your AI healthcare question, I think in the last few years, we have been very dedicated to building a professional healthcare search platform. Therefore, we have strong presence in health search, and that as a foundation we gradually operate AI healthcare as an independent business unit. And our ultimate goal is to grow into a digital family, doctor model. I think Sogou's AI healthcare is due on targeting our consumer market, given that healthcare is a low frequency request. It's very likely that ultimate gateway will be -- will still be search. And by then the AI healthcare platform will not only provide healthcare information, but also provide additional healthcare services like Smart Triage [ph] etcetera. So our core competitive edge is actually search plus AI, because we have a very well recognized healthcare search platform that's acting on traffic engines for AI healthcare. And nearly 10% of our total traffic is coming from healthcare. It's traffic gateway that users has been used to and in the past few years we've been trying to build this platform into a authoritative and reliable healthcare search platform, providing both content and services. Therefore, this has laid a solid foundation for us to develop AI healthcare. And second, Sogou has very strong AI. capabilities. This will be our leading AI technologies able to help alleviate the shortage of [indiscernible] resources and to create a barrier to industry peers in the competition. And in 2019, we've actually done a lot in developing AI healthcare. We've received Internet hospital license, and during the epidemic we've seen new opportunities with the rollout of our online healthcare search, online healthcare consultation, symptom checker and intelligent Q&A robots. Notably, healthcare search traffic has increased 100%. Our online healthcare consultation has significantly grown by 400%. In addition, we've launched RMB50 million, a special purpose fund to drive AI capitation in healthcare. Lastly, we are also seeking M&A to accelerate AI healthcare development, latest investment in [indiscernible] doctor is actually our first mover in the sector as part of the efforts. We believe by partnering with [indiscernible] it will facilitate our development in AI healthcare in the future.

[Operator:]

The next question today comes from Alicia Yap of Citigroup. Please go ahead.

[Alicia Yap:]

Hi. Good evening, management. Thanks for taking my question. So my question is related to management comment regarding into the second half where you expect revenue to accelerate. So despite the smart hardware new product launch which is going to contribute a pretty big driver on that for such a revenue, do you also expect a reacceleration? If so, what are the driver for the search revenue to reaccelerate? And then, just another quick follow-up is that currently what are the traffic redirection from the mobile keyboard to your search currently? Thank you.

[Joe Zhou:]

Okay. So for search revenue, basically, if you look at Q1, Q2 and the second half, the trend will be that for Q1 basically it will be flattish, 1% to 2% increase year-over-year in RMB terms. And in second quarter with the epidemic [indiscernible] and the advertising revenue will recover -- largely recover. So the growth rate will accelerate. And in the second half it will further accelerate to say maybe to around 5%. So if you look at Q4, for search related revenue, the year-over-year growth rate, it's about something around 1% RMB terms year-over-year. So that's the basic trend for search part. For revenue from mobile keyboard, we leverage our mobile keyboard to build up our recommendations continuing to focus a lot the value of our mobile keyboard. So we expect that contribution will continue to expand.

[Alicia Yap:]

Thank you.

[Operator:]

The next question comes from Elsie Cheng of Goldman Sachs.

[Elsie Cheng:]

Hello. Thank you, management. I have three questions. The first one is to follow-up on the recovery question earlier. Just want to understand little bit more about what kind of recovery ratio we're looking at right now? And if possible, any color on the speed of recovery? And second question is about our strategy on search [indiscernible] method and Smart Hardware. If we go beyond 2020, how should we think about the synergies in developing the hardware internet business together? And the third question is, I want to ask about Mini program and the thinking about Mini program strategy at Sogou, because as we understand its more integrated with the input method in terms of product features for now and how do we think about developing these two type business in future? Thank you.

[Joe Zhou:]

Okay. So for the first question regarding how the advertising revenue will recover. So with a relatively small scale, maybe we are not a very good indicator for the whole industry and as the epidemic is still evolving and post a lot of uncertainties, so there is limited utility regarding how it will fully recover. But if you look at Sogou, as I mentioned, we expect Q2 we will largely recover from the epidemic. And for second half we will fully recover from the epidemic. I think Xiaochuan will take the second and third question.

[Xiaochuan Wang:]

So in terms of your question about -- on the synergies between search and mobile keyboard and hardware, basically we are very -- we have a very strong core asset, mobile keyboard is actually helping users to input and express themselves. And search is about to help users to get information. But before you get information, you'll have to input something. And hardware is a very good carrier of connecting with input and output. It integrates the basic functions of search and mobile keyboard. And in 2019 we launched a new category of hardware called Smart Recorder. It's basically a hardware version of the split internet search. And in the future, we are going to integrate increasingly more AI capabilities, not only on the interaction -- interactive features like voice, image or computer vision, but also integrating more knowledge computing capabilities that provide users with direct answers, best solutions or services. So this is something that only hardware can do and we believe we have very strong synergies between all the core assets -- all the core assets at Sogou. We think many programs are a very good medium that we can leverage. Actually, we have been integrating Mini programs in both search and mobile keyboard. Mini programs have been across all the information use cases across Sogou's products, and that allows us to provide users with both content and services and develop a closed loop of ecosystem for them. But what we have observed is that Mini programs are not material to driving search traffic and existing Mini programs, how they can benefit content providers or advertisers is yet to be seen. I think the most successful Mini program at Sogou with the innovation ecosystem. But having said that, we are really trying to tap into the potential of the Mini programs and we will definitely do something about it later.

[Operator:]

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

[Jessie Zheng:]

Thank you, everyone for joining today's call and for your continued support for Sogou. We look forward to speaking to you again in the future.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.