Sohu.com Ltd Q2 FY2020 Earnings Call

Good evening. Thank you for joining Sohu's Second Quarter 2020 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 would now like to turn the conference over to your host for today's conference call, Huang Pu, Investor Relations Director of Sohu. Please go ahead.

Thanks, operator. Thank you for joining us today to discuss Sohu's second quarter 2020 results. On the call are Chairman and Chief Executive Officer, Dr. Charles Zhang; CFO, Joanna Lv; and Vice President of Finance, James Deng. Also with us today are Changyou's CEO, Dewen Chen; and CFO, Yaobin Wang. Before management begins their prepared remarks, I would like to remind you of the company's Safe Harbor statements in connection with today's conference call. Except for the historical information contained herein, the matters discussed in this conference call may contain 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 Securities and Exchange Commission, including the most recent annual report on Form 20-F. With that, I will now turn the call over to Dr. Charles Zhang. Charles, please proceed.

Thank you, Huang Pu. Thank you everyone for joining us for the second quarter of 2020. Our brand advertising business performed well. The brand advertising revenue had a decent increase of 48% quarter over quarter. Both the brand advertising revenue and the bottom line exceeded our prior guidance. During the quarter, we integrated our media portals’ grant advantage and influence with Sohu Video's advanced live broadcast technologies. These initiatives allowed us to more effectively generate and distribute our high-quality original content and further enhanced our credibility, reflecting the attitude and value of Sohu. For Changyou, the privatization was completed on April 17, 2020. After that, Chinese net income and loss was wholly attributable to Sohu.com Limited. During the second quarter 2020, online game revenue met our prior guidance and declined quarter over quarter, primarily due to the resumption of work following the easing of COVID-19 restrictions. For Sohu, it delivered in-line results in the second quarter with search maintaining a steady share of traffic and mobile keyboard input further expanding its daily active user base. Before I go into more detail of our key financial results, please be reminded that for the second quarter of 2020, Changyou recognized an additional $88 million accrual for withholding income tax. Changyou changed its policy for its TRT subsidiaries regarding the distribution of cash dividends following the completion of the privatization. In addition, back in the third quarter of 2019, Changyou's cinema advertising business ceased operations. Unless indicated otherwise, the results that we'll discuss today exclude the impact of the abovementioned withholding income tax and the cinema advertising business. Now for the second quarter of 2020, total revenues were $421 million, down 9% year over year and 3% quarter over quarter. Brand advertising revenues were $38 million, down 14% year over year and up 48% quarter over quarter. Search and search-related advertising revenues were $241 million, down 13% year over year and up 1% quarter over quarter. Online game revenues were $106 million, up 4% year over year and down 21% quarter over quarter. GAAP net loss attributable to Sohu.com Limited was $80 million. Excluding the impact of the additional accrual of withholding income tax described above, GAAP net income attributable to Sohu.com Limited was $8 million, compared with a net loss of $35 million in the second quarter of 2019 and a net loss of $20 million in the first quarter of 2020. Excluding the impact of the additional accrual of withholding income tax, non-GAAP net income attributable to Sohu.com Limited was $11 million. Further excluding the loss generated by Sohu, non-GAAP net income attributable to Sohu.com Limited was $12 million, compared with a net loss of $41 million in the second quarter of last year and a net loss of $8 million in the first quarter of 2020. So now let me go through some of our key businesses. First, Media Portal and Sohu Video; for Media Portal we continue to consolidate our core competitiveness and credibility as a mainstream media platform. By generating and distributing news and premium content, we also continue to upgrade the quality of our content and recommendation algorithms to provide users with a broader and more personalized experience. As a result, we saw the consumption of content increase significantly during the second quarter. For video, we continue to strengthen our long-form and short-form so-called true engine strategy. For the long-form original content, we released two original idol romance dramas. One is the 'High School Big Bang,' recognized as a bandwagon, and another one is 'My Dear Lady 2020,' which were well received by audiences and gained widespread attention. For short-form content, we further strengthened our live broadcast capabilities. By being able to establish a good reputation with our medical and health live broadcasters, we are generating and distributing accurate and reliable information in these areas. We will continue to push forward in this area while proactively exploring new opportunities in other verticals. On the monetization side, we kept exploring new monetization opportunities by integrating the brand influence of our media portal with Sohu Video's advanced broadcast technologies. During the quarter, we successfully hosted several events that integrated both online and offline features. We launched a new live broadcast series called 'Boss1+1,' where we invited industry celebrities to share their insights on the economy and the market, wherever they are, using live broadcast sharing technology. We also successfully hosted the Sohu Tech 5G Summit and Sohu News Marathon, which broke geographical boundaries and provided participants with broader views and a greater user experience. In June and July, we moved further towards the field of e-commerce by hosting the best of sisters' selection live from Sohu. We invited celebrities to share their thoughts live while recommending premium goods, the product was noted to be of good use. We have seen a number of positive results from these new initiatives, given that they are providing advertisers with a variety of marketing strategies that fit the current moment and meet general public demand. Going forward, we will continue to diversify revenue sources and actively explore new opportunities to grow advertising. Next, let's talk about Changyou. For the second quarter of 2020, online game revenues decreased quarter over quarter against our prior guidance, mainly due to a decrease in player engagement as a result of the work resumption following the COVID-19 pandemic in China. For PC games, Changyou launched the new expansion pack of TLBB PC during the quarter with various anniversary events, and also new maps and dungeons were developed using advanced rendering technologies. All of this new content served to greatly improve the user experience. For mobile games, the expansion pack of legacy TLBB Mobile's three-year anniversary was launched during the quarter. The newly introduced gameplay, which allowed players to explore randomly generated content, was also well received. For the third quarter of 2020, Changyou will focus on stabilizing player engagement and rolling out in-game rewarding events and fresh content for TLBB PC and mobile games. Looking ahead, Changyou will continue to focus on executing its core strategy of top games. MMORPG mobile games will remain a key strategic focus, as we are also scanning the market for opportunities across various genres as we look to diversify our product portfolio. Meanwhile, we'll also increase our efforts overseas; currently, several key games are being developed and prepared for launch. We believe Changyou will bring more quality games for players in the future. Lastly, let me talk about Sogou. Despite great challenges under the COVID-19 pandemic, Sogou has been proactively upgrading its development strategy to focus on generating more user value and building out a business that is oriented toward long-term value-added growth. In the second quarter of 2020, Sogou delivered in-line results with healthy momentum in its search and mobile keyboard businesses. Sogou search maintained a steady share of traffic and reinforced its position as China's second largest search engine, while mobile keyboard further expanded its daily active user base to 484 million, maintaining the third largest Chinese mobile app in terms of DAU according to AI research. Additionally, its AI hardware business recorded solid growth during the quarter. Going forward, Sogou will further boost AI empowerment and synergies across their businesses while continually driving technological advances. Now let me turn the call over to Joanna, our CFO, who will walk you through our financial results. Joanna?

Thank you, Charles. I will walk you through the key financials of our four major segments for the second quarter of 2020. All of the numbers that I will mention are on a non-GAAP basis. You can find a reconciliation of non-GAAP to GAAP measures on our IR website. For Sohu Media Portal, quarterly revenues were $22 million; down 7% year-over-year and up 49% quarter-over-quarter. The quarterly operating loss was $80 million compared with an operating loss of $38 million in the same quarter last year. For Sohu Video, quarterly revenues were $22 million, up 6% year-over-year and down 4% quarter-over-quarter. The quarterly operating loss was $10 million compared with an operating loss of $23 million in the same quarter last year. For Changyou, quarterly revenues, including 17173, were $109 million, up 3% year-over-year and down 20% quarter-over-quarter. Changyou posted an operating profit of $37 million, compared with an operating profit of $38 million in the same quarter last year. For Sogou, quarterly revenues were $261 million, down 14% year-over-year and up 2% quarter-over-quarter. The net loss was $6 million compared with net income of $28 million in the same quarter last year. For the third quarter of 2020, we expect brand advertising revenue to be between $37 million and $42 million. This implies an annual decrease of 9% to 20% and a sequential decrease of 3% to a sequential increase of 11%. Online game revenue is expected to be between $85 million and $95 million, implying an annual decrease of 12% to 21% and a sequential decrease of 10% to 20%. Excluding the total loss generated by Sogou, the non-GAAP net loss attributable to Sohu.com Limited is expected to be between $10 million and $20 million. GAAP net loss attributable to Sohu.com Limited is expected to be between $50 million and $25 million. This forecast reflects Sohu's management's current and preliminary review, which is subject to substantial uncertainty, particularly in view of the potential ongoing impact of the COVID-19 virus, which remains difficult to predict. Lastly, please be reminded that we won't take questions regarding any Sogou business updates and the intent of the non-binding proposal for Sogou privatization in the Q&A session. This concludes our prepared remarks. Operator, we would now like to open the call for questions.

Thank you. Our first question comes from Eddie Leung from Bank of America Merrill Lynch. Please ask your question.

Hey, good evening, guys. I just have two quick questions. The first one is about podcasting. I think, Charles you mentioned that there has been some synergy from reducing the influence, as well as broadcasting. I wonder if you have any operating metrics or financial share to share with us on the performance of broadcasting you have shifted in the quarter. And how's it growing into the third quarter? So, that's my first question. The second question is about games. I also think you mentioned that after people returning to work, there has been some weakness in the gaming industry in general. So, I'm just wondering whether we have seen some stabilization on that front. And now as we end the summer, which traditionally should be a good quarter in general for the gaming industry, any color on the general industry trend of gaming into the third quarter would be great? Thanks.

So, Eddie, your first query is about live broadcasting, right?

Yes.

So we have quite a few influencers on a daily basis, like dozens of influencers broadcasting. However, it is probably just 10 or 20 that we are actually using our platform to market them. So there are live broadcasts that we are pushing to market about 10 broadcasts. We call it value broadcasting or where we have people from different industries such as medical health, lifestyle, or cosmetic industries teaching and sharing knowledge and information. We have a few top broadcasts each month with some top celebrities to share their life experiences and some products, and we're able to connect our chat rooms or live broadcast room to e-commerce platforms. When a celebrity recommends some products they use, the user can click that small shopping cart to purchase directly. This transaction-based advertising, along with giving out rewards or lotteries for users who click, has really driven the sales volume of those products. The popularity of those chat rooms and the celebrity recommendations have become a good reason for some of the big advertisers to spend money on our overall advertising. This is a central part of the whole contract. Am I answering your question, Eddie?

Yes. So basically, there is no direct e-commerce platform. Charles, you are using the content to attract advertising in general, that's actually the current operation.

There is an e-commerce component because the advertisers give out substantial discounts. This is why people are really coming to our chat rooms—they are getting the best prices online. Advertisers are willing to give big discounts because it’s beneficial for the brand. This price difference is considered our e-commerce revenue.

Understood.

I'm saying that another big part, the main part, is really the total advertising dollar spent. That becomes a very important component of our overall growth. Let's say, if a car company spends about RMB 3 million on advertising, within this contract, probably 1 million would be spent on these chat room advertisements. We believe this creativity gets people talking about our platform.

Yes. Understood. And any color on the industry trend of our games as this traditionally strong quarter may be helpful. Thanks.

Compared with Q1, the work done in less time at home and also, because of the declined economy, people are spending less income—right? Two reasons for that.

First of all, during the pandemic, the impact has varied for different gaming companies and different genres of games. So we experienced different impacts caused by the pandemic. Our games are mostly MMORPG Hardcore RPG games, reliant on higher-paying users, so we benefited during the first quarter due to restrictions. However, during the second quarter, we saw some pressures on the economy, leading to pressure on player investments in games. This is evident from data showing a decline in our active players in the second quarter. Nevertheless, we expect stabilization in the third quarter.

Got it. Thank you.

So, my question is about stabilization of the earnings less due to cost increases because of marketing.

The industry will be more stabilized.

All right. Next?

Thank you. Our next question comes from the line of Thomas Chong from Jefferies. Please ask the question.

Hi. Thanks, management, for taking my questions. First, I have a question about the 3Q brand advertising guidance. Given the -3% to positive over 10% sequential growth, I am wondering under what circumstances we would expect to hit the low end and the high end of the guidance? Can you also comment about the ad spending among different categories?

For your second question, regarding international advertisers, we have seen an increase in their advertising spending. So to answer your second question, to clarify, international advertisers are actually increasing their advertising. Your first question about the forecast range is dependent on the COVID-19 situation and the economy. We are focused on product innovation and user base growth to create momentum despite uncertainties that result in a wide range of forecasts.

I see. Then Charles, is there any color about our key categories? Is the momentum similar to what we saw recently?

I think the ranking of categories would be as follows: auto industry is number one, e-commerce is number two, FMCG, fast-moving consumer goods is number three, and then IT companies, followed by financial sectors and real estate. That's the ranking of ad spending.

I see. Got it. Thank you, Charles.

Okay.

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

Hi, thank you. Good evening, Charles and management. Thanks for taking my question. I have two questions. One is following the closer integrations of your ad system and also, the sales team between the Sohu Video and Sohu Portal. Could you elaborate and help us to understand more the future prospects of Sohu Portal? What is your plan and aspiration to transform the Sohu Portal to become? And then the second question is on your video content strategy. Assuming you're getting more cash, will you spend more money in video content production again, or will you actually continue your strategy on cutting the loss in the video business? Thank you.

Yes, we now have a clear strategy for both our key applications—the Sohu News app and Sohu Video app. Our focus will be on improving information delivery in the Sohu News app through high-quality content, editorial content, and collaborators. We will also continue to enhance our algorithms to make news more relevant to individual users. Additionally, the integration and delivery mechanism via social media, where followers can interact, will be a key focus. As for video, our long-form content strategy includes dramas, and for short-form, we will focus on user-generated content and live broadcasting. We will not allow the news app to reinvent the wheel, instead directing traffic to the Sohu Video app, where live broadcasting will drive user engagement.

So that means we are not going to spend more money in long-form content production again, right?

In the last few years, we managed to produce lower budget episodes that would still become hits. If we have more money, we're not going to spend as we did in 2017 or 2016 on expensive content. However, we might increase the number of TV dramas. For example, rather than three TV dramas per quarter, we could increase that to about 10 to 12. This means we will still focus on short-form and user-generated content for video growth. Long-form and exclusive content will help with user acquisition and retention. That's our overall strategy.

Okay, great. Thank you, Charles. Very helpful.

Okay. Welcome.

Thank you. All right, there are no further questions. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.