Sohu.com Ltd Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by and good evening. Thank you for joining Sohu's First Quarter 2021 Earnings Conference Call. At this time, all participants are in listen-only mode. After management's prepared remarks, there'll be a question-and-answer session. Today's conference call is being recorded. If you have any objections, you may disconnect at this time. I would like to turn the call 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 first quarter 2021 results. On the call are Chairman and Chief Executive Officer, Dr. Charles Zhang; CFO, Joanna Lu; and Vice President of Finance, James Deng. Also with us today are Changyou's CEO, Dewen Chen; and the CFO, Yaobin Wang. 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 measures discussed on this 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 risk 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. Please also be reminded that Sohu's results of operations have been excluded from our results from continuing operations, and respective adjustments to the historical statements have been made in order to provide a consistent basis of comparison. Unless indicated otherwise, the results that we talk about are related to continuing operations only. With that, I will now turn the call over to Dr. Charles Zhang. Charles, please proceed.

Thanks, Huang Pu. Thank you to everyone for joining our call. In the first quarter of 2021, we continued to execute the operational strategy from last year and delivered better-than-expected performance on the top line. In addition, we're happy to report positive non-GAAP net income of U.S.$37 million, which greatly exceeded our previous guidance. This was mainly attributable to our strict budget control and the solid performance of our online game business. In summary, for Sohu Media, we kept focusing on improving our products and technology, while at the same time stimulating content generation and social distribution. For Sohu Video, we made continuous progress producing both long-form original dramas and short-form livestreaming content. Further, we integrated advanced live broadcasting technologies into our product matrix and applied these technologies to our content marketing campaigns. These campaigns not only effectively promoted the creation of premium content, but also attracted a lot of user attention as well as advertiser budgets. For Changyou, our online game business remained solid during the first quarter of 2021, with its revenue significantly exceeding our prior guidance. I'll go through more details about each of these businesses in a moment, but first, let's review our financial performance quickly. For the first quarter of 2021, total revenues were U.S.$222 million, up 24% year-over-year and down 12% quarter-over-quarter. Brand advertising revenues were U.S.$31 million, up 20% year-over-year and down 26% quarter-over-quarter. Online game revenues were U.S.$176 million, up 32% year-over-year and down 10% quarter-over-quarter. GAAP net income from continuing operations attributable to Sohu.com Limited was U.S.$32 million, compared with a net loss of U.S.$10 million in the first quarter of 2020 and net income of U.S.$47 million in the fourth quarter of 2020. Non-GAAP net income from continuing operations attributable to Sohu.com Limited was U.S.$37 million, compared with a net loss of U.S.$8 million in the first quarter of last year and net income of U.S.$53 million in the fourth quarter of 2020. Now let me go through some of our key business areas. In the Media Portal and Sohu Video, we continue to upgrade our products and technology to stimulate high-quality content generation and further enhance our social network distribution features. Based on our advanced livestreaming technology, strong operating experience, and extensive media resources, we further fortified our credentials as a mainstream media platform. By distributing our premium content across the Sohu Media and Sohu Video platforms, we are attracting more exposure from viewers and advertisers, which is helping us diversify our revenue streams and explore new monetization opportunities. For example, in March, we successfully aired the live-streamed 13th Sohu News marathon, which is a well-known event that we host with a variety of celebrities and pop stars. Leveraging our live broadcasting technology, we conducted more than five hours of non-stop real-time live shows, and the premium content generated by this campaign successfully attracted attention and advertising dollars. Through this event, we not only raised awareness of fitness and health, but also motivated users to create their own interactive content and promote it on Sohu’s product matrix. For Sohu Video, we execute our team engine strategy. For long-format content in 2021, we released several audio dramas, including the recent Mysterious Love, which has become another big hit after Well-Intended Love two years ago. Mysterious Love combines idle romance with crime scenes and was warmly welcomed by audiences. It has further broadened our leading position in these two categories and significantly boosted our user base and revenue. In terms of short-form content, we kept working hard on developing valuable livestreaming content, where we disseminate professional knowledge and reliable information. For example, we launched a live show called the New Year for the Chinese New Year holidays. The show featured more than 40 live broadcasts and attracted numerous KOL who shared their thoughts on multiple topics. Now let me turn to Changyou. For the first quarter of 2021, thanks to the latest updates our team made for in-game content, as well as the drop in travel, during which people were encouraged to stay safe for the festival, player engagement was better than expected. Our TLBB franchise remained stable, and online game revenue exceeded our prior guidance. For PC games, revenue decreased on a sequential basis as TLBB Vintage revenue experienced a natural decline after its initial launch peaked. During the quarter, we improved TLBB Vintage by making various enhancements based on player feedback. We also introduced some promotional events around the Spring Festival for regular TLBB PC. For mobile games, we also launched a variety of spring festival-related events for Legacy TLBB Mobile, including activities that improved player engagement. These efforts helped Legacy TLBB Mobile perform better than anticipated. Next quarter, Changyou will release new expansion packs and plan in-game events to celebrate the anniversary of regular TLBB PC and Legacy TLBB Mobile. For TLBB Vintage, we plan to reduce some in-game content and introduce other special features. In terms of our pipeline, several key games are being fine-tuned. We look forward to launching them later this year. Looking ahead, we'll continue to execute our top game strategies, promote innovations, and roll out more high-quality mobile games, including MMORPG games in various genres. 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 now walk you through the key financials of our major segments for the first quarter of 2021. All of the numbers that I will mention are on a non-GAAP basis. You may find our reconciliation for non-GAAP to GAAP measure on our IR website. For Sohu Media Portal, quarterly revenues were $80 million, up 18% year-over-year and down 26% quarter-over-quarter. The quarterly operating loss was $31 million compared with an operating loss of $23 million in the same quarter last year. For Sohu Video, quarterly revenues were $90 million, down 17% year-over-year and 15% quarter-over-quarter. The quarterly operating loss was $13 million compared to an operating loss of $11 million in the same quarter last year. For Changyou, quarterly revenue, including 17173, was $180 million, up 32% year-over-year and down 10% quarter-over-quarter. Changyou posted an operating profit of $101 million compared with $56 million in the same quarter last year. For the second quarter of 2021, we expect brand advertising revenues to be between $36 million and $40 million; online game revenues to be between $134 million and $144 million; non-GAAP net income from continuing operations attributable to Sohu.com Limited to be between $8 million and $18 million; and GAAP net income from continuing operations attributable to Sohu.com Limited to be between $3 million and $13 million. This forecast reflects our current and preliminary view, which is subject to substantial uncertainty. Lastly, please be reminded that in the Q&A session, we won't take questions regarding any Sogou business updates or the agreements with Tencent for Sogou's privatization. This concludes our prepared remarks. Operator, we would now like to open the call for questions.

Thank you. Our first question comes from Alicia Yap of Citi. Your line is open, please go ahead.

Thank you for taking my questions. Good evening, Charles, Joanna and the other management team. So I have two questions, the first one on the gaming outperformance. I think you mentioned a little bit the reasons it is driven by the PC, TLBB and all that. But I guess, my question is more when you provided your guidance, I think because the actual gaming revenue came in much stronger than your guidance range. So just wondering what's the performance mainly happen in March that caused the quarter results to come in stronger than what you guided on the gaming revenue? And then with the 2Q sequential declines we see that might be some drop-off and all that, but given these promotions that TLBB Mobile may be launching the anniversary, should we also expect the games should be seasonally rather than scaling back. So any color you give on this gaming front? And then I have a question on the advertising.

Well, let me clarify, Alicia, and give you a genuine answer. First of all, I think in the first quarter of the year, the decline of TLBB PC Vintage – TLBB Vintage is actually slower than we expected, right? Because we thought that Vintage – TLBB Vintage peaked in Q4 last year. And then we expected that it would decline faster, but that did not happen. That was probably because people were looking for the Vintage – for the old game. And so that’s why it actually contributed to better than expected gaming revenue. Yes. So is that your question? And also you are also wondering about the current quarter or the future, right, of the mobile game?

Yes. That’s right.

The Vintage game performed better than we anticipated. We initially thought it would decline more quickly after peaking in Q4 last year, but that wasn't the case. It seems people were still seeking the older version of the game, which helped boost our gaming revenue. Is that what you were asking? You’re also interested in the current quarter and the future of the mobile game, correct?

Yes, Vintage – TLBB Vintage reached its peak in the fourth quarter of last year. We anticipated a quicker decline, which did not occur, likely because players were interested in the older version of the game. This demand contributed to better-than-expected gaming revenue. Is that your question? You also want to know about the current quarter or the future of the mobile game, correct?

It was anticipated that it would decrease more rapidly, but that did not occur. This was likely due to a demand for the Vintage – for the classic game. As a result, it actually helped drive gaming revenue beyond expectations. Is that your question? And you are also interested in the current quarter or the future of the mobile game, correct? Yes, that’s right.

Okay. Thank you.

Alicia, yes, sorry, please let me briefly translate that answer. In the first quarter, as I said, TLBB Mobile, we had less travel because people were encouraged to stay in place during the Spring Festival. So we availed a higher reducing in the first quarter. In the second quarter, although we will have expansion packs for both mobile and our PC TLBB team, the games will face a natural decline in the second quarter. Especially for Vintage, which peaked after the initial launch, so in the second quarter, it will decline further compared to the first quarter. Thank you.

Thank you. I have a second question on the online advertising. Regarding the second quarter guidance, it seems like the year-over-year guidance of negative 5% to positive 5% doesn't sound strong enough. So I'm just wondering, because we should be benefiting from the secular recovery trend and also last year the COVID impact should also affect the first half as well. So just any color you can provide in terms of the second quarter. And just broadly also wondering if Charles or the management team could comment on the overall economy very recently given the regulatory headwinds, we know these upcoming 100 years anniversary and nice Olympic Games. So they are positive and negative external environments. So how will that impact the general attitude that you are seeing? Thank you.

I think compared to last year in Q2, right? The Q2 of 2020 was a rebound, right? So we had a strong Q2 in 2020. Then this year, the overall macroeconomic situation is actually not that good. Especially, there's, I would say, a shortage of mobile chips for automotive companies that simply do not have enough products for cars to sell to the market. If they aren't able to sell, they won't spend as much. So that's why, compared with Q2 last year, Q2 2021 seems not to be a good or strong quarter. In terms of our revenue base of our advertising campaigns, it is quite small, and I think it has not much to do with what happened recently with the e-commerce platform and also regarding the anniversary celebrations.

I see. Okay. All right. Thank you. Thanks, Charles.

Thank you. Our next question is from the line of Thomas Chong of Jefferies. Please go ahead. Your line is open.

Hi Charles, thanks for management for picking my questions. I have a question regarding our content strategies. Can Charles comment on how we think about content distribution and other measures like live streaming, etc. How it helps to drive user engagement and on that front, how we should think about the advertising revenue goal or user trends in 2021? My second question relates to the cost side. Can Charles also comment on how we should think about the OpEx and costs for the Sohu Portal and the Video business going forward? Thank you.

Yes. I think the advertising revenue will depend significantly on the user base. So that's why we need to grow our user base faster. Until we achieve that, our revenue needs to grow – we have unique activities like events or content generation activities, such as our Sohu News marathon, or the expedition we're going to do this quarter. All these major events are part of our content strategy, and the live streaming turns these activities into real-time events that attract users. However, in terms of content distribution, we explore various methods like everyone else, utilizing information stream with AI and computer algorithm distribution. But we are also focusing on social network distribution as our battleground to distribute both short-form and video content. Yes, so our live streaming technology is a central product in our matrix to turn events or activities into trending ones, thus attracting advertisers and users. However, in the long run, we depend on the successful distribution of our content through social networks, not merely algorithm distribution but through social networks. So we have launched a few social network products within our apps, Sohu News, and Sohu Video. So basically, we are growing our user base organically without spending much on promotion, but rather by improving technology, products, and distribution. As for costs, they will remain similar, as we are not spending significant amounts on channel promotions. Therefore, costs will remain steady. And the revenue side will be proportional to our successful development of social network features and user base growth. I hope I explained that clearly.

Got it. Thank you, Charles.

Thank you. Next question is from Eddie Leung of Bank of America Merrill Lynch. Your line is open. Please go ahead.

Good evening, guys. Thank you for taking my question. Just a follow-up question on advertising. Charles, when you answered Alicia's questions, you mentioned that one of the concerns for the online advertising sector was the automobile advertisers, right? So could you remind us of some of the top advertising industries at the moment for Sohu? And could you also provide some insight into the kind of ads demand or budgeting process for the rest of the year based on conversations between your sales team and these three client industries? Thank you.

Yes. As you pointed out, the auto industry is actually the top advertising industry. The auto industry is facing issues due to the shortage of chips, leading to a decrease in production for car factories and manufacturers. Therefore, they are not looking at spending much on advertising in the upcoming quarters. This is where we are having difficulty maintaining our normal advertising spending. Hence, we need to offer unique advertising solutions with less budget, organizing content activities and online live streaming events for brand marketing.

Charles, could you also give us some insight into other important advertising industries? For example, any trends you can share regarding FMCG brands or financial services, etc.? Thank you.

Yes, FMCG and other industries are those we can explore, as they don’t have chip shortages. The situation in other industries is somewhat better, so we are keen on securing those advertisers, including FMCG and luxury products as well as electronics.

I understand. Thank you very much.

A better picture.

Thank you. The next question is from the line of Jason. Please go ahead. Your line is open.

Thank you for taking my question, Charles. My question is what steps are you taking to support the stock price, given that it's trading at two-thirds of incoming cash? This implies that the entire company without this cash is worth negative. Can you elaborate?

Well, we only have about $327 million in cash. The market cap is about five times or less. Yes, I think in terms of stock price, we need to demonstrate growth potential, right? As I said, we need to explore and develop, especially building this social network platform to distribute content and create social networks with our current apps, and grow our user base to larger scales. In fact, a larger user base would allow us to capture a greater share of the advertising market and market our own products, like our TV dramas as well. Even if Sohu builds our own platform with a significantly larger user base, Changyou can benefit because we can promote Changyou within our own matrix, which also reduces costs. Until we demonstrate successful growth in our social network, our financial growth will remain at the current pace, which is not exciting. In other words, to improve our stock price, we need to demonstrate hyper-growth.

Yes. Thank you. I was referring more to the incoming cash with a potential merger, the $1 billion plus in cash.

Okay. As we said, we don't talk about this because it’s still – I mean, we don’t speculate on what we’ll do with more cash because the deal is still not done.

Great. Thank you.

Thank you. Next question is from the line of Alex Poon of Morgan Stanley. Please go ahead.

All right. Thank you, Charles. Thank you, management for taking my question. Management, you mentioned that there are key game launches fine-tuning, and plans to introduce more MMORPG games later this year. Could we get more granularity on the game pipeline? Such as which games are license approved or what the most anticipated game launch is? Thank you.

Thank you, Charles. Thank you, management, for taking my question. You mentioned that there are key game launches being fine-tuned and plans to introduce more MMORPG games later this year. Could you provide more details on the game pipeline? Specifically, which games have received license approval and what the most anticipated game launch is? Thank you.

We have a couple of key products to be launched later this year or next year. The first one is Taxi Adventure, which will be published by Tencent and is expected to launch in July. The second one is Bright Star, which is similar to a previous game and licensed by Tencent, expected to launch in August of this year. The other title is a card game called Little Raccoon, and we will do a round of testing; we just got the license approval. If the results are satisfactory, we will publish it ourselves in the third quarter. It is a card game. For the MMO segment, we have a self-developed key MMORPG that we plan to launch at the end of this year or early next year. The next one is the next generation of TLBB mobile. We have yet to decide on the official name, but it will also be published by Tencent, either at the end of this year or early next year. Thank you.

Soon, we will begin testing now that we have received the license approval. If the results are positive, we will release it ourselves in the third quarter. It is a card game. For the MMO segment, we are preparing to launch our self-developed key MMORPG by the end of this year or early next year. Additionally, we are working on the next generation of TLBB mobile. The official name has not been finalized yet, but it will also be published by Tencent, either at the end of this year or early next year. Thank you.

Thank you. Ladies and gentlemen, that concludes the conference for today. And thank you for participating. You may now all disconnect.