Sohu.com Ltd Q3 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and good evening. Thank you for joining Sohu's Third Quarter 2021 Earnings Conference Call. After management's prepared remarks, there will 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 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 Third Quarter 2021 Results. On the call are Chairman and Chief Executive Officer, Dr. Chaoyang Zhang; CFO, Joanna Lu; and Vice President of Finance, James Deng. Also with us today are Changyou 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 matters 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 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 Sogou's results of operations and the disposal gain recognized in this quarter have been classified as discontinued operations. The results that we talk about are related to continuing operations only. With that, I will now turn the call over to Dr. Chaoyang Zhang. Charles, please proceed.

Thank you, Huang Pu, and thanks to everyone for being on the call. In the third quarter of 2021, despite challenges from COVID-19 outbreaks and a volatile macroeconomic environment, we concentrated on enhancing our technology and developing new products. Overall, we exceeded expectations in both revenue and profit, driven by strong results from our online game business. For Sohu Media, we focused on enhancing our products, expanding premium content, and boosting social media distribution, strengthening our position as a leading media platform. In terms of Sohu Video, we continued implementing our 'Twin Engine' strategy, utilizing our advanced live broadcasting technology to generate more video content across various events and scenarios. Changyou's online games showed strong performance this quarter, with revenue surpassing our previous forecasts. I will discuss each business in detail shortly, but first, here's a brief overview of our financial performance. In Q3 2021, total revenue was $216 million, up 37% year-over-year and 6% quarter-over-quarter. Brand advertising revenues were $34 million, down 18% year-on-year and 8% quarter-over-quarter. Online game revenues reached $167 million, a 65% increase from last year and a 10% increase from the previous quarter. GAAP net income from continuing operations attributable to Sohu.com Limited was $12 million, compared to a net loss of $15 million in Q3 2020 and net income of $22 million last quarter. Non-GAAP net income from continuing operations was $17 million, compared to a net loss of $7 million last year and net income of $25 million last quarter. Now, let's discuss our key businesses, starting with the Media Portal and Sohu Video. In Sohu Media Portal, we have been consistently upgrading our products and refining our technology. This quarter, we improved the audio function of our News App and significantly enhanced the overall audio-video experience, which improved content distribution efficiency and highlighted our News App's unique advantages. Regarding Sohu Video, we are continuing to execute our Twin Engine strategy, focusing on developing long-form original dramas and reality shows to enhance our content library. Short video content and our advanced live broadcasting technology are now fully integrated into our offerings and are widely used in content marketing campaigns and major events. This technology is also crucial for our daily life reality show and assists in creating premium content. Now, about Changyou. In Q3 2021, Changyou performed well, with revenue exceeding our earlier forecasts. The licensed card game, Little Raccoon: Heroes, has been well-received following its August launch, and both TLBB PC and Legacy TLBB Mobile games have retained their user base and exceeded expectations as they age. For PC games, we introduced new expansion packs and holiday events for TLBB PC and TLBB Vintage. We also refined TLBB Vintage based on player feedback. For TLBB Mobile, we released an expansion pack with a new dungeon and storyline, which players have enjoyed. In the next quarter, we will launch a new continent for TLBB PC, Legacy TLBB Mobile, Little Raccoon: Heroes, and other games to keep them engaged. We are also in the process of developing several key games that will be introduced to players soon. We will continue implementing our top game strategy, fostering innovation, and presenting more high-quality mobile games, including MMORPGs and other diverse products. Before I hand over to Joanna for a detailed financial review, I'm happy to announce that on November 13, our Board of Directors approved a share repurchase program of up to $100 million over the next year. This program reflects our ongoing confidence in long-term growth and our commitment to enhancing shareholder value. Now, I will turn it over to Joanna for the financial details.

Thank you, Charles. I will walk you through the key financials of our major segments for the third quarter of 2021. All of the numbers that I will mention are on a non-GAAP basis. You may find a reconciliation for non-GAAP to GAAP measures on our IR website. For Sohu Media Portal, quarterly revenues were $70 million, down 32% year-over-year and 23% quarter-over-quarter. The quarterly operating loss was $37 million, compared with an operating loss of $23 million in the same quarter last year. For Sohu Video, quarterly revenues were $23 million, flat year-over-year and up 1% quarter-over-quarter. The quarterly operating loss was $10 million, compared with an operating loss of $12 million in the same quarter last year. For Changyou, quarterly revenues, including 17173, were $117 million, up 63% year-over-year and 10% quarter-over-quarter. Changyou posted an operating profit of $79 million, compared with $33 million in the same quarter last year. For the fourth quarter of 2021, we expect brand advertising revenues to be between $28 million and $31 million. This indicates an annual decrease of 26% to 33% and a sequential decrease of 8% to 17%. Online game revenues are expected to be between $140 million and $150 million, which implies an annual decrease of 23% to 29% and a sequential decrease of 10% to 16%. Non-GAAP net loss attributable to Sohu.com Limited is expected to be between 0 and $10 million, and GAAP net loss attributable to Sohu.com Limited is anticipated to be between $3 million and $13 million. This forecast reflects our current and preliminary result, which is subject to substantial uncertainties. This concludes our prepared remarks. Operator, we would now like to open the call to questions.

We have a question coming from Alicia Yap from Citigroup.

I have a few questions regarding the advertising. Can you elaborate on the decline in online ad revenue that we observed in the third quarter? How much of that can be attributed to the soft macroeconomic conditions that led to cuts in ad budgets? Additionally, is there any impact from recent regulations affecting celebrities or the crackdown on the fan-based economy that could influence your video ad revenue? For the third quarter, could you remind us which industry verticals experienced lower-than-expected ad budgets and which ones exceeded your expectations? Lastly, regarding your guidance for fourth quarter online ad revenue, does it reflect ongoing macro weakness, or is there a specific ad industry vertical that might be more adversely affected?

For both the third quarter and fourth quarter, it’s more of the vertical industry, like the real estate. We had some exposure to the real estate industry at some of the companies, yes. Then there is – secondly, yes, there is also some factor in the macroeconomic situation, yes. But in terms of regulatory, fan base, those kinds of things, there are very few impacts on the ad revenue.

Okay. So the same thing for the fourth quarter because of the real estate, that's why the guidance came in soft?

Yes. But the fourth quarter, the impact varies; the impact will be less, right? And we are basically organizing our sales team efforts to expand our ad base and to bring in new kinds of customers.

Maybe can you remind us a little bit of your top 3 or top 5 categories before, which were like a year ago? What were the top 3 ad categories? And then for this year, 3Q, given some of the impacts, what are the top 3?

Yes. Definitely, the auto is the number one, then FMCG number two and real estate number three, right? So the impact really landed on the real estate sector. Additionally, the pandemic has affected our brand advertising because it depends a lot on content marketing and event-driven advertising. Due to the pandemic, some of those major key events, we couldn't conduct, and that has an impact as well. So yes, the top 3 were auto, FMCG, and real estate. Also, there's an impact due to the shortage of chips, which has altered the marketing plans for other companies.

I see. Okay. That's very helpful. And then if I have a last one, if I may. The gaming guidance that you have for the fourth quarter on the sequential decline, is that because of the performance of Little Raccoon: Heroes? Are you expecting that game to drop off in performance in the fourth quarter? And then are there any expansion plans for TLBB in the fourth quarter?

Yes, Chen Dewen can answer that.

I see. That's very helpful. For my last question, regarding the gaming guidance for the fourth quarter and the anticipated decline, is that attributed to the performance of Little Raccoon: Heroes? Are you expecting that game's performance to decrease in the fourth quarter? Additionally, are there any expansion plans for TLBB in the fourth quarter? Yes, Chen Dewen can address that.

Yes, the revenue drop next quarter was mainly due to the decline of Little Raccoon: Heroes. And for other TLBB games, we will provide updates on the expansion pack regularly.

We have the next question. This is coming from Thomas Chong from Jefferies.

Perhaps a question regarding the online games regulatory environment. Can management comment on how the sector is trending? And any color on gaming approvals? And then my second question is about Metaverse. How should we think about this new industry trend and our thoughts about our long-term spending or investment in this area?

We will provide updates on the expansion pack regularly. The next question is from Thomas Chong from Jefferies. He asks about the online games regulatory environment and how the sector is trending, requesting insights on gaming approvals. He also inquires about the Metaverse and how the company views this emerging industry trend in relation to long-term spending or investment in the area.

We don't have further comments on the approval issues. But for our key title, we received the license approval last year, and for new TLBB, we don’t plan to launch it currently. So it's not a big concern for Changyou.

We don't have further comments on the approval issues. However, for our key title, we received the license approval last year, and we don’t plan to launch new TLBB at this time. So it's not a significant concern for Changyou.

As for the Metaverse, we have actually built up a small team to conduct more research and explore new opportunities brought by the Metaverse concept. Thank you.

We have the next question. The next one comes from Eddie Leung from Bank of America.

Just a quick follow-up on the advertising weakness. So we understand that there is a demand issue because of some advertisers. Could you also talk a little bit about the potential you have seen from the data front, including new privacy policy as well as the new data protection law in China?

That has a small impact or no impact. There are stricter requirements for the kind of advertising you can have, the format that requires to be smaller and not trick people into clicking it. Those kinds of things. But that’s not a major impact on the advertising. As for privacy policy, yes, Sohu has been very careful and compliant with requirements. We are not very aggressive in collecting users’ data and taking advantage of users’ data for marketing and targeting. So that's why this policy has the least effect on Sohu.

We have the next question coming from the line of Alex Ko from Morgan Stanley.

I have a follow-up regarding the quarterly loss for the Sohu Media Portal. How does that compare to the quarterly loss for Sohu Video? We are maintaining strong cost discipline, so I would like to understand the investment strategy moving forward for both the Sohu Media Portal and Video business.

So the loss for Sohu Video has increased because the advertising side has more exposure to the real estate industry. The Sohu Video advertising is mostly about FMCG advertisers. Also, Sohu Video generates half of its revenue from paid subscriptions of dramas. This explains why it's declining. Additionally, we are, yes, increasing investments in the third quarter and going forward, we will invest more into user acquisition for Sohu Video and Sohu Media first. This explains why the media loss is larger.

We have the next question. This is coming from the line of Alicia Yap from Citigroup.

I just have one question on the use of cash. So in addition to the buyback that you announced, would you also consider a one-time special dividend given the amount of cash that you now have?

Regarding the use of cash, first of all, I think besides the buyback, we plan to use it for user acquisition. Over the last few years, we have been innovating on our products, like our better content and better product features with our Media Portal and the Sohu News App and also, Sohu Video innovations. In order to validate those innovations or product features in the right direction and prove their traction, we need more users. So that's why we've been underspending in recent years, focusing on profitability rather than user acquisition. With this new capital, we plan to spend more to acquire users to validate our product innovations from the past two years. So you may ask, when is the breakeven point? Before we break even, we need to build up a significant user base for a media platform like ours. So before reaching that point, we need to allocate some funds to user acquisition. We also plan to invest more in artificial intelligence R&D, like the News App's audio features being a direct application of AI technology. We need to invest in R&D to support our product innovations.

Just to follow up on your user acquisition. Would that involve more outreach into lower-tier cities or any particular demographic focus?

Yes. I think particularly for our Sohu News App, we’ll target more the younger generation, targeting younger age demographics. Our Sohu News users have, in the past, been more of the mid-80s and high-income individuals, focusing on major breaking news or international news. However, we want to develop and acquire more younger users and focus on third or fourth tier cities.

We have a question coming from Vlad Jiang from Palace Capital.

This is Connie from Palace Capital. Congratulations to Chen on closing Sogou sale and unlocking value. We understand the company has announced the buyback and also, Charles just explained on the potential use of cash for user acquisition and AI R&D. First question would be after the closing of the Sogou sale, with significant firepower, will there be any other potential future investment areas that Sohu has in mind? Will you consider M&A or other investment strategies? It would be great to hear more about this.

So far, we don't have a plan for a merger or acquisition. Mostly, we will focus on the areas where we have been operating, where we have underspent, and now we are going to invest more. As time goes on, we may consider some small investments in early-stage companies and technologies for strategic purposes and to defend our technological standing. No major M&A action is planned.

Understood. In terms of technology investment, are there any specific sectors that Sohu is particularly interested in?

Yes. As I said, probably artificial intelligence is an area we are interested in. We were previously involved with Sogou, which had some promising technologies. We need to establish our own tech center to build technological firepower for product innovation. Therefore, we see AI applications, such as audio features and digital images, as integral areas requiring investment for our media and communication strategies.

My last question relates more to the Changyou business. We know that Changyou has great IP and attracts a loyal gamer base with strong cash-generating abilities. Just wondering if you have any capital market strategy for Changyou in the future, considering the numerous listing markets in China and Hong Kong, which are very attractive for this type of business. Is this aligned with your corporate strategy for the future?

If it is an attractive option, we will seek that path. It depends on the regulatory requirements for, let's say, domestic listing; it is not currently possible. However, in other markets, if it is appealing, we will consider that.

We have no further questions at this moment. Ladies and gentlemen, that concludes our conference call for today. Thank you all for your participation. You may disconnect now.