Earnings Call Transcript - SOHU Q2 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and good evening. Thank you for joining Sohu's Second Quarter 2021 Earnings Conference Call. Today's conference call is being recorded. I would now like to hand the conference over to your host for today's conference call, Huang Pu, Investor Relations Director of Sohu. Please go ahead.

Huang Pu, Investor Relations Director

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 Lu; 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 this 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 may 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 have been excluded from our results from continuing operations, which respective adjustments to the historic 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.

Charles Zhang, CEO

Thank you, Huang Pu, and thank you, everyone, for joining our call. For the second quarter of 2021, despite the challenges posed by COVID-19, we continued to seek new monetization opportunities while effectively managing our budget. The strong performance of our online gaming division allowed us to surpass our previous profitability forecasts. In Sohu Media, we focused on innovating our products and technology and on efficiently generating and distributing high-quality content. For Sohu Video, we remain committed to our Twin engine strategy, developing both high-quality long-form and short-form content, while also refining our advanced live broadcasting technologies for various applications. We have diversified our revenue streams and are better positioned to capture advertising budgets by integrating these technologies into our unique events. Changyou's online games performed exceptionally well this quarter, with revenue surpassing the upper end of our previous guidance. Now, I will provide a quick overview of our financial performance. For the second quarter, total revenues reached $204 million, an increase of 28% year-over-year, but a decrease of 8% quarter-over-quarter. Brand advertising revenues were $37 million, down 3% year-over-year, and up 20% quarter-over-quarter. Online game revenues totaled $151 million, a 43% increase year-over-year, but a decrease of 14% quarter-over-quarter. GAAP net income from continuing operations attributable to Sohu.com Limited was $22 million, compared to $11 million in the same quarter last year and $32 million in the previous quarter. On a non-GAAP basis, net income from continuing operations attributable to Sohu.com Limited was $25 million, compared to $12 million last year and $37 million this year. Please note that the previously mentioned GAAP and non-GAAP net income for the second quarter last year exclude an additional withholding income tax accrual of $88 million from Changyou. Now let’s discuss some of our key businesses. First, the Media Portal and Sohu Video. In Sohu Media Portal, we continue to innovate our products and technologies, encouraging the organic development of premium content and enhancing our social network distribution features. We have expanded the presentation formats of our content and introduced an audio feature during the Sohu Tech 5G & AI Conference we hosted in May. We introduced an exclusive feature called Sohu AI Anchor, which uses Sogou's advanced technology to synthesize the image and voice of a well-known celebrity using artificial intelligence. This AI Anchor is embedded in a 24-hour channel with the Sohu News App, allowing viewers to catch up on real-time news and events. We also added an audio function to the news feed and each article, enabling users to listen to their preferred articles and updates anytime. These initiatives have greatly enhanced the audio and video experience of the Sohu News App and facilitated easier access to our news and premium content for users with limited time. For Sohu Video, we continue to develop engaging long-form and short-form content through our Twin engine strategy. We launched Mysterious Love, an original drama that combines elements of idle romance and friendship, which became a significant hit, garnering public attention and boosting our subscriber base and revenue. With short-form content and live broadcasting, we have optimized our live broadcasting technologies and consolidated our strengths by reporting major breaking news events through real-time live streaming, reinforcing our brand and establishing us as a key mainstream media platform. Additionally, we have leveraged the strengths of Sohu Media and Sohu Video to explore new monetization opportunities by integrating our live broadcasting technologies into unique content marketing campaigns. For example, in July, we hosted the Sohu News Snow Mountain expedition, providing users with a visually stunning mountaineering experience through a five-day nonstop live broadcast. Participants, including top stars, shared their experiences and interacted with the audience throughout the live stream. This allowed us to generate significant derivative content and turn the expedition into an engaging real-time event for viewers and advertisers. These unique marketing opportunities help us meet advertisers' needs and capture their budgets. Moving on to Changyou. In the second quarter of 2021, Changyou launched new expansion packs for TLBB PC and Legacy TLBB Mobile, receiving positive feedback from players and stabilizing our overall online game performance, exceeding our expectations. For PC games, we hosted in-game events for TLBB PC's anniversary and launched a new dungeon for TLBB Vintage while improving the game based on player feedback. In mobile games, we released an expansion pack for Legacy TLBB Mobile's anniversary, including holiday events and graphic upgrades. thanks to these efforts, user engagement and payments remained stable, resulting in broadly flat revenue on a sequential basis. In the next quarter, we plan to continue rolling out new content for TLBB PC and Legacy TLBB Mobile to maintain their appeal. For new games, we launched a licensed card game, Little Raccoon Heroes, on August 4, which has performed well so far. In terms of our pipeline, several key games are currently being developed and refined, with plans to introduce them to players in the future. Going forward, we will persist with our top game strategy, promote innovation, and launch more high-quality mobile games, including MMORPGs and games from other genres.

Joanna Lu, CFO

Thank you, Charles. I will now walk you through the key financials of our major segments for the second quarter of 2021. All of the numbers that I will mention are based on non-GAAP measures. You can find a reconciliation for non-GAAP to GAAP measures on our IR website. For Sohu Media Portal, quarterly revenues were $22 million, down 3% year-over-year and up 21% quarter-over-quarter. The quarterly operating loss was $28 million compared with an operating loss of $18 million in the same quarter last year. For Sohu Video, quarterly revenues were $23 million, up 1% year-over-year and 16% quarter-over-quarter. The quarterly operating loss was $30 million compared with an operating loss of $10 million in the same quarter last year. For Changyou, quarterly revenues, including 17173, were $154 million, up 41% year-over-year and down 14% quarter-over-quarter. Changyou posted an operating profit of $75 million compared with $37 million in the same quarter last year. For the third quarter of 2021, we expect brand advertising revenues to be between $35 million and $39 million. Online game revenue to be between $145 million and $155 million. Non-GAAP net income from continuing operations attributable to Sohu.com Limited to be between nil and $10 million. And GAAP net income and loss from continuing operations attributable to Sohu.com Limited to be between a net loss of $4 million and a net income of $6 million. This forecast reflects our current and preliminary view, which is subject to substantial uncertainty. Lastly, please be reminded that in the Q&A section, we won’t answer questions regarding any Sogou business updates or any agreements with Tencent regarding Sogou's privatization. This concludes our prepared remarks. Operator, we would now like to open the call to questions.

Operator, Operator

We have the first question coming from the line of Eddie Leung from Bank of America Merrill Lynch. Please, go ahead.

Eddie Leung, Analyst

I would like to understand the recent regulation changes and how they are affecting your advertising business, particularly in the education and property sectors, as there have been some tightening in those areas. How significant are these sectors to your advertising business, and what might be the implications? I realize you have already provided your first quarter guidance, but I'm curious about how the third quarter might appear without the restrictions in these sectors. Additionally, congratulations on the games. Can you share what percentage of revenue from the second quarter comes from young people for Changyou?

Charles Zhang, CEO

So Eddie, you mentioned the two factors, right, education and what? What's the second factor you said?

Eddie Leung, Analyst

Property, Charles.

Charles Zhang, CEO

Okay. Well, in our portfolio of advertisers, we don't have a lot of education-related advertising. So advertising revenue is not impacted by recent regulatory developments in education. There may be a little impact from property, but since our revenue base is still relatively small, it's not a major factor. On Changyou, basically, the question is about the Chinese users, with the young people or the recent regulation on young people.

Dewen Chen, CEO, Changyou

Our major products are designed for mostly adults, so contributions from teenagers are very few, nearly 0.

Charles Zhang, CEO

Secondly, it kind of levels, right? A lot of older users are already in their 30s and 40s.

Operator, Operator

To the next question comes from the line of Alicia Yap from Citigroup.

Alicia Yap, Analyst

I have two questions. First one is, can you elaborate on what the effective tax rate for the Changyou entity is currently paying? And does Changyou actually qualify for the key software enterprise tax rate? Will there be any changes to effective tax rate in the coming quarters? My second question is just to get your opinion, Charles, on given your experience and years of operating Internet companies in China. What is your view of the latest tightening regulatory measures? What are some of the outcomes you foresee that could evolve for the industry, and how is Sohu positioned in the current environment? Any potential impact to our current business model?

Dewen Chen, CEO, Changyou

In the past, several of our subsidiaries applied for and enjoyed some preferential tax rates if they received the key national software enterprise status, but our applications this year were not approved. However, we still qualify for the high-end new technology enterprise status. In the future, we expect there will be a 4% to 5% impact on this issue.

Charles Zhang, CEO

Regarding the regulation on the internet, I think what happened recently is more company-specific, and I don't see any general policy tightening or any change. So I see definitely more regulation on user privacy and other aspects. But I don't foresee that it will hinder the industry from developing robustly; there are still many new products that need to be developed and rolled out.

Alicia Yap, Analyst

Can I just quickly ask one follow-up? I think according to some media interviews, you did mention there is an intention for Changyou to potentially be listed in Hong Kong. Just wondering if there's any timeframe for this plan?

Charles Zhang, CEO

Yes. During my interview, I did mention that a possibility exists for next year.

Operator, Operator

We have the next question coming from the line of Thomas Chong from Jefferies.

Thomas Chong, Analyst

I also have a question regarding the advertising space. Can management comment on our thoughts on the auto advertising outlook? Given that I think auto represents about one-third of our ad revenue, I want to see how it is trending in Q3 because we are seeing the production capacity of a lot of OEMs suffering these days. My second question is regarding our targeting technology. I think, Charles, you also talked about our content strategies, these short-form and long-form strategies regarding targeting. But given that the regulations are also talking about potentially more stringent regulations on targeting, should we expect our content distribution to be affected if these rules are implemented? Also, I have a third question related to the gaming sector in general. How should we think about the gaming regulations? Should we expect that the gaming space remains relatively stable or steady if we consider the regulatory impact other than the main protection?

Charles Zhang, CEO

Yes. Let me answer the first two questions. The auto industry is experiencing some recent issues like the shortage of chips. So I think in Q3, the auto industry will not be too good but not too bad; it seems flat. In terms of content distribution, we rely more on product distribution and social media distribution, so targeting is not a large part of our products. Therefore, I don't expect there to be any problem. Our video, both long-form and short-form content, is also exploring social media distribution.

Dewen Chen, CEO, Changyou

Yes.

Charles Zhang, CEO

Regarding the gaming sector, I think my answer will be similar because it is more company-specific. In general, I don't see significant regulation changes.

Operator, Operator

Ladies and gentlemen, that does conclude our conference call for today. Thank you all for your participation. You may disconnect now.