Changyou.com's (CYOU) CEO Dewen Chen on Q2 2016 Results - Earnings Call Transcript

| About: Changyou.com Limited (CYOU)

Changyou.com Limited (NASDAQ:CYOU)

Q2 2016 Earnings Conference Call

August 1, 2016 8:00 AM ET

Executives

Jasmine Zhou – Chief Financial Officer

Dewen Chen – Chief Executive Officer

Wei Qing – Chief Games Development Officer

Analysts

Zoe Zhao – Credit Suisse

Eddie Leung – Merrill Lynch

Xin Wang – Citi

Hillman Chan – Macquarie

Chi Tsang – HSBC

Natalie Wu – CICC

Alex Yao – JPMorgan

Ching Wong – Citi

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Second Quarter 2016 Changyou.com Limited Earnings Conference Call. At this time, all participants are in listen-only mode. There will be a presentation followed by a question-and-answer session. [Operator Instructions] I must advise you that this conference is being recorded Today Monday August 1, 2016.

I would now like to hand the conference over to your first speaker for today, Ms. Jasmine Zhou, the CFO of Changyou. Please go ahead ma'am.

Jasmine Zhou

Thank you, operator. Joining me on the call today are Mr. Dewen Chen, CEO; Mr. Xiaojian Hong, COO; and Mr. Qing Wei, Chief Games Development Officer. For today's agenda, management will discuss highlights for second quarter of 2016. This will be followed by a question-and-answer session. Before we continue, please allow me to read you the Chinese Safe Harbor statements. Statements that are not historical facts, including statements about the Company's beliefs and expectations, are 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 filing with the Securities and Exchange Commission, including its registration statement and most recent Annual Report on Form 20-F.

I’ll now turn the call over to our CEO, Mr. Dewen.

Dewen Chen

[Foreign Language] We are pleased to report that our total revenue for the second quarter was $129 million, meeting the top-end of our revenue guidance. Online games revenue remains stable at around $100 million, compared with the first quarter, which is encouraging considering that no new games was launched. While revenues stabilized, non-GAAP net income was $36 million, an increase of $5 million from the first quarter and ahead of our guidance.

[Foreign Language] More excitingly, since we announced our new Top Games, Big IP and Mass Marketing strategy, at the beginning of the year, we have been working hard to fortify our pipeline. We have been enjoying a much more concrete and focused plan for mobile games and we will be releasing more high quality titles starting in the third quarter.

[Foreign Language] For PC games, over the last two years, players have been migrating to mobile devices, which in quite while those remaining on the PC side are truly core players. As a result retaining a core base of game players is now our top priorities for PC games in order to extend their life-span. Additionally to realize the full value of IP from legacy PC games, our adaptation of TLBB and Blade Online into mobile formats, are both on charge is scheduled. With this, we are hoping to bring back the PC game players; we previously lost to the mobile games market, where Xiaojian Hong will talk more about the details of our new Legacy TLBB mobile game a bit later.

[Foreign Language] For our TLBB PC games, second quarter revenues was fairly stable compared with the first. In our second quarter expansion pack, we introduced a new accessory targeting female players in new game play involving hidden weapons both of which help to stimulate overall activity within the game. We also strategically reduced the number of in-game promotions within TLBB to achieve a more sustainable game environment. We expect revenues from TLBB to be stable in the third quarter.

[Foreign Language] For mobile games, revenue from TLBB 3D was stable on a sequential basis as we launched the two expansion packs during the second quarter. As we mentioned last quarter, in order to provide more competition in social functionality within the game, we introduced cross server clan battles and [indiscernible] in the two expansion packs. Nevertheless as TLBB 3D moves into this 30-year-old population, we expect revenue from the game to decline in the third quarter as a result of its natural progression. We will continue to add new social features, new game play and more convenient fixtures that encourage internet users in order to prolong its life-span.

[Foreign Language] In terms of our overall mobile game strategy, we have developed a more concrete and focused plan. [Foreign Language] In the domestic market, we’re seeing growth of users on two ends of the spectrum. On one hand, we are able to meet hardcore players, who prefer MMORPGs; on the other hand, we have players who prefer simple game play and more combative eSports and SLG type of games. So, that to these trends, we are moving towards a more diversified strategy in the domestic market. We’re now focusing on MMORPG, eSports, and car combat games.

[Foreign Language]

The launch of Hortensia Saga in July was one of first attempts in our diversification strategy Hortensia Saga is an anime-style card combat game that we licenses from Sega with that we’re looking to target a niche group of Japanese comic sense. The game was featured by the Apple Store just two weeks after its launch. Hortensia Saga is strategically important to us. But it help us gain more experience in releasing anime-style mobile games and deepen our relationship with both large Japanese game developers in the Apple Store.

[Foreign Language]

In terms of new technology, we continue to strengthen our competitive advantage through technology innovation. We have overcome the technical difficulties associated with bringing global players onto a common server. And we will be applying the new technology to new mobile game development. At the same time, we have began working with internal partners to develop our games using our Unreal 4 game engine technology, which can provide more realistic visual effects and also best playing experience due to a strong graphic processing and rendering capabilities.

This technology also meets the requirement of VR games. And therefore provides a good technical framework for VR game development in the future. We currently have two VR projects under development.

[Foreign Language]

Our strong R&D capability and rich IP library are the foundation of our high quality mobile games strategy. Our R&D strength includes the industry well proven team with extensive experience in MMORPG PC games, which is capable to realign to the development of hardcore mobile games and allow us to recreate a similar or even better user experience for our mobile game players. Our rich library of IP including rights to novels by the legendary Louis Cha and Huang Yi as well as highly successful offline PC games Legend of Sword and Fairy and Xuan Yuan Jian give us access to content that will be perfect for developing hardcore MMORPG PC games.

In addition this effort also mean that our games are highly sought after by strong mobile game publishers, to a simple after all legacy TLBB mobile game, we have reached a knowledge for future agreement with Tencent to license Xue Zhan Qian Ye which is a 3D game featuring a classic fantasy martial arts theme and strong social element. We expect the game to be launched in the first half of 2017.

[Foreign Language]

Overall, we will continue executing our Top Games, Big IP and Mass Marketing strategy. Our Product Appraisal Committee will review and assess our game portfolio on a weekly basis to make sure that we are developing popular games that resonate with users and retain their interest over the long run.

In the first half of 2016 some games have passed the review and went on to the next stages of development. Some games were terminated due to poor test results. Others have been sent back for modification. Under this strict quality control policy, we plan to launch eight games in the next two to three quarters. Among this games Hortensia Saga was launched in July Tian Long Ba Bu will be the next to follow.

[Foreign Language]

In terms of revenue expectation for the second half of the year excluding the impact of the depreciating R&D total revenue for online game is expected to be stable. The new games that I just mentioned are expected to make up for the declining of our older games. With more games scheduled to launch in the next two to three quarters we expect online game revenue to gradually recover.

[Foreign Language]

With that, let me turn the call to Wei Qing, our Chief Games Development Officer to give you an update on the latest progress of our legacy TLBB mobile game.

Wei Qing

[Foreign Language]

The development of our legacy TLBB mobile game is on schedule. The game is expected to be launched by the end of the year or in early 2017. Tencent has completed the first round of techno testing. And the feedback we have received is that the legacy TLBB mobile game has recreated the TLBB PC game experience and meets the expectation of game players.

[Foreign Language]

We will continue to work closely with Pen 15 [ph] to make improvements to the game based on user feedback and suggestions from Tencent. At Tencent China exhibition this year we presented the test version of the game to the public and have collected user feedback from users that we were used to fully improve the quality of the game.

[Foreign Language]

Tencent will soon initiate marketing campaign of the legacy TLBB mobile and we will of course share our back resources with Tencent to bring back the huge come in of TLBB players, who where once loyal to the PC game.

Wei Qing

[Foreign Language]

Now let me turn the call over to our CFO Ms. Jasmine Zhou to discuss the financial highlights.

Jasmine Zhou

Thank you, Wei Qing. Let me walk you through our financial highlights for the second quarter. Total revenue came in at $129 million, meeting the top end of our guidance, down 36% year-over-year and 1% quarter-over-quarter. The depreciation of the RMB against U.S. dollar impacted our reported financial results on a yearly basis.

On a constant exchange rate basis, total revenues in the second quarter of 2016 would have been $9 million higher, down 32% instead of 36% year-over-year. Online game revenue was inline with our guidance at $99 million, down 42% year-over-year and 3% quarter-over-quarter. The year-over-year decrease was mainly due to the natural decline in revenue of older games, such as TLBB and TLBB 3D, and a decrease in Web game revenues upon the completion of the sale of the 7Road during the third quarter of 2015.

Online advertising revenues were $12 million, down 24% year-over-year and increased by 46% quarter-over-quarter. The year-over-year decrease was mainly due to fewer PC games being marketed on the 17173 website. The quarter-over-quarter increase was mainly due to a seasonal pickup typical for advertising in the second quarter of 2016.

Internet value-added services revenues decreased 23% year-over-year and 17% quarter-over-quarter to $5 million. The year-over-year and quarter-over-quarter decreases were a result of the lower revenue from mobile internet products in the second quarter of 2016.

Other revenues, which consist of cinema advertising revenues, increased 61% year-over-year and was flat quarter-over-quarter at $40 million. The year-over-year increase reflected the strong growth of China’s movie and the cinema industry in general.

Now let me provide some more details about other financials. From now on, most of the figures discussed will be non-GAAP basis. As a reminder you can find a reconciliation of these non-GAAP measures in our published earnings release. Non-GAAP gross profit was $87 million, down 39% year-over-year and 1% quarter-over quarter. Gross margin was 68%, compared with 71% in the second quarter of 2015 and 68% in the first quarter of 2016.

Non-GAAP operating profit was $33 million which compares with $52 million in the second quarter of 2015 and $33 million in the first quarter of 2016. Non-GAAP net income attributable to Changyou.com Limited was $36 million, compared with $52 million in the second quarter of 2015 and $31 million in the first quarter of 2016. Non-GAAP fully-diluted net income attributable to Changyou.com Limited per ADS was $0.68, compared with $0.95 in the second quarter of 2015 and $0.58 in the first quarter of 2016.

Next, moving onto the balance sheet and cash flow statements, as of June 30, 2016, we had net cash of $822 million, compared with $755 million as of December 31, 2015. For the second quarter we had net operating cash inflow of $62 million.

Finally, for the third quarter of 2016 guidance we expect total revenue to be between $125 million and $135 million. This implies a sequential increase of 5% at a high end or decrease of 3% at low end.

Within total revenue online gaming revenue to be between $90 million and $100 million, this implied a sequential increase of 1% at a high-end or a decrease of 9% at the low end.

Non-GAAP net income attributable to Changyou.com Limited to be between US$25 million and US$30 million. Non-GAAP fully diluted earnings attributable to Changyou.com Limited per ADS to be between $0.47 and $0.56.

A tax expense adjustment to be made in the third quarter, which may lead to the increase in non-GAAP net income attributable to Changyou and non-GAAP fully diluted net income per ADS attributable to Changyou.com from our current projections.

Assuming no new grants of share-based awards and at constant share price, we estimate share-based compensation expense to be between US$2.0 million and US$2.4 million. In our guidance we have adopted a presumed exchange rate RMB6.7 to US$1.00, as compared with the actual exchange rate of approximately RMB6.53 to US$1.00 for the second quarter 2016.

This concludes our prepared remarks. Thank you for joining the call today. Operator, we would now like to open the call to discussions – to questions.

Question-and-Answer Session

Operator

Thank you mam. We would now being the question-and-answer session. [Operator Instructions] We will take our first question from Zoe Zhao from Credit Suisse. Please go ahead. Your line is open.

Zoe Zhao

Hi management, thank you for taking my question. I have a housekeeping questing on the mobile revenue percentage. Could you share the percentage with us for this quarter? And also could you share a little bit about your full-year revenue budget, given that we’re probably going to see a good recovery in the fourth quarter with the new titles launch? Thank you.

Unidentified Company Representative

[Foreign Language]

For mobile game revenue second quarter total revenue about 20% to 25% and – but we don’t give any actual the year numbers where we will have the like the third quarter’s guidance and we expect to gain revenue to be recalled or at least more and more new games are launched at later this quarter and the Q4. Thank you.

Zoe Zhao

Thank you.

Operator

Thank you. We will now take our next question from Eddie Leung from Merrill Lynch. Please go ahead.

Eddie Leung

Hi good evening. Thank you for taking my question. Just a question on the industry development, how management thinks about the impact of augmented reality and virtual reality on the Chinese game industry in the future and how would Changyou was a prepared for any change. Thanks.

Dewen Chen

[Foreign Language]

Firstly, we thought AR and BR will have a relatively significant impact on our industry.

[Foreign Language]

If at all more than a year ago, we’ve already started the process of looking into this new technology, in especially the Google Ingress Game. And we’ve been trying to recruit game development teams, especially producers to develop location based games. But however, we haven’t found any suitable teams or we already find some teams, but their current R&D size hasn’t met our standard yet.

[Foreign Language]

In terms of VR games, we currently have two projects in hand, especially the project team member are very passionate about the VR technology in the upcoming games.

[Foreign Language]

We’re continued to pay attention to these two directions, but I think the main point is to find the right person and especially the one who is passionate and with the right capabilities.

[Foreign Language]

Thank you.

Unidentified Analyst

Thank you.

Operator

Thank you. We will now take our next question from Xin Wang from Citi. Please go ahead.

Xin Wang

Hi, management. Thank you for taking my questions. My question is how should we see your advertising revenue and Internet value-added revenue going forward? Do you think the year-on-year decline swing will continue in the next like one or two years? Thank you.

Jasmine Zhou

[Foreign Language]

For next quarter, the advertising revenue and IVAS revenue to be really stable. But in the future – because it we’re shrinking our – our operations for mobile platform products. So in fact, IVAS revenues to be decreased a little bit and also for the advertising revenue, because of the mobile – because of the PC game markets still remains soft. It’s still going to be decreased. And we will, what you working on to like just to switch it to mobile platform to add mobile version of that game, of the website. Thank you.

Dewen Chen

[Foreign Language]

Okay, okay.

Jasmine Zhou

Okay. Thank you. Do you have follow-up questions or can we take the next one.

Operator

Yes. From Hillman Chan from Macquarie. Please go ahead, your line is open.

Hillman Chan

Thank you management for taking my questions. I have question about the like of TLBB, so I think second line of beta testing was scheduled to be in July, but then it was delayed a little bit into August. Could management talk about the reasons for the delay and that’s my first question. And my second question is about [indiscernible], I think this title was announced to back in 2015. And also did punish [ph] of Tencent and could management talk about the progress of the defilement of this title? Thank you.

Jasmine Zhou

[Foreign Language]

Dewen Chen

[Foreign Language]

Okay. Currently, the legacy TLBB are not in [indiscernible] and the current status is of schedule. And we plan to launch a big scale user test in August.

[Foreign Language]

Actually, the one we announced in 2015, [indiscernible] ARPG game, while the one we recently announced that we will cooperate Tencent is a social MMORPG.

[Foreign Language]

In other words, we actually replaced the previous announced come back ARPG game with social MMORPG game, which was announced.

[Foreign Language]

Thank you.

Hillman Chan

Well, thank you, management.

Operator

We will now take our next question from Chi Tsang from HSBC. Please go ahead.

Chi Tsang

Good day, good morning, good evening, everyone. Thanks for taking my questions. Congratulations on a good set of results, especially the unstable revenue Q-on-Q. I had a question regarding legacy TLBB mobile game. So clearly, you guys are sort of focused on driving initially, success but also building a sustainable franchise from this game over the next few years.

So my question is for the initial success parts, what do you think the game is going add in terms of – bring to the table in terms of being fresh or innovative and in specific new marketing approach, as you may take to ensure the success initially. And as it relates to the sustainable part, how do you expect to maintain this game to be successful over the next two to three years following it’s initially launch? Thank you.

Jasmine Zhou

[Foreign Language]

Dewen Chen

[Foreign Language]

When we develop that TLBB games, we follow the general conduct that with adapting the mobile industry. For example, we don’t like gaming starting with a tremendous version. And then we go through 30 minutes, one day even 30 days version. So to make sure the game has a more comprehensive development progress.

Dewen Chen

[Foreign Language]

For PC games actually the retention timing is around 30 minutes per user but for mobile games only 3 to 5 minutes. So the next day retention is actually important for mobile games and for each version of the cloud we develop the mobile game we were closely was tensioned to test and do for end group of users to make sure and our development has met any sort of their interest.

[Foreign Language]

Two true longer life stand of a mobile game, things we use a same thing for co-develop the PC game and we have actually reviewed our data in the past nine years and to make sure the features we using the mobile game is good enough or sustain enough to retain users.

Thank you.

Operator

Thank you. We will now take our next question from Natalie Wu from CICC. Please go ahead.

Natalie Wu

Hi, good morning, management. Thank you for taking my question. You have a net cash position of US$800.22 million by the end of second quarter. And you used to have a positive operating cash flow every quarter, for last quarter is about US$62 million. So just wondering what’s kind of those cash in-hand, will you decide to like payout dividend or something you just to want to have some color on that. Thank you.

Dewen Chen

[Foreign Language]

There is no plan for the dividend payment and for using cash we may considering potential M&As and we are also looking for like Big IPs and if there is any good target will make us purchase. Thank you.

Natalie Wu

Okay. Thank you.

Operator

Thank you. We will now take our next question come Alex Yao from JPMorgan. Please go ahead.

Alex Yao

Hi, good evening everyone and thank you for taking my question. I have a question on the PC gaming side. Can management to talk about your view on how financial PC gaming market will grow or develop over the next one to two years. And how would you position in this market for example what percentage of your R&D resources do on the PC side versus on the mobile. And in addition to the ones that you currently are running do you still have plan to self develop or probably just third-party PC games. Thank you.

Jasmine Zhou

[Foreign Language]

Dewen Chen

[Foreign Language]

According to the game industry reporting for the first half of 2016, we actually see the revenue had like a single-digit growth and are reaching the scale of $50 billion. So with that going forward the scale of PC game marketing can retained its current data.

Xiaojian Hong

[Foreign Language]

As for Changyou, for TLBB and Blade online we still have dedicated R&D team to work on that. And we also have two new – two upcoming PC games that we’re working on. And clearly as a firm, we have 400 people focused on PC game development, accounting for around one-third of our total – our research development team.

Dewen Chen

[Foreign Language]

We also have two licensed games in hand right now. And according to test results there are possible to be launched at the end of year or early next year.

[Foreign Language]

Thank you.

Alex Yao

Thank you.

Operator

[Operator Instructions] We will now take our next question from Ching Wong from Citi. Please go ahead.

Ching Wong

Thank you again for taking my question. If I understand correctly it seems your Q3 revenue guidance include revenue contribution from two new games, [indiscernible]. So how much of the revenue contribution from these two names like what percentage of total revenue and how about eight games you mentioned earlier what type of games are they like how many are [Audio Dip]? Thanks.

Jasmine Zhou

[Foreign Language]

Dewen Chen

[Foreign Language]

Currently, we cannot precisely predict the revenue contribution from new games, as most of our new game still under tax changing modification stage.

[Foreign Language]

Currently in our pipeline MMORPG accounting for the third or a quarter within the pipeline.

Ching Wong

Thank you.

Operator

Thank you. There are no further questions at this time. I would like to turn the program back to Ms. Jasmine Zhou for any additional or closing remarks.

Jasmine Zhou

Once again I would like to thank you for joining today’s call. If you have any follow-up questions, please do not hesitate to contact us. Thank you.

Operator

Thank you. This concludes the conference for today. Thank you for participating. Ladies and gentlemen, you may now disconnect.

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