Sohu Beats, Outlook Disappoints

Sohu.com Inc.’s (SOHU - Analyst Report) third-quarter earnings beat the Zacks Consensus Estimate by 6 cents. This was the due to its strong online games unit and compelling portal business. Net income on a non-GAAP basis was $40.9 million or 96 cents per share versus $42.8 million or $1.08 per share last year. This was at the high-end of the company’s guidance of 92 cents to 97 cents per share.
 
Revenues for the quarter were $136.6 million, up 13.2% from $120.7 million in the year-ago period. This was in line with the company’s guidance of $133.5- $137.5 million. Revenues were mainly driven by a 25.8% increase in online gaming revenues to $68.7 million.
 
The increase in online gaming revenues was due to the higher active paying accounts (APA) and user base expansion, which reflects the growing popularity of Changyou's online games. Aggregate registered accounts increased 46%, while APA increased 20% year over year. Average revenue per user (ARPU) also increased 7% year over year. Aggregate peak concurrent users (PCU) for Changyou’s games were approximately 910,000, an increase of 18% year over year.
 
However, brand advertising revenue fell 1.8% to $48.5 million in the quarter, due to the global financial crisis and weak advertising spending. Moreover, overseas licensing revenues decreased 33% year over year to $1.8 million due to increased competition in the online games sector in the U.S. Despite this, both the online gaming revenue and brand advertising revenues were in line with the company’s guidance.
 
Operating Performance
 
Gross margin on a non-GAAP basis increased 200 basis points year over year to 76% due to higher brand advertising gross margin. Operating expenses in the quarter increased 9% year over year primarily due to continued investment in product development and an increase in salaries and bonuses. Despite this increase, operating margin on a non-GAAP basis increased 400 basis points year over year to 42% driven by higher revenues.
 
We are encouraged by the company’s growing cash balance as well as its debt free balance sheet. Sohu exited the quarter with $596.4 million in cash and cash equivalents versus $546.7 million in the previous quarter.
 
Outlook Disappoints
 
Sohu’s fourth-quarter earnings guidance was below the Zacks Consensus estimate of 96 cents per share. The company expects net income on a non-GAAP basis in the range of $35 million (90 cents per share) to $37 million (95 cents per share).
 
Sohu expects total revenues in the range of $134.5 million to $138.5 million, with advertising revenues in the $48 – $50 million range. Brand advertising revenues are expected to be within $45 – $47 million and Online game revenues in the $69 – $71 million range.

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