SOHU / CYOU Joint Presentation November 2010 1
Safe Harbor Statement This presentation contains forward-looking statements. Statements that are not historical facts, including statements about Sohu and Changyou 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 statement. Potential risks and uncertainties include, but are not limited to, the current global financial and credit markets crisis and its potential impact on the Chinese economy, the slower growth the Chinese economy experienced during the latter half of 2008 and in 2009, which could recur in the future, the uncertain regulatory landscape in the People's Republic of China, fluctuations in Sohu's quarterly operating results, and Sohu s reliance on online advertising sales, online games and wireless services (most wireless revenues are collected from a few mobile network operators) for its revenues. Further information regarding these and other risks is included in Sohu's annual report on Form 10-K for the year ended December 31, 2009 and quarterly reports on Form 10-Q for the quarter ended June 30, 2010, Changyou s annual report on Form 20-F for the year ended December 31, 2009, and other filings by Sohu and Changyou with the Securities and Exchange Commission. 2
Unique Combination of Strong Businesses: Sohu Portal - Leading Mainstream Media Platform Changyou - Leading MMORPG Company Sogou- Online Search Subsidiary Strong brand recognition User base of more than 250m Extensive advertising resources Industry expertise of 17173.com China's largest gaming portal Diversified game portfolio Acquisition of new users, particularly teenagers Contribution of revenues/ earnings/ strong cash flows Sogou Pinyin - the dominant software for Chinese language-input in China, with 70-80% market share in China Portal business: traction is picking up as increasingly higher value advertising solutions are provided to our advertising partners around China Online game business conducted by Changyou: a leading player in the MMORPG industry; an effective way to drive high growth and high profitability as well as to generate strong cash flows Sogou search business: Strategic investment from Alibaba provides great opportunity to compete and capture market share 3
Financial Track Record Total revenues Brand advertising Search Online games (CYOU) Operating margin (non- GAAP)* 2010 Q2 2010 Q3 $146.1m $53.2m $3.9m $77.7m $164.1m $59.1m $5.4m $85.6m Q-o-Q % 2009 Q3 12% 11% 38% 10% $136.6m $48.5m $2.3m $68.7m Y-o-Y % 20% 22% 134% 25% 2010 Q4 Guidance $163m~168m $58m~60m $6m $86m~89m Q-o-Q % -1%~2% -2%~2% 11% 0%~4% 39% 44% N/A 42% N/A N/A N/A Net income before NCI (non- GAAP)* Net income after NCI for diluted EPS (non-gaap) * Diluted EPS after NCI (non- GAAP) * $52.5m $61.3m 17% $51.6m 19% $59m~61.5m -4%~0% $37.5m $45.2m 21% $37.4m 21% $43m~45m -5%~0% $0.96 $1.16 21% $0.96 21% $1.10~1.15-5%~1% Cash Balance $599m $535m -11% $597m -10% N/A N/A Cash inflow from operations $58m $84m 45% $65m 29% N/A N/A * Non-GAAP operating income, net income and diluted EPS exclude the impact of share-based awards. Please refer to our earnings release, which is posted on the IR section of Sohu s website at http://corp.sohu.com/investorrelations for GAAP numbers. Ranked by Fortune magazine as the 12 th fastest growing U.S.-listed company based on financial performance over the past three years 4
Supplementary Financial Data by Business Lines 2010 Q3 Revenue Operating Profit Non-GAAP Operating Margin Operating Profit GAAP Operating Margin Brand Advertising, wireless and others $73.1m $21.5m 29% $17.2m 24% Search $5.4m $-4.9m NA $-5.4m NA Subtotal $78.5m $16.6m 21% $11.8m 15% Online Games (before NCI) $85.6m $55.2m 64% $53.4m 62% Total $164.1m $71.8m 44% $65.2m 40% 5
Strong Results Delivered by an Experienced and Focused Team Title Years Title Years Dr. Charles Zhang Chief Executive Officer 14 Mr. Tao Wang Chief Executive Officer 6 Ms. Carol Yu Co-President and Chief Financial Officer 7 Mr. Alex Ho Chief Financial Officer 6 Ms. Belinda Wang Co-President and Chief Operating Officer 11 Mr. Dewen Chen President and Chief Operating Officer 6 Mr. Xiaochuan Wang Chief Technology Officer 10 Mr. Xiaojian Hong Chief Technology Officer 6 The management team has been making all the right moves over the past 5+ years and is flush with confidence and strong execution capability 6
Portal Business: Brand Advertising 7
China Online Advertising Industry More advertising spending anticipated in 2010 Recovered from the global financial crisis Ad spending has been stimulated by events such as World Cup and Asian Games Online media continues to gain market share from traditional media Greater efficiency and effectiveness Ongoing advertising budgets shifting from offline to online Internet penetration expansion Online video is one of the fastest growing segments where Sohu has secured a leading position Optimistic about the remainder of the year 8
SOHU Brand Advertising Performance by Industry Brand advertising revenue for 2010 is expected to grow by 18% - 20% as compared to 2009, or by 24% - 25% as compared to 2008. IT-related industries, auto, online games, FMCG were fast growing sectors for 2010 Q3. Auto & FMCG: will remain stable revenue growth in 2010 Q4. Real Estate: New government policies and regulations have negative impact on the volume of sales. Overall, we ll see a revenue growth, especially from second-tier cities in 2010 Q4, through our efforts to offer more online promotion plans to advertisers. 9
Online video: our potential future revenue driver Online video is one of the fastest growing segments where Sohu has secured a leading position Ad revenues of the online video industry in China are expected to grow 73% in 2010, and over 65% each year from 2011 to 2013, reaching 11 billion RMB in 2013. (iresearch) ComScore and iresearch: for 2010 Q3 Sohu ranked 3 rd in terms of the total number of online video views and total effective time spent watching videos in China. Further expansion of content offering and improvement on innovative applications to enhance broadcast solutions for various devices. E.g., we ve made all of the content on our video site accessible to ipad and iphone users to ensure that their user experience will be as dynamic as the devices they are using. Average daily video views of high-definition video channel grew by 40% Q-o-Q The growing traffic attracted more advertising spending. Video revenues for 2010 Q3 increased 71% Q-o-Q. 10
Online Search: Sogou 11
Sogou Business Sogou Pinyin The dominant software for Chinese language-input in China, installed on 70%~80% of PCs in China Sogou Browser Sogou browser has been installed on roughly 10% of PCs in China and is No. 3 in terms of market share in China Sogou Search Sogou search engine now has a 1.2% market share based on the latest iresearch report, and is No. 3 in China We ll leverage Sogou Pinyin s success to promote Sogou Browser which in turn will bring traffic to Sogou Search 12
Search Revenue Mix 2009 Q1 2009 Q2 2009 Q3 2009 Q4 2010 Q1 2010 Q2 2010 Q3 Bid listing $0.9m $1.3m $1.8m $2.3m $2.1m $3.1m $4.6m Paid listing $0.7m $0.5m $0.5m $0.6m $0.7m $0.8m $0.8m Total $1.6m $1.8m $2.3m $2.9m $2.8m $3.9m $5.4m 13
Sogou completed the sale of newly-issued Series A Preferred Shares On October 22, 2010, Sogou completed the sale of newly-issued Series A Preferred Shares to Alibaba Investment Limited, a private investment subsidiary of Alibaba Group Holding Limited, China Web Search (HK) Limited, an investment vehicle of Yunfeng Fund, LP, and the investment fund of Dr. Charles Zhang, Sohu s Chairman and Chief Executive Officer. Xiaochuan Wang, Sohu s CTO, was appointed as the CEO of Sogou. Upon closing of the sale, Sogou has been restructured to include our search business, Sogou Pinyin and Sogou Browser. We will leverage Sogou Pinyin s success to promote Sogou Browser which in turn will bring traffic to Sogou Search. The restructuring in addition to the potential business cooperation with Alibaba have helped the Sogou team become more committed and motivated 14
Financial Implication of Sogou s issuance of Preferred Shares Sogou received the $48 million proceeds from preferred shareholders, which will be used to fund Sogou s operations over the next two years. Sohu will retain 53% of Sogou on a fully-diluted basis, and intends to retain majority ownership in Sogou. Going forward, Sohu will continue to consolidate Sogou s financial statements, with interest of preferred shareholders to be reflected in our consolidated balance sheet as noncontrolling interest. For 2010 Q3, Sogou s net losses were around $5.0 million on a pro forma basis. Starting from 2011 onwards, Sohu s diluted EPS calculations will only include 53% of Sogou s losses, which is in proportion to our ownership in Sogou on a fully diluted basis. 15
Resource Allocation Focused on Content and Technology Sohu non-game Employees Content 1,527 Tech 231 Sales & CS 323 Back office 243 Subtotal 2,324 Sogou 420 Total 2,744 16
Online Games: CYOU 17
Industry Update 18
China s Growing Online Game Market Internet user growth drives the expansion of the online game market in China China world s largest Internet market and still growing (In millions) 450 400 350 300 250 200 150 100 50 0 137.0 162.0 210.0 253.0 298.0 338.0 384.0 420.0 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10 Internet users in China Macro trends driving robust online game revenue growth (In RMB billions) 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 3.8 5.7 6.3 8.5 9.8 11.7 14.4 15.6 2H06 1H07 2H07 1H08 2H08 1H09 2H09 1H10 China online game revenue Government strengthens online games management, encourages creativity and focuses on healthy and sustainable development of the industry On July 28, 2010, Chinese government officials stated that the government will: o Introduce policies related to online gaming in China to provide a solid foundation for the sustainable growth of the industry o Explore ways to effectively protect intellectual property rights o Encourage innovation and support domestic online games companies to expand overseas We believe the formalization of a standard set of regulations will help the sustained development of the industry. Changyou will continue to strongly support the work of the regulators and join in the formulation and implementation of these regulations and make greater contributions to the industry s development. Source: CNNIC, Analysys 19
Financial Overview 20
Strong Financial Track Record 2010 Q3 2010 Q2 2009 Q3 QoQ YoY 2010 Q4 Guidance Total revenues Game operation revenues Overseas licensing revenues $85.6m $83.6m $2.0m $77.7m $75.6m $2.1m $68.7m $66.9m $1.8m 10% 11% -7% 25% 25% 11% $86.0m~89.0m N/A N/A Gross margin (non-gaap)* 90% 91% 93% N/A N/A N/A Operating margin (non-gaap)* 64% 63% 67% N/A N/A N/A Net income (non-gaap)* $47.1 m $44.1 m $41.3m 7% 14% $46.5m~48.0m Diluted EPS (non-gaap)* $0.88 $0.82 $0.77 7% 14% $0.87~0.90 Cash Balance $292.0m $294.5m $312.9m -1% -7% N/A Debt Balance $0 $0 $0 N/A N/A N/A Cash inflow from operations $55.5m $49.2m $46.2m 13% 20% N/A * Non-GAAP numbers exclude share-based compensation costs. Please refer to our earnings release, which is posted on the IR section of Changyou s website at http://www.changyou.com/ir/ for GAAP numbers. Changyou is a highly profitable online game developer with a strong, debt-free balance sheet and rich cash flows 21
Business Highlights 22
1 Solid Growth Momentum in Existing Games TLBB Remains Our Flagship Game Diversified Portfolio of Games Adding Incremental Growth Tian Long Ba Bu ( TLBB ): Latest upgrades include new content introduced in July and October featuring new in-game events and more customization options for avatar and in-game chat to cater to the social needs of today s youngsters Plan to launch TLBB 3, another major expansion pack, in 2011 to further enrich the in-game experience of users and extend the game s lifespan We are also adding incremental growth from our growing portfolio of differentiated games, including Blade Online, Blade Hero 2, Da Hua Shui Hu, Zhong Hua Ying Xiong and the newly released Immortal Faith We ll continue to update the games based on user feedback Regular game content updates drives steady expansion of user base with potential for further upside growth in ARPU (In millions) 120 100 80 60 40 20 0 Aggregate Registered Accounts * (In thousands) Aggregate APA * ARPU * * as a Percentage of Peers 3,000 2,500 2,000 Average:73% 1,500 1,000 500 0 User-centric game development model incorporating extensive feedback and solid operating strategy deliver organic growth and maintain healthy game portfolio * Comprises the following games operated in China: Tian Long Ba Bu ( TLBB ), Blade Online, Blade Hero 2, Da Hua Shui Hu, Zhong Hua Ying Xiong and Immortal Faith * * Based on company filings and research 23
1 Solid Growth Momentum in Existing Games(Cont d) - Franchise Games are Cornerstone of Growth Launched a hit game Year 1 Launched a hit game that surpassed 400,000 peak concurrent users during the first month of its launch Introduced the first 2.5D game that combines both martial arts and community-building features in China Continued to grow user base Year 2-3 Continued to grow user base by releasing regular game updates and expansion packs The game has become a leading 2.5D martial arts MMORPG in China s online game market Formed a large community Year 4 Major expansion pack TLBB 2 launched in April 2010 with important upgrades, boosting PCU to a record high Another major expansion pack in development for 2011 to further grow the game s community To date, we have released 16 expansion packs based on a vast amount of user feedback We will continue to release expansion packs regularly to grow the community and build TLBB into an even more valuable franchise An Award-winning Game The Most-installed MMORPGs in China s Internet Café * The Most-liked Online Game by Game Players by ChinaJoy for five consecutive years from 2006 to 2010 World s Top Five Most Profitable Game Franchises in 2009 by Forbes TLBB remains our flagship title and a testament to our ability to create a sustained blockbuster * Data from barchina.net for the period Oct 18-24, 2010 1 2 3 4 5 Fantasy Westward Journey Wendao TLBB Dragon Nest World of Warcraft NetEase Netdragon Changyou Shanda Games NetEase 24
2 Delivering Growth with New Inhouse-developed Games Duke of Mount Deer Unique features to differentiate game from others on the market Multiple graphic modes Social interactive game-play Cartoonish graphic style The first in the industry to allow players to freely switch between multiple graphic modes Vivid graphics and 360 degree viewing angles Target a wide range of people, across different genders and nationalities Various forms of social activities to foster larger community and enhance gamer stickiness Adorable exaggerations of characters Visually attractive scenery and realistic weather effects Dawn in the main city Team-based activities Adorable characters Moon and stars in the sky Team-based cooking game Realistic snow view Content development for the game has been completed and we are evaluating marketing proposals for the game s launch 25
3 Diversify Game Portfolio through Licensing New games put in operation in 2010 Upcoming games Game title Da Hua Shui Hu ( DHSH ) Zhong Hua Ying Xiong ( ZHYX ) Immortal Faith ( IF ) San Jie Qi Yuan ( SJQY ) Legend of Ancient World ( LAW ) Theme 2D turn-based, cartoon-style game 3D martial arts game 2D mystical adventure game 2D turn-based, cartoon-style game 2.5D fantasy game Development Progress Began open beta testing on March 18 Released the first expansion pack in July Began open beta testing on May 20 Began open beta testing on September 9 Under close beta testing Under close beta testing Continue to collect user feedback and data to fine-tune the game Plan Plan to introduce expansion pack in 2010Q4 to further stimulate interest from students and casual gamers Continue to work with developer to launch new virtual ingame items and localize the game for hardcore domestic gamers Plan to introduce new content based on user feedback in the coming quarters Plan to launch the game in December Plan to launch the game in 2011 Continue to bring new games to market that complement our portfolio and attract different types and demographics of users 26
4 Gain International Exposure with Strategic Overseas Expansion Export Strategy Changyou s TLBB franchise has been licensed to game operators in Vietnam, Taiwan, Hong Kong, Malaysia, Singapore and Thailand We will pursue strategic licensing opportunities to selective countries to broaden our exposure to different online game markets and cultures Self-Operation Strategy Domestic market Export market Market for self-operations We began open beta testing of Dragon Oath, the English version of TLBB, in the United States in December 2009 We began open beta testing of TLBB in the United Kingdom in April 2010 Our objective is to deepen our understanding of Western gaming markets and gain valuable insight on user protection and customer service standards so as to introduce these back in China 27
5 Building Human Capital for Long-term Development Recruit top-notch talent Added over 300 game engineers in the third quarter of 2010 Total employees were approximately 2,050 as of Sept 30, 2010 Focused on recruiting fresh graduates from leading universities across China to enhance our R&D and game operation capabilities Plan to recruit another 100 marketing and offline promotional staff to promote upcoming games Train and incentivize R&D engineers 3,000 2,000 1,000 0 Total Headcount ~2,200 Jun 2009A Dec 2009A Jun 2010A Sep 2010A Dec 2010E Developed a number of new in-house training programs for engineers in the third quarter of 2010 TLBB s well-established game development platform is a training base for R&D talent Experienced game development personnel provide valuable guidance to new hires and help them assimilate into Changyou s culture After new hires are properly trained, core developers are allocated to new game projects The team currently working on TLBB is already the third generation of game developers Unique incentive systems ensure maximum sharing of experience and know-how Streamlined hiring and training practices strengthen foundation for long-term growth 28
Key Investment Takeaways Winning formula: strong brand ad and online game businesses to deliver sustainable growth through various economic cycles Sogou search business is gaining potential to compete and capture market share Strong, debt-free balance sheets and healthy operating cash flows: combined cash balance of $535 million with quarterly operating cash flow around $84 million 29
Thank You! 30