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Sogou Inc. (NYSE:SOGO)
Q2 2020 Earnings Call
Aug 10, 2020, 6:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, thank you for standing by, and welcome to Sogou's second-quarter 2020 earnings conference call. [Operator instructions] Today's conference call is being recorded, and if you have any objections, you may disconnect at this time. [Operator instructions] Again, the conference call is being recorded. I would now like to turn the conference call over to your host today, Jessie Zheng, investor relations of Sogou.

Please go ahead.

Jessie Zheng -- Investor Relations Contact

Hello, everyone, and thank you for joining Sogou's second-quarter 2020 earnings conference call. On the call, our CEO, Xiaochuan Wang; and our CFO, Fion Zhou, will give an overview of the business and the financial results. In line with our practice on the previous earnings conference calls, Xiaochuan's prepared remarks will be made in Xiaochuan's voice using personalized speech synthesis and style transfer learning technology, which was developed by the Sogou Voice Interaction Technology Center. Please note that due to the pending going private transaction, we will not be holding the Q&A session at the end of this call.

If you have any questions, please contact us at ir@sogou-inc.com. 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 here, the measures discussed in this conference call are forward-looking statements. These statements are based on our 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 potential risks and uncertainties, please refer to the company's filings with the Securities and Exchange Commission. With that, I will now turn the call over to our CEO, Xiaochuan Wang.

Xiaochuan Wang -- Chief Executive Officer

Thank you, Jessie. Hello, everyone. We delivered overall in line results in the second quarter of 2020, with healthy momentum in our core search and mobile keyboard businesses. In particular, Sogou search maintained a steady share of traffic and reinforced its position as China's second largest search engine.

Mobile keyboard further expanded its DAU base to 484 million, maintaining the third largest Chinese mobile app in terms of DAUs according to iResearch. In addition, our AI hardware business recorded solid growth in the quarter. Since the beginning of this year, the online advertising industry, particularly search advertising, has been facing great challenges. The pandemic exacerbates the structural changes the industry is undergoing, and it continues to dampen the overall advertising sentiment and the business operations as SME.

We expect the situation to continue for some time, and Sogou is not immune to that. Amidst this unfavorable environment, Sogou has been proactively upgrading its development strategy to focus on generating more user value and building out a business that is oriented toward long-term value and growth. We will further boost AI empowerment and synergies across our businesses as we continuously enhance our technological advances in natural interaction and knowledge computing and leverage our strength in voice, computer vision, machine translation, dialogue and Q&A. Now, let me walk you through each of our core businesses.

In search, as we move beyond consolidating information to offering valuable knowledge, we are evolving to become a knowledge engine, thanks to our program in knowledge producing and computing capabilities. In terms of knowledge producing, we have focused on building up both general and vertical content, such as for encyclopedia and Chinese linguistics, to better meet users' needs. This also lays a solid foundation for knowledge computing. In the second quarter, the click-through rate of our search content leveraging our optimized knowledge graph increased 90% year over year.

In terms of knowledge computing, we have been able to provide users with more accurate answer and comprehensive knowledge through structured content offering. We are happy to see our search quality further improved with the fulfillment of our top direct anchor continuing to climb. In addition, with our healthcare search that serves as a traffic gateway for AI healthcare, we are creating an accessible and reliable healthcare platform for every user. In the second quarter, we established the Sogou AI healthcare center and made it clear that our goal is to develop healthcare services that feature our unique vocational avatar, which leverage our natural interaction and knowledge computing technology.

For example, our world's first AI nutritionist jointly launched with China Nutrition Society has gained much attention in the industry. In the second half of the year, we will launch more vocational avatar in AI healthcare to accelerate our progress in the sector. Turning to mobile keyboard, which is on track to become an AI communication assistant. On top of enriching its AI smart input function and expanding its vertical use cases, we continuously built up this service model in the quarter.

Our AI smart input in the second quarter, we launched a new function within smart Wang Zai, which is able to automatically building users conversation on WeChat and QQ. Smart Wang Zai penetrated into more than half of our organic users as of June 2020. We also extended mobile keyboard vertical use cases from handwriting multi-language to barrier-free input. Our recently launched the barrier-free smart keyboard helped visually impaired users improve input efficiency by over 60%.

In addition, we rolled out more AI input services, ranging from voice, OCR translations to others, which helped reinforce mobile keyboard's position as the largest voice recognition app in China. As of the end of June, its average daily voice requests more than doubled year over year, with a peak at 1.4 billion requests per day. All these efforts have resulted in sustained user growth, which laid a solid foundation for our subsequent efforts to build a membership system to unlock the value of our user assets. At the same time, among our many service-oriented initiatives, on top of further optimizing our recommendation service, we are also exploring new opportunities in value-added services, such as AI input and emoticon SaaS, which users tend to feel most comfortable to subscribe to.

In terms of smart hardware, we have been driving AI empowerment of our products with the mission to enhance human machine input and output capabilities and to transform our products into virtual personal assistant, VPA. This year, we have been increasing investments in R&D to further boost our AI competencies in hardware. Our flagship product, Sogou AI Recorder, has covered a full range of high-, mid- and low-end market, with leading product competitiveness, while enjoying strong synergies with AI input stemming from our mobile keyboard. We also successfully launched our first children education product, Sogou Dictionary Pen, with AI-enabled functions such as smart dialogue and translation.

Both our AI Recorder and Dictionary Pen topped the mainstream e-commerce platform in sales during the June 18 shopping festival. In the second half, we will accelerate product upgrades, enrich the existing category and further tap into mainstream hardware sectors. Now, I'd like to move to an important recent update. As announced a short time ago, Sogou received a preliminary nonbinding proposal from Tencent, under which Tencent will acquire all of the outstanding ordinary shares of Sogou, including ADSs that are not already owned by Tencent, for USD 9 in cash per ordinary share or ADS.

We appreciate Tencent's recognition of our value and technology and innovation capabilities. We have formed a special committee that consists of independent directors to consider the proposal, and we will ensure maximum protection of our shareholders' interest. Finally, I want to welcome Fion Zhou as our new CFO who joined us in early July. Fion's 14 years of experience in finance and strategic planning will further strengthen the suite of our management team's capabilities.

With that, I will now transfer to her to go through our financials. Fion, please go ahead.

Fion Zhou -- Chief Financial Officer

Thank you, Xiaochuan. Hello, everyone. I'm delighted to have joined Sogou and be part of the strong team. I'll now provide an overview of our results.

In the second quarter of 2020, our total revenues reached $261 million, in line with our previous guidance. As noted earlier, search was relatively soft due to the external headwinds as well as our initiatives to reduce low ROI traffic acquisition and cut back advertising inventories that interact user experience, which is part of our strategic upgrade to focus more on user value. However, we are pleased to see the robust momentum of smart hardware. On the bottom line, our net loss narrowed significantly compared to the prior quarter, thanks to the gradually normal TAC growth, coupled with the government's tax incentives.

Now, I'll walk you through our second-quarter financials in greater detail. Please note that unless otherwise noted, all monetary amounts that I discuss are in U.S. dollars. Also note that I will refer to some non-GAAP numbers which excludes share-based compensation expenses, and you can find a reconciliation of non-GAAP to GAAP measures in our earning release.

Total revenues in the second quarter were $261 million, a 14% decrease year over year. On a constant currency basis, total revenues in the second quarter decreased 11% year over year. Search and search-related revenues were $241 million, a 13% decrease year over year. On a constant currency basis, search and search-related revenues decreased 9% year over year.

The decrease was primarily due to the decrease in auction-based pay-for-click services, which accounted for 87% of search and search-related revenues compared to 88% in the corresponding period in 2019. Other revenues were $21 million, a 25% decrease year over year. The decrease was primarily due to the decreased revenues from non-core businesses, partially offset by a 20% year over year increase in AI-enabled hardware. Cost of revenues were $197 million, a 1% increase year over year.

Traffic acquisition costs, a primary driver of cost of revenues, was $159 million, a 9% increase year over year, representing 61% of total revenues compared to 48% in the corresponding period in 2019. The increase in TAC slowed down significantly from the first quarter as user traffic gradually normalized, with the pandemic stabilizing in the second quarter. Gross profit and non-GAAP gross profit were both $64 million, both a 40% decrease year over year. Both GAAP and non-GAAP gross margin were 25%, compared to 36% a year ago.

The decrease primarily resulted from the growth of traffic acquisition costs outpacing that of revenues. Total operating expenses were $90 million, a 6% decrease year over year. Research and development expenses were $49 million, a 4% decrease year over year, representing 19% of total revenues compared to 17% in the corresponding period in 2019. The decrease was primarily attributable to a decrease in share-based compensation.

Sales and marketing expenses were $32 million, a 13% decrease year over year, representing 12% of total revenues, largely flat with the corresponding period in 2019. The decrease was primarily due to a decrease in personnel-related expenses. G&A expenses were $10 million, a 9% increase year over year, representing 4% of total revenues compared to a 3% in the corresponding period in 2019. Operating loss was $26 million compared to operating income of $12 million in the corresponding period in 2019, and non-GAAP operating loss was $23 million, compared to operating income of $18 million in the corresponding period of 2019.

Other income, net was $16 million compared to $4 million in the corresponding period in 2019, and the increase was primarily due to a tax refund that was part of the Chinese government's initiatives taken in response to COVID-19 and other tax exemptions. Income tax benefit was $1.1 million compared to $1.4 million in the corresponding period of 2019, and net loss attributable to Sogou was $8 million compared to net income of $21 million in the corresponding period in 2019, and non-GAAP net loss attributable to Sogou was $6 million compared to a net income of $28 million in the corresponding period in 2019. GAAP basic and diluted loss per ADS was $0.02 and non-GAAP basic and diluted loss per ADS was $0.01. As of June 30, 2020, we had cash and cash equivalents and short-term investments of $1.2 billion compared to $1.1 billion as of December 31, 2019, and net operating cash inflow for the second quarter of 2020 was $49 million.

Capital expenditures for the second quarter was $6 million. Given that the going private transaction is under review and evaluation, we will not provide guidance this time. At the current stage, we cannot comment on any details of the pending transaction. We will keep the market updated as the process moves along and provide further information as it becomes available.

With that, I'd like to conclude our conference call today, and thank you, everyone, for joining and for your continued support for Sogou.

Questions & Answers:


Operator

[Operator signoff]

Duration: 22 minutes

Call participants:

Jessie Zheng -- Investor Relations Contact

Xiaochuan Wang -- Chief Executive Officer

Fion Zhou -- Chief Financial Officer

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