achievewebmessenger

Aftercontinuoustechnologicaldevelopmentandmarketingefforts,ourin-housedevelopedChineseinputmethod,SogouPinyin,hasprovedtobeasuccessfulChineseinputsolutionandhasbeeninstalledon80%ofPCsinChina.
Moreover,SogouCloudinputhasestablishedanewmarketstandardforChineseinputpreciseness,reflectingourinnovativeabilitytodevelopcutting-edgetechnologyandenhancingSohu'scognitiontousers'inputbehaviors.
ThemobileversionofSogouPinyinisalsoincreasinginpopularityasagrowingnumberofuserssurftheinternetthroughtheirmobilephones.
SogouPinyin'slargemarketshareaffordsustheopportunitytocross-marketSohu'sotherleadingproducts,suchasonlinevideosandnewssites,whichwillhelpsecureourleadingmarketpositionandattractmoreuserstotheSohuplatform.
SogouPinyin,theLeadingChineseInputMethodSoftwareDearShareholders:IampleasedtosharewithyoutheresultsofanothersuccessfulyearforSohu.
In2009,ourmanagementteamwasonceagainabletosuccessfullyexecuteourbusinessstrategiesacrossourcorebusinesssegments,deliveringsolidnancialresultsandenhancingvalueforshareholders,eveninchallengingeconomicconditions.
Bothourportalandonlinegamebusinessescontinuedtogrow,ndingnewandinnovativewaystoreachouttousersandadvertisers.
Oursuccessdidnotgounnoticed—FortuneMagazinerankedSohuthethirdfastestgrowingU.
S.
listedcompanyinAugust2009,basedonournancialperformanceoverthepastthreeyears.
Goingforward,wewillmakeongoinginvestmentsincontent,technologyandmarketingthatwillstrengthenourpositionasaleadingmainstreammediaplatforminChina.
Oneofthehighlightsof2009forourcompanywasthehighlysuccessfulinitialpublicoffering(IPO)ofChangyou.
com,ourmassivelymultiplayeronlinerole-playinggame(MMORPG)subsidiary,ontheNASDAQGlobalSelectMarket.
ThelandmarkIPOovercameanumberofchallengesduringaparticularlydifculttimeintheglobalcapitalmarkets,winningTheAssetmagazine's"TripleARegionalAward"forBestADREquityDeal/IPOof2009.
ThesuccessfulexecutionoftheIPOandcontinuedgrowthanddevelopmentoftheonlinegamesbusinessspeakstothestrategicvisionandexecutioncapabilitiesofourmanagementteam.
In2009,wefurtherbolsteredourmanagementteamwiththepromotionofBelindaWangandXiaochuanWangtoSohu'sChiefOperatingOfcerandChiefTechnologyOfcer,respectively.
AtChangyou,Mr.
DewenChen,thecompany'sChiefOperatingOfcer,tookontheadditionalroleofPresident.
Wealsopromotedthreemorevice-presidentsatSohu,namelyLinZhou,VicePresidentofTechnology;WeiYu,VicePresidentofMedia;andYeDeng,VicePresidentofEntertainmentMediatoexpandourcoremanagementteam.
ThesepromotionsreectthecontinuedandvaluedcontributionsoftheseindividualsandstrengthentheSohugroup'sleadershipteam.
2009FinancialHighlightsSohu's2009nancialresultsareatestamenttoouremphasisontheapplicationofnew,highlydesiredanddifferentiatedcontent,technologicalinnovation,andanabilitytomaintainandgrowuserloyalty.
Ourtotalrevenuesreachedarecordhighof$515.
2million,up20%comparedto2008—animpressiveyear-over-yeargainconsideringthesofteconomicclimateandstrongrevenuecontributionfromconsumerdemandrelatedtotheBeijingOlympicGamesinthepreviousyear.
Ourbalancesheetremainedfreeofdebt.
AfterthesuccessfulstockrepurchasingofUS$40millioninthefourthquarterof2009,ourcashbalanceasofDecember31,2009wasover$560million.
PortalBusinessOurfocusonhighdenitionvideocontentdifferentiatedourofferingsanddrovenewviewerstoourplatform.
Ourproactivestepstobattleonlinevideopiracyhaveledmanylocalvideositestoremovetheirpiratedcontentandprovideduswithampleopportunitiestoexpanduserbaseandincreaseadvertisingrevenues.
OureffortsbringsSohutobecomethepartnerofchoiceformanyleadinglocalandglobalmediacompanies,resultinginnewopportunitiestoofferimpressiveanddifferentiatedlicensedcontentfromaroundtheworldtoourusers.
Withourcontinuoustechnologicaldevelopmentandmarketingefforts,SogouPinyinhasbeeninstalledon80%ofpersonalcomputersinChina.
TheintroductionofcloudcomputingtechnologytoSogouPinyinhelpsfurthercementitsleadingmarketpositionwithrevolutionaryinputpreciseness.
Inaddition,themobileversionofSogouPinyinisalsoincreasinginpopularity.
SogouPinyin'slargemarketshareaffordsustheopportunitytocross-marketSohu'sotherproductswhichwillhelpattractmoreuserstotheSohuplatform.
OnlineGamesOurindependentlylistedonlinegamingsubsidiary,Changyou,enjoyedsolidgrowthin2009.
ThehighlightoftheyearwasclearlythesuccessfulIPOinApril2009.
However,wewerealsoabletopushthroughanumberofstrategicandoperatinginitiativesthathelpedgeneraterecordreturnsinthecompany'shistory.
Ourperiodicreleasesofnewgameupdatesandcontinuedfocusonenhancingourusers'in-gameexperiencefurtherenlargedouruserbase.
Aggregateregisteredusersgrewstronglyoverthesamequarterlastyear,increasingbyover40%year-over-yearto80.
9millioninthefourthquarterof2009.
Aggregatepeakconcurrentusers(PCU)forourgamesalsoexpanded,growingby19%fromthesamequarterlastyearto990,000inthefourthquarterof2009.
Aggregateactivepayingaccounts(APA)reached2.
4millioninthefourthquarterof2009,anincreaseofmorethan20%overthesamequarterlastyear.
Ourexistinggames,consistingofouragshipgameTianLongBaBu(TLBB),twogamesintheBladeOnlineseries,andDaHuaShuiHucontinuetogaintractionamongstuserswhilereectingpositivegrowthmomentum.
TLBBremainsoneofthemostpopulargamesinChina,providingasolidrevenuebaseforfundinggrowthinourotherexistingandpipelinegames.
Wehaveadiversepipelineofgames,includingourin-housedevelopedtitle,DukeofMountDeer(DMD),aswellasasuiteofhigh-quality2Dand3Dlicensedgames.
Welookforwardtoabrightfuture,asoursuccessfuluser-centricgamedevelopmentplatform,innovativegamesandnewtechnologieswillrmlyestablishChangyouinkeymarketsub-segmentsanddeliveradditionalgrowthinthecomingyears.
StockRepurchaseProgramBetweenOctober2008andDecember31,2009,wepurchasedatotalof1,252,910SohusharesintheopenmarketatanaveragepriceofUS$47.
89foratotalconsiderationofUS$60million.
ThiscompletedthestockrepurchaseprogramweannouncedinOctober2008.
2009wasayearofachievementsandgrowthforSohu.
Inchallengingmarketconditions,wewereabletodemonstratethesuccessofourlong-termstrategicvisiontobealeadinginternetcompany.
Astheeconomymarchestowardrecovery,wewillremainfocusedonanddedicatedtothegrowthandenhancementofshareholdervalue.
Ithankyou,ourshareholders,foryourongoingsupport,andlookforwardtocommunicatingfurthergrowthandsuccessinthecomingyear.
Sincerely,CharlesZhangChairmanandCEOSohu.
comThisannouncementcontainsforward-lookingstatements.
ItiscurrentlyexpectedthattheBusinessOutlookwillnotbeupdateduntilreleaseofSohu'snextquarterlyearningsannouncement;however,SohureservesrighttoupdateitsBusinessOutlookatanytimeforanyreason.
Statementsthatarenothistoricalfacts,includingstatementsaboutSohu'sbeliefsandexpectations,areforward-lookingstatements.
Thesestatementsarebasedoncurrentplans,estimatesandprojections,andthereforeyoushouldnotplaceunduerelianceonthem.
Forward-lookingstatementsinvolveinherentrisksanduncertainties.
Sohucautionsyouthatanumberofimportantfactorscouldcauseactualresultstodiffermateriallyfromthosecontainedinanyforward-lookingstatement.
Potentialrisksanduncertaintiesinclude,butarenotlimitedto,thecurrentglobalnancialandcreditmarketscrisisanditspotentialimpactontheChineseeconomy,theslowergrowththeChineseeconomyexperiencedduringthelatterhalfof2008andin2009,whichcouldcontinuethrough2010,theuncertainregulatorylandscapeinthePeople'sRepublicofChina,uctuationsinSohu'squarterlyoperatingresults,Sohu'shistoricalandpossiblefuturelosses,anditsrelianceononlineadvertisingsales,onlinegamesandwirelessservices(mostwirelessrevenuesarecollectedfromafewmobilenetworkoperators)foritsrevenues.
FurtherinformationregardingtheseandotherrisksisincludedinSohu'sannualreportonForm10-KfortheyearendedDecember31,2009,andotherlingswiththeSecuritiesandExchangeCommission.
UNITEDSTATESSECURITIESANDEXCHANGECOMMISSIONWASHINGTON,D.
C.
20549FORM10-K(MARKONE)HANNUALREPORTPURSUANTTOSECTION13OR15(d)OFTHESECURITIESEXCHANGEACTOF1934ForthescalyearendedDecember31,2009ORTRANSITIONREPORTPURSUANTTOSECTION13OR15(d)OFTHESECURITIESEXCHANGEACTOF1934ForthetransitionperiodfromtoCOMMISSIONFILENUMBER0-30961SOHU.
COMINC.
(Exactnameofregistrantasspeciedinitscharter)Delaware98-0204667(Stateorotherjurisdictionofincorporation)(I.
R.
S.
EmployerIdenticationNo.
)Level12,Sohu.
comInternetPlazaNo.
1UnitZhongguancunEastRoad,HaidianDistrictBeijing100084People'sRepublicofChina(Addressofprincipalexecutiveofces)(011)8610-6272-6666(Registrant'sTelephoneNumber,IncludingAreaCode)SECURITIESREGISTEREDPURSUANTTOSECTION12(b)OFTHEACT:CommonStock,$0.
001ParValueSECURITIESREGISTEREDPURSUANTTOSECTION12(g)OFTHEACT:NoneIndicatebycheckmarkiftheregistrantisawell-knownseasonedissuer,asdenedinRule405oftheSecuritiesAct.
YesHNohIndicatebycheckmarkiftheregistrantisnotrequiredtolereportspursuanttoSection13orSection15(d)oftheExchangeAct.
YeshNoHIndicatebycheckmarkwhethertheregistrant:(1)hasledallreportsrequiredtobeledbySection13or15(d)oftheSecuritiesExchangeActof1934duringthepreceding12months(orforsuchshorterperiodthattheregistrantwasrequiredtolesuchreports),and(2)hasbeensubjecttosuchlingrequirementsforthepast90days.
YesHNohIndicatebycheckmarkwhethertheregistranthassubmittedelectronicallyandpostedonitscorporateWebsite,ifany,everyInteractiveDataFilerequiredtobesubmittedandpostedpursuanttoRule405ofRegulationS-T(§232.
405ofthischapter)duringthepreceding12months(orforsuchshorterperiodthattheregistrantwasrequiredtosubmitandpostsuchles).
YeshNohIndicatebycheckmarkifdisclosureofdelinquentlerspursuanttoItem405ofRegulationS-K(§229.
405ofthischapter)isnotcontainedherein,andwillnotbecontained,tothebestofregistrant'sknowledge,indenitiveproxyorinformationstatementsincorporatedbyreferenceinPartIIIofthisForm10-KoranyamendmenttothisForm10-K.
hIndicatebycheckmarkwhethertheregistrantisalargeacceleratedler,anacceleratedler,anon-acceleratedler,orasmallerreportingcompany.
Seedenitionsof"largeacceleratedler","acceleratedler"and"smallerreportingcompany"inRule12b-2oftheExchangeAct.
LargeacceleratedlerHAcceleratedlerhNon-acceleratedlerhSmallerreportingcompanyhIndicatebycheckmarkwhethertheregistrantisashellcompany(asdenedinRule12b-2oftheExchangeAct).
YeshNoHTheaggregatemarketvalueofcommonstockheldbynon-afliatesoftheregistrant,baseduponthelastsalepriceonJune30,2009asreportedontheNASDAQGlobalSelectMarket,wasapproximately$1,552million.
AsofJanuary31,2010,therewere37,766,593sharesoftheregistrant'scommonstockoutstanding.
DOCUMENTSINCORPORATEDBYREFERENCEPortionsoftheProxyStatementforSohu's2009AnnualMeetingofStockholderstobeledonoraboutApril30,2010areincorporatedintoPartIIIofthisreport.
-1-SOHU.
COMINC.
TableofContentsPAGEPARTIItem1BusinessOverview3Item1ARiskFactors41Item1BUnresolvedStaffComments83Item2Properties83Item3LegalProceedings83Item4SubmissionofMatterstoaVoteofSecurityHolders84PARTIIItem5MarketfortheRegistrant'sCommonStock,RelatedStockholderMattersandIssuerPurchasesofEquitySecurities85Item6SelectedFinancialData87Item7Management'sDiscussionandAnalysisofFinancialConditionandResultsofOperations90Item7AQuantitativeandQualitativeDisclosureAboutMarketRisk117Item8FinancialStatementsandSupplementaryData119Item9ChangesinandDisagreementswithAccountantsonAccountingandFinancialDisclosure119Item9AControlsandProcedures119Item9BOtherInformation120PARTIIIItem10Directors,ExecutiveOfcersandCorporateGovernance121Item11ExecutiveCompensation121Item12SecurityOwnershipofCertainBenecialOwnersandManagementandRelatedStockholderMatters121Item13CertainRelationshipsandRelatedTransactions,andDirectorIndependence121Item14PrincipalAccountantFeesandServices121PARTIVItem15ExhibitsandFinancialStatementSchedules122Signatures123IndextoConsolidatedFinancialStatementsF-1ExhibitIndex-2-PARTIAsusedinthisreport,referencesto"us,""we,""our,""ourcompany,""ourgroup,""Sohu"and"Sohu.
com"aretoSohu.
comInc.
and,exceptwherethecontextrequiresotherwise,ourwholly-owned,majority-owedsubsidiariesandvariableinterestentities("VIEs"),Sohu.
comLimited,Sohu.
com(HongKong)Limited("SohuHongKong"),KylieEnterprisesLimited,AllHonestInternationalLimited,Sohu.
com(Game)Limited("SohuGame"),Go2MapInc.
,Sohu.
com(Search)Limited,SogouInc.
,Sogou(BVI)Limited,SogouHongKongLimited,21EastEntertainmentLimited("21EastHK"),BeijingSohuNewEraInformationTechnologyCo.
,Ltd.
("SohuEra"),BeijingSohuInteractiveSoftwareCo.
,Ltd.
("SohuSoftware"),Go2MapSoftware(Beijing)Co.
,Ltd.
("Go2MapSoftware"),BeijingSogouTechnologyDevelopmentCo.
,Ltd.
("SogouTechnology"),BeijingSohuNewMediaInformationTechnologyCo.
,Ltd.
("SohuMedia"),BeijingSohuSoftwareTechnologyCo.
,Ltd.
("NewSoftware"),BeijingFireFoxDigitalTechnologyCo.
,Ltd.
("BeijingFireFox",alsoknownasBeijingHuohuDigitalTechnologyCo.
,Ltd.
,or"Huohu"),BeijingCenturyHighTechInvestmentCo.
,Ltd.
("HighCentury"),BeijingSohuEntertainmentCultureMediaCo.
,Ltd.
("SohuEntertainment",formerlyknownasBeijingHengdaYitongInternetTechnologyDevelopmentCo.
,Ltd.
,or"Hengda"),BeijingSohuInternetInformationServiceCo.
,Ltd.
("SohuInternet"),BeijingGoodFeelInformationTechnologyCo.
,Ltd.
("GoodFeel"),BeijingTuXingTianXiaInformationConsultancyCo.
,Ltd.
("TuXingTianXia"),BeijingFengYangTianLangAdvertisingCo.
,Ltd.
("FengYangTianLang"),BeijingSogouInformationServiceCo.
,Ltd.
("SogouInformation"),Beijing21EastCultureDevelopmentCo.
,Ltd.
("21EastBeijing"),New21EastArtDevelopment(Beijing)Co.
,Ltd.
("New21East"),andourindependently-listedmajority-ownedsubsidiaryChangyou.
comLimited("Changyou",formerlyknownasTLAgeLimited)aswellasfollowingmajority-ownedsubsidiariesandtheVIEofSohuthataredirectlyandindirectlyheldbyChangyou:Changyou.
comHKLimited("ChangyouHK",formerlyknownasTLAgeHongKongLimited),Changyou.
com(US)Inc.
(formerlyknownasAmazGameEntertainment(US)Inc.
),Changyou.
com(UK)CompanyLimited("ChangyouUK"),ChangyouMySdn.
Bhd("ChangyouMalaysia"),BeijingAmazGameAgeInternetTechnologyCo.
,Ltd.
("AmazGame"),Changyou.
comKoreaLimited("ChangyouKorea"),andBeijingGameaseAgeDigitalTechnologyCo.
,Ltd.
("Gamease"),andthesereferencesshouldbeinterpretedaccordingly.
Unlessotherwisespecied,referencesto"China"or"PRC"refertothePeople'sRepublicofChinaanddonotincludetheHongKongSpecialAdministrativeRegion,theMacauSpecialAdministrativeRegionorTaiwan.
Thisreportcontainsforward-lookingstatementswithinthemeaningofSection27AoftheSecuritiesActof1933andSection21EoftheSecuritiesExchangeActof1934,including,withoutlimitation,statementsregardingourexpectations,beliefs,intentionsorfuturestrategiesthataresigniedbythewords"expect,""anticipate,""intend,""believe,"orsimilarlanguage.
Allforward-lookingstatementsincludedinthisdocumentarebasedoninformationavailabletousonthedatehereof,andweassumenoobligationtoupdateanysuchforward-lookingstatements.
Ourbusinessandnancialperformancearesubjecttosubstantialrisksanduncertainties.
Actualresultscoulddiffermateriallyfromthoseprojectedintheforward-lookingstatements.
Inevaluatingourbusiness,youshouldcarefullyconsidertheinformationsetforthbelowunderthecaption"RiskFactors.
"Readersarecautionednottoplaceunduerelianceontheseforward-lookingstatements.
ITEM1.
BUSINESSOVERVIEWOurCompanyOurcompany,Sohu,isaleadingInternetcompanyinChinaprovidinghundredsofmillionsofChineseInternetuserswithnews,information,videocontent,entertainmentandcommunication.
WeoperateoneofthemostcomprehensivematricesofChineselanguageWebpropertiesandoneofthemostpopularonlinegamesinChina.
Substantiallyallofouroperationsareconductedthroughourindirectwhollyandmajority-ownedChina-basedsubsidiariesandvariableinterestentities(collectivelythe"SohuGroup").
WewereincorporatedinDelawareinAugust1996asInternetTechnologiesChinaIncorporated,andlaunchedouroriginalWebsite,itc.
com.
cn,inJanuary1997.
InFebruary1998,were-launchedourWebsiteunderthedomainnameSohu.
comand,inSeptember1999,werenamedourcompanySohu.
comInc.
-3-OurBusinessOurbusinessesmainlyconsistofadvertising(composedofbrandadvertisingandsponsoredsearch),onlinegame(conductedviaChangyou.
comLimited,"Changyou"),andwireless,amongwhichbrandadvertisingandonlinegamearethetwocorebusinessesoftheSohuGroup.
AdvertisingBusinessOuradvertisingbusiness,includingbrandadvertisingservicesandsponsoredsearchservices,offersvariousproductsandservicestoourusers(suchasfree-of-chargepremiercontent,interactivecommunity,integrationsearchandothercompetitiveInternetservices),andprovidesadvertisingservicestoadvertisersonourmatricesofChineselanguageWebpropertiesconsistingof:sohu.
com,aleadingmassportalandonlinemediadestination;17173.
com,aleadingonlinegameinformationportal;focus.
cn,atoprealestateWebsite;chinaren.
com,aleadingonlinealumniclub;andsogou.
com,aninteractiveproprietarysearchengine.
BrandadvertisingservicesprovideadvertisementsonourportalWebsitestocompaniesseekingtoincreasetheirbrandawarenessonline.
FortheyearendedDecember31,2009,brandadvertisingservicesgenerated$177.
1millionor34%oftotalrevenuesof$515.
2million.
Sponsoredsearchservicesprovidepriorityplacementsinoursearchdirectoryandpay-for-clickservicestocustomers,especiallysmallandmedium-sizedenterprises.
OnlineGameBusinessOuronlinegamebusinessisconductedviaSohu'smajority-ownedsubsidiaryChangyou.
FortheyearendedDecember31,2009,ouronlinegamebusinessgenerated$267.
6millionor52%oftotalrevenuesof$515.
2million.
ChangyouisaleadingonlinegamedeveloperandoperatorinChinaasmeasuredbythepopularityofoneofourgames,TianLongBaBu("TLBB").
TLBB,whichwaslaunchedinMay2007,wasrankedbyInternationalDataCorporation("IDC"),for2008asthefourthmostpopularonlinegameoverallinChinaandthesecondmostpopularonlinegameinChinaamonglocally-developedonlinegames.
Changyouengagesinthedevelopment,operationandlicensingofourmassivelymulti-playeronlinerole-playinggames("MMORPGs"),whichareinteractiveonlinegamesthatmaybeplayedsimultaneouslybyhundredsofthousandsofgameplayers.
ChangyoucurrentlyoperatesthreeMMORPGs,TLBB,whichwedevelopedin-house,BladeOnline("BO"),whichwelicensedfromthirdparties,andBladeHero2("BH2",thesequeltoBO).
ForthethreemonthsendedDecember31,2009,thesegameshadapproximately80.
9millionaggregateregisteredaccounts,2.
4millionaggregateactivepayingaccounts,990,000aggregatepeakconcurrentusersandaveragerevenueperactivepayingaccountofRenminbi("RMB")196.
TLBBisamartialartsgamewith2.
5DgraphicsthatisadaptedfromthepopularChinesemartialartsnovel"TianLongBaBu,"whichmeans"NovelofEightDemigods,"writtenbythefamouswriterLouisCha.
Millionsofcopiesofhisnovelshavebeensoldinnumerouslanguages,andtheyhavebeenadaptedintovariousmoviesandtelevisionseries.
Sinceitslaunch,TLBBhaswonvariousawardsinChina,including2008"BestSelf-DevelopedOnlineGames(FirstPlace)"and2008and2009"MostLikedOnlineGamesby-4-GamePlayers(FirstPlace)"awardsattheChinaDigitalEntertainmentExpoandConference("ChinaJoy").
ToleveragethesuccessofTLBB,welicensedthegametothird-partyoperatorstooperatethegameinVietnam,Taiwan,HongKong,MalaysiaandSingapore.
WealsooperateamodiedversionofTLBBintheU.
S.
throughourU.
S.
subsidiary.
ChangyouhasveMMORPGsinthepipeline,withdifferentgraphicstyles,themesandfeaturestoappealtodifferentsegmentsoftheonlinegameplayercommunity.
GamesinourpipelineincludetheDukeofMountDeer("DMD"),ZhongHuaYingXiong("ZHYX"),DaHuaShuiHu("DHSH"),ImmortalFaith("IF"),andtheLegendofAncientWorld("LAW").
DMD,whichwearedevelopingin-house,isalsobasedonapopularmartialartsnovelwrittenbyLouisCha.
WehavelicensedZHYX,DHSH,IFandLAWfromthirdparties.
Changyouoperatesourcurrentgamesundertheitem-basedrevenuemodel,meaninggameplayerscanplayourgamesforfree,butmaychoosetopayforvirtualitems,whicharenon-physicalitemsthatgameplayerscanpurchaseandusewithinanMMORPG,suchasgems,pets,fashionitems,magicmedicine,ridinganimals,hierograms,skillbooksandreworks,toenhancethegame-playingexperience.
ChangyousellsprepaidgamecardstoarangeofregionaldistributorsthroughoutChina,whointurnsub-distributethemtonumerousretailoutlets,includingInternetcafesandvariousWebsites,newsstands,softwarestores,bookstoresandretailstores.
Changyoualsodirectlysellsgamepointstogameplayersthroughouronlinesalesplatform.
Changyoucontinuallycollectsfeedbackfromgameplayersthroughmultiplechannels.
Ourproductdevelopmentteamandgameoperationsteamworkcloselytogether,allowingustotranslategameplayerfeedbackintogameupdatesandexpansionpacksinatimelymanner.
Wetypicallyreleaseexpansionpacks,whicharesoftwarepackagesthatcontainsignicantupgradesandimprovementstoagamewithintheexistinggame'sframework,everyfewmonthsorasregularlyasnecessarybasedongameplayers'feedback,marketdemandandotherfactors.
Theseupgradesmayincludenewgamecontentsuchasstorylines,characters,tasks,mapsandvirtualitems.
Wealsoupdateourgamesonaweeklybasiswithinterimenhancements.
Webelievethatsuchexpansionpacksandregularupdatesimprovethegame-playingexperienceandhelptomaintaintheinterestlevelofourgameplayers,therebyhelpingustoextendthelifespanofourgames.
InitialPublicOfferingofChangyouOurMMORPGbusinessbeganoperationsin2003.
Inafewyears,ouronlinegamebusinesshasdevelopedfromnascencytobecomeoneofthetopMMORPGoperatorsinChina.
Itssuccesswasfurtherendorsedbythecarve-outandinitialpublicofferingofourMMORPGsubsidiaryChangyou(Nasdaq:CYOU)inApril2009.
ThesuccessfulinitialpublicofferinghasprovidedChangyouwiththeplatformandresourcestobecomealeadingcompanyintheMMORPGindustry,andhasenabledChangyoutocompeteheadtoheadwithrsttierplayers.
SubsequenttoChangyou'sinitialpublicoffering,asChangyou'scontrollingshareholder,SohucontinuestoconsolidateChangyoubutrecognizesnoncontrollinginterestsreectingthesharesheldbytheshareholdersotherthanSohu.
Duringthesecondquarterthroughfourthquarterof2009,treatingallexistingrestrictedsharesandrestrictedshareunitsasfullyvested,Sohuownedapproximately66%oftheeconomicinterestinChangyou,withtheremaining34%oftheeconomicinterestinChangyouownedbyChangyou'sshareholdersotherthanSohu.
WedonotexpectthepercentageofSohu'seconomicinterestinChangyoutouctuatesignicantly,giventhatSohudoesnothaveanyplantosellanyadditionalsharesinChangyouintheforeseeablefuture.
FordetailedinformationChangyou'sinitialpublicofferingandshareholdingstructure,pleaseseeNote2—ChangyouTransactionsofNotestoConsolidatedFinancialStatements.
WirelessandOthersBusinessesOurwirelessandothersbusinessesmainlyconsistofwirelessbusiness,whichoffersvalue-addedservicesformobilephoneuserssuchasnews,weatherforecasts,chatting,entertainmentinformationandmobilephoneringtoneandlogodownloads.
-5-PRODUCTSANDSERVICESAdvertisingBusinessWebPropertiesTheSohuGrouphasoneofthemostcomprehensivematricesofWebproperties.
AmongtheseWebproperties,Sohu.
comisattractingthehighestlevelofInternettrafcinChina.
OnallofourWebsites,weofferbasiccontenttoourusersonafreeofchargebasis.
SohupropertiesconsistofsophisticatedChineselanguageWebnavigationalcapabilities,approximately40maincontentchannels,Web-basedcommunicationandcommunityservices.
Eachofourinterest-specicmainchannelscontainsmulti-levelsub-channelsthatcoveracomprehensiverangeoftopicsincludingnews,entertainment,sports,businessandnance,informationtechnology,automobile,realestate,andwomen-focusedissues.
WealsoofferfreeWeb-basedcommunicationandcommunity,andotherInternetservicestoenhancetheusers'experience.
OurportalattractsconsumersandmerchantsalikebecauseitisdesignedtomeetthespecicneedsandinterestsofInternetusersinChina.
KeyfeaturesofourportalincludeproprietaryWebnavigationalcapabilitiesthatreectparticularculturalcharacteristicsandviewinghabitsofPRCInternetusers.
Wedeliverauthorizedhigh-denitionvideocontentandoriginalin-houseproducedvideocontentsurroundingnationwideeventsonchannelsgearedforspecictypesofcontent,includingv.
sohuforentertainment,s.
sohuforsportsandtv.
sohuforTVprograms,andattractedalargenumberofusers.
Thesechannelsprovideusersfreeaccesstoextensiveandvariedvideocontent,includingpopulardomesticandoverseasmoviesandTVdramas,in-houseproducedonlinetalkshows,exclusivecelebrityinterviews,liveWebcasts,on-demandsportsgames,anduser-generatedvideoclips.
Wecontinuetoupgradeourcommunicationandcommunityservicessoastoincreaseuserexperienceandstickinesstoourportalnetwork.
Communicationandcommunityserviceshelpuserstobuildcustomizedspaceandpersonalizedpagelayoutsandofferimprovedinformationsharingandreal-timecommunication,sothatusersareabletoexpandandmaintaintheirsocialnetworkwithSohu.
VerticalSites17173.
comOurgameportal17173.
comwaslaunchedin2000astherstonlinegameportalinChina.
17173.
comisaleadingonlinedestinationforgameplayersseekinginformationongamesandfeedbackfromotherplayersonthesite'smessageboards.
Withover500gamezonesandtensofmillionsofregistereduserssupportedbyallianceswithmanythousandsofInternetcafes,17173.
comisoneofthelargestonlinegameinformationandcommunityWebsitesinChina,andwidelyrecognizedasamarketleaderamonggameWebsitesinChina,withstrongexpertiseinrunningtheWebsite,buildingagamecommunityanddevelopingrelationshipswithadvertisersintheonlinegameindustry.
Asaresult,17173.
comisthemarketingplatformofchoiceformanyonlinegames,includingourown.
Inaddition,17173.
com'sexperiencedgameeditorsreviewandcritiqueChangyou'sgamespriortolaunch,therebyimprovingthegamequality.
Focus.
cnFocus.
cnisoneoftheleadingrealestateWebsitesinChina,providingcomprehensivesolutionsforhouseseekers,homeowners,potentialpropertyorhouseholdappliancebuyerswithhighincomes,andrealestateprofessionals.
Launchedin1999,Focus.
cnhasdevelopedintowhatwebelieveisoneofthemostinuentialWebsitesservingtheBeijingmarket.
TheFocus.
cnplatformservesasabasisforregionalexpansioninotherkeyurbanareaswhereInternetpenetrationisamongthehighestinChina.
AsofDecember31,2009,the-6-Websitehadbeensuccessfullyrolledoutinto33cities.
Focushasalsobeenenrichingitscontentandhasdiversiedfromresidentialpropertiestocommercialproperties,aswellasotherauxiliaryindustries,suchashomedecoration,furnitureandxtures.
Chinaren.
comChinaRenisthelargestonlineyouthcommunityinChina,withoverninetymillionregisteredusersasofDecember31,2009.
SchoolsanduniversitiesinChinagenerallydonothavealumniofcestocatertotheneedsofformerstudentstoorganizetheirclassesintolong-termcommunities.
AsinotherAsiansocieties,Chinesepeopleholdstrongtiesoffriendshipandloyaltywiththeirfellowalumni,whichformthebasisoftheirpersonalandprofessionalrelationshipnetworks.
ChinaRenhasleveragedacriticalmassofloyaluserstocreateoneoftheleadingonlinealumninetworksinChina.
Sogou.
comSogou,whichmeans"SearchDog",isSohu'sproprietarysearchenginelaunchedinAugust2004.
SogouperformsinteractivesearchesofbillionsofWebpagesusingadvancedalgorithms.
TheuseristakenthroughafastandconvenientinteractiveprocesstoreachthemostrelevantselectionoftheintegratedWebsiteandpagesearchresultsuponsearchquery.
Sogouprovidesouruserswithhighupdatingspeeds,shortresponsetimesandaccuratesearchresults,basedonalargedatabasecapacityofmorethantwentybillionretrievedpages.
WewillcontinuetoupdateSogousearchenginewithadvancedtechniquestoenhanceuserexperienceandgrowsearchtrafc.
ServiceOfferingstoUsersAggregatedContentAsaleadingcontentaggregator,weorganizeourcontentaround40mainchannelsontheSohuportal.
Eachmainchannelcontainsnumeroussub-channelsandfeaturesnews,commentariesandvariousutilitiesandsolutionsrelatingtoaspecictopic.
OurregionalWebsiteshaveextensivereachacrossChina.
Forexample,Focus.
cnhaspenetrated33rstandsecondtiercitiesinChina.
AsofDecember31,2009,wehadover1,500contentpartners,whichenableustoprovideawiderangeofcontentofferings.
OurcontentpartnersincludeleadingChineselanguagemediaandinformationprovidersinavarietyofeldsacrossChina,suchasXinhuaNewsAgency,People'sDailyOnline,21CenturyBusinessHerald,andChinaCentralTelevision("CCTV"),aswellasprestigiousinternationalcontentproviderssuchastheNBAandReuters.
Ourarrangementswithcontentpartnersarenormallyshort-termandnon-exclusive.
OurmainchannelsincludeNews,Entertainment,Sports,BusinessandFinance,InformationTechnology,Automobile,andWomen:Newschanneldeliversacomprehensiveselectionoflocal,nationalandinternationalnewsfromnewspapers,magazinesandotherinformationprovidersthroughoutChina.
Fulltextsearchisalsoavailableoneachpage.
EntertainmentchannelcontainsextensivecoverageofentertainmentareasthatareofinteresttoChineseusers,includingmovies,televisionprograms,plays,operasandpopularandclassicalmusic.
Sportschannelprovidesthelatestinnationalandinternationalsportsheadlines,results,commentariesandanalyses.
BusinessandFinancechannelfeaturesbusinessandnancialnewsprovidedbyleadingnancialinformationservicesinChinacoveringbothdomesticandinternational-7-markets.
Userscanretrievereal-timestockquotes,fundprices,exchangerates,annualreports,researchreportsandotherinformationonselectedlistedcompaniesinChina.
InformationTechnologychannelofferseasyaccesstoindustrypoliciesandstories,industryforums,andonlinecommunicationswiththemanagementoftopChineseITcompanies.
Itfeaturesinformationtechnologynews,productreviewsandsoftwaredownloads.
Automobilechannelprovidesamassivedatabaseofcarmodelsthatcanbesortedorrankedbasedonkeyparameters,industrypoliciesandtrends,andonlinecommunicationswiththeCEOsofthetopChineseautomakers.
Italsoprovidesautomobilefeatures,news,andproductpreviews.
Womenchannelcoversabroadrangeoflifestyle-relatedtopicsthatareofparticularinteresttoChinesewomen,includingfashionandtrends,beauty,society,relationshipsandotherareas.
Inadditiontoprovidingtraditionaltextandpicture-basedcontent,wehavefocusedondevelopingnewmediatechnologies.
OuronlineTV-likechannels,suchasv.
sohuforentertainment,s.
sohuforsportsandtv.
sohuforTVprograms,arespecicallygearedforStreamingOnlineVideocontent.
Inadditiontowatchingpre-setprogramswithbroadcastingschedules,userscanalsoenjoycertainprogramsonanon-demandbasis.
CommunicationandCommunityToolsWeofferavarietyofcommunicationandcommunitytoolsforourChineseonlineusersthatareimportantinpromotinguserafnitytoourportalnetwork:AlumniClub,offeredthroughChinaren.
com,isadatabaseservicecontaininginformationonschools,classesandclassmatesthatallowsclassmatestocommunicateandndeachother.
AsofDecember31,2009,Chinaren.
comhadoverninetymillionregisteredusers.
Blogisaninteractiveplatformforuserstobuildtheirpersonalizedspacebypostingtheirarticlesandpictures,uploadingvideos,andsharinginformationamongstusers.
Further,Sohublogsprovidemultipleapplicationsforuser-customizedfrontpagelayouts,interactivecommunicationfacilitiesandservicesintegratedwithaselectionofSohuproducts.
E-Mailoffersfreee-mailserviceswithuptotwogigabytesofmemoryandpremiummailservicewithmorefeatures.
MessageBoardsallowsuserstopostandexchangeinformationonmessageboardscovering20maintopics,rangingfromeducationandtraveltofashion,sportsandallnewsWebpages.
WebMessengerenablesSohuregistereduserstosendinstantmessagestootherSohuuserssimplybyoneclick.
SocialNetworkingServices("SNS")isanetworkingWebsitethatallowsuserstoshareideas,musicandphotosandplaygameswithinindividual-centeredonlinecommunities.
AfterournewSNSWebsite,namely,BaiSociety,waslaunchedinJuly2009,wekeptaddingnew-8-interactiveWebgamesandfeaturestoattractusersandincreasethecommunity'sstickinesstoenlargeouruserbase.
SogouPinyinSogouPinyinisourself-developedChineseCharacterInputMethodsoftware,whosevocabularydatabaseistiedtothesearchqueriesdatabaseofSogousearchengineandthuscancapturethelatesttrendofwordsusedbyInternetusers.
Sinceitslaunchin2006,SogouPinyinhasbeenwellreceivedbyusers.
Itcontinuestogainpopularityandexpandmarketsharethroughsuperiorproductqualityandeffectivemarketingcampaigns.
AsofDecember31,2009,SogouPinyinhadbeeninstalledinover100millionpersonalcomputers("PCs")inChina,orover70%ofthePCsinChina.
During2009wealsolaunchedthemobileversionofSogouPinyin,andcontinuedtoregularlyupdateourexistingproductstooptimizeperformance.
ServiceOfferingstoAdvertisersInbrandadvertising,weenjoyastrongcompetitivepositionasoneoftheleadingInternetcompaniesinChina.
WeprovidebrandadvertisingservicesacrossourmatricesofWebproperties.
Ourofferingsenableadvertiserstoposttheiradvertisementsindifferentforms,includingtextual,richmediaandvideoadvertisements,andindifferentlocationsacrosstheSohumatrixofWebproperties.
Ourbrandadvertisingproductsincludebutarenotlimitedtobanners,links,logos,buttonsandstreamadvertisementsplacedonourWebsitesandsponsorshipsthattypicallyfocusonaparticulareventoraparticularWebsitearea.
Wechargeadvertisersmainlyonatimebasis.
SponsorshipcontractsforaparticularareaofaWebsiteorforaparticulareventmayrequirexedpaymentsoverthecontractperiod.
Ourstandardadvertisingchargesvarydependingonthetermsofthecontractandtheadvertisement'slocationwithinourWebsite.
Discountsfromstandardratesaretypicallyprovidedforhigher-volume,longer-termadvertisingcontracts,andmaybeprovidedforpromotionalpurposes.
WerelyonbothdirectsalesbyourinternalsalesforceandsalesbyadvertisingagentsforadvertisingonourWebsites.
DuringtheyearendedDecember31,2009,approximately1,900companiesadvertisedonourWebsites.
OurcustomersincludemultinationalcompaniesthathavesignicantoperationsinChinesemarkets,manyofwhichareFortune500companies,aswellasnumerousChinesedomesticcompanies.
WecontinuefocusingonmultinationalandChinesedomesticcompaniesasourkeyadvertisers.
In2009,salestoourvelargestadvertisersaccountedforapproximately15%oftotalbrandadvertisingrevenues.
Wehaveenteredintoagreementswitheachoftheseadvertisers.
Mostoftheseagreementshavetermsoflessthan12months.
AsofDecember31,2009,wehadobligationstoprovide,andadvertisershadobligationstopurchase,advertisingservicesunderexistingcontractsintheamountof$0.
8million,whicharerequiredtobeprovidedduringtheyearendingDecember31,2010.
OnlineGameBusinessOnlineGamesWecurrentlyoperatethreeMMORPGs,beingTLBB,BOandBH2,allofwhichareoperatedundertheitem-basedrevenuemodel,wheregameplayersplayourgameforfreebutcanpurchasevirtualitemstoenhancethegame-playingexperience.
Wegeneraterevenuethroughthesaleandconsumptionofsuchvirtualitems.
WealsohaveveMMORPGsinthepipeline,includingDMD,whichwearedevelopingin-house,andZHYX,DHSH,IFandLAW,allofwhichwelicensedfromthirdparties.
WeplantooperatethesenewMMORPGsbasedontheitem-basedrevenuemodel.
-9-Thefollowingtablesummarizesthetype,theme,andstatusofthegameswearecurrentlyoperatingandplantooperate:GamesGameTypeThemeIn-houseDevelopedorLicensedStatusOurexistinggames:–TLBB2.
5DMMORPGMartialartsandcommunitybuildingIn-houseOpenbetatestinginMay2007–BO2.
5DMMORPGMartialartsandghtingLicensedOpenbetatestinginJuly2004–BH22.
5DMMORPGMartialartsandghtingLicensedOpenbetatestinginSeptember2009Ourpipeline:–DMDMMORPGsupporting2D,2.
5Dand3DgraphicmodesCartoonstylemartialartsandcommunitybuildingIn-houseClosedbetatesting–ZHYX3DMMORPGMartialartsandghtingLicensedTechnicalclosedbetatesting–DHSH2DMMORPGCartoonstyleandcommunitybuildingLicensedClosedbetatesting–IF2DMMORPGChinesemythLicensedClosedbetatesting–LAW2.
5DMMORPGMartialartsandfantasyLicensedTechnicalclosedbetatestingOnlineGamesinOperationTLBBTLBBisourrstin-housedevelopedMMORPG,forwhichwecommenceddevelopmentinlate2004.
Itisa2.
5Dmartialartsandcommunitybuildinggame,adaptedfromtheverypopularChinesenovel,"TianLongBaBu,"whichmeans"NovelofEightDemigods.
"Themissionsandactivitiesofthegamegenerallyfollowthestorylineofthenovel,whichwehaveadaptedtoaddnewfeaturesandcharacters.
TLBBfeaturesacombinationofmartialarts-style-ghtingandcommunity-buildingamongitsgameplayers,whichwebelieveholdsstrongappealforgameplayers.
Fighting-basedgamestendtohavehighgameplayerparticipationwhentheyarelaunchedduetotheexcitementlevelofthecontent,butthelifespanofsuchgamestendstobeshorterthangamesthatarecommunity-based,andparticipationtendstodropastheinitialexcitementfades.
Conversely,community-basedgamestendtotakelongertobuildparticipationinthebeginningoftheirlifespansbecauseittakestimefornewgameplayerstobuildrelationshipswitheachotherinthevirtualworld,buttheyalsotendtohavelongerlifespansastherelationshipsamonggameplayersstrengthenovertime.
InTLBB,gameplayerschoosefromninecategoriesofteam-basedidentitieswithdistinctskillsetsandmissions,andgameplayerscanengageinnumerousvirtualactivities,suchasmakingfriends,nurturingpets,learningskillsorcompletingothertasks.
Gameplayerscancommunicatewitheachotherinrealtimethroughanin-gameinstantmessagingsystem.
Thesecommunity-basedfeaturesfostergroupinteractionandrelationship-buildingamonggameplayers,whichwebelievealsohelpstomaintainourgameplayers'interestovertime.
Themajorcategoriesofvirtualitemsweselltogeneraterevenuesaregems,pets,fashionitems,magicmedicine,ridinganimals,hierograms,materials,skillbooksandreworks.
Thesevirtualitemshelpgameplayerstoadvancetothenextlevelandenhancethegame-playingexperience.
Virtualitemscanbe"purchased"atvirtualstoreswithinthegameusingoneoftwokindsofcurrencies:eitherwithanin-gamevirtualcurrencyknownas"yuanbao,"whichgameplayersobtainbypurchasingprepaid-10-gamecardsorgamepointswithrealmoney,orwithanotherin-gamevirtualcurrencyknownas"goldcoins,"whichgameplayerscanobtainforfreebycompletingcertainmissionsandactivitieswithinthegame.
Eachvirtualitemcanbepurchasedwithonlyoneofthesetwotypesofvirtualcurrencies.
Wehavefoundthatthemutualexclusivityofthevirtualitemsavailableforpurchaseundereachofthesetwovirtualcurrenciescreatesademandforgameplayerstoexchangethecurrencytheyholdfortheothercurrencytyperequiredtopurchaseaparticularvirtualitem.
WetypicallyreleaseupdatesforTLBBonceortwiceaweekandmoresignicantenhancementsintheformofexpansionpackseveryfewmonths.
Wehavedeveloped11expansionpackssincethegamebeganopenbetatestinginMay2007.
Ourexpansionpackstypicallyincludefeaturessuchasnewterritories,themes,tasks,characters,virtualitemsandotherenhancedfeatures.
Wehavefoundthatexpansionpackseffectivelyincreasegameplayers'interestinthegameandenhancethegame-playingexperiencebykeepingthegame-playingexperiencefreshevenforlong-timegameplayers.
Webelievethattheexpansionpackshelpustomaintaingameplayerloyalty,andinturnextendthelifespansofourgames.
BladeOnlineseriesTheBladeOnlineseriesconsistoftwo2.
5DMMORPGs,BO,whichwelicensedfromathirdparty,andBH2,whichisasequelofBladeOnline.
Bothgamesaremartialarts-styleghtinggamessettothebackdropofaChinesemyth.
InBO,gameplayerscansettheirownrulesforin-gameghtingandtakeonvariousroles,includingahuman,anevilspiritoranimmortalinthegame.
Eachrolehasdifferentskillsetsthatcanbelearnedandimprovedbycompletingdifferenttasks.
BH2incorporatespopularfeaturesofBOaswellasnewfeaturessuchasnewmaps,newcharacters,newghtingtechniquesandadditionalteam-combatfunctionstogiveplayersamoreintenseandrealisticghtingexperience.
ThegamealsoincludesupgradestosomeofthecommunityfeaturesfoundinBO,suchasanauto-navigationsystemandanimprovedmissiontrackingsystem.
LikeTLBB,bothBOandBH2providearangeofvirtualitemsforgameplayerstopurchasetoenhancethegame-playingexperience.
WebeganoperatingBOinOctober2004underthetime-basedrevenuemodel.
OnDecember27,2006,welaunchedanupgradedversionofthegameandchangeditsrevenuemodelfromtime-basedtoitem-based.
InDecember2006,priortothelaunchoftheupgradedgameoperatedundertheitem-basedrevenuemodel,thenumberofpeakconcurrentusersofBOwasapproximately26,000,whichincreasedtoapproximately57,000inJanuary2007.
Webelievethisincreaseresultedfromourupgradingofthegameanditschangedrevenuemodel.
InAugust2007,wepurchasedBO'ssourcecodes,enablingustohavecompletecontroloverthefutureenhancementofBO.
WehavedevelopedfourexpansionpacksforBOsincewebeganoperationsofit.
InSeptember2009,webeganoperatingitssequel,BH2,undertheitem-basedrevenuemodel.
OnlineGamesinPipelineWehaveveMMORPGsinthepipeline,withdifferentgraphicstyles,themesandfeatures.
GamesinourpipelineincludeDMD,whichwearedevelopingin-house,andZHYX,DHSH,IFandLAW,allofwhichwelicensedfromthirdparties.
Weintendtooperateeachofthesegamesusingtheitem-basedrevenuemodelandexpecttobeginopenbetatestingofthesegamesin2010.
DMDisadaptedfromthepopularnovel"DukeofMountDeer"writtenbyLouisCha,thesameauthorfromwhosenovelwedevelopedTLBB.
DMDwillbeanMMORPGtargetingabroaderaudiencethanTLBBbyusingcartoon-stylegraphicsandotherfeatures,includingfashionableouttsandvariationstogameplayerappearancesthatmayappealtomorefemalegameplayers.
Gameplayerswillbeabletochoosewhethertheywanttoplaythegamein2D,2.
5Dor3Dgraphicsmode.
Gameplayerscanengageinadventuresandformpartnershipswithothergameplayersandcompetebasedonmartialartsskills.
Thegameiscurrentlyinclosedbetatesting.
-11-ZHYXisa3Dmartial-artMMORPG.
ThegameisbasedonapopularstoryfromawidelyreadHongKongcomicbookaboutthechallengeoflifeforaChineseexpatriateoutsidehishomeland.
Thisgametargetsgameplayerswhoprefer3Dgamesandenjoyreadingcomicbooks.
Thegameiscurrentlyintechnicalclosedbetatesting.
DHSHisa2Dcartoon-style,turn-basedMMORPG.
ThegameisbasedonastoryfromoneofthefourgreatclassicalnovelsofChineseliterature"OutlawsoftheMarsh,"abouttheadventuresof108heroesinNorthernSongdynasty.
Thegameiscurrentlyinclosedbetatesting.
IFisa2DMMORPGsetagainstabackdropofanumberofancientChinesemythsandfolklore,whichareusedtocreatevariousmissionsinthegametoattractgameplayers.
Gameplayersplaycharactersthatcantravelbetweenheavenandearth,whileencounteringlegendaryguresinmythicalsettings.
Thegameiscurrentlyinclosedbetatesting.
LAWisa2.
5DMMORPGsetinancientChinaatthebeginningofChinesecivilization,approximately5,000yearsago.
Gameplayerscantravelfromthemodernworldtotheancientworldinthegame,andchangetheworldwithmagic,martialarts,machinery,andtechnology.
Thisgametargetsgameplayersintheirlateteenstolate20swhoenjoyreadingfantasyliterature.
Thegameiscurrentlyintechnicalclosedbetatesting.
GameDevelopmentandEnhancementAsofDecember31,2009,wehad528productdevelopmentpersonnel,whichincludesacoreproductdevelopmentteamthatisresponsiblefordevelopingnewMMORPGs,andadedicatedproductdevelopmentteamthatisresponsiblefordevelopinggameenhancementsandexpansionpacksforeachofourgamesinoperation.
Webelievethatsuchenhancementsimproveourgames'appealandextendourgames'lifespan.
WeintendtoexpandourproductofferingsbycontinuingtodevelopadditionalMMORPGsin-houseandcontinuingtolicenseMMORPGsfromthirdparties.
NewGameDevelopmentWehavein-housecapabilitiesthatallowustodevelopqualityMMORPGsefcientlyandinresponsetoconstantlychangingmarketdemandsandtrends.
Ourgamedevelopmentprocessgenerallyincludesthefollowingkeysteps:–ConceptgenerationOurdesigndepartmenttakestheleadingeneratinggamedevelopmentideasbasedonthelatesttrendsingameplayerpreferences.
WerecruitgameplayersintoourdesignteamtoascertainpopulartrendsamongourgameplayersandontheInternet.
Wealsoencourageallofouremployeestosuggestcreativeideasandconceptsforgamedevelopment.
–DetailedproposalUponmanagement'sapprovalofthenewgameconcept,thedesigndepartmentpreparesadetailedproposalthatsetspreliminarystorylines,gamecharacters,estimatesofcostsandtargetmarkets.
–DevelopmentplanAfterthecompletionoftechnicalreviewoftheproposal,aprojectteamconsistingofoursoftwareprogrammers,platformtechnicians,mediaspecialists,designstaffandgraphicsartistsworktogethertosetthetechnicalcriteriafordevelopmentofthegame,andthenformulateagamedevelopmentplanwithdevelopmentmilestones.
Thedevelopmentplanistypicallycompletedwithintwotothreemonthsofconceptgeneration.
-12-–Design,styleandstoryconceptsBasedonthegamedevelopmentplan,ourgraphicsartistsdeterminethestyleofthenewgameanddesigngamecharacters;ourgamedesignersdevelopthegamestoryanddenegameenvironments;andourprogramdevelopersdevelopboththeserver-endsoftwareandtheuser-endsoftwaremodules.
–InternalreviewsMid-termmanagementreviewstakeplaceuponthecompletionofeachmilestoneofthedevelopmentplan.
Concurrently,ourtestingdepartmentteststheaccuracyandcompletenessofthedevelopment,andourmarketingdepartmentinitiatesmarketingcampaignsaccordingtothedevelopmentmilestones.
–Technicalclosedbetatesting,closedbetatestingandopenbetatestingWeconducttechnicalclosedbetatestingtoworkouttechnicalissuesandeliminatetechnicalproblemsinthegameengineandsystem.
Thereafter,weconductclosebetatestingtotestandworkouttechnicalissuesingamefeaturesandmakeadjustmentstothein-gameeconomicsystem.
Lastly,weconductopenbetatestingtotesttheoperationofnewgamesunderopenmarketconditionsandintroducenewgamestoplayers.
Webegintogeneraterevenueforouritem-basedgamesduringopenbetatesting.
Ourgamesaredevelopedthroughcoordinationamongteamsofprogramdevelopers,gamedesignersandgraphicartists.
Wetrytodesigneachofourgamestocatertodifferentaudiencestogrowouroverallplayerbaseratherthanmerelyshiftingplayersfromonegametoanother.
Ateachstageofanewgame'sdevelopment,werelyonourqualitycontroldepartmenttoensurethegame'squalityandplayability.
ExistingGameEnhancementWederivemanyofourgamedevelopmentandenhancementideasfromourgameplayersbymaintainingmultiplechannelswherebyweobtainourgameplayers'ideasandfeedback.
Theseincludeonlinesurveys,onlinediscussionforums,in-gameinstantmessaging,our24-hourtelephonehotline,andalinktoaformforfeedbackwithinourgames.
Weusethisinformationnotonlytocreatenewgameswiththesamequalityofdesign,contentandprogramming,butalsotoenhanceexistinggamesthatwehaveeitherdevelopedin-houseorlicensedfromthirdparties.
Wetypicallyreleasegameupdatesforourgamesonceortwiceaweekandmoresignicantenhancementsintheformofexpansionpackseveryfewmonthsorasregularlyasnecessarybasedongameplayers'feedback,marketdemandandotherfactors.
Ourexpansionpackstypicallyincludefeaturessuchasnewterritories,themes,tasks,characters,virtualitemsandotherenhancedfeatures.
Aftertesting,thegameupdatesandexpansionpacksaretypicallydistributedelectronicallythroughourofcialgameWebsite.
Webelievethatthesegameupdatesandexpansionpackshelpextendthelifespanofourgames.
AccesstoourGamesOurgameplayerstypicallyaccessourgamesatInternetcafesoronpersonalcomputersconnectedtotheInternet.
Inordertoaccessourgames,ourgameaccesssoftwaremustbeinstalledinthecomputerbeingused.
GameplayersusingpersonalcomputersandInternetcafeoperatorscantypicallydownloadourgameaccesssoftware,interimupdatesandexpansionpacksdirectlyfromourofcialgameWebsite.
WealsodistributeourgameaccesssoftwareinCDformthroughourdistributionnetwork.
SalesandDistributionWehavedevelopedamulti-channel,nationwidesalesanddistributionsystemtosellanddistributeourprepaidgamecards.
Wealsodirectlysellgamepointstoourgameplayersthroughouronlinesalesplatform.
-13-Third-PartyDistributorsWesellprepaidgamecardsinvirtualandphysicalformtoarangeofregionalthird-partydistributors,whointurnsub-distributethemtonumerousretailoutletsacrossChina.
PhysicalcardsareavailableinInternetcafes,newsstands,softwarestores,bookstoresandretailstores.
Virtualcardsareavailablethroughvariousonlinechannels,telecommunicationsserviceprovidersandatInternetcafes.
Wetypicallycollectpaymentfromourdistributorsupondeliveryofourprepaidgamecards.
Wecurrentlyoffersalesdiscountsandrebatestoourdistributors.
Wegenerallyenterintodistributionagreementswithourdistributorsofprepaidgamecardsforone-yearterms.
Ourdistributionagreementscontainbothpre-setsalestargetsandpre-setpenetrationtargets,wherebyeachofourdistributorsisrequiredtosellourprepaidgamecardsinaminimumnumberofInternetcafesinitsdesignatedsalesterritory.
Wealsorequirethateachdistributorworkcloselywithourmarketingteamandsupportitsactivities.
Ourdistributionagreementsarenotexclusive,anddonotprohibitourdistributorsfromworkingwithourcompetitors.
DirectSalesGameplayerscanpurchasegamepointsandchargethemtotheiraccountsdirectly.
Todothis,theylogintotheiraccountsfromthegame.
Fromtheaccountlink,gameplayerscanchoosetoeitherpayfromtheirbankaccountsorthroughotherpaymentmethods,includingthird-partyonlinepaymentplatforms.
Weprovidediscountstogameplayerswhochargetheiraccountsdirectly.
Transactioncostsalsoapplytotheuseofthird-partyonlinepaymentplatforms.
MarketingChangyouhasathree-prongedmarketingandpromotionstrategy,whichincludesonlineadvertising,off-linepromotionsandtraditionalmedia.
Changyouusesdifferentmethodstotargetdifferentdemographicgroupsofgameplayers.
Withrespecttoonlineadvertising,ChangyouisabletoleverageitsafliationwithSohu,andaggregateSohu'slargeuserbasetoChangyou'sgamesbyadvertisingonSohu'svariousWebsites,whichtypicallyprovideadirectlinktoChangyou'sgames.
Inaddition,Changyou'stechnologyallowsittodistinguishwhichSohuusersarenotcurrentlyChangyou'sgameplayers,sothatChangyoucanspecicallytargetitsadvertisementstowardthem.
ChangyoualsoadvertisesonavarietyofWebsites,includingonInternetcafehomepages.
Inaddition,Changyouusesin-gamepromotionalevents24hoursaday,sevendaysaweek.
Changyoualsocreateseventstorallycurrentandnewgameplayersthroughevent-relatedfeatures,suchasofferingspecialholidayeditionvirtualitemstoenhancegameplayerparticipationatholidaytimewhenparticipationmaybelowerthanusual.
Wealsouseavarietyofphysical,ofinepromotionalevents,includingInternetcafeevents,freetrialplays,posters,gameplayers'gatherings,"freshmen"(ornewgameplayer)incentivesandthegivingawayofpromotionalsouvenirs.
Wehavefoundthatthesepromotionaleventsoffergoodexposuretotargetedcustomersatalowercost.
Withrespecttotraditionalmedia,wefocusourmarketingeffortsonprintadvertisementsinmagazinesthattargetourgameplayerbaseandoutdoormultimedia,includingclosedcircuittelevisionadvertisementsonbuildingsandinelevators.
Thesemediatargetsgameplayerswhoarelesslikelytohavefreely-availableaccesstoacomputer.
-14-PricingWeusetheitem-basedrevenuemodelforthegamesthatwecurrentlyoperateandplantouseitforourgamescurrentlyindevelopment.
Undertheitem-basedrevenuemodel,gameplayerscanplaythebasicfunctionsofthegamefreeofchargeforaslongastheywant.
Wegeneraterevenuesthroughthesaleofvirtualitemssuchasperformance-enhancingitems,clothing,accessoriesandpetsthatenhancethegame-playingexperience.
Wedeterminethepriceofvirtualitemsbasedonthedemandorexpecteddemandforsuchvirtualitems.
Wemaychangethepricingofcertainvirtualitemsbasedontheirconsumptionpatterns.
CustomerServiceWeprovidehigh-qualitycustomerserviceandareresponsivetoourgameplayers'needs.
Ourgameplayerscanaccessourcustomerservicecenterviain-gamechats,phoneore-mail24hoursaday,sevendaysaweek.
Inaddition,wehaveaWebsiteforgameplayerstosubmitfeedbackandaphysicalservicecenterinBeijing,whichisopentowalk-ingameplayersduringnormalbusinesshours.
Wecurrentlyhaveover150dedicatedcustomerservicerepresentatives,manyofwhomareMMORPGenthusiastswithadeepunderstandingofgameplayers.
Wehavededicatedsupervisorstomonitorourcallstoensurequalityservice.
Feedbackcollectedbyourcustomerserviceteamisimportanttotheintegrationofourproductdevelopmentandgameoperationsteams.
Theinformationcollectedbyourcustomerserviceteamformsthebasisofourfeedbackdatabase,whichhelpsusdesignchanges,upgradesandexpansionpacksforourgames.
LicensingGamesLicensedfromThirdPartiesWelicensedrightstooperateandfurtherdevelopeachofBO,ZHYX,DHSH,IFandLAWfromtheirrespectivedevelopers,withexclusiverightstooperatesuchgamesinChina.
WelicensedBOfromaBeijing-basedgamestudioin2003.
Underourexistinglicensingarrangement,wehavetheexclusiverighttooperateandfurtherdevelopBOinChina.
Wepaidaone-timelicensefeein2004andwepaidroyaltiesuntilJune30,2008basedontherevenuesfromthegame.
WearenotrequiredtopayanyroyaltiesstartingfromJuly1,2008.
In2007,weobtainedtherightstothesourcecodesofBO,andweownallenhancementsanddevelopmentswemaketoBO.
BH2wasdevelopedbasedonBO.
WelicensedZHYXfromChineseGamerInternationalCorporation,aleadinggamedeveloperinTaiwan,inSeptember2009.
Pursuanttothelicensingarrangement,wehaveanexclusiverighttooperateZHYXinChina.
Wepaidaone-timelicensingfeeandwewillpayroyaltiesbasedontherevenuesfromthegame.
WelicensedDHSHfromalocalindependentstudioinSeptember2009.
Underthelicensingarrangement,wehaveanexclusiverighttooperateDHSHinChina.
Wepaidaone-timelicensingfeeandwewillpayroyaltiesbasedontherevenuesfromthegame.
WelicensedIFfromanindependentstudioinJuly2008.
Underthelicensingarrangement,wehaveanexclusiveandperpetualrighttooperateIFinChina,anexclusiverighttolicensethegameoverseasandarightofrstrefusalfornewgamesdevelopedbythesamedeveloperforthetermofthelicense.
Inaddition,wehaverightstosellancillaryproductsofthegame.
Thelicensorhasagreedtotransferthesourcecodesofthegametousbytheendofopenbetatesting,whichwillallowustodevelopenhancementsin-house.
Wepaidaone-timelicensingfeeandwewillpayroyaltiesbasedontherevenuesfromthegame.
WelicensedLAWfromalocalindependentstudioinDecember2007.
Underthelicensingarrangement,wehaveanexclusiveandperpetualrighttooperateLAWinChina.
Wealsohavearightofrstrefusalfornewgamesdevelopedbythesamedeveloperforthetermofthelicense.
Twoyearsafterwelaunchthegame,thelicensorwilltransfertousthesourcecodesofthegame,whichwillenableustodevelopenhancements-15-toLAWin-house.
Wepaidaone-timelicensingfeeandwewillpayroyaltiesbasedontherevenuesfromthegame.
RightsfromThirdPartyBookAuthorUndertheexistinglicenseagreementswithLouisCha,theauthorofthenovels"TianLongBaBu"and"DukeofMountDeer,"wehavetheexclusiverightinChinatoadaptthesetwonovelsintoonlinegamesandtooperatesuchgames,includingtherighttousethetitleofthenovelsandthenameofthecharacters.
Wealsohavethenon-exclusivelicensetooperate,andthenon-exclusiverighttolicensetherighttooperate,thegamesadaptedfromthesenovelsoutsideofChina.
Ifwewishtocontinuetooperateandlicensethesegamesaftertheexpirationofthetermsoftheselicenseagreements,wewillneedtorenewtheselicenseagreements.
OverseasLicensingofOurGamesWelicensedtherightstooperateTLBBinoverseasmarkets,includingTaiwan,HongKong,Vietnam,MalaysiaandSingapore.
Underourlicensingarrangementswiththeoverseasoperators,thelicenseeoperatorspayusanupfrontlicensefeeandwehaverevenuesharingrightsoverthedurationofthelicense.
Thelicensesaretypicallyforatermoftwotothreeyears.
Weprovideupdatesandexpansionpackstothelicensedgames,typicallyafterwelaunchsuchupdatesandexpansionpacksinChina.
Thelicenseesareresponsibleforallotheroperatingservicesandcosts,includingcostsrelatedtocustomerserviceandleasingandmaintenanceofservers.
WelicensedTLBBtoanoperatorinVietnam,andlaunchedthegamethereinAugust2007,andwelicensedTLBBtoanoperatorineachofTaiwanandHongKong,andlaunchedthegamethereinApril2008.
WealsolicensedTLBBtoanoperatorinMalaysiaandSingapore,andlaunchedthegamethereinApril2009.
WirelessandOthersBusinessesWirelessandotherbusinessesmainlyconsistofwirelessvaluedaddedservices.
Fortheseservices,weoperateasaserviceprovidertoChina'sleadingmobilenetworkoperators,offeringawiderangeofwirelessproductsfocusedonentertainment,informationandcommunications.
Theseproductsareavailabletoendusersviaabroadchoiceoftechnologies,suchasshortmessagingservices("SMS"),RingBackTone("RBT"),WirelessApplicationProtocol("WAP"),multi-mediamessagingservices("MMS")andinteractivevoiceresponse("IVR").
WeprovidewirelessservicesmainlypursuanttoourcooperationarrangementswithallofthethreeChinesemobilenetworkoperatorsandtheirprovincialsubsidiaries.
Wewillcontinuetobuildoutourwirelesscapabilitiestoprovideopportunitiesforouruserstocapitalizeonimproved3GtechnologiesastheserviceincreasesitspenetrationwithinChina,ratherthanfocusingonrevenueexpansionofourwirelessbusiness.
COMPETITIONTheInternetandInternet-relatedmarketsinChinaarerelativelynewandrapidlyevolving.
Therearemanycompaniesinthedomesticandinternationalmarketsthatdistributeonlinecontent,onlinegames,andvalue-addedtelecommunicationsservicestargetingChineseusers.
WenowarefacingmoreintensecompetitionfrombothdomesticandinternationalcompetitorsforprovidingcontentandservicesovertheInternet,includingbrandadvertising,content,communitytools,searchengines,Webdirectories,onlinegamesandwirelessservices.
AdvertisingBusinessInthePRCInternetspace,competitionisintenseandisexpectedtoincreasesignicantlyinthefuture.
WecompetewithourpeersandcompetitorsinChinaprimarilyonthefollowingbasis:technologicaladvancements;attractivenessofproducts;-16-brandrecognition;volumeoftrafcandusers;qualityofWebsitesandcontent;strategicrelationships;qualityofservices;effectivenessofsalesandmarketingefforts;talentedstaff;andpricing.
Overtime,ourcompetitorsmaygraduallybuildcertaincompetitiveadvantagesoverusintermsof:greaterbrandrecognitionamongInternetusersandclients;betterproductsandservices;largeruserandcustomerbases;moreextensiveandwelldevelopedmarketingandsalesnetworks;andsubstantiallygreaternancialandtechnicalresources.
ThereareanumberofexistingornewPRCInternetcompanies,includingthosecontrolledorsponsoredbyprivateandPRCgovernmententities.
AsanInternetportal,wecompetewiththeseportals,includingbutnotlimitedtoSina,TencentandNetEase,andverticalsites,suchasYouKu,TuDou,Ku6,PCOnline,SouFunandCRIC.
Oursearchenginefacesintensecompetitionfromothersearchengines,suchasBaidu,Google,Yahoo!
ChinaandSoSo.
Moreover,wearecompetingwithothertechnology-drivencompaniesondevelopingandpromotingclient-endsoftware.
Forexample,wedevelopedandlaunchedSogouPinyinInputmethodin2006andithasbeenwellreceivedbyusers.
However,manycompanies,suchasGoogle,Tencentand360,havepresentedtheirownmethodsofpinyininputandcompetedwithus.
Inaddition,wecompetewithoperatorsofgloballeadingWebsitesorInternetserviceproviders,includingYahoo!
,Microsoft/MSNandAOL,whicharecurrentlyoffering,andcouldexpandtheironlineproductsandservicestargetingChina.
Thesesitesandcompaniescompetewithusforvisitortrafc,advertisingdollars,Internetservices,wirelessservicesandpotentialpartners.
Wealsocompetewithtraditionalformsofmedia—suchasnewspapers,magazines,radioandtelevision—foradvertisers,advertisingrevenuesandcontent.
Someofthesetraditionalmedia,suchasCCTV.
comandXinHuaNet,haveextendedtheirbusinessesintotheInternetmarket.
Accordingly,wewillfacemoreintensecompetitionwithtraditionalmediacompaniesinboththeirtraditionalmedia,andintheInternet-relatedmarkets.
WebelievetherapidincreaseinChina'sonlinepopulationwilldrawmoreattentionfromdomesticandmultinationalplayerstothePRCInternetmarket.
Ourexistingcompetitorsmayinthefutureachievegreatermarketacceptanceandgainadditionalmarketshare.
Itisalsopossiblethatnewcompetitorsmayemergeandacquiresignicantmarketshare.
Inaddition,ourcompetitorsmayleveragetheirexistingInternetplatformstocross-sellnewlylaunchedproductsandservices.
Itisalsopossiblethat,asaresultofdecienciesinlegal-17-protectionsaffordedintellectualpropertyintheInternetindustryinChina,orinadequateenforcementofexistingPRClawsprotectingsuchintellectualproperty,wemaynotbeabletopreventexistingornewcompetitorsfromaccessingandusingourin-housedevelopedWebcontent.
OnlineGameBusinessForouronlinegamebusiness,wecompeteprincipallywiththefollowingthreegroupsofcompetitorsinChina:onlinegamedevelopersandoperatorsinChina,includingTencentHoldingsLitmited,ShandaGamesLimited,NetEase.
com,Inc.
,PerfectWorldCo.
,Ltd.
,GiantInteractiveGroupInc.
,NetDragonWebsoftInc.
,KingsoftCorporationLimitedandThe9Limited;otherprivatecompaniesinChinadevotedtogamedevelopmentoroperation,manyofwhicharebackedbyventurecapital;andinternationalcompetitors.
OurMMORPGscurrentlycompetewith,amongothers,thefollowingMMORPGsinChina:FantasyWestwardJourney,developedandoperatedbyNetEase.
com,Inc.
;WorldofWarcraft,developedbyBlizzardEntertainmentandoperatedbyNetEase.
com,Inc.
inChina;Asktao,developedandoperatedbyBeijingGuangyuHuaxiaTechnologyLimitedDungeonandFighter,developedandoperatedbyTencentHoldingsLimited;EudemonsOnline,developedandoperatedbyNetDragonWebsoftInc.
;andZhuXianandBattleoftheImmortals,developedandoperatedbyPerfectWorldCo.
,Ltd.
Ourexistingandpotentialcompetitorscompetewithusfortalent,gameplayerspending,timespentongameplaying,marketingactivities,qualityofgames,anddistributionnetwork.
Someofourexistingandpotentialcompetitorshavesignicantlygreaternancialandmarketingresourcesthanwedo.
GovernmentRegulationandLegalUncertaintiesThefollowingdescriptionofPRClawsandregulationsisbasedupontheopinionsofTransAsiaLawyers,ourPRCcounsel.
Foradescriptionoflegalrisksrelatingtoourownershipstructureandbusiness,see"RiskFactors.
"RegulatoryAuthoritiesCertainareasrelatedtotheInternet,suchastelecommunications,Internetinformationservices,internationalconnectionstocomputerinformationnetworks,informationsecurityandcensorshiparecoveredextensivelybyanumberofexistinglawsandregulationsissuedbyvariousPRCgovernmentalauthorities,including:theMinistryofIndustryandInformationTechnology(orMIIT,formerlytheMinistryofInformationIndustry);theMinistryofCulture(orMOC);-18-theMinistryofPublicSecurity;theStateAdministrationofIndustryandCommerce(orStateAIC);theGeneralAdministrationforPressandPublication(orGAPPformerlytheStatePressandPublicationsAdministration,orSPPA);theStateAdministrationforRadio,FilmandTelevision(orSARFT);theStateCouncilInformationOfce(orSCIO);andtheStateAdministrationofForeignExchange,orSAFE.
OurPRCCorporateStructureWehavethefollowingsubsidiariesinChina(collectivelythe"China-basedsubsidiaries",orthe"PRCsubsidiaries"):Thefollowingarethesubsidiariesengagedinthebusinesssegmentsotherthanonlinegame:ForAdvertisingBusinessBrandAdvertisingBusinessSohuSoftware,establishedin2003bySohuHongKong;SohuMedia,establishedin2006bySohuHongKong;andNewSoftware,establishedin2008bySohuEra.
SponsoredSearchBusinessGo2MapSoftware,acquiredin2005asaresultoftheacquisitionofGo2MapInc;andSogouTechnology,establishedin2006bySogouBVI.
ForWirelessandOthersBusinessesSohuEra,establishedin2003bySohuHongKong;andBeijingFireFox,establishedin2005andcurrentlywholly-ownedbySohuEra.
Thefollowingisthesubsidiaryengagedintheonlinegamebusinesssegment.
ThissubsidiaryisindirectlycontrolledbyChangyou,whichisSohu.
comInc.
'sindependently-listedmajority-ownedsubsidiary:AmazGame,establishedin2007byChangyouHK.
TheaboveChina-basedsubsidiariesarestructuredtoengageinthedevelopmentofInternettechnologies,onlinegameandrelatedsoftware.
SohuEra,SohuSoftware,Go2MapSoftware,SogouTechnology,SohuMediaandAmazGamearewhollyforeign-ownedenterprises("WFOEs"),whileNewSoftwareandBeijingFireFoxarecompaniesinvestedbyaWFOE.
UndercurrentPRClaws,theestablishmentofWFOEmustbeapprovedbytherelevantlocalbranchoftheMinistryofCommerce.
Moreover,alloftheChina-basedsubsidiariesmaycommenceoperationsonlyupontheissuanceofabusinesslicensebytherelevantlocal-19-branchoftheStateAIC,suchastheBeijingAIC,andallofourChina-basedentitieshavebeenissuedbusinesslicensesbyBeijingAIC.
SohuEra,SohuMedia,SogouTechnologyandAmazGame,haveobtainedaNewTechnologyEnterpriseQualicationCerticateissuedbyBeijingScienceandTechnologyCommission.
IntheopinionofTransAsiaLawyers,theaboveChina-basedsubsidiarieshavepresentlysatisedthebusinesslicensesand/ortheNewTechnologyEnterpriseQualicationCerticatesoftheaforementionedrequirements.
Asmentionedabove,thetelecommunicationsvalue-addedservicesbusinessisanareainwhichforeigninvestmentisrestricted.
Thus,wehaveestablishedthefollowingVIEsinChinathroughcontractualarrangementswithoursubsidiariestoperformcertainvalue-addedtelecommunicationsservices.
ThefollowingaretheVIEsengagedinthebusinesssegmentsotherthanonlinegame:ForAdvertisingBusinessBrandAdvertisingBusinessSohuEntertainment,formerlyknownasBeijingHengdaYitongInternetTechnologyDevelopmentCo.
,Ltd.
(orHengda),aPRCcompanyestablishedin2002,whichisownedbytwoofouremployees.
HengdaprovidesInternet-relatedservicesinChina.
Thecompany'snameofHengdawaschangedtoSohuEntertainmentasofJune9,2006;andFengYangTianLang,aPRCcompanythatweestablishedinDecember2005.
HighCenturyandSohuInterneteachholds50%oftheequityinterestsinFengYangTianLang,whichengagesintheonlineadvertisingbusiness.
SponsoredSearchBusinessTuXingTianXia,aPRCcompanyweacquiredin2005.
HighCenturyandSohuInternetown56.
1%and43.
9%interestsinTuXingTianXia,respectively.
TuXingTianXiaprovidesonlinemappingserviceinChina;andSogouInformation,aPRCcompanythatweestablishedinDecember2005.
SogouInformationisownedbytwoofouremployeesandprovidesInternet-relatedservicesinChina.
ForWirelessandOthersBusinessesSohuInternet,aPRCcompanyestablishedin2003,thatis75%ownedbyHighCenturyand25%ownedbySohuEntertainment.
SohuInternetprovidesInternet-relatedservicesinChina;GoodFeel,aPRCcompanyweacquiredin2004.
GoodFeelisownedbytwoofouremployeesandhasenteredintoaseriesofagreementstoprovidewirelessservicesinChina;HighCentury,aPRCcompanyestablishedin2001,and80%ownedbyDr.
Zhang,ourfounder,ChairmanandChiefExecutiveOfcer,and20%ownedbyoneofouremployees.
HighCenturyoperatesasaninvestmentmanagementandconsultingcompanyinChina;21EastBeijing,aPRCcompanyengaginginentertainmentbusinessinChina.
Weacquired70%interestsin21EastBeijingthroughHighCenturyinOctober2006.
Theremaining30%interestsin21EastBeijingisownedbyoneofouremployees;andNew21East,aPRCcompanythatweestablishedinDecember2007thatengagesinentertainmentbusinessinChina.
New21Eastis70%ownedbyHighCenturyand30%ownedbyoneofouremployees.
-20-ThefollowingistheVIEengagedintheonlinegamebusinesssegment.
ThisVIEisindirectlycontrolledbyChangyou,whichisSohu.
comInc.
'sindependently-listedmajority-ownedsubsidiary:Gamease,aPRCcompanythatweestablishedinAugust2007.
GameaseisownedbytwoofouremployeesandprovidesonlinegameservicesinChina.
Sohuhasextendedinterest-freeloanstotheindividualshareholdersoftheVIEstofundtheircapitalinvestmentintheVIEs.
WehavealsoenteredintoaseriesofagreementswiththeindividualshareholderstotransfertheirsharesintheVIEstouswhenrequiredtodoso.
AllofourVIEspresentlyhavevalidbusinesslicensesissuedbytherelevantlocalbranchoftheStateAIC.
SogouInformationandSohuInternethaveobtainedaNewTechnologyEnterpriseQualicationCerticateissuedbyBeijingScienceandTechnologyCommission.
InJanuary2008,wecompletedtheliquidationofoneofourformerVIEs,GuangzhouSohuInteractiveNetworkTechnologyCo.
,Ltd.
(orGuangzhouInteractive),aPRCcompanythatwas50%ownedbySohuInternetand50%ownedbyHighCentury.
TheMIITpromulgatedonJuly13,2006aNoticeoftheMinistryofInformationIndustryonIntensifyingtheAdministrationofForeignInvestmentinValue-addedTelecommunicationsServices.
ThenoticeisdesignedtostrengthentheadministrationofforeigninvestmentinPRCtelecommunicationbusinesses,particularlythoseinvolvingvalue-addedtelecommunicationsservices,whichencompassawidevarietyofactivitiesrelatedtotheprovisionofservice/contentviatelecommunicationsnetworks.
Assuch,thenoticerequiresthefollowing:Telecomcompanies(ortheirshareholders)mustholdthedomainnamesandtrademarksthattheyuseintheirprovisionofvalue-addedtelecommunicationservices,andmustholdnecessarybusinesspremisesandfacilities(includingservers)withintheregioncoveredbytheirICPlicensesandcorrespondtotheICPservices.
IncompliancewiththeNoticeoftheMinistryofInformationIndustryonIntensifyingtheAdministrationofForeignInvestmentinValue-addedTelecommunicationsServices,anenterpriseholdinganICPlicensemustbetheentitythatpossessesthekeyintellectualpropertyrights,e.
g.
,domainnamesandtrademarks.
Inthisconnection,SohuErahastransferredsomeofitsdomainnamesandtrademarkstoSohuInternet,whichwilllicensethesametoSohuEraandSohuMedia.
IntheopinionofTransAsiaLawyers,theownershipstructuresofourPRCsubsidiariesandVIEscomplywithallexistinglaws,rulesandregulationsofthePRCandeachoftheeighteencompaniesasdescribedhereinhasthefulllegalright,powerandauthority,andhasbeendulyapprovedtocarryonandengageinthebusinessasdescribedinitsbusinesslicense.
TelecommunicationsLawsandRegulationsAmongalloftheapplicablelawsandregulations,theTelecommunicationsRegulationsofthePeople'sRepublicofChina(ortheTelecomRegulations),implementedonSeptember25,2000,istheprimarygoverninglaw,andsetsoutthegeneralframeworkfortheprovisionoftelecommunicationservicesbydomesticPRCcompanies.
UndertheTelecomRegulations,itisarequirementthattelecommunicationsserviceprovidersprocureoperatinglicensespriortotheircommencementofoperations.
TheTelecomRegulationsdrawadistinctionbetween"basictelecommunicationsservices"and"value-addedtelecommunicationsservices".
Value-addedtelecommunicationsservicesaredenedastelecommunicationsandinformationservicesprovidedthroughpublicnetworks.
A"CatalogueofTelecommunicationsBusiness"wasissuedasanattachmenttotheTelecomRegulationstocategorizetelecommunicationsservicesasbasicorvalue-added.
InFebruary2003,theCataloguewasupdated,categorizingonlinedataandtransactionprocessing,on-demandvoiceandimagecommunications,domesticInternetvirtualprivatenetworks,Internetdatacenters,messagestorageandforwarding(includingvoicemailbox,e-mailandonlinefaxservices),callcenters,Internetaccess,andonlineinformationanddatasearchasvalue-addedtelecommunicationsservices.
Accordingly,therearevarioustypesoftelecommunicationsservices,inwhichSohuisengagedthatareregulatedasvalue-addedtelecommunicationsservices.
-21-ForeigndirectinvestmentintelecommunicationscompaniesinChinaisregulatedbytheRegulationsfortheAdministrationofForeign-InvestedTelecommunicationsEnterprises(ortheFITERegulations),whichwereissuedbythePRCStateCouncilonDecember11,2001,andbecameeffectiveonJanuary1,2002.
TheFITERegulationsstipulatethattelecommunicationsenterprisesinthePRCwithforeigninvestors(orFITEs),mustbeestablishedasSino-foreignequityjointventures.
FITEscanundertakeoperationsinbasictelecommunicationsservicesandvalue-addedtelecommunicationsservices.
UndertheFITERegulationsandinaccordancewithWTO-relatedagreements,theforeignpartytoanFITEengaginginvalue-addedtelecommunicationsservicesmayholdupto50%oftheequityoftheFITE,withnogeographicrestrictionsonitsoperations.
ThePRCgovernmenthasnotmadeanyfurthercommitmenttoliberalizeitsregulationofFITEs.
OnSeptember10,2008,thePRCStateCouncilissuedtheAmendedRegulationsfortheAdministrationofForeign-InvestedTelecommunicationsEnterprises(orAmendedFITERegulations),asDecreeNo.
534,whichcameintoeffectonthesameday.
Amongotherthings,theminimumregisteredcapitalforaFITEofferingbasictelecommunicationsserviceshasbeenreducedby50%:fromRMB2billiontoRMB1billionforthoseoperatingnationwideortrans-provincialservicesandfromRMB200milliontoRMB100millionforintra-provincialoperators.
Therehasbeennochangeinthecapitalizationrequirementsforvalue-addedtelecomsserviceoperators.
TherestrictionontheequityratiooftheforeignpartyinaFITEremainsamaximumof50%.
Inviewoftherestrictionsonforeigndirectinvestmentinthetelecommunicationssector,weestablishedseveraldomesticVariableInterestEntities(orVIEs),toengageinvalue-addedtelecommunicationsservices.
ForadetaileddiscussionofourVIEs,pleaserefertobelow"OurPRCCorporateStructure".
InviewoftheFITERegulationsandSino-ForeignEquityJointVentureLaw,wemayconsiderestablishingaforeign-investedtelecomentityatanappropriatetime.
OnMarch1,2009,theMIITpromulgatedtheMeasuresontheAdministrationofTelecommunicationsBusinessOperatingPermits(ortheTelecomLicenseMeasures)tosupplementtheTelecomRegulationsandreplacethepreviousAdministrativeMeasuresforTelecommunicationsBusinessOperatingLicenses(or2001TelecomOperatingMeasures).
TheTelecomLicenseMeasuresconrmthattherearetwotypesoftelecomoperatinglicensesforoperatorsinChina(includingFITEs),namely,licensesforbasictelecommunicationsservicesandlicensesforvalue-addedtelecommunicationsservices.
Withrespecttothelatter,adistinctionismadeastowhetheralicenseisgrantedforintra-provincialor"trans-regional"(inter-provincial)activities.
Anappendixtothelicensewilldetailthepermittedactivitiesoftheenterprisetowhichitwasgranted.
Anapprovedtelecommunicationservicesoperatormustconductitsbusiness(whetherbasicorvalue-added)inaccordancewiththespecicationsrecordedonitsTelecommunicationsServicesOperatingLicense.
Comparedtothe2001TelecomOperatingMeasure,theTelecomLicenseMeasuresloweredthecapitalrequirementforintra-provincialbasictelecomservicesoperatorsfromRMB200milliontoRMB100millionandforinter-provincialbasictelecomservicesoperatorsfromRMB2billiontoRMB1billion.
OnAugust19,2009andJanuary21,2008,theMIITissuedtoSohuInternetandGoodFeel,respectively,arenewedValue-AddedTelecommunicationsServicesOperatingLicenseeachofwhichauthorizedtheprovisionofvalue-addedtelecommunicationservicesnationwide.
Bothoftheselicenseshaveavalidtermofveyearsandaresubjecttoannualinspections.
InadditiontotheValue-AddedTelecommunicationsServicesOperatingLicense,werequirevariousotherlicensesandpermitssoastoprovideInternet-relatedservicesinChina.
Foradetaileddiscussion,pleasereferbelowto"ClassiedRegulations".
-22-ClassiedRegulationsLawsandRegulationsRelatedtoContentProvisionInternetInformationServicesOnSeptember25,2000,theStateCouncilapprovedtheMeasuresfortheAdministrationofInternetInformationServices(orthe"ICPMeasures").
UndertheICPMeasures,anyentitythatprovidesinformationtoonlineusersontheInternetisobligedtoobtainanoperatinglicensefromtheMIIToritslocalbranchattheprovincialormunicipallevelinaccordancewiththeTelecomRegulationsdescribedabove.
TheICPMeasuresstipulatefurtherthatentitiesprovidingonlineinformationservicesregardingnews,publishing,education,medicine,health,pharmaceuticalsandmedicalequipmentmustprocuretheconsentofthenationalauthoritiesresponsibleforsuchareaspriortoapplyingforanoperatinglicensefromtheMIIToritslocalbranchattheprovincialormunicipallevel.
Moreover,ICPsmustdisplaytheiroperatinglicensenumbersinconspicuouslocationsontheirhomepages.
ICPsarerequiredtopolicetheirWebsitesandremovecertainprohibitedcontent.
ThisobligationreiteratesInternetcontentrestrictionsthathavebeenpromulgatedbyotherPRCministries.
Mostimportantlyforforeigninvestors,theICPMeasuresstipulatethatICPsmustobtainthepriorconsentoftheMIITpriortoestablishinganequityorcooperativejointventurewithaforeignpartner.
OnJune12,2009,theBeijingTelecomAdministration(orBTA)issuedtoSohuInternetarenewedTelecommunicationsandInformationServicesOperatingLicense(orICPlicense).
OnNovember24,2008,theBTAissuedtoSogouInformationarenewedICPlicense.
OnMay9,2008,theBTAissuedtoGameaseanICPlicense.
AlloftheseICPlicenseshaveatermofveyearsandaresubjecttoannualinspections.
OnlineNewsDisseminationOnSeptember25,2005,theAdministrativeRegulationsforInternetNewsInformationServices(orNewsRegulations)werejointlypromulgatedbytheStateCouncilInformationOfceandMIITtoreplacethepreviousProvisionalRulesfortheAdministrationoftheOperationofNewsPublicationServicesbyWebSites(orOldNewsRules)issuedonNovember7,2000.
TheNewsRegulationsstipulatethatgeneralWebsitesestablishedbynon-newsorganizations,suchasSohu,maypublishnewsreleasedbycertainofcialnewsagenciesifsuchWebsitessatisfytherequirementssetforthinArticle8oftheregulationsbutmaynotpublishnewsitemsproducedbythemselvesorothernewssources.
Theaforementionedrequirementsincludethefollowing:theymustcomplywiththeconstitution,lawsandregulationsofthePRC,upholdandnotmisleadthesociety'spublicopinion,andsafeguardnationalandpublicinterests;theymusthavesoundadministrativerulesandregulationsconcerningInternetnewsservices;theymusthavethenecessarypremises,equipmentandlegally-raisedfunds;theymusthavetenormoreprofessionalnewseditors,atleastveofwhomhaveworkedatanewsagencyforaminimumofthreeyears;theymustbelegalpersonswhohavebeenlegallyestablishedforatleasttwoyears,engagedintheoperationofInternetnewsservicesandhavenothadadministrativepenaltiesimposedduetoviolationoflawsandregulationsontheadministrationofInternetnewsserviceswithinthelasttwoyears;-23-iftheapplicantisanenterpriselegalperson,itsregisteredcapitalmustnotbelessthanRMB10,000,000;andtheymustonlyrepublishordisseminatenewspublishedbyStatenewsagenciesornewsagenciesdirectlysubordinatetotherespectivegovernmentsoftheprovinces,autonomousregionsordirectly-administeredmunicipalitieswithoutdistortingtheoriginalnewsinformationregardingcurrenteventsandpoliticalaffairstothepublic,andindicatethesourceofsuchnewsinformation;andshallnotpublishnewsgatheredandeditedbythemselves.
TheaforementionedrulesalsorequirethegeneralWebsitesofnon-newsorganizationstoapplytotheSCIOatthenationallevelforapprovalaftersecuringtheconsentoftheSCIOattheprovinciallevelbeforetheycommenceprovidingnewsdisseminationservices.
Also,generalWebsitesintendingtopublishnewsreleasedbytheaforementionednewsagenciesorbureausmustenterintoagreementswiththemandsubmitcopiesofthoseagreementstotherelevantadministrationdepartment.
OnMay11,2004,SohuInternetobtainedapermittoengageinonlinenewsdisseminationservices,whichwasissuedbytheInformationOfceoftheBeijingMunicipalGovernment(thelocalarmoftheSCIO)undertheOldNewsRules.
OnJune6,2006,suchpermitwasupdatedbytheSCIOinaccordancewiththeNewsRegulations.
InternetMedical,HealthandPharmaceuticalsInformationDisseminationOnMay1,2009,theMinistryofHealth(orMOH)issuedtheMeasuresfortheAdministrationofInternetMedicalandHealthcareInformationServiceswhichreplacedthepreviousMeasuresfortheAdministrationofInternetMedicalandHealthInformationServicesissuedbytheMOHonJanuary8,2001.
ThesemeasuresstipulatethattheMOHisresponsibleforreviewingthequalicationsofWebsitesandapprovingtheirpublicationofhealth-relatedinformation.
Additionally,inaccordancewiththeMeasuresfortheAdministrationofInternetPharmaceuticalsInformationServices,issuedbytheStateFoodandDrugAdministration(orSFDA),onJuly8,2004,theformalapprovaloftheSFDAoroneofitslocalbranchesisrequiredbeforeaWebsitemaydisseminateinformationconcerningpharmaceuticals.
Accordingtotheaforementionedregulations,medical,healthandpharmaceuticalinformationprovidedbyWebsitesmustbescienticandaccurateandmustindicatethesourcesofsuchinformation.
Websitesthatareapprovedtodisseminatesuchinformationmustalsopublishorreprinthealthpolicies,informationonepidemicsandmajorhealth-relatedincidents,andotherhealth-relatedinformationinaccordancewithlaw.
Furthermore,medicalandpharmaceuticaladvertisementspublishedbysuchWebsitesmustnotexaggeratetheefcacyorpromotethemedicalusesofsuchproducts.
OnDecember11,2009,SohuInternetreceivedtherenewedSFDAapproval.
Inaddition,SohuInternetobtainedtheaforementionedapprovalsfromtheMOHandcompletedtheregistrationprocesswiththeMOHonNovember17,2005.
OnlineAudiovisualTransmissionOnJuly6,2004,theSARFTissuedtheMeasuresfortheAdministrationoftheTransmissionofAudiovisualProgramsoverInformationNetworkssuchastheInternet,whichcameintoeffectonOctober11,2004.
ThesemeasuresprovidethatWebsitesauthorizedtodisseminatenewsmayapplytotheSARFTtoobtainaPermitfortheNetworkTransmissionofAudiovisualProgramsallowingtheonlinedisseminationofstreamingvideo.
Inaccordancewiththesemeasures,weappliedtotheSARFTforthispermitin2005,buthavenotyetobtainedsaidPermit.
OnDecember20,2007,theSARFTandtheMIITjointlyissuedtheRulesfortheAdministrationofInternetAudiovisualProgramServices(orDocument56),whichcameintoeffectasofJanuary31,2008.
Therules-24-requireallonlineaudioandvideoserviceproviderstobeeitherstate-ownedorstate-controlled.
Theyalsoencouragestate-ownedentitiestoactivelyinvestinonlineaudiovisualservices.
However,furthertothis,apressconferenceonFebruary3,2008,theSARFTandtheMIITclariedthatonlineaudio-visualserviceprovidersthatwerealreadylawfullyoperatingpriortotheissuanceofDocument56mayre-registerandcontinuetooperatewithoutbecomingstate-ownedorcontrolled,providedthatsuchprovidersdonotengageinanyunlawfulactivities.
ThisexemptionwillnotbegrantedtoserviceproviderssetupafterDocument56wasissued.
AswewerealreadyengagedinonlineaudiovisualtransmissionpriortotheissuanceofDocument56,wearepresumablyexemptedfromtherequirementofbeingstate-ownedorstate-controlled.
SohuInternetobtainedanonlineaudiovisualtransmissionlicensefromSARFTonMay31,2008.
OnMarch30,2009,theSARFTreleaseditsNoticeonStrengtheningtheAdministrationofOnlineAudiovisualContent.
ThisnoticerequiresthatonlythoselmsorTVprogramsthathavealreadyobtainedfromtheSARFTaFilmPublicScreeningPermit,TVDramaDistributionPermit,TVAnimationDistributionPermit,orTVDocumentaryFilmScreeningPermitcouldbeallowedtobetransmittedviaaudiovisualWebsites.
ThesepermitsarealreadymandatoryforalllmsandprogramsshownonTVandincinemasinChinaandshallbeobtainedbeforesuchlmorTVorprogramisallowedtobereleased.
TheapprovalapplicationsfortheabovementionedFilmPublicScreeningPermit,TelevisionDramaDistributionPermit,TelevisionAnimationDistributionPermitorTelevisionDocumentaryFilmScreeningPermitareextremelydifcultandtime-consuming.
However,theSARFTcurrentlydoesnotenforcerequirementforthesepermitsverystrictly.
MostforeignaudiovisualprogramstransmittedviaInternetinChinathereforedonothavesuchpermits.
Thatbeingsaid,theSARFT'scurrentapproachdoesnotnecessarilymeanthatitwillforegoenforcingthisprovisioninthefuture.
Moreover,audiovisualWebsitesareobligatedtoenhancetheircopyrightprotectionsystems,andtotakeappropriatemeasurestoprotectthelegitimaterightsandinterestsofcopyrightholders.
Operatorsofsuchsitesmusthold,orbelicensedwith,thecopyrighttoallcontenttheytransmit.
InternetPublishingTheRulesfortheAdministrationofthePublicationsMarket,issuedbytheGAPPonJuly16,2003,denetheonlinedistributionofpublicationsastheofferingofonlinesubscriptionsfor,andthepurchase,storage,shipment,andsaleof,publicationsovertheInternet.
Inaddition,theProvisionalRulesfortheAdministrationforInternetPublishing(orInternetPublishingRules)jointlyissuedbytheGAPPandMIITonJune27,2002,dene"Internetpublications"asworksthatareeitherselectedoreditedtobepublishedontheInternetortransmittedtoend-usersthroughtheInternetforthepurposesofbrowsing,reading,usingordownloadingbythegeneralpublic.
Suchworksprimarilyincludecontentorarticlesformallypublishedpubliclyinotherpresssuchas:(a)books,newspapers,periodicals,audio-visualproductsandelectronicpublicationsand(b)literature,artandarticlesonnaturalscience,socialscience,engineeringandothertopicsthathavebeenedited.
UndertheInternetPublishingRules,WebportalssuchasoursarerequiredtoapplytoandregisterwiththeGAPPbeforedistributingInternetpublications.
Inthisregard,SohuInternetobtainedarenewedapprovalfromtheBeijingNewsandPublicationsBureau(thelocalarmoftheGAPP)onApril1,2009todistributeInternetpublications.
OnlineCulturalProductsTheOnlineCultureRegulationsapplytoentitiesengaginginactivitiesrelatedto"onlineculturalproducts",includingmusicandvideoles,networkgames,animationfeaturesandaudiovisualproducts,performedplaysandartworkconvertedfordisseminationviatheInternet.
Pursuanttothislegislation,commercialentitiesarerequiredtoapplytotherelevantlocalbranchoftheMOCforanOnlineCultureOperatingPermitiftheyengageinanyofthefollowingtypesofactivities:theproduction,duplication,importation,wholesale,retail,leasingorbroadcastingofonlineculturalproducts;-25-thedisseminationofonlineculturalproductsontheInternetortransmissionthereoftocomputers,xed-lineormobilephones,radios,televisionsetsorgamingconsolesforthepurposeofbrowsing,reading,usingordownloadingsuchproducts;ortheexhibitionorholdingofcontestsrelatedtoonlineculturalproducts.
OnSeptember3,2009,theMOCissueditsNoticeonStrengtheningandImprovingtheContentCensorshipofOnlineMusicContent(ortheMOCNotice).
TheMOCNoticeprovidesthatdirectlinkstoonlinemusicshallbedenedasengaginginonlinemusicbusinessandthereforetheOnlineCultureOperatingPermitisrequiredforprovidingsuchsearchservices.
Inaddition,theMOCNoticealsorequiresanydomesticmusicproductsshallbeledforrecordwiththeMOCwithin30daysafterbeingmadeavailableonline.
Forimportedmusicproducts,theyshallbeapprovedbytheMOCbeforebeingmadeavailableonline.
InSeptember2003andDecember2007,theMOCissuedanOnlineCultureOperatingPermittoSohuInternetandGamease,respectively,authorizingustoprovideonlinegameservices.
Thispermitissubjecttoannualinspection.
SogouInformationledanapplicationforanOnlineCultureOperatingPermitwiththeMOCinSeptember2009.
InternationalConnectionsforComputerInformationNetworksTheStateCouncilandtheMIIThavepromulgatedregulationsgoverninginternationalconnectionsforPRCcomputernetworks,including:MeasuresfortheAdministrationofInternationalConnectionstoChina'sPublicComputerInterconnectedNetworks(1996);ProvisionalRegulationsofthePeople'sRepublicofChinafortheAdministrationofInternationalConnectionstoComputerInformationNetworks(1997)andtheirImplementingMeasures(1998);ReplyConcerningtheVericationandIssuanceofOperatingPermitsforBusinessRelatingtoInternationalConnectionsforComputerInformationNetworksandforPublicMultimediaTelecommunicationsBusiness(1998);andAdministrativeMeasuresforInternationalCommunicationsGateways(2002).
Undertheaboveregulations,anyentitywishingtoaccessinternationalconnectionsfortheircomputerinformationnetworksinthePRCmustcomplywiththefollowingrequirements:beaPRClegalperson;havetheappropriateequipment,facilitiesandtechnicalandadministrativepersonnel;haveimplementedandregisteredasystemofinformationsecurityandcensorship;andeffectallinternationalconnectionsthroughaninternationalcommunicationsgatewayestablishedwiththeapprovaloftheMIIT.
Weadoptedtherelevantmeasurestoensurethatweareinpropercompliancewithalloftheserequirements.
-26-InformationSecurityandCensorshipTheprincipalpiecesofPRClegislationconcerninginformationsecurityandcensorshipare:TheLawofthePeople'sRepublicofChinaonthePreservationofStateSecrets(1988)anditsImplementingRules(1990);TheLawofthePeople'sRepublicofChinaRegardingStateSecurity(1993)anditsImplementingRules(1994);RulesofthePeople'sRepublicofChinaforProtectingtheSecurityofComputerInformationSystems(1994);NoticeConcerningWorkRelatingtotheFilingofComputerInformationSystemswithInternationalConnections(1996);AdministrativeRegulationsfortheProtectionofSecrecyonComputerInformationSystemsConnectedtoInternationalNetworks(1999);RegulationsfortheProtectionofStateSecretsforComputerInformationSystemsontheInternet(2000);NoticeissuedbytheMinistryofPublicSecurityofthePeople'sRepublicofChinaRegardingIssuesRelatingtotheImplementationoftheAdministrativeMeasurefortheSecurityProtectionofInternationalConnectionstoComputerInformationNetworks(2000);TheDecisionoftheStandingCommitteeoftheNationalPeople'sCongressRegardingtheSafeguardingofInternetSecurity(2000);andMeasuresfortheAdministrationofCommercialWebsiteFilingsfortheRecord(2002)andtheirImplementingRules(2002).
ThesepiecesoflegislationspecicallyprohibittheuseofInternetinfrastructurewhereitresultsinabreachofpublicsecurity,theprovisionofsociallydestabilizingcontentorthedivulgenceofStatesecrets,asfollows:"Abreachofpublicsecurity"includesbreachofnationalsecurityordisclosureofstatesecrets;infringementonstate,socialorcollectiveinterestsorthelegalrightsandinterestsofcitizensorillegalorcriminalactivities.
"Sociallydestabilizingcontent"includesanyactionthatincitesdeanceorviolationofChineselaws;incitessubversionofstatepowerandtheoverturningofthesocialistsystem;fabricatesordistortsthetruth,spreadsrumorsordisruptssocialorder;advocatescultactivities;orspreadsfeudalsuperstition,involvesobscenities,pornography,gambling,violence,murder,orhorricactsorinstigatescriminalacts.
"Statesecrets"aredenedas"mattersthataffectthesecurityandinterestofthestate".
Thetermcoverssuchbroadareasasnationaldefense,diplomaticaffairs,policydecisionsonstateaffairs,nationaleconomicandsocialdevelopment,politicalpartiesand"otherStatesecretsthattheStateSecrecyBureauhasdeterminedshouldbesafeguarded.
"Accordingtotheaforementionedlegislation,itismandatoryforInternetcompaniesinthePRCtocompletesecuritylingprocedureswiththelocalpublicsecuritybureauandforthemtoupdateregularlywiththelocalpublicsecuritybureauregardinginformationsecurityandcensorshipsystemsfortheirWebsites.
Inthisregard,-27-onOctober1,2004,theAdministrativeRulesontheFilingofCommercialWebsiteswerepromulgatedbytheBeijingAICtoreplacethepreviousDetailedImplementingRulesfortheMeasuresfortheAdministrationofCommercialWebsiteFilingsfortheRecord,promulgatedonSeptember1,2000,bytheBeijingAIC.
TheAdministrativeRulesontheFilingofCommercialWebsitesstatethatWebsitesmustcomplywiththefollowingrequirements:theymustlewiththeBeijingAICandobtainelectronicregistrationmarks;theymustplacetheregistrationmarksontheirWebsites'homepages;andtheymustregistertheirWebsitenameswiththeBeijingAIC.
SohuInternetsuccessfullyregistereditsWebsitewiththeBeijingAIConSeptember11,2003.
Accordingly,theelectronicregistrationmarkisprominentlyplacedonitshomepage.
Inaddition,theStateSecurityBureauhasissuedregulationsauthorizingtheblockingofaccesstoanysiteitdeemstobeleakingStatesecretsorfailingtomeettherelevantlegallegislationregardingtheprotectionofStatesecretsinthedistributionofinformationonline.
Specically,InternetcompaniesinChinawithmessageboards,chatroomsorsimilarservices,suchasSohu,mustapplyfortheapprovaloftheStateSecretsBureaupriortooperatingsuchservices.
Accordingly,wehaveestablishedaninternalsecuritycommitteeandadoptedsecuritymaintenancemeasures,employedafull-timesupervisorandexchangedinformationonaregularbasiswiththelocalpublicsecuritybureauwithregardtosensitiveorcensoredinformationandWebsites.
RegulationofInternetContentandAnti-PornographyThePRCgovernmenthaspromulgatedmeasuresrelatingtoInternetcontentthroughanumberofgovernmentauthorities,includingtheMIIT,MOC,GAAPandtheMinistryofPublicSecurity.
ThesemeasuresspecicallyprohibitcertainInternetactivities,includingtheoperationofonlinegamesthatresultinthepublicationofanycontentwhichisfoundto,amongotherthings,propagateobscenity,gamblingorviolence,instigatecrimes,underminepublicmoralityortheculturaltraditionsofthePRC,orcompromiseStatesecurityorsecrets.
IfanICPlicenseholderviolatesthesemeasures,thePRCgovernmentmayrevokeitsICPlicenseandshutdownitsWebsites.
Inaddition,thePRCgovernmenthasissuedseveralregulationsconcerningtheinstallationofltersoftwaretolteroutunhealthyandvulgarcontentfromtheInternet.
InApril1,2009,theMinistryofEducation,theMIITandotherministriesandagenciespromulgatedanoticerequiringthat,bytheendofMay2009,allcomputerterminalsconnectedwiththeInternetatallelementaryandsecondaryschoolsbeabletoincludeandoperatetheGreenDam-YouthEscort,softwareaimedatlteringoutunhealthyandvulgarcontentintextandgraphicsfromtheInternet,which,accordingtotheofcialWebsiteofthesoftware,maybeusedtocontrolthetimeonInternet,prohibitaccesstocomputergames,andlteringoutunhealthyWebsites.
TheMIITfurtherexpandedthescopeofusageofthisltersoftwarebyissuinganoticeonMay19,2009requiringthat,effectiveasofJuly1,2009,allcomputersmanufacturedandsoldinChinahavethelatestavailableversionofGreenDam-YouthEscortpreinstalledwhentheyleavethefactoriesandallimportedcomputersshallhavethelatestavailableversionofGreenDam-YouthEscortpreinstalledbeforebeingsoldinChina.
TheGreen-DamYouthEscortistobepreinstalledontheharddriveofthecomputerorintheformofaCDaccompanyingthecomputerandisalsotobeincludedinthebackuppartitionandsystemrestoreCD.
However,onJune30,2009,MIITpostponedtheimplementationofthisrequirementregardingpre-installationofGreenDam-YouthEscort.
TheChinesegovernmentalsohasstringentregulationsononlinepornographicinformationandhaslaunchedseveralcrackdownsonInternetpornographyin2009.
OnDecember4,2009,theMIITandother3-28-governmentauthoritiesjointlyissuedtheIncentivesMeasuresforReportofPornographic,ObsceneandVulgarMessagesonInternetandMobileMedia(ortheAnti-PornographyNotice)tofurthercrackdownononlinepornography.
PursuanttothisAnti-PornographyNotice,rewardsofuptoRMB10,000willbeprovidedtoInternetuserswhoreportWebsitesthatfeaturepornography,andacommitteehasbeenestablishedtoreviewsuchreportstodetermineanappropriateaward.
DuringtheAnti-Pornographycampaign,manyWebsites(includingmobileWebsites)thatcontainedpornographyinformationwerecloseddown.
Inaddition,mobilenetworkoperatorssuchasChinaMobileCommunicationCorporation(orCMCC),haveannouncedatemporaryofbillingofWAPservices,asanefforttoghtagainstWebsitesprovidingpornographiccontent.
EncryptionSoftwareInOctober1999,theStateEncryptionAdministrationCommissionpromulgatedtheRegulationsfortheAdministrationofCommercialEncryption,followedinNovember1999bytheNoticeoftheGeneralOfceoftheStateEncryptionAdministrationCommission.
BothoftheseregulationsaddresstheuseinChinaofsoftwarewithencryptionfunctions.
Accordingtotheseregulations,encryptionproductspurchasedforusemustbereported.
Violationoftheencryptionregulationsmayresultintheissuanceofawarning,levyingofapenalty,conscationoftheencryptionproductsandevencriminalliabilities.
OnMarch18,2000,theOfceoftheStateCommissionfortheAdministrationofCryptographyissuedapublicannouncementregardingtheimplementationofthoseregulations.
Theannouncementclariesthat:Onlyspecializedhardwareandsoftware,thecorefunctionsofwhichareencryptionanddecoding,fallwithintheadministrativescopeoftheregulationsas"encryptionproductsandequipmentcontainingencryptiontechnology.
"Otherproductssuchaswirelesstelephone,Windowssoftwareandbrowsersdonotfallwithinthisscope.
TheStateCommissionfortheAdministrationofCryptographychangeditsnametotheStateCryptographyAdministrationBureau(SCAB)inMarch2005.
TheSCABmaintainsauthorityovertheimportation,research,production,saleanduseofcryptographicproductsinChina("products"aredenedtoincludeanycryptographictechnologiesandproductstobeappliedintheencryptionorsecureauthenticationofinformationotherthanstatesecrets).
Legislationwasissuedtorestricttheimportation,research,productionandsaleofencryptionproductsandrequiringthattheencryptionfunctionsofsuchproductsbeplacedinescrowwiththeSCABforreasonsofnationalsecurity.
WeareinfullcompliancewithcurrentPRClegislationgoverningencryptionsoftware.
LawsandRegulationsRelatedtoOnlineAdvertisingsServicesUndertheAdministrativeRegulationsforAdvertisingLicensesandtheImplementationRulesfortheAdministrativeRegulationsforAdvertising,bothofwhichwereissuedbytheStateAIConNovember30,2004andeffectiveasofJanuary1,2005,enterprises(exceptforbroadcaststations,televisionstations,newspapersandmagazines,non-corporateentitiesandotherentitiesspeciedinlawsoradministrativeregulations)aregenerallyexemptedfromthepreviousrequirementtoobtainanadvertisinglicense.
Exemptedenterprisesareonlyrequiredtoapplyfortheinclusionofadvertisingservicesintheirbusinesslicense.
WeestablishedSohuMediain2006,whosebusinessscopehasincludedtheprovisionofadvertisingservicesontheirbusinesslicenses.
LawsandRegulationsRelatedtoOnlineGamesPursuanttotheInternetPublishingRules,theGAPPrequireseveryentitywishingtooperateonlinegamestoholdanOnlinePublishingPermit,whichspecicallyauthorizesthepublishingofgamesontheInternet.
-29-OnFebruary21,2008,theGAPPissuedtheRulesfortheAdministrationofElectronicPublications("ElectronicPublicationRules"),whichtookeffectasofApril15,2008.
TheElectronicPublicationRulesoutlinealicensingsystemforbusinessoperationsinvolvingelectronicpublications,whicharecurrentlyinterpretedbytheGAPPtoincludeonlinegames.
UndertheElectronicPublicationRules,ifaPRCcompanyiscontractuallyauthorizedtopublishforeignelectronicpublications,itmustobtaintheapprovalof,andregisterthecopyrightlicensecontractwiththeGAPP.
OnSeptember28,2009,theGAPPtogetherwithNationalAdministrationofCopyright("NAC")andOfceoftheNationalCampaignonAnti-pornographyandAnti-delinquencyjointlyissuedNoticeonFurtherStrengtheningPre-examinationandPre-approvalofOnlineGameandAdministrationofImportedOnlineGameApproval(the"GAPPNotice").
AccordingtotheGAPPNotice,GAPPistheonlyauthorityresponsibleforpre-examinationandpre-approvalofonlinegame,andalltheonlinegameoperatorsshallobtainInternetPublishingLicensetoprovideonlinegameservices.
SohuInternetwasissuedanInternetPublishingLicensebyGAPPonApril28,2007.
GameaseisintheprocessofapplyingforanInternetPublishingLicensewithGAPP.
OnlineGameContentOnMay14,2004,theMOCissuedtheNoticeRegardingtheStrengtheningofOnlineGameCensorship.
ThisnoticemandatestheestablishmentofanewcommitteeundertheMOCthatwillscreenthecontentofimportedonlinegames.
Inaddition,allimportedanddomesticonlinegamesarerequiredtobeledwiththeMOC.
WehavesubmittedtherelevantlingdocumentstotheMOCforthelingofallthegamesinoperation.
OnJuly12,2005,theMOCandtheMIITpromulgatedtheOpinionsontheDevelopmentandAdministrationofOnlineGamereectingthePRCgovernment'sintenttofosterandcontrolthedevelopmentoftheonlinegameindustryinChina.
Inaddition,theMOCwillcensoronlinegamesthat"threatenstatesecurity,""disturbthesocialorder,"orcontain"obscenity"or"violence.
"OnNovember13,2009,theMOCissueditsNoticeRegardingImprovingandStrengtheningtheAdministrationofOnlineGameContent(ortheOnlineGameContentNotice).
Thisnoticecallsforonlinegameoperatorstoimproveandinnovatetheirgamemodels.
Emphasisisplacedspecicallyonthefollowing:(1)mitigatingthepre-dominanceofthe"upgradebymonsterghting"model,(2)imposingmoresevererestraintsonthe"playerkill"model(i.
e.
,whereoneplayer'scharacterattemptstokillanotherplayer'scharacter),(3)restrictingin-gamemarriagesamonggameplayers,and(4)improvingtheenforcementofthelegalrequirementsfortheregistrationofminorsandgametime-limits.
TheOnlineGameContentNoticealsorequiresonlinegameoperatorstosetupcommitteestocarryouttheself-censorshipofgamecontent.
Thepersonresponsibleforsuchself-censorshipmustreceivetrainingfromtheMOCoritslocaldepartment/counterpart.
TheMOCalsointendstointroduceatrainingandevaluationsystemforthepersonsinchargeofresearchanddevelopmentandoperationsatonlinegamecompanies.
Thissystemisexpectedtobelaunchedintwoyears'time.
AccordingtotheOnlineGameContentNotice,theMOCintendstoformulatetechnicalstandardsandnormsforgamedevelopment,inordertoprovidetechnologicalsupportfororiginaldomesticgames.
Thedevelopmentandoperationof"thoughtfulandeducational"onlinegamesisalsotobeencouraged.
TheMOCisplanningtoexpeditetheestablishmentofanonlinegameindustryassociation,toplayaroleintheself-regulationsystem.
-30-OnlineGamesPublishingandCulturalProductsOnDecember30,1997,GAPPissuedtheRulesfortheAdministrationofElectronicPublications,orElectronicPublicationRules,whichtookeffectonJanuary1,1998.
TheseruleswerereplacedbynewElectronicPublicationRulespromulgatedonFebruary21,2008,whichtookeffectonApril15,2008.
TheElectronicPublicationRulesregulatetheproduction,publishingandimportationofelectronicpublicationinthePRCandoutlinealicensingsystemforbusinessoperationsinvolvingelectronicpublishing.
UndertheElectronicPublicationRulesandotherregulationsissuedbyGAPP,onlinegamesareclassiedasakindofelectronicproductionandpublishingofonlinegamesisrequiredtobedonebylicensedelectronicpublishingentitieswithstandardpublicationcodes.
UndertheElectronicPublicationRules,ifaPRCcompanyiscontractuallyauthorizedtopublishforeignelectronicpublications,itmustobtaintheapprovalof,andregisterthecopyrightlicensecontractwith,GAPP.
Theonlinegameswecurrentlyofferarepublishedbythirdpartieswhoholdelectronicpublishinglicenses.
Thetermofouragreementswiththepublishersinconnectionwiththepublicationofouronlinegames,namely,TLBB,BOandBH2,willexpireonDecember5,2010,December20,2010andFebruary22,2012,respectively.
OurexistingonlinegamesinoperationhavebeenledwithGAPPaselectronicpublications.
GAPPandtheMIITjointlypromulgatedtheTentativeMeasuresforInternetPublicationAdministration,orInternetPublicationMeasures,onJune27,2002,whichtookeffectonAugust1,2002andimposedalicenserequirementforanycompanythatintendstoengageinInternetpublishing,denedasanyactbyanInternetinformationserviceprovidertoselect,editandprocesscontentorprogramsandtomakesuchcontentorprogramspubliclyavailableontheInternet.
SincetheprovisionofonlinegamesisdeemedanInternetpublicationactivity,anonlinegameoperatorneedstoobtainanInternetpublishinglicenseinordertodirectlymakeitsonlinegamespubliclyavailableinthePRC.
WeareintheprocessofapplyingforsuchlicensewithGAPP.
OnMay10,2003,theMOCissuedtheProvisionalRegulationsfortheAdministrationofOnlineCulture,whichtookeffectonJuly1,2003,asamendedonJuly1,2004(ortheOnlineCultureRegulations).
Thisregulationappliestoentitiesengaginginactivitiesrelatedto"onlineculturalproducts,"includingmusicandvideoles,networkgames,animationfeaturesandaudiovisualproducts,performedplaysandartworkconvertedfordisseminationviatheInternet.
Pursuanttothislegislation,commercialentitiesarerequiredtoapplytotherelevantlocalbranchoftheMOCforanOnlineCultureOperatingPermitiftheyengageinanyofthefollowingtypesofactivities:theproduction,duplication,importation,wholesale,retail,leasingorbroadcastingofonlineculturalproducts;thedisseminationofonlineculturalproductsontheInternetortransmissionthereoftocomputers,xed-lineormobilephones,radios,televisionsetsorgamingconsolesforthepurposeofbrowsing,reading,usingordownloadingsuchproducts;ortheexhibitionorholdingofcontestsrelatedtoonlineculturalproducts.
InJanuary2008,theMOCissuedanOnlineCultureOperatingPermittoGamease,authorizingGameasetooperateonlinegames.
Inaddition,accordingtotheOnlineCultureRegulations,domesticallydevelopedonlinegamesarerequiredtobeledwiththeMOCwithin60daysafterreleaseinthePRC.
Accordingly,wehaveledwithMOCapplicationtoregisterourin-housedevelopedonlinegame,TLBB.
OnJuly1,2009,GAPPissuedtheNoticeonStrengtheningtheApprovalandAdministrationofImportedOnlineGames,whichtookeffectonthesamedateofpromulgation.
Pursuanttothisnotice,GAPPistheonlycompetentapprovalauthorityauthorizedbytheStateCouncilforimportedonlinegamesauthorizedbyoffshorecopyrightowners.
AnyenterprisewhichengagesinonlinegamepublicationandoperationservicewithinChinamustobtaintheexaminationandapprovalofGAPPandrelevantInternetpublicationservice-31-license.
Moreover,theactivitieswhichinvolvetheshowing,exhibiting,tradingandpromotingofoffshoreonlinegameproductionheldinChinashallalsoobtaintheexaminationandapprovalofGAPPaccordingtothisnotice.
OnSeptember7,2009,theStateCommissionOfceforPublicSectorReformhasissuedtheNoticeonInterpretationoftheStateCommissionOfceforPublicSectorReformonSeveralProvisionsrelatingtoAnimation,OnlineGameandComprehensiveLawEnforcementinCultureMarketinthe'ThreeProvisions'jointlypromulgatedbyMOC,SARFTandGAPP,whichtookeffectonthesamedateofpromulgation.
Accordingtothisnotice,GAPPshallberesponsiblefortheexaminationandapprovaloftheonlinegamestobeuploadedontheInternet,andaftertheuploadontheInternet,theonlinegamesshallbecompletelyadministratedbyMOC.
ThenoticefurtherclariesthatGAPPshallberesponsiblefortheexaminationandapprovalofthegamepublicationswhichareauthorizedbyoffshorecopyrightownerstobeuploadedontheInternet,andtheotherimportedonlinegamesshallbeexaminedandapprovedbyMOC.
OnSeptember28,2009,GAPP,NationalCopyrightAdministration,andNationalOfceofCombatingPornographyandIllegalPublicationsjointlypublishedtheFurtherStrengtheningoftheAdministrationofPre-examinationandApprovalofOnlineGamesandtheExaminationandApprovalofImportedOnlineGameswhichtookeffectonthesamedateofpromulgation.
ThisnoticerestatesthatforeigninvestorsarenotpermittedtoinvestinonlinegameoperatingbusinessesinChinaviawholly-owned,equityjointventureorcooperativejointventureinvestmentsandexpresslyprohibitsforeigninvestorsfromgainingcontroloverorparticipatingindomesticonlinegameoperatorsthroughestablishingotherjointventurecompanies,orcontractualortechnicalarrangements.
Accordingtothisnotice,wherenewversions,expansionpacksornewcontentshallbeupdatedforonlinegameswhichhavebeenapprovedbyGAPP,theoperationentityshallundertakethesameproceduresfortheexaminationandapprovalbyGAPPofsuchnewversions,expansionpacksornewcontent.
OnNovember13,2009,MOCissuedtheCircularonImprovingandStrengtheningtheAdministrationofContentinOnlineGames.
Thiscircularemphasizesthatacorrectculturevaluetendencyshallbemaintainedtoenhancethecultureimplicationinonlinegames,andmodesofthegameswhichmainlycompriseofupgradingbykillingthebeasts,thePKsystemandmarriagesysteminthegameshallbefurtherrestricted,aswellastoprotectminorgameplayersbyguidingtheminregistrationandlimitingtheirgamingtimethroughtechnicalmeasures.
SoftwareProductsRegistrationOnOctober27,2000,theMIITissuedtheMeasuresConcerningSoftwareProductsAdministration,orSoftwareMeasures,toregulatesoftwareproductsandpromotethedevelopmentofthesoftwareindustryinthePRC.
TheseSoftwareMeasureshavebeenamendedandreplacedbythenewSoftwareMeasuresissuedbytheMIITonMarch1,2009effectiveasofApril10,2009.
PursuanttothenewSoftwareMeasures,softwaredevelopersorproducersareallowedtosellorlicensetheirsoftwareproductsindependentlyorthroughagents.
SoftwareproductsdevelopedinthePRCcanberegisteredwiththelocalprovincialgovernmentauthoritiesinchargeoftheinformationindustryandledwiththeMIIT.
Uponregistration,thesoftwareproductsshallbegrantedregistrationcerticates.
Eachregistrationcerticateisvalidforveyearsandmaybereneweduponexpiration.
SoftwareproductsdevelopedinthePRCwhichsatisfytherequirementsoftheSoftwareMeasuresandhavebeenregisteredandledinaccordancewiththeSoftwareMeasuresmayenjoypreferentialtreatmentsunderrelevantpolicyoftheStateCouncil.
TheMIITandotherrelevantdepartmentsmaysuperviseandinspectthedevelopment,production,saleandimportandexportofsoftwareproductsinthePRC.
Wehaveregisteredallsoftwareproductswhichwecurrentlyoperate.
ImportandExportofOnlineGamesPursuanttotheOnlineCultureRegulations,anOnlineGameImportApprovalmustbeobtainedfromtheGAPPbeforeagameislaunchedinChina.
TheGAPPhandlesapplicationsforsuchapprovalthroughits-32-provincialbranches.
ThelocalprovincialbureauoftheGAPPwillreviewanapplicationandforwardittotheGAPPforapprovalwithin20daysofitsowndecision,togetherwithapreliminaryapprovaldocument.
TheOnlineCultureRegulationsalsorequirethatimportedonlinegamesbesubjecttoacontentreviewandapprovalbytheMOC.
OnMay14,2004,theMOCissuedtheNoticeRegardingtheStrengtheningofOnlineGameCensorship(ortheOnlineGameNotice).
Thisnoticemandatestheestablishmentofanewcommitteenamed"CommitteefortheCensorshipoftheContentofImportedGameProducts"undertheMOC,whichwillberesponsibleforthecensorshipofpoliticallysensitivecontentinimportedonlinegames.
Thecommitteewillalsoberesponsibleforcensorshipofgamesthat"threatennationalsecurity","disturbsocialorder","distorthistoricalfacts"or"infringeonthirdpartyintellectualpropertyrights".
OnApril24,2009,theMOCissuedthePublicAnnouncementonRegulatingApplicationsfortheExaminationoftheContentofImportedOnlineGames(ortheAnnouncement).
TheAnnouncementemphasizesthatenterprisesoperatingimportedonlinegamesmustapplyforthecontentofthosegamestobeexaminedbytheMOCinaccordancewiththeOnlineGameNotice.
Theversionofanimportedonlinegamewhichisledforexaminationmustbethesameasthatwhichisultimatelyoperatedorpubliclytested.
Inadditiontotheindustryregulationonimportofonlinegames,Chinaimposescontrolsontheimportandexportofonlinegameastechnology.
OnDecember10,2001,theStateCouncilpromulgatedRegulationsonAdministrationofImportandExportofTechnologies.
Theterm"technologyimportandexport"isbroadlydenedintheregulationstoinclude,withoutlimitation,thetransferorlicenseofpatents,softwareandknow-how,andtheprovisionofservicesinrelationtotechnology.
Dependingonthenatureoftherelevanttechnology,theimportandexportoftechnologyrequireeitherapprovalby,orregistrationwith,therelevantPRCgovernmentalauthorities.
WehaveenteredintolicenseagreementswiththirdpartiesoutsideofChinatolicenseourgames,whichconstitutetheexportoftechnologyundertheregulations.
Asaresult,suchlicensesarerequiredtoberegisteredwithapplicablePRCgovernmentalauthorities.
GameaseiscurrentlyinprocessofregisteringtheexportofcertainofitstechnologiesanditslicenseagreementswiththerelevantPRCgovernmentalauthorities.
Anti-FatigueSystemandReal-nameRegistrationSystemOnApril15,2007,theMIIT,theGAPP,theMinistryofEducationandveothergovernmentauthorities,jointlyissuedtheNoticeontheImplementationofOnlineGameAnti-FatigueSystemtoProtectthePhysicalandPsychologicalHealthofMinors(ortheAnti-FatigueNotice).
PursuanttotheAnti-FatigueNotice,onlinegameoperatorsarerequiredtoinstallan"anti-fatiguesystem"thatdiscouragesgameplayersfromplayinggamesformorethanvehoursperday.
Undertheanti-fatiguesystem,threehoursorlessofcontinuousplaybyminorsisconsideredtobe"healthy,"threetovehourstobe"fatiguing,"andvehoursormoretobe"unhealthy.
"Gameoperatorsarerequiredtoreducethevalueofin-gamebenetstoagameplayerbyhalfifthegameplayerhasreached"fatiguing"level,andtozerointhecaseof"unhealthy"level.
Toidentifywhetheragameplayerisaminorandthussubjecttotheanti-fatiguesystem,areal-nameregistrationsystemisalsoadopted,whichrequiresonlinegameplayerstoregistertheirrealidentityinformationbeforetheyplayonlinegamesandrequiresustosubmittheidentityinformationofgameplayerstothepublicsecurityauthorityforverication.
Wehavedevelopedourownanti-fatiguesystemandreal-nameregistrationsystemforourgames,andhaveimplementedthemsince2007.
Underoursystem,gameplayersmustuserealidenticationinordertocreateaccounts,andinthisway,weareabletotellwhichofourgameplayersareminorsandthussubjecttotheseregulations.
Forgameplayerswhodonotregister,weassumethattheyareminors.
Inordertocomplywiththeanti-fatiguerules,gameplayersunder18yearsofageonlyreceivehalfoftheexperiencetimetheyactuallyearnafterthreehoursofplay.
And,aftervehoursofplay,minorsreceivenoexperiencepoints.
Weusethissystemtodis-incentivizeminorsfromplayinginexcessofvehoursatatime.
-33-VirtualCurrencyOnFebruary15,2007,theMOC,thePeople'sBankofChinaandotherrelevantgovernmentauthoritiesjointlyissuedtheNoticeontheReinforcementoftheAdministrationofInternetCafesandOnlineGames(ortheInternetCafesNotice).
UndertheInternetCafesNotice,thePeople'sBankofChinaisdirectedtostrengthentheadministrationofthevirtualcurrencyinonlinegamestoavoidanyadverseimpactontherealeconomicandnancialorder.
Thisnoticeprovidesthatthetotalamountofvirtualcurrencyissuedbyonlinegameoperatorsandtheamountpurchasedbyindividualusersshouldbestrictlylimited,withastrictandcleardivisionbetweenvirtualtransactionsandrealtransactionscarriedoutbywayofelectroniccommerce.
Thisnoticealsoprovidesthatvirtualcurrencyshouldonlybeusedtopurchasevirtualitems.
OnJune4,2009theMOCandtheMinistryofCommercejointlyissuedtheNoticeontheStrengtheningofAdministrationonOnlineGameVirtualCurrency(ortheVirtualCurrencyNotice).
VirtualCurrencyisbroadlydenedintheNoticeasfollows:AtypeofvirtualexchangeinstrumentissuedbyInternetgameoperationenterprises,purchaseddirectlyorindirectlybythegameuserbyexchanginglegalcurrencyatacertainexchangerate,savedoutsidethegameprograms,storedinserversprovidedbytheInternetgameoperationenterprisesinelectronicrecordformatandrepresentedbyspecicnumericunits.
VirtualcurrencyisusedtoexchangeInternetgameservicesprovidedbytheissuingenterpriseforadesignatedextentandtime,andisrepresentedbyseveralforms,suchasprepaidgamecards,prepaidamountsorInternetgamepoints,anddoesnotincludegamepropsobtainedfromplayingonlinegames.
Notably,gameprops(i.
e.
,virtualitemsorequipmentusedinaparticulargame),areexplicitlyexcludedfromtheabovedenition.
TheVirtualCurrencyNoticespecicallystatesthatgamepropsshouldnotbeconfusedwithvirtualcurrencyandthattheMOC,jointlywithotherauthorities,willissueseparaterulestogovernthem.
OnJuly20,2009,MOCpromulgatedtheFilingGuidelinesonOnlineGameVirtualCurrencyIssuingEnterpriseandOnlineGameVirtualCurrencyTradingEnterprise,whichspecicallydenesthemeaningsof"issuingenterprise"and"tradingenterprise"andstipulatesthatthebothbusinessmaynotbeoperatedbythesameenterprise.
PrivacyProtectionChineselawdoesnotprohibitInternetcontentprovidersfromcollectingandanalyzingpersonalinformationfromtheirusers.
Werequireouruserstoacceptauseragreementwherebytheyagreetoprovidecertainpersonalinformationtous.
ChineselawprohibitsInternetcontentprovidersfromdisclosingtoanythirdpartiesanyinformationtransmittedbyusersthroughtheirnetworksunlessotherwisepermittedbylaw.
IfanInternetcontentproviderviolatestheseregulations,theMIIToritslocalbureausmayimposepenaltiesandtheInternetcontentprovidermaybeliablefordamagescausedtoitsusers.
InternetCafePursuanttotheInternetCafesNotice,InternetcafesarerequiredtoobtainanOnlineCultureOperatingPermitfromtheMOCandregisterthesamewiththeStateAIC.
TheInternetCafesNoticealsoprovidesrestrictionswithrespecttoInternetcafes'location,size,numberofcomputers,businesshoursandtheagesoftheircustomers.
Forinstance,Internetcafesareprohibitedfromoperatingduringthehoursbetween12a.
m.
and8a.
m.
AlthoughwedonotoperateanyInternetcafes,therestrictiveregulationsontheoperationofInternetcafesmaynegativelyaffectourbusinessoperations,becausemanyofourMMORPGusersaccessthegamesthroughcomputersatInternetcafes.
OnFebruary15,2007,theMOCandotherrelevantgovernmentauthoritiesjointlyissuedtheNoticeontheReinforcementoftheAdministrationofInternetCafesandOnlineGames,ortheInternetCafesNotice,whichsuspendednationwidetheapprovalfortheestablishmentofnewInternetcafesin2007andimposedtougherpenaltiesforInternetcafesadmittingminors.
In2008and2009,theMOC,SAICandotherrelevantgovernmentauthorities,individuallyorjointly,haveissuedseveralnoticeswhichprovidevariouswaystostrengthentheregulationofInternetcafes,includinginvestigatingandpunishingtheInternetcafeswhichacceptminors,crackingdownonInternetcafeswithoutsufcientandvalid-34-licenses,limitingthetotalnumberofInternetcafes,screeningunlawfulgamesandWebsites,andimprovingthecoordinationofregulationoverInternetcafesandonlinegames.
LawsandRegulationsRelatedtoWirelessServicesSohuInternetandGoodFeel'sbusinessactivitiesincludetheprovisionofonlineservicesrelatedtowirelessservices,includingSMS,RBT,WAP,MMSandIVR.
OnApril25,2004,theMIITissuedanoticestatingthatmobilenetworkoperatorscanonlyprovidemobilenetworkaccesstothosemobileInternetserviceproviderswhichhaveobtainedlicensesfromtherelevantlocalarmoftheMIITbeforeconductingoperations,andthatsuchcarriersmustterminatemobilenetworkaccessforthoseproviderswhohavenotsecuredtherequiredlicenseswithinathirty-daygraceperiod.
Onthebasisofthenotice,CMCChasrequiredeachofitsmobileInternetserviceproviderstorstobtainalicensefortrans-regionalvalue-addedtelecommunicationsservicesinordertogainfullaccesstoitsmobilenetwork,whichisanationwidepolicyinlinewithasimilarnoticeissuedbytheBeijingbranchofCMCConApril12,2004.
SohuInternetandGoodFeelweregrantedrenewedlicensestoprovidetrans-regionalvalue-addedtelecommunicationservicesonAugust19,2009andJanuary21,2008,respectively.
LawsandRegulationsRelatedtoConsumerProtectionandE-mailServicesTheMIIThassetforthvariousrequirementsforconsumerprotectioninanoticeissuedonApril15,2004,whichaddressescertainproblemsinthetelecommunicationssector,includingambiguityinbillingpracticesforpremiumservices,poorqualityofconnectionsandunsolicitedSMSmessages,allofwhichinfringeupontherightsofconsumers.
ThistrendwascontinuedwiththeissuanceoftheNoticeRegardingtheRaticationandAdministrationofMobileInformationServicesFeesandChargesMethodbyMIITonSeptember8,2006.
Inaddition,therehasbeenamovementinChinatowardindustryself-regulationtocombattheproblemofunsolicitede-mails.
Specically,onMarch25,2003,theChinaInternetAssociationissuedtheAnti-SpamE-MailGuidelines.
TheseguidelinessetforthanumberofmechanismsthatInternetserviceprovidersinChinamayadopttocutdowntheuseoftheirsystemstosendunsolicitede-mail.
Wehaveadoptedtheseguidelinesinouroperations.
OnFebruary20,2006,theMIITpromulgatedtheMeasuresfortheAdministrationofInternetE-mailsServices,effectiveasofMarch30,2006.
Underthesenewregulations,the"Opt-in"Systemisexpectedtobeintroducedintotheareaofe-mailservices,wherebye-mailscontainingcommercialadvertisementsarenotdeliveredunlessspecicallyrequestedbyusers.
Furthermore,thesubjectlineofalle-mailscontainingcommercialadvertisementswillberequiredtohavethelabelof"advertisement"or"AD".
Inaddition,theIPaddressofeachserverthatsupportse-mailwillberegisteredinordertofacilitatethetracingandidenticationofspamsources.
Wehaveadjustedoure-mailsystemsandformstofullltherelevantrequirements.
WeareawareoftheincreasinglystrictlegalenvironmentcoveringconsumerprotectioninChina,andweattempttoadoptallnecessarymeasurestoensurethatourbusinesscomplieswiththeseevolvingstandards.
LawsandRegulationsRelatedtoForeignCurrencyExchangeandDividendDistributionForeignCurrencyExchange.
TheprincipalregulationsgoverningforeigncurrencyexchangeinChinaaretheForeignExchangeAdministrationRegulations,asamendedinAugust2008.
UndertheRegulations,theRMBisfreelyconvertibleforcurrentaccountitems,includingthedistributionofdividends,interestpayments,tradeandservice-relatedforeignexchangetransactions,butnotforcapitalaccountitems,suchasdirectinvestments,-35-loans,repatriationofinvestmentsandinvestmentsinsecuritiesoutsideofChina,unlessthepriorapprovaloftheSAFEisobtainedandpriorregistrationwiththeSAFEismade.
OnAugust29,2008,SAFEpromulgatedanotice,Circular142,regulatingtheconversionbyaforeign-investedcompanyofforeigncurrencyintoRMBbyrestrictinghowtheconvertedRMBmaybeused.
Thenoticerequiresthattheregisteredcapitalofaforeign-investedcompanysettledinRMBconvertedfromforeigncurrenciesmayonlybeusedforpurposeswithinthebusinessscopeapprovedbytheapplicablegovernmentalauthorityandmaynotbeusedforequityinvestmentswithinthePRC.
Inaddition,SAFEstrengtheneditsoversightoftheowanduseoftheregisteredcapitalofaforeign-investedcompanysettledinRMBconvertedfromforeigncurrencies.
TheuseofsuchRMBcapitalmaynotbechangedwithoutSAFE'sapproval,andmaynotinanycasebeusedtorepayRMBloansiftheproceedsofsuchloanshavenotbeenused.
ViolationsofCircular142willresultinseverepenalties,suchasheavynes.
Asaresult,Circular142maysignicantlylimitourabilitytotransferthenetproceedsfromChangyou'sinitialpublicofferingtoGameasethroughoursubsidiaryinthePRC,whichmayadverselyaffectthebusinessexpansionofGamease,andwemaynotbeabletoconvertthenetproceedsintoRMBtoinvestinoracquireanyotherPRCcompanies,orestablishotherVIEsinthePRC.
ThedividendspaidbythesubsidiarytoitsoverseasshareholderaredeemedincomeoftheshareholderandaretaxableinChina.
PursuanttotheAdministrationRulesoftheSettlement,SaleandPaymentofForeignExchange(1996),foreign-investedenterprisesinChinamaypurchaseorremitforeigncurrency,subjecttoacapapprovedbytheSAFE,forsettlementofcurrentaccounttransactionswithouttheapprovaloftheSAFE.
Foreigncurrencytransactionsunderthecapitalaccountarestillsubjecttolimitationsandrequireapprovalsfrom,orregistrationwith,theSAFEandotherrelevantPRCgovernmentalauthorities.
DividendDistribution.
TheprincipalregulationsgoverningdistributionofdividendsofforeignholdingcompaniesincludetheForeignInvestmentEnterpriseLaw(1986),asamended,andtheAdministrativeRulesundertheForeignInvestmentEnterpriseLaw(2001).
Undertheseregulations,foreigninvestmententerprisesinChinamaypaydividendsonlyoutoftheiraccumulatedprots,ifany,determinedinaccordancewithPRCaccountingstandardsandregulations.
Inaddition,foreigninvestmententerprisesinChinaarerequiredtoallocateatleast10%oftheirrespectiveaccumulatedprotseachyear,ifany,tofundcertainreservefundsunlessthesereserveshavereached50%oftheregisteredcapitaloftheenterprises.
Thesereservesarenotdistributableascashdividends.
Furthermore,effectivefromJanuary1,2008,accordingtotheCorporateIncomeTaxLaw,themaximumtaxrateforthewithholdingtaximposedondividendspaymentfromPRCforeigninvestedcompaniestotheiroverseasinvestorsthatarenotregardedas"resident"fortaxpurposeis20%.
Theratehasbeenreducedto10%undertheImplementingRegulationsforthePRCCorporateIncomeTaxLawissuedbytheStateCouncil.
However,alowerwithholdingtaxrate,whichis5%,mightbeappliedifthereisataxtreatyarrangementbetweenChinaandthejurisdictionoftheforeignholdingcompanies,suchasHongKong.
Circular75.
OnOctober21,2005,theSAFEissuedCircular75,whichbecameeffectiveasofNovember1,2005.
UnderCircular75,priorregistrationwiththelocalSAFEbranchisrequiredforPRCresidentstoestablishortocontrolanoffshorecompanyforthepurposesofnancingthatoffshorecompanywithassetsorequityinterestsinanonshoreenterpriselocatedinthePRC.
AnamendmenttoregistrationorlingwiththelocalSAFEbranchbysuchPRCresidentisalsorequiredfortheinjectionofequityinterestsorassetsofanonshoreenterpriseintheoffshorecompanyoroverseasfundsraisedbysuchoffshorecompany,oranyothermaterialchangeinvolvingachangeinthecapitaloftheoffshorecompany.
Moreover,Circular75appliesretroactively.
Asaresult,PRCresidentswhohaveestablishedoracquiredcontrolofoffshorecompaniesthathavemadeonshoreinvestmentsinthePRCinthepastarerequiredtocompletetherelevantregistrationprocedureswiththelocalSAFEbranchbyMarch31,2006.
Undertherelevantrules,failuretocomplywiththeregistrationproceduressetforthinCircular75mayresultinrestrictionsbeingimposedontheforeignexchangeactivitiesoftherelevantonshorecompany,includingtheincreaseofitsregisteredcapital,thepaymentofdividendsandotherdistributionstoitsoffshoreparentorafliateandthecapitalinowfromtheoffshoreentity,andmayalsosubjectrelevantPRCresidentsto-36-penaltiesunderPRCforeignexchangeadministrationregulations.
PRCresidentswhocontrolourcompanyfromtimetotimearerequiredtoregisterwiththeSAFEinconnectionwiththeirinvestmentsinus.
StockOptionRule.
OnDecember25,2006,thePBOCissuedtheAdministrationMeasuresonIndividualForeignExchangeControl,anditsImplementationRuleswasissuedbySAFEonJanuary5,2007,bothofwhichbecameeffectiveonFebruary1,2007.
Undertheseregulations,allforeignexchangemattersinvolvedintheemployeestockownershipplan,stockoptionplanandetc.
participatedbyonshoreindividualsshallbetransactedupontheapprovalfromtheSAFEoritsauthorizedbranch.
OnMarch28,2007,SAFEpromulgatedtheApplicationProcedureofForeignExchangeAdministrationforDomesticIndividualsParticipatinginEmployeeStockHoldingPlanorStockOptionPlanofOverseasListedCompany,ortheStockOptionRule.
UndertheStockOptionRule,PRCcitizenswhoaregrantedstockoptionsorrestrictedshareunits,orissuedrestrictedsharesbyanoverseaspubliclylistedcompanyarerequired,throughaPRCagentorPRCsubsidiaryofsuchoverseaspubliclylistedcompany,tocompletecertainotherproceduresandtransactionalforeignexchangemattersundertheStockOptionPlanupontheexaminationby,andapprovalof,SAFE.
WeandourPRCemployeeswhohavebeengrantedstockoptionsorrestrictedshareunits,orissuedrestrictedsharesaresubjecttotheStockOptionRule.
Weandouremployees,whoarePRCcitizensandhavebeengrantedstockoptionsorrestrictedshareunitsorissuedrestrictedshares,aresubjecttotheStockOptionRule.
WeandouremployeesintendtomakesuchapplicationandcompletealltherequisiteproceduresinaccordancewiththeStockOptionRule.
However,wecannotassureyouthatwecancompletealltheproceduresinatimelymanner.
IftherelevantPRCregulatoryauthoritydeterminesthatourPRCemployeeswhoholdsuchoptions,restrictedshareunitsorrestrictedsharesortheirPRCemployerfailtocomplywiththeseregulationsafterourinitialpublicoffering,suchemployeesandtheirPRCemployermaybesubjecttonesandotherlegalsanctions.
NewM&ARegulationsandOverseasListingsOnAugust8,2006,sixPRCregulatoryagencies,includingtheMinistryofCommerce,theStateAssetsSupervisionandAdministrationCommission,theStateAdministrationforTaxation,theStateAdministrationforIndustryandCommerce,theCSRCandtheSAFE,jointlyissuedtheRegulationsonMergersandAcquisitionsofDomesticEnterprisesbyForeignInvestors,ortheNewM&ARule,whichbecameeffectiveonSeptember8,2006.
ThisNewM&ARule,amongotherthings,includesprovisionsthatpurporttorequirethatanoffshorespecialpurposevehicleformedforpurposesofoverseaslistingofequityinterestsinPRCcompaniesandcontrolleddirectlyorindirectlybyPRCcompaniesorindividualsobtaintheapprovaloftheCSRCpriortothelistingandtradingofsuchspecialpurposevehicle'ssecuritiesonanoverseasstockexchange.
OnSeptember21,2006,theChinaSecuritiesRegulatoryCommission,orCSRC,publishedonitsofcialWebsiteproceduresregardingitsapprovalofoverseaslistingsbyspecialpurposevehicles.
TheCSRCapprovalproceduresrequirethelingofanumberofdocumentswiththeCSRCanditwouldtakeseveralmonthstocompletetheapprovalprocess.
TheapplicationofthisnewPRCregulationremainsunclear,withnoconsensuscurrentlyexistingamongleadingPRClawrmsregardingthescopeoftheapplicabilityoftheCSRCapprovalrequirement.
EmploymentContractOnJune29,2007,theNationalPeople'sCongresspromulgatedtheEmploymentContractLawofPRC(orEmploymentContractLaw),whichbecameeffectiveasofJanuary1,2008.
TheEmploymentContractLawrequiresemployerstoprovidewrittencontractstotheiremployees,restrictstheuseoftemporaryworkersandaimstogiveemployeeslong-termjobsecurity.
PursuanttotheEmploymentContractLaw,employmentcontractslawfullyconcludedpriortotheimplementationoftheEmploymentContractLawandcontinuingasofthedateofitsimplementationshallcontinuetobeperformed.
Whereanemploymentrelationshipwasestablishedpriortotheimplementationof-37-theEmploymentContractLawbutnowrittenemploymentcontractwasconcluded,acontractmustbeconcludedwithinonemonthafteritsimplementation.
OnSeptember18,2008,theStateCouncilpromulgatedtheImplementingRegulationsforthePRCEmploymentContractLawwhichcameintoeffectimmediately.
TheseregulationsinterpretandsupplementtheprovisionsoftheEmploymentContractLaw.
WehavemodiedourstandardemploymentcontracttocomplywiththerequirementsoftheEmploymentContractLawanditsimplementingregulations.
Wehaveenteredintowrittenemploymentcontractswithallofouremployees.
ConclusionIntheopinionofTransAsiaLawyers,ourcompaniesareapprovedtoengageinthespeciconlineservices(categorizedandaddressedintheabovesections)asdescribedintherespectivescopesindicatedinthecorrespondinglicensesand/orpermitsissuedtotherespectivecompanies.
INTELLECTUALPROPERTYANDPROPRIETARYRIGHTSWeregardourpatents,copyrights,servicemarks,trademarks,tradesecretsandotherintellectualpropertyascriticaltooursuccess.
Werelyonpatent,trademarkandcopyrightlaw,tradesecretprotection,non-competitionandcondentialityand/orlicenseagreementswithouremployees,customers,partnersandotherstoprotectourintellectualpropertyrights.
Despiteourprecautions,itmaybepossibleforthirdpartiestoobtainanduseourintellectualpropertywithoutauthorization.
Furthermore,thevalidity,enforceabilityandscopeofprotectionofintellectualpropertyrightsinInternet-relatedindustriesareuncertainandstillevolving.
ThelawsofthePRCandcertainothercountriesdonotprotectintellectualpropertytothesameextentasdothelawsoftheUnitedStates.
WehaveregisteredthreeservicemarkswiththeU.
S.
PatentandTrademarkOfce.
Theyare(i)Sohu.
com,registeredonAugust1,2000;(ii)Sohu.
com(stylized),registeredonAugust1,2000;and(iii)Sohu,registeredonJune13,2000.
Wereceivedtheregistrationcerticateforthemark"Sohu.
com"issuedbytheChinaTrademarkOfceinOctober2000.
WehavealsoledregistrationapplicationswiththeChinaTrademarkOfcetoregisterotherkeymarks,includingtheSohuFoxlogo,17173.
com,Focus.
cn,GoodFeel,Sogou,Go2Map,TLBB,Changyou,DMDandtheircorrespondingChineseversionmarks.
Wesucceededinregisteringcertainmarkssuchas17173,Focus.
cn,GoodFeel,Go2MapandSogouandTLBBinthePRCundercertainclasses,whiletheothersarestillunderexaminationbytheChinaTrademarkOfce.
WealsoledregistrationoftrademarksrelatingtooursubsidiarycompanynameandourMMOPRGsinvariouscountriesandregions,suchasUnitedStates,Europe,Malaysia,TurkeyandVietnam.
Ourrightstothesemarkscouldbeaffectedadverselyifanyofourapplicationsarerejected.
Inaddition,itispossiblethatourcompetitorswilladoptproductorservicenamessimilartoours,therebyimpedingourabilitytodistinguishourbrandandpossiblyleadingtocustomerconfusion.
Manypartiesareactivelydevelopingchat,homepage,searchandrelatedWebtechnologies.
Weexpectthesepartiestocontinuetotakestepstoprotectthesetechnologies,includingseekingpatentprotection.
Theremaybepatentsissuedorpendingthatareheldbyothersandcoversignicantpartsofourtechnology,businessmethodsorservices.
Forexample,weareawarethatanumberofpatentshavebeenissuedintheareasofe-commerce,Web-basedinformationindexingandretrievalandonlinedirectmarketing.
Disputesoverrightstothesetechnologiesmayariseinthefuture.
Wecannotbecertainthatourproductsdonotorwillnotinfringevalidpatents,copyrightsorotherintellectualpropertyrightsheldbythirdparties.
Wemaybesubjecttolegalproceedingsandclaims,fromtimetotime,relatingtotheintellectualpropertyofothersintheordinarycourseofourbusiness.
-38-Wealsointendtocontinuelicensingtechnologyfromthirdparties.
Themarketisevolvingandwemayneedtolicenseadditionaltechnologiestoremaincompetitive.
Wemaynotbeabletolicensethesetechnologiesoncommerciallyreasonabletermsoratall.
Inaddition,wemayfailtosuccessfullyintegrateanylicensedtechnologyintoourservices.
Ourinabilitytoobtainanyoftheselicensescoulddelayproductandservicedevelopmentuntilalternativetechnologiescanbeidentied,licensedandintegrated.
TECHNOLOGYINFRASTRUCTUREWehavebuiltwhatwebelieveisareliableandsecurenetworkinfrastructure,thatwillfullysupportouroperations,whichincludeoneofthemostcomprehensivematricesofChineselanguageWebpropertiesandoneofthemostpopularonlinegamesinChina.
TofullysupportouroperationoftheWebproperties,wehaveestablishedthreemainserviceprovisioncentersinBeijingthroughChinaUnitedNetworkCommunicationGroupCompanyLimited(orChinaUnicom),ChinaTelecomCorporation(orChinaTelecom),andChinaEducationandResearchNetwork(orCERNET),tomaintainmostofourservers.
ChinaUnicom,ChinaTelecom,andCERNETarethethreelargestInternetconnectionserviceprovidersinChinaandtheirnodesinBeijingareoneoftheircorenodesacrossChina.
Inaddition,wehaveestablishedmanybranchnodesindifferentprovincesthroughoutChinathroughdifferentInternetconnectionoperators,suchasChinaUnicom,ChinaTelecom,CERNET,andChinaMobileinordertoestablishnationalcoverageandprovidefastandstableaccesstoourWebsitepropertiestousersacrossChina.
WehavedevelopedacloseworkingrelationshipwithChinaUnicomanditsBeijingSubsidiary,ChinaTelecomandCERNET.
OuroperationsdependontheabilityofChinaUnicomanditsBeijingSubsidiary,ChinaTelecomandCERNETtoprotecttheirsystemsagainstdamagefromre,powerloss,telecommunicationsfailure,break-insandotherevents.
ChinaUnicomanditsBeijingSubsidiary,ChinaTelecomandCERNETprovideuswithsupportservicestwenty-fourhoursperday,sevendaysperweek.
ChinaUnicomanditsBeijingSubsidiary,ChinaTelecomandCERNETalsoprovideconnectivityforourserversthroughmultiplehigh-speedconnections.
Allfacilitiesareprotectedbymultiplepowersupplies.
Forreliability,availability,andserviceability,wehavecreatedanenvironmentinwhicheachservercanfunctionseparately.
Keycomponentsofourserverarchitectureareservedbymultipleredundantmachines.
Wealsousein-houseandthird-partymonitoringsoftware.
Ourreportingandtrackingsystemsgeneratedailytrafc,demographicandadvertisingreports.
Wedeployloadbalanceequipmenttoavoidsinglepointfailure.
Ouroperationsmustaccommodateahighvolumeoftrafcanddeliverfrequentlyupdatedinformation.
Componentsorfeaturesofourproductsandserviceshaveinthepastsufferedoutagesorexperiencedslowerresponsetimesbecauseofequipmentorsoftwaredowntime.
Theseeventshavenothadamaterialadverseeffectonourbusinesstodate,butsucheventscouldhaveamaterialadverseeffectinthefuture.
Wehavealsobuiltwhatwebelieveisareliableandsecurenetworkinfrastructurethatwillfullysupportouronlinegameoperations.
InordertomaintainstableoperationsofourMMORPGs,asofDecember31,2009wemaintainedapproximately2,600serverslocatedinInternetdatacentersineightmajorcitiesinChina,withthecapacitytoaccommodateupto1.
7millionconcurrentgameplayers,andasufcientamountofconnectivitybandwidthtomaintainsuchservice.
Inordertoenhanceourgameplayers'experienceandminimizetheimpactofcross-regionconnections,wehavelocatedourgameserversinanumberofregionsthroughoutChina,enablingourgameplayerstoplayourgamesbyconnectingtothenearestserverslocatedintheirregionwithoutneedingtoexchangedataacrossthenationalbackbonenetwork.
Wehavetechnicalsupportemployeestomaintainourcurrenttechnologyinfrastructureanddevelopnewsoftwarefeaturestofurtherenhancethefunctionalityofourmanagementandsecuritysystem.
Wemonitortheoperationofourservernetwork24hoursaday,sevendaysaweek.
Ourremotecontrolsystemallowsustotrackourconcurrentonlineusersinrealtime,anddiscoverandxproblemsintheoperationofhardwareandsoftwareinourservernetworkinatimelyfashion.
Inaddition,wefrequentlyupdateourgameserverstoensurethestabilityofouroperationandreducerisks.
-39-EMPLOYEESAsofDecember31,2009,wehad3,997full-timeandpart-timeemployees,including1,734employeesforourbrandadvertisingbusinessand1,368employeesforouronlinegamebusiness.
Wealsoemployindependentcontractorstosupportourresearchanddevelopment,sales,marketing,andeditorialdepartments.
Noneofourpersonnelarerepresentedundercollectivebargainingagreements.
Wehaveenteredintostandardemploymentagreementswithouremployeesthroughoursubsidiariesandvariableinterestentities.
Inaddition,allofourfull-timeemployeeshaveenteredintocondentiality,non-competitionandnon-solicitationagreementswithus.
However,thedegreeofprotectionaffordedtoanemployerpursuanttocondentialityandnon-competitionundertakingsgovernedbyPRClawmaybemorelimitedwhencomparedtothedegreeofprotectionaffordedunderthelawsofotherjurisdictions.
Anumberofouremployeesholdshare-basedawardsgrantedbySohu.
comInc.
andChangyou.
comLimited,whichprovideadditionalnancialincentivestothem.
Theseawardsgenerallyvestoveraperiodoffouryears.
AVAILABLEINFORMATIONOurcorporateWebsiteislocatedathttp://corp.
sohu.
com.
WemakeavailablefreeofchargeonorthroughourcorporateWebsiteourannualreportonForm10-K,ourquarterlyreportsonForm10-Q,ourcurrentreportsonForm8-KandanyamendmentstothosereportsledorfurnishedpursuanttoSection13(a)or15(d)oftheSecuritiesExchangeActof1934assoonasreasonablypracticableaftertheyareelectronicallyledwithorfurnishedtotheSecuritiesandExchangeCommission,orSEC.
Youwillndlinkstocopiesofthesereports,andtocopiesofSection16lingsrelatedtoSohu,byclickingon"InvestorRelations"ontherstfullEnglishpage.
InformationcontainedonourcorporateWebsiteisnotpartofthisreportoranyotherreportledwiththeSEC.
-40-ITEM1A.
RISKFACTORSRisksRelatedtoOurBusinessWearearelativelyyoungcompanysubjecttotherisksassociatedwithoperatinginanewandevolvingmarket.
AsarelativelyyoungcompanyinthenewandrapidlyevolvingPRCInternetmarket,wefacenumerousrisksanduncertainties.
Someoftheserisksrelatetoourabilityto:continuetoattractalargeraudiencetoourmatricesofWebpropertiesandproprietarysearchenginesbyexpandingthetypeandtechnicalsophisticationofthecontentandservicesweoffer;maintainourcurrent,anddevelopnew,strategicrelationshipstoincreaseourrevenuestreamsaswellasproductandserviceofferings;increasetherevenuesderivedfromourfee-basedservicesandproductsweofferonline;buildoursponsoredsearch,onlinegame,andwirelessbusinessessuccessfully;andattractandretainqualiedpersonnel.
Ouroperatingresultsarelikelytouctuatesignicantlyandmaydifferfrommarketexpectations.
Ourannualandquarterlyoperatingresultshavevariedsignicantlyinthepast,andmayvarysignicantlyinthefuture,duetoanumberoffactorswhichcouldhaveanadverseimpactonourbusiness,suchasourrelianceonadvertisersincertainindustriesforbrandadvertisingrevenues,ourrelianceoncertainkeythirdpartydistributorsforsponsoredsearchrevenues,ourrelianceonoperationofTLBBforonlinegamerevenuesandourrelianceonmobilenetworkoperatorsforourwirelessrevenues.
TheChineseInternetindustryisatanearlystageofdevelopment.
Weareunsureifitwillcontinuetogrow,andifitdoes,therateatwhichitwillgrow.
Inaddition,wearesubjecttogovernmentregulationsthatmaychangeatanytimewithorwithoutnotice.
Fluctuationsintheindustriesofourkeyadvertisersmayaffectourbrandadvertisingrevenuesmaterially,becausetheymaycuttheirspendingononlinemarketingifthereisanydownturnintheirindustries.
Werelyoncertainthirdpartydistributorstoselloursponsoredsearchproducts.
Ifweloseanyofourkeydistributors,ourbusinessmaybemateriallyaffected.
WerelyonouroperationofTLBBtoderivemostofouronlinegamerevenue.
IftherewereanyinterruptionsofTLBB'soperation,ouronlinegamerevenuecouldbeadverselyaffected.
Werelyonmobilenetworkoperatorsfor,amongotherthings,billingofandcollectionofwirelessservicefeesfrommobilephoneusers.
Ifourarrangementswiththeoperatorsweretobeterminated,alteredornotrenewed,oriftheoperatorsdidnotprovidecontinuousoradequateservice,ourwirelessrevenuescouldbereducedsignicantly.
Asaresult,webelievethatyear-to-yearandquarter-to-quartercomparisonsofouroperatingresultsarenotagoodindicationofourfutureperformance.
Inaddition,wehaveexperiencedveryhighgrowthratesincertainbusinesslinesinthepast,andtheremaybeexpectationsthatthesegrowthrateswillcontinue.
Inthepast,ouroperatingresultshavesometimesfallenbelowtheexpectationsofpublicmarketanalystsandinvestors,andtheymaydosoagaininthefuture.
Inthisevent,thetradingpriceofourcommonstockmayfall.
Changyou'slimitedoperatinghistorymakesevaluatingourbusinessandprospectsdifcult.
ChangyouwasincorporatedonAugust6,2007intheCaymanIslandsasanindirectwholly-ownedsubsidiaryofSohu.
comInc.
OnDecember1,2007,SohutransferredallofitsMMORPGbusinesstoChangyou.
ChangyoulaunchedthreeMMORPGswhenChangyouwasstillabusinessunitoftheSohuGroup,includingKnightOnline("KO")inJune2003,BOinOctober2004andTLBBinMay2007,ofwhichKOandBOarelicensedgames.
InSeptember2009,ChangyoulaunchedBH2,thesequeltoBO.
Changyouterminatedthe-41-operationofKOinNovember2006whenitslicenseexpired.
ChangyoudevelopedTLBBin-house.
TLBBgeneratedasubstantialmajorityoftheSohuGroup'sonlinegamerevenuesfortheyearsendedDecember31,2007,2008and2009.
Changyou'slimitedoperatinghistorymaynotprovideameaningfulbasisforyoutoevaluateitsbusinessandprospects.
Furthermore,ChangyouwasabusinessunitwithintheSohuGrouppriortoitsreorganizationandhadnoexperiencerunningitsbusinessasaseparate,stand-alonecompany.
Changyou'sbusinessstrategyhasnotbeenprovenovertimeandwecannotbecertainthatitwillbeabletosuccessfullyexpanditsMMORPGbusiness.
Youshouldalsoconsideradditionalrisksanduncertaintiesthatmaybeexperiencedbyearlystagecompaniesoperatinginarapidlydevelopingandevolvingindustry.
SomeoftheserisksanduncertaintiesrelatetoChangyou'sabilityto:developorlicensenewMMORPGsthatareappealingtogameplayersandmeetChangyou'sexpectedtimetableforlaunchesofnewgames;raiseChangyou'sbrandrecognitionandgameplayerloyalty;andsuccessfullyadapttoanevolvingbusinessmodel.
Wemaynotbesuccessfulinaddressingtheriskslistedabove,whichmaymateriallyandadverselyaffectouronlinegamebusinessprospects.
Changyouisnotlikelytosustainitsrecentgrowthrate.
Changyou'srevenueshavegrownsignicantlyinarelativelyshortperiodoftime,inparticularafteritslaunchofTLBBinMay2007.
PrimarilyduetothecommercialsuccessofTLBB,Changyou'srevenuesgrewfrom$1.
6millionforthethreemonthsendedMarch31,2007beforethelaunchofTLBBto$58.
4millionforthethreemonthsendedDecember31,2008and$70.
7millionforthethreemonthsendedDecember31,2009,representinganincreaseof35.
5timesoversevenquartersand43.
2timesoverelevenquarters,anditsnetincomegrewfromanetlossof$1.
4millionforthethreemonthsendedMarch31,2007tonetincomeof$29.
1millionforthethreemonthsendedDecember31,2008and$38.
9millionforthethreemonthsendedDecember31,2009.
Changyouisnotlikelytosustainsimilargrowthrateinrevenuesornetincomeinfutureperiodsduetoanumberoffactors,including,amongothers,thegreaterdifcultyofgrowingatsustainedratesfromalargerrevenuebase,theuncertainlevelofpopularityofitsfuturegames,thepotentialneedtoexpendgreateramountsinordertodeveloporacquirenewgames,andthepotentialincreasesinitscostsandexpensesasaseparate,stand-alonepubliccompany.
Forexample,forthethreemonthsendedDecember31,2009,Changyou'srevenuesgrew2.
9%overthethreemonthsendedSeptember30,2009,whichwassignicantlylowerthantherevenuegrowthrateofthepreviousseveralquarters,asTLBBhasenteredintoamorematurestage.
Accordingly,youshouldnotrelyontheresultsofanypriorperiodasanindicationofChangyou'sfuturenancialandoperatingperformance.
WerelyonasingleMMORPG,TLBB,forasignicantportionofourrevenuesandgrossprotandadecreaseinitspopularitycouldhaveamaterialadverseeffectonouroperatingresults.
Ourin-housedevelopedMMORPG,TLBB,contributesasignicantpercentageofourtotalrevenuesandofourtotalgrossprot.
Accordingly,anydecreaseinTLBB'spopularitycouldmateriallyandadverselyaffectourbusiness.
FortheyearendedDecember31,2009,revenuesgeneratedfromTLBBaccountedforapproximately94%ofouronlinegamerevenuesand49%ofourtotalrevenues.
Ourgrossprotfromonlinegameconstitutedapproximately64%ofourtotalgrossprot.
WelaunchedTLBBinMay2007,andwecannotguaranteehowlongTLBBwillcontinuetosustainitscurrentlevelofpopularity.
ToprolongTLBB'slifespan,weneedtocontinuallyimproveandupdateitonatimelybasiswithnewfeaturesthatappealtoexistinggameplayersandattractnewgameplayers,andtomarketthesenewfeatures.
DespiteoureffortstoimproveTLBB,ourgameplayersmayneverthelessloseinterestinthegameovertimeormaybeattractedto-42-othergames,whicharecopiedfromTLBB.
InviewofourrelianceonTLBB,ourlimitedhistorydevelopingandoperatingMMORPGsandtheuncertaintyofourabilitytolaunchandcommercializenewgamesinourpipeline,ifwefailtoimproveandupdateTLBBonatimelybasis,orifourcompetitorsintroducemorepopulargamescateringtoourgameplayerbase,ourrevenuesandprotabilitycouldbemateriallyandadverselyaffected.
Furthermore,iftherewereanyinterruptionsinTLBB'soperationduetounexpectedserverinterruptions,networkfailuresorotherfactors,gameplayerscouldbepreventedordeterredfrommakingpurchasesofvirtualitems,whichcouldresultinsignicantdecreasesinouronlinegamesrevenues.
Rapidtechnologicalchangesmayincreaseourgamedevelopmentcosts.
Theonlinegameindustryisevolvingrapidly,soweneedtoanticipatenewtechnologiesandevaluatetheirpossiblemarketacceptance.
Inaddition,governmentauthoritiesorindustryorganizationsmayadoptnewstandardsthatapplytogamedevelopment.
AnynewtechnologiesandnewstandardsmayrequireincreasesinexpendituresforMMORPGdevelopmentandoperations,andwewillneedtoadaptourbusinesstocopewiththechangesandsupportthesenewservicestobesuccessful.
Ifwefallbehindinadoptingnewtechnologiesorstandards,ourexistinggamesmaylosepopularity,andournewlydevelopedgamesmaynotbewellreceivedinthemarketplace.
Asaresult,ourbusinessprospectsandresultsofoperationscouldbemateriallyandadverselyaffected.
Wefaceintensecompetitionwhichcouldreduceourmarketshareandadverselyaffectournancialperformance.
TherearemanycompaniesthatdistributeonlinecontentandservicestargetingChineseInternetusers.
WecompetewithdistributorsofcontentandservicesovertheInternet,includingcontentsites,Webdirectories,searchengines,onlinegames,Internetserviceprovidersandsitesmaintainedbygovernmentandeducationalinstitutions.
Thesesitescompetewithusforvisitortrafc,advertisingdollars,onlinegameplayers,potentialpartnersandwirelessservices.
TheInternetmarketinChinaisrelativelynewandrapidlyevolving.
Competitionisintenseandexpectedtoincreasesignicantlyinthefuture,becausetherearenosubstantialbarrierstoentryinourmarket.
WehavemanycompetitorsinthePRCInternetmarket,includingSina,Tencent,NetEase,YouKu,TuDou,Ku6,PConline,SouFun,CRIC,Baidu,Google,Yahoo!
China,SoSo,ShandaInteractiveEntertainment,PerfectWorld,GiantInteractive,The9,Netdragon,Kingsoft,Nineyou,TomOnline,KongZhong,LinktoneandHurray!
.
Inaddition,thereareanumberofexistingornewPRCInternetportals,includingthosecontrolledorsponsoredbyPRCgovernmententities.
WecompetewithourpeersandcompetitorsinChinaprimarilyonthefollowingbasis:technologicaladvancements;attractivenessofproducts;brandrecognition;volumeoftrafcandusers;qualityofWebsitesandcontent;strategicrelationships;qualityofservices;-43-effectivenessofsalesandmarketingefforts;talentedstaff;andpricing.
Overtime,ourcompetitorsmaygraduallybuildcertaincompetitiveadvantagesoverusintermsof:greaterbrandrecognitionamongInternetusersandclients;betterproductsandservices;largeruserandcustomerbases;moreextensiveandwelldevelopedmarketingandsalesnetworks;andsubstantiallygreaternancialandtechnicalresources.
Ourexistingcompetitorsmayinthefutureachievegreatermarketacceptanceandgainagreatermarketsharethroughlaunchingofnewproducts,introducingnewtechnologies,orformingalliancesamongthemselves,orthroughmergersandacquisitionsinordertoenhancetheirabilitytocompetewithus.
Forexample,ShandaInteractiveEntertainment'sonlinegamesubsidiary,ShandaGames,completedaninitialpublicofferingonNASDAQinSeptember2009.
TheproceedsfromtheofferingwillprovideShandaGameswithadditionalnancialrecoursesthatwillenhanceitscompetiveness.
Moreover,ChinaRealEstateInformationCorporation,ajointventureestablishedbySinaCorporationandE-House(China)HoldingsLimitedthatprovidesanewpathforInternetcompaniestocooperatewiththerealestateindustrytogaincompetitiveadvantages,completedaninitialpublicofferingonNASDAQinOctober2009.
Itisalsopossiblethatnewcompetitorsmayemergeandacquiresignicantmarketshare.
Inaddition,operatorsofleadingWebsitesorInternetserviceproviders,includingYahoo!
,Microsoft/MSNandAOL,currentlyoffer,andcouldexpand,theironlineproductsandservicestargetingChina.
Suchentitiesmaycooperatewithotherorganizations,suchastelecommunicationoperators,inChinatoacceleratetheirentryinto,andtoenhancetheircompetitivenessin,theChinesemarket.
Ifwefailtosuccessfullydevelopandintroducenewproductsandservices,ourcompetitivepositionandabilitytogeneraterevenuescouldbeharmed.
Wearecontinuouslydevelopingnewproductsandservicesforourusers.
Theplannedtimingorintroductionofnewproductsandservicesissubjecttorisksanduncertainties.
Actualtimingmaydiffermateriallyfromoriginalplans.
Unexpectedtechnical,operational,distributionorotherproblemscoulddelayorpreventtheintroductionofoneormoreofournewproductsorservices.
Moreover,wecannotbesurethatanyofournewproductsandserviceswillachievewidespreadmarketacceptanceorgenerateincrementalrevenue.
WemaybeadverselyaffectedbytheslowdownoftheChineseeconomycausedinpartbytheglobalcrisisinthenancialservicesandcreditmarkets,andourbrandadvertisingbusinessinparticularcouldbeseverelyaffectedbysuchslowdown.
TheChineseeconomyhasexperiencedaslowinggrowthrateandthisslowinggrowthratemaycontinueforawhile.
Anumberoffactorshavecontributedtothisslowdown,includingappreciationoftheRMB,whichadverselyaffectedChina'sexports,andtightenedmacroeconomicmeasuresandmonetarypoliciesadoptedbytheChinesegovernmentaimedatpreventingoverheatingoftheChineseeconomyandcontrollingChina'shighlevelofination.
Theslowdownhasbeenexacerbatedbytheglobalcrisisinthenancialservicesandcreditmarkets,whichhasresultedinsignicantvolatilityanddislocationoftheglobalcapitalmarkets.
ItisuncertainhowlongtheglobalcrisisinthenancialservicesandcreditmarketswillcontinueandhowmuchofanimpactitwillhaveontheglobaleconomyingeneralortheChineseeconomyinparticular,andwhether-44-slowingeconomicgrowthinChinacouldresultinourcustomers'reducingtheirspendingonWebsiteservices,advertising,andonlinegame.
SlowergrowthintheChineseeconomycouldaffectourbusinessesgenerally,andcouldhaveasignicantimpactonourbrandadvertisingbusinessinparticular,asourbrandadvertisingrevenuescoulddecreaseasaresultofourbrandadvertisingcustomers'reducingtheiradvertisingbudgets.
Ourbusinessdependsonastrongbrand;thuswewillnotbeabletoattractusers,customersandclientsofourproductsandofferingsifwedonotmaintainanddevelopourbrands.
Itiscriticalforustomaintainanddevelopourbrandssoastoeffectivelyexpandouruserbaseandourrevenues.
WebelievethattheimportanceofbrandrecognitionwillincreaseasthenumberofInternetusersinChinagrows.
InordertoattractandretainInternetusers,advertisers,onlinegameandwirelesscustomers,wemayneedtosubstantiallyincreaseourexpendituresforcreatingandmaintainingbrandloyalty.
Accordingly,ourrevenueswillneedtoincreaseatleastproportionatelyinorderforustomaintainourcurrentlevelsofprotability.
Oursuccessinpromotingandenhancingourbrands,aswellasourabilitytoremaincompetitive,willalsodependonoursuccessinofferinghighqualitycontent,featuresandfunctionality.
IfwefailtopromoteourbrandssuccessfullyorifvisitorstoourWebsitesoradvertisersdonotperceiveourcontentandservicestobeofhighquality,wemaynotbeabletocontinuegrowingourbusinessandattractingvisitors,advertisers,wireless,andonlinegameplayers.
Ourfailuretokeepupwithrapidtechnologychangesmayseverelyaffectourfuturesuccess.
TheInternetindustryisundergoingrapidtechnologicalchanges.
Ourfuturesuccesswilldependonourabilitytorespondtorapidlyevolvingtechnologies,adaptourservicestochangingindustrystandardsandimprovetheperformanceandreliabilityofourservices.
Ifwefailtoadapttosuchchanges,ourbusinessmaybeadverselyaffected.
Forexample,withtheevolutionofWeb2.
0,Internetusersmayshifttonewmodesofinformationsharing,suchasSocialNetworkingSeriesandclient-endsoftware.
Ourcompetitorsmaydeveloptheirownpeer-to-peerstreamingtechnologyorupdatetheirexistingtechnologytosurpassus.
Withthedevelopmentofsearchenginetechnologies,Internetusersmaychoosetoaccessinformation,newsandcontentthroughsearchenginesratherthanportals.
Inaddition,theonlinegameindustryisevolvingrapidly,soweneedtoanticipatenewtechnologiesandgamesandevaluatetheirpossiblemarketacceptance.
Wemaybeunabletorecoverourgamedevelopmentcostsifournewonlinegamesarelessattractivetousers.
Inaddition,withthedevelopmentof2.
5Gandeven3Gtechnology,thefocusofwirelessapplicationshasbeentransferredfromtextmessageservicestomulti-mediamessageservices,wirelessgames,wirelessdownloadsandotherapplications.
Accordingly,wewillneedtoadaptourbusinesstocopewiththechangesandsupportthesenewservicestobesuccessful.
Inaddition,theMIITiscooperatingwithotheradministrations,includingtheMinistryofPublicSecurity,theMinistryofCultureandtheMinistryofJustice,todraftindustrystandardsorregulationsregardingSpywaresoftware.
Ifwecannotadapttonewindustrystandards,moretechnicalexpensescouldberequiredinthefuture.
Ourstrategyofacquiringcomplementaryassets,technologiesandbusinessesmayfailandresultinequityorearningsdilution.
Asacomponentofourgrowthstrategy,wehaveacquiredandintendtoactivelyidentifyandacquireassets,technologiesandbusinessesthatarecomplementarytoourexistingbusinesses.
Ouracquisitionscouldresultintheuseofsubstantialamountsofcash,potentiallydilutiveissuancesofequitysecurities,signicantimpairmentlossesrelatedtogoodwilloramortizationexpensesrelatedtointangibleassetsandexposuretoundisclosedorpotentialliabilitiesofacquiredcompanies.
Moreover,theresourcesexpendedinidentifyingandconsummatingacquisitionsmaybesignicant.
Furthermore,anyacquisitionwedecidetopursuemaybesubjecttotheapprovaloftherelevantPRCgovernmentalauthorities,aswellasanyapplicablePRCrulesandregulations.
Consideringthefastchanginglegalenvironment,ouracquisitionmaybesubjecttogovernment'sfurtherscrutinyandtheacquisitionstructuresweusedtoadoptmaybefoundtobeinappropriate.
-45-Wemayberequiredtorecordasignicantchargetoearningsifwearerequiredtoreassessourgoodwillorotheramortizableintangibleassetsarisingfromacquisitions.
WearerequiredunderU.
S.
GAAPtoreviewouramortizableintangibleassetsforimpairmentwheneventsorchangesincircumstancesindicatethecarryingvaluemaynotberecoverable.
Goodwillisrequiredtobetestedforimpairmentannually,ormorefrequentlyiffactsandcircumstanceswarrantareview.
Factorsthatmaybeconsideredachangeincircumstancesindicatingthatthecarryingvalueofouramortizableintangibleassetsmaynotberecoverableincludeadeclineinstockpriceandmarketcapitalizationandslowerordeclininggrowthratesinourindustry.
Wemayberequiredtorecordasignicantchargetoearningsinournancialstatementsduringtheperiodinwhichanyimpairmentofourgoodwilloramortizableintangibleassetsisdetermined.
Werecordedgoodwillof$7.
5millionrelatedtoouracquisitionofGo2mapforoursponsoredsearchbusiness.
Weassessthegoodwillrelatedtooursponsoredsearchforimpairmentannually.
Intheassessmentofgoodwillimpairmentrelatingtooursponsoredsearchbusiness,bothincomeapproachandmarketapproachwereapplied,inwhichtheassumptionsusedwerebasedontheinformationavailabletousatthetime.
Furtherdeclineintheperformanceofoursponsoredsearchbusinessandotherfactorsmayrequireustorecordasignicantimpairmentchargetoearnings.
Anychangesinaccountingrulesforshare-basedcompensationmayadverselyaffectouroperatingresults,ourstockpriceandourcompetitivenessintheemployeemarketplace.
Ourperformanceislargelydependentontalentedandhighlyskilledindividuals.
Ourfuturesuccessdependsonourcontinuingabilitytoidentify,develop,motivateandretainhighlyskilledpersonnelforallareasofourorganization.
Wehaveahistoryofusingemployeeshareoptionsandrestrictedstockunitstoalignemployees'interestwiththeinterestsofourshareholdersandencouragequalityemployeestojoinusandretainourqualityemployeesbyprovidingcompetitivecompensationpackages.
OnJanuary1,2006,weadoptedrevisedguidanceonaccountingforshare-basedcompensation,whichrequiresthemeasurementandrecognitionofcompensationexpenseforallshare-basedcompensationbasedonestimatedfairvalues.
Asaresult,ouroperatingresultscontainachargeforshare-basedcompensationexpenserelatedtoemployeeshareoptionsandrestrictedstockunits.
Therecognitionofshare-basedcompensationinourstatementofoperationswouldhaveanegativeeffectonourreportedresultsandearningspershare,whichcouldinturnnegativelyaffectourstockprice.
Ontheotherhand,ifwealterouremployeestockincentiveplantominimizetheshare-basedcompensationexpenses,itmaylimitourabilitytocontinuetouseshare-basedawardsasatooltoattractandretainouremployees,anditmayadverselyaffectouroperations.
Wecannotassurethattherewillbenochangesintheaccountingrulesforshare-basedcompensationinfuture;thusouroperatingresults,ourstockpriceandourcompetitivenessintheemployeemarketplacemaybeadverselyaffected.
AnyutilizationofU.
S.
federalnetoperatinglossesgeneratedfromexcesstaxdeductionsrelatedtoshare-basedawardswillberecordedinshareholders'equitySohu.
comInc.
mayutilizeexcesstaxbenetsfromU.
S.
federalnetoperatinglosses("NOL")generatedfromexcesstaxdeductionsrelatedtoshare-basedawards("windfalltaxbenet")tooffsettheirU.
S.
taxableincome.
However,inaccordancewithU.
S.
GAAP,thiswindfalltaxbenetwillbechargedtotheshareholders'equitysectioninourconsolidatedbalancesheetsratherthanoffsettingcurrentyearincometaxexpenses.
RealizingthisbenetreducestheamountoftaxespayableintheU.
S.
anddoesnototherwiseinvolvecashows.
CurrentyearincometaxexpensesstillariseduetohavingU.
S.
taxableincome.
FortheyearendedDecember31,2009,werealized$3.
9millionofsuchitemsandwerecorded$3.
9millionincometaxexpensesforU.
S.
taxableincome.
-46-Ourfailuretomanagegrowthanddiversifyourbusinesscouldharmus.
Wehaveexperienceddramaticgrowthinpersonnelinthepastveyearsandweexpecttocontinuetohireadditionalpersonnelinselectedareas.
Thisgrowthrequiressignicanttimeandresourcecommitmentsfromusandourseniormanagement.
Ifweareunabletoeffectivelymanagealargeandgeographicallydispersedgroupofemployeesoranticipateourfuturegrowth,ourbusinesscouldbeadverselyaffected.
Additionally,ourbusinessreliesonournancialreportinganddatasystems(includingoursystemsforbillingusersofourfee-basedservices),whichhavegrownincreasinglycomplexintherecentpastduetoacquisitionsandthediversicationandcomplexityofourbusiness.
Ourabilitytooperateourbusinessefcientlydependsonthesesystems,andifweareunabletoadapttothesechanges,ourbusinesscouldbeadverselyaffected.
Ifwefailtoestablishandmaintainrelationshipswithcontent,technologyorinfrastructureproviders,wemaynotbeabletoattractandretainusers.
Werelyonanumberofthirdpartyrelationshipstoprovidehigh-qualityvideo,audioandtextcontentinordertomakeourWebsitesmoreattractivetousersandadvertisers.
Mostofourarrangementswithcontentprovidersareshort-termandmaybeterminatedattheconvenienceoftheotherparty.
Mostcontentprovidershaveincreasedthefeestheychargeusfortheircontent.
Thistrendcouldincreaseourcostsandoperatingexpensesandcouldadverselyaffectourabilitytoobtaincontentataneconomicallyacceptablecost.
Wehavealsoenteredintoexclusiveagreementswithsomeofourvideocontentproviders.
Ifwearenotabletorenewourexclusivedealsorvideocontentbecomeexclusivetoourcompetitors,ourattractivenesstouserswillbeseverelyimpaired.
Exceptfortheexclusivecontent,muchofthethirdpartycontentprovidedtoourWebsitesisalsoavailablefromothersourcesormaybeprovidedtootherInternetcompanies.
IfotherInternetcompaniespresentthesameorsimilarcontentinasuperiormanner,itwouldadverselyaffectourvisitortrafc.
Ourbusinessalsodependssignicantlyonrelationshipswithleadingtechnologyandinfrastructureprovidersandthelicensesthatthetechnologyprovidershavegrantedtous.
Ourcompetitorsmayestablishthesamerelationshipsaswehave,whichmayadverselyaffectus.
Wemaynotbeabletomaintaintheserelationshipsorreplacethemoncommerciallyattractiveterms.
Wedependonkeypersonnelandourbusinessmaybeseverelydisruptedifwelosetheservicesofourkeyexecutivesandemployees.
Ourfuturesuccessisheavilydependentuponthecontinuedserviceofourkeyexecutives,particularlyDr.
Zhang,whoisthefounder,ChiefExecutiveOfcer,ChairmanoftheBoard,andamajorshareholderofourcompany.
Werelyonhisexpertiseinourbusinessoperations.
OurfuturesuccessinonlinegamebusinessdependssubstantiallyonthecontinuedservicesofChangyou'sexecutiveofcersanditskeydevelopmentpersonnel,suchasChangyou'sChiefExecutiveOfcer,TaoWang,whohasbeeninstrumentalinthedevelopmentofTLBB,itsChiefTechnologyOfcer,XiaojianHong,anditsPresidentandChiefOperatingOfcer,DewenChen.
Wealsorelyonotherseniorexecutives.
Ifoneormoreofourkeyexecutivesandemployeesareunableorunwillingtocontinueintheirpresentpositions,wemaynotbeabletoreplacethemeasilyandourbusinessmaybeseverelydisrupted.
Inaddition,ifanyofourkeyexecutivesoremployeesjoinsacompetitororformsacompetingcompany,wemayloseknow-how,keyprofessionalsandstaffmembersaswellascustomers,suppliersandincuradditionalexpensestorecruitandtrainpersonnel.
Changyou'sexecutiveofcersandkeyemployeescoulddevelopandoperategamesthatcouldcompetewithandtakegameplayersawayfromourexistingandfuturegames.
Eachofourexecutiveofcershasenteredintoanemploymentagreementandacondentiality,non-competitionandnon-solicitationagreementwithus.
However,thedegreeofprotectionaffordedtoanemployerpursuanttocondentialityandnon-competitionundertakingsgovernedbyPRClawmaybemorelimitedwhencomparedtothedegreeofprotectionaffordedunderthelawsofotherjurisdictions.
Wedonotmaintainkey-manlifeinsuranceforanyofourkeyexecutives.
-47-Wealsorelyonanumberofkeytechnologystaffforourbusiness.
Giventhecompetitivenatureoftheindustry,theriskofkeytechnologystaffleavingSohuishighandcouldhaveadisruptiveimpactonouroperations.
Changyouisrapidlyexpandingitsbusinessandneedtohireasignicantnumberofnewemployees.
IfChangyouisunabletoattractasufcientnumberofqualiednewemployeesorretainitsexistingemployees,itsbusinessprospectsmaybemateriallyandadverselyaffected.
AsChangyouisintheearlystagesofitsdevelopmentanditsbusinessisgrowingrapidly,ithasneeded,andexpectstocontinuetoneed,toincreasethenumberofitsemployees,includingsenior-levelexecutives,experiencedprojectmanagersandgamedevelopmentpersonnel.
Thenumberofitsemployeesnearlydoubledbetweentheendof2008andtheendof2009.
OnlinegameindustryinChinaischaracterizedbyhighdemandandintensecompetitionfortalent,particularlyforgamedevelopersandrelatedtechnicalpersonnel,andChangyoumaynotbeabletoattractasufcientnumberofadditionalqualiednewemployeesorretainexistingemployeestomeetthegrowthofourbusiness,inwhichcaseChangyou'sgrowthstrategyanditsbusinessprospectscouldbemateriallyandadverselyaffected.
Rapidgrowthandarapidlychangingoperatingenvironmentstrainourlimitedresources.
Wehavelimitedoperational,administrativeandnancialresources,whichmaybeinadequatetosustainthegrowthwewanttoachieve.
Asthedemandsofouraudienceandtheneedsofourcustomerschange,asthenumberofourusersandvolumeofonlineadvertising,andwirelessactivitiesincrease,andasrequirementsformaintainingsufcientserverstoprovidehigh-denitiononlinevideoandtoprovidegameplayerssmoothonlinegameexperiencesincrease,wewillneedtoincreaseourinvestmentinournetworkinfrastructure,facilitiesandotherareasofoperations.
Ifweareunabletomanageourgrowthandexpansioneffectively,thequalityofourservicescoulddeteriorateandourbusinessmaysuffer.
Ourfuturesuccesswilldependon,amongotherthings,ourabilityto:adaptourservicesandmaintainandimprovethequalityofourservices;protectourWebsitefromhackersandunauthorizedaccesscontinuetraining,motivatingandretainingourexistingemployeesandattractandintegratenewemployees;anddevelopandimproveouroperational,nancial,accountingandotherinternalsystemsandcontrols.
Wefacerisksrelatedtohealthepidemicsandotheroutbreaks.
OurbusinesscouldbeadverselyaffectedbytheeffectsofH1N1u,avianu,SARSorotherepidemicsoroutbreaks.
ChinareportedanumberofcasesofSARSinApril2003.
Inrecentyears,therehavebeenreportsofoccurrencesofH1N1uandavianuinvariouspartsofChina,includingafewconrmedhumancasesanddeaths.
AnyprolongedrecurrenceofH1N1u,avianu,SARSorotheradversepublichealthdevelopmentsinChinamayhaveamaterialadverseeffectonourbusinessoperations.
Thesecouldincludeillnessandlossofourmanagementandkeyemployees,aswellastemporaryclosureofourofcesandrelatedbusinessoperations,suchasserveroperations,uponwhichwerely.
Suchlossofmanagementandkeyemployeesorclosureswouldseverelydisruptourbusinessoperationsandadverselyaffectourresultsofoperations.
WehavenotadoptedanywrittenpreventivemeasuresorcontingencyplanstocombatanyfutureoutbreakofH1N1u,avianu,SARSoranyotherepidemic.
Inaddition,othermajornaturaldisastersmayalsoadverselyaffectourbusinessby,forexample,causingdisruptionsoftheInternetnetworkorotherwiseaffectingaccesstoourportalsandourgames.
Forexample,aftertheSichuanearthquakeinMay2008,wesuspendedourdeliveringofonlineadvertisementsandourMMORPGoperationsduringathree-daynationalmourningperiod.
-48-Wedonothavebusinessinsurancecoverage.
TheinsuranceindustryinChinaisstillatanearlystageofdevelopment.
InsurancecompaniesinChinaofferlimitedbusinessinsuranceproducts,orofferthematahighprice.
Asaresult,wedonothaveanybusinessliability,lossofdataordisruptioninsurancecoverageforouroperationsinChina.
Anybusinessdisruption,litigationornaturaldisastermightresultinourincurringsubstantialcostsandthediversionofourresources.
Wedependononlineadvertisingforasignicantportionofourrevenues,buttheonlineadvertisementmarketincludesmanyuncertainties,whichcouldcauseouradvertisingrevenuestodecline.
Wederiveasignicantportionofourrevenues,andexpecttoderiveasignicantportionofourrevenuesfortheforeseeablefuture,fromthesaleofadvertisingonourWebsites.
Advertisingrevenuesrepresentedapproximately36%and41%ofourtotalrevenuesfortheyearsendedDecember31,2009and2008respectively.
FortheyearsendedDecember31,2009and2008,salestoourvelargestadvertisersaccountedforapproximately15%ofourtotalbrandadvertisingrevenues.
ThegrowthofouradvertisingrevenuesreliesonincreasedrevenuefromthesaleofadvertisingspacesonourWebsites,whichmaybeaffectedbymanyofthefollowingriskfactors:Theonlineadvertisingmarketisnewandrapidlyevolving,particularlyinChina.
Asaresult,manyofourcurrentandpotentialadvertisingclientshavelimitedexperienceusingtheInternetforadvertisingpurposesandhistoricallyhavenotdevotedasignicantportionoftheiradvertisingbudgettoInternet-basedadvertising.
Changesingovernmentpolicycouldrestrictorcurtailouronlineadvertisingservices.
Forexample,duringthelastseveralyears,thePRCgovernmentenactedaseriesofregulations,administrativeinstructionsandpoliciestorestrictonlinemedicaladvertising.
Asaresultoftheseregulations,wemaylosesomeofourexistingmedicaladvertisingclients.
Advertisingclientsmayadoptthenewmethodsandstrategiesotherthanonlineadvertisingtopromotetheirbrandandthereforeouradvertisingrevenuewouldbenegativelyaffected.
TheacceptanceoftheInternetasamediumforadvertisingdependsonthedevelopmentofameasurementstandard.
Nostandardshavebeenwidelyacceptedforthemeasurementoftheeffectivenessofonlineadvertising.
Industry-widestandardsmaynotdevelopsufcientlytosupporttheInternetasaneffectiveadvertisingmedium.
Ifthesestandardsdonotdevelop,advertisersmaychoosenottoadvertiseontheInternetingeneralorthroughourportalsorsearchengines.
Inaddition,ourabilitytogenerateandmaintainsignicantonlineadvertisingrevenueswillalsodependupon:thedevelopmentofalargebaseofuserspossessingdemographiccharacteristicsattractivetoadvertisingclients;theacceptanceofonlineadvertisementasaneffectivewayforbusinessmarketingbyadvertisingclients;theeffectivenessofouradvertisingdelivery,trackingandreportingsystems;andtheresistancepressureononlineadvertisingpricesandlimitationsoninventory.
-49-Werelyonadvertisingagenciestosellourbrandadvertisingservices.
IfcurrenttrendsofconsolidationofadvertisingagenciesintheChinesemarketcontinue,thebargainingpowerofthelargeadvertisingagenciesresultingfromsuchconsolidationmaypermitthemtorequirethatwepayhighersalesrebates,whichwouldadverselyaffectourgrossmargin.
Mostofourbrandadvertisingservicesaredistributedbyadvertisingagencies.
In2009,forexample,approximately94%ofourbrandadvertisingrevenueswerederivedfromadvertisingagencies.
Inconsiderationfortheseagencies'services,wearerequiredtopaycertainpercentagesofrevenuesassalesrebates.
During2009,thebiggest10advertisingagenciesinChinacontributedapproximately50%ofourbrandadvertisingrevenue.
Theseadvertisingagenciescurrentlyareseekingconsolidationinthemarket.
Iftheonlineadvertisingmarketisconsolidatedandeffectivelycontrolledbyasmallnumberoflargeadvertisingagencies,suchadvertisingagenciesmaybeinapositiontodemandhighersalesrebatesbasedonincreasedbargainingpower,whichcouldnegativelyaffectourbrandadvertisinggrowthaswebookourbrandadvertisingrevenuenettedoffoursalesrebatestoadvertisingagencies.
TheexpansionofInternetadvertisementblockingsoftwaremayresultinadecreaseofadvertisingrevenues.
ThedevelopmentofWebsoftwarethatblocksInternetadvertisementsbeforetheyappearonauser'sscreenmayhinderthegrowthofonlineadvertising.
TheexpansionofadvertisementblockingontheInternetmaydecreaseourrevenuesbecausewhenanadvertisementisblocked,itisnotdownloadedfromouradvertisementserver.
Asaresult,suchadvertisementswillnotbetrackedasadeliveredadvertisement.
Inaddition,advertisersmaychoosenottoadvertiseontheInternetoronourWebsitesbecauseoftheusebythirdpartiesofInternetadvertisementblockingsoftware.
Ourfailuretoretainkeydistributorsorattractadditionaldistributorsforoursponsoredsearchcustomerscouldhaveanadverseimpactonourbusiness.
SponsoredsearchisatanearlystageofdevelopmentinChinaandisnotaswidelyacceptedbyoravailabletobusinessesinChinaasintheUnitedStates.
Asaresult,werelyheavilyonournationwidedistributionnetworkofthird-partydistributorsforoursalesto,andcollectionofpaymentfrom,oursponsoredsearchcustomers.
Ifourdistributorsdonotprovidequalityservicestoourcustomersorotherwisebreachtheircontractswiththem,wemayloseourcustomers.
Wedonothavelong-termagreementswithanyofourdistributors,includingourkeydistributors,andcannotassurethatwewillcontinuetomaintainfavorablerelationshipswiththem.
WerelyonourWebsiteAlliancemembersforasignicantportionofoursponsoredsearchrevenues.
IfwefailtoretainexistingWebsiteAlliancemembersorattractadditionalmembers,ourrevenuesandgrowthmaybeadverselyaffected.
BypostingbidlistinglinksontheirWebsites,wesharetherevenuesgeneratedfromclicksbyuserswithourWebsiteAlliancemembers.
FortheyearendedDecember31,2009,thetotalrevenuesgeneratedfromWebsiteAllianceaccountedforapproximately50%ofourtotalbidlistingrevenues.
WeconsiderourWebsiteAlliancecriticaltothefuturegrowthofoursponsoredsearchrevenues.
IfourWebsiteAlliancemembersdecidetouseacompetitor'sortheirownInternetsearchservices,orifwefailtoattractadditionalWebsitestojoinourWebsiteAlliance,oursponsoredsearchrevenuesmaydecline.
RestrictionsononlinemusicsearchmayadverselyaffectouronlinesearchbusinessOnSeptember3,2009,theMOCissuedaNoticeonStrengtheningandImprovingtheContentCensorshipofOnlineMusicContent(ortheMOCNotice).
TheMOCNoticeprovidesthatprovidingdirectlinkstoonlinemusicwillconstituteengaginginonlinemusicbusiness,andthatthereforetheOnlineCultureOperatingPermitisrequiredforprovidingsuchsearchservices.
Inaddition,theMOCNoticealsorequiresanydomesticmusicproductstobeledforrecordwiththeMOCwithin30daysafterbeingmadeavailableonline.
Further,-50-theMOCNoticeprovidesthatimportedmusicproducts,mustbeapprovedbytheMOCbeforebeingmadeavailableonline.
Tocomplywiththisprovision,wehaveledanapplicationforanOnlineCultureOperatingPermitwiththeMOCforourSogouentity.
However,wecannotassureyouthatourSogouentitywillbeapprovedtoreceivethelicense.
Ifweareunabletoobtainthelicense,oursearchbusinesscouldbeseverelyadverselyaffected.
WecannotassureyouthatwehavefullycompliedwiththeMOCNoticeapprovalandlingprocedures.
InordertocomplywiththerequirementsoftheMOCNotice,itmaybenecessaryforustochangeorimproveoursearchmodelandtechnology.
Theserestrictionsmayresultinhighercostsforoursearchengineoperation,whichmayhaveanadverseeffectonourprotability.
Ouronlinegamebusinessmaynotsucceedinahighlycompetitivemarket.
CompetitionintheonlinegamemarketinChinaisbecomingincreasinglyintense.
Forexample,accordingtodatafromthe2009ChinaOnlineGameMarketWhitePaperissuedbytheMinistryofCultureofthePeople'sRepublicofChina("MOC"),therewereabout360newgameslaunchedinChinain2009,andthenumberofnewgamelaunchesin2010isforecastedtoreach400.
Therewerefouronlinegamecompanies,PerfectWorldCo.
,Ltd.
,GiantInteractiveGroupInc.
,KingsoftCorporationLimitedandNetDragonWebsoftInc.
,thatsuccessfullylistedtheirsharesonNasdaq,theNewYorkStockExchangeortheHongKongStockExchangeinthesecondhalfof2007alone,addingtothepreviouslylistedpubliccompaniesfocusingontheonlinegamemarketinChina,suchasNetEase.
com,Inc.
,TencentHoldingsLimitedandThe9Limited,mostofwhichfocusonMMORPGs.
InSeptember2009,ShandaGamesLimited,whichengagedinonlinegamebusiness,wascarvedoutfromShandaInteractiveEntertainmentLimitedandlisteditssharesonNasdaq.
Moreover,therearemanyventure-backedprivatecompaniesfocusingononlinegamedevelopment,andMMORPGdevelopmentinparticular,furtherintensifyingthecompetition.
Recently,manyofourcompetitorshavebeenaggressivelyhiringtalentforgamedevelopment,increasingspendingonmarketingforgamesandbiddingforlicensesofgames.
WehavealsoobservedthattherearesomeonlinegamesoperatedinChinathatincludesimilarelementsofdesignandgameconceptstothoseofTLBB,whichcouldhaveanadverseeffectonthepotentialforincreasesinthenumberofplayersofTLBB.
Increasedcompetitionintheonlinegamemarketmaymakeitdifcultforustoretainourexistingemployeesandattractnewemployees,andtosustainourgrowthrate.
Furthermore,wealsofaceintensecompetitionforcost-effectivemarketingresourcesforonlinegames,suchasonlinegame-relatedWebsites,whichcoulddriveupourmarketingcostsanddecreasetheeffectivenessofourmarketingcampaigns.
ThereareuncertaintiesregardingthefuturegrowthoftheonlinegameindustryinChina.
Theonlinegameindustry,fromwhichwederiveasignicantpercentageofourrevenues,isarelativelynewandevolvingindustry.
Thegrowthoftheonlinegameindustryandthelevelofdemandandmarketacceptanceofouronlinegamesaresubjecttoahighdegreeofuncertainty.
Ourfutureoperatingresultswilldependonnumerousfactorsaffectingtheonlinegameindustry,manyofwhicharebeyondourcontrol,including:thegrowthofpersonalcomputer,InternetandbroadbandusersandpenetrationinChinaandothermarketsinwhichweofferourgames,andtherateofanysuchgrowth;whethertheonlinegameindustry,particularlyinChinaandtherestoftheAsia-Pacicregion,continuestogrowandtherateofanysuchgrowth;generaleconomicconditions,particularlyeconomicconditionsadverselyaffectingdiscretionaryconsumerspending,suchastheslowdowninChineseeconomygrowthbetweenthethirdquarterof2007andtherstquarterof2009;-51-theavailabilityandpopularityofotherformsofentertainment,particularlygamesofconsolesystems,whicharealreadypopularindevelopedcountriesandmaygainpopularityinChina;andchangesinconsumerdemographicsandpublictastesandpreferences.
Thereisnoassurancethatonlinegames,inparticularMMORPGs,willcontinuetobepopularinChinaorelsewhere.
Adeclineinthepopularityofonlinegamesingeneral,ortheMMORPGsthatweoperate,willlikelyadverselyaffectourbusinessandprospects.
FurtherstrengthenedsupervisionoftheonlinegameindustrymayadverselyaffectouronlinegameoperationUndertheGAPPNotice,GAPPistheonlyauthorityresponsibleforpre-examinationandpre-approvalofonlinegames,andallonlinegameoperatorsmustobtainaninternetpublishinglicensetoprovideonlinegameservices.
Moreover,additionalapprovalsfromGAPParerequiredwhengameoperatorsreleasenewversionsorexpansionpacks,ormakeanychangestotheoriginallyapprovedonlinegame.
Inaddition,onJuly1,2009,GAPPissuedaNoticeonStrengtheningtheApprovalandAdministrationofImportedOnlineGames;pursuanttothisnotice,GAPPistheonlyauthorityauthorizedbytheStateCounciltoapprovetheimportationofonlinegamesfromoffshorecopyrightowners.
Intheeventofanyfailuretomeettheabove-mentionedrequirements,anoperatormayfaceheavypenalties,suchasbeingorderedtostopoperation,orhavingitsbusinesslicenserevoked.
OuronlinegamebusinessmaybeadverselyaffectedbythesetwoGAPPnotices.
Thelaunchofexpansionpacksandimportedgamesmightbedelayedbecauseoftheextraapprovalrequired.
Suchdelayinreleasingexpansionpacksorimportedgamesmayresultinhighercostsforouronlinegameoperationandhaveanadverseeffectonourgamerevenue.
WedonotholdInternetpublishinglicensesthatarerequiredunderPRCregulationsforthegameswecurrentlyoperate,duetothetemporarysuspension,effectivesinceourinception,oftheissuanceofsuchlicensesbyGAPP.
IfGAPPlaterchallengesthecommercialoperationofourgames,orifwefailtoobtainorrenewnecessarylicensestocommerciallyoperateourgames,wemaybesubjecttovariouspenalties,includingrestrictionsonouroperations.
PursuanttoPRCregulationsissuedbyGAPPandMIITrelatingtotheregulationofonlinepublication,anonlinegameoperatorneedstoobtainanInternetpublishinglicenseinordertodirectlymakeitsonlinegamespubliclyavailableinthePRC,asoperatingonlinegamesisdeemedtobeanonlinepublishingactivity.
Changyoudoesnotholdsuchlicenses,asGAPPtemporarilysuspendedtheissuanceofsuchlicenses.
PriortothetransferofalloftheassetsandoperationsrelatingtoSohu'sMMORPGbusinessunittoChangyouonDecember1,2007,ourMMORPGsTLBBandBOwerepublishedinChinaunderanInternetpublishinglicenseheldbySohuInternet,aVIEofSohu,andelectronicpublicationlicensesheldbythird-partypublishers.
TLBBandBOarecurrentlypublishedinChinaaselectronicpublicationsbythesamethird-partypublishers.
ThecurrentPRCregulationsarenotclearastotheconsequenceofoperatingwithoutanInternetpublishinglicense.
WehavemadeoralinquirieswiththeofcialsatGAPPandhavebeeninformedthatGAPPisawareofanddoesnotobjecttosuchpractice,solongastheapplicationsfortheInternetpublishinglicensesforsuchonlinegameshavebeenledwithGAPP.
WeappliedforInternetpublishinglicenseswithrespecttoourexistinggamesinoperation.
However,wemaynotbeabletoobtainInternetpublishinglicensesforourgames.
IfourcurrentpracticeislaterchallengedbyGAPP,wemaybesubjecttovariouspenalties,includingnes,conscationofpublishingequipmentandtherevenuesgeneratedfromtheillegalpublishingactivities,therevocationofourbusinesslicense,ortheforceddiscontinuationorrestrictiononouroperations.
-52-TherearecurrentlynolawsorregulationsinthePRCgoverningpropertyrightsofvirtualassetsandthereforeitisnotclearwhatliabilities,ifany,wemayhaverelatingtothelossofvirtualassetsbyourgameplayers.
Inthecourseofplayingourgames,TLBBandtheBOseriesincludingBOandBH2,somevirtualassets,suchasgameplayerexperience,skillsandweaponry,areacquiredandaccumulated.
Suchvirtualassetscanbehighlyvaluedbygameplayersandinsomecasesaretradedamonggameplayersforrealmoneyorassets.
Inpractice,virtualassetscanbelostforvariousreasons,suchasdatalosscausedbydelayofnetworkservicebyanetworkcrash,orbyhackingactivities.
TherearecurrentlynoPRClawsandregulationsgoverningpropertyrightsofvirtualassets.
Asaresult,itisunclearwhothelegalownerofvirtualassetsisandwhethertheownershipofvirtualassetsisprotectedbylaw.
Inaddition,itisunclearunderPRClawwhetheranoperatorofonlinegamessuchasuswouldhaveanyliability(whetherincontract,tortorotherwise)forlossofsuchvirtualassetsbygameplayers.
Basedonseveraljudgmentsregardingtheliabilitiesofonlinegameoperatorsforlossofvirtualassetsbygameplayers,thecourtshavegenerallyrequiredtheonlinegameoperatorstoprovidewell-developedsecuritysystemstoprotectsuchvirtualassetsownedbygameplayers.
Intheeventofalossofvirtualassets,wemaybesuedbygameplayersandmaybeheldliablefordamages.
Wemayfailtomaintainastableandefcientphysicaldistributionnetworkforourprepaidonlinegamecards.
OnlinepaymentsystemsinChinaareinadevelopmentalstageandarenotaswidelyavailabletooracceptedbyconsumersinChinaastheyareintheUnitedStates.
Werelyheavilyonaphysicaldistributionnetworkcomposedofthird-partydistributorstocoveranetworkofretailoutletsacrossChinaforthesalesofourprepaidgamecardstoourgameplayers.
Asaresult,ourrevenuescouldbeadverselyaffectedbytheunder-performanceofourdistributors,suchasthefailuretomeetminimumsalesorpenetrationtargetsorthefailuretoestablishanextensiveretailnetwork.
Wegenerallysignone-yearagreementswithourdistributors.
Wemaynotcontinuetomaintainfavorablerelationshipswiththem.
Inaddition,ourdistributorsmayviolateourdistributionagreements.
Suchviolationsmayinclude,amongotherthings,their:failuretomaintainminimumpricelevelsforourprepaidgamecardsinaccordancewithourdistributionagreements;failuretoproperlypromoteourMMORPGsinlocalInternetcafesandotherimportantoutlets,orcooperatewithoursalesandmarketingteam'seffortsintheirdesignatedterritories;andsellingourprepaidgamecardsoutsidetheirdesignatedterritories.
Inthepast,someofourdistributorshavefailedtocarryouttheirobligationsinaccordancewiththedistributionagreements,whichresultedinourterminationofourdistributionrelationshipwiththem.
Ifwedecidetopenalize,suspendorterminateourdistributorsforactinginviolationofourdistributionagreements,orifthedistributorsfailtoaddressmaterialviolationscommittedbyanyoftheirretailoutletsinatimelymanner,ourabilitytoeffectivelysellourprepaidgamecardsinanygiventerritorycouldbenegativelyimpacted,whichcouldmateriallyandadverselyaffectouronlinegamerevenues.
Wecouldbeliableforbreachesofsecurityofourandthird-parties'onlinepaymentplatforms,andsalesmadethroughthosechannelsmighthaveanegativeimpactonouronlinegamerevenues.
Currently,wedirectlysellasubstantialportionofvirtualprepaidgamecardsandgamepointstoourgameplayersthroughthird-partyonlinepaymentplatforms.
Inalltheseonlinetransactions,securedtransmissionofcondentialinformation,suchascustomers'creditcardnumbersandexpirationdates,personalinformationandbillingaddresses,overpublicnetworksisessentialtomaintainconsumercondence.
Inaddition,weexpectthatanincreasingamountofoursaleswillbeconductedovertheInternetasaresultofthegrowinguseofonlinepaymentsystems.
Asaresult,theassociatedonlinecrimewilllikelyincreaseaswell.
Ourcurrentsecuritymeasuresandthoseofthethirdpartieswithwhomwetransactbusinessmaynotbeadequate.
-53-Wemustbepreparedtoincreaseoursecuritymeasuresandeffortssothatourgameplayershavecondenceinthereliabilityoftheonlinepaymentsystemsthatweuse,whichwillrequireadditionalcostsandexpensesandmaystillnotbecompletelysafe.
Inaddition,wedonothavecontroloverthesecuritymeasuresofourthird-partyonlinepaymentvendors.
Securitybreachesoftheonlinepaymentsystemsthatweusecouldexposeustolitigationandpossibleliabilityforfailingtosecurecondentialcustomerinformationandcouldharmourreputation,abilitytoattractcustomersandabilitytoencouragecustomerstopurchasevirtualitems.
Ifwefailtosatisfythechangingdemandsofgameplayers,ouronlinegamerevenuesmaybeadverselyaffected.
Wedependonpurchaseandcontinualconsumptionofvirtualitemsbyourgameplayerstogeneraterevenues,whichinturndependsonthecontinuedattractivenessofourgamestothegameplayersandtheirsatisfactorygame-playingexperience.
Weprovidesupportforourgamesandcollectgameplayers'feedbackontheirgame-playingexperienceinordertoresolveanyprogrammingawsorothergameoperationalissuesinatimelymanner.
Wealsousesoftwareandsystemstomonitorgameplayers'preferencesinordertodevelopandimprovegamefeaturesandvirtualitemsinawaythatisattractivetoourgameplayers.
Wecontinuetoimproveourgamesthroughregularupdatesaswellasperiodicmajorenhancementsusingexpansionpacks.
However,wecannotassureyouthatoureffortswillbeeffectiveineliminatingprogramerrorsassociatedwithourgames,satisfyinggameplayerdemands,orretainingthecontinuedattractivenessofourgames.
Forexample:wemayfailtoprovidegameupdatesandexpansionpacksinatimelymannerduetotechnologies,resourcesorotherfactors;ourgameupdatesandexpansionpacksmaycontainprogramerrors,andtheirinstallationmaycreateotherunforeseenissuesthatadverselyaffectthegame-playingexperience;wemayfailtotimelyrespondand/orresolvecomplaintsfromourgameplayers;wemayfailtoeliminatethecomputerbotswhichmaydestroyharmoniousgameenvironmentandreducetheattractivenessofourgames;andourgameupdatesandexpansionpacksmaychangerulesorotheraspectsofourgamesthatourgameplayersdonotwelcome,resultinginreductionofpeakconcurrentusersand/oraverageconcurrentusersofourgames.
Ourfailuretoaddresstheabove-mentionedissuescouldadverselyaffectthegame-playingexperienceofourgameplayers,damagethereputationofourgames,shortenthelifespanofourgames,andeventuallyresultinthelossofgameplayersandadecreaseinouronlinegamerevenues.
Furthermore,forthegamesthatwelicensefromthirdparties,wemaynothaveaccesstothegamesourcecodesduringtheinitialperiodofthelicenseoratall.
Withoutthesourcecodes,wehavetorelyonthelicensorstoprovideupdatesandenhancementsduringtheinitialperiod,givinguslesscontroloverthequalityandtimelinessofupdatesandenhancements.
Ifourgameplayersarenotsatisedwiththelevelofservicestheyreceive,theymaychoosetonotplaythegames,leadingtoadecreaseinouronlinegamerevenues.
Wemayfailtolaunchnewgamesaccordingtoourtimetable,andournewgamesmaynotbecommerciallysuccessful,ormayattractgameplayersawayfromourexistinggames.
Wemustintroducenewgamesthatcangenerateadditionalonlinegamerevenueanddiversifyouronlinegamerevenuesourceinordertoremaincompetitive.
Wehaveseveralgamesinthepipeline,DMD,ZHYX,DHSH,IFandLAW.
Weexpecttobeginopenbetatestingofthesegamesin2010.
WearedevelopingDMDin-houseandwehavelicensedZHYX,DHSH,IFandLAWfromthird-partydevelopers.
Wewillnotgenerateanyrevenuefromagameuntilitentersopenbetatesting.
However,wecannotassureyouthatwewillbe-54-abletomeetourtimetablefornewgamelaunches.
Anumberoffactors,includingtechnicaldifculties,lackofsufcientgamedevelopmentpersonnelandotherresources,relevantauthorities'approvalsandadversedevelopmentsinourrelationshipwiththelicensorsofournewlicensedgamescouldresultindelayedlaunchingofournewgames.
Inaddition,wecannotassureyouthatournewgameswillbeaswellreceivedinthemarketasTLBB,andyoushouldnotuseTLBBasanindicationofthecommercialsuccessofourfuturegames.
Therearemanyfactorsthatmayadverselyaffectthepopularityofournewgames.
Forexample,wemayfailtoanticipateandadapttofuturetechnicaltrends,newbusinessmodelsandchangedgameplayerpreferencesandrequirements,failtoeffectivelyplanandorganizemarketingandpromotionactivities,orfailtodifferentiateournewgamesfromourexistinggames.
Ifthenewgamesweintroducearenotcommerciallysuccessful,wemaynotbeabletorecoverourproductdevelopmentcosts,whichcanbesignicant.
Inaddition,ournewgamesmayattractgameplayersawayfromourexistinggames.
Inparticular,DMDisanMMORPGbasedonanovelwrittenbyLouisCha,thesameauthorof"TianLongBaBu,"basedonwhichwedevelopedTLBB.
WecannotassureyouthatourTLBBgameplayerswillnotbeattractedtoplayDMDinsteadofTLBBafterDMD'slaunch.
Ifthisoccurred,itwoulddecreaseourexistinggames'playerbases,whichcouldinturnmakethesegameslessattractivetoothergameplayers,resultingindecreasedonlinegamerevenuesfromourexistinggames.
Gameplayersofourexistinggamesmayalsospendlessmoneytopurchasevirtualitemsinournewgamesthantheywouldhavespentiftheyhadcontinuedplayingourexistinggames,whichcouldmateriallyandadverselyaffectourtotalonlinegamerevenues.
Allofouronlinegamerevenuesaregeneratedundertheitem-basedrevenuemodel,whichhasashorthistoryofcommercialapplicationandpresentsrisksrelatedtoconsumerpreferencesandregulatoryrestrictions.
WhenwerstlaunchedBOinOctober2004,itgeneratedrevenueunderthetime-basedrevenuemodel.
Currently,weoperateourgames,TLBBandtheBOseries,undertheitem-basedrevenuemodel.
Underthisrevenuemodel,ourgameplayersarefreetoplaythegamesforanunlimitedamountoftime,butarechargedforthepurchasesofcertainvirtualitems.
Wecurrentlyexpectthatasubstantialmajorityofourrevenues,includingrevenuesfromallofourcurrentpipelinegames,willcontinuallybegeneratedundertheitem-basedrevenuemodel.
Theitem-basedrevenuemodelrequiresustodesigngamesthatnotonlyattractgameplayerstospendmoretimeplaying,butalsoencouragethemtopurchasevirtualitems.
Thesaleofvirtualitemsrequiresustotrackcloselyconsumertastesandpreferences,especiallyastoin-gameconsumptionpatterns.
Ifwefailtodesignvirtualitemssoastoincentivizegameplayertopurchasethem,wemaynotbeabletoeffectivelytranslateourgameplayerbaseandtheirplayingtimeintorevenues.
Althoughtheitem-basedrevenuemodeliscurrentlyaprevalentrevenuemodelforMMORPGsinChina,itdoesnothavealonghistoryofprovencommercialapplication.
Inaddition,theitem-basedrevenuemodelmaycauseadditionalconcernswithPRCregulatorswhohavebeenimplementingregulationsdesignedtoreducetheamountoftimethatChineseyouthsspendononlinegamesandintendedtolimitthetotalamountofvirtualcurrencyissuedbyonlinegameoperatorsandtheamountofpurchasebyindividualgameplayer.
ArevenuemodelthatdoesnotchargefortimemaybeviewedbythePRCregulatorsasinconsistentwiththisgoal.
Wecannotassureyouthattheitem-basedrevenuemodelwillcontinuetobecommerciallysuccessful,orthatwewillnotinthefutureneedtochangeourrevenuemodelbacktothetime-basedrevenuemodelortoanewrevenuemodel.
Anychangeinrevenuemodelcouldresultindisruptionofourgameoperationsanddecreaseinthenumberofourgameplayers.
ThePRCgovernmenthasbeguntotightenitsregulationofInternetcafes,whicharecurrentlyoneoftheprimaryplaceswhereourgamesareplayed.
StrictergovernmentregulationofInternetcafescouldrestrictourabilitytomaintainorincreaseourrevenuesandourgameplayerbase.
Internetcafesareoneoftheprimaryplaceswhereourgamesareplayed.
InApril2001,thePRCgovernmentbegantighteningitsregulationandsupervisionofInternetcafes.
Inparticular,alargenumberofInternetcafeswithoutrequisitegovernmentlicenseshavebeenclosed.
Inaddition,thePRCgovernmenthasimposedhighercapitalandfacilityrequirementsfortheestablishmentofInternetcafes.
ThePRCgovernment'spolicy,which-55-encouragesthedevelopmentofalimitednumberofnationalandregionalInternetcafechainsanddiscouragestheestablishmentofindependentInternetcafes,mayalsoslowdownthegrowthinthenumberofnewInternetcafes.
InFebruary2007,severalcentralgovernmentalauthoritiesjointlyissuedanoticesuspendingtheissuanceofnewInternetcafelicenses,andthetotalnumberofInternetCafesnationwideisrestrictedandcontrolledbytherelevantauthorities.
Governmentalauthoritiesmayfromtimetotimeimposestricterrequirements,suchasthecustomers'agelimitandhoursofoperation,amongothers,asaresultoftheoccurrenceandperceptionof,andthemediaattentionon,gangghts,arsonandotherincidentsinorrelatedtoInternetcafes.
SolongasInternetcafesremainasoneoftheprimaryplacesforgameplayerstoplayourgames,anyreductioninthenumber,oranyslowdowninthegrowth,ofInternetcafesorrestrictionsintheiroperationsinChinacouldlimitourabilitytomaintainorincreaseourrevenuesandourgameplayerbase,therebyadverselyaffectingourresultsofoperationsandbusinessprospects.
OuronlinegamebusinessmaybemateriallyharmedifwedonotfeatureourgamesinasufcientnumberofInternetcafesinChina.
AsubstantialnumberofplayersaccessourgamesthroughInternetcafes.
Duetolimitedhardwarecapacity,Internetcafesgenerallyfeaturealimitednumberofgamesontheircomputers.
Wethuscompetewithagrowingnumberofotheronlinegameoperatorstoensurethatourgamesarefeaturedonthesecomputers.
ThiscompetitionmayintensifyinChinaduetoanationwidesuspensionofapprovalfortheestablishmentofnewInternetcafesin2007,andtherestrictionsandcontrolonthetotalnumberofInternetcafesnationwidebytheMOCthereafter.
WetakestepstoensurethatourgamesarefeaturedinasufcientnumberofInternetcafes,includingmaintaininggoodrelationshipswithInternetcafeadministrators,requiringourdistributorstomaintainasalespresenceinawiderangeofInternetcafesandgeneralsalesandmarketingefforts.
IfwefailtomaintaingoodrelationshipswithInternetcafeadministrators,orifweand/orourdistributorsfailtosuccessfullypersuadeInternetcafestofeatureouronlinegamesontheircomputers,ourbusiness,nancialconditionandoperatingresultsmaybemateriallyandadverselyaffected.
Further,pursuanttotheInternetCafesNotice,InternetcafesarerequiredtoobtainanOnlineCultureOperatingPermitfromtheMOCandregisterthesamewiththeStateAIC.
TheInternetCafesNoticealsoprovidesrestrictionswithrespecttoInternetcafes'location,size,numberofcomputers,businesshoursandtheagesofcustomers.
Forinstance,Internetcafesareprohibitedfromoperatingbetweenthehoursof12a.
m.
and8a.
m.
TheseregulatoryrestrictionsontheoperationofInternetcafesmaynegativelyaffectouronlinegamebusinessoperations.
RestrictionsonVirtualCurrencymayadverselyaffectouronlinegamerevenue.
Ouronlinegamerevenuesarecollectedthroughthesaleofourprepaidcardsoronlinesaleofgamepoints.
PursuanttotheInternetCafesNotice,thePeople'sBankofChinahasbeendirectedtostrengthentheadministrationofvirtualcurrencyinonlinegamestoavoidanyadverseimpactontheeconomicandnancialorder.
Thisnoticeprovidesthatthetotalamountofvirtualcurrencyissuedbyonlinegameoperatorsandtheamountpurchasedbyindividualusersshouldbestrictlylimited,withastrictandcleardivisionbetweenvirtualtransactionsandrealtransactionscarriedoutbywayofelectroniccommerce.
Thisnoticealsoprovidesthatvirtualcurrencyshouldonlybeusedtopurchasevirtualitems.
PursuanttotheVirtualCurrencyNotice,theauthoritiesforthersttimedene"VirtualCurrency"asatypeofvirtualexchangeinstrumentissuedbyonlinegameoperators,purchaseddirectlyorindirectlybythegameuserbyexchanginglegalcurrencyatacertainexchangerate,savedoutsidethegameprograms,storedinserversprovidedbytheonlinegameoperatorsinelectronicrecordformatandrepresentedbyspecicnumericunits.
Inaddition,theVirtualCurrencyNoticecategorizescompaniesinvolvedwithvirtualcurrencyaseitherissuersortradingplatformsandprohibitscompaniesfromsimultaneouslyengagingasbothissuerandtradingplatform.
Mostimportantly,oneoftheVirtualCurrencyNotice'sstatedintendedobjectivesistolimitthecirculationofvirtualcurrencyandtherebyreduceconcernsthatitmayimpactrealworldination.
Specically,theVirtualCurrencyNoticeprovidesthatonlinegameoperatorsarerequiredtoreportthetotalamountoftheirissuedvirtualcurrenciesonaquarterlybasisandgameoperatorsareprohibitedfromissuingdisproportionateamountsofvirtual-56-currenciesinordertogeneraterevenues.
Inaddition,theVirtualCurrencyNoticereiteratesthatvirtualcurrencycanonlybeprovidedtousersinexchangeforanRMBpaymentandcanonlybeusedtopayforvirtualgoodsandservicesoftheissuers.
Onlinegameoperatorsarestrictlyprohibitedfromprovidingluckydrawsorlotterieswhichareconductedontheconditionthatparticipantscontributecashorvirtualcurrenciesinexchangeforgamepropsorvirtualcurrencies.
TheVirtualCurrencyNoticealsoplacespotentiallyburdensomeobligationsononlinegameoperators,includingarequirementthatoperatorskeeptransactiondatarecordsfornolessthan180daysandaprohibitiononoperatorsprovidingvirtualcurrencytradingservicestominors.
InordertocomplywiththerequirementsoftheVirtualCurrencyNotice,itmaybenecessaryforustochangeourvirtualcurrencydistributionchannel,andourbusinessmodelmaybeaffectedaccordinglyandwemayputmoreeffortinmaintainingourdatabasesoastokeepusers'informationlonger.
Theserestrictionsmayresultinhighercostsforouronlinegameoperationandlowersalesofourprepaidcardsorgamepoints,whichmayhaveanadverseeffectonourgamesrevenues.
Werelyondatarecordedinouronlinegamebillingsystemsforrevenuerecognitionaswellasidenticationofgameplayerconsumptionpatternsofvirtualitems.
Ifsuchbillingsystemsfailtooperateeffectively,itwillnotonlyaffectthecompletenessandaccuracyoftherecognitionofourrevenues,butalsoourabilitytodesignandimprovevirtualitemsthatappealtogameplayers.
Ouronlinegamerevenuesarecollectedthroughthesaleofourprepaidcardsoronlinesaleofgamepoints.
However,wedonotrecognizerevenuewhenourprepaidcardorgamepointsaresold.
Rather,ouronlinegamerevenuesarerecognizedwhenthevirtualitemspurchasedbyourgameplayersareconsumed.
Forconsumablevirtualitems,includingthosewithapre-determinedexpirationtime,revenuesarerecognizedastheyareconsumed,andforperpetualvirtualitems,revenuesarerecognizedovertheirestimatedlives.
Werelyonouronlinegamebillingsystemstocapturethepurchaseandconsumptionofvirtualitemsbyourgameplayers.
Ifouronlinegamebillingsystemsfailtoaccuratelyrecordthepurchaseandconsumptioninformationofthevirtualitems,wemaynotbeabletoaccuratelyrecognizeourrevenues.
Inaddition,variousfactorsaffecttheestimatedlivesofperpetualvirtualitems,suchastheaverageperiodthatgameplayerstypicallyplayourgamesandothergameplayersbehaviorpatterns,theacceptanceandpopularityofexpansionpacks,promotionaleventslaunchedandmarketconditions,andwerelyonouronlinegamebillingsystemstocapturesuchhistoricalgameplayers'behaviorpatternsandotherinformation.
Ifsuchinformationisnotaccuratelyrecorded,orifwedonothavesufcientinformationduetotheshortoperatinghistoryofMMORPGs,wewillnotbeabletoaccuratelyestimatethelivesoftheperpetualvirtualitems,whichwillalsoaffectourabilitytoaccuratelyrecognizeouronlinegamerevenuesfromsuchperpetualvirtualitems.
Therefore,ifouronlinegamebillingsystemsweredamagedbysystemfailure,networkinterruption,orvirusinfection,orattackedbyahacker,theintegrityofdatawouldbecompromised,whichcouldhaveasignicantaffectonouronlinegamerevenuerecognitionandtheaccuracyofourrecordedonlinegamerevenues,resultinginpossiblerestatementofournancialstatementsandlossofinvestorcondenceinus.
Inaddition,werelyonouronlinegamebillingsystemstorecordgameplayerconsumptionpatterns,basedonwhichweimproveourexistingvirtualitemsanddesignnewvirtualitems.
Forexample,weintendtoincreasedevelopmenteffortsonthenumberandvarietyofvirtualitemsthatourgameplayersliketopurchase,andmayalsoadjustpricesaccordingly.
Ifouronlinegamebillingsystemsfailtorecordsuchdataaccurately,ourabilitytoimproveexistingvirtualitemsordesignnewvirtualitemsthatareappealingtoourgameplayersmaybeadverselyaffected,whichcouldinturnmateriallyandadverselyaffectouronlinegamerevenues.
WeincuradditionalcostsandfacesignicantriskswhenwelicenseourgamesoutsideofChinaandseektoexpandouroperationstoselectmarkets,suchastheUnitedStates,EuropeandMalaysia.
Ifwefailtomanagetheserisks,ourgrowthandbusinessprospectscouldbemateriallyandadverselyaffected.
WecurrentlylicenseTLBBtothird-partyoperatorstooperatethegameinTaiwan,HongKong,Vietnam,MalaysiaandSingapore.
Pursuanttoourstrategy,weplantocontinuetolicenseTLBBandotherfuturegamesintheseandotheroverseasmarkets.
WehavealsoexpandedourdirectMMORPGoperationstoselectmarkets,suchastheUnitedStates,theUnitedKingdomandMalaysia.
Identifyingappropriateoverseas-57-markets,negotiatingwithpotentialthird-partylicenseesandmanagingourrelationshipswithourlicenseesallrequiresubstantialmanagementeffortandskillsandtheincurrenceofadditionalexpenditures.
Licensinggames,oroperatingthemdirectlyinoverseasalsorequirestranslationofourgamestothelocallanguageoftheoverseasmarketinwhichweplantolicenseoroperate,andmayrequirecustomizationaswell,bothofwhichrequireadditionalcostsandexpenses.
Furthermore,thereareadditionalrisksinconnectionwiththelicensingordirectoperationofourgamesoverseas,including:difcultiesinidentifyingandmaintaininggoodrelationshipswithlicenseeswhoareknowledgeableabout,andcaneffectivelydistributeandoperateourgamesin,overseasmarkets;difcultiesandcostsrelatingtocompliancewiththedifferentlegalrequirementsandcommercialtermsintheoverseasmarketsinwhichwelicenseordirectlyoperateourgames,suchasgameexportregulatoryprocedures,taxesandotherrestrictionsandexpenses;difcultiesinmaintainingthereputationofourcompanyandourgames,whenourgamesareoperatedbylicenseesintheoverseasmarketspursuanttotheirownstandards;difcultiesinmanagingouroverseasemployeeswhenweoperateourgamesdirectlyoverseas;changesinthepolitical,regulatoryoreconomicconditionsinaforeigncountryorregion,orpublicpoliciestowardonlinegames;uctuationsincurrencyexchangerate;difcultiesinverifyingrevenuesgeneratedfromourgamesbyourlicenseesforpurposesofdeterminingtheroyaltiestous;difcultiesinprotectingourintellectualproperty;exposuretodifferentregulatorysystemsgoverningtheprotectionofintellectualpropertyandtheregulationofonlinegames,theInternetandtheexportoftechnology;theriskthattheregulatoryauthoritiesinforeigncountriesorregionsmayimposewithholdingtaxes,orplacerestrictiononrepatriationofourprots;andinherentdifcultiesanddelaysincontractenforcementandcollectionofreceivablesthroughtheuseofforeignlegalsystems.
Ifweareunabletomanagetheseriskseffectively,ourabilitytolicenseoroperatedirectlyourgamesoverseasmaybeimpaired,whichmaymateriallyandadverselyaffectthefuturegrowth,nancialconditionandresultsofoperationsofouronlinegamebusiness.
Weusedtorelyonwirelessservicesforasignicantportionofourrevenues.
Wirelessrevenueshaveuctuatedinpriorperiodsandmaydecreaseinthefuture.
WehavederivedourwirelessrevenuesinpriorperiodsfromprovidingSMS,RBT,WAP,MMSandIVR,mainlyconsistingofnews,weatherforecast,chatting,entertainmentinformation,music,ringtone,pictureandlogodownloadsandvariousothermobilerelatedproductstomobilephoneusersandPersonalHandy-phoneSystem(orPHS)users.
Weusedtoderiveasignicantportionofourrevenuesfromwirelessservices,buttheportionhasdecreasedincertainpriorperiods.
FortheyearendedDecember31,2009,wirelessrevenueswas12%ofourtotalrevenues.
Wirelessrevenuesmaydecreaseinthefutureduetothepossibilitiesthat:Ourconsumersmaynotunderstandourservicesorthefeestheyarebeingcharged,maynotbesatisedwithourservicesand/ormaynotuseourservicesonaregularbasis;-58-Consumersmaycanceltheirservicesatanytimewithoutnotice;RevenuesfromnewwirelessservicessuchasRBT,WAP,MMSandIVRmaynotcontinuetogrowsignicantlyandbecomeasignicantportionofourtotalwirelessrevenues;Competitors,includingmobilenetworkoperators,maylaunchcompetingorbetterproductsthanoursatanytime;Therearelimitedbarrierstoentrytothewirelessservicessector;Changesinthebillingpracticesoroperationalrulesandproceduresofanyofthethreemobilenetworkoperators,CMCC,ChinaUnicomandChinaTelecom,onwhomwerelyforservicedeliveryandfeecollection,couldhaveamaterialimpactonourwirelessrevenues.
Forinstance,onJanuary1,2007,anoticeoftheMIITcameintoeffectthatfocusesontheprotectionofamobilephoneusers'righttoselectservicesandthestrengtheningofregulationonbillingprocedure.
OnMay17,2007,CMCCinitiatedanewpolicyunderwhichallWAPusersareremindedofchargestheymayincurforWAPservices.
ThepolicyhasresultedinadecreaseintrafcforWAPportals,andinturnadecreaseinsubscriptionsforourWAPservices.
OnNovember29,2009,CMCCannouncedatemporarysuspensionofbillingofWAPservices,asanefforttoghtagainstWebsitesprovidingpornographiccontent.
Asaresult,beginninginDecember2009wehavenotbeenabletocollectanyrevenuesfromWAPservices.
WearenotsurewhenCMCCwillresumebillingforWAPservicesandweexpectourwirelessrevenueswillbenegativelyaffected.
Additionally,beginningfromJanuary25,2010,CMCCissuedseveralnoticesaimingtotightencontrolsoversubscriptionsembeddedinmobilehandsetsbymobilemanufacturers.
Specically,wirelessservicesembeddedinhandsetsarerequiredtorequestdoubleconrmationswhenconsumerspurchasesuchservicesandasingleSMScodemayonlybeusedforaspecicserviceofferingorservicespartnerinsteadofformultipleserviceofferingsorpartnersaswaspermittedpreviously.
Ourwirelessrevenueshavebeennegativelyaffectedbytheimplementationofsuchregulationsandpolicies,andtherecouldbenewregulationsorpoliciesthatcouldfurtheradverselyaffectourwirelessrevenues;Changesingovernmentpolicycouldrestrictorcurtailtheserviceswhichweprovide.
TheMIIThasproposedrequiringallhandsetusers(includingpre-paidmobilephoneusers)toregisterusingtheirrealnames.
Ifthisrequirementisimplemented,itmaycauseadecreaseinnewcustomers,andinturn,reduceourwirelessrevenues;Mobilenetworkoperatorsmayimposepenaltiesonwirelessserviceproviders(orSPs),forviolatingcertainoperatingpoliciesrelatingtotheprovisionofwirelessservices.
Wehavereceivedseveralpenaltynoticesfrommobilenetworkoperators,claimingabreachofcooperationcontractsandimposingbothservicesuspensionsanctionsforaperiodofnotmorethanayearand/ormonetarypenalties.
Thereisnoguaranteethatwewillnotbesubjecttosimilar,ormoresevere,penaltiesfrommobilenetworkoperatorsinthefuture,whichcouldsignicantlyimpairourwirelessbusiness;Wemayenterintocooperationagreementswithmobilenetworkoperatorsontermsthatarenotfavorabletous,sincewehavelimitedbargainingpowertonegotiatecontractterms.
Inaddition,mobilenetworkoperatorsmayunilaterallyrevisetheiragreementsatanytime.
Asaresultofsuchcontractterms,wecouldeasilybefoundinbreachofouragreementwithanoperatorandmaybesubjecttopenalties;andMobilenetworkoperatorsmaynotenternewagreementsorrenewexistingagreementswithSPswithrespecttowirelessservices.
Neworrenewedagreementswithmobilenetworkoperatorscouldchangeinawaythatwouldbeunfavorabletous,orsuchagreementsmaynotbeenteredintoatall.
-59-Werelyoncontractswiththemobilenetworkoperatorsinanumberofwayswithrespecttoourwirelessservices,includingthebillingof,andcollectionfrom,mobilephoneusersofwirelessservicefees.
Ifourarrangementswithmobilenetworkoperatorsweretobeterminated,alteredornotrenewed,orifsuchoperatorsdidnotprovidecontinuousoradequateservice,ourrevenuescouldbereduced.
OurwirelessservicesdependmainlyonthecooperationofmobilenetworkoperatorssuchasCMCC,ChinaUnicom,ChinaTelecomandtheirrespectivesubsidiaries.
Werelyonmobilenetworkoperatorsinthefollowingways:weusemobilenetworkoperators'networksandgatewaystoprovidewirelessservices;weuseandrelyonmobilenetworkoperators'billingsystemstochargeoursubscribersthroughthesubscribers'mobilephonebills;werelyonmobilenetworkoperators'collectionproxyservicestocollectpaymentsfromsubscribers;andwerelyonmobilenetworkoperators'infrastructuretofurtherdevelopourwirelessservices.
Wefacesignicantriskswithrespecttoourarrangementswithmobilenetworkoperatorswhichcouldadverselyaffectourwirelessrevenues.
Suchrisksincludethefollowing:Mobilenetworkoperatorshavechangedtheiroperatingrulesandmaymakefurtherchangesatanytime.
Suchpreviousoranyfuturechangescouldresultinourbeingrequiredtopaypenaltiesforbreachingorbeingallegedtohavebreachedcertainprovisionsofouragreementswiththemobilenetworkoperatorsunderneworrevisedoperationrules,orhavingourservicediscontinuedwithorwithoutnotice.
Changesintheseoperatingrulescouldalsohaveamaterialimpactonourwirelessrevenues;WeprovidewirelessservicesthroughourWebsiteandrecordthedeliveryoftheserviceinourinternalsystems.
However,inordertorecognizerevenuesandreceivepaymentforservicesprovided,werelyonbillingconrmationsfrommobilenetworkoperatorsastotheactualamountofservicestheyhavebilledtotheirmobilecustomers.
Weareunabletocollectwirelessservicefeesfromanoperatorincertaincircumstancesduetotechnicalissueswiththeoperator'snetwork.
Werefertothesefailuresasanoperator's"failurerate",whichcanvaryfromoperatortooperator.
Anoperator'sfailureratecanvaryfrommonthtomonth,rangingfrom0%to94%andmaychangeatanytimewithoutnotice.
Ifanoperatorencounterstechnicalproblems,increasesinthefailurerateforthatoperatorcouldoccur;Theservicefeeswepayforusinganoperator'sinfrastructurearesetonthebasisofnegotiationofannualcontracts.
Ournegotiationleverageislimitedandifanoperatorincreasesitsservicefeesordoesnotcomplywiththetermsofourcontract,ourgrossmarginandprotabilitycouldbemateriallyreduced.
Itispossiblethatsomesubsidiariesofthemobilenetworkoperatorsmayconsiderincreasingtheirservicefees;Wearerequiredtofollowtheoperators'guidanceinsettingupwirelessservicefees.
Wealsorelyonthemobilenetworkoperatorstocollectthefeesonourbehalfwhichtheyhavebilledtoourmobilecustomers.
Ifanoperatorrequiresustoreducethewirelessservicefeeschargedtomobilecustomers,disallowsusfrombillingofcertaininactivecustomers,refusestopayus,requiresustosharebaddebtsexpenses,or,limitstheamountofwirelessservicefeeswhichcanbebilledorrequiresustocomplywithanynewbillingrules,ourwirelessrevenuescouldbeadverselyaffected;Anoperator'srefusaltoallowustosupplycertainservicescoulddisruptourwirelessservices.
Forexample,duringtheperiodfromSeptember1,2004toJuly31,2005,ourMMSserviceswere-60-temporarilysuspendedbyCMCC,basedonallegationsthatBeijingSohu,whichwasoneofourVIEsatthetime,breachedcertainprovisionsofitsagreementwithaCMCCsubsidiary;AnoperatorcouldlaunchcompetingservicesatanytimeandcouldworkwithcontentprovidersdirectlysothatSPs'abilitiestodiversifytheirproductsmightbelimited.
Forexample,inJuly2006,CMCCintroducedM.
Music,anintegratedmusicserviceplatformwhichCMCCworksdirectlywithmusicrecordcompaniestoprovidedownloadsofvarioussongsandmusic.
InDecember2006,CMCCintroduceditsownWAPchannel,"WAPPremierSelect",whichisplacedinprominentpositionsonMonternetanddirectlycompeteswithSPs.
Ifmobilenetworkoperatorswereunwillingtoworkwithus,wewouldnotbeabletondsubstitutepartners;andCMCCsetuprulesforrankingofWAPserviceprovidersonitsMonternetbrowser,whichhashadasignicantimpactonWAPrevenues.
CMCCmaychangetherulesatanytimetoaffecttherankofthetopvelistings.
Asaresult,thegrowthofourWAPrevenueswaslowerthanexpectedandwemayloseourexistingrankingbecauseoflowervisitrates.
OnNovember29,2009,CMCCannouncedatemporarysuspensionofbillingofWAPservices,asanefforttoghtagainstWebsitesprovidingpornographiccontent.
Asaresult,sinceDecember2009,wehavenotbeenabletocollectanyrevenuesfromWAPservices.
WearenotsurewhenCMCCwillresumebillingforWAPservicesandweexpectourwirelessrevenueswillbenegativelyaffected.
RisksRelatedtoChina'sTelecommunicationsInfrastructureThetelecommunicationsinfrastructureinChina,whichisnotaswelldevelopedasintheUnitedStates,maylimitourgrowth.
ThetelecommunicationsinfrastructureinChinaisnotwelldeveloped.
OurgrowthwilldependonthePRCgovernmentandstate-ownedenterprisesestablishingandmaintainingareliableInternetandtelecommunicationsinfrastructuretoreachabroaderbaseofInternetusersinChina.
TheInternetinfrastructure,standards,protocolsandcomplementaryproducts,servicesandfacilitiesnecessarytosupportthedemandsassociatedwithcontinuedgrowthmaynotbedevelopedonatimelybasisoratallbythePRCgovernmentandstate-ownedenterprises.
WedependonChinaUnicom,ChinaTelecomandCERNETfortelecommunicationsservices,andanyinterruptionintheseservicesmayresultinseveredisruptionstoourbusiness.
AlthoughprivateInternetserviceprovidersexistinChina,almostallaccesstotheInternetismaintainedthroughChinaUnicom,ChinaTelecomandCERNET,undertheadministrativecontrolandregulatorysupervisionoftheMIIT.
WerelyonthisinfrastructureandChinaUnicom,ChinaTelecomandCERNETtoprovidedatacommunicationscapacityprimarilythroughlocaltelecommunicationslines.
Althoughthegovernmenthasannouncedaggressiveplanstodevelopthenationalinformationinfrastructure,thisinfrastructuremaynotbedevelopedandtheInternetinfrastructureinChinamaynotbeabletosupportthecontinuedgrowthofInternetusage.
Inaddition,wewillhavenoaccesstoalternativenetworksandservices,onatimelybasisifatall,intheeventofanyinfrastructuredisruptionorfailure.
WehavesignedBandwidthProvisionandServerHostingAgreementswithChinaUnicom,ChinaTelecomandCERNET.
Undertheseagreements,weestablishedthreemainserviceprovisioncenterstomaintainmostofourserversinBeijing.
However,astherearelimitedtelecommunicationinfrastructureserviceproviders,wemaynotbeabletoleaseadditionalbandwidthonacceptableterms,onatimelybasis,oratall.
Ifwearenotabletoleaseadditionalbandwidth,thedevelopmentofourbusinesscanbeaffected.
-61-Thesuccessfuloperationofourbusinessandimplementationofourgrowthstrategies,includingourabilitytoaccommodateadditionalgameplayersinthefuture,dependupontheperformanceandreliabilityoftheInternetinfrastructureandxedtelecommunicationsnetworksinChina.
AlthoughprivateInternetserviceproviderscurrentlyexistinChina,almostallaccesstotheInternetismaintainedthroughstate-ownedtelecommunicationsoperatorsundertheadministrativecontrolandregulatorysupervisionoftheMinistryofIndustryandInformationTechnology,orMIIT(formerlytheMinistryofInformationIndustry).
Werelyonthisinfrastructuretoprovidedatacommunicationscapacityprimarilythroughlocaltelecommunicationslines.
Althoughthegovernmenthasannouncedplanstodevelopaggressivelythenationalinformationinfrastructure,wecannotassureyouthatthisinfrastructurewillbedevelopedasplannedoratall.
Inaddition,wewillhavenoaccesstoalternativenetworksandservices,onatimelybasisifatall,intheeventofanyinfrastructuredisruptionorfailure.
TheInternetinfrastructureinChinamaynotsupportthedemandsnecessaryforthecontinuedgrowthinInternetusage.
ThelimiteduseofpersonalcomputersinChinaandtherelativelyhighcostofInternetaccessinrelationtopercapitagrossdomesticproductmaylimitthedevelopmentoftheInternetinChinaandimpedeourgrowth.
ThepenetrationrateforpersonalcomputersinChinaissignicantlylowerthanitisintheUnitedStatesandotherdevelopedcountries.
Furthermore,thecostofInternetaccessisstillrelativelyhighascomparedtootherdevelopedcountries.
ThelimiteduseofpersonalcomputersinChinaandtherelativelyhighcostofInternetaccessmaylimitthegrowthofourbusiness.
Inaddition,theremaybeincreasesinInternetaccessfeesortelecommunicationfeesinChina.
Ifthathappens,thenumberofourgameplayersmaydecreaseandthegrowthofourgameplayerbasemaybemateriallyimpacted.
ThehighcostofInternetaccessmaylimitthegrowthoftheInternetinChinaandimpedeourgrowth.
AccesstotheInternetinChinaremainsrelativelyexpensive,andmaymakeitlesslikelyforuserstoaccessandtransactbusinessovertheInternet.
UnfavorableratedevelopmentscouldfurtherdecreaseourvisitortrafcandourabilitytoderiverevenuesfromtransactionsovertheInternet.
TotheextentweareunabletoscaleoursystemstomeettheincreasingPRCInternetpopulation,wewillbeunabletoexpandouruserbaseandincreaseourattractivenesstoadvertisersandmerchants.
AsWebpagevolumeandtrafcincreaseinChina,wemaynotbeabletoscaleoursystemsproportionately.
Totheextentwedonotsuccessfullyaddressourcapacityconstraints,ouroperationsmaybeseverelydisrupted,andwemaynotbeabletoexpandouruserbaseandincreaseourattractivenesstoadvertisersandmerchants.
Evenifwescaleoursystemsproportionately,anyunforeseenincreaseintrafcmaydisruptouroperationsandmakeitdifcultforouruserstovisitourWebsitescauseuserstobeunabletoaccessourWebsitesatall,whichcouldresultinalossofusers.
Unexpectednetworkinterruptionscausedbysystemfailuresmayresultinreducedvisitortrafc,reducedrevenueandharmtoourreputation.
OurWebsiteoperationsaredependentuponWebbrowsers,Internetserviceproviders,contentprovidersandotherWebsiteoperatorsinChina,whichhaveexperiencedsignicantsystemfailuresandsystemoutagesinthepast.
Ourusershaveinthepastexperienceddifcultiesduetosystemfailuresunrelatedtooursystemsandservices.
Anysystemfailureorinadequacythatcausesinterruptionsintheavailabilityofourservices,orincreasestheresponsetimeofourservices,asaresultofincreasedtrafcorotherwise,couldreduceourusersatisfaction,futuretrafcandourattractivenesstousersandadvertisers.
Forexample,onFebruary14,2009,ourblogservicesweredisconnectedbecauseofapowerlossaffectingChinaUnicom.
-62-Ouroperationsarevulnerabletonaturaldisastersandotherevents,asweonlyhavelimitedbackupsystemsanddonotmaintainanybackupserversoutsideofChina.
Wehavelimitedbackupsystemsandhaveexperiencedsystemfailuresandelectricaloutagesfromtimetotimeinthepast,whichhavedisruptedouroperations.
MostofourserversandroutersarecurrentlyhostedinasinglelocationwithinthepremisesofBTA.
Ourdisasterrecoveryplancannotfullyensuresafetyintheeventofdamagefromre,oods,typhoons,earthquakes,powerloss,telecommunicationsfailures,break-insandsimilarevents.
Ifanyoftheforegoingoccurs,wemayexperienceacompletesystemshutdown.
Wedonotcarryanybusinessinterruptioninsurance.
Toimprovetheperformanceandtopreventdisruptionofourservices,wemayhavetomakesubstantialinvestmentstodeployadditionalserversoroneormorecopiesofourWebsitestomirrorouronlineresources.
Althoughwecarrypropertyinsurancewithlowcoveragelimits,ourcoveragemaynotbeadequatetocompensateusforalllosses,particularlywithrespecttolossofbusinessandreputationthatmayoccur.
Ournetworkoperationsmaybevulnerabletohacking,virusesandotherdisruptions,whichmaymakeourproductsandserviceslessattractiveandreliable.
Internetusagecoulddeclineifanywell-publicizedcompromiseofsecurityoccurs.
"Hacking"involveseffortstogainunauthorizedaccesstoinformationorsystemsortocauseintentionalmalfunctionsorlossorcorruptionofdata,software,hardwareorothercomputerequipment.
Hackers,ifsuccessful,couldmisappropriateproprietaryinformationorcausedisruptionsinourservice.
WemayberequiredtoexpendcapitalandotherresourcestoprotectourWebsiteagainsthackers.
Wecannotassureyouthatanymeasurewemaytakewillbeeffective.
Inaddition,theinadvertenttransmissionofcomputervirusescouldexposeustoamaterialriskoflossorlitigationandpossibleliability,aswellasmateriallydamageourreputationanddecreaseourusertrafc.
RisksRelatedtoChina'sRegulationEnvironmentAllofChangyou'srevenuesaregeneratedthroughGamease,itsVIE,andChangyoureliesonpaymentsmadebyGameasetoAmazGame,itssubsidiary,pursuanttocontractualarrangementstotransferanysuchrevenuestoAmazGame.
AnyrestrictiononsuchpaymentsandanyincreaseintheamountofPRCtaxesapplicabletosuchpaymentsmaymateriallyandadverselyaffectChangyou'sbusinessanditsabilitytopaydividendstoitsshareholdersandAmericandepositaryshares("ADS")holders.
ChangyouconductssubstantiallyallofitsoperationsthroughGamease,itsVIE,whichgeneratesallofChangyou'srevenues.
AsGameaseisnotownedbyChangyou'ssubsidiaries,itisnotabletomakedividendpaymentstoChangyou'ssubsidiaries.
Instead,AmazGame,Changyou'ssubsidiaryinChina,enteredintoanumberofcontractswithGamease,includingaBusinessOperationAgreement,aTechnologySupportandUtilizationAgreement,andaServicesandMaintenanceAgreement,pursuanttowhichGameasepaysAmazGameforcertainservicesthatAmazGameprovidestoGamease.
However,dependingonthenatureofservicesprovided,certainofthesepaymentsaresubjecttoPRCtaxesatdifferentrates,includingbusinesstaxesandvalueaddedtaxes("VATs"),whicheffectivelyreducetheamountthatAmazGamereceivesfromGamease.
WecannotassureyouthatthePRCgovernmentwillnotimposerestrictionsonsuchpaymentsorchangethetaxratesapplicabletosuchpayments.
AnysuchrestrictionsonsuchpaymentorincreasesintheapplicabletaxratesmaymateriallyandadverselyaffectChangyou'sabilitytoreceivepaymentsfromGameaseortheamountofsuchpayments,andmayinturnmateriallyandadverselyaffectChangyou'sbusiness,itsnetincomeanditsabilitytopaydividendstoitsshareholdersandADSholders.
-63-AmazGame'scontractualarrangementswithGameaseanditsshareholdersmaynotbeaseffectiveinprovidingcontroloverGameaseasdirectownershipofGameaseandtheshareholdersofGameasemayhavepotentialconictsofinterestwithus.
ChangyouhasnoownershipinterestinGameaseanditconductssubstantiallyallofChangyou'soperationsandgeneratessubstantiallyallofouronlinegamerevenuesthroughcontractualarrangementsthatChangyou'ssubsidiary,AmazGame,hadenteredintowithGameaseanditsshareholders,andsuchcontractualarrangementsaredesignedtoprovideuswitheffectivecontroloverGamease.
WedependonGameasetoholdandmaintaincertainlicensesnecessaryforourgamebusiness.
Gameasealsoownsallofthenecessaryintellectualproperty,facilitiesandotherassetsrelatingtotheoperationofourgames,andemployspersonnelforourgameoperationsanddistribution.
ThesecontractualarrangementsmaynotbeaseffectiveinprovidinguswithcontroloverGameaseasdirectownership.
IfwehaddirectownershipofGamease,wewouldbeabletoexerciseourrightsasashareholdertoeffectchangesintheboardofdirectorsofGamease,whichinturncouldeffectchanges,subjecttoanyapplicableduciaryobligations,atthemanagementlevel.
DuetoourVIEstructure,wehavetorelyoncontractualrightstoeffectcontrolandmanagementofGamease,whichexposesustotheriskofpotentialbreachofcontractbytheshareholdersofGamease.
Inaddition,asGameaseisjointlyownedbyitsshareholders,itmaybedifcultforustochangeourcorporatestructureifsuchshareholdersrefusetocooperatewithus.
TheshareholdersofGameasemaybreach,orcauseGameasetobreach,thecontractsforanumberofreasons.
Forexample,theirinterestsasshareholdersofGameaseandtheinterestsofourcompanymayconictandwemayfailtoresolvesuchconicts;theshareholdersmaybelievethatbreachingthecontractswillleadtogreatereconomicbenetforthem;ortheshareholdersmayotherwiseactinbadfaith.
Ifanyoftheforegoingweretohappen,wemayhavetorelyonlegalorarbitralproceedingstoenforceourcontractualrights,includingspecicperformanceorinjunctiverelief,andclaimingdamages.
Sucharbitralandlegalproceedingsmaycostussubstantialnancialandotherresources,andresultindisruptionofourbusiness,andwecannotassureyouthattheoutcomewillbeinourfavor.
Inaddition,asallofthesecontractualarrangementsaregovernedbyPRClawandprovidefortheresolutionofdisputesthrougheitherarbitrationorlitigationinthePRC,theywouldbeinterpretedinaccordancewithPRClawandanydisputeswouldberesolvedinaccordancewithPRClegalprocedures.
ThelegalenvironmentinthePRCisnotasdevelopedasinotherjurisdictions,suchastheUnitedStates.
Asaresult,uncertaintiesinthePRClegalsystemcouldfurtherlimitourabilitytoenforcethesecontractualarrangements.
Furthermore,thesecontractsmaynotbeenforceableinChinaifPRCgovernmentauthoritiesorcourtstakeaviewthatsuchcontractscontravenePRClawsandregulationsorareotherwisenotenforceableforpublicpolicyreasons.
Intheeventweareunabletoenforcethesecontractualarrangements,wemaynotbeabletoexerteffectivecontroloverGamease,andourabilitytoconductourbusinessmaybemateriallyandadverselyaffected.
AmazGameandGamease'scontractualarrangementsmayresultinadversetaxconsequencestous.
UnderPRClawsandregulations,arrangementsandtransactionsamongrelatedpartiesmaybesubjecttoauditorchallengebythePRCtaxauthorities.
WecouldfacematerialadversetaxconsequencesifthePRCtaxauthoritiesdeterminethatAmazGameandGamease'scontractualarrangementswerenotmadeonanarm'slengthbasisandadjustourincomeandexpensesforPRCtaxpurposesintheformofatransferpricingadjustment.
Atransferpricingadjustmentcouldresultinareduction,forPRCtaxpurposes,ofadjustmentsrecordedbyGamease,whichcouldadverselyaffectusby(i)increasingGamease'staxliabilitywithoutreducingAmazGame'staxliability,whichcouldfurtherresultininterestbeingleviedtousforunderpaidtaxes;or(ii)limitingtheabilityofAmazGameandGameasetomaintainpreferentialtaxtreatmentsandothernancialincentives.
Ifforanyreasonweneedtocausethetransferofoneoftheshareholders'sharesinGameasetoadifferentnomineeshareholder(suchasif,forexample,oneofsuchshareholdersisnolonger-64-employedbyus)wemightberequiredtopayindividualincometax,onbehalfofthetransferringshareholder,onanygaindeemedtohavebeenrealizedbysuchshareholderonsuchtransfer.
IfthePRCgovernmentdeterminesthattheVIEstructureforoperatingourbusinessdoesnotcomplywithPRCgovernmentrestrictionsonforeigninvestmentintheonlinegameindustry,wecouldfaceseverepenalties.
VariousregulationsinChinacurrentlyrestrictorpreventforeign-investedentitiesfromengagingintelecommunicationservices,includingoperatingonlinegames.
Becauseoftheserestrictions,ourMMORPGoperationsinthePRCareconductedthroughChangyou'sVIE,Gamease,aPRCcompanythatisownedbyChangyou'sChiefExecutiveOfcerandaChangyouemployee,bothofwhomarePRCcitizens,butwhichiseffectivelycontrolledbyBeijingAmazGameAgeInternetTechnologyCo.
,Ltd.
,orAmazGame,aPRCcompanyandourindirectwholly-ownedsubsidiary,throughaseriesofcontractualarrangements.
AcircularissuedbyMIITinJuly2006,ortheMIITcircular,reiteratedtheregulationsonforeigninvestmentintelecommunicationsbusinesses.
Underthiscircular,adomesticcompanythatholdsalicensefortheprovisionofInternetinformationservice,oranICPlicense,oralicensetoconductanyvalue-addedtelecommunicationsbusinessinChina,isprohibitedfromleasing,transferringorsellingthelicensetoforeigninvestorsinanyform,andfromprovidinganyassistance,includingprovidingresources,sitesorfacilities,toforeigninvestorstoconductvalue-addedtelecommunicationsbusinessesillegallyinChina.
Furthermore,therelevanttrademarksanddomainnamesthatareusedinthevalue-addedtelecommunicationsbusinessmustbeownedbythelocalICPlicenseholder.
TheMIITcircularfurtherrequireseachICPlicenseholdertohavethenecessaryfacilitiesforitsapprovedbusinessoperationsandtomaintainsuchfacilitiesintheregionscoveredbyitslicense.
Inaddition,allvalue-addedtelecommunicationsserviceprovidersarerequiredtomaintainnetworkandinformationsecurityinaccordancewiththestandardssetforthunderrelevantPRCregulations.
Duetoalackofinterpretativematerialsfromtheregulators,itisuncertainwhetherMIITwouldconsiderourcorporatestructuresandcontractualarrangementsasakindofforeigninvestmentintelecommunicationservices.
Therefore,itisunclearwhatimpactthiscircularwillhaveonusortheotherChineseInternetcompaniesthathaveadoptedthesameorsimilarcorporatestructuresandcontractualarrangementsasChangyou.
OnSeptember28,2009,theGAPP,togetherwiththeNationalCopyrightAdministration,andNationalOfceofCombatingPornographyandIllegalPublicationsjointlyissuedaNoticeonFurtherStrengtheningontheAdministrationofPre-examinationandApprovalofOnlineGameandtheExaminationandApprovalofImportedOnlineGame(the"GAPPNotice").
TheGAPPNoticerestatesthatforeigninvestorsarenotpermittedtoinvestinonlinegameoperatingbusinessesinChinaviawholly-owned,equityjointventureorcooperativejointventureinvestmentsandexpresslyprohibitsforeigninvestorsfromgainingcontroloverorparticipatingindomesticonlinegameoperatorsthroughindirectwayssuchasestablishingotherjointventurecompanies,orcontractualortechnicalarrangements.
ItisunclearwhethertheauthoritieswilldeemChangyou'sVIEstructureasakindofsuch"indirectways"byforeigninvestorstogaincontroloverorparticipateindomesticonlinegameoperators.
IfChangyou'sVIEstructureisdeemedasonesuch"indirectway"undertheGAPPNotice,itsVIEstructuremaybechallengedbytheauthorities.
IfwearefoundtobeinviolationofanyexistingorfuturePRClawsorregulations,includingtheMIITcircularandtheGAPPNotice,therelevantregulatoryauthoritieswouldhavebroaddiscretionindealingwithsuchviolation,includinglevyingnes,conscatingourincome,revokingGamease's,orAmazGame'sbusinessoroperatinglicenses,requiringustorestructuretherelevantownershipstructureoroperations,andrequiringustodiscontinuealloranyportionofourgameoperations.
Anyoftheseactionscouldcausesignicantdisruptiontoourbusinessoperations.
-65-IfourcurrentownershipstructureisfoundtobeinviolationofcurrentorfuturePRClaws,rulesorregulationsregardingthelegalityofforeigninvestmentinthePRCInternetsector,wecouldbesubjecttoseverepenalties.
WeconductourInternetandvalue-addedtelecommunicationoperationssolelyinthePRCthroughourindirectwholly-owned,majority-ownedsubsidiariesandVIEsasfollowing:Forbrandadvertisingbusiness,subsidiariesareSohuSoftware,SohuMedia,andNewSoftware.
VIEsareSohuEntertainmentandFengYangTianLang;Forsponsoredsearchbusiness,subsidiariesareGo2MapSoftwareandSogouTechnology.
VIEsareTuXingTianXiaandSogouInformation;Foronlinegamebusiness,subsidiaryisAmazGame.
VIEisGamease;Forwirelessandothersbusinesses,subsidiariesareSohuEraandBeijingFireFox.
VIEsareSohuInternet,GoodFeel,HighCentury,21EastBeijing,andNew21East.
WeareaDelawarecorporation,whileSohuHongKong,ourindirectwholly-ownedsubsidiaryandtheparentcompanyofSohuEra,SohuMediaandSohuSoftware,togetherwithChangyouHK,ourindirectmajority-ownedsubsidiaryandtheparentcompanyofAmazGameisHongKongcorporationsandforeignpersonsunderPRClaw.
InordertomeetownershiprequirementsunderPRClawwhichrestrictorprohibitwhollyforeignownedenterprises,orWFOEs,fromoperatingincertainindustriessuchasInternetinformation,wireless,Internetaccess,andcertainotherindustries,ourVIEsarecompaniesincorporatedinthePRCandownedbycertainofouremployees.
ThePRCbeganseveralyearsagotoregulateitsInternetsectorbymakingpronouncementsorenactingregulationsregardingthelegalityofforeigninvestmentinthePRCInternetsectorandtheexistenceandenforcementofcontentrestrictionsontheInternet.
WebelievethatourcurrentownershipstructurecomplieswithallexistingPRClaws,rulesandregulations.
Thereare,however,substantialuncertaintiesregardingtheinterpretationofcurrentPRCInternetlawsandregulations.
ThePRCgovernmentmayissuenewinterpretationsoftheregulationsregardingsupervisionoftheInformationindustryfromtimetotime.
InJuly2006,theMIITissuedanoticetostrengthenmanagementofforeigninvestmentinandoperationofvalue-addedtelecommunicationservices.
Thenoticeemphasizesthatforeigninvestorswhowishtoengageinvalue-addedtelecommunicationservicesmuststrictlyfollowtherelevantrulesandregulationsonforeigninvestmentintelecommunicationsectors.
Thenoticealsoprohibitsdomestictelecommunicationservicesprovidersfromleasing,transferringorsellingtelecommunicationsbusinessoperatinglicensestoanyforeigninvestorinanyform,orprovidinganyresources,sitesorfacilitiestoanyforeigninvestorfortheirillegaloperationofatelecommunicationsbusinessinChina.
Accordingtothenotice,eithertheholderofavalue-addedtelecommunicationservicelicenseoritsshareholdersmustdirectlyownthedomainnamesandtrademarksusedbysuchlicenseholdersintheirprovisionofValue-addedTelecommunicationServices.
Thenoticefurtherrequireseachlicenseholdertohavethenecessaryfacilities,includingservers,foritsapprovedbusinessoperationsandtomaintainsuchfacilitiesintheregionscoveredbyitslicense.
Value-addedserviceslicenseholdersarerequiredtoevaluatethecompliancewiththerequirementssetforthinthenotice.
WeareintheprocessoftransferringseveralofourdomainnamesandtrademarkstoSohuInternet,whichlicensedthesametoSohuEraandSohuMedia,andwemaymodifyothercertainaspectsofourbusinessstructureinordertofurthercomplywiththeserequirements.
Inaddition,newPRCInternetandforeignexchangelawsandregulationswererecentlyadopted.
Accordingly,itispossiblethatthePRCgovernmentmayultimatelytakeaviewcontrarytoours.
Inaddition,undertheagreementreachedinNovember1999betweenthePRCandtheUnitedStatesconcerningtheUnitedStates'supportofChina'sentryintotheWorldTradeOrganization(orWTO),regulationofforeigninvestmentinPRCInternetservicesistobeliberalizedtoallowfor30%foreign-66-ownershipinkeytelecommunicationservices,includingPRCInternetventures,fortherstyearafterChina'sentryintotheWTO,49%inthesecondyearand50%thereafter.
ChinaofciallyenteredtheWTOonDecember11,2001.
However,theimplementationofChina'sWTOaccessionagreementsisstillsubjecttovariousconditions.
Accordingly,itispossiblethattherelevantPRCauthoritiescould,atanytime,assertthatanyportionoralloftheSohuPRCsubsidiaries'andVIEs'existingorfutureownershipstructureandbusinessesviolateexistingorfuturePRClaws,regulationsorpolicies.
ItisalsopossiblethatthenewlawsorregulationsgoverningPRCInternetsectorthathavebeenadoptedormaybeadoptedinthefuturewillprohibitorrestrictforeigninvestmentin,orotheraspectsof,anyofourPRCsubsidiaries'andVIEs'currentorproposedbusinessesandoperations.
Inaddition,anysuchnewlawsandregulationsmayberetroactivelyappliedtousandourPRCsubsidiariesandVIEs.
IfweoranyofourPRCsubsidiariesandVIEswerefoundtobeinviolationofanyexistingorfuturePRClawsorregulations,therelevantPRCauthoritieswouldhavebroaddiscretionindealingwithsuchviolations,including,withoutlimitation,thefollowing:levyingnes;conscatingourincome;revokingourlicenses;shuttingdownourserversand/orblockingourWebsites;requiringustorestructureourownershipstructureoroperations;andrequiringustodiscontinueanyportionorallofitsInternetandvalue-addedtelecommunicationbusinesses.
Wemaybeunabletocollectlong-termloanstoofcersandemployeesorexercisemanagementinuenceassociatedwithHighCentury,SohuEntertainment,GoodFeel,SogouInformationandGamease.
AsofDecember31,2009,Sohuhadoutstandinglong-termloansof$11.
9milliontoDr.
Zhang,Sohu'sChiefExecutiveOfcerandamajorSohushareholder,andcertainofouremployees.
Theselong-termloansareusedtonanceinvestmentsinHighCentury,SohuEntertainment,GoodFeel,SogouInformationandGamease,whichareusedtofacilitateourparticipationintelecommunications,InternetcontentandcertainotherbusinessesinChinawhereforeignownershipiseitherprohibitedorrestricted.
Theloanagreementscontainprovisionsthat,subjecttoPRClaws,(i)theloanscanonlyberepaidtousbytransferringthesharesofHighCentury,SohuEntertainment,GoodFeel,SogouInformationorGameasetous;(ii)thesharesofHighCentury,SohuEntertainment,GoodFeel,SogouInformationorGameasecannotbetransferredwithoutourapproval;and(iii)wehavetherighttoappointalldirectorsandseniormanagementpersonnelofHighCentury,SohuEntertainment,GoodFeel,SogouInformationandGamease.
IntheloanagreementstheborrowershavepledgedalloftheirsharesinHighCentury,SohuEntertainment,GoodFeel,SogouInformationandGameaseascollateralfortheloansandtheloansbearnointerestandaredueondemandafterNovember2003inthecaseofHighCentury;afterAugust2006inthecaseofSogouInformation;afterOctober2006inthecaseofGoodFeel;afterNovember2006inthecaseofSohuEntertainment;andafterSeptember2008inthecaseofGameaseandtheearlierofademandor,inanycase,atsuchtimeasDr.
Zhangoroneoftheotheremployeeborrowers,asthecasemaybe,isnotanemployeeofSohu.
SohudoesnotintendtorequestrepaymentoftheloansaslongasPRCregulationsprohibititfromdirectlyinvestinginbusinessesbeingundertakenbytheVIEs.
-67-Becausetheseloanscanonlyberepaidbytheborrowers'transferringthesharesofthevariousentities,ourabilitytoultimatelyrealizetheeffectivereturnoftheamountsadvancedundertheseloanswilldependontheprotabilityofHighCentury,SohuEntertainment,GoodFeel,SogouInformationandGameaseandisthereforeuncertain.
Inaddition,totheextentthattheVIEshaveundistributedaftertaxnetincome,wewillberequiredtopayindividualincometax,atthetaxrateof20%,onbehalfoftheemployeeswhoholdinterestsintheVIEswhentransferringtheshareholdingfromotherindividuals,whichmayfurtherincreasetheuncertaintyinvolvedfortransferringsharesofvariousentities.
Furthermore,becauseofuncertaintiesassociatedwithPRClaw,ultimateenforcementoftheloanagreementsisuncertain.
Accordingly,wemayneverbeabletocollecttheseloansorexerciseinuenceoverHighCentury,SohuEntertainment,GoodFeel,SogouInformationandGamease.
WedependuponcontractualarrangementswithourVIEsforthesuccessofourbusinessandthesearrangementsmaynotbeaseffectiveinprovidingoperationalcontrolasdirectownershipofthesebusinessesandmaybedifculttoenforce.
BecauseweconductourInternetoperationsonlyinthePRC,andarerestrictedorprohibitedbythePRCgovernmentfromowningInternetcontentortelecommunicationoperationsinthePRC,wearedependentonourVIEsinwhichwehavenodirectownershipinterest,toprovidethoseservicesthroughcontractualagreementsbetweentheparties.
ThesearrangementsmaynotbeaseffectiveinprovidingcontroloverourInternetcontentortelecommunicationsoperationsasdirectownershipofthesebusinesses.
Forexample,someofoursubsidiariesandVIEscouldfailtotakeactionsrequiredforourbusiness,suchasenteringintocontentdevelopmentcontractswithpotentialcontentsuppliersorfailingtomaintainthenecessarypermitforthecontentservers.
IftheseVIEsfailtoperformitsobligationsundertheseagreements,wemayhavetorelyonlegalremediesunderPRClaw.
WecannotassureyouthatsuchremediesunderPRClawwouldbeeffectiveorsufcient.
ThecontractualarrangementsbetweenoursubsidiariesandourVIEsmayresultinadversetaxconsequences.
PRClawsandregulationsemphasizetherequirementofanarm'slengthbasisfortransferpricingarrangementsbetweenrelatedparties.
Thelawsandregulationsalsorequireenterpriseswithrelatedpartytransactionstopreparetransferpricingdocumentationtodemonstratethebasisfordeterminingpricing,thecomputationmethodologyanddetailedexplanations.
RelatedpartyarrangementsandtransactionsmaybesubjecttochallengeortaxinspectionbyPRCtaxauthorities.
Underataxinspection,ifourtransferpricingarrangementsbetweentheChina-basedsubsidiariesandVIEsarejudgedastaxavoidance,orrelateddocumentationdoesnotmeettherequirements,ourChina-basedsubsidiariesandVIEsmaybesubjecttomaterialadversetaxconsequences,suchastransferpricingadjustment.
Atransferpricingadjustmentcouldresultinareduction,forPRCtaxpurposes,ofadjustmentsrecordedbyGamease,whichcouldadverselyaffectusby(i)increasingVIE'staxliabilitieswithoutreducingoursubsidiaries'taxliabilities,whichcouldfurtherresultininterestbeingleviedtousforunpaidtaxes;or(ii)limitingtheabilityofourPRCcompaniestomaintainpreferentialtaxtreatmentandothernancialincentives.
IfwearefoundtobeinviolationofcurrentorfuturePRClaws,rulesorregulationsregardingInternet-relatedservicesandtelecom-relatedactivities,wecouldbesubjecttoseverepenalties.
ThePRChasenactedregulationsthatapplytoInternet-relatedservicesandtelecom-relatedactivities.
Whilemanyaspectsoftheseregulationsremainunclear,theypurporttolimitandrequirelicensingofvariousaspectsoftheprovisionofInternetinformationandcontent,onlineadvertising,onlinegameandvalue-addedtelecommunicationservices.
Inaddition,thePRCgovernmentmaypromulgatenewlaws,rulesorregulationsatanytime.
Ifthesecurrentorfuturelaws,rulesorregulationsregardingInternet-relatedactivities,areinterpretedtobeinconsistentwithourownershipstructureand/orourbusinessoperations,ourbusinesswillbe-68-severelyimpairedandwecouldbesubjecttoseverepenalties.
Anysuchdisruptioninourbusinessoperationswouldmateriallyandadverselyaffectourbusiness,nancialconditionandresultsofoperations.
Forexample,astheonlinegameindustryisatanearlystageofdevelopmentinChina,thePRCgovernmentmightreleasenewlaws,newregulationsandpoliciesfromtimetotimetoimplementrestrictionsandfurtherregulationontheonlinegameindustry.
Recently,eightPRCgovernmentauthorities,includingtheGAPP,theMinistryofEducationandMIITissuedanoticerequiringallChineseonlinegameoperatorstoadoptan"anti-fatiguesystem"inanefforttocurbaddictiontoonlinegamesbyminors.
Undertheanti-fatiguesystem,threehoursorlessofcontinuousplayisdenedtobe"healthy,"threetovehoursisdenedtobe"fatiguing,"andvehoursormoreisdenedtobe"unhealthy.
"Gameoperatorsarerequiredtoreducethevalueofgamebenetsforminorgameplayersbyhalfwhenthosegameplayersreachthe"fatigue"level,andtozerowhentheyreachthe"unhealthy"level.
Inaddition,onlinegameplayersinChinaarenowrequiredtoregistertheiridentitycardnumbersbeforetheycanplayanonlinegame.
Thissystemallowsgameoperatorstoidentifywhichgameplayersareminors.
Theserestrictionscouldlimitourabilitytoincreaseourbusinessamongminors.
Furthermore,iftheserestrictionswereexpandedtoapplytoadultgameplayersinthefuture,ourbusinesscouldbemateriallyandadverselyaffected.
Inaddition,thePRCgovernmenthasimplementedacompulsoryrequirementthatonlinegameplayersregistertheirrealnamesandprovideIDnumberswhenplayinggames.
Withthisrequirementastoreal-nameregistrationforonlinegameplayers,thegovernmentimplementedaratingsystemforonlinegames.
Forthoseonlinegamesratedasnotsuitableforchildrenundertheageof18,childrenundertheageof18willbeunabletoaccesssuchgameifarealnameregistrationisinplace.
Asaresult,ourrevenuesfromonlinegamesmaybeadverselyaffected.
Inaddition,wemayberequiredtoapplyforanewlicenseornewqualicationortransferfromanoldtypeoflicensetoanewtypeoflicenseatanytimeasaresultoftherequirementsofnewlypromulgatedlawsornewregulations.
Thereoftenisalengthyperiodbetweentheenactmentofsuchnewrequirementsandthenalissuanceofanyrequiredlicenseorqualication.
Althougheffectivenessofanysuchnewlicenseordinarilywillbeasofthedateoflingoftheapplication,wemaybeheldliableforoperatingwithoutaproperlicenseandmaybenedforanyoperationsconductedduringtheapplicationperiod.
Moreover,formusicsearch,becausetherehasbeennospeciclegislationregulatingthesearchenginesector,disputesandlawsuitshavefrequentlyariseninconnectionwithsearchoutcomes.
ThePRCgovernmentisconsideringlegislationtostrictlyregulatethesearchenginesector.
Intheeventthatspecicregulationsarepromulgatedandcomeintoeffect,thereisnoassurancethatoursearchenginewillnotbeadverselyaffectedand/orsubjectedtopenaltiesfromthePRCgovernment.
OurbusinessmaybeadverselyaffectedbypublicopinionandgovernmentalpoliciesinChinaaswellasinotherjurisdictionswherewelicenseourMMORPGstothirdparties.
Currently,mostofourgameplayersinChinaareyoungmales,manyofwhomarestudents.
DuetoarelativelyhighdegreeofgameplayerloyaltytoMMORPGs,easyaccesstopersonalcomputersandInternetcafes,andthelackofotherappealingformsofentertainmentinChina,manyteenagersinChinafrequentlyplayonlinegames.
Thismayresultintheseteenagersspendinglesstimeonorrefrainingfromotheractivities,includingeducation,vocationaltraining,sports,andtakingrest,whichcouldresultinadversepublicreactionandstrictergovernmentregulation.
Forexample,thePRCgovernmenthaspromulgatedanti-fatigue-relatedregulationstolimittheamountoftimeminorscanplayonlinegames.
ThePRCgovernmenthasalsobeguntotightenitsregulationsonInternetcafes,currentlyoneoftheprimaryplaceswhereonlinegamesareplayed,includinglimitingtheissuanceofInternetcafeoperatinglicensesandimposinghighercapitalandfacilityrequirementsfortheestablishmentofInternetcafes.
Adversepublicopinioncoulddiscouragegameplayersfromplayingourgames,andcouldresultingovernmentregulationsthatimposeadditionallimitationsontheoperationsofonlinegamesaswellasthegameplayers'accesstoonlinegames,forexample,MOCrecentlysuggestedthatgameoperatorsratethe-69-game,postanoteshowingtheagegroupforthegameandtoinstallasystemofparents'supervisionofminors'gameplaying.
Webelievestrictergovernmentregulations,suchasregulationsimposingstricterageandhourlimitsonInternetcafes,limitingtheissuanceofvirtualcurrencybyonlinegameoperatorsortheamountofvirtualcurrencythatcanbepurchasedbyanindividualgameplayer,orextendinganti-fatigue-relatedregulationstoadults,couldbeimplementedinthefuture.
Suchadversepublicopinionandtightenedgovernmentregulationscouldmateriallyandadverselyaffectourbusinessprospectsandourabilitytomaintainorincreaserevenues.
Inaddition,thePRCStateAdministrationofTaxationrecentlyannouncedthatitwilltaxgameplayersontheincomederivedfromthetradingofvirtualcurrenciesattherateof20%.
However,itiscurrentlyunclearhowthetaxwillbecollectedoriftherewillbeanyeffectonourgameplayersorourbusiness.
Moreover,similaradversepublicreactionmayarise,andsimilargovernmentpoliciesmaybeadopted,inotherjurisdictionswherewelicenseoroperateourgames,whichcouldmateriallyandadverselyaffectouroverseaslicensingorgameoperationsrevenues.
EvenifweareincompliancewithPRCgovernmentalregulationsrelatingtolicensingandforeigninvestmentprohibitions,thePRCgovernmentmaypreventusfromdistributing,andwemaybesubjecttoliabilityfor,contentthatitbelievesisinappropriate.
ThePRChasenactedregulationsgoverningInternetaccessandthedistributionofnewsandotherinformation.
Inthepast,thePRCgovernmenthasstoppedthedistributionofinformationovertheInternetthatitbelievestoviolatePRClaw,includingcontentthatisobscene,incitesviolence,endangersnationalsecurity,iscontrarytothenationalinterestorisdefamatory.
Inaddition,wemaynotpublishcertainnewsitems,suchasnewsrelatingtonationalsecurity,withoutpermissionfromthePRCgovernment.
Furthermore,theMinistryofPublicSecurityhastheauthoritytomakeanylocalInternetserviceproviderblockanyWebsitemaintainedoutsidethePRCatitssolediscretion.
EvenifwecomplywithPRCgovernmentalregulationsrelatingtolicensingandforeigninvestmentprohibitions,ifthePRCgovernmentweretotakeanyactiontolimitorprohibitthedistributionofinformationthroughournetworkortolimitorregulateanycurrentorfuturecontentorservicesavailabletousersonournetwork,ourbusinesswouldbeharmed.
WearealsosubjecttopotentialliabilitiesforcontentonourWebsitesthatisdeemedinappropriateandforanyunlawfulactionsofoursubscribersandotherusersofoursystemsunderregulationspromulgatedbytheMIIT,suchpotentialliabilitiesincluding,butnotlimitedto,theimpositionofnesoreventheshuttingdownoftheWebsite.
Furthermore,wearerequiredtodeletecontentthatclearlyviolatesthelawsofthePRCandreportcontentthatwesuspectmayviolatePRClaw.
Wemayhavedifcultydeterminingthetypeofcontentthatmayresultinliabilityforusand,ifwearewrong,wemaybepreventedfromoperatingourWebsites.
Sohu.
comInc.
mayneedtorelyondividendsandotherdistributionsonequitypaidbySohu.
comLimitedandChangyou,ourwholly-ownedsubsidiaryandmajority-ownedsubsidiary,tofundanycashrequirementswemayhave.
Sohu.
comInc.
maynotbeabletoobtaincashfromdistributionstotheextentsuchdistributionsarerestrictedbyPRClaworfuturedebtcovenants.
Sohu.
comInc.
isaholdingcompanywithnooperatingassetsotherthaninvestmentsinChineseoperatingentitiesthroughourintermediateholdingcompanies,Sohu.
comLimitedandChangyou,ourwholly-ownedsubsidiaryandmajority-ownedsubsidiaryintheCaymanIslands,andourVIEs.
Sohu.
comInc.
mayneedtorelyondividendsandotherdistributionsonequitypaidbySohu.
comLimitedandChangyouforthecashrequirementsinexcessofanycashraisedfrominvestorsandretainedbySohu.
comInc.
IfourChina-basedsubsidiariesincurdebtontheirownbehalfinthefuture,theinstrumentsgoverningthedebtmayrestrictourChina-basedsubsidiaries'abilitytopaydividendsormakeotherdistributionstousthroughtheintermediatecompanies.
-70-Inaddition,PRClegalrestrictionspermitpaymentofdividendsbySohuEra,SohuMedia,SohuSoftware,SogouTechnology,Go2MapSoftware,andAmazGameonlyoutoftheirnetincome,ifany,determinedinaccordancewithPRCaccountingstandardsandregulations.
UnderPRClaw,SohuEra,SohuMedia,SohuSoftware,SogouTechnology,Go2MapSoftwareandAmazGamearealsorequiredtosetaside10%oftheirnetincomeeachyeartofundcertainreservefundsuntilthesereservesequal50%oftheamountofpaid-incapital.
Thesereservesarenotdistributableascashdividends.
OursubsidiariesandVIEsinChinaaresubjecttorestrictionsonpayingdividendsormakingotherpaymentstoouroverseasentities.
AnydividendreceivedbySohu.
comInc.
wouldbesubjecttoU.
S.
taxat34%or35%.
Sohu.
comInc.
maydependonSohu.
comLimitedandChangyoudividendpaymentswhicharegeneratedfromoursubsidiariesinChinaaftertheyreceivepaymentsfromourVIEsundervariousservicesandotherarrangements.
ItispossiblethatourChinesesubsidiarieswillnotcontinuetoreceivethepaymentsinaccordancewithourcontractswithourVIEs.
TotheextentthattheVIEshaveundistributedaftertaxnetincome,wemustpaytaxonbehalfofouremployeeswhoholdinterestsintheVIEswhentheVIEsdistributedividendsinthefuture.
Thecurrentindividualincometaxrateis20%.
Inaddition,underPRClaw,ourChinesesubsidiariesarerequiredtosetasideatleast10%oftheirrespectiveaccumulatedprots,upto50%oftheirpaid-incapital,tofundcertainmandatedreservefundsthatarenotpayableordistributableascashdividends.
ThePRCgovernmentalsoimposescontrolsontheconvertibilityofRMBintoforeigncurrenciesand,incertaincases,theremittanceofcurrenciesoutofChina.
Wemayexperiencedifcultiesincompletingtheadministrativeproceduresnecessarytoobtainandremitforeigncurrencies.
Ifweoranyofoursubsidiariesareunabletoreceivealloftherevenuesfromouroperationsthroughthesecontractualordividendarrangements,wemaybeunabletoeffectivelynanceouroperationsorpaydividendsonourshares.
Furthermore,anydividendsoranydeemeddividendsreceivedbySohu.
comInc.
wouldbesubjectto34%or35%U.
S.
CorporateIncomeTaxunderthetaxlawoftheUnitedStates.
Wemaynothaveexclusiverightsoverthemarksthatarecrucialtoourbusiness,includingbutnotlimitedtoSohu.
com,SohuFoxlogo,17173.
com,Focus.
cn,GoodFeel,Sogou,Go2Map,TianLongBaBu,BladeOnline,Changyou,DMD.
WehaveappliedfortheregistrationofourkeymarksinthePRC,includingbutnotlimitedtoSohu.
com,SohuFoxlogo,17173.
com,Focus.
cn,GoodFeel,Sogou,Go2Map,TianLongBaBu,BladeOnline,Changyou,DMDandtheircorrespondingChineseversionmarkssoastoestablishandprotectourexclusiverightstothemarks.
WehavesucceededinregisteringthemarksSohu.
com,17173,Focus.
cn,GoodFeel,Go2MapandSogouinthePRCundercertainclasses.
TheapplicationsfortheregistrationoftheothermarksorsomemarksunderotherclassesarestillunderexaminationbytheTrademarkOfceofPRC.
CompletionoftheregistrationsissubjecttotheTrademarkOfceofPRC'sdeterminationthattherearenopriorrightsinthePRC.
Anyrejectionoftheseapplicationscouldadverselyaffectourrightstothesemarks.
Unauthorizeduseofourintellectualpropertybythirdparties,andtheexpensesincurredinprotectingourintellectualpropertyrights,mayadverselyaffectourbusiness.
Weregardourcopyrights,servicemarks,trademarks,tradesecretsandotherintellectualpropertyascriticaltooursuccess.
Unauthorizeduseofourintellectualpropertybythirdpartiesmayadverselyaffectourbusinessandreputation.
Werelyontrademarkandcopyrightlaw,tradesecretprotectionandcondentialityagreementswithouremployees,customers,businesspartnersandotherstoprotectourintellectualpropertyrights.
Despiteourprecautions,itmaybepossibleforthirdpartiestoobtainanduseourintellectualpropertywithoutauthorization.
Forexample,underthenewlyamendedPatentLawofthePRC(promulgatedbytheNPCStandingCommitteeonDecember27,2008,andeffectiveasofOctober1,2009),theStateCouncil'sPatentAdministrationDepartmentmaygrantacompulsorylicensetoindividualsorentitiestouseourpatent,once-71-ourexploitationofthepatenthasbeendeterminedtobeviolatetheantitrustlaws.
Furthermore,thevalidity,enforceabilityandscopeofprotectionofintellectualpropertyinInternet-relatedindustriesareuncertainandstillevolving.
Inparticular,thelawsofthePRCandcertainothercountriesareuncertainordonotprotectintellectualpropertyrightstothesameextentasdothelawsoftheUnitedStates.
Moreover,litigationmaybenecessaryinthefuturetoenforceourintellectualpropertyrights,toprotectourtradesecretsortodeterminethevalidityandscopeoftheproprietaryrightsofothers.
Futurelitigationcouldresultinsubstantialcostsanddiversionofresources.
Wemayneedtoincursignicantexpensestoenforceourproprietaryrights,andifweareunabletoprotectsuchrights,ourcompetitivepositioncouldbeharmed,especiallyforouronlinegamebusiness.
Weregardourproprietarysoftware,domainnames,tradenames,copyrights,trademarks,tradesecretsandotherintellectualpropertyascriticaltooursuccess.
Inparticular,wehavespentasignicantamountoftimeandresourcesindevelopingTLBBandourabilitytoprotectourproprietaryrightsinconnectionwithTLBBiscriticalforthesuccessofthisgameandouroverallnancialperformance.
WehaveregisteredanumberofsoftwareinChinaforcopyrightprotection,includingourTLBBsoftware,andwehavetakenvariousmeasurestoprotectoursourcecodes,includingcondentialityagreementsandsegregationofsourcecodes,sothatonlyourChiefTechnologyOfcerhasaccesstotheentiresourcecodesforanyofourgames.
Wehaveappliedforregistrationof253trademarksinthePRC,includingthoserelatedtoourcompanynameandourMMORPGs.
WehaveobtainedatrademarkregistrationcerticateinthePRCrelatingtoTLBB.
Inaddition,wehaveobtainedfourtrademarksinTaiwanrelatingtoTLBBandtwotrademarksinTaiwanrelatingtoDMD.
Wehavealsoappliedfortwenty-fourtrademarksintotalincountriesandregionssuchastheUnitedStates,Europe,Malaysia,TurkeyandVietnamrelatingtoourcompanynameandourMMORPGs.
However,wemaynotsucceedinobtainingtrademarksthatwehaveappliedfor,includinganytrademarksrelatingtoourgameTLBB.
Anyfailuretoregistertrademarksinanycountryorregionmaylimitourabilitytoprotectourrightsinsuchcountryorregionunderrelevanttrademarklaws,andwemayevenneedtochangethenameortherelevanttrademarkincertaincases,whichmayadverselyaffectourbrandingandmarketingefforts.
Inaddition,wecannotassureyouthatourmeasureswillbesufcienttoprotectourproprietaryinformationandintellectualproperty.
IntellectualpropertyrightsandcondentialityprotectioninChinamaynotbeaseffectiveasintheUnitedStatesorotherdevelopedcountries.
Policingunauthorizeduseofproprietarytechnologyisdifcultandexpensive.
Anystepswehavetakentopreventthemisappropriationofourproprietarytechnologymaybeinadequate.
Thevalidity,enforceabilityandscopeofprotectionofintellectualpropertyinInternet-relatedindustriesareuncertainandstillevolving.
Inparticular,thelawsandenforcementproceduresinthePRCareuncertainandmaynotprotectintellectualpropertyrightsinthisareatothesameextentasdothelawsandenforcementproceduresintheUnitedStatesandotherdevelopedcountries.
Despiteoureffortstoprotectourintellectualproperty,otheronlinegamedevelopersmaycopyourideasanddesigns,andotherthirdpartiesmayinfringeourintellectualpropertyrights.
Forexample,certainthirdpartieshavemisappropriatedthesourcecodesofpreviousversionsofTLBBandhavesetupunauthorizedserversinChinaandelsewheretooperateTLBBtocompetewithus.
Asaresult,wehavetakenmeasurestoenforceourintellectualpropertyrights.
However,suchmeasuresmaynotbesuccessfulineliminatingtheseunauthorizedservers.
Theexistenceofunauthorizedserversmayattractgameplayersawayfromourgamesandmayresultindecreasesinourrevenues.
Litigationrelatingtointellectualpropertyrightsmayresultinsubstantialcoststousanddiversionofresourcesandmanagementattentionawayfromourbusiness,andmaynotbesuccessful.
Inaddition,asourideasanddesignsarenotprotectedbypatents,otheronlinegamedevelopersmayindependentlydevelopideasanddesignsthatcompetewithus.
Wemaybesubjecttointellectualpropertyinfringementclaims,whichmayforceustoincursubstantiallegalexpensesand,ifdeterminedadverselyagainstus,materiallydisruptourbusiness.
Wecannotbecertainthatourproducts,servicesandintellectualpropertyusedinournormalcourseofbusinessdonotorwillnotinfringevalidpatents,copyrightsorotherintellectualpropertyrightsheldby-72-thirdparties.
Wehaveinthepastbeen,arecurrently,andmayinthefuturebe,subjecttoclaimsandlegalproceedingsrelatingtotheintellectualpropertyofothersintheordinarycourseofourbusiness.
Inparticular,ifwearefoundtohaveviolatedtheintellectualpropertyrightsofothers,wemaybeenjoinedfromusingsuchintellectualproperty,maybeorderedtopayaneandmayincurlicensingfeesorbeforcedtodevelopalternatives.
Wemayincursubstantialexpensesindefendingagainstthesethirdpartyinfringementclaims,regardlessoftheirmerit.
Successfulinfringementclaimsagainstusmayresultinsubstantialmonetaryliabilityormaymateriallydisrupttheconductofourbusinessbyrestrictingorprohibitingouruseoftheintellectualpropertyinquestion.
Forexample,during2006veUnitedStatesmoviecompaniescommencedalawsuitagainstusinthePRCallegingthatamoviedownloadservicewehadbeenprovidinginfringedtheircopyrightsinthemovies.
InDecember2006,thecourtdecidedthecaseagainstus,andorderedustopaydamagesofapproximately$138,000totheU.
S.
moviecompanies.
Inaddition,in2007awriterbroughtalawsuitagainstinChinaclaimingthatweviolatedhiscopyrightto190SMSmessagesin2007.
TheChinesecourtdecidedthecaseagainstus,andwepaiddamagesofapproximately$13,000tothewriter.
Inaddition,weprovidesearchenginefacilitiescapableoflocatingandaccessinglinkstodownloadMP3music,movies,imagesandothermultimedialesand/orothercontenthostedonthirdpartyWebsites,whichmaybeprotectedbycopyrightlaw.
InMarch2008,weweresuedbyfourmajorrecordcompanies,SonyBMG,Warner,UniversalandGoldLabel,whichallegedthatweprovidedmusicsearchlinksanddownloadservicesthatviolatedcopyrightstheyowned.
AsofDecember31,2009,thelawsuitswiththesefourrecordcompanieswerestillinprocess.
Althoughaninitialjudgmenthasbeeninourfavorastomostaspectsofthecase,bothpartieshavetherighttoappealtothehighercourtandthereforethejudgmenthasnotyetcomeintoeffect.
Webelievethatthelawsuitswillnotbeconcludedatthisstageoftheproceedings,andthatthereforewecannotpredicttheoutcomeorresolutionoftheseclaims,andcannotdetermineatthispointtowhatextenttheplaintiffs'allegationsaremeritoriouseitherfactuallyorlegally,norcanwepredictwhethertheplaintiffswillbesuccessfulintheselawsuits.
Itispossiblethattheselawsuitscouldconcludewithnaljudgmentsagainstus,orsettlementspriortonaljudgment,thatwouldrequireustopaydamagesorroyaltiestotheplaintiffs.
Wemaybesubjectto,andmayexpendsignicantresourcesindefendingagainstclaimsbasedonthecontentandservicesweprovideoverallofourWebsites.
Asourservicesmaybeusedtodownloadanddistributeinformationtoothers,thereisariskthatclaimsmaybemadeagainstusfordefamation,negligence,copyrightortrademarkinfringementorotherclaimsbasedonthenatureandcontentofsuchinformation.
Furthermore,wecouldbesubjecttoclaimsfortheonlineactivitiesofourvisitorsandincursignicantcostsintheirdefense.
Inthepast,claimsbasedonthenatureandcontentofinformationthatwaspostedonlinebyvisitorshavebeenmadeintheUnitedStatesagainstcompaniesthatprovideonlineservices.
Wedonotcarryanyliabilityinsuranceagainstsuchrisks.
WecouldbeexposedtoliabilityfortheselectionoflistingsthatmaybeaccessiblethroughourWebsitesorthroughcontentandmaterialsthatourvisitorsmaypostinclassieds,messageboards,chatroomsorotherinteractiveservices.
Ifanyinformationprovidedthroughourservicescontainserrors,thirdpartiesmaymakeclaimsagainstusforlossesincurredinrelianceontheinformation.
WealsoofferWeb-basede-mailandsubscriptionservices,whichexposeustopotentialliabilitiesorclaimsresultingfrom:unsolicitede-mail;lostormisdirectedmessages;illegalorfraudulentuseofe-mail;orinterruptionsordelaysine-mailservice.
Investigatinganddefendinganysuchclaimsmaybeexpensive,eveniftheydonotresultinliability.
-73-ActivitiesofInternetcontentprovidersareorwillbesubjecttoadditionalPRCregulations,whichhavenotyetbeenputintoeffect.
Ouroperationsmaynotbeconsistentwiththesenewregulationswhenputintoeffect,and,asaresult,wecouldbesubjecttoseverepenalties.
TheMIIThasstatedthattheactivitiesofInternetcontentprovidersaresubjecttoregulationbyvariousPRCgovernmentauthorities,dependingonthespecicactivitiesconductedbytheInternetcontentprovider.
Variousgovernmentauthoritieshavestatedpubliclythattheyareintheprocessofpreparingnewlawsandregulationsthatwillgoverntheseactivities.
Theareasofregulationcurrentlyincludeonlineadvertising,onlinenewsreporting,onlinepublishing,provisionofonlineorwirelessmusic,onlinesecuritiestrading,theprovisionofindustry-specic(e.
g.
,drug-related)informationovertheInternetandforeigninvestmentinvalue-addedtelecommunicationservices.
Forinstance,theMOCissued"SeveralOpinionsofDevelopmentandSupervisionofOnlineMusic"inNovember2006.
InaccordancewiththerequirementsoftheMOC,wehavesubmittedmostoftheonlinemusicwhichwedistributedinthePRConlineorthroughwirelesstotheMOCforcensoringandrecordinginMarch2007.
Wemayberequiredtoberesponsibleforsupervisingnonprotusers'distributionofonlinemusiconourportal.
Ifwefailtocomplywiththeserequirements,wemaybened.
Otheraspectsofouronlineoperationsmaybesubjecttoregulationsinthefuture.
Ouroperationsmaynotbeconsistentwiththesenewregulationswhenputintoeffectand,asaresult,wemaybesubjecttoseverepenaltiesasdiscussedabove.
RegulationandcensorshipofinformationdistributioninChinamayadverselyaffectourbusiness.
ChinahasenactedregulationsgoverningInternetaccessandthedistributionofnewsandotherinformation.
Furthermore,thePropagandaDepartmentoftheChineseCommunistPartyhasbeengiventheresponsibilitytocensornewspublishedinChinatoensure,superviseandcontrolaparticularpoliticalideology.
Inaddition,theMIIThaspublishedimplementingregulationsthatsubjectonlineinformationproviderstopotentialliabilityforcontentsincludedintheirportalsandtheactionsofsubscribersandothersusingtheirsystems,includingliabilityforviolationofPRClawsprohibitingthedistributionofcontentdeemedtobesociallydestabilizing.
Furthermore,theMIITmayimplementarequirementthatusersofblogsregisterundertheirrealnames.
Ifsucharegulationisimplemented,ourbusinessmaybenegativelyaffectedduetoadecreaseinthenumberofblogusers.
Furthermore,becausemanyPRClaws,regulationsandlegalrequirementswithregardtotheInternetarerelativelynewanduntested,theirinterpretationandenforcementmayinvolvesignicantuncertainty.
Inaddition,thePRClegalsystemisacivillawsysteminwhichdecidedlegalcaseshavelimitedbindingforceaslegalprecedents.
Asaresult,inmanycasesaWebsiteoperatormayhavedifcultiesdeterminingthetypeofcontentthatmaysubjectittoliability.
Periodically,theMinistryofPublicSecurityhasstoppedthedistributionovertheInternetofinformationwhichitbelievestobesociallydestabilizing.
TheMinistryofPublicSecurityhastheauthoritytorequireanylocalInternetserviceprovidertoblockanyWebsitemaintainedoutsideChinaatitssolediscretion.
IfthePRCgovernmentweretotakeactiontolimitoreliminatethedistributionofinformationthroughourportalortolimitorregulatecurrentorfutureapplicationsavailabletousersofourportal,ourbusinesswouldbeadverselyaffected.
TheStateSecrecyBureau,whichisdirectlyresponsiblefortheprotectionofstatesecretsofallPRCgovernmentandChineseCommunistPartyorganizations,isauthorizedtoblockanyWebsiteitdeemstobeleakingstatesecretsorfailingtomeettherelevantregulationsrelatingtotheprotectionofstatesecretsinthedistributionofonlineinformation.
Undertheapplicableregulations,wemaybeheldliableforanycontenttransmittedonourportal.
Furthermore,wherethetransmittedcontentclearlyviolatesthelawsofthePRC,wewillberequiredtodeleteit.
Moreover,ifweconsidertransmittedcontentsuspicious,wearerequiredtoreportsuchcontent.
Wemustalsoundergocomputersecurityinspections,andifwefailtoimplementtherelevantsafeguardsagainstsecuritybreaches,wemaybeshutdown.
Inaddition,underrecentlyadoptedregulations,Internetcompanieswhichprovidebulletinboardsystems,chatroomsorsimilarservices,suchasourcompany,mustapplyfortheapprovaloftheStateSecrecyBureau.
Astheimplementingrulesofthesenew-74-regulationshavenotbeenissued,wedonotknowhoworwhenwewillbeexpectedtocomply,orhowourbusinesswillbeaffectedbytheapplicationoftheseregulations.
WemaybesubjecttothePRCgovernment'songoingcrackdownonInternetpornographiccontent.
TheChinesegovernmenthasstringentregulationsononlinepornographicinformationandhaslaunchedseveralcrackdownsonInternetpornographyinthelastyear.
OnDecember4,2009,theMIITandotherthreegovernmentauthoritiesjointlyissuedtheIncentivesMeasuresforReportofPornographic,ObsceneandVulgarMessagesonInternetandMobileMedia(ortheAnti-PornographyNotice)tofurthercrackdownononlinepornography.
PursuanttothisAnti-PornographyNotice,rewardsofuptoRMB10,000willbeprovidedtoInternetuserswhoreportWebsitesthatfeaturepornography,andacommitteehasbeenestablishedtoreviewsuchreportstodetermineanappropriateaward.
WehavedeletedallWebpageswithallegedlyvulgarmaterialfromourrelevantchannelsandcommunities.
Inaddition,wehavestrengthenedourinternalcensorshipandsupervisionoflinksandcontentuploadedbytheusers.
Wehavenot,todate,receivedanypenaltyfromthePRCgovernmentinthisregard.
However,thereisnoassurancethatcontentconsideredvulgarbyPRCgovernmentagencieswillnotappearinthefuture.
Intheeventthatweareaccusedbythegovernmentofhostingvulgarcontent,ourreputationcouldbeadverselyaffected.
Political,economicandsocialpoliciesofthePRCgovernmentcouldaffectourbusiness.
Allofourbusiness,operatingassets,xedassetsandoperationsarelocatedinChina,andallofourrevenuesarederivedfromouroperationsinChina.
Accordingly,ourbusinessmaybeadverselyaffectedbychangesinpolitical,economicorsocialconditionsinChina,adjustmentsinPRCgovernmentpoliciesorchangesinlawsandregulations.
TheeconomyofChinadiffersfromtheeconomiesofmostcountriesbelongingtotheOrganizationforEconomicCooperationandDevelopmentinanumberofrespects,including:structure;levelofgovernmentinvolvement;levelofdevelopment;levelofcapitalreinvestment;growthrate;controlofforeignexchange;andmethodsofallocatingresources.
Since1949,Chinahasbeenprimarilyaplannedeconomysubjecttoasystemofmacroeconomicmanagement.
AlthoughthePRCgovernmentstillownsasignicantportionoftheproductiveassetsinChina,economicreformpoliciessincethelate1970shaveemphasizeddecentralization,autonomousenterprisesandtheutilizationofmarketmechanisms.
WecannotpredictthefutureeffectsoftheeconomicreformandmacroeconomicmeasuresadoptedbythePRCgovernmentonourbusinessorresultsofoperations.
Furthermore,thePRCgovernmentbegantofocusmoreattentiononsocialissuesinrecentyearsandhavepromulgatedormaypromulgateadditionallawsorregulationsonthisarea,whichcouldaffectourbusinessinChina.
Forexample,inJuly2007,thePRCgovernmentissuedthenewEmploymentContractLaw,effectivefromJanuary1,2008,providingmoreemploymentprotectiontoemployeesinChina.
Althoughwebelievethatthiswillenhanceourgeneralstaffmoralandloyalty,wemayincuradditionalstaffcostsinthefuture.
-75-ThePRClegalsystemembodiesuncertaintieswhichcouldlimitthelegalprotectionsavailabletousandyou,orcouldleadtopenaltiesonus.
ThePRClegalsystemisacivillawsystembasedonwrittenstatutes.
Unlikecommonlawsystems,itisasysteminwhichdecidedlegalcaseshavelittleprecedentialvalue.
In1979,thePRCgovernmentbegantopromulgateacomprehensivesystemoflawsandregulationsgoverningeconomicmattersingeneral.
OurPRCoperatingsubsidiaries,SohuEra,SohuMedia,SohuSoftware,SogouTechnology,Go2MapSoftware,andAmazGameareWFOEs,whichareenterprisesincorporatedinChinaandwholly-ownedbyourindirectsubsidiary,SohuHongKong.
ThoseWFOEsaresubjecttolawsandregulationsapplicabletoforeigninvestmentinChina.
Inaddition,allofoursubsidiariesandVIEsareincorporatedinChinaandsubjecttoallapplicableChineselawsandregulations.
Becauseoftherelativelyshortperiodforenactingsuchacomprehensivelegalsystem,itispossiblethatthelaws,regulationsandlegalrequirementsarerelativelyrecent,andtheirinterpretationandenforcementinvolveuncertainties.
Theseuncertaintiescouldlimitthelegalprotectionsavailabletousandotherforeigninvestors,includingyou,andmayleadtopenaltiesimposedonusbecauseofthedifferentunderstandingbetweentherelevantauthorityandus.
Forexample,accordingtocurrenttaxlawsandregulation,weareresponsibletopaybusinesstaxona"Self-examinationandSelf-application"basis.
However,sincethereisnoclearguidanceastotheapplicabilityofthosepreferentialtreatments,wemaybefoundinviolationoftheinterpretationoflocaltaxauthoritieswithregardtothescopeoftaxableservicesandthepercentageoftaxrateandthereforemightbesubjecttopenalties,includingbutnotlimitedtomonetarypenalties.
Inaddition,wecannotpredicttheeffectoffuturedevelopmentsinthePRClegalsystem,particularlywithregardtotheInternet,includingthepromulgationofnewlaws,changestoexistinglawsortheinterpretationorenforcementthereof,orthepreemptionoflocalregulationsbynationallaws.
ThelawsandregulationsgoverningtheonlinegameindustryinChinaareevolvingandsubjecttofuturechanges.
Wemayfailtoobtainormaintainallapplicablepermitsandapprovals.
TheonlinegameindustryinChinaishighlyregulatedbythePRCgovernment.
VariousregulatoryauthoritiesofthePRCcentralgovernment,suchastheStateCouncil,theMIIT,GAPP,theMOCandtheMinistryofPublicSecurity,areempoweredtoissueandimplementregulationsgoverningvariousaspectsoftheonlinegameindustry.
WearerequiredtoobtainapplicablepermitsorapprovalsfromdifferentregulatoryauthoritiesinordertooperateourMMORPGs.
Forexample,asanonlinegameoperatorinChina,ChangyoumustobtainanOnlineCulturalOperatingPermitfromtheMOCandanInternetpublishinglicensefromGAPPinordertodistributegamesthroughtheInternetand,undertheGAPPNotice,ChangyoumustalsoobtainadditionalapprovalfromGAPPforanyupgrade,expansionpackornewversionofanyexistinggamethathaspreviouslybeenapprovedbyGAPP.
IfChangyoufailstomaintainanyofitspermitsorapprovalsortoapplyforpermitsandapprovalsonatimelybasis,Changyoumaybesubjecttovariouspenalties,includingnesandthediscontinuationorrestrictionofouronlinegameoperations.
AstheonlinegameindustryisatanearlystageofdevelopmentinChina,newlawsandregulationsmaybeadoptedfromtimetotimetorequireadditionallicensesandpermitsotherthanthoseChangyoucurrentlyhave,andaddressnewissuesthatarise.
Inaddition,substantialuncertaintiesexistregardingtheinterpretationandimplementationofcurrentandanyfuturePRClawsandregulationsapplicabletotheonlinegameindustry.
Forexample,thereisambiguityontheregulatoryauthorityandresponsibilitiesbetweenGAPPandtheMOCinregulatingonlinegamesand,asaresult,theremaybeoverlappingapprovalrequirementswithrespecttothesameaspectofourgamesorourgameoperation.
Wecannotassureyouthatwewillbeabletoobtaintimely,oratall,requiredlicensesoranyothernewlicenserequiredinthefuture.
WecannotassureyouthatwewillnotbefoundinviolationofanycurrentPRClawsorregulationsshouldtheirinterpretationschange,orthatwewillnotbefoundinviolationofanyfuturePRClawsorregulations.
-76-Contractdrafting,interpretationandenforcementinChinainvolvesignicantuncertainty.
WehaveenteredintonumerouscontractsgovernedbyPRClaw,manyofwhicharematerialtoourbusiness.
AscomparedwithcontractsintheUnitedStates,contractsgovernedbyPRClawtendtocontainlessdetailandarenotascomprehensiveindeningcontractingparties'rightsandobligations.
Asaresult,contractsinChinaaremorevulnerabletodisputesandlegalchallenges.
Inaddition,contractinterpretationandenforcementinChinaisnotasdevelopedasintheUnitedStates,andtheresultofanycontractdisputeissubjecttosignicantuncertainties.
Therefore,wecannotassureyouthatwewillnotbesubjecttodisputesunderourmaterialcontracts,andifsuchdisputesarise,wecannotassureyouthatwewillprevail.
Duetothematerialityofcertaincontractstoourbusiness,suchasouronlinegamelicenseagreementswithLouisCharegardingourrightstodevelopandoperateTLBBandDMD,anydisputeinvolvingsuchcontracts,evenwithoutmerit,maymateriallyandadverselyaffectourreputationandouronlinegamebusinessoperations,andmaycausethepriceofoursharestodecline.
RecentregulationsrelatingtooffshoreinvestmentactivitiesbyPRCresidentsmaylimitourabilitytoacquirePRCcompaniesandcouldadverselyaffectourbusiness.
InOctober2005,SAFEpromulgatedRelevantIssuesConcerningForeignExchangeControlonDomesticResidents'CorporateFinancingandRoundtripInvestmentThroughOffshoreSpecialPurposeVehicles,orCircular75,thatstatesthatifPRCresidentsuseassetsorequityinterestsintheirPRCentitiesascapitalcontributionstoestablishoffshorecompaniesorinjectassetsorequityinterestsoftheirPRCentitiesintooffshorecompaniestoraisecapitaloverseas,theymustregisterwithlocalSAFEbrancheswithrespecttotheiroverseasinvestmentsinoffshorecompanies.
Theymustalsoleamendmentstotheirregistrationsiftheiroffshorecompaniesexperiencematerialeventsinvolvingcapitalvariation,suchaschangesinsharecapital,sharetransfers,mergersandacquisitions,spin-offtransactions,long-termequityordebtinvestmentsorusesofassetsinChinatoguaranteeoffshoreobligations.
Underthisregulation,theirfailuretocomplywiththeregistrationproceduressetforthinsuchregulationmayresultinrestrictionsbeingimposedontheforeignexchangeactivitiesoftherelevantPRCentity,includingthepaymentofdividendsandotherdistributionstoitsoffshoreparent,aswellasrestrictionsonthecapitalinowfromtheoffshoreentitytothePRCentity.
WehaverequestedourshareholderswhoarePRCresidentstomakethenecessaryapplications,lingsandamendmentsasrequiredunderCircular75andotherrelatedrules.
Weattempttocomply,andattempttoensurethatourshareholderswhoaresubjecttotheserulescomply,withtherelevantrequirements.
However,wecannotprovideanyassurancesthatallofourshareholderswhoarePRCresidentswillcomplywithourrequesttomakeorobtainanyapplicableregistrationsorcomplywithotherrequirementsrequiredbyCircular75orotherrelatedrules.
AnyfuturefailurebyanyofourshareholderswhoisaPRCresident,orcontrolledbyaPRCresident,tocomplywithrelevantrequirementsunderthisregulationcouldsubjectustonesorsanctionsimposedbythePRCgovernment,includingrestrictionsonoursubsidiaries'abilitytopaydividendsormakedistributionstousandourabilitytoincreaseourinvestmentinthesesubsidiaries.
SAFErulesandregulationsmaylimitourabilitytotransferthenetproceedsfromChangyou'sinitialpublicofferingtoGamease,ourVIEinthePRC,whichmayadverselyaffectthebusinessexpansionofGamease,andwemaynotbeabletoconvertthenetproceedsfromChangyou'sinitialpublicofferingintoRMBtoinvestinoracquireanyotherPRCcompanies,orestablishotherVIEsinthePRC.
OnAugust29,2008,SAFEpromulgatedCircular142,anoticeregulatingtheconversionbyaforeign-investedcompanyofforeigncurrencyintoRMBbyrestrictinghowtheconvertedRMBmaybeused.
Thenoticerequiresthattheregisteredcapitalofaforeign-investedcompanysettledinRMBconvertedfromforeigncurrenciesmayonlybeusedforpurposeswithinthebusinessscopeapprovedbytheapplicablegovernmentalauthorityandmaynotbeusedforequityinvestmentswithinthePRC.
Inaddition,SAFEstrengtheneditsoversightoftheowanduseoftheregisteredcapitalofaforeign-investedcompanysettledinRMBconvertedfromforeigncurrencies.
TheuseofsuchRMBcapitalmaynotbechangedwithoutSAFE'sapproval,andmaynotinanycasebeusedtorepayRMBloansiftheproceedsofsuchloanshavenotbeen-77-used.
ViolationsofCircular142willresultinseverepenalties,suchasheavynes.
Asaresult,Circular142maysignicantlylimitourabilitytotransferthenetproceedsfromChangyou'sinitialpublicofferingtoChangyou'sVIEGameasethroughChangyou'ssubsidiaryinthePRC,whichmayadverselyaffectthebusinessexpansionofGamease,andwemaynotbeabletoconvertthenetproceedsfromChangyou'sinitialpublicofferingintoRMBtoinvestinoracquireanyotherPRCcompanies,orestablishotherVIEsinthePRC.
WemaybesubjecttonesandlegalsanctionsifweorouremployeeswhoarePRCcitizensfailtocomplywithrecentPRCregulationsrelatingtoemployeestockoptionsgrantedbyoverseaslistedcompaniestoPRCcitizens.
OnDecember25,2006,thePBOCissuedtheAdministrationMeasuresonIndividualForeignExchangeControl,anditsImplementationRuleswereissuedbySAFEonJanuary5,2007,whichbothhavetakeneffectonFebruary1,2007.
Undertheseregulations,allforeignexchangemattersinvolvedinanemployeestockholdingplan,stockoptionplanorsimilarplaninwhichPRCcitizens'participationrequiresapprovalfromtheSAFEoritsauthorizedbranch.
OnMarch28,2007,SAFEpromulgatedtheApplicationProcedureofForeignExchangeAdministrationforDomesticIndividualsParticipatinginEmployeeStockHoldingPlanorStockOptionPlanofOverseasListedCompany,ortheStockOptionRule.
UndertheStockOptionRule,PRCcitizenswhoaregrantedstockoptionsorrestrictedshareunits,orissuedrestrictedsharesbyanoverseaspubliclylistedcompanyarerequired,throughaPRCagentorPRCsubsidiaryofsuchoverseaspubliclylistedcompany,tocompletecertainotherproceduresandtransactionalforeignexchangemattersupontheexaminationby,andapprovalof,SAFE.
WeandouremployeeswhoarePRCcitizensandhavebeengrantedstockoptionsorrestrictedshareunits,orissuedrestrictedsharesaresubjecttotheStockOptionRule.
WeandouremployeesintendtomakesuchapplicationandcompletealltherequisiteproceduresinaccordancewiththeStockOptionRule.
However,wecannotassureyouthatwecancompletealltheproceduresinatimelymanner.
IftherelevantPRCregulatoryauthoritydeterminesthatourPRCemployeeswhoholdsuchoptions,restrictedshareunitsorrestrictedsharesortheirPRCemployerfailtocomplywiththeseregulationsafterourlisting,suchemployeesandtheirPRCemployermaybesubjecttonesandotherlegalsanctions.
Itmaybedifculttoenforceanyciviljudgmentsagainstusorourboardofdirectorsorofcers,becausemostofouroperatingand/orxedassetsarelocatedoutsidetheUnitedStates.
AlthoughweareincorporatedintheStateofDelaware,mostofouroperatingandxedassetsarelocatedinthePRC.
Asaresult,itmaybedifcultforinvestorstoenforcejudgmentsoutsidetheUnitedStatesobtainedinactionsbroughtagainstusintheUnitedStates,includingactionspredicateduponthecivilliabilityprovisionsofthefederalsecuritieslawsoftheUnitedStatesorofthesecuritieslawsofanystateoftheUnitedStates.
Inaddition,certainofourdirectorsandofcers(principallybasedinthePRC)andallorasubstantialportionoftheirassetsarelocatedoutsidetheUnitedStates.
Asaresult,itmaynotbepossibleforinvestorstoeffectserviceofprocesswithintheUnitedStatesuponthosedirectorsandofcers,ortoenforceagainstthemorusjudgmentsobtainedinUnitedStatescourts,includingjudgmentspredicateduponthecivilliabilityprovisionsofthefederalsecuritieslawsoftheUnitedStatesorofthesecuritieslawsofanystateoftheUnitedStates.
WehavebeenadvisedbyourPRCcounselthat,intheiropinion,thereisdoubtastotheenforceabilityinthePRC,inoriginalactionsorinactionsforenforcementofjudgmentsofUnitedStatescourts,ofcivilliabilitiespredicatedsolelyuponthefederalsecuritieslawsoftheUnitedStatesorthesecuritieslawsofanystateoftheUnitedStates.
IfthestatusofthePRCsubsidiaryandVIEas"NewTechnologyEnterprise"or"SoftwareEnterprise"arerevoked,wemayhavetopayadditionaltaxestomakeupanypreviouslyunpaidtaxandmaybesubjecttoahighertaxrate,whichmaymateriallyandadverselyaffectourresultsofoperations.
InMarch2007,theChinesegovernmentenactedtheCorporateIncomeTaxLaw,andpromulgatedrelatedregulationImplementingRegulationsforthePRCCorporateIncomeTaxLaw.
ThelawandregulationwentintoeffectonJanuary1,2008.
TheCorporateIncomeTaxLawimposes,amongstothers,auniedincometax-78-rateof25%forbothdomesticandforeigninvestedenterprises.
NewTechnologyEnterpriseswillenjoyafavorabletaxrateof15%.
TheImplementingRegulationsforthePRCCorporateIncomeTaxLawalsoemphasizesthattheownershipof"coreproprietaryintellectualproperty"isessentialtoqualicationforthispreferentialtaxrate.
TheCorporateIncomeTaxLawalsoprovidesave-yeartransitionalperiodforthoseentitiesestablishedbeforeMarch16,2007,whichenjoyedafavorableincometaxrateoflessthan25%underthepreviousincometaxlaws,tograduallychangetheirratesto25%.
Inaddition,theCorporateIncomeTaxLawprovidesgrandfathertreatmentforenterpriseswhichwerequaliedas"NewTechnologyEnterprise"underthepreviousincometaxlawsandwereestablishedbeforeMarch16,2007,iftheycontinuetomeetthecriteriaforNewTechnologyEnterprisesafterJanuary1,2008.
Thegrandfatherprovisionallowstheseenterprisescontinuetoenjoytheirunexpiredtaxholidayprovidedbythepreviousincometaxlawsandrules.
Intheyearof2009,SohuEra,SohuMedia,SogouTechnology,SohuInternetandSogouInformationwereNewTechnologyEnterprisesandSohuMedia,SogouTechnologyandSogouInformationenjoyedtheirunexpiredtaxholidays.
Inaddition,theCorporateIncomeTaxLawprovidesthat"SoftwareEnterprise"canenjoyanincometaxexemptionfortwoyearsbeginningwiththeirrstprotableyearanda50%taxreductiontorateof12.
5%forthesubsequentthreeyears.
Intheyearof2009,AmazGameandGamease,conductingouronlinegamebusiness,wereSoftwareEnterprisesandenjoyed12.
5%taxratein2009andsubsequenttwoyearsunderthenewCorporateIncomeTaxLawandtherelevantregulations.
AsthenewCorporateIncomeTaxLawanditsimplementationrulesonlyrecentlywentintoeffect,thereareuncertaintiesontheirfutureinterpretationandimplementation.
WecannotassureyouthattheNewTechnologyEnterpriseandSoftwareEnterprisequalicationsofthoseoperatingentitieswillnotbechallengedbyhigherleveltaxauthoritiesandberepealed,orthattherewillnotbeanyfutureimplementationrulesthatareinconsistentwithcurrentinterpretationoftheCorporateIncomeTaxLaw.
Ifthoseoperatingentitiescannotqualifyforsuchincometaxholidays,oureffectiveincometaxratewillbeincreasedsignicantlyandwemayhavetopayadditionalincometaxtomakeupthepreviouslyunpaidtax,whichcouldmateriallyandadverselyaffectourresultsofoperations.
DividendswereceivefromouroperatingsubsidiarieslocatedinthePRCaresubjecttoPRCwithholdingtax.
TheCorporateIncomeTaxLawimposes,amongstothers,thatamaximumwithholdingtaxrateof20%maybeapplicabletodividendspayabletonon-PRCinvestorsthatare"non-residententerprises,"totheextentthatsuchdividendsarederivedfromsourceswithinthePRC,andtheStateCouncilhasreducedsuchrateto10%throughtheImplementingRegulationsforthePRCCorporateIncomeTaxLaw.
AlowerwithholdingtaxratewillbeappliedifthereisataxtreatyarrangementbetweenChinaandthejurisdictionoftheforeignholdingcompanies,suchasHongKong,whichwillbetaxedat5%.
MostofourChina-basedsubsidiariesareinvestedbyimmediateforeignholdingcompaniesinHongKong.
Alloftheseforeign-investedenterprisesaresubjectedtothewithholdingtaxfromJanuary1,2008.
Inthefourthquarterof2008,AmazGamedeclaredadividendtoitsimmediateholdingcompanyinHongKongandweaccruedawithholdingtaxofapproximately$5.
0millionbasedona5%withholdingtaxrate.
Exceptforthis,sinceweintendtoreinvestourearningstofurtherexpandourbusinessesinChina,ourforeign-investedenterprisesdonotintendtodeclaredividendstotheirimmediateforeignholdingcompaniesintheforeseeablefuture.
Accordingly,asofDecember31,2009,wehavenotrecordedanyotherwithholdingtaxontheretainedearningsofourforeign-investedenterprisesinChina.
WemaybedeemedaPRCresidententerpriseundertheCorporateIncomeTaxLawandbesubjecttoPRCtaxationonourworldwideincome.
TheCorporateIncomeTaxLawprovidesthatenterprisesestablishedoutsideofChinawhose"defactomanagementbodies"arelocatedwithinChinaareconsidered"residententerprises"andaregenerallysubjecttotheuniform25%enterpriseincometaxrateontheirworldwideincome(includingdividendincome-79-receivedfromsubsidiaries).
UndertheImplementingRegulationsfortheCorporateIncomeTaxLaw,"defactomanagementbody"isdenedasabodythathasmaterialandoverallmanagementandcontroloverthemanufacturingandbusinessoperations,personnelandhumanresources,nancesandtreasury,andacquisitionanddispositionofpropertiesandotherassetsofanenterprise.
AlthoughsubstantiallyallofouroperationalmanagementiscurrentlybasedinthePRC,itisunclearwhetherPRCtaxauthoritieswouldrequire(orpermit)ustobetreatedasaPRC-residententerprise.
IfweweretreatedasaresidententerpriseforPRCtaxpurposes,wewillbesubjecttoPRCtaxonourworldwideincomeatthe25%uniformtaxrate,whichcouldhaveanimpactonoureffectivetaxrateandanadverseeffectonournetincomeandtheresultsofoperations,althoughdividendsdistributedfromourPRCsubsidiariestouscouldbeexemptedfromChinesedividendwithholdingtax,sincesuchincomeisexemptedunderthenewCorporateIncomeTaxLawforPRC-residentrecipients.
DividendspayablebyustoourforeigninvestorsandprotsonthesaleofoursharesmaybesubjecttotaxunderPRCtaxlaws.
UndertheImplementingRegulationsfortheCorporateIncomeTaxLaw,PRCincometaxattherateof10%isapplicabletodividendspayabletoinvestorsthatare"non-residententerprises,"nothavinganestablishmentorplaceofbusinessinthePRC,orwhichdohavesuchestablishmentorplaceofbusinessbuttherelevantincomeisnoteffectivelyconnectedwiththeestablishmentorplaceofbusiness,totheextentthatsuchdividendshavetheirsourceswithinthePRC.
Similarly,anyprotsrealizedthroughthetransferofsharesbysuchinvestorsarealsosubjectto10%PRCincometaxifsuchprotsareregardedasincomederivedfromsourceswithinthePRC.
IfweareconsideredaPRC"residententerprise,"itisunclearwhetherdividendswepaywithrespecttoourshare,ortheprotsyoumayrealizefromthetransferofourshares,wouldbetreatedasincomederivedfromsourceswithinthePRCandbesubjecttoPRCtax.
IfwearerequiredundertheImplementingRegulationsfortheCorporateIncomeTaxLawtowithholdPRCincometaxondividendspayabletoournon-PRCinvestorsthatare"non-residententerprises,"orifyouarerequiredtopayPRCincometaxonthetransferofourshares,thevalueofyourinvestmentinoursharesmaybemateriallyandadverselyaffected.
Restrictionsoncurrencyexchangemaylimitourabilitytoutilizeourrevenueseffectively.
SubstantiallyallofourrevenuesandoperatingexpensesaredenominatedinRMB.
TheRMBiscurrentlyfreelyconvertibleunderthe"currentaccount",whichincludesdividends,tradeandservicerelatedforeignexchangetransactions,butnotunderthe"capitalaccount",whichincludesforeigndirectinvestment.
Currently,ourChina-basedsubsidiariesmaypurchaseforeignexchangeforsettlementof"currentaccounttransactions",includingpaymentofdividends,withouttheapprovaloftheStateAdministrationforForeignExchange(orSAFE).
OurChina-basedsubsidiariesmayalsoretainforeignexchangeinitscurrentaccount(subjecttoaceilingapprovedbytheSAFE)tosatisfyforeignexchangeliabilitiesortopaydividends.
However,therelevantPRCgovernmentalauthoritiesmaylimitoreliminateourabilitytopurchaseandretainforeigncurrenciesinthefuture.
SinceasignicantamountofourfuturerevenueswillbeintheformofRMB,theexistingandanyfuturerestrictionsoncurrencyexchangemaylimitourabilitytoutilizerevenuegeneratedinRMBtofundourbusinessactivitiesoutsideChina,ifany,orexpendituresdenominatedinforeigncurrencies.
ForeignexchangetransactionsunderthecapitalaccountarestillsubjecttolimitationsandrequireapprovalsfromtheSAFE.
ThiscouldaffectourChina-basedsubsidiaries'abilitytoobtainforeignexchangethroughdebtorequitynancing,includingbymeansofloansorcapitalcontributionsfromus.
-80-WemaysuffercurrencyexchangelossesiftheRMBdepreciatesrelativetotheU.
S.
Dollar.
OurreportingcurrencyistheU.
S.
Dollar.
However,substantiallyallofourrevenuesaredenominatedinRMB.
InJuly2005,Chinareformeditsexchangerateregimebyestablishingamanagedoatingexchangerateregimebasedonmarketsupplyanddemandwithreferencetoabasketofcurrencies.
TheRMBisnolongerpeggedtotheU.
S.
dollarandtheexchangeratewillhavesomeexibility.
Hence,consideringtheoatingexchangerateregime,iftheRMBdepreciatesrelativetotheU.
S.
Dollar,ourrevenuesasexpressedinourU.
S.
Dollarnancialstatementswilldeclineinvalue.
OnMay19,2007,thePeople'sBankofChinaannouncedapolicytoexpandthemaximumdailyoatingrangeofRMBtradingpricesagainsttheU.
S.
dollarintheinter-bankspotforeignexchangemarketfrom0.
3%to0.
5%.
WhiletheinternationalreactionstotheRMBrevaluationandwideningoftheRMB'sdailytradingbandhavegenerallybeenpositive,withtheincreasedoatingrangeoftheRMB'svalueagainstforeigncurrencies,theRMBmayappreciateordepreciatesignicantlyinvalueagainsttheU.
S.
dollarorotherforeigncurrenciesinthelongterm,dependingontheuctuationofthebasketofcurrenciesagainstwhichitiscurrentlyvalued.
Inaddition,thereareverylimitedhedgingtransactionsavailableinChinatoreduceourexposuretoexchangerateuctuations.
Whilewemaydecidetoenterintohedgingtransactionsinthefuture,theavailabilityandeffectivenessofthesehedgesmaybelimitedandwemaynotbeabletosuccessfullyhedgeourexposure,ifatall.
Inaddition,ourcurrencyexchangelossesmaybemagniedbyPRCexchangecontrolregulationsthatrestrictourabilitytoconvertRMBintoU.
S.
Dollars.
Themarketpriceofourcommonstockhasbeenandwilllikelycontinuetobevolatile.
Thepriceofourcommonstockmayuctuatesignicantly,whichmaymakeitdifcultforstockholderstosellsharesofourcommonstockwhendesiredoratattractiveprices.
Themarketpriceofourcommonstockhasbeenvolatileandislikelytocontinuetobeso.
TheinitialpublicofferingpriceofourcommonstockinJuly2000was$13.
00pershare.
Thetradingpriceofourcommonstocksubsequentlydroppedtoalowof$0.
52pershareonApril9,2001.
During2007,thetradingpriceofourcommonstockrangedfromalowof$20.
94persharetoahighof$64.
83pershare.
During2008,thetradingpriceofourcommonstockrangedfromalowof$34.
10persharetoahighof$91.
50pershare.
During2009,thetradingpriceofourcommonstockrangedfromalowof$37.
41persharetoahighof$72.
29pershare.
OnFebruary25,2010,theclosingpriceofourcommonstockwas$49.
06pershare.
Inaddition,theNasdaqGlobalSelectMarkethasfromtimetotimeexperiencedsignicantpriceandvolumeuctuationsthathaveaffectedthemarketpricesforthesecuritiesoftechnologycompanies,andparticularlyInternet-relatedcompanies.
Thepriceforourcommonstockmayuctuateinresponsetoanumberofeventsandfactors,suchasquarterlyvariationsinoperatingresults,announcementsoftechnologicalinnovationsornewproductsandmediapropertiesbyusorourcompetitors,changesinnancialestimatesandrecommendationsbysecuritiesanalysts,theoperatingandstockpriceperformanceofothercompaniesthatinvestorsmaydeemcomparabletous,andnewsreportsrelatingtotrendsinourmarketsorgeneraleconomicconditions.
Additionally,volatilityoralackofpositiveperformanceinourstockpricemayadverselyaffectourabilitytoretainkeyemployees,allofwhomhavebeengrantedshareoptionsorotherstockawards.
Wearecontrolledbyasmallgroupofourexistingstockholders,whoseinterestsmaydifferfromotherstockholders.
OurChiefExecutiveOfcer,Dr.
Zhang,beneciallyownsapproximately20%oftheoutstandingsharesofourcommonstockandisourlargeststockholder.
OurChiefExecutiveOfcer,togetherwithourotherexecutiveofcersandmembersofourBoardofDirectors,beneciallyownapproximately22%oftheoutstandingsharesofourcommonstock.
Accordinglythesestockholdersactingtogetherwillhavesignicantinuenceindeterminingtheoutcomeofanycorporatetransactionorothermattersubmittedtothestockholdersforapproval,includingmergers,consolidations,thesaleofallorsubstantiallyallofourassets,-81-electionofdirectorsandothersignicantcorporateactions.
Theywillalsohavesignicantinuenceinpreventingorcausingachangeincontrol.
Inaddition,withouttheconsentofthesestockholders,wemaybepreventedfromenteringintotransactionsthatcouldbebenecialtous.
Theinterestsofthesestockholdersmaydifferfromtheinterestsoftheotherstockholders.
Anti-takeoverprovisionsoftheDelawareGeneralCorporationLaw,ourcerticateofincorporationandSohu'sStockholderRightsPlancoulddelayordeterachangeincontrol.
Someprovisionsofourcerticateofincorporationandby-laws,aswellasvariousprovisionsoftheDelawareGeneralCorporationLaw,maymakeitmoredifculttoacquireourcompanyoreffectachangeincontrolofourcompany,evenifanacquisitionorchangeincontrolwouldbeintheinterestofourstockholdersorifanacquisitionorchangeincontrolwouldprovideourstockholderswithapremiumfortheirsharesoverthencurrentmarketprices.
Forexample,ourcerticateofincorporationprovidesforthedivisionoftheboardofdirectorsintotwoclasseswithstaggeredtwo-yeartermsandprovidesthatstockholdershavenorighttotakeactionbywrittenconsentandmaynotcallspecialmeetingsofstockholders,eachofwhichmaymakeitmoredifcultforathirdpartytogaincontrolofourboardinconnectionwith,orobtainanynecessarystockholderapprovalfor,aproposedacquisitionorchangeincontrol.
Inaddition,wehaveadoptedastockholderrightsplanunderthetermsofwhich,ingeneral,ifapersonorgroupacquiresmorethan20%oftheoutstandingsharesofcommonstock,allotherSohustockholderswouldhavetherighttopurchasesecuritiesfromSohuatasubstantialdiscounttothosesecurities'fairmarketvalue,thuscausingsubstantialdilutiontotheholdingsofthepersonorgroupwhichacquiresmorethan20%.
Thestockholderrightsplanmayinhibitachangeincontroland,therefore,couldadverselyaffectthestockholders'abilitytorealizeapremiumoverthethen-prevailingmarketpriceforthecommonstockinconnectionwithsuchatransaction.
ThepowerofourBoardofDirectorstodesignateandissuesharesofpreferredstockcouldhaveanadverseeffectonholdersofourcommonstock.
Ourcerticateofincorporationauthorizesourboardofdirectorstodesignateandissueoneormoreseriesofpreferredstock,havingrightsandpreferencesastheboardmaydetermine,andanysuchdesignationsandissuancescouldhaveanadverseeffectontherightsofholdersofcommonstock.
Changyou'sinitialpublicofferingcouldhaveanadverseimpactonSohu.
OnApril7,2009,ChangyoucompleteditsinitialpublicofferingontheNasdaqGlobalSelectMarket.
Theimpactofthisofferingonuscouldincludethefollowingfactorsthatcouldbeconsideredtobeadverse:Share-basedcompensationexpensewillincreaseastheunvestedrestrictedshareunitsgrantedtoChangyouexecutiveofcersandemployeesbegintovestunderashare-basedawardarrangement.
RestrictedshareunitsgrantedtoChangyouexecutiveofcersandemployeeswillbedilutivesecuritiesforthepurposesofcomputingdilutedearningspershareofChangyou.
ThiswillhaveacorrespondingimpactonthecomputationofSohu'sdilutedearningspershare.
Asaseparatepubliclylistedcompany,Changyoumayhaveintereststhatdifferfrom,ormayevenbecontraryto,thoseofSohu.
AlthoughwehaveenteredintovariousagreementscoveringtransactionsbetweenChangyouandus,wemayhavedisagreementsoncertainmatters.
Ourbusinessmightbeadverselyaffectedbysuchdisagreements.
WecannotassureyouthatChangyou'sinitialpublicofferingwillresultinincreaseforourshareholdersinthemarketvalueoftheirholdingsinourcompanysufcienttooffsetthereductioninourinterestinChangyouresultingfromtheinitialpublicoffering.
Inaddition,themarketpriceofourcommonstock-82-couldbevolatilethanourcommonstockwouldhavebeeniftheinitialpublicofferinghadnotoccurred.
AsSohuGrouphastwolistedcompanies,Sohu.
comInc.
andChangyou.
comLimited,whichareregardedasseparatelegalentitiesforU.
S.
taxpurposes,certaintransactionsbetweenthesetwocompaniesaswellasbetweentheirsubsidiariesandVIEsmightexposeSohu.
comInc.
to34%or35%U.
S.
tax.
Moreover,certaintransactionsofChangyouanditssubsidiariesandVIEs,forexample,investinginU.
S.
properties,mightalsoexposeSohu.
comInc.
totheU.
S.
taxriskthatthesewillbetreatedastaxabletransactions.
IfChangyoupaysdividends,asoneoftheshareholdersofChangyou,Sohu.
comInc.
mightbesubjecttoU.
S.
taxat34%or35%forthedividendsreceived.
Undercertaincircumstances,whenSohusellsChangyouAmericandepositarysharesoriginallyheldbySohuatapricehigherthanitsU.
S.
taxbasis,aportionoftheproceedswillbesubjecttoU.
S.
taxat34%or35%.
ITEM1B.
UNRESOLVEDSTAFFCOMMENTSNone.
ITEM2.
PROPERTIESOurprincipalexecutiveofcesarelocatedintheSohu.
comInternetPlazaintheZhongguancunareaofBeijing,China.
Wepurchasedthepremises,withspaceofapproximately18,265squaremeters,inFebruary2007atacostofapproximately$35.
3million.
InAugust2009,ChangyoupurchasedanofcebuildinginBeijing,withspaceofapproximately14,950squaremetersatacostofapproximately$33.
4million.
InNovember2009,SohuenteredintoanagreementtopurchaseanofcebuildingtobebuiltinBeijing,whichistoserveasSohu'sheadquarters,forapurchasepriceofapproximately$110million.
Theconstructionisexpectedtobecompletedbytheendof2012.
AsofDecember31,2009,weleasedofcespaceinBeijingandTianjinofapproximately4,500squaremeterstoaccommodateincreasedheadcount.
WealsoleasesalesandmarketingofcespaceinShanghai,Guangzhou,Fuzhou,Wuhan,Chengdu,Tianjin,Chongqing,Hangzhou,Nanjing,Shijiazhuang,ShenyangandHongKong.
ITEM3.
LEGALPROCEEDINGSInMarch2008fourcompanies,SonyBMG,WarnerMusic,UniversalMusicandGoldLabelEntertainment,commencedlawsuitsagainstusintheBeijingNo.
1IntermediatePeople'sCourtallegingthatwehaveprovidedmusicsearchlinksanddownloadservicesforsongsinwhichtheyowncopyrights,andthatprovisionoftheselinksandservicesinfringedtheircopyrights.
Theaggregatedamagesclaimedintheselawsuitsareapproximately$7.
5million.
Thelawsuitsareinthepreliminaryphaseandweareassessingtheplaintiffs'claims.
Althoughaninitialjudgmenthasbeeninourfavorastomostaspectsofthecase,bothpartieshavetherighttoappealtothehighercourtandthereforethejudgmenthasnotyetcomeintoeffect.
Webelievethatthelawsuitswillnotbeconcludedatthisstageoftheproceedings,andthatthereforewecannotpredicttheoutcomeorresolutionoftheseclaims,andcannotdetermineatthispointtowhatextenttheplaintiffs'allegationsaremeritoriouseitherfactuallyorlegally,norcanwepredictwhethertheplaintiffswillbesuccessfulintheselawsuits.
Itispossiblethattheselawsuitscouldconcludewithnaljudgmentsagainstus,orsettlementspriortonaljudgment,thatwouldrequireustopaydamagesorroyaltiestotheplaintiffs.
-83-Fromtimetotimewebecomesubjecttolegalproceedingsandclaimsintheordinarycourseofourbusiness,includingclaimsofallegedinfringementoftrademarks,copyrightsandotherintellectualpropertyrights,andavarietyofclaimsarisinginconnectionwithouremail,messageboardsandothercommunicationsandcommunityfeatures,suchasclaimsallegingdefamationorinvasionofprivacy.
However,suchlegalproceedingsorclaims,evenifnotmeritorious,couldresultintheexpenditureofsignicantnancialandmanagementresources.
ITEM4.
SUBMISSIONOFMATTERSTOAVOTEOFSECURITYHOLDERSNomattersweresubmittedtoavoteofoursecurityholdersduringthelastquarteroftheyearendedDecember31,2009.
-84-PARTIIITEM5.
MARKETFORTHEREGISTRANT'SCOMMONSTOCK,RELATEDSTOCKHOLDERMATTERSANDISSUERPURCHASESOFEQUITYSECURITIESMarketInformationOurcommonstockistradedontheNasdaqGlobalSelectMarket,underthesymbol"SOHU".
PublictradinginourcommonstockcommencedonJuly12,2000.
ThefollowingtablesetsforththehighandlowsalepricesofourcommonstockasreportedbytheNasdaqStockMarketforthequartersindicated.
20092008HighLowHighLowFirstquarter$51.
00$37.
41$55.
35$35.
75Secondquarter69.
5440.
8991.
5045.
30Thirdquarter72.
2955.
8587.
9949.
10Fourthquarter71.
5051.
1559.
4034.
10TheclosingpriceofourcommonstockonFebruary25,2010asreportedbytheNasdaqGlobalSelectMarketwas$49.
06.
HoldersAsofFebruary9,2010,therewere26holdersofrecordofourcommonstock.
Becausemanyofoursharesareheldbybrokersandotherinstitutionsonbehalfofstockholders,weareunabletoestimatetheexactnumberofbenecialholdersrepresentedbytheserecordholders.
AsofFebruary9,2010,thelatestpracticabledate,therewereapproximately27,800benecialholdersofourcommonstock.
DividendsSinceourinception,wehavenotdeclaredorpaiddividendsonourcommonstockandwedonotexpecttopayanydividendsintheforeseeablefuture.
SecuritiesAuthorizedforIssuanceunderEquityCompensationPlansAdditionalinformationrequiredunderthisitemisincorporatedhereinbyreferencetoItem12ofthisAnnualReportonForm10-Kundertheheading"EquityCompensationPlanInformation.
"RecentSalesofUnregisteredSecuritiesNone.
IssuerPurchasesofEquitySecuritiesInOctober2008,theboardofdirectorsapprovedourrepurchaseofoutstandingsharesofourcommonstockfromtheopenmarket,onanopportunisticbasis,upto$150millionuntiltheendof2009.
InNovember2008,wepurchased501,686sharesintheopenmarketatanaveragepriceof$39.
86fortotalconsiderationof$20million.
InDecember2009,wepurchased751,224sharesintheopenmarketatanaveragepriceof$53.
26fortotalconsiderationof$40million.
Inaggregate,asofDecember31,2009,wehadrepurchasedatotalof1,252,910sharesintheopenmarketatanaveragepriceof$47.
89fortotalconsiderationof$60million.
-85-ReportofOfferingofSecuritiesandUseofProceedsTherefromInitialPublicOfferingofourCommonStockOnJuly17,2000,wecompletedanunderwritteninitialpublicofferingofourcommonstockpursuanttoaRegistrationStatementonFormS-1(SECleNo.
333-96137),whichbecameeffectiveonJuly10,2000.
Ournetproceeds,afterdeductionoftheunderwritingdiscountof$4.
2millionandofferingexpensesof$3.
2million,wereapproximately$52.
4million.
Noneoftheexpensepaymentsweremadetotheunderwriters,toanyofourdirectors,ofcersorafliatesortoanypersonsowning10%ormoreofanyclassofourequitysecurities.
ThroughDecember31,2009,wehadused$8.
2millionofthenetproceedsfromtheofferingforoperatingactivities,purchasesofxedassets,fundingforcertainequityinvestmentsandstrategicacquisitionsofcomplementarybusinesses.
Theremainingnetproceedsfromtheofferinghavebeeninvestedincashandcashequivalents.
TheuseoftheproceedsfromtheofferingdoesnotrepresentamaterialchangeintheuseofproceedsdescribedintheprospectuscontainedintheRegistrationStatementonFormS-1describedabove.
PERFORMANCEGRAPHThefollowinggraphcomparesthecumulativetotalstockholderreturnforSohu,theNasdaqStockMarket(U.
S.
companies)Index(ortheNasdaqMarketIndex)andtheHemscottGroupIndexforInternetInformationProviders(orHemscottGroupIndex).
ThegraphcoverstheperiodfromDecember31,2004toDecember31,2009.
Thegraphassumesthat$100wasinvestedonDecember31,2004inourcommonstock,theNasdaqMarketIndexandtheHemscottGroupIndex,andthereinvestmentofanydividends.
Thestockpriceperformanceonthefollowinggraphisnotnecessarilyindicativeoffuturestockpriceperformance.
Sohu.
comInc.
HemscottGroupIndexNasdaqMarketIndex12/31/2004100.
00100.
00100.
0012/31/2005103.
56151.
97102.
2012/31/2006135.
52148.
28112.
6812/31/2007307.
85202.
28124.
5712/31/2008267.
3191.
9974.
7112/31/2009323.
43187.
26108.
56-86-TheStockPerformanceGraphisnot"solicitingmaterial",isnotdeemedledwiththeSecuritiesandExchangeCommissionandisnotdeemedtobeincorporatedbyreferencebyanygeneralstatementincorporatingbyreferencethisannualreportonForm10-KintoanylingoftheCompanyundertheSecuritiesActof1933,oranylingundertheSecuritiesExchangeActof1934,excepttotheextentthatwespecicallyrequestthattheinformationbetreatedassolicitingmaterialorspecicallyincorporatethisinformationbyreferenceintoanysuchling,andwillnototherwisebedeemedincorporatedbyreferenceintoanyotherlingundertheSecuritiesActortheSecuritiesExchangeAct,excepttotheextentthatwespecicallyincorporateitbyreference.
InformationusedonthegraphswasobtainedfromMorningstar,Inc.
,asourcebelievedtobereliable.
ITEM6.
SELECTEDFINANCIALDATATheselectedconsolidatednancialdatabelowshouldbereadinconjunctionwith"Management'sDiscussionandAnalysisofFinancialConditionandResultsofOperations",theconsolidatednancialstatementsandnotestheretoandtheotherinformationcontainedinthisForm10-K.
In2005,inordertoimprovethemeasurementofperformanceofeachsegment,webeganallocatingWebsiteoperatingcoststothecostofrevenuesofeachsegmentbasedonactualusage,whilewehadincludedallofourWebsiteoperatingcostsincostofrevenuesofbrandadvertisinginpreviousyears.
In2006,inordertofocusmoreonourcorebusinesses,wediscontinuedourunprotablee-commercebusiness.
Asaresult,thee-commercebusinesswasaccountedforasadiscontinuedoperationandourstatementsofoperationsseparatethediscontinuedoperationforallperiodspresented.
In2007,weadjustedourreportablesegmentsandreclassiedouronlinegameresultsfromtheotherssegmenttobeaseparatesegment.
Accordingly,wereclassiedtherevenueandcostofrevenueoftheonlinegamesegmentfortheyearspriorto2007toconformtotheclassication.
In2007,inordertobetterpresentoperatingresultsandenhancecomparabilitywithindustrypeers,wereclassiedexpensesinrelationtogameoperationstocostofonlinegamerevenues,whilemostofthecostsandexpensesofonlinegamewererelatedtoproductdevelopmentandresearchpriorto2007.
Accordingly,wereclassiedexpensesinrelationtogameoperationstocostofonlinegamerevenuesfortheyearspriorto2007toconformtotheclassication.
In2009,werenamedminorityinteresttononcontrollinginterestandreclassieditinourconsolidatedbalancesheetsfromthemezzaninesectionbetweenliabilitiesandequitytoaseparatelineiteminequityinaccordancewithU.
S.
GAAP.
Accordingly,weappliedthesepresentationrequirementsretrospectivelyforallperiodspresentedforcomparability.
In2009,weadjustedourbusinessgroupingfromadvertisingbusinessandnon-advertisingbusinesstoadvertisingbusiness(composedofbrandadvertisingandsponsoredsearch),onlinegamebusiness,andwirelessandothersbusiness.
Accordingly,weadjustedourpresentationbasedonthenewclassicationfortheyearspriorto2009toconformtothecurrentyearclassication.
-87-YearEndedDecember31,20092008200720062005(inthousands,exceptpersharedata)StatementsofOperationsData:Revenues:Advertising$185,625$175,937$119,216$91,758$70,897Onlinegame267,585201,84542,0968,5255,809Wirelessandothers62,02951,26927,62233,95327,841Totalrevenues515,239429,051188,934134,236104,547Costofrevenues:Advertising69,82166,25944,37728,45717,688Onlinegame17,50514,5677,1133,8952,732Wirelessandothers36,06926,48813,27316,01112,897Totalcostofrevenues123,395107,31464,76348,36333,317Grossprot391,844321,737124,17185,87371,230Operatingexpenses:Productdevelopment56,94349,71325,44317,65112,832Salesandmarketing93,49884,69147,50628,53220,110Generalandadministrative36,62422,69517,41813,09210,153Amortizationofintangibleassets3887961,0931,9931,948Totaloperatingexpenses187,453157,89591,46061,26845,043Operatingprot204,391163,84232,71124,60526,187Otherincome(expense)342(535)8874772,447Interestincomeandexchangedifference5,0014,2882,7933,2162,500Incomebeforeincometaxexpense209,734167,59536,39128,29831,134Incometaxexpense33,7459,0091,4871,57911Incomefromcontinuingoperations175,989158,58634,90426,71931,123Gain(loss)fromdiscontinuede-commerceoperations446—(20)(841)(1,342)Netincome176,435158,58634,88425,87829,781Less:Netincome(loss)attributabletothenoncontrollinginterest28,602(51)(47)(7)—NetincomeattributabletoSohu.
comInc.
$147,833$158,637$34,931$25,885$29,781BasicnetincomepershareattributabletoSohu.
comInc.
$3.
86$4.
16$0.
94$0.
70$0.
82SharesusedincomputingbasicnetincomepershareattributabletoSohu.
comInc.
38,29438,16837,13336,73036,309DilutednetincomepershareattributabletoSohu.
comInc.
$3.
57$4.
06$0.
90$0.
68$0.
77SharesusedincomputingdilutednetincomepershareattributabletoSohu.
comInc.
38,96939,11738,91939,10539,680-88-AsofDecember31,20092008200720062005(inthousands)BalanceSheetsData:Cashandcashequivalents$563,782$314,425$122,706$124,756$119,091Investmentsinmarketabledebtsecurities———4,94213,995Restrictedcash—2,6714,3244,774991Workingcapital470,676248,06385,70261,909116,962Totalassets828,273521,876290,517253,591239,681Zerocouponconvertibleseniornotes——659,78074,780Totalliabilities150,497130,78271,61397,575109,833Noncontrollinginterest67,9955,148753—Totalshareholders'equity677,776391,094218,904156,016129,848-89-ITEM7.
MANAGEMENT'SDISCUSSIONANDANALYSISOFFINANCIALCONDITIONANDRESULTSOFOPERATIONSOVERVIEWSohuisaleadingInternetcompanyinChina,providinghundredsofmillionsofChineseInternetuserswithnews,information,videocontent,entertainment,andcommunication.
WeoperateoneofthemostcomprehensivematricesofChineselanguageWebpropertiesandoneofthemostpopularonlinegamesinChina.
Substantiallyallofouroperationsareconductedthroughourindirectwhollyandmajority-ownedChina-basedsubsidiariesandvariableinterestentities(collectivelythe"SohuGroup").
OurBusinessOurbusinessesmainlyconsistofadvertising(composedofbrandadvertisingandsponsoredsearch),onlinegame(conductedviaChangyou.
comLimited,"Changyou"),andwirelessbusiness,amongwhichbrandadvertisingandonlinegameareourtwocorebusinesses.
Startingfrom2003,ouronlinegamebusinesshasdevelopedfromnascencytobecomeoneofthetopmassivelymulti-playeronlinerole-playinggame("MMORPG")operatorsinChina.
Itssuccesswasfurtherendorsedbythecarve-outandinitialpublicofferingofourMMORPGsubsidiaryChangyou(Nasdaq:CYOU)inApril2009.
ThesuccessfulinitialpublicofferinghasprovidedChangyouwiththeplatformandresourcestobecomealeadingcompanyintheMMORPGindustry,andhasenabledChangyoutocompeteheadtoheadwithrsttierplayers.
AsChangyou'scontrollingshareholder,SohucontinuestoconsolidateChangyoubutrecognizesnoncontrollinginterestsreectingthesharesheldbytheshareholdersotherthanSohu.
Duringthesecondquarterthroughfourthquarterof2009,treatingallexistingrestrictedsharesandrestrictedshareunitsasfullyvested,Sohuownedapproximately66%oftheeconomicinterestinChangyou,withtheremaining34%oftheeconomicinterestinChangyouownedbyChangyou'sshareholdersotherthanSohu.
WedonotexpectthepercentageofSohu'seconomicinterestinChangyoutouctuatesignicantly,giventhatSohudoesnothaveanyplantosellanyadditionalsharesinChangyouintheforeseeablefuture.
FordetailedinformationChangyou'sinitialpublicofferingandshareholdingstructure,pleaseseeNote2—ChangyouTransactions.
FortheyearendedDecember31,2009,ourtotalrevenuesincreasedby20%to$515.
2million,grossmarginincreasedfrom75%to76%.
Ourbrandadvertisingbusinessgeneratedrevenuesof$177.
1millionwith5%annualgrowth,representing34%oftotalrevenues.
Ouronlinegamebusinessgeneratedrevenuesof$267.
6millionwith33%annualgrowth,representing52%oftotalrevenues.
In2009,ournetincomebeforedeductingtheeconomicinterestinChangyouattributabletotheshareholdersotherthanSohuwas$176.
4million,comparedto$158.
6millionin2008.
In2009,thenetincomeafterdeductingtheeconomicinterestinChangyouattributabletotheshareholdersotherthanSohuwas$147.
8million.
DilutednetincomepershareattributabletoSohu.
comIncwas$3.
57in2009,comparedto$4.
06in2008.
AdvertisingBusinessOuradvertisingbusiness,includingbrandadvertisingservicesandsponsoredsearchservices,offersvariousproductsandservicestoourusers(suchasfreeofchargepremiercontent,interactivecommunity,integrationsearchandothercompetitiveInternetservices),andprovidesadvertisingservicestoadvertisersonourmatricesofChineselanguageWebpropertiesconsistingof:sohu.
com,aleadingmassportalandonlinemediadestination;17173.
com,aleadinggameinformationportal;focus.
cn,atoprealestateWebsite;-90-chinaren.
com,aleadingonlinealumniclub;andsogou.
com,aninteractiveproprietarysearchengine.
BrandadvertisingservicesprovideadvertisementsonourportalWebsitestocompaniesseekingtoincreasetheirbrandawarenessonline.
Sponsoredsearchservicesprovidepriorityplacementsinoursearchdirectoryandpay-for-clickservicestocustomers,especiallysmallandmedium-sizedenterprises.
OnlineGameBusinessOuronlinegamebusinessisconductedviaSohu'smajority-ownedsubsidiaryChangyou.
ChangyouisaleadingonlinegamedeveloperandoperatorinChinaasmeasuredbythepopularityofoneofourgames,TianLongBaBu("TLBB").
TLBB,whichwaslaunchedinMay2007,wasrankedbyInternationalDataCorporation("IDC")in2008asthefourthmostpopularonlinegameoverallinChinaandthesecondmostpopularonlinegameinChinaamonglocally-developedonlinegames.
Changyouengagesinthedevelopment,operationandlicensingofourMMORPGs,whichareinteractiveonlinegamesthatmaybeplayedsimultaneouslybyhundredsofthousandsofgameplayers.
ChangyoucurrentlyoperatesthreeMMORPGs,TLBB,whichwedevelopedin-house,BladeOnline("BO"),whichwelicensedfromthirdparties,andBladeHero2("BH2",thesequeltoBO).
ForthethreemonthsendedDecember31,2009,thesegameshadapproximately80.
9millionaggregateregisteredaccounts,2.
4millionaggregateactivepayingaccounts,990,000aggregatepeakconcurrentusersandaveragerevenueperactivepayingaccountofRenminbi("RMB")196.
ChangyouhasveMMORPGsinthepipeline,withdifferentgraphicstyles,themesandfeaturestoappealtodifferentsegmentsoftheonlinegameplayercommunity.
GamesinourpipelineincludeDukeofMountDeer("DMD"),whichwearedevelopingin-house,ZhongHuaYingXiong("ZHYX"),DaHuaShuiHu("DHSH"),ImmortalFaith("IF")andtheLegendofAncientWorld("LAW"),allofwhichwelicensedfromthirdparties.
Changyouoperatesourcurrentgamesundertheitem-basedrevenuemodel,meaningthatgameplayerscanplayourgamesforfree,butmaychoosetopayforvirtualitemstoenhancethegame-playingexperience.
Gameplayerspurchaseprepaidgamecardsorgamepoints,whichareusedtopurchasevirtualitems.
Changyousellsourprepaidgamecardstoapproximately100regionaldistributorsthroughoutChina,whointurnsub-distributetheprepaidgamecardstonumerousretailoutlets,includingInternetcafesandvariousWebsites,newsstands,softwarestores,bookstoresandretailstores.
Changyoualsodirectlysellsgamepointstogameplayersthroughouronlinesalesplatform.
Asaforementioned,onApril7,2009,ChangyoucompleteditsinitialpublicofferingontheNasdaqGlobalSelectMarket,tradingunderthesymbol"CYOU".
AgreementsbetweenSohuandChangyouThefollowingaresummariesofaMasterTransactionAgreement,aNon-CompetitionAgreement,andaMarketingServicesAgreementbetweenSohuandChangyou:MasterTransactionAgreementTheMasterTransactionAgreementcontainskeyprovisionsrelatingtoChangyou'scarve-outfromSohu.
TheMasterTransactionAgreementprovidesforcross-indemnitiesthatgenerallywillplacethenancialresponsibilityonChangyouforallliabilitiesassociatedwiththecurrentandhistoricalMMORPGbusinessandoperationstransferredtoChangyou,andgenerallywillplaceonSohuthenancialresponsibilityforliabilitiesassociatedwithallofSohu'sothercurrentandhistoricalbusinessesandoperations,ineachcaseregardlessofthetimethoseliabilitiesarise.
TheMasterTransactionAgreementalsocontainsindemnicationprovisions-91-underwhichChangyouandSohuindemnifyeachotherwithrespecttobreachesoftheMasterTransactionAgreementoranyrelatedinter-companyagreement.
InadditiontoChangyou'sgeneralindemnicationobligationsdescribedaboverelatingtothecurrentandhistoricalSohubusinessandoperations,ChangyouhaveagreedtoindemnifySohuagainstliabilitiesarisingfrommisstatementsoromissionsintheprospectusforChangyou'sinitialpublicofferingortheregistrationstatementofwhichitisapart,exceptformisstatementsoromissionsrelatingtoinformationthatSohuprovidedtoChangyouspecicallyforinclusionintheprospectusortheregistrationstatementofwhichitformsapart.
ChangyoualsohaveagreedtoindemnifySohuagainstliabilitiesarisingfromanymisstatementsoromissionsinChangyou'speriodicSEClingsandfrominformationChangyouprovidetoSohuspecicallyforinclusioninSohu'sannualorquarterlyreports,butonlytotheextentthattheinformationpertainstoChangyouorChangyou'sbusinessortotheextentSohuprovidesChangyoupriorwrittennoticethattheinformationwillbeincludedinSohu'sannualorquarterlyreportsandtheliabilitydoesnotresultfromtheactionorinactionofSohu.
InadditiontoSohu'sgeneralindemnicationobligationsdescribedaboverelatingtothecurrentandhistoricalSohubusinessandoperations,SohuwillindemnifyChangyouagainstliabilitiesarisingfrommisstatementsoromissionswithrespecttoinformationthatSohuprovidedtoChangyouspecicallyforinclusionintheprospectusforChangyou'sinitialpublicofferingortheregistrationstatementofwhichitisapart.
SohuwillalsoindemnifyChangyouagainstliabilitiesarisingfrominformationSohuprovidestoChangyouspecicallyforinclusioninChangyou'speriodicSEClings,butonlytotheextentthattheinformationpertainstoSohuorSohu'sbusinessortotheextentChangyouprovideSohupriorwrittennoticethattheinformationwillbeincludedinChangyou'speriodicSEClingsandtheliabilitydoesnotresultfromChangyou'sactionorinaction.
ForliabilitiesarisingfromeventsoccurringonorbeforethedateoftheprospectusforChangyou'sinitialpublicoffering,theMasterTransactionAgreementcontainsageneralrelease.
Underthisprovision,ChangyoureleaseSohuanditssubsidiaries,VIEs,successorsandassigns,andSohuwillreleaseChangyouandChangyou'ssubsidiaries,VIEs,successorsandassigns,fromanyliabilitiesarisingfromeventsbetweenChangyouontheonehand,andSohuontheotherhand,occurringonorbeforethedateoftheprospectus,includinginconnectionwiththeactivitiestoimplementChangyou'sinitialpublicoffering.
ThegeneralreleasedoesnotapplytoliabilitiesallocatedbetweenthepartiesundertheMasterTransactionAgreementortheotherinter-companyagreementsortospeciedongoingcontractualarrangements.
Furthermore,undertheMasterTransactionAgreement,ChangyouhaveagreedtouseitsreasonablebesteffortstousethesameindependentcertiedpublicaccountingrmselectedbySohuandtomaintainthesamescalyearasSohuuntilsuchtimeasSohunolongerownsatleastamajorityofChangyou'svotingsecurities.
ChangyoualsohaveagreedtouseitsreasonablebesteffortstocompletetheauditandprovideSohuwithallnancialandotherinformationonatimelybasissothatSohumaymeetitsdeadlinesforitslingannualandquarterlynancialstatements.
Non-CompetitionAgreementUndertheNon-CompetitionAgreement,Sohuhasagreed,untilthelaterofthreeyearsafterSohunolongerownsintheaggregateatleast10%ofthevotingpowerofChangyou'sthenoutstandingvotingsecuritiesandveyearsafterMarch17,2009,thedatethattheregistrationstatementforChangyou'sinitialpublicofferingwasrstpubliclyledwiththeSEC,orthenon-competitionperiod,thatitwillnotcompetewithChangyouintheMMORPGbusinessanywhereintheworld.
Changyouhaveagreedduringthenon-competitionperiodnottocompetewithSohuintheInternetportal,search,mobilevalue-addedservicesandgamesbusiness,andanyotherbusinesses,exceptMMORPGsandrelatedsupportservices,conductedorcontemplatedtobeconductedbySohuasofthedateoftheprospectusforChangyou'sinitialpublicoffering.
SohuisentitledtocontinuetoprovidelinkstoMMORPGsandothergames,includingtothoseofChangyou'scompetitors,that-92-itprovidesonits17173.
comwebsite.
Inaddition,bothpartieshaveagreednottosolicittheemployeesoftheotherparty.
MarketingServicesAgreementTheMarketingServicesAgreementprovidesthatSohuwillprovidecertainrightsandservicestoChangyou,includingmarketingservicesandSohu'sPEAKsystemforthedistributionofChangyou'svirtualprepaidgamecards.
TheagreementfurtherprovidesforthelicensefromSohutoChangyouofcertaindomainnames,permitsChangyoutoco-brandChangyou'sgameswiththeSohunameandlogos,andallowsChangyoutoidentifyChangyouasamemberoftheSohuGroup.
TheagreementwillterminateuponthelaterofthedatethatisthreeyearsaftertherstdateuponwhichSohuceasestoownintheaggregateatleast10%ofthevotingpowerofthethenoutstandingsecuritiesofChangyouandthefthanniversaryofMarch17,2009.
LoansOutstandingbetweenChangyouandSohu.
comLimitedChangyoureceivedloansintheamountof$5.
0millionand$3.
5millionfromSohu.
comLimitedinSeptember2007andDecember2008,respectively.
The$5.
0millionloanmadein2007wasadvancedbySohutofundtheestablishmentofAmazGame,andthe$3.
5millionloanmadein2008wasadvancedtoprovideforworkingcapitalneedsofChangyouHK.
TheloanswererepaidinApril2009.
AmountsChangyouDueto/fromSohuChangyou'sintercompanypayablestoSohu,arisingmainlyfromexpenseschargedfromSohuforsalesandmarketingservicesprovidedtoChangyou,amountedto$5.
0millionasofDecember31,2009,comparedto$10.
8millionasofDecember31,2008.
Changyou'sintercompanypayablestoSohu,arisingmainlyfromassetstransferredfromandservicesprovidedbySohuin2007,amountedto$21.
7millionasofDecember31,2007.
IntercompanyreceivablesfromSohu,arisingmainlyfromcustomeradvancescollectedbySohuonChangyoubehalf,were$0.
3million,$8.
5millionand$8.
8millionasofDecember31,2009,2008and2007,respectively.
Thesebalancesareinterestfreeandsettleableondemand,andaremeasuredattheamountofconsiderationestablishedandagreedtobytherelatedparties,whichapproximatesamountsthatwouldbechargedtothirdparties.
WirelessandOthersBusinessesOurwirelessandothersbusinessesmainlyconsistofthewirelessbusiness,whichoffersvalue-addedservicesformobilephoneuserssuchasnews,weatherforecasts,chatting,entertainmentinformationandmobilephoneringtoneandlogodownloads.
EconomyandIndustryTheChineseeconomybegantoexperienceaslowinggrowthrateduringtheglobalnancialcrisisinthelatterhalfof2008.
In2009,theChinesegovernmentcarriedoutaseriesofstimulusplansandtheChineseeconomyrecoveredgraduallywithGDPgrowthexceeding8%.
Headinginto2010,itisuncertainhowstrongtheeconomyrecoveryinChinawillbeandhowlongitwilltaketheeconomytogobacktonormal.
However,webelievewearewellpositionedtocapitalizeontheeconomyrecovery.
Fortheportalbusiness,wearefocusingonourlong-termstrategicvisiontomakeSohuoneofthemostpowerfulmainstreammediaplatformsinChina.
Webelieveamodestmacroenvironmentprovidesgreatmedia-drivenopportunityforus.
Moreover,ouronlinegamebusinesshasbeenmoreresilienttotheweakeconomicconditionandcontinuestoshowgrowthmomentum.
Thismorethanoffsetsanytemporaryimpactonourportalbusinessbroughtonbytheeconomyweakness.
-93-CRITICALACCOUNTINGPOLICIESANDESTIMATESOurdiscussionandanalysisofournancialconditionandresultsofoperationsrelatestoourconsolidatednancialstatements,whichhavebeenpreparedinaccordancewithGenerallyAcceptedAccountingPrinciplesintheUnitedStates("U.
S.
GAAP").
Thepreparationofthesenancialstatementsrequiresustomakeestimatesandjudgmentsthataffectthereportedamountsofassets,liabilities,revenuesandexpenses,andrelateddisclosureofcontingentassetsandliabilities.
Onanon-goingbasis,weevaluateourestimatesbasedonhistoricalexperienceandonvariousotherassumptionsthatarebelievedtobereasonableunderthecircumstances,theresultsofwhichformthebasisformakingjudgmentsaboutthecarryingvaluesofassetsandliabilitiesthatarenotreadilyapparentfromothersources.
Actualresultsmaydifferfromtheseestimatesunderdifferentassumptionsorconditions.
Webelievetherevenuerecognition,theshare-basedcompensationexpenserecognition,incometaxesanduncertaintaxpositions,recognitionofnoncontrollinginterest,computationofnetincomepershare,allowancefordoubtfulaccounts,assessmentofimpairmentforlong-livedassetsandgoodwill,anddeterminationoffunctionalcurrenciesrepresentcriticalaccountingpoliciesthatreectthemoresignicantjudgmentsandestimatesusedinthepreparationofourconsolidatednancialstatements.
RevenueRecognitionWerecognizerevenuewhenpersuasiveevidenceofanarrangementexists,deliveryhasoccurred,thesalespriceisxedordeterminable,andcollectabilityisreasonablyassured.
AdvertisingRevenuesAdvertisingrevenuesincluderevenuesfrombrandadvertisingservicesandsponsoredsearchservices.
Advertisingrevenueisrecognizedafterdeductingagentrebatesandapplicablebusinesstax.
Theadvertisingrevenuerecognitioninvolvescertainmanagementjudgments.
Theamountandtimingofouradvertisingrevenuescouldbemateriallydifferentforanyperiodifmanagementmadedifferentjudgmentsorutilizeddifferentestimates.
Wedonotenterintoadvertising-for-advertisingbartertransactions.
BrandAdvertisingRevenuesForbrandadvertisingrevenues,acontractissignedtoestablishthexedpriceandadvertisingservicestobeprovided.
Basedonthecontracts,weprovideadvertisementplacementsonourdifferentWebsitechannelsand/orindifferentformats,includingbutnotlimitedtobanners,links,logos,buttons,richmediaandcontentintegration.
Forbrandadvertisingrevenuerecognition,priortoenteringintocontracts,wemakeacreditassessmentofthecustomertoassessthecollectabilityofthecontract.
Forthosecontractsforwhichthecollectabilitywasassessedasreasonablyassured,werecognizerevenueratablyovertheperiodduringwhichtheadvertisingserviceswereprovidedandwhenallrevenuerecognitioncriteriaweremet.
Forthosecontractsforwhichthecollectabilitywasassessedasnotreasonablyassured,werecognizerevenueonlywhenthecashwasreceivedandallrevenuerecognitioncriteriaweremet.
Wetreatallelementsofadvertisingcontractsasasingleunitofaccountingforrevenuerecognitionpurposes.
Asonekindofbrandadvertisingservices,sponsorshipserviceissimilartootherbrandadvertisingservicesbutgenerallywithlargeramountandforalongercontractualperiod.
SponsorshipservicemayallowadvertiserstosponsoraparticularareaonourWebsites,andmayincludebrandafliationservicesand/oralargervolumeofservices,andmayrequiresomeexclusivityorpremierplacements.
Sponsorshipadvertisementrevenuesarenormallyrecognizedonastraight-linebasisoverthecontractperiod,providedourobligationsunderthecontracthavebeenmetandallrevenuerecognitioncriteriahavebeenmet.
-94-SponsoredSearchRevenuesSponsoredsearchservicesmainlyincludepriorityplacementsservicesandpay-for-clickservices.
Thepriorityplacementsservicesareplacedinoursearchdirectoryandarenormallyprovidedforaxedfeeovertheserviceperiodofthecontracts.
Pay-for-clickservicesmainlyconsistofdisplayingthetext-basedlinksofouradvertisersonourWebsitesandourWebsiteAlliancenetwork.
Sponsoredsearchcontractsarenormallyforrelativelysmallamountsandaresignedwithsmallandmedium-sizedenterprises.
Revenueforthepriorityplacementsservicesisnormallyrecognizedonastraight-linebasisoverthecontractperiodprovidedourobligationsunderthecontracthavebeenmetandallrevenuerecognitioncriteriahavebeenmet.
Revenueforpay-for-clickservicesisrecognizedonaperclickbasiswhentheusersclickonthedisplayedlinks.
Thepriorityofthedisplayoftext-basedlinksisbasedonthebiddingpriceofdifferentadvertisers.
OnlineGameRevenuesGameOperationRevenuesWeearnrevenuesfromourcurrentMMORPGoperationsbyprovidingonlineservicestogameplayerspursuanttotheitem-basedrevenuemodel.
Forperiodspriortoourupgradingandre-launchingofBOinDecember2006,weoperatedBOunderthetime-basedrevenuemodel,wheregameplayersarechargedbasedonthetimetheyspendplayingthegame.
Undertheitem-basedrevenuemodel,gameplayersplaygamesfreeofchargeandarechargedforpurchasesofvirtualitems.
Underboththeitem-basedandthetime-basedrevenuemodels,proceedsreceivedfromsalesofprepaidcardsareinitiallyrecordedasreceiptsinadvance.
Proceedsfromsaleofprepaidcardstodistributorsaredeferredwhenreceivedand,fortheitem-basedrevenuemodel,revenueisrecognizedovertheestimatedlivesofthevirtualitemspurchasedorasthevirtualitemsareconsumed.
Forthetime-basedrevenuemodel,revenueisrecognizedbasedupontheactualusageoftimeunitsbythegameplayers.
Therevenuesarerecordednetofbusinesstax,salesdiscountsandrebatestoourdistributors.
Underouritem-basedrevenuemodel,gameplayerscanaccessourgamesfreeofcharge,butmaypurchaseconsumablevirtualitems,includingthosewithapre-determinedexpirationtime,suchasthreemonths,orperpetualitems,suchascertaincostumesthatstayboundtoagameplayerforthelifeofthegame.
Revenuesinrelationtoconsumablevirtualitemsarerecognizedastheyareconsumed,asourservicesinconnectionwiththeseitemshavebeenfullyrenderedtoourgameplayersasofthattime.
Revenuesinrelationtoperpetualvirtualitemsarerecognizedovertheirestimatedlives.
Wewillprovidecontinuousonlinegameservicesinconnectionwiththeseperpetualvirtualitemsuntiltheyarenolongerusedbyourgameplayers.
Wehaveconsideredtheaverageperiodthatgameplayerstypicallyplayourgamesandothergameplayerbehaviorpatternstoarriveatourbestestimatesforthelivesoftheseperpetualvirtualitems.
Wehavealsoconsideredthattheestimatedlivesofperpetualvirtualitemsmaybeaffectedbyvariousfactors,includingtheacceptanceandpopularityofexpansionpacks,promotionaleventslaunchedandmarketconditions.
However,giventherelativelyshortoperatinghistoryofourgames,andofourmostpopulargameTLBBinparticular,ourestimateoftheperiodthatgameplayerstypicallyplayourgamesmaynotaccuratelyreecttheestimatedlivesoftheperpetualvirtualitems.
Wehaveadoptedapolicyofassessingtheestimatedlivesofperpetualvirtualitemsonaquarterlybasis.
Allpayingusers'datacollectedsincethelaunchofthegamesareusedtoperformtherelevantassessments.
Historicalbehaviorpatternsofthesepayingusersduringtheperiodbetweentheirrstlog-ondateandlastlog-ondateareusedtoestimatethelivesofperpetualvirtualitems.
Whilewebelieveourestimatestobereasonablebasedonavailablegameplayerinformation,wemayrevisesuchestimatesinthefutureasourgames'operationperiodsbecomelongerandwecontinuetogainmoreoperatinghistoryanddata.
Anyadjustmentsarisingfromchangesintheestimatesofthelivesofperpetualvirtualitems-95-wouldbeappliedprospectivelyonthebasisthatsuchchangesarecausedbynewinformationindicatingachangeinthegameplayerbehaviorpatterns.
Anychangesinourestimateoflivesofperpetualvirtualitemsmayresultinourrevenuesbeingrecognizedonabasisdifferentfrompriorperiods'andmaycauseouroperatingresultstouctuate.
OverseasLicensingRevenuesWealsoderiveonlinegamerevenuesfromlicensingourgamesinothercountriesandterritories.
Thelicensingagreementsprovidedfortworevenuestreams,aninitiallicensefeeandamonthlyrevenue-basedroyaltybasedonmonthlyrevenuesfromthegames.
Theinitiallicensefeeconsistsofbothaxedamountandadditionalamountsreceivableuponachievingcertainsalestargets.
Sincewearerequiredtoprovidewhen-and-if-availableupgradestothelicenseesduringthelicenseperiod,boththexedportionandtheadditionalportionoftheinitiallicensefeearerecognizedratablyasrevenueoverthelicenseperiod.
Thexedportionoftheinitiallicensefeeisrecognizedratablyovertheremaininglicenseperiodfromthedatethegameislaunched,andtheadditionalportionoftheinitiallicensefeeisrecognizedratablyovertheremaininglicenseperiodfromthedatesuchadditionalamountiscertain.
Themonthlyusage-basedroyaltyfeeisrecognizedwhenearned,providedthatcollectabilityisreasonablyassured.
WirelessandOthersRevenuesOurwirelessandothersrevenuesaremainlyfromourwirelessbusiness.
Wirelessrevenuesarederivedfromawiderangeofwirelessproductsfocusedonentertainment,informationandcommunications,suchasshortmessagingservices("SMS"),RingBackTone("RBT"),WirelessApplicationProtocol("WAP"),multi-mediamessagingservices("MMS")andinteractivevoiceresponse("IVR").
Wemainlyoffernews,weatherforecasts,chatting,entertainmentinformation,mobilephoneringtones,andlogodownloadsandvariousothermobilerelatedservicestomobilephoneusersthroughcontractssignedwiththirdpartymobilenetworkoperators.
Wirelessservicefeesarechargedonamonthlyorpermessage/downloadbasis.
Duetothetechnicalissueswiththeoperator'snetwork,wemightunabletocollectcertainwirelessservicefeesfromanoperatorincertaincircumstances.
Thisun-collectabilityisreferredtoasthe"failurerate",whichcanvaryfromoperatortooperator.
Wirelessrevenuesarerecognizedinthemonthinwhichtheserviceisperformed,providedthatnosignicantobligationsremain.
Torecognizewirelessrevenue,werelyonChinamobilenetworkoperatorstoprovideusthebillingconrmationsfortheactualamountofservicestheyhavebilledtotheirmobilecustomers.
Attheendofeachreportingperiod,whenanoperatorhasnotprovidedusthemonthlybillingconrmations,weusetheinformationgeneratedfromourinternalsystemaswellasthehistoricaldatatoestimatethefailurerate,toestimatetheamountofcollectablewirelessservicefeesandtorecognizerevenue.
Inthelaterperiodwhenwegettheactualbillingconrmation,wethenrecordatrue-upaccountingadjustment.
Althoughwebelievewehavetheabilitytomakereasonableestimates,thedifferencesbetweentheactualfactsandourestimationsmayresultinsignicantuctuationsintheamountandtimingoftherevenuerecognized.
ForthethreemonthsendedDecember31,2009,74%ofourestimatedwirelessrevenueswereconrmedbythemonthlybillingconrmationsreceivedfromthemobilenetworkoperators.
Generally,(i)within15to120daysaftertheendofeachmonth,wereceivebillingconrmationsfromeachoftheoperatorsconrmingtheamountofwirelessservicechargesbilledtothatoperator'smobilephoneusersand(ii)within30to180daysafterdeliveringbillingconrmations,eachoperatorremitsthewirelessservicefees,netofitsservicefees,forthemonthtous.
Ourmanagementmustdeterminewhethertorecordourwirelessrevenuesusingthegrossornetmethodofreporting.
Determiningwhetherrevenueshouldbereportedgrossornetisbasedonanassessmentofvariousfactors,theprimaryfactorsarewhetherweareactingastheprincipalinofferingservicestothecustomerorwhetherweareactingasanagentinthetransactionandthespecicrequirementofeachcontract.
Currently,wehavetheprimaryresponsibilityforfulllmentandacceptabilityofthewirelessservices,andassucha-96-majorityofourwirelessrevenuesarerecordedonagrossbasis.
Totheextentweareactingasaprincipalinatransaction,wereportasrevenuethepaymentsreceivedonagrossbasis,andreportascostsofrevenuetheamountsattributabletoservicesprovidedbymobilenetworkoperatorsandothervendors.
Totheextentweareactingasanagentinatransaction,wereportonanetbasisasrevenuethepaymentsreceivedlesscommissionandotherpaymentstothirdparties.
Whetherweareservingasprincipaloragentinatransactionisjudgmentalinnatureandisdeterminedbyevaluatingtermsofthearrangement.
Therelatedcommissionsand/orotherpaymentstothirdpartiesarerecordedascostsorexpenses.
Share-basedCompensationExpenseShare-basedcompensationexpenseisforshareawards,includingordinaryshares,shareoptions,restrictedsharesandrestrictedshareunitsgrantedbySohu.
comInc.
andChangyou.
comLimitedtotheiremployeesanddirectors.
Share-basedcompensationexpenseisrecognizedascostsand/orexpensesintheconsolidatednancialstatementsbasedonthefairvaluesoftherelatedshareawardsontheirgrantdates.
ForshareawardsgrantedbySohu.
comInc.
,indeterminingthefairvalueofshareoptionsgranted,theBlack-Scholesvaluationmodelisapplied;indeterminingthefairvalueofrestrictedshareunitsgranted,thefairvalueoftheunderlyingsharesonthegrantdatesisapplied.
ForshareawardsgrantedbyChangyou.
comLimited,indeterminingthefairvalueoftheordinaryshares,restrictedsharesandrestrictedshareunitsgrantedin2008,theincomeapproach/discountedcashowmethodwithadiscountforlackofmarketabilityisappliedgiventhatthesharesunderlyingtheawardswerenotpubliclytradedatthetimeofgrant.
Indeterminingthefairvalueofrestrictedshareunitsgrantedin2009beforeChangyou'sinitialpublicoffering,thefairvalueoftheunderlyingshareswasdeterminedbasedonChangyou'sofferingpriceforitsinitialpublicoffering.
IndeterminingthefairvalueofrestrictedshareunitsgrantedafterChangyou'sinitialpublicoffering,thefairvalueoftheunderlyingsharesonthegrantdatesisapplied.
Share-basedcompensationexpensefortheordinarysharesgrantedisfullyrecognizedinthequarterduringwhichtheseordinarysharesaregranted.
Share-basedcompensationexpenseforshareoptions,restrictedsharesandrestrictedshareunitsgrantedisrecognizedonanacceleratedbasisovertherequisiteserviceperiod.
Thenumberofshare-basedawardsforwhichtheserviceisnotexpectedtoberenderedovertherequisiteperiodisestimated,andtherelatedcompensationexpenseisnotrecordedforthatnumberofawards.
Theassumptionsusedinshare-basedcompensationexpenserecognitionrepresentmanagement'sbestestimates,buttheseestimatesinvolveinherentuncertaintiesandtheapplicationofmanagementjudgment.
Iffactorschangeordifferentassumptionsareused,ourshare-basedcompensationexpensecouldbemateriallydifferentforanyperiod.
Moreover,theestimatesoffairvaluearenotintendedtopredictactualfutureeventsorthevaluethatultimatelywillberealizedbyemployeeswhoreceiveequityawards,andsubsequenteventsarenotindicativeofthereasonablenessoftheoriginalestimatesoffairvaluemadebyusforaccountingpurposes.
IncomeTaxesandUncertainTaxPositionsIncomeTaxesIncometaxesareaccountedforusinganassetandliabilityapproachwhichrequirestherecognitionofincometaxespayableorrefundableforthecurrentyearanddeferredtaxliabilitiesandassetsforthefuturetaxconsequencesofeventsthathavebeenrecognizedinournancialstatementsortaxreturns.
Deferredincometaxesaredeterminedbasedonthedifferencesbetweenthenancialreportingandtaxbasisofassetsandliabilitiesandaremeasuredusingthecurrentlyenactedtaxratesandlaws.
Deferredtaxassetsarereducedbyavaluationallowance,ifbasedonavailableevidence,itisconsideredthatitismorelikelythannotthatsomeportionoforallofthedeferredtaxassetswillnotberealized.
-97-OurdeferredtaxassetsarerelatedtonetoperatinglossesofSohu.
comInc.
thatwouldbesubjecttoCorporateIncomeTaxintheUnitedStates("U.
S.
CorporateIncomeTax"),andnetoperatinglossesandtemporarydifferencesbetweenaccountingandtaxbasisforourChina-basedsubsidiariesandvariableinterestentities("VIEs").
SincesubstantiallyallofourincomeisearnedthroughChina-basedsubsidiariesandVIEs,andintheforeseeablefuturewedonotintendtorepatriateincometotheUnitedStates("U.
S.
")whereitwouldbesubjecttoU.
S.
CorporateIncomeTax,exceptthat,undercertaincircumstances,wemayrepatriatetotheU.
S.
incomethatwillbesubjecttoU.
S.
AlternativeMinimumTax.
Intheforeseeablefuture,itismorelikelythannotthatthedeferredtaxassetsresultingfromthenetoperatinglossesofSohu.
comInc.
willnotberealized.
Hence,werecordedavaluationallowanceagainstourgrossdeferredtaxassetsinordertoreducethedeferredtaxassetstotheamountthatismorelikelythannottoberealized.
Ifeventsweretooccurinthefuturethatwouldallowustorealizemoreofourdeferredtaxassetsthanthepresentlyrecordednetamount,anadjustmentwouldbemadetothedeferredtaxassetsthatwouldincreaseincomefortheperiodwhenthoseeventsoccurred.
Ifeventsweretooccurinthefuturethatwouldrequireustorealizelessofourdeferredtaxassetsthanthepresentlyrecordednetamount,anadjustmentwouldbemadetothevaluationallowanceagainstdeferredtaxassetsthatwoulddecreaseincomefortheperiodwhenthoseeventsoccurred.
Signicantmanagementjudgmentisrequiredindeterminingincometaxexpenseanddeferredtaxassetsandliabilities.
UncertainTaxPositionsInordertoassessuncertaintaxpositions,weapplyamorelikelythannotthresholdandatwo-stepapproachforthetaxpositionmeasurementandnancialstatementrecognition.
Forthetwo-stepapproach,therststepistoevaluatethetaxpositionforrecognitionbydeterminingiftheweightofavailableevidenceindicatesthatitismorelikelythannotthatthepositionwillbesustained,includingresolutionofrelatedappealsorlitigationprocesses,ifany.
Thesecondstepistomeasurethetaxbenetasthelargestamountthatismorethan50%likelyofbeingrealizeduponsettlement.
NoncontrollingInterestNoncontrollinginterest("NCI")istheportionofeconomicinterestinSohu.
comInc.
'smajority-ownedsubsidiariesandVIEswhichisnotattributable,directlyorindirectly,toSohu.
comInc.
Currently,theNCIinourconsolidatednancialstatementsconsistofNCIforChangyouand21EastBeijing,New21Eastand21EastHongKong(collectively"21East").
NetIncomeperShareBasicnetincomepershareiscomputedusingtheweightedaveragenumberofcommonsharesoutstandingduringtheperiod.
Dilutednetincomepershareiscomputedusingtheweightedaveragenumberofcommonsharesand,ifdilutive,potentialcommonsharesoutstandingduringtheperiod.
Potentialcommonsharescomprisesharesissuableupontheexerciseofshare-basedawardsusingthetreasurystockmethodandsharesissuableupontheconversionofzerocouponconvertibleseniornotesusingif-convertedmethod.
Additionally,forpurposesofcalculatingdilutednetincomepershare,Sohu'sconsolidatednetincomeisadjustedforChangyou'snetincomemultipliedbythedifferencebetween:(a)thepercentageofthetotaleconomicinterestinChangyouheldbySohu,and(b)thepercentageoftheweightedaveragenumberofChangyousharesheldbySohutotheweightedaveragenumberofChangyouordinarysharesandsharesissuableupontheexerciseofshare-basedawards.
AllowanceforDoubtfulAccountsReceivableOurmanagementmakesestimationsforthecollectabilityofouraccountsreceivable.
Inestimatingthegeneralallowance,manyfactorsareconsideredincludingbutnotlimitedtoreviewingdelinquentaccountsreceivable,-98-performingaginganalysisandcustomercreditanalysis,analyzinghistoricalbaddebtrecordsandcurrenteconomictrends.
Additionalallowanceforspecicdoubtfulaccountsmightbemadeifthenancialconditionsofourcustomersormobilenetworkoperatorsdeteriorateorthemobilenetworkoperatorsareunabletocollectfeesfromtheirendcustomers,resultingintheirinabilitytomakepaymentsduetous.
Long-LivedAssetsLong-livedassetsincludexedassets,intangibleassetsandotherassets.
Fixedassetscomprisecomputerequipmentandhardware,ofcebuilding,investmentproperties,leaseholdimprovements,vehiclesandofcefurniture.
Fixedassetsarerecordedatcostlessaccumulateddepreciationwithnoresidualvalue.
Depreciationiscomputedusingthestraight-linemethodovertheestimatedusefullives.
Intangibleassetsprimarilycomprisecomputersoftware,domainnames,trademarks,marketingrights,operatingrightsforlicensedgamesandcustomerlistspurchasedfromunrelatedthirdparties.
Intangibleassetsarerecordedatcostlessaccumulatedamortizationwithnoresidualvalue.
Amortizationofintangibleassetsiscomputedusingthestraight-linemethodovertheirestimatedusefullives.
Theweightedaverageamortizationperiodforintangibleassetsisveyears.
Otherassetsprimarilyincludeprepaidcontentfees,prepaidlicensefeesandrentaldeposits.
Weamortizethecontentfeesandlicensefeesoverthetermsoftherelatedcontracts.
Management'sjudgmentisrequiredintheassessmentoftheusefullivesoflong-livedassets,andisrequiredinthemeasurementofimpairment.
Basedontheexistenceofoneormoreindicatorsofimpairment,wemeasureanyimpairmentoflong-livedassetsusingtheprojecteddiscountedcashowmethod.
Theestimationoffuturecashowsrequiressignicantmanagementjudgmentbasedonourhistoricalresultsandanticipatedresultsandissubjecttomanyfactors.
Thediscountratethatiscommensuratewiththeriskinherentinourbusinessmodelisdeterminedbyourmanagement.
Animpairmentchargewouldberecordedifwedeterminedthatthecarryingvalueoflong-livedassetsmaynotberecoverable.
Theimpairmenttoberecognizedismeasuredbytheamountbywhichthecarryingvaluesoftheassetsexceedthefairvalueoftheassets.
Assetstobedisposedofarereportedatthelowerofthecarryingvalueorfairvaluelesscosttosell.
GoodwillGoodwillrepresentstheexcessofthepurchasepriceoverthefairvalueoftheidentiableassetsandliabilitiesacquiredasaresultofouracquisitionsofinterestsinoursubsidiariesandVIEs.
Goodwillisnotdepreciatedoramortizedbutistestedforimpairmentatreportingunitlevel(businesssegment)onanannualbasis,andbetweenannualtestswhenaneventoccursorcircumstanceschangethatcouldindicatethattheassetmightbeimpaired.
Theimpairmenttestconsistsofacomparisonofthefairvalueofgoodwillwithitscarryingvalue.
Applicationofagoodwillimpairmenttestrequiressignicantmanagementjudgment,includingtheidenticationofreportingunits,assigningassetsandliabilitiestoreportingunits,assigninggoodwilltoreportingunits,anddeterminingthefairvalueofeachreportingunit.
Thejudgmentinestimatingthefairvalueofreportingunitsincludeestimatingfuturecashows,determiningappropriatediscountratesandmakingotherassumptions.
Changesintheseestimatesandassumptionscouldmateriallyaffectthedeterminationoffairvalueforeachreportingunit.
Anyimpairmentlossesrecordedinthefuturecouldhaveamaterialadverseimpactonournancialconditionandresultsofoperations.
-99-FunctionalCurrencyandForeignCurrencyTranslationFunctionalCurrencyAnentity'sfunctionalcurrencyisthecurrencyoftheprimaryeconomicenvironmentinwhichitoperates,normallythatisthecurrencyoftheenvironmentinwhichitprimarilygeneratesandexpendscash.
Management'sjudgmentisessentialtodeterminethefunctionalcurrencybyassessingvariousindicators,suchascashows,salespriceandmarket,expenses,nancingandinter-companytransactionsandarrangements.
ThefunctionalcurrencyofSohu.
comInc.
isU.
S.
dollar.
ThefunctionalcurrencyofoursubsidiariesandVIEsinthePRC,UnitedKingdomofGreatBritain,MalaysiaandKoreaareRMB,GreatBritainPound,MalaysianRinggitandKoreanWon,respectively,whilethefunctionalcurrencyofoursubsidiariesinU.
S.
ForeignCurrencyTranslationAssetsandliabilitiesofourChina-basedsubsidiariesandVIEsaretranslatedintoU.
S.
dollars,ourreportingcurrency,attheexchangerateineffectatthebalancesheetsdateandrevenuesandexpensesaretranslatedattheaverageexchangeratesineffectduringthereportingperiod.
Foreigncurrencytranslationadjustmentsarenotincludedindeterminingnetincomefortheperiodbutareaccumulatedinaseparatecomponentofequityinourconsolidatedbalancesheets.
RESULTSOFOPERATIONSIn2006,inordertofocusmoreonourcorebusinesses,wediscontinuedourunprotablee-commercebusiness.
Asaresult,thee-commercebusinesswasaccountedforasadiscontinuedoperationandourstatementsofoperationsseparatethediscontinuedoperationforallperiodspresented.
In2007,weadjustedourreportablesegmentsandreclassiedouronlinegameresultsfromtheotherssegmenttobeaseparatesegment.
Accordingly,wereclassiedtherevenueandcostofrevenueoftheonlinegamesegmentfortheyearspriorto2007toconformtotheclassication.
In2007,inordertobetterpresentoperatingresultsandenhancecomparabilitywithindustrypeers,wereclassiedexpensesinrelationtogameoperationstocostofonlinegamerevenues,whilemostofthecostsandexpensesofonlinegamewererelatedtoproductdevelopmentandresearchpriorto2007.
Accordingly,wereclassiedexpensesinrelationtogameoperationstocostofonlinegamerevenuesfortheyearspriorto2007toconformtotheclassication.
In2009,weadjustedourbusinessgroupingfromadvertisingbusinessandnon-advertisingbusinesstoadvertisingbusiness(composedofbrandadvertisingandsponsoredsearch),onlinegamebusiness,andwirelessandothersbusiness.
Accordingly,weadjustedourpresentationbasedonthenewclassicationfortheyearspriorto2009toconformtothecurrentyearclassication.
-100-RevenuesThefollowingtablepresentsourrevenuesbyrevenuesourceandbyproportionfortheperiodsindicated:YearendedDecember31,20092008200709VS0808VS07(inthousands,exceptpercentages)Revenues:Advertising:Brandadvertising$177,07334%$169,26839%$112,10659%$7,805$57,162Sponsoredsearch8,5522%6,6692%7,1104%1,883(441)Subtotalofadvertisingrevenues185,62536%175,93741%119,21663%9,68856,721Onlinegame267,58552%201,84547%42,09622%65,740159,749Wirelessandothers62,02912%51,26912%27,62215%10,76023,647Totalrevenues$515,239100%$429,051100%$188,934100%$86,188$240,117Totalrevenueswere$515.
2millionfor2009,comparedto$429.
1millionand$188.
9millionfor2008and2007,respectively.
Theyear-on-yearincreaseintotalrevenuesfor2009and2008was$86.
2millionand$240.
1million,respectively.
Theincreasesintotalrevenuesweremainlyattributabletobrandadvertisingrevenuesandonlinegamerevenues.
AdvertisingRevenuesAdvertisingrevenueswere$185.
6millionfor2009,comparedto$175.
9millionand$119.
2millionfor2008and2007,respectively.
Theyear-on-yearincreaseinadvertisingrevenuesfor2009and2008was$9.
7millionand$56.
7million,respectively.
Theincreasewasmainlyattributabletobrandadvertisingrevenues.
Wedonotenterintoadvertising-for-advertisingbartertransactionsforthesethreeyears.
BrandAdvertisingRevenuesBrandadvertisingrevenueswere$177.
1millionfor2009,comparedto$169.
3millionand$112.
1millionfor2008and2007,respectively.
Theyear-on-yearincreaseinbrandadvertisingrevenuesfor2009and2008was$7.
8millionand$57.
2million,respectively.
Theincreasewasmainlyduetoincreasedadvertisingdollarsfromexistingadvertisersandtoalesserextentanincreasednumberofadvertisers.
Salestoourvelargestadvertiserscomprisedapproximately15%oftotalbrandadvertisingrevenuesfor2009,comparedto15%and14%for2008and2007,respectively.
FortheyearsendedDecember31,2009,2008and2007,thevalueofbrandadvertisingservicesprovidedbyourbrandadvertisingsegmenttoouronlinegamesegment(conductedviaChangyou)wereapproximately$20million,$30millionand$18million,respectively.
Norevenueand/orexpensewererecognizedinSohu'sconsolidatedstatementsofoperationsasallintercompanytransactionswereeliminated.
FortheyearsendedDecember31,2009,2008and2007,werecordedbrandadvertisingrevenuesofapproximately$1.
2million,$1.
6millionand$1.
0million,respectivelyfromNetDragonWebsoftInc.
(orNetDragon),whichisalsoknownasFujianTianQingDigitalCo.
,Ltd.
(orFujianTianQing)inconnectionwithitsadvertisementsonour17173.
comWebsite.
Thoseadvertisingservicesareprovidedpursuanttoathree-yearadvertisingframeworkagreementwhichhasexpiredinNovember2009.
NetDragonwasthepreviousownerof17173.
comWebsitefromwhomweacquiredthisWebsite.
AsofDecember31,2009,2008and2007,werecorded$1.
5million,$5.
2millionand$1.
4millionofreceiptsinadvancefromadvertisers,respectively.
Weexpectbrandadvertisingrevenuetoincreasein2010comparedto2009.
-101-SponsoredSearchRevenuesSponsoredsearchrevenueswere$8.
5millionfor2009,comparedto$6.
6millionand$7.
1millionfor2008and2007,respectively.
Theyear-on-yearincreaseinsponsoredsearchrevenuesfor2009was$1.
9million.
Theyear-on-yeardecreaseinsponsoredsearchrevenuesfor2008was$0.
5million.
Theincreaseinsponsoredsearchrevenuesfor2009wasmainlyduetoinitialachievementsfromtheadjustmentinoursalesandproductdevelopmentstrategyconductedfrom2008.
Thedecreaseinsponsoredsearchrevenuesfor2008wasmainlyduetoanadjustmentinourstrategy.
Sponsoredsearchservicesprimarilyincludepriorityplacementsinoursearchdirectoryandpay-for-clickservicesofdisplayingthetext-basedlinksofouradvertisersonourWebsitesandourWebsiteAlliancenetwork.
Revenuesfrompay-for-clickservicesaccountedforapproximately73%ofthetotalsponsoredsearchrevenuesfor2009,comparedto47%and32%,for2008and2007,respectively.
Weexpectsponsoredsearchrevenuetoremainatlowlevelin2010.
OnlineGameRevenuesOnlineGamerevenueswere$267.
6millionfor2009,comparedto$201.
8millionand$42.
1millionfor2008and2007,respectively.
Theyear-on-yearincreaseinonlinegamerevenuesfor2009and2008was$65.
8millionand$159.
7million,respectively.
Theincreaseinonlinegamerevenuesfor2009and2008weremainlyduetoincreasedpopularityofouragshipgame,TLBB,whichwelaunchedinMay2007.
Weexpectonlinegamerevenuetoincreasein2010comparedto2009.
RevenueSourcesThefollowingtablesetsforththerevenuesgeneratedfromourgameoperationsinmainlandChinaandoverseaslicensing(inthousands):YearEndedDecember31,200920082007Onlinegamerevenues:Gameoperationsrevenues$259,783$194,607$41,751Overseaslicensingrevenues7,8027,238345Totalonlinegamerevenues$267,585$201,845$42,096GameOperationsRevenuesOurcurrentthreeMMORPGs,TLBB,BOandBH2,arefreetoplayandgeneraterevenuesusingtheitem-basedrevenuemodelthroughthesaleofvirtualitemsthatenhancethegame-playingexperience.
Gameplayerscanpurchasevirtualitems,suchasgems,pets,fashionitems,magicmedicine,ridinganimals,hierograms,materials,skillbooksandreworksbypurchasingprepaidgamecardsorgamepoints.
WeinitiallyoperatedBOunderthetime-basedrevenuemodelandswitchedtotheitem-basedrevenuemodelinDecember2006.
Wereportourgameoperationsrevenuesafternettingbusinesstaxes,salesdiscountsandrebatestoourdistributors.
OverseasLicensingRevenuesWebeganlicensingourgameTLBBtooperatorsoutsideofChinain2007.
WebegangeneratingoverseaslicensingrevenuesfromTLBBinMalaysiaandSingaporeinApril2009,inTaiwanandHongKonginApril2008,andinVietnaminAugust2007.
Thelicensesarefortermsofeithertwoyearsorthreeyears.
Underour-102-licensingarrangements,thelicenseeoperatorspayusaninitiallicensefeeandongoingroyaltiesbasedonapercentageofrevenuesgeneratedbythemoverthetermofthelicenseperiod.
Ouroverseaslicensingrevenueswere$7.
8millionfor2009,comparedto$7.
2millionand$345,000for2008and2007,respectively.
TheincreasewasmainlyduetoincreasedmomentumofTLBBinVietnamandMalaysia.
WeexpecttoexpandourlicensingofTLBBtoadditionalcountriesandmaydecidetolicensecertainofournewMMORPGsoverseasaftertheyarelaunched.
RevenueCollectionGameOperationsWesellvirtualandphysicalprepaidgamecardstoregionaldistributors,whointurnsub-distributetoretailoutlets,includingInternetcafes,variousWebsites,newsstands,softwarestores,bookstoresandretailstores.
Wetypicallycollectpaymentfromourdistributorsupondeliveryofourprepaidgamecards,butonlyrecognizerevenuesasthevirtualitemsareconsumed.
Wegenerallyofferasalesdiscounttoourprepaidgamecarddistributorsbasedonthepopularityofourgames.
In2006,priortothelaunchofTLBB,weofferedasalesdiscountashighas20.
0%.
SincethelaunchofTLBBin2007,weofferedaninitialsalesdiscountattherateof15.
0%,whichhasdecreasedtothecurrentrateof11.
0%,effectiveasofJanuary2009.
Inaddition,weofferadiscountof5.
0%toourgameplayerswhodirectlypurchasevirtualprepaidgamecardsandgamepointsfromouronlinesalessystem.
Thesalesdiscountrepresentsthedifferencebetweenthepriceatwhichwesellprepaidgamecardstodistributorsorgameplayers,asthecasemaybe,andthefacevalueoftheprepaidgamecardsortheequivalentofgamepoints.
Wealsoofferrebatesintheformofcreditsonfuturepurchasesofprepaidgamecardstodistributorsofourprepaidgamecards.
Distributorsofprepaidgamecardswillreceiveacreditonfuturepurchasesofourprepaidgamecardsinanamountequalto1.
0%to3.
0%ofthediscountedvalueofourprepaidgamecards,providedthatthedistributorsmeetcertainpresetsalesconditions.
Historically,mostofourdistributorshavemettheconditionsrequiredtoreceivethesecredits.
Creditsareintheformoffreeprepaidgamecards.
Weincurtransactioncostsof0.
4%to0.
9%ofthefacevalueofthevirtualprepaidgamecardsortheequivalentofgamepointsbyusingthird-partypaymentplatforms.
Thecurrenttotaldiscountandrebateratewetypicallyoffertoallofourprepaidgamecarddistributorsisapproximately12.
0%to14.
0%ofthefacevalueofourprepaidgamecards.
Thetotaldiscountandtransactioncostsassociatedwithgameplayers'useofthird-partypaymentplatformsis5.
4%to5.
9%ofthefacevalueofthevirtualprepaidgamecardsortheequivalentofgamepointspurchased.
OverseasLicensingOuroverseaslicensingrevenuesconsistofaninitiallicensefeeandongoingrevenue-basedroyalties.
Theinitiallicensefeeincludesaxedamountpayableuponsigningthelicenseagreementandadditionallicensefeespayableuponachievingcertainsalestargets.
Theongoingrevenue-basedroyaltiesaregenerallydeterminedbasedontheamountchargedtogameplayers'accountsinagivencountryorregionandsalesofancillaryproductsofthegameinsuchcountryorregion.
Wetypicallyreceiveongoingrevenue-basedroyaltiesonamonthlybasis.
RevenueRecognitionGameOperationsProceedsreceivedfromsalesofprepaidgamecardsformthebasisofourrevenuesandarerecordedinitiallyasreceiptsinadvance.
Uponactivationoftheprepaidgamecards,proceedsaretransferredfromreceiptsinadvancetodeferredrevenues.
Proceedsreceivedfromonlinesalesofgamepointsdirectlytogameplayersare-103-recordedasdeferredrevenues.
AsofDecember31,2009,wehadreceiptsinadvancefromdistributorsanddeferredrevenuesfromourgameoperationsof$29.
6million,comparedwith$19.
9millionand$8.
1millionasofDecember31,2008and2007,respectively.
Werecognizerevenueswhenvirtualitemspurchasedbygameplayersareconsumed.
Forconsumablevirtualitems,includingthosewithapredeterminedexpirationtime,revenuesarerecognizedastheyareconsumed,andforperpetualvirtualitems,revenuesarerecognizedovertheirestimatedlives.
Inaddition,prepaidgamecardswillexpiretwoyearsafterthedateofcardproductioniftheyhaveneverbeenactivated.
Theproceedsfromtheexpiredgamecardsarerecognizedasrevenuesuponexpirationofthecards.
Incontrast,oncetheprepaidgamecardsareactivatedandcreditedtoagameplayer'saccount,theywillnotexpireaslongasthegameaccountremainsactive.
Weareentitledtocloseagameplayer'saccountifithasbeeninactiveforaperiodof180consecutivedays.
Theunusedbalancesinaninactivegameplayer'saccountarerecognizedasrevenueswhentheaccountisclosed.
FortheyearendedDecember31,2009,therevenuefromexpiredgamecardsandinactivegameplayers'accountswas$236,000.
OverseasLicensingFortheinitiallicensefeesreceivableunderouroverseaslicensingagreements,werecognizerevenuesratablyovertheremaininglicenseperiod,duringwhichweareobligatedtoprovidepost-salesservicessuchastechnicalsupportandprovisionofupdatesorupgradestothelicensedgames.
Unrecognizedinitiallicensefeesreceivedarerecordedasdeferredrevenues.
AsofDecember31,2009,suchdeferredrevenueswere$0.
6million,comparedwith$0.
8millionand$0.
1millionasofDecember31,2008and2007,respectively.
Withrespecttotheongoingrevenue-basedroyalties,werecognizerevenueswhentherevenue-basedroyaltiesareearnedunderthetermsoftheoverseaslicensingagreements,andthecollectionofsuchroyaltiesisprobable.
WirelessandOthersRevenuesWirelessRevenuesWirelessrevenueswere$60.
8millionfor2009,comparedto$47.
0millionand$26.
3millionfor2008and2007,respectively.
Theyear-on-yearincreaseinwirelessrevenuesfor2009and2008was$13.
8millionand$20.
7million,respectively.
Theincreaseinwirelessrevenuewasmainlyduetosuccessfulproductdistributionprogramsandourcontinuedmarketdevelopmenteffortsandproductdiversication.
Theincreaseinwirelessrevenuesfor2009wasmainlycontributedbyanincreaseof$7.
6millioninIVRrevenues,anincreaseof$5.
4millioninSMSrevenues,a$2.
1millionincreaseduetoreducedrevenueinthesecondquarterof2008resultingfrombusinesstaxprovision,andanincreaseof$1.
5millioninRBTrevenues,whichwasoffsetbyadecreaseof$2.
8millioninMMSandWAPrevenues.
Theincreaseinwirelessrevenuesfor2008wasmainlycontributedbyanincreaseof$11.
4millioninSMSrevenues,anincreaseof$4.
9millioninRBTrevenues,anincreaseof$3.
2millioninMMSrevenues,andanincreaseof$3.
3millioninWAPandIVRrevenues,whichwasoffsetbycertainbusinesstaxprovisionof$2.
1millionmadeinthesecondquarterof2008.
Weexpectwirelessrevenuestodecreasein2010comparedto2009,duetomobilenetworkoperatorstighteningtheircontrolsoverwirelessservices.
RevenuesforOtherServicesOtherservicesmainlyconsistofsalesofsoftwaretothirdparties,provisionofapplicationsserviceprovider("ASP")services,ofcespacerentalincomeandconstructionofWebsites.
Revenuesforotherserviceswere$1.
2millionfor2009,comparedto$4.
3millionand$1.
3millionfor2008and2007,respectively.
-104-CostandExpensesCostofRevenuesThefollowingtablepresentsourcostofrevenuesbysourceandbyproportionfortheperiodsindicated:YearendedDecember31,20092008200709VS0808VS07(inthousands,exceptpercentages)Costofrevenues:Advertising:Brandadvertising$59,45148%$59,44355%$38,73360%$8$20,710Sponsoredsearch10,3708%6,8166%5,6449%3,5541,172Subtotalofcostofadvertisingrevenues69,82156%66,25961%44,37769%3,56221,882Onlinegame17,50514%14,56714%7,11311%2,9387,454Wirelessandothers36,06930%26,48825%13,27320%9,58113,215Totalcostofrevenues$123,395100%$107,314100%$64,763100%$16,081$42,551Totalcostofrevenueswas$123.
4millionfor2009,comparedto$107.
3millionand$64.
8millionfor2008and2007,respectively.
Theyear-on-yearincreaseintotalcostofrevenuesfor2009and2008was$16.
1millionand$42.
5million,respectively.
CostofAdvertisingRevenuesCostofadvertisingrevenueswas$69.
8millionfor2009,comparedto$66.
2millionand$44.
4millionfor2008and2007,respectively.
Theyear-on-yearincreaseincostofadvertisingrevenuesfor2009and2008was$3.
6millionand$21.
8million,respectively.
Theincreaseincostofadvertisingrevenuesfor2009wasrelatedtotheincreaseincostofsponsoredsearchrevenues.
Theincreaseincostofadvertisingrevenuesfor2008wasmainlyrelatedtotheincreaseincostofbrandadvertisingrevenues.
CostofBrandAdvertisingRevenuesCostofbrandadvertisingrevenuesincludescompensationandrelatedoverheadcostsforemployees,depreciationexpenses,contentandservicespurchases,bandwidthleasingcosts,andrevenuesharingpaymentstothirdparties.
Costofbrandadvertisingrevenueswas$59.
5millionfor2009,comparedto$59.
4millionand$38.
7millionfor2008and2007,respectively.
Costofbrandadvertisingrevenuesfor2009wasinlinewiththatfor2008.
Theyear-on-yearincreaseincostofbrandadvertisingrevenuesfor2008was$20.
7million.
Theminorincreaseincostofbrandadvertisingrevenuesfor2009mainlyconsistedofa$3.
6millionincreaseinpersonnelexpense,a$3.
2millionincreaseinbandwidthleasingcosttoourexpandedbusiness,a$0.
9millionincreaseinfacilityexpenses,offsetbya$5.
7milliondecreaseincontentpurchasesanda$1.
1milliondecreaseinrevenuesharingpaymentstothirdparties.
Theincreaseincostofbrandadvertisingrevenuesfor2008mainlyconsistedofan$8.
5millionincreaseincontentpurchasessurroundingtheBeijing2008OlympicGames,a$5.
7millionincreaseinpersonnelexpense,a$3.
3millionincreaseinbandwidthleasingcosttoourexpandedbusinessanda$1.
4millionincreaseindepreciationexpense.
Ourbrandadvertisinggrossmarginwas66%for2009,comparedto65%forboth2008and2007.
-105-CostofSponsoredSearchRevenuesCostofsponsoredsearchrevenuesmainlyconsistsofdepreciationexpenses,bandwidthleasingcosts,paymentstoourWebsiteAllianceandpersonnelcosts.
Costofsponsoredsearchrevenueswas$10.
3millionfor2009,comparedto$6.
8millionand$5.
6millionfor2008and2007,respectively.
Theyear-on-yearincreaseincostofsponsoredsearchrevenuesfor2009and2008was$3.
5millionand$1.
2million,respectively.
Theincreaseincostofsponsoredsearchrevenuesfor2009mainlyconsistedofa$2.
7millionincreaseinrelevantdepreciationandbandwidthleasingcosts.
Theincreaseincostofsponsoredsearchrevenuesfor2008wasduetoanincreaseindepreciationandbandwidthleasingcosts.
CostofOnlineGameRevenuesCostofonlinegamerevenuesmainlyconsistsofsalaryandbenetsexpenses,includingshare-basedcompensationexpenses,relatingtotheoperationofourgames,revenue-basedroyaltypaymentstothegamedevelopersofourlicensedgames,bandwidthleasingcosts,amortizationoflicensingfees,depreciationexpenses,PRCbusinesstaxandvalueaddedtax("VAT")arosefromtransactionsbetweenChangyou'ssubsidiaryandVIE.
Costofonlinegamerevenueswas$17.
5millionfor2009,comparedto$14.
6millionand$7.
1millionfor2008and2007,respectively.
Theyear-on-yearincreaseincostofonlinegamerevenuesfor2009and2008was$2.
9millionand$7.
5million,respectively.
Theincreaseincostofonlinegamerevenuesfor2009mainlyconsistedof$1.
1millionincreaseinbandwidthleasingcostsanda$1.
0millionincreaseinPRCbusinesstaxandVATarosefromtransactionsbetweenChangyou'ssubsidiaryandVIE.
ThechangeswereprimarilyattributabletotheincreasedpopularityofTLBB.
Theincreaseincostofonlinegamerevenuesfor2008mainlyconsistedofa$2.
8millionincreaseinsalaryandbenetsexpenses,a$2.
2millionincreaseinPRCbusinesstaxandVATarosefromtransactionsbetweenChangyou'ssubsidiaryandVIE,a$1.
1millionincreaseinbandwidthleasingcostsanda$1.
0millionincreaseindepreciationexpenses.
ThechangeswereprimarilyattributabletothegrowthofTLBB.
Ouronlinegamegrossmarginwas93%,93%and83%for2009,2008and2007,respectively.
Weexpectthatrevenue-basedroyaltypaymentswillincreasein2010comparedwith2009,oncethelicensedgamesinourpipelinearelaunched.
CostofWirelessandOthersRevenuesCostofWirelessRevenuesCostofwirelessrevenuesconsistsofcollectionchargesandtransmissionfeespaidtomobilenetworkoperators,paymentstothirdpartywirelessservicealliancesandcontentsuppliers,penalties,depreciationexpenses,andbandwidthleasingcosts.
Costofwirelessrevenueswas$34.
4millionfor2009,comparedto$24.
5millionand$12.
3millionfor2008and2007,respectively.
Theyear-on-yearincreaseincostofwirelessrevenuesfor2009and2008was$9.
9millionand$12.
2million,respectively.
-106-Theincreaseincostofwirelessrevenuesfor2009mainlyconsistedofa$7.
4millionincreaseinpaymentstothirdpartywirelessservicealliancesandcontentproviders,anda$2.
0millionincreaseincollectionchargesandtransmissionchargespaidtomobilenetworkoperators.
Theincreaseincostofwirelessrevenuesfor2008mainlyconsistedofan$8.
0millionincreaseinpaymentstothirdpartywirelessservicealliancesandcontentproviders,anda$4.
2millionincreaseincollectionchargesandtransmissionchargespaidtomobilenetworkoperators.
Thecollectionandtransmissionchargesvarybetweenmobilenetworkoperators.
Thecollectionandtransmissionchargesmainlyinclude(1)agatewayfeeof$0.
003to$0.
029permessagein2009,thesameasthatin2008,and$0.
003to$0.
027permessagein2007,dependingonthevolumeofthemonthlytotalwirelessmessages,and(2)acollectionfeeof15%to75%oftotalfeescollectedbymobilenetworkoperatorsfrommobilephoneusers(withtheresidualpaidtous)in2009,comparedto10%to70%in2008and15%to60%in2007.
Ourwirelessgrossmarginswere43%,for2009,comparedto48%and53%for2008and2007,respectively.
CostofRevenuesforOtherServicesCostofrevenuesforotherservicesmainlyconsistsofpersonnelandotherexpensesinconnectionwithsalesofsoftware,provisionofASPservicesandconstructionofWebsites.
Costofrevenuesforotherserviceswas$1.
7millionfor2009,comparedto$2.
0millionand$939,000for2008and2007,respectively.
OperatingExpensesThefollowingtablepresentsouroperatingexpensesbynatureandbyproportionfortheperiodsindicated:YearendedDecember31,20092008200709VS0808VS07(inthousands,exceptpercentages)Operatingexpenses:Productdevelopment$56,94330%$49,71331%$25,44328%$7,230$24,270Salesandmarketing93,49850%84,69154%47,50652%8,80737,185Generalandadministrative36,62420%22,69514%17,41819%13,9295,277Amortizationofintangibleassets3880%7961%1,0931%(408)(297)Totaloperatingexpenses$187,453100%$157,895100%$91,460100%$29,558$66,435Totaloperatingexpenseswere$187.
5millionfor2009,comparedto$157.
9millionand$91.
5millionfor2008and2007,respectively.
Theyear-on-yearincreaseintotaloperatingexpensesfor2009and2008was$29.
6millionand$66.
4million,respectively.
TheincreaseintotaloperatingexpenseswasmainlyduetoincreasesinexpensesforproductdevelopmentandforsalesandmarketingProductDevelopmentExpensesProductdevelopmentexpensesmainlyconsistofpersonnel-relatedexpensesincurredfortheenhancementtoandmaintenanceofourWebsitesaswellascostsassociatedwithnewproductdevelopmentandenhancementforexistingproductsandservices.
Productdevelopmentexpenseswere$56.
9millionfor2009,comparedto$49.
7millionand$25.
4millionfor2008and2007,respectively.
Theyear-on-yearincreaseinproductdevelopmentexpensesfor2009and2008was$7.
2millionand$24.
3million,respectively.
-107-Theincreaseinproductdevelopmentexpensesfor2009mainlyconsistedofa$3.
0millionincreaseinpersonnelexpensesresultingfromanincreaseinheadcount,salaryandbonuses,a$2.
0millionincreaseinshare-basedcompensationexpense,a$1.
3millionincreaseinfacilityexpensesanda$0.
9millionincreaseindepreciationexpense.
Theincreaseinproductdevelopmentexpensesfor2008mainlyconsistedofa$18.
7millionincreaseinpersonnelexpensesresultingfromanincreaseinheadcount,salaryandbonusesanda$3.
9millionincreaseinshare-basedcompensationexpense.
SalesandMarketingExpensesSalesandmarketingexpensesmainlyconsistofadvertisingandpromotionalexpenditures,compensationexpenses,salescommissionsandtravelexpenses.
Salesandmarketingexpenseswere$93.
5millionfor2009,comparedto$84.
7millionand$47.
5millionfor2008and2007,respectively.
Theyear-on-yearincreaseinsalesandmarketingexpensesfor2009and2008was$8.
8millionand$37.
2million,respectively.
Theincreaseinsalesandmarketingexpensesfor2009wasprimarilyresultedfromtheincreaseinadvertisingandpromotionexpensesforamarketingcampaignin2009.
Theincreaseinsalesandmarketingexpensesfor2008mainlyconsistedofa$26.
0millionincreaseinadvertisingandpromotionexpenses,whichwasmainlyduetotherelevantmarketingexpensessurroundingtheBeijing2008OlympicGames,anda$7.
7millionincreaseinpersonnelexpensesresultingfromanincreaseinheadcount,salariesandsalescommission.
GeneralandAdministrativeExpensesGeneralandadministrativeexpensesmainlyconsistofpersonnelcompensationexpensesandprofessionalservicefees.
Generalandadministrativeexpenseswere$36.
6millionfor2009,comparedto$22.
7millionand$17.
4millionfor2008and2007,respectively.
Theyear-on-yearincreaseingeneralandadministrativeexpensesfor2009and2008was$13.
9millionand$5.
3million,respectively.
Theincreaseingeneralandadministrativeexpensesfor2009mainlyconsistedofa$5.
2millionincreaseinpersonnelexpenses,a$5.
0millionincreaseinshare-basedcompensationexpense,a$2.
9millionincreaseinprofessionalfee,anda$0.
6millionincreaseinfacilityexpenses.
Theincreaseingeneralandadministrativeexpensesfor2008mainlyconsistedofa$2.
4millionincreaseinpersonnelexpenses,anda$1.
4millionincreaseinprofessionalfee.
AmortizationofIntangibleAssetsAmortizationofintangibleassetswasmainlyrelatedtotheacquisitionsofthe17173.
com,Focus.
cn,GoodFeelandGo2Map.
Amortizationofintangibleassetswas$0.
4millionfor2009,comparedto$0.
8millionand$1.
1millionfor2008and2007,respectively.
Share-basedCompensationExpenseBothSohu.
comInc.
andChangyou.
comLimitedhavestockincentiveplansforthegrantingofshareawards,includingordinaryshares,shareoptions,restrictedsharesandrestrictedshareunits,totheiremployeesanddirectors.
-108-Share-basedcompensationexpenserecordedfortheseshareawardsincostsandexpenseswas(inthousands):YearEndedDecember31,200920082007Share-basedcompensationexpenseCostofrevenues$1,149$1,238$1,678Productdevelopmentexpenses8,7296,7492,805Salesandmarketingexpenses7478961,541Generalandadministrativeexpenses6,6941,7372,762$17,319$10,620$8,786Share-basedcompensationexpenserecordedforshareawardsgrantedbySohu.
comInc.
andChangyou.
comLimitedwas(inthousands):YearEndedDecember31,200920082007Share-basedcompensationexpenseFortheshareawardsgrantedbySohu.
comInc.
$4,176$5,868$8,786FortheshareawardsgrantedbyChangyou.
comLimited*13,1434,752—$17,319$10,620$8,786*In2009,share-basedcompensationexpenserecordedforshareawardsgrantedbyChangyou.
comLimitedincluded$2.
6millionexpensegeneratedbutnotrecognizedbeforethecompletionofChangyou'sinitialpublicofferingbecauseinitialvestingwasconditionedoncompletionoftheoffering.
ForshareoptionsgrantedbySohu.
comInc.
,asofDecember31,2009,therewasnounrecognizedcompensationexpenseforoptionsbecausetherequisiteserviceperiodsfortheremainingoptionsexpiredin2009.
ForrestrictedshareunitsgrantedbySohu.
comInc.
,asofDecember31,2009,therewas$1.
6millionofrelatedunrecognizedcompensationexpense.
ForshareawardsgrantedbyChangyou.
comLimited.
,asofDecember31,2009,therewas$14.
5millionofrelatedunrecognizedcompensationexpense.
OperatingProtAsaresultoftheforegoing,ouroperatingprotwas$204.
4millionfor2009,comparedto$163.
8millionand$32.
7millionfor2008and2007,respectively.
Theyear-on-yearincreaseinoperatingprotwas$40.
6millionand$131.
1millionfor2009and2008,respectively.
OtherIncome(Expense)Otherincomewas$342,000for2009,comparedto$535,000otherexpenseand$887,000otherincomefor2008and2007,respectively.
Theotherincomein2009mainlyconsistedof$146,000otherincomefromgovernmentgrantand$109,000otherincomefromthewrite-offoflong-agedpayableswhichwereunlikelytoberequiredtobesettledinthefuture.
Theotherexpensein2008mainlyconsistedofcharitabledonationsof$573,000madefortheSichuanEarthquake.
Theotherincomein2007mainlyconsistedof$561,000otherincomefromdisposalofinterestinanassociate,$503,000otherincomefromcertaintaxrefund,offsetbyotherexpenseof$248,000fromtheamortizationoftheofferingcostsofourzerocouponconvertibleseniornotesissuedinJuly2003.
-109-InterestIncomeandExchangeDifferenceInterestincomeandexchangedifference,mainlyconsistingofinterestincome,was$5.
0millionfor2009,comparedto$4.
3millionand$2.
8millionfor2008and2007,respectively.
IncomeTaxExpenseIncometaxexpensewas$33.
7millionfor2009,comparedto$9.
0millionand$1.
5millionfor2008and2007,respectively.
Theincreasein2009primarilyresultedfromtheapplicableincometaxratechangesfrom0%totherangeof7.
5%to15%forourmajoroperatingsubsidiariesandVIEsinthePRCin2009,astheseentities'taxexemptionperiodsexpiredattheendof2008.
Inaddition,thisincreaseincluded$3.
9millionofutilizationofwindfalltaxbenetsfromexistingU.
S.
federalnetoperatinglossesgeneratedfromexcesstaxdeductionsrelatedtoshare-basedawardswhichreducedourtaxespayablein2009inaccordancewithU.
S.
GAAP.
Thisexcesstaxbenetwascorrespondinglychargedtotheshareholders'equitysectionintheconsolidatedbalancesheetandpresentedasacashoutowfromoperatingactivitiesandacashinowfromnancingactivities.
Realizingthisbenetreducedtheamountoftaxespayableanddoesnototherwiseinvolvecashows.
Theincreasein2008mainlyresultedfromthe$5.
0millionwithholdingtaxaccruedbyAmazGameforthedividenddeclaredtoitsimmediateholdingcompanyinHongKong,inaccordancewithcurrentPRCCorporateIncomeTaxLaw.
Thiswithholdingtaxwaspaidinthethirdquarterof2009.
IncomefromContinuingOperationsIncomefromcontinuingoperationswas$176.
0millionfor2009,comparedto$158.
6millionand$35.
0for2008and2007,respectively.
Gain(loss)fromDiscontinuedE-commerceOperationsGainfromdiscontinuede-commerceoperationswas$446,000for2009,mainlyasaresultofthewrite-offofsomelong-agedpayableswhichwereunlikelytoberequiredtobesettledinthefuture.
Lossfromdiscontinuede-commerceoperationswaszeroand$20,000for2008and2007,respectively.
NetIncomeAsaresultoftheforegoing,wehadnetincomeof$176.
4millionfor2009,comparedto$158.
6millionand$34.
9millionfor2008and2007,respectively.
NetIncome(Loss)AttributabletotheNoncontrollingInterestNetincomeattributabletothenoncontrollinginterestwas$28.
6millionfor2009,comparedtonegative$51,000andnegative$47,000for2008and2007,respectively.
For2009,26%oftheeconomicinterestinChangyouand30%oftheeconomicinterestin21EastwhichwasattributabletotheshareholdersotherthanSohuhasbeenrecognizedasnoncontrollinginterestinSohu'sconsolidatedstatementsofoperations.
Thesignicantincreasein2009iscausedbythenoncontrollinginterestrecognizedforChangyouafteritsinitialpublicofferinginApril2009.
For2008and2007,thenoncontrollinginterestonlyincludedthatrecognizedfor21East.
WeexpectthenoncontrollinginterestrecognizedforChangyoutoincreasein2010comparedwith2009.
-110-NetIncomeattributabletoSohu.
comInc.
Asaresultoftheforegoing,wehadnetincomeattributabletoSohu.
comInc.
of$147.
8millionfor2009,comparedto$158.
6millionand$34.
9millionfor2008and2007,respectively.
QUARTERLYRESULTSOFOPERATIONSIn2009,weadjustedourbusinessgroupingfromadvertisingbusinessandnon-advertisingbusinesstoadvertisingbusiness(composedofbrandadvertisingandsponsoredsearch),onlinegamebusiness,andwirelessandothersbusiness.
Accordingly,weadjustedourpresentationbasedonthenewclassicationfortheyearspriorto2009toconformtothecurrentyearclassication.
Thefollowingtablesetsforth,fortheperiodspresented,ourunauditedquarterlyresultsofoperationsfortheeightquartersendedDecember31,2009.
Thedatahavebeenderivedfromourconsolidatednancialstatementsand,inourmanagement'sopinion,theyhavebeenpreparedonsubstantiallythesamebasisastheauditedconsolidatednancialstatementsandincludealladjustments,consistingonlyofnormalrecurringadjustments,necessaryforafairstatementofthenancialresultsfortheperiodspresented.
ThisinformationshouldbereadinconjunctionwiththeannualconsolidatednancialstatementsincludedelsewhereinthisForm10-K.
Theoperatingresultsinanyquarterarenotnecessarilyindicativeoftheresultsthatmaybeexpectedforanyfutureperiod.
-111-ThreeMonthsEndedDec.
31,2009Sep.
30,2009Jun.
30,2009Mar.
31,2009Dec.
31,2008Sep.
30,2008Jun.
30,2008Mar.
31,2008(unaudited,inthousands,exceptpersharedata)Revenues:Advertising:Brandadvertising$45,876$48,502$43,621$39,074$45,024$49,398$41,691$33,155Sponsoredsearch2,9292,2921,7691,5621,6251,7371,6931,614Subtotalofadvertisingrevenues48,80550,79445,39040,63646,64951,13543,38434,769Onlinegame70,69868,68466,59661,60758,39054,60447,89640,955Wirelessandothers16,32817,10715,09913,49516,53314,93710,7009,099Totalrevenues135,831136,585127,085115,738121,572120,676101,98084,823Costofrevenues:Advertising:Brandadvertising16,23815,41814,06513,73015,26619,01813,90711,252Sponsoredsearch3,0792,7282,2652,2981,9161,7751,6051,520Subtotalofcostofadvertisingrevenues19,31718,14616,33016,02817,18220,79315,51212,772Onlinegame5,4194,7133,9373,4364,3743,4803,5053,208Wirelessandothers9,09710,3318,5128,1298,6777,6415,8584,312Totalcostofrevenues33,83333,19028,77927,59330,23331,91424,87520,292Grossprot101,998103,39598,30688,14591,33988,76277,10564,531Operatingexpenses:Productdevelopment14,46114,53114,63713,31414,42413,01210,79811,479Salesandmarketing25,40525,45725,81016,82619,50027,64321,40816,140Generalandadministrative8,80110,7219,2087,8947,5354,1484,8276,185Amortizationofintangibleassets939312874200201199196Totaloperatingexpenses48,76050,80249,78338,10841,65945,00437,23234,000Operatingprot53,23852,59348,52350,03749,68043,75839,87330,531Otherincome(expense)23940621(54)51(575)43Interestincomeandexchangedifference1,1361,4691,2741,1221,2211,4211,480166Incomebeforeincometaxexpense54,61354,10249,85951,16050,84745,23040,77830,740Incometaxexpense12,1687,0227,9696,586(5,745)4,9925779,185Incomefromcontinuingoperations42,44547,08041,89044,57456,59240,23840,20121,555Gain(loss)fromdiscontinuede-commerceoperations——446——1—(1)Netincome42,44547,08042,33644,57456,59240,23940,20121,554Less:Netincome(loss)attributabletothenon-controllinginterest10,0969,7268,801(21)(33)(22)12(8)NetincomeattributabletoSohu.
comInc.
$32,349$37,354$33,535$44,595$56,625$40,261$40,189$21,562BasicnetincomepershareattributabletoSohu.
comInc.
$0.
84$0.
97$0.
88$1.
17$1.
48$1.
05$1.
05$0.
57SharesusedincomputingbasicnetincomepershareattributabletoSohu.
comInc.
38,31738,41038,28438,16238,31138,49638,10837,759DilutednetincomepershareattributabletoSohu.
comInc.
$0.
76$0.
88$0.
79$1.
15$1.
45$1.
02$1.
02$0.
55SharesusedincomputingdilutednetincomepershareattributabletoSohu.
comInc.
38,92039,08239,01838,85139,09039,32139,42939,037-112-LIQUIDITYANDCAPITALRESOURCESResourcesAnalysisOurprincipalsourcesofliquidityarecashandcashequivalents,marketablesecurities,aswellasthecashowgeneratedfromouroperations.
AsofDecember31,2009,2008and2007,wehadcashandcashequivalentsofapproximately$563.
8million,$314.
4millionand$122.
7million,respectively.
For2009and2008,cashequivalentsprimarilycomprisetimedeposits.
For2007,cashequivalentsalsoincludemarketabledebtsecurities.
InOctober2008,ourboardofdirectorsapprovedastockrepurchaseprogramofupto$150millionofSohu'soutstandingsharesofcommonstockuntiltheendof2009.
InNovember2008,wepurchased501,686sharesintheopenmarketatanaveragepriceof$39.
86fortotalconsiderationof$20million.
InDecember2009,wepurchased751,224sharesintheopenmarketatanaveragepriceof$53.
26fortotalconsiderationof$40million.
Inaggregate,asofDecember31,2009,wehadrepurchasedatotalof1,252,910sharesintheopenmarketatanaveragepriceof$47.
89fortotalconsiderationof$60million.
In2009,weenteredintotwoofcebuildingpurchaseagreementsforSohuandforChangyou,withpurchasepricesunderthecontractsofapproximately$110millionand$33.
4million,respectively,oratotalof$143.
4million.
AsofDecember31,2009,wehadpaid$22millionforSohu'sofcebuilding,andwehadmadethefullpaymentforChangyou'sofcebuilding.
Inaddition,weexpectthatthecapitalexpendituresforpurchasesofservers,networkequipmentandsoftwarewillbearound$20millionandforothermiscellaneouspurchaseswillbearound$11millionin2010.
Moreover,researchanddevelopmenteffortsforChangyouareprimarilytokeeppacewithtechnologicaladvancesinordertomakeouronlinegamedevelopmentcapabilitiesandourgamescompetitiveinthemarket.
Wealsofocusontheimprovementofourlicensedgames.
WeintendtofurtherexpandourinternalgamedevelopmentcapabilitiesandlicensemorenewgamesthatareattractivetousersinChina.
Webelieveourcurrentliquidityandcapitalresourcesaresufcienttomeetanticipatedworkingcapitalneeds(netcashusedinoperatingactivities),commitmentsandcapitalexpendituresoverthenexttwelvemonths.
Wemay,however,requireadditionalcashresourcesduetochangeofbusinessconditionsandotherfuturedevelopments,orchangeofgeneraleconomicconditions.
CashGeneratingAbilityWebelievewewillcontinuetogeneratestrongcashowfromourbrandadvertisingbusinessandonlinegamebusiness,which,alongwithouravailablecash,willprovidesufcientliquidityandnancialexibility.
Ourcashowsweresummarizedbelow(inthousands):YearEndedDecember31,200920082007Netcashprovidedbyoperatingactivities$235,021$218,358$91,425Netcashusedininvestingactivities(79,645)(27,021)(49,742)Netcashprovidedby(usedin)nancingactivities93,674(7,390)(47,492)Effectofexchangeratechangeoncashandcashequivalents3077,7723,759Netincrease(decrease)incashandcashequivalents249,357191,719(2,050)Cashandcashequivalentsatbeginningofyear314,425122,706124,756Cashandcashequivalentsatendofyear$563,782$314,425$122,706-113-NetCashProvidedbyOperatingActivitiesFor2009,$235.
0millionnetcashprovidedbyoperatingactivitieswasprimarilyattributabletoournetincomeof$176.
4million,adjustedbynon-cashitemsofshare-basedcompensationexpenseof$17.
3million,depreciationandamortizationof$18.
4million,othermiscellaneousnon-cashexpenseof$1.
4millionandanetincreaseincashfromworkingcapitalitemsof$24.
7million,offsetby$3.
2millionwindfalltaxbenets.
The$3.
2millionwindfalltaxbenetsconsistedofexcesstaxdeductionsof$3.
9millionpartiallyoffsetbythereversalofexcesstaxdeductionsof$0.
7milliontakenpreviously,bothrelatedtoshare-basedpaymentarrangements.
InaccordancewithU.
S.
GAAP,the$3.
9millionwindfalltaxbenetswaspresentedasreductionofcashowsfromoperatingactivitiesandacashinowfromnancingactivities.
Realizingthisbenetreducedtheamountoftaxespayableanddoesnototherwiseinvolvecashows.
For2008,$218.
4millionnetcashprovidedbyoperatingactivitieswasprimarilyattributabletoournetincomeof$158.
6million,adjustedbynon-cashitemsofdepreciationandamortizationof$16.
6million,share-basedcompensationexpenseof$10.
6million,provisionforallowancefordoubtfulaccountsandothermiscellaneousnon-cashexpensesof$1.
6million,andanetincreaseincashfromworkingcapitalitemsof$31.
0million.
For2007,$91.
4millionnetcashprovidedbyoperatingactivitieswasprimarilyattributabletoournetincomeof$34.
9million,adjustedbynon-cashitemsofdepreciationandamortizationof$12.
9million,share-basedcompensationexpenseof$8.
8million,provisionforallowancefordoubtfulaccountsof$1.
7million,andanetincreaseincashfromworkingcapitalitemsof$33.
4million.
NetCashUsedinInvestingActivitiesFor2009,$79.
6millionnetcashusedininvestingactivitieswasprimarilyattributableto$82.
3millionusedinacquiringxedassetsandotherassets,offsetbya$2.
7millionreleaseofrestrictedcash.
The$82.
3millionincluded$22millionand$33.
4millionpaidforSohuandChangyou'sofcebuildings,respectively.
For2008,$27.
0millionnetcashusedininvestingactivitieswasprimarilyattributableto$28.
7millionusedinpurchasingxedassetsandotherassets,offsetbya$1.
7millionreleaseofrestrictedcash.
For2007,$49.
7millionnetcashusedininvestingactivitieswasprimarilyattributableto$55.
8millionusedinpurchasingxedassetsandotherassets,and$1.
1millionforanearn-outpaymentforGo2Map.
Thisamountwaspartiallyoffsetby$5.
0millionreceivedasaresultofthematuritiesofmarketabledebtsecurities,$1.
7millioninproceedsfromdisposalofinterestinanassociate,anda$450,000releaseofrestrictedcash.
NetCashProvidedby(Usedin)FinancingActivitiesFor2009,$93.
7millionnetcashprovidedbynancingactivitieswasprimarilyattributableto$128.
3millionofproceedsgeneratedfromChangyou'sinitialpublicoffering,$4.
1millionfromtheissuanceofcommonstockupontheexerciseofshareoptionsgrantedunderourstockincentiveplanand$3.
2millionwindfalltaxbenetsmentionedinabove"NetCashProvidedbyOperatingActivities".
Thenetcashprovidedbynancingactivitieswasoffsetby$40.
0millionusedfortherepurchaseofourcommonstockand$1.
9millionforpaymentsmadeinothernancingactivities.
For2008,$7.
4millionnetcashusedinnancingactivitieswasprimarilyattributableto$20.
0millionusedfortherepurchaseofourcommonstock,$6,000usedforredemptionofourzerocouponconvertibleseniornotes,and$0.
9millionusedformiscellaneousnancingactivities.
Thisamountwaspartiallyoffsetby$13.
1millionreceivedfromtheissuanceofcommonstockupontheexerciseofshareoptionsgrantedunderourstockincentiveplan,and$427,000fromcashcontributionsreceivedfromanoncontrollinginterestshareholder.
-114-For2007,$47.
5millionnetcashusedinnancingactivitieswasprimarilyattributableto$58.
5millionusedinredemptionofzerocouponconvertibleseniornotes.
Thisamountwaspartiallyoffsetby$10.
8millioncashcollectionfromissuanceofcommonstockupontheexerciseofshareoptionsgrantedunderourstockincentiveplanand$247,000inexcesstaxbenetsfromshare-basedpaymentarrangements.
RestrictionsonCashTransferstoSohu.
comInc.
Tofundanycashrequirementsitmayhave,Sohu.
comInc.
mayneedtorelyondividendsandotherdistributionsonequitypaidbySohu.
comLimitedandChangyou,ourwholly-ownedsubsidiaryandmajority-ownedsubsidiary.
Sincesubstantiallyallofouroperationsareconductedthroughourindirectwhollyandmajority-ownedChina-basedsubsidiariesandVIEs,Sohu.
comLimitedandChangyouthenmayneedtorelyondividends,loansoradvancesmadebyourPRCsubsidiary.
ForChangyou,substantiallyallofitsoperationsareconductedthroughGamease,ourVIE,whichgeneratesallofouronlinegamerevenues.
AsGameaseisnotownedbyoursubsidiaries,itisnotabletomakedividendpaymentstooursubsidiaries.
Instead,AmazGame,oursubsidiaryinChina,hasenteredintoanumberofcontractswithGameasetoprovideservicestoGameaseinreturnforcashpayments.
Inorderforustoreceiveanydividends,loansoradvancesfromAmazGame,ortodistributeanydividendstoourshareholders,wemayneedtorelyonthesepaymentsmadefromGameasetoAmazGame.
DependingonthenatureofservicesprovidedbyAmazGametoGamease,certainofthesepaymentsaresubjecttoPRCtaxes,includingbusinesstaxesandvalueaddedtax,whicheffectivelyreducetheamountthatAmazGamereceivesfromGamease.
Inaddition,thePRCgovernmentcouldimposerestrictionsonsuchpaymentsorchangethetaxratesapplicabletosuchpayments.
Inaddition,regulationsinthePRCcurrentlypermitpaymentofdividendsofaPRCcompany,suchasAmazGame,onlyoutofaccumulatedprotsasdeterminedinaccordancewithaccountingstandardsandregulationsinChina.
AmazGame,andourotherChina-basedsubsidiarieswhichareWFOEs,arealsorequiredtosetasideatleast10%oftheirafter-taxprotbasedonPRCaccountingstandardseachyeartotheirgeneralreservesuntilthecumulativeamountreaches50%oftheirpaid-incapital.
Thesereservesarenotdistributableascashdividends,orasloansoradvances.
TheseWOFEsmayalsoallocateaportionofitsafter-taxprots,asdeterminedbyitsboardofdirectors,totheirstaffwelfareandbonusfunds,whichmaynotbedistributedtoChangyou.
comLimitedand/ortoSohu.
comLimited,somaynotbedistributedtoSohu.
comInc.
eventually.
Furthermore,underregulationsoftheSAFE,theRMBisnotconvertibleintoforeigncurrenciesforcapitalaccountitems,suchasloans,repatriationofinvestmentsandinvestmentsoutsideofChina,unlessthepriorapprovaloftheSAFEisobtainedandpriorregistrationwiththeSAFEismade.
AnydividendspaidbyWOFEstotheirinvestorslocatedinHKwillbesubjecttoawithholdingtaxattherateof5%,whichwillreducetheamountofcashavailablefordistribution.
Wedonotexpectanyofsuchrestrictionsortaxestohaveamaterialimpactonourabilitytomeetourcashobligations.
-115-CONTRACTUALOBLIGATIONSThefollowingtablesetsforthourcontractualobligationsasofDecember31,2009(inthousands):PaymentDuebyPeriodContractualObligationsTotalLessthan1year1–3years3–5yearsMorethan5yearsOfcebuildingpurchase$87,848$27,452$58,199$2,197$—Contentandservicepurchases51,44532,97918,40462—Operatingleaseobligations15,1474,3916,1254,631—Licensefeesofonlinegamesdevelopedbythird-parties2,0061,889117——Totalcontractualobligations$156,446$66,711$82,845$6,890$—OfceBuildingPurchaseOnNovember20,2009,weenteredintoanagreementtopurchaseanofcebuildingtobebuiltinBeijing,whichistoserveasourheadquarter.
Thepurchasepricewasapproximately$110million,ofwhich$22millionhadbeenpaidasofDecember31,2009.
Theremaining$88millionwillbepaidininstallmentsatvariousstagesofthedevelopmentplan.
Theconstructionisexpectedtobecompletedbytheendof2012.
ContentandServicePurchasesWehaveenteredintovariouspurchaseobligationsforcontentandservice.
Purchaseobligationsrepresentednon-cancelablecontractualobligationsasofDecember31,2009.
OperatingLeaseObligationsWehaveenteredintovariousnon-cancelableoperatingleaseagreementsforcertainofSohuandChangyou'sofces,landanddatacenterswithoriginalleaseperiodsexpiringbetween2010and2014.
Wearecommittedtopayaportionoftherelatedoperatingexpensesundercertainoftheseleaseagreements.
Werecognizerentexpenseundersuchleasesonastraight-linebasisovertheleaseterms.
OFF-BALANCESHEETCOMMITMENTSANDARRANGEMENTSWehavenotenteredintoanynancialguaranteesorothercommitmentstoguaranteethepaymentobligationsofthirdparties.
Wehavenotenteredintoanyderivativecontractsthatareindexedtooursharesandclassiedasshareholder'sequity,orthatarenotreectedinourconsolidatednancialstatements.
Furthermore,wedonothaveanyretainedorcontingentinterestinassetstransferredtoanunconsolidatedentitythatservesascredit,liquidityormarketrisksupporttosuchentity.
Wedonothaveanyvariableinterestinanyunconsolidatedentitythatprovidesnancing,liquidity,marketriskorcreditsupporttousorthatengagesinleasing,hedgingorproductdevelopmentserviceswithus.
IMPACTOFRECENTLYISSUEDACCOUNTINGSTANDARDSInJune2009,theFinancialAccountingStandardsBoard("FASB")issuedrevisedguidanceontheaccountingfortransfersofnancialassets.
Therevisedguidancerequiresmoreinformationabouttransfersofnancialassets,includingsecuritizationtransactions,andwhereentitieshavecontinuingexposuretotherisksrelatedtotransferrednancialassets.
Iteliminatestheconceptofa"qualifyingspecial-purposeentity,"changestherequirementsforderecognizingnancialassets,andrequiresadditionaldisclosures.
Thisguidancewillbeeffectiveatthestartofareportingentity'srstscalyearbeginningafterNovember15,2009.
Theadoptionofthisguidancewillhavenoimpactonourconsolidatednancialstatements.
-116-InJune2009,theFASBissuedrevisedguidanceontheconsolidationofvariableinterestentities.
Therevisedguidancerequiresananalysistodeterminewhetheravariableinterestgivestheentityacontrollingnancialinterestinavariableinterestentity.
Additionally,therevisedguidancerequiresanongoingreassessmentandeliminatesthequantitativeapproachpreviouslyrequiredfordeterminingwhetheranentityistheprimarybeneciary.
Thisguidancewillbeeffectiveatthestartofareportingentity'srstscalyearbeginningafterNovember15,2009.
Theadoptionofthisguidancewillhavenomaterialimpactonourconsolidatednancialstatements.
InOctober2009,theFASBissuednewguidanceonrevenuerecognitionforarrangementswithmultipledeliverablesandcertainrevenuearrangementsthatincludesoftwareelements.
Byprovidinganotheralternativefordeterminingthesellingpriceofdeliverables,theguidanceforarrangementswithmultipledeliverableswillallowcompaniestoallocatearrangementconsiderationinmultipledeliverablearrangementsinamannerthatbetterreectsthetransaction'seconomicsandwilloftenresultinearlierrevenuerecognition.
Thenewguidancemodiesthefairvaluerequirementsofpreviousguidancebyallowing"bestestimateofsellingprice"inadditiontovendor-specicobjectiveevidence("VSOE")andothervendorobjectiveevidence("VOE",nowreferredtoas"TPE"standingforthird-partyevidence)fordeterminingthesellingpriceofadeliverable.
AvendorisnowrequiredtouseitsbestestimateofthesellingpricewhenVSOEorTPEofthesellingpricecannotbedetermined.
Inaddition,theresidualmethodofallocatingarrangementconsiderationisnolongerpermittedunderthenewguidance.
Thenewguidanceforcertainrevenuearrangementsthatincludesoftwareelementsremovesnon-softwarecomponentsoftangibleproductsandcertainsoftwarecomponentsoftangibleproductsfromthescopeofexistingsoftwarerevenueguidance,resultingintherecognitionofrevenuesimilartothatforothertangibleproducts.
ThenewguidanceiseffectiveforscalyearsbeginningonorafterJune15,2010.
However,companiesmaybeabletoadoptasearlyasinterimperiodsendedSeptember30,2009.
Theguidancemaybeappliedeitherprospectivelyfromthebeginningofthescalyearfornewormateriallymodiedarrangementsorretrospectively.
Wehavenotearlyadoptedthenewguidanceandarecurrentlyevaluatingtheimpactonitsconsolidatednancialstatementsofadoptingthisguidance.
InDecember2009,theFASBissuedConsolidations—ImprovementstoFinancialReportingbyEnterprisesInvolvedwithVIEs.
TheamendmentsinthisAccountingStandardsUpdatereplacethequantitative-basedrisksandrewardscalculationfordeterminingwhichreportingentity,ifany,hasacontrollingnancialinterestinavariableinterestentitywithanapproachfocusedonidentifyingwhichreportingentityhasthepowertodirecttheactivitiesofavariableinterestentitythatmostsignicantlyimpacttheentity'seconomicperformanceandhas(1)theobligationtoabsorblossesoftheentityor(2)therighttoreceivebenetsfromtheentity.
Anapproachthatisexpectedtobeprimarilyqualitativewillbemoreeffectiveforidentifyingwhichreportingentityhasacontrollingnancialinterestinavariableinterestentity.
TheamendmentsinthisUpdatealsorequireadditionaldisclosuresaboutareportingentity'sinvolvementinvariableinterestentities,whichwillenhancetheinformationprovidedtousersofnancialstatements.
Webelievetherewillbenomaterialimpactonourconsolidatednancialstatementsuponadoptionofthisstandard.
ITEM7A.
QUANTITATIVEANDQUALITATIVEDISCLOSUREABOUTMARKETRISKFOREIGNCURRENCYEXCHANGERATERISKWhileourreportingcurrencyistheU.
S.
dollar,todatethemajorityofourrevenuesandcostsaredenominatedinRMBandasignicantportionofourassetsandliabilitiesaredenominatedinRMB.
Asaresult,weareexposedtoforeignexchangeriskasourrevenuesandresultsofoperationsmaybeaffectedbyuctuationsintheexchangeratebetweenU.
S.
dollarandRMB.
IftheRMBdepreciatesagainsttheU.
S.
dollar,thevalueofourRMBrevenuesandassetsasexpressedinourU.
S.
dollarnancialstatementswilldecline.
Wedonotholdanyderivativeorothernancialinstrumentsthatexposeustosubstantialmarketrisk.
See"RiskFactors—WemaysuffercurrencyexchangelossesiftheRMBdepreciatesrelativetotheU.
S.
dollar.
"-117-TheRMBiscurrentlyfreelyconvertibleunderthe"currentaccount",whichincludesdividends,tradeandservice-relatedforeignexchangetransactions,butnotunderthe"capitalaccount",whichincludesforeigndirectinvestment.
Inaddition,commencingonJuly21,2005,Chinareformeditsexchangerateregimebychangingtoamanagedoatingexchangerateregimebasedonmarketsupplyanddemandwithreferencetoabasketofcurrencies.
Underthemanagedoatingexchangerateregime,theRMBisnolongerpeggedtotheU.
S.
dollar.
TheexchangerateoftheRMBagainsttheU.
S.
dollarwasadjustedtoRMB8.
11perU.
S.
dollarasofJuly21,2005,representinganappreciationofabout2%.
ThePeople'sBankofChinawillannouncetheclosingpricesofforeigncurrenciessuchastheU.
S.
dollartradedagainsttheRMBintheinter-bankforeignexchangemarketaftertheclosingofthemarketoneachbusinessday,andwillmakesuchpricesthecentralparityfortradingagainsttheRMBonthefollowingbusinessday.
OnMay19,2007,thePeople'sBankofChinaannouncedapolicytoexpandthemaximumdailyoatingrangeofRMBtradingpricesagainsttheU.
S.
dollarintheinter-bankspotforeignexchangemarketfrom0.
3%to0.
5%.
WhiletheinternationalreactionstotheRMBrevaluationandwideningoftheRMB'sdailytradingbandhavegenerallybeenpositive,withtheincreasedoatingrangeoftheRMB'svalueagainstforeigncurrencies,theRMBmayappreciateordepreciatesignicantlyinvalueagainsttheU.
S.
dollarorotherforeigncurrenciesinthelongterm,dependingontheuctuationofthebasketofcurrenciesagainstwhichitiscurrentlyvalued.
Todate,wehavenotenteredintoanyhedgingtransactionsinanefforttoreduceourexposuretoforeigncurrencyexchangerisk.
Whilewemaydecidetoenterintohedgingtransactionsinthefuture,theeffectivenessofthesehedgesmaybelimitedandwemaynotbeabletosuccessfullyhedgeourexposure.
Accordingly,wemayincureconomiclossesinthefutureduetoforeignexchangerateuctuations,whichcouldhaveanegativeimpactonournancialconditionandresultsofoperations.
ThefollowingtablesetsforthasummaryofourforeigncurrencysensitivenancialinstrumentsasofDecember31,2009,whichconsistedofcashandcashequivalents,accountreceivables,prepaidandothercurrentassets,andcurrentliabilities.
Thematurityofthosenancialinstrumentswaslessthanoneyearandtheirbookvalueapproximatedfairvalue.
Denominatedin(inthousands)US$RMBHK$TotalCashandcashequivalents$269,900$292,741$1,141$563,782AccountReceivables95445,6441246,610Prepaidandothercurrentassets47610,297810,781Currentliabilities5,166145,118213150,497INFLATIONRATERISKAccordingtotheNationalBureauofStatisticsofChina,thechangeintheconsumerpriceindexinChinawasnegative0.
7%,positive5.
9%andpositive4.
8%in2009,2008and2007,respectively.
Althoughtheconsumerpriceindexisnegativein2009,thereissignicantriskininationinthefuturewhichcouldhaveamaterialadverseeffectonourbusiness.
INTERESTRATERISKThebasicobjectivesofourinvestmentprogramaretoprotecttheinvestedfundsfromexcessiveriskandtoprovideforliquiditythatissufcienttomeetoperatingandinvestmentcashrequirements.
Ourinvestmentpolicylimitsourinvestmentsofexcesscashinhigh-qualitycorporatesecuritiesandlimitstheamountofcreditexposuretoanyoneissuer.
Ourexposuretointerestrateriskprimarilyrelatestotheinterestincomegeneratedfromexcesscashinvestedindemanddeposits.
Wehavenotusedderivativenancialinstrumentsinourinvestmentportfolioinordertoreducethisrisk.
Wehavenotbeenexposednordoweanticipatebeingexposedtomaterialrisksduetochangesininterestrates.
-118-ITEM8.
FINANCIALSTATEMENTSANDSUPPLEMENTARYDATAReferenceismadetotheIndextoConsolidatedFinancialStatementswhichappearonpageF-1ofthisreport.
TheManagement'sReportonInternalControloverFinancialReporting,ReportofIndependentRegisteredPublicAccountingFirm,ConsolidatedFinancialStatements,NotestoConsolidatedFinancialStatementsandFinancialStatementScheduleswhicharelistedintheIndextoConsolidatedFinancialStatementsandwhichappearbeginningonpageF-2ofthisreportareincorporatedintothisItem8.
QuarterlyResultsofOperationsinformationisincludedonpage85ofthisreportandisincorporatedintothisItem8.
DividendPolicyThetwolistedcorporationswithintheSohuGroup,Sohu.
comInc.
andChangyou.
comLimited,donotexpecttopaydividendsontheirordinarysharesintheforeseeablefuture.
TheSohuGroupcurrentlyintendstoretainallavailablefundsandanyfutureearningsforuseintheoperationandexpansionofitbusiness,anddonotanticipatepayinganycashdividendsonSohu.
comInc.
'sand/oronChangyou.
comLimited'sordinaryshares,orindirectlyonChangyou.
comLimited'sAmericandepositaryshares("ADSs"),fortheforeseeablefuture.
FuturecashdividendsdistributedbySohu.
comInc.
andChangyou.
comLimited,ifany,willbedeclaredatthediscretionoftheirboardofdirectors,respectively,andwilldependupontheirfutureoperationsandearnings,capitalrequirementsandsurplus,generalnancialcondition,contractualrestrictionsandotherfactorsastheirboardofdirectorsmaydeemrelevant.
ForChangyou.
comLimited,holdersofADSswillbeentitledtoreceivedividends,subjecttothetermsofthedepositagreement,tothesameextentastheholdersofChangyou.
comLimited'sordinaryshares,lessthefeesandexpensespayableunderthedepositagreement.
CashdividendswillbepaidbythedepositarytoholdersofADSsinU.
S.
dollars,subjecttothetermsofthedepositagreement.
Otherdistributions,ifany,willbepaidbythedepositarytoholdersofADSsinanymeansitdeemslegal,fairandpractical.
OnApril1,2009,Changyou.
comLimiteddeclaredacashdividendof$96.
8millionpayablesolelytoSohu.
com(Game)Limited,whichisanindirectwholly-ownedsubsidiaryofSohu.
comInc.
Inthefourthquarterof2009,afterreceivingapprovalfromthegovernment,Changyou.
comLimitedpaidthedividendtoSohu.
com(Game)Limited.
Changyou.
comLimited'sonlyothershareholderonApril1,2009,ProminenceInvestmentsLtd.
,aBritishVirginIslandscompanybeneciallyownedbyTaoWang,ChiefExecutiveOfcerofChangyou,wasnotentitledtoparticipateinthisdividend.
ITEM9.
CHANGESINANDDISAGREEMENTSWITHACCOUNTANTSONACCOUNTINGANDFINANCIALDISCLOSURENone.
ITEM9A.
CONTROLSANDPROCEDURESEvaluationofDisclosureControlsandProceduresOurChiefExecutiveOfcerandChiefFinancialOfcer,afterevaluatingtheeffectivenessofour"disclosurecontrolsandprocedures"(asdenedintheSecuritiesExchangeActof1934Rules13a-15(e)and15d-15(e))asoftheendoftheperiodcoveredbythisreport(the"EvaluationDate"),haveconcludedthatasoftheEvaluationDateourdisclosurecontrolsandprocedureswereeffectiveanddesignedtoensurethatallmaterialinformationrelatingtoSohurequiredtobeincludedinourreportsledorsubmittedundertheSecuritiesExchangeActof1934isrecorded,processed,summarizedandreportedwithinthetimeperiodsspeciedintherulesandformsoftheSecuritiesandExchangeCommissionandtoensurethatinformationrequiredtobedisclosedisaccumulatedandcommunicatedtoourmanagement,includingourprincipalexecutiveandnancialofcers,asappropriatetoallowtimelydecisionsregardingrequireddisclosure.
-119-Management'sReportonInternalControloverFinancialReportingOurmanagement'sannualreportoninternalcontrolovernancialreportingandtherelatedreportofourindependentregisteredpublicaccountingrmareincludedinthisReportonpagesF-2andF-3,respectively.
ChangesinInternalControloverFinancialReportingTherehavenotbeenanychangesintheCompany'sinternalcontrolovernancialreporting,assuchtermisdenedinRules13a-15(f)and15d-15(f)undertheExchangeActduringtheCompany'sscalquarterendedDecember31,2009thathavemateriallyaffected,orarereasonablylikelytomateriallyaffect,theCompany'sinternalcontrolovernancialreporting.
ITEM9B.
OTHERINFORMATIONNone.
-120-PARTIIIITEM10.
DIRECTORS,EXECUTIVEOFFICERSANDCORPORATEGOVERNANCETheinformationrequiredbythisitemwillbeincludedintheProxyStatementforSohu's2009AnnualMeetingofStockholderstobeledwiththeSecuritiesandExchangeCommissiononoraboutApril30,2010andisincorporatedhereinbyreference.
ITEM11.
EXECUTIVECOMPENSATIONTheinformationrequiredbythisitemwillbeincludedintheProxyStatementforSohu's2009AnnualMeetingofStockholdersundertheheading"ExecutiveCompensation"andisincorporatedhereinbyreference.
ITEM12.
SECURITYOWNERSHIPOFCERTAINBENEFICIALOWNERSANDMANAGEMENTANDRELATEDSTOCKHOLDERMATTERSTheinformationrequiredbythisitem,otherthanthetableincludedbelow,willbeincludedintheProxyStatementforSohu's2009AnnualMeetingofStockholdersundertheheading"BenecialOwnershipofCommonStock"andisincorporatedhereinbyreference.
EquityCompensationPlanInformationPlancategoryNumberofsecuritiestobeissueduponexerciseofoutstandingoptions,warrantsandrights(a)(inthousands)Weighted-averageexercisepriceofoutstandingoptions,warrantsandrights(b)Numberofsecuritiesremainingavailableforfutureissuanceunderequitycompensationplans(excludingsecuritiesreectedincolumn(a))(c)(inthousands)Equitycompensationplansapprovedbysecurityholders-2000StockIncentivePlanShareOptions555$16.
55RestrictedStockUnits209$—Subtotal7641,087Equitycompensationplansnotapprovedbysecurityholders——Total7641,087ITEM13.
CERTAINRELATIONSHIPSANDRELATEDTRANSACTIONS,ANDDIRECTORINDEPENDENCETheinformationrequiredbythisitemwillbeincludedintheProxyStatementforSohu's2009AnnualMeetingofStockholdersundertheheading"CertainRelationshipsandRelatedTransactions"andisincorporatedhereinbyreference.
ITEM14.
PRINCIPALACCOUNTANTFEESANDSERVICESTheinformationrequiredbythisitemwillbeincludedintheProxyStatementforSohu's2009AnnualMeetingofStockholdersundertheheading"PrincipalAccountantFeesandServices"andisincorporatedhereinbyreference.
-121-PARTIVITEM15.
EXHIBITSANDFINANCIALSTATEMENTSCHEDULES(a)(1)IndextoConsolidatedFinancialStatementsPleaseseetheaccompanyingIndextoConsolidatedFinancialStatementswhichappearsonpageF-1ofthisreport.
TheManagement'sReportonInternalControloverFinancialReporting,ReportofIndependentRegisteredPublicAccountingFirm,ConsolidatedFinancialStatementsandNotestoConsolidatedFinancialStatementswhicharelistedintheIndextoConsolidatedFinancialStatementsandwhichappearbeginningonpageF-2ofthisreportareincludedinItem8above.
(a)(2)FinancialStatementsScheduleScheduleI,CondensedFinancialInformationofRegistrant,isincludedonpageF-38ofthisreportandisincorporatedintothisItem15(a)(2)byreference.
AllothernancialstatementsscheduleshavebeenomittedbecausetheinformationrequiredtobesetforththereinisnotapplicableorisincludedintheConsolidatedFinancialStatementsornotesthereto.
(b)ExhibitsSeetheExhibitIndexfollowingthesignaturepagesofthisreport.
-122-SIGNATURESPursuanttotherequirementsofSection13or15(d)oftheSecuritiesExchangeActof1934,theregistranthasdulycausedthisreporttobesignedonitsbehalfbytheundersigned,theretodulyauthorized.
Date:February26,2010Sohu.
comInc.
By:/s/CAROLYUCarolYuCo-PresidentandChiefFinancialOfcerKNOWALLMENBYTHESEPRESENTS,thateachpersonwhosesignatureappearsbelowherebyconstitutesandappointsCharlesZhangandCarolYu,andeachofthem,histrueandlawfulproxies,attorneys-in-factandagents,withfullpowerofsubstitutionandresubstitution,forhimandinhisname,placeandstead,inanyandallcapacities,to(i)acton,signandtitlewiththeSECanyandallamendmentstothisAnnualReportonForm10-K,togetherwithallexhibitsthereto,(ii)act,signandlesuchcerticates,instruments,agreementsandotherdocumentsasmaybenecessaryorappropriateinconnectiontherewith,and(iii)takeanyandallactionswhichmaybenecessaryorappropriateinconnectiontherewith,grantinguntosuchagents,proxiesandattorneys-in-fact,andeachofthemandhisandtheirsubstituteorsubstitutes,fullpowerandauthoritytodoandperformeachandeveryactandthingnecessaryorappropriatetobedoneinconnectiontherewith,asfullyforallintentsandpurposesashemightorcoulddoinperson,herebyapproving,ratifyingandconrmingallthatsuchagents,proxiesandattorneys-in-fact,anyofthemoranyofhisortheirsubstituteorsubstitutesmaylawfullydoorcausetobedonebyvirtuehereof.
PursuanttotherequirementsoftheSecuritiesExchangeActof1934,thisreporthasbeensignedbelowbythefollowingpersonsonbehalfoftheregistrantandinthecapacitiesandonthedatesindicated.
SIGNATURETITLEDATE/s/CHARLESZHANGCharlesZhangChairmanoftheBoardofDirectorsandChiefExecutiveOfcer(PrincipalExecutiveOfcer)February26,2010/s/CAROLYUCarolYuCo-PresidentandChiefFinancialOfcer(PrincipalFinancialOfcerandPrincipalAccountingOfcer)February26,2010/s/EDWARDB.
ROBERTSEdwardB.
RobertsDirectorFebruary26,2010/s/CHARLESHUANGCharlesHuangDirectorFebruary26,2010/s/DAVEQIDaveQiDirectorFebruary26,2010/s/SHIWANGShiWangDirectorFebruary26,2010/s/JOHNDENGJohnDengDirectorFebruary26,2010-123-SOHU.
COMINC.
INDEXTOCONSOLIDATEDFINANCIALSTATEMENTSPageCONSOLIDATEDFINANCIALSTATEMENTS:Management'sReportonInternalControloverFinancialReportingF-2ReportofIndependentRegisteredPublicAccountingFirmF-3ConsolidatedBalanceSheetsasofDecember31,2009and2008F-4ConsolidatedStatementsofOperationsfortheyearsendedDecember31,2009,2008and2007F-5ConsolidatedStatementsofCashFlowsfortheyearsendedDecember31,2009,2008and2007F-6ConsolidatedStatementsofChangesinEquityfortheyearsendedDecember31,2009,2008and2007F-7NotestoConsolidatedFinancialStatementsF-10FINANCIALSTATEMENTSSCHEDULES:ScheduleI—CondensedFinancialInformationofRegistrantF-48AllotherscheduleshavebeenomittedbecausetheinformationrequiredtobesetforththereinisnotapplicableorisshownintheConsolidatedFinancialStatementsorNotes.
F-1MANAGEMENT'SREPORTONINTERNALCONTROLOVERFINANCIALREPORTINGTheCompany'smanagementisresponsibleforestablishingandmaintainingadequateinternalcontrolovernancialreportingasdenedinRules13a-15(f)and15d-15(f)undertheExchangeAct.
UnderthesupervisionandwiththeparticipationoftheCompany'smanagement,includingourChiefExecutiveOfcerandChiefFinancialOfcer,theCompanyconductedanevaluationoftheeffectivenessofitsinternalcontrolovernancialreportingbasedoncriteriaestablishedinInternalControl—IntegratedFrameworkissuedbytheCommitteeofSponsoringOrganizationsoftheTreadwayCommission.
Basedonthisevaluation,theCompany'smanagementconcludedthatitsinternalcontrolovernancialreportingwaseffectiveasofDecember31,2009.
Becauseofitsinherentlimitations,internalcontrolovernancialreportingmaynotpreventordetectmisstatements.
Also,projectionsofanyevaluationofeffectivenesstofutureperiodsaresubjecttotheriskthatcontrolsmaybecomeinadequatebecauseofchangesinconditions,orthatthedegreeofcompliancewiththepoliciesorproceduresmaydeteriorate.
TheeffectivenessofourinternalcontrolovernancialreportingasofDecember31,2009hasbeenauditedbyPricewaterhouseCoopersZhongTianCPAsLimitedCompany,anindependentregisteredpublicaccountingrm,asstatedintheirreportwhichisincludedherein.
F-2REPORTOFINDEPENDENTREGISTEREDPUBLICACCOUNTINGFIRMToBoardofDirectorsandShareholdersofSohu.
comInc.
:Inouropinion,theconsolidatednancialstatementslistedintheaccompanyingindexpresentfairly,inallmaterialrespects,thenancialpositionofSohu.
comInc.
(the"Company")anditssubsidiariesatDecember31,2009andDecember31,2008,andtheresultsoftheiroperationsandtheircashowsforeachofthethreeyearsintheperiodendedDecember31,2009inconformitywithaccountingprinciplesgenerallyacceptedintheUnitedStatesofAmerica.
Inaddition,inouropinion,thenancialstatementscheduleslistedintheaccompanyingindexpresentfairly,inallmaterialrespects,theinformationsetforththereinwhenreadinconjunctionwiththerelatedconsolidatednancialstatements.
Alsoinouropinion,theCompanymaintained,inallmaterialrespects,effectiveinternalcontrolovernancialreportingasofDecember31,2009,basedoncriteriaestablishedinInternalControl—IntegratedFrameworkissuedbytheCommitteeofSponsoringOrganizationsoftheTreadwayCommission(COSO).
TheCompany'smanagementisresponsibleforthesenancialstatementsandnancialstatementschedules,formaintainingeffectiveinternalcontrolovernancialreportingandforitsassessmentoftheeffectivenessofinternalcontrolovernancialreporting,includedinManagement'sReportonInternalControloverFinancialReportingappearingonPageF-2ofForm10-K.
Ourresponsibilityistoexpressopinionsonthesenancialstatements,onthenancialstatementschedules,andontheCompany'sinternalcontrolovernancialreportingbasedonourintegratedaudits.
WeconductedourauditsinaccordancewiththestandardsofthePublicCompanyAccountingOversightBoard(UnitedStates).
Thosestandardsrequirethatweplanandperformtheauditstoobtainreasonableassuranceaboutwhetherthenancialstatementsarefreeofmaterialmisstatementandwhethereffectiveinternalcontrolovernancialreportingwasmaintainedinallmaterialrespects.
Ourauditsofthenancialstatementsincludedexamining,onatestbasis,evidencesupportingtheamountsanddisclosuresinthenancialstatements,assessingtheaccountingprinciplesusedandsignicantestimatesmadebymanagement,andevaluatingtheoverallnancialstatementpresentation.
Ourauditofinternalcontrolovernancialreportingincludedobtaininganunderstandingofinternalcontrolovernancialreporting,assessingtheriskthatamaterialweaknessexists,andtestingandevaluatingthedesignandoperatingeffectivenessofinternalcontrolbasedontheassessedrisk.
Ourauditsalsoincludedperformingsuchotherproceduresasweconsiderednecessaryinthecircumstances.
Webelievethatourauditsprovideareasonablebasisforouropinions.
AsdisclosedinNote22totheconsolidatednancialstatements,in2009theCompanychangedthemannerinwhichitaccountsforbusinesscombinationsandnoncontrollinginterestsinconsolidatedsubsidiaries.
Acompany'sinternalcontrolovernancialreportingisaprocessdesignedtoprovidereasonableassuranceregardingthereliabilityofnancialreportingandthepreparationofnancialstatementsforexternalpurposesinaccordancewithgenerallyacceptedaccountingprinciples.
Acompany'sinternalcontrolovernancialreportingincludesthosepoliciesandproceduresthat(i)pertaintothemaintenanceofrecordsthat,inreasonabledetail,accuratelyandfairlyreectthetransactionsanddispositionsoftheassetsofthecompany;(ii)providereasonableassurancethattransactionsarerecordedasnecessarytopermitpreparationofnancialstatementsinaccordancewithgenerallyacceptedaccountingprinciples,andthatreceiptsandexpendituresofthecompanyarebeingmadeonlyinaccordancewithauthorizationsofmanagementanddirectorsofthecompany;and(iii)providereasonableassuranceregardingpreventionortimelydetectionofunauthorizedacquisition,use,ordispositionofthecompany'sassetsthatcouldhaveamaterialeffectonthenancialstatements.
Becauseofitsinherentlimitations,internalcontrolovernancialreportingmaynotpreventordetectmisstatements.
Also,projectionsofanyevaluationofeffectivenesstofutureperiodsaresubjecttotheriskthatcontrolsmaybecomeinadequatebecauseofchangesinconditions,orthatthedegreeofcompliancewiththepoliciesorproceduresmaydeteriorate.
PricewaterhouseCoopersZhongTianCPAsLimitedCompanyBeijing,thePeople'sRepublicofChinaFebruary26,2010F-3SOHU.
COMINC.
CONSOLIDATEDBALANCESHEETS(inthousands)AsofDecember31,20092008ASSETSCurrentassets:Cashandcashequivalents$563,782$314,425Accountsreceivable,net46,61036,869Prepaidandothercurrentassets10,78127,551Totalcurrentassets621,173378,845Fixedassets,net115,08876,237Goodwill55,55555,555Intangibleassets,net7,9335,654Restrictedcash—2,671Otherassets,net28,5242,914Totalassets$828,273$521,876LIABILITIESANDSHAREHOLDERS'EQUITYCurrentliabilities:Accountspayable$4,602$4,339Accruedliabilitiestosuppliersandagents41,10333,054Receiptsinadvanceanddeferredrevenue36,94431,446Accruedsalaryandbenets28,86027,348Taxpayable21,95318,892Otheraccruedliabilities17,03515,703Totalcurrentliabilities150,497130,782Commitmentsandcontingencies(Note19)Shareholder'sequitySohu.
comInc.
shareholders'equity:Commonstock:$0.
001parvaluepershare(75,400authorized;37,749and38,095sharesissuedandoutstanding,respectively)4343Additionalpaid-incapital317,052201,196Treasurystock(5,389and4,638shares,respectively)(114,690)(74,683)Accumulatedothercomprehensiveincome21,50221,349Retainedearnings385,874238,041TotalSohu.
comInc.
shareholders'equity609,781385,946Noncontrollinginterest67,9955,148Totalshareholders'equity677,776391,094Totalliabilitiesandshareholders'equity$828,273$521,876Theaccompanyingnotesareanintegralpartoftheseconsolidatednancialstatements.
F-4SOHU.
COMINC.
CONSOLIDATEDSTATEMENTSOFOPERATIONS(inthousands,exceptpersharedata)YearEndedDecember31,200920082007Revenues:Advertising:Brandadvertising$177,073$169,268$112,106Sponsoredsearch8,5526,6697,110Subtotalofadvertisingrevenues185,625175,937119,216Onlinegame267,585201,84542,096WirelessandOthers62,02951,26927,622Totalrevenues515,239429,051188,934Costofrevenues:Advertising:Brandadvertising59,45159,44338,733Sponsoredsearch10,3706,8165,644Subtotalofcostofadvertisingrevenues69,82166,25944,377Onlinegame17,50514,5677,113WirelessandOthers36,06926,48813,273Totalcostofrevenues123,395107,31464,763Grossprot391,844321,737124,171Operatingexpenses:Productdevelopment56,94349,71325,443Salesandmarketing93,49884,69147,506Generalandadministrative36,62422,69517,418Amortizationofintangibleassets3887961,093Totaloperatingexpenses187,453157,89591,460Operatingprot204,391163,84232,711Otherincome(expense)342(535)887Interestincomeandexchangedifference5,0014,2882,793Incomebeforeincometaxexpense209,734167,59536,391Incometaxexpense33,7459,0091,487Incomefromcontinuingoperations175,989158,58634,904Gain(loss)fromdiscontinuede-commerceoperations446—(20)Netincome176,435158,58634,884Less:Netincome(loss)attributabletothenoncontrollinginterest28,602(51)(47)NetincomeattributabletoSohu.
comInc.
$147,833$158,637$34,931BasicnetincomepershareattributabletoSohu.
comInc.
$3.
86$4.
16$0.
94SharesusedincomputingbasicnetincomepershareattributabletoSohu.
comInc.
38,29438,16837,133DilutednetincomepershareattributabletoSohu.
comInc.
$3.
57$4.
06$0.
90SharesusedincomputingdilutednetincomepershareattributabletoSohu.
comInc.
38,96939,11738,919Theaccompanyingnotesareanintegralpartoftheseconsolidatednancialstatements.
F-5SOHU.
COMINC.
CONSOLIDATEDSTATEMENTSOFCASHFLOWS(inthousands)YearEndedDecember31,200920082007Cashowsfromoperatingactivities:Netincome$176,435$158,586$34,884Adjustmentstoreconcilenetincometonetcashprovidedbyoperatingactivities:Depreciation16,60713,4859,801Share-basedcompensationexpense17,31910,6208,786Amortizationofintangibleassetsandotherassets1,8103,1593,082Lossesondisposalofxedassets2901,269837Provisionforallowancefordoubtfulaccounts1,1585791,719Excesstaxbenetsfromshare-basedpaymentarrangements(3,249)—(247)Others—(241)(793)Changesincurrentassetsandliabilities:Accountsreceivable(10,922)(8,653)(1,977)Prepaidandothercurrentassets15,905(19,630)(81)Accountspayable2631,6721,490Taxpayable5,25512,0423,286Accruedliabilitiestosuppliersandagents8,0499,31311,440Receiptsinadvanceanddeferredrevenue5,49817,3077,949Otheraccruedliabilities60318,85011,249Netcashprovidedbyoperatingactivities235,021218,35891,425Cashowsfrominvestingactivities:Purchaseofxedassets(78,915)(26,373)(53,588)Purchaseofintangibleassetsandotherassets(3,401)(2,301)(2,218)Decreaseofrestrictedcash2,6711,653450Acquisitions,netofcashacquired——(1,117)Proceedsfrommaturitiesofmarketabledebtsecurities——5,000Proceedsfromdisposalofinterestinanassociate——1,731Netcashusedininvestingactivities(79,645)(27,021)(49,742)Cashowsfromnancingactivities:Issuanceofcommonstock4,14013,10310,785Repurchaseofcommonstock(40,007)(19,997)—Redemptionofzerocouponconvertibleseniornotes—(6)(58,524)Cashcontributionreceivedfromanoncontrollinginterest—427—Excesstaxbenetsfromshare-basedpaymentarrangements3,249—247ProceedsfromChangyou'sinitialpublicoffering128,340——Otherproceedsrelatingtonancingactivities1,087——Otherpaymentsrelatingtonancingactivities(3,135)(917)—Netcashprovidedby(usedin)nancingactivities93,674(7,390)(47,492)Effectofexchangeratechangeoncashandcashequivalents3077,7723,759Netincrease(decrease)incashandcashequivalents249,357191,719(2,050)Cashandcashequivalentsatbeginningofyear314,425122,706124,756Cashandcashequivalentsatendofyear$563,782$314,425$122,706Supplementalcashowdisclosures:Cashpaidforincometaxes23,3534,4841,292Non-cashnancingactivities:Issuanceofcommonstockinconnectionwithconversionofzerocouponconvertibleseniornotes——1,250Bartertransactions691519397Theaccompanyingnotesareanintegralpartoftheseconsolidatednancialstatements.
F-6SOHU.
COMINC.
CONSOLIDATEDSTATEMENTOFCHANGESINEQUITYYearEndedDecember31,2009(inthousands)Sohu.
comInc.
Shareholders'EquityTotalComprehensiveIncomeCommonstockAdditionalPaid-inCapitalTreasurystockAccumulatedOtherComprehensiveIncomeRetainedEarningsNoncontrollingInterestBeginningbalance$391,094$—$43$201,196$(74,683)$21,349$238,041$5,148Issuanceofcommonstock4,140——4,140————Repurchaseofcommonstock(40,007)40,007)———Compensatoryshare-basedawards17,319——8,095———9,224Excesstaxbenetsfromshare-basedpaymentarrangements3,069——3,069————Comprehensiveincome:Netincome176,435176,435————147,83328,602Othercomprehensiveincome:Foreigncurrencytranslationadjustment351351———153—198Totalothercomprehensiveincome351351Totalcomprehensiveincome176,786$176,786RecognitionofchangeinSohu'seconomicinterestinChangyou125,375—100,552———24,823Endingbalance$677,776$43$317,052$(114,690)$21,502$385,874$67,995Theaccompanyingnotesareanintegralpartoftheseconsolidatednancialstatements.
F-7SOHU.
COMINC.
CONSOLIDATEDSTATEMENTOFCHANGESINEQUITYYearEndedDecember31,2008(inthousands)Sohu.
comInc.
Shareholders'EquityTotalComprehensiveIncomeCommonstockAdditionalPaid-inCapitalTreasurystockAccumulatedOtherComprehensiveIncomeRetainedEarningsNoncontrollingInterestBeginningbalance$218,904$—$42$182,225$(54,686)$11,912$79,404$7Contributionsreceivedfromanoncontrollinginterestshareholder427427Issuanceofcommonstock13,104—113,103————Repurchaseofcommonstock(19,997)19,997)———Compensatoryshare-basedawards10,620——5,868———4,752Comprehensiveincome:Netincome158,586158,586————158,637(51)Othercomprehensiveincome:Foreigncurrencytranslationadjustment9,4509,450———9,437—13Totalothercomprehensiveincome9,4509,450Totalcomprehensiveincome168,036$168,036Endingbalance$391,094$43$201,196$(74,683)$21,349$238,041$5,148Theaccompanyingnotesareanintegralpartoftheseconsolidatednancialstatements.
F-8SOHU.
COMINC.
CONSOLIDATEDSTATEMENTOFCHANGESINEQUITYYearEndedDecember31,2007(inthousands)Sohu.
comInc.
Shareholders'EquityTotalComprehensiveIncomeCommonstockAdditionalPaid-inCapitalTreasurystockAccumulatedOtherComprehensiveIncomeRetainedEarningsNoncontrollingInterestBeginningbalance$156,016$—$41$161,033$(54,686)$5,102$44,473$53Issuanceofcommonstock12,035—112,034————Compensatoryshare-basedawards8,786——8,786————Excesstaxbenetsfromshare-basedpaymentarrangements372——372————Comprehensiveincome:Netincome34,88434,884————34,931(47)Othercomprehensiveincome:Netunrealizedgainsonmarketabledebtsecurities5858———58——Foreigncurrencytranslationadjustment6,7536,753———6,752—1Totalothercomprehensiveincome6,811$6,811Totalcomprehensiveincome41,69541,695Endingbalance$218,904$42$182,225$(54,686)$11,912$79,404$7Theaccompanyingnotesareanintegralpartoftheseconsolidatednancialstatements.
F-91.
OrganizationandNatureofOperationsSohu.
comInc.
("Sohu"or"theCompany"),aDelawarecorporationorganizedin1996,isaleadingInternetcompanyprovidingcomprehensiveonlineproductsandservicesinthePeople'sRepublicofChina(the"PRC"or"China").
TheCompany,togetherwithitswholly-ownedandmajority-ownedsubsidiariesandvariableinterestentities(collectivelythe"SohuGroup")mainlyoffersadvertisingservices(throughbrandadvertisingandsponsoredsearch),onlinegameservices(viaChangyou.
comLimited)andwirelessservicesthroughitsInternetsites:sohu.
com,17173.
com,focus.
cn,chinaren.
com,sogou.
comandchangyou.
com.
BrandadvertisingandonlinegamearetwocorebusinessesoftheSohuGroup.
ThebrandadvertisingbusinessprovidesadvertisementsontheSohuGroup'sportalmatrixtoadvertiserswhowishtobuilduptheirbrandawarenessonline.
TheonlinegamebusinessisconductedbyoneofSohu'smajority-ownedsubsidiariesChangyou.
comLimited("Changyou"),whichcurrentlyoperatesthreemassivelymulti-playeronlinerole-playinggames("MMORPGs"),TianLongBaBu("TLBB"),BladeOnline("BO")andBladeHero2("BH2",whichisthesequeltoBO).
TLBBisChangyou'srstin-housedevelopedMMORPGandhasbeenoneofthemostpopularonlinegamesinChina.
InordertofocusmoreontheSohuGroup'scorebusinessesandtoprovideChangyouwiththeplatformandresourcestobecomealeadingcompanyintheMMORPGindustryandtocompeteheadtoheadwithrsttierplayers,ChangyoucompleteditsinitialpublicofferingontheNasdaqGlobalSelectMarketonApril7,2009,tradingunderthesymbol"CYOU".
AfterChangyou'soffering,SohucontinuestoconsolidateChangyouasitscontrollingshareholder,butrecognizesnoncontrollinginterestreectingthesharesheldbytheshareholdersotherthanSohuinSohu'sconsolidatednancialstatements.
AsofDecember31,2009,26%oftheeconomicinterestinChangyouwererecognizedasnoncontrollinginterestinSohu'sconsolidatednancialstatements.
SeeNote2—ChangyouTransactions—Sohu'sShareholdinginChangyou,andNote3—SummaryofSignicantAccountingPolicies—BasisofConsolidationandRecognitionofNoncontrollingInterest.
2.
ChangyouTransactionsShareAwardtoTaoWang,ChiefExecutiveOfcerofChangyouInJanuary2008,SohucommunicatedtoandagreedwithTaoWang,whoisnowthechiefexecutiveofcerofChangyou,togranthim700,000ordinarysharesand800,000restrictedordinaryshares,inlieuofhiscontingentrightinBeijingFireFoxDigitalTechnologyCo.
,Ltd.
("BeijingFireFox"),whichwasoneofSohu'ssubsidiariesdevotedtothedevelopmentofTLBB.
The800,000restrictedordinarysharesweresubjecttoafour-yearvestingperiodcommencingFebruary1,2008.
Inaddition,TaoWangwouldnotbeentitledtoparticipateinanydistributionsonChangyoushares,whetherornotvested,untiltheearlierofChangyou'scompletionofaninitialpublicofferingorFebruary2012,andinanyevententitlementtodistributionswouldbesubjecttovestingoftheshares.
InJanuary2009,underChangyou's2008ShareIncentivePlandescribedbelow,Changyouissued700,000ofitsClassBordinarysharesand800,000ofitsClassBrestrictedordinarysharestoTaoWangthroughProminenceInvestmentsLtd.
("Prominence"),whichisanentitydeemedunderapplicableSecuritiesandExchangeCommission("SEC")rulestobebeneciallyownedbyTaoWang.
InFebruary2009,200,000ClassBrestrictedordinarysharesheldbyProminencebecamefullyvested.
Uponthisvesting,thenumberofClassBordinarysharesheldbeneciallybyTaoWangincreasedto900,000sharesandthenumberofClassBrestrictedordinarysharesheldbeneciallybyTaoWangdecreasedto600,000shares.
SOHU.
COMINC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTSF-10InMarch2009,Changyoueffectedaten-for-onesharesplitthatresultedintheaforementioned900,000ClassBordinarysharesand600,000ClassBrestrictedordinarysharesbecoming9,000,000ClassBordinarysharesand6,000,000ClassBrestrictedordinaryshares,respectively.
AsofDecember31,2009,thenumberofClassBordinarysharesandClassBrestrictedordinarysharesheldbyTaoWangthroughProminenceremainedunchanged.
Changyou's2008ShareIncentivePlanOnDecember31,2008,Changyoureserved2,000,000ofitsordinaryshares,whichincluded1,774,000ClassBordinarysharesand226,000ClassAordinaryshares,forissuancetoitsexecutiveofcersandkeyemployeesasincentivecompensationunderChangyou's2008ShareIncentivePlan.
Theaforementioned700,000ordinarysharesand800,000restrictedordinarysharesgrantedtoTaoWangthroughProminencewereunderthisincentiveplan.
InMarch2009,the2,000,000reservedordinarysharesweresubjecttoaten-for-onesharespliteffectedbyChangyouandbecame20,000,000ordinaryshares.
InitialPublicOfferingofChangyouOnApril7,2009,ChangyoucompleteditsinitialpublicofferingontheNasdaqGlobalSelectMarket,tradingunderthesymbol"CYOU".
TheinitialpublicofferingconsistedofAmericandepositaryshares("ADSs"),witheachADSrepresentingtwoClassAordinaryshares.
Changyou'sordinarysharesaredividedintoClassAordinarysharesandClassBordinaryshares.
HoldersofClassAordinarysharesandholdersofClassBordinaryshareshavethesamerightsinChangyou,withtheexceptionofvotingandconversionrights.
EachClassAordinaryshareisentitledtoonevoteonallmatterssubjecttoashareholdervote,andeachClassBordinaryshareisentitledtotenvotesonallmatterssubjecttoashareholdervote.
EachClassBordinaryshareisconvertibleintooneClassAordinaryshareatanytimeattheelectionoftheholder.
ClassAordinarysharesarenotconvertibleintoClassBordinarysharesunderanycircumstances.
Attheclosingoftheinitialpublicoffering,Changyouissuedandsold7,500,000ClassAordinarysharesrepresentedby3,750,000ADSs,andSohu,throughitsindirectlywholly-ownedsubsidiarySohu.
com(Game)Limited("SohuGame"),sold9,750,000ClassAordinarysharesrepresentedby4,875,000ADSs,including2,250,000ClassAordinarysharesrepresentedby1,125,000ADSssoldpursuanttotheexerciseoftheunderwriters'over-allotmentoption.
Subsequenttotheoffering,Changyouhas102,500,000ClassAandClassBordinarysharesissuedandoutstanding.
Thoseoutstandingsharesconsistof(1)70,250,000ClassBordinarysharesheldbySohuthroughSohuGame;(2)15,000,000ClassBordinarysharesheldbyTaoWangthroughProminence,including6,000,000ClassBrestrictedordinarysharesthatwerenotvestedasofthecompletionoftheoffering;and(3)17,250,000ClassAordinarysharesheldbypublicshareholders.
ProceedstoChangyouandSohuGamefromthisinitialpublicofferingwereapproximately$55.
8millionand$72.
5million,respectively,fortotalproceedsofapproximately$128.
3million,afterdeductingunderwritingdiscountsandcommissionsbutbeforedeductingofferingexpenses.
Afterdeductingofferingexpenses,netproceedstoChangyouandSohuGamewereapproximately$54.
7millionand$70.
7million,respectively,fortotalnetproceedsofapproximately$125.
4million.
F-11GainonInitialPublicOfferingofChangyouInthesecondquarterof2009,asaresultofthecompletionofChangyou'sinitialpublicoffering,Sohurecognizedaone-timegainof$100.
6millionintheshareholders'equitysectionofSohu'sconsolidatedbalancesheets,toreectthenetproceedsSohureceivedfromtheinitialpublicofferingandtheincrementalchangeinSohu'seconomicinterestinChangyouimmediatelybeforeandaftertheoffering.
Sohu'sShareholdinginChangyouShareholdingandControlFollowingthecompletionoftheofferingandthroughtheyearendedDecember31,2009,610,000ClassBrestrictedshareunitsgrantedtoChangyou'scertainkeyemployeeswerevestedandsettledinClassBordinarysharesandthenconvertedintoClassAordinaryshares.
Hence,asofDecember31,2009,Changyouhas103,110,000ClassAandClassBordinarysharesissuedandoutstanding.
Theseoutstandingsharesconsistof(1)70,250,000ClassBordinarysharesheldbySohuthroughSohuGame;(2)15,000,000ClassBordinarysharesheldbyTaoWangthroughProminence,including6,000,000ClassBrestrictedordinarysharesthatwerenotvested;(3)17,250,000ClassAordinarysharesheldbypublicshareholders;and(4)610,000ClassAordinarysharesheldbycertainkeyemployeesofChangyou,whichwereconvertedfromClassBordinarysharesthatweresettledfromClassBrestrictedshareunitsgrantedandvestedtothoseemployees.
AsofDecember31,2009,treatingTaoWang's6,000,000ClassBrestrictedordinarysharesasownedbyTaoWang,Sohuheldapproximately68%ofthecombinedtotalofChangyou'soutstandingClassAandClassBordinarysharesandcontrolledapproximately81%ofthetotalvotingpowerinChangyou.
Asaresult,SohuhadthepowertoelecttheentireboardofdirectorsofChangyouanddeterminetheoutcomeofallmatterssubmittedtoashareholdervote.
AsChangyou'scontrollingshareholder,SohuwillcontinuetoconsolidateChangyoubutrecognizenoncontrollinginterestreectingthesharesheldbyshareholdersotherthanSohu,seeNote3—SummaryofSignicantAccountingPolicies—BasisofConsolidationandRecognitionofNoncontrollingInterest.
EconomicInterestBecauseTaoWang's6,000,000ClassBrestrictedordinarysharesaresubjecttoforfeituretoSohuuntiltheybecomevested,thosesharesaretreatedasownedbySohu,ratherthanasownedbyTaoWang,inthenoncontrollinginterestlineitemsinSohu'sconsolidatednancialstatements.
Asaresult,Sohuwastreatedasholdingapproximately74%oftheeconomicinterestsinChangyouasofDecember31,2009.
Accordingly,shareholdersotherthanSohuweretreatedasholdingtheremaining26%oftheeconomicinterestwhichwasrecognizedasnoncontrollinginterestinSohu'sconsolidatednancialstatements.
SeeNote3—SummaryofSignicantAccountingPolicies—BasisofConsolidationandRecognitionofNoncontrollingInterest.
Sohu'seconomicinterestinChangyou,aswellasthenoncontrollinginterestrecognizedforChangyouinSohu'sconsolidatednancialstatements,willcontinuetochangeastheClassBrestrictedordinarysharesgrantedtoTaoWang,andtherestrictedshareunitsgrantedtoChangyou'sexecutiveofcersotherthanTaoWangandtoitskeyemployeesbecomevestedandsettled.
DilutiveImpactThroughDecember31,2009,underChangyou's2008ShareIncentivePlan,Changyouhasgranted9,000,000ClassBordinaryshares(including2,000,000ClassBrestrictedordinarysharesvestedinFebruary2009)and6,000,000ClassBrestrictedordinarysharestoTaoWangthroughProminenceand4,396,000ClassAandF-12ClassBrestrictedshareunits(settleablebyChangyou'sissuanceofClassAordinarysharesandClassBordinaryshares,respectively)toitsexecutiveofcersotherthanTaoWangandtoitskeyemployees.
AsofDecember31,2009,thenumberofChangyou'soutstandingrestrictedshareunitsdecreasedfrom4,396,000to3,762,000,asaresultofforfeituresandvestingandsettlementofrestrictedshareunits.
SeeNote21—Sohu.
comInc.
Shareholders'Equity—ChangyouShareAwards.
BecausenoClassAordinarysharesorClassBordinaryshareswillbeissuedwithrespecttotheserestrictedshareunitsuntiltherestrictedshareunitsarevestedandsettled,theunvestedrestrictedshareunitsandvestedrestrictedshareunitsthathavenotyetbeensettledarenotincludedasoutstandingsharesofChangyouandhavenoimpactonSohu'sbasicnetincomepershare.
Nevertheless,theyhaveadilutiveimpactonSohu'sdilutednetincomepershare.
InthecalculationofSohu'sdilutednetincomepershare,Sohu'seconomicinterestinChangyouiscalculatedtreatingallofChangyou'sexistingunvestedrestrictedshares,unvestedrestrictedshareunits,andvestedrestrictedshareunitsthathavenotyetbeensettledasvestedandissuedbyChangyou.
SeeNote23—NetIncomeperShare.
3.
SummaryofSignicantAccountingPoliciesAccountingStandardsTheconsolidatednancialstatementshavebeenpreparedonahistoricalcostbasistoreectthenancialpositionandresultsofoperationsoftheCompanyinaccordancewithGenerallyAcceptedAccountingPrinciplesintheUnitedStates("U.
S.
GAAP").
UseofEstimationThepreparationoftheconsolidatednancialstatementsrequirestheCompanytomakeestimatesandjudgmentsthataffectthereportedamountsofassets,liabilities,revenuesandexpenses,andrelateddisclosureofcontingentassetsandliabilities.
Onanongoingbasis,theCompanyevaluatestheestimatesbasedonhistoricalexperienceandonvariousotherassumptionsthatarebelievedtobereasonableunderthecircumstances,theresultsofwhichformthebasisformakingjudgmentsaboutthecarryingvaluesofassetsandliabilitiesthatarenotreadilyapparentfromothersources.
Actualresultsmaydifferfromtheseestimatesunderdifferentassumptionsorconditions.
TheCompanybelievestherevenuerecognition,theshare-basedcompensationexpenserecognition,incometaxesanduncertaintaxpositions,recognitionofnoncontrollinginterest,computationofnetincomepershare,allowancefordoubtfulaccounts,assessmentofimpairmentforlong-livedassetsandgoodwill,anddeterminationoffunctionalcurrenciesrepresentcriticalaccountingpoliciesthatreectthemoresignicantjudgmentsandestimatesusedinthepreparationoftheconsolidatednancialstatements.
BasisofConsolidationandRecognitionofNoncontrollingInterestTheconsolidatednancialstatementsincludetheaccountsofSohuanditswholly-ownedandmajority-ownedsubsidiariesandvariableinterestentities("VIEs").
Allintercompanytransactionshavebeeneliminated.
Certaincomparativegureshavebeenreclassiedtoconformtothecurrentpresentation.
ForSohu'smajority-ownedsubsidiariesandVIEs,noncontrollinginterestisrecognizedtoreecttheportionoftheirequitywhichisnotattributable,directlyorindirectly,toSohu.
AsSohuisChangyou'scontrollingshareholder,Changyou'snancialresultshavebeenconsolidatedwiththoseofSohuforallperiodspresented.
ToreecttheeconomicinterestinChangyouheldbytheshareholdersotherthanSohu,Changyou'sresultsofoperationsattributabletotheseshareholdersarerecordedasnoncontrollinginterestinSohu'sconsolidatedstatementsofoperations,andChangyou'scumulativeresultsofoperationsattributabletotheseshareholders,alongwithitschangesinshareholders'equityandadjustmentforshare-basedcompensationexpenseinF-13relationtothoseshare-basedawardswhichareunvestedandvestedbutnotyetsettled,arerecordedasnoncontrollinginterestinSohu'sconsolidatedbalancesheets.
SeeNote22—NoncontrollingInterest.
FunctionalCurrencyandForeignCurrencyTranslationFunctionalCurrencyAnentity'sfunctionalcurrencyisthecurrencyoftheprimaryeconomicenvironmentinwhichitoperates,normallythatisthecurrencyoftheenvironmentinwhichitprimarilygeneratesandexpendscash.
Management'sjudgmentisessentialtodeterminethefunctionalcurrencybyassessingvariousindicators,suchascashows,salespriceandmarket,expenses,nancingandintercompanytransactionsandarrangements.
ThefunctionalcurrencyofSohu.
comInc.
isU.
S.
dollar.
ThefunctionalcurrencyoftheCompany'ssubsidiariesandVIEsinthePRC,UnitedKingdomofGreatBritain,MalaysiaandKoreaareRenminbi("RMB"),GreatBritainPound,MalaysianRinggitandKoreanWon,respectively,whilethefunctionalcurrencyoftheCompany'ssubsidiariesinU.
S.
andHongKongisU.
S.
dollar.
ForeignCurrencyTranslationAssetsandliabilitiesoftheCompany'sChina-basedsubsidiariesandVIEsaretranslatedintoU.
S.
dollars,theCompany'sreportingcurrency,attheexchangerateineffectatthebalancesheetsdateandrevenuesandexpensesaretranslatedattheaverageexchangeratesineffectduringthereportingperiod.
Foreigncurrencytranslationadjustmentsarenotincludedindeterminingnetincomefortheperiodbutareaccumulatedinaseparatecomponentofequityintheconsolidatedbalancesheets.
SegmentReportingInaccordancewithSohuGroup'sinternalnancialreportingstructure,theCompanyhasdeterminedthatthebusinesssegmentsthatconstituteitsprimaryreportingsegmentsarebrandadvertising,sponsoredsearch,onlinegameandwireless.
Priorto2009,theCompanydisclosedsegmentoperatingperformanceonlythroughthegrossprotslineitem,anddidnotallocateanyoperatingexpensesorassetstothosesegmentsasmanagementdidnotusethisinformationtomeasuretheperformanceoftheoperatingsegments.
CommencingJanuary1,2009,thechiefoperatingdecisionmaker("CODM")beganreviewingcertainadditionalinformationfortheonlinegamesegment.
Accordingly,theCompanyhasadjustedtheonlinegamesegmentoperatingperformancemeasurementdisclosurestoincludeincomefromoperationsandthemainsegmentassetsfortheonlinegamesegment.
Fortheremainingsegments,theoperatingperformancemeasurementsareunchanged.
Consistentwithpriorperiods,someitems,suchasshare-basedcompensationexpense,operatingexpenses,otherincomeandexpense,andincometaxexpense,arenotreviewedbytheCODM.
Theseitemsaredisclosedinthesegmentinformationforreconciliationpurposesonly.
TheCompanyhasrestatedthepresentationofitssegmentsforpriorperiodstoconformtothecurrentpresentation,anditwillrestateallcomparableperiodshereafter.
RevenueRecognitionTheCompanyrecognizesrevenuewhenpersuasiveevidenceofanarrangementexists,deliveryhasoccurred,thesalespriceisxedordeterminable,andcollectabilityisreasonablyassured.
F-14AdvertisingRevenuesAdvertisingrevenuesincluderevenuesfrombrandadvertisingservicesandsponsoredsearchservices.
Advertisingrevenueisrecognizedafterdeductingagentrebatesandapplicablebusinesstax.
TheCompanydoesnotenterintoadvertising-for-advertisingbartertransactions.
BrandAdvertisingRevenuesForbrandadvertisingrevenues,acontractissignedtoestablishthexedpriceandadvertisingservicestobeprovided.
Basedonthecontracts,theCompanyprovidesadvertisementplacementsonitsdifferentWebsitechannelsand/orindifferentformats,includingbutnotlimitedtobanners,links,logos,buttons,richmediaandcontentintegration.
Forbrandadvertisingrevenuerecognition,priortoenteringintocontracts,theCompanymakesacreditassessmentofthecustomertoassessthecollectabilityofthecontract.
Forthosecontractsforwhichitscollectabilitywasassessedasreasonablyassured,theCompanyrecognizesrevenueratablyovertheperiodduringwhichtheadvertisingserviceswereprovidedandwhenallrevenuerecognitioncriteriaweremet.
Forthosecontractsforwhichitscollectabilitywasassessedasnotreasonablyassured,theCompanyrecognizesrevenueonlywhenthecashwasreceivedandallrevenuerecognitioncriteriaweremet.
TheCompanytreatsallelementsofadvertisingcontractsasasingleunitofaccountingforrevenuerecognitionpurposes.
Asonekindofbrandadvertisingservices,sponsorshipserviceissimilartootherbrandadvertisingservicesbutgenerallywithlargeramountandforalongercontractualperiod.
SponsorshipservicemayallowadvertiserstosponsoraparticularareaonWebsitesoftheCompany,andmayincludebrandafliationservicesand/oralargervolumeofservices,andmayrequiresomeexclusivityorpremierplacements.
Sponsorshipadvertisementrevenuesarenormallyrecognizedonastraight-linebasisoverthecontractperiod,providedobligationsunderthecontracthavebeenmetandallrevenuerecognitioncriteriahavebeenmet.
SponsoredSearchRevenuesSponsoredsearchservicesmainlyincludepriorityplacementsservicesandpay-for-clickservices.
ThepriorityplacementsservicesareplacedintheCompany'ssearchdirectoryandarenormallyprovidedforaxedfeeovertheserviceperiodofthecontracts.
Pay-for-clickservicesmainlyconsistofdisplayingthetext-basedlinksoftheCompany'sadvertisersontheCompany'sWebsitesanditsWebsiteAlliancenetwork.
Sponsoredsearchcontractsarenormallyforrelativelysmallamountsandaresignedwithsmallandmedium-sizedenterprises.
Revenueforthepriorityplacementsservicesisnormallyrecognizedonastraight-linebasisoverthecontractperiodprovidedtheCompany'sobligationsunderthecontracthavebeenmetandallrevenuerecognitioncriteriahavebeenmet.
Revenueforpay-for-clickservicesisrecognizedonaperclickbasiswhentheusersclickonthedisplayedlinks.
Thepriorityofthedisplayoftext-basedlinksisbasedonthebiddingpriceofdifferentadvertisers.
OnlineGameRevenuesGameOperationRevenuesOnlinegamerevenuesfromChangyou'sMMORPGoperationsareearnedthroughprovidingMMORPGstoplayerspursuanttotheitem-basedrevenuemodel.
Undertheitem-basedrevenuemodel,thebasicgameplayfunctionsarefreeofchargeandplayersarechargedforpurchasesofin-gamevirtualitems.
PriortoDecember2006,Changyou'sMMORPGswereoperatedunderthetime-basedrevenuemodel,wherebyplayersarechargedbasedonthetimetheyspendplayinggames.
F-15GameoperationsrevenuesarecollectedthroughthesaleofChangyou'sprepaidcards,whichitsellsinbothvirtualandphysicalformstothird-partydistributors.
Forgameswhichusetheitem-basedrevenuemodel,proceedsfromsaleofprepaidcardsaredeferredwhenreceivedandrevenueisrecognizedovertheestimatedlivesofthevirtualitemspurchasedorasthevirtualitemsareconsumed.
Ifdifferentassumptionswereusedinderivingtheestimatedlivesofthevirtualitems,thetiminginwhichChangyourecordsitsrevenueswouldbeimpacted.
Forgameswhichusethetime-basedrevenuemodel,proceedsfromthesaleofprepaidcardsfromdistributorsaredeferredwhenreceivedandrevenueisrecognizedbasedupontheactualusageoftimeunitsbythegameplayers.
Revenuesarerecordednetofbusinesstax,discountsandrebatestodistributors.
Underboththeitem-basedandthetime-basedrevenuemodels,proceedsreceivedfromsalesofprepaidcardsareinitiallyrecordedasreceiptsinadvancefromcustomersand,uponactivationorchargeoftheprepaidcards,aretransferredfromreceiptsinadvancefromcustomerstodeferredrevenues.
AsChangyoudoesnothavecontrolof,andgenerallydoesnotknow,theultimatesellingpriceoftheprepaidcardssoldbydistributors,netproceedsfromdistributorsformthebasisofrevenuerecognition.
Prepaidcardswillexpiretwoyearsafterthedateofcardproductioniftheyhaveneverbeenactivated.
Theproceedsfromtheexpiredgamecardsarerecognizedasrevenueuponexpirationofcards.
Incontrast,oncetheprepaidcardsareactivatedandcreditedtoaplayer'spersonalgameaccount,theywillnotexpireaslongasthepersonalgameaccountremainsactive.
Changyouisentitledtosuspendandcloseaplayer'spersonalgameaccountifithasbeeninactiveforaperiodof180consecutivedays.
Theunusedbalancesinaninactiveplayer'spersonalgameaccountarerecognizedasrevenueswhentheaccountissuspendedandclosed.
OverseasLicensingRevenuesChangyouentersintolicensingarrangementswithoverseaslicenseestooperateitsMMORPGsinothercountriesorterritories.
Theselicensingagreementsprovidetworevenuestreams,consistingofaninitiallicensefeeandamonthlyrevenue-basedroyaltyfeebasedonmonthlyrevenueandsalesfromancillaryproductsofthegames.
Theinitiallicensefeeisbasedonbothaxedamountandadditionalamountsreceivableuponachievingcertainsalestargets.
SinceChangyouisobligatedtoprovidepost-salesservicessuchastechnicalsupportandprovisionofupdatesandwhen-and-if-availableupgradestothelicenseesduringthelicenseperiod,theinitiallicensefeefromthelicensingarrangementisrecognizedasrevenueratablyoverthelicenseperiod.
Thexedamountoftheinitiallicensefeeisrecognizedratablyovertheremaininglicenseperiodfromthelaunchofthegameandtheadditionalamountisrecognizedratablyovertheremaininglicenseperiodfromthedatesuchadditionalamountiscertain.
Themonthlyrevenue-basedroyaltyfeeisrecognizedwhenearned,providedthatcollectabilityisreasonablyassured.
WirelessandOthersRevenuesTheCompany'swirelessandothersrevenuesaremainlyfromitswirelessbusiness.
Wirelessrevenuesarederivedfromawiderangeofwirelessproductsfocusedonentertainment,informationandcommunications,suchasshortmessagingservices("SMS"),RingBackTone("RBT"),WirelessApplicationProtocol("WAP"),multi-mediamessagingservices("MMS")andinteractivevoiceresponse("IVR").
TheCompanymainlyoffersnews,weatherforecasts,chatting,entertainmentinformation,mobilephoneringtones,andlogodownloadsandvariousothermobilerelatedservicestomobilephoneusersthroughcontractssignedwiththirdpartymobilenetworkoperators.
F-16Wirelessservicefeesarechargedonamonthlyorpermessage/downloadbasis.
Duetotechnicalissueswiththeoperator'snetwork,theCompanymightunabletocollectcertainwirelessservicefeesfromanoperatorincertaincircumstances.
Thisun-collectabilityisreferredtoasthe"failurerate",whichcanvaryfromoperatortooperator.
Wirelessrevenuesarerecognizedinthemonthinwhichtheserviceisperformed,providedthatnosignicantobligationsremain.
Torecognizewirelessrevenue,theCompanyreliesonChinamobilenetworkoperatorstoprovideitthebillingconrmationsfortheactualamountofservicestheyhavebilledtotheirmobilecustomers.
Attheendofeachreportingperiod,whenanoperatorhasnotprovidedtheCompanythemonthlybillingconrmations,theCompanyusesinformationgeneratedfromitsinternalsystemaswellasthehistoricaldatatoestimatethefailurerate,toestimatetheamountofcollectablewirelessservicefeesandtorecognizerevenue.
InthelaterperiodwhentheCompanygetstheactualbillingconrmation,itthenrecordatrue-upaccountingadjustment.
Generally,(i)within15to120daysaftertheendofeachmonth,theCompanyreceivesbillingconrmationsfromeachoftheoperatorsconrmingtheamountofwirelessservicechargesbilledtothatoperator'smobilephoneusersand(ii)within30to180daysafterdeliveringbillingconrmations,eachoperatorremitsthewirelessservicefees,netofitsservicefees,forthemonthtotheCompany.
Whethertorecordwirelessrevenuesusingthegrossornetmethodofreportingmustbedetermined.
Thedeterminationisbasedonanassessmentofvariousfactors;theprimaryfactorsarewhethertheCompanyisactingastheprincipalinofferingservicestothecustomerorasanagentinthetransaction,andthespecicrequirementofeachcontract.
Currently,theCompanyhastheprimaryresponsibilityforfulllmentandacceptabilityofthewirelessservices,andassuchamajorityofwirelessrevenuesarerecordedonagrossbasis.
TotheextenttheCompanyisactingasaprincipalinatransaction,thepaymentsreceivedarerecognizedasrevenueonagrossbasis,andtheamountsattributabletoservicesprovidedbymobilenetworkoperatorsandothervendorsascostsofrevenue.
TotheextenttheCompanyisactingasanagentinatransaction,thepaymentsreceivedlesscommissionandotherpaymentstothirdpartiesarerecognizedasrevenueonanetbasis.
WhethertheCompanyisservingasprincipaloragentinatransactionisjudgmentalinnatureandisdeterminedbyevaluatingtermsofthearrangement.
Therelatedcommissionsand/orotherpaymentstothirdpartiesarerecordedascostsorexpenses.
CostofRevenuesCostofAdvertisingRevenuesCostforadvertisingbusinessincludescostforbrandadvertisingbusinessandcostforsponsoredsearchbusiness.
Costofbrandadvertisingrevenuesprimarilyconsistsofcompensationandrelatedoverheadcostsforemployees,depreciationexpenses,contentandservicespurchases,bandwidthleasingcosts,andrevenuesharingpaymentstothirdparties.
Royaltiespaidtocontentprovidersareexpensedasincurredandincludedascostofrevenues.
Contractswithcontentprovidersgenerallyrangefromonetothreeyearsindurationandmaybeterminatedbyeitherpartyuponnotice.
Costofsponsoredsearchrevenuesprimarilyconsistsofdepreciationexpenses,bandwidthleasingcosts,paymentstoWebsiteAllianceandpersonnelcosts.
CostofOnlineGameRevenuesCostofonlinegamerevenuesprimarilyconsistsofsalaryandbenets,revenue-basedroyaltypaymentstothegamedevelopers,bandwidthleasingandcommunicationcosts,amortizationoflicensingfees,depreciationexpenses,andPRCbusinesstaxandvalueaddedtax("VAT")arosefromtransactionsbetweenChangyou'ssubsidiaryandVIE.
F-17CostofWirelessandOthersRevenuesCostofwirelessrevenuesprimarilyconsistsofcollectionchargesandtransmissionfeespaidtomobilenetworkoperators,paymentstothirdpartywirelessservicealliancesandcontentsuppliers,penalties,depreciationexpenses,andbandwidthleasingcosts.
ProductDevelopmentExpensesProductdevelopmentexpensesprimarilyconsistofpersonnel-relatedexpensesincurredfortheenhancementtoandmaintenanceoftheCompany'sWebsitesaswellascostsassociatedwithnewproductdevelopmentandenhancementforexistingproductsandservices.
Operating,classicationandorganizationoflistingsandenhancementexpensesoftheWebsiteareexpensedasincurred.
Signicantdirectcostsofmaterials,laborandservicesincurredduringtheapplicationdevelopmentstageofaprojectarecapitalized.
Share-basedCompensationExpenseShare-basedcompensationexpenseisforshareawards,includingordinaryshares,shareoptions,restrictedsharesandrestrictedshareunitsgrantedbySohu.
comInc.
andChangyou.
comLimitedtotheiremployeesanddirectors.
Share-basedcompensationexpenseisrecognizedascostsand/orexpensesintheconsolidatednancialstatementsbasedonthefairvaluesoftherelatedshareawardsontheirgrantdates.
ForshareawardsgrantedbySohu.
comInc.
,indeterminingthefairvalueofshareoptionsgranted,theBlack-Scholesvaluationmodelisapplied;indeterminingthefairvalueofrestrictedshareunitsgranted,thefairvalueoftheunderlyingsharesonthegrantdatesisapplied.
ForshareawardsgrantedbyChangyou.
comLimited,indeterminingthefairvalueoftheordinaryshares,restrictedsharesandrestrictedshareunitsgrantedin2008,theincomeapproach/discountedcashowmethodwithadiscountforlackofmarketabilityisappliedgiventhatthesharesunderlyingtheawardswerenotpubliclytradedatthetimeofgrant.
Indeterminingthefairvalueofrestrictedshareunitsgrantedin2009beforeChangyou'sinitialpublicoffering,thefairvalueoftheunderlyingshareswasdeterminedbasedonChangyou'sofferingpriceforitsinitialpublicoffering.
IndeterminingthefairvalueofrestrictedshareunitsgrantedafterChangyou'sinitialpublicoffering,thefairvalueoftheunderlyingsharesonthegrantdatesisapplied.
Share-basedcompensationexpensefortheordinarysharesgrantedisfullyrecognizedinthequarterduringwhichtheseordinarysharesaregranted.
Share-basedcompensationexpenseforshareoptions,restrictedsharesandrestrictedshareunitsgrantedisrecognizedonanacceleratedbasisovertherequisiteserviceperiod.
Thenumberofshare-basedawardsforwhichtheserviceisnotexpectedtoberenderedovertherequisiteperiodisestimated,andtherelatedcompensationexpenseisnotrecordedforthatnumberofawards.
Theassumptionsusedinshare-basedcompensationexpenserecognitionrepresentmanagement'sbestestimates,buttheseestimatesinvolveinherentuncertaintiesandtheapplicationofmanagementjudgment.
Iffactorschangeordifferentassumptionsareused,theshare-basedcompensationexpensecouldbemateriallydifferentforanyperiod.
Moreover,theestimatesoffairvaluearenotintendedtopredictactualfutureeventsorthevaluethatultimatelywillberealizedbyemployeeswhoreceiveequityawards,andsubsequenteventsarenotindicativeofthereasonablenessoftheoriginalestimatesoffairvaluemadebytheCompanyforaccountingpurposes.
F-18IncomeTaxesandUncertainTaxPositionsIncomeTaxesIncometaxesareaccountedforusinganassetandliabilityapproachwhichrequirestherecognitionofincometaxespayableorrefundableforthecurrentyearanddeferredtaxliabilitiesandassetsforthefuturetaxconsequencesofeventsthathavebeenrecognizedintheCompany'snancialstatementsortaxreturns.
Deferredincometaxesaredeterminedbasedonthedifferencesbetweenthenancialreportingandtaxbasisofassetsandliabilitiesandaremeasuredusingthecurrentlyenactedtaxratesandlaws.
Deferredtaxassetsarereducedbyavaluationallowance,ifbasedonavailableevidence,itisconsideredthatitismorelikelythannotthatsomeportionoforallofthedeferredtaxassetswillnotberealized.
UncertainTaxPositionsInordertoassessuncertaintaxpositions,theCompanyappliesamorelikelythannotthresholdandatwo-stepapproachforthetaxpositionmeasurementandnancialstatementrecognition.
Forthetwo-stepapproach,therststepistoevaluatethetaxpositionforrecognitionbydeterminingiftheweightofavailableevidenceindicatesthatitismorelikelythannotthatthepositionwillbesustained,includingresolutionofrelatedappealsorlitigationprocesses,ifany.
Thesecondstepistomeasurethetaxbenetasthelargestamountthatismorethan50%likelyofbeingrealizeduponsettlement.
NetIncomeperShareBasicnetincomepershareiscomputedusingtheweightedaveragenumberofcommonsharesoutstandingduringtheperiod.
Dilutednetincomepershareiscomputedusingtheweightedaveragenumberofcommonsharesand,ifdilutive,potentialcommonsharesoutstandingduringtheperiod.
Potentialcommonsharescomprisesharesissuableupontheexerciseofshare-basedawardsusingthetreasurystockmethodandsharesissuableupontheconversionofzerocouponconvertibleseniornotesusingif-convertedmethod.
Additionally,forpurposesofcalculatingdilutednetincomepershare,Sohu'sconsolidatednetincomeisadjustedforChangyou'snetincomemultipliedbythedifferencebetween:(a)thepercentageofthetotaleconomicinterestinChangyouheldbySohu,and(b)thepercentageoftheweightedaveragenumberofChangyousharesheldbySohutotheweightedaveragenumberofChangyouordinarysharesandsharesissuableupontheexerciseofshare-basedawards.
CashandCashEquivalentsTheCompanyconsidersallhighlyliquidinvestmentswithanoriginalmaturityofthreemonthsorlesswhenpurchasedtobecashequivalents.
Cashequivalentsarecomposedprimarilyoftimedepositsandinvestmentsinmoneymarketaccountsrecordedatcostwhichapproximatesfairvalue.
AccountsReceivable,netThecarryingvalueofaccountsreceivableisreducedbyanallowancethatreectstheCompany'sbestestimateoftheamountsthatwillnotbecollected.
TheCompanymakesestimationsforthecollectabilityofaccountsreceivable.
Inestimatingthegeneralallowance,manyfactorsareconsideredincludingbutnotlimitedtoreviewingdelinquentaccountsreceivable,performingaginganalysesandcustomercreditanalyses,analyzinghistoricalbaddebtrecordsandcurrenteconomictrends.
AdditionalallowanceforspecicdoubtfulaccountsmightbemadeifthenancialconditionsoftheCompany'scustomersormobilenetworkoperatorsdeteriorateorthemobilenetworkoperatorsareunabletocollectfeesfromtheirendcustomers,resultingintheirinabilitytomakepaymentsduetotheCompany.
F-19InvestmentsinMarketableDebtSecuritiesTheCompanymayinvestitsexcesscashincertainmarketabledebtsecuritiesofhigh-qualitycorporateissuers.
TheCompany'smarketabledebtsecuritiesareclassiedasavailable-for-saleandarereportedatfairmarketvalueswiththeunrealizedgainsorlossesrecordedasaccumulatedothercomprehensiveincomeinshareholders'equity.
Additionally,theCompanyassesseswhetheranother-than-temporaryimpairmentlossoninvestmentsinmarketabledebtsecuritieshasoccurredduetodeclinesinfairvalueorothermarketconditions.
Declinesinfairvaluesthatareconsideredasother-than-temporaryarerecordedasanimpairmentofthemarketabledebtsecuritiesintheconsolidatedstatementsofoperations.
Investmentsinmarketabledebtsecuritieswithoriginalmaturitiesgreaterthantwelvemonthswhenpurchasedareconsideredlong-terminvestments.
Long-terminvestmentsinmarketablesecuritieswithmaturitieslessthantwelvemonthsfromthebalancesheetdatearerecordedascurrentportionoflong-terminvestmentsinmarketabledebtsecurities.
FairValueofFinancialInstrumentsThecarryingvalueoftheCompany'snancialinstruments,includingcashandcashequivalents,accountsreceivable,marketablesecurities,accountspayableandaccruedliabilities,approximatesthefairvaluebecauseoftheirgenerallyshortmaturities.
AssociatesAssociatesareentitiesoverwhichtheCompanyhassignicantinuencebutdoesnotcontrol.
Investmentsinassociatesareaccountedforbytheequitymethod.
Underthismethod,theCompany'sshareofthepost-acquisitionprotsorlossesofassociatesisrecognizedintheCompany'sconsolidatedstatementsofoperations;andtheCompany'sshareofpost-acquisitionmovementsinequityofassociatesisrecognizedinequityintheCompany'sconsolidatedbalancesheets.
UnrealizedgainsontransactionsbetweentheCompanyanditsassociatesareeliminatedtotheextentoftheCompany'sinterestintheassociates.
Unrealizedlossesarealsoeliminatedunlessthetransactionprovidesevidenceofanimpairmentoftheassettransferred.
WhentheCompany'sshareoflossesinanassociateequalsorexceedsitsinterestintheassociates,theCompanydoesnotrecognizefurtherlosses,unlesstheCompanyhasincurredobligationsormadepaymentsonbehalfoftheassociates.
FixedAssetsFixedassetscomprisecomputerequipmentandhardware,ofcebuilding,investmentproperties,leaseholdimprovements,vehiclesandofcefurniture.
Fixedassetsarerecordedatcostlessaccumulateddepreciationwithnoresidualvalue.
Depreciationiscomputedusingthestraight-linemethodovertheirestimatedusefulliveslistedbelow.
FixedassetsEstimatedusefullives(years)Computerequipmentandhardware4Ofcebuilding47Investmentproperties47LeaseholdimprovementsLesseroftermoftheleaseortheestimatedusefullivesoftheassetsVehicles10Ofcefurniture5Expenditureformaintenanceandrepairsisexpensedasincurred.
F-20Thegainorlossonthedisposalofxedassetsisthedifferencebetweenthenetsalesproceedsandthecarryingamountoftherelevantassetsandisrecognizedinoperatingexpensesintheconsolidatedstatementofoperations.
GoodwillGoodwillrepresentstheexcessofthepurchasepriceoverthefairvalueoftheidentiableassetsandliabilitiesacquiredasaresultoftheCompany'sacquisitionsofinterestsinitssubsidiariesandVIEs.
Goodwillisnotdepreciatedoramortizedbutistestedforimpairmentatthereportingunitlevel(businesssegment).
Goodwillisnotdepreciatedoramortizedbutistestedforimpairmentatreportingunitlevelonanannualbasis,andbetweenannualtestswhenaneventoccursorcircumstanceschangethatcouldindicatethattheassetmightbeimpaired.
Theimpairmenttestconsistsofacomparisonofthefairvalueofgoodwillwithitscarryingvalue.
Applicationofagoodwillimpairmenttestrequiressignicantmanagementjudgment,includingtheidenticationofreportingunits,assigningassetsandliabilitiestoreportingunits,assigninggoodwilltoreportingunits,anddeterminingthefairvalueofeachreportingunit.
Thejudgmentinestimatingthefairvalueofreportingunitsincludesestimatingfuturecashows,determiningappropriatediscountratesandmakingotherassumptions.
Changesintheseestimatesandassumptionscouldmateriallyaffectthedeterminationoffairvalueforeachreportingunit.
AnyimpairmentlossesrecordedinthefuturecouldhaveamaterialadverseimpactontheCompany'snancialconditionandresultsofoperations.
IntangibleAssetsIntangibleassetsprimarilycomprisecomputersoftware,domainnames,trademarks,marketingrights,operatingrightsforlicensedgamesandcustomerlistspurchasedfromunrelatedthirdparties.
Intangibleassetsarerecordedatcostlessaccumulatedamortizationwithnoresidualvalue.
Amortizationofintangibleassetsiscomputedusingthestraight-linemethodovertheestimatedusefullives.
Theweightedaverageamortizationperiodforintangibleassetsisveyears.
OtherAssetsOtherassetsprimarilyincludeprepaidcontentfees,prepaidlicensefeesandrentaldeposits.
TheCompanyamortizesthecontentfeesandlicensefeesoverthetermsoftherelatedcontracts.
ImpairmentofLong-livedAssetsTheCompany'slong-livedassetsincludexedassets,intangibleassetsandotherassets.
Thecarryingvaluesoflong-livedassetsarereviewedforimpairmentwhenevereventsorchangesincircumstancesindicatethatthecarryingvalueofanassetmaynotberecoverable.
Basedontheexistenceofoneormoreindicatorsofimpairment,theCompanymeasuresanyimpairmentoflong-livedassetsusingtheprojecteddiscountedcashowmethod.
TheestimationoffuturecashowsanddiscountraterequiresignicantmanagementjudgmentbasedontheCompany'shistoricalresultsandanticipatedresultsandissubjecttomanyfactors.
AnimpairmentchargewouldberecordediftheCompanydeterminedthatthecarryingvalueofthelong-livedassetsmaynotberecoverable.
Theimpairmenttoberecognizedismeasuredbytheamountbywhichthecarryingvaluesoftheassetsexceedthefairvalueoftheassets.
Assetstobedisposedofarereportedatthelowerofthecarryingvalueorfairvaluelesscosttosell.
ComprehensiveIncomeComprehensiveincomeisdenedasthechangeinequityofacompanyduringaperiodfromtransactionsandothereventsandcircumstancesexcludingtransactionsresultingfrominvestmentsfromownersanddistributionstoowners.
Accumulatedothercomprehensiveincome,aspresentedontheCompany'sF-21consolidatedbalancesheets,consistsoftheunrealizedgainsoninvestmentsinmarketabledebtsecurities,andthecumulativeforeigncurrencytranslationadjustment.
EffectofRecentAccountingPronouncementsInJune2009,theFinancialAccountingStandardsBoard("FASB")issuedrevisedguidanceontheaccountingfortransfersofnancialassets.
Therevisedguidancerequiresmoreinformationabouttransfersofnancialassets,includingsecuritizationtransactions,andwhereentitieshavecontinuingexposuretotherisksrelatedtotransferrednancialassets.
Iteliminatestheconceptofa"qualifyingspecial-purposeentity,"changestherequirementsforderecognizingnancialassets,andrequiresadditionaldisclosures.
Thisguidancewillbeeffectiveatthestartofareportingentity'srstscalyearbeginningafterNovember15,2009.
TheadoptionofthisguidancewillhavenoimpactontheCompany'sconsolidatednancialstatements.
InJune2009,theFASBissuedrevisedguidanceontheconsolidationofvariableinterestentities("VIEs").
Therevisedguidancerequiresananalysistodeterminewhetheravariableinterestgivestheentityacontrollingnancialinterestinavariableinterestentity.
Additionally,therevisedguidancerequiresanongoingreassessmentandeliminatesthequantitativeapproachpreviouslyrequiredfordeterminingwhetheranentityistheprimarybeneciary.
Thisguidancewillbeeffectiveatthestartofareportingentity'srstscalyearbeginningafterNovember15,2009.
TheadoptionofthisguidancewillhavenomaterialimpactontheCompany'sconsolidatednancialstatements.
InOctober2009,theFASBissuednewguidanceonrevenuerecognitionforarrangementswithmultipledeliverablesandcertainrevenuearrangementsthatincludesoftwareelements.
Byprovidinganotheralternativefordeterminingthesellingpriceofdeliverables,theguidanceforarrangementswithmultipledeliverableswillallowcompaniestoallocatearrangementconsiderationinmultipledeliverablearrangementsinamannerthatbetterreectsthetransaction'seconomicsandwilloftenresultinearlierrevenuerecognition.
Thenewguidancemodiesthefairvaluerequirementsofpreviousguidancebyallowing"bestestimateofsellingprice"inadditiontovendor-specicobjectiveevidence("VSOE")andothervendorobjectiveevidence("VOE",nowreferredtoas"TPE"standingforthird-partyevidence)fordeterminingthesellingpriceofadeliverable.
AvendorisnowrequiredtouseitsbestestimateofthesellingpricewhenVSOEorTPEofthesellingpricecannotbedetermined.
Inaddition,theresidualmethodofallocatingarrangementconsiderationisnolongerpermittedunderthenewguidance.
Thenewguidanceforcertainrevenuearrangementsthatincludesoftwareelementsremovesnon-softwarecomponentsoftangibleproductsandcertainsoftwarecomponentsoftangibleproductsfromthescopeofexistingsoftwarerevenueguidance,resultingintherecognitionofrevenuesimilartothatforothertangibleproducts.
ThenewguidanceiseffectiveforscalyearsbeginningonorafterJune15,2010.
However,companiesmaybeabletoadoptasearlyasinterimperiodsendedSeptember30,2009.
Theguidancemaybeappliedeitherprospectivelyfromthebeginningofthescalyearfornewormateriallymodiedarrangementsorretrospectively.
Thecompanyhasnotearlyadoptedthenewguidanceandiscurrentlyevaluatingtheimpactonitsconsolidatednancialstatementsofadoptingthisguidance.
InDecember2009,theFASBissuedConsolidations—ImprovementstoFinancialReportingbyEnterprisesInvolvedwithVIEs.
TheamendmentsinthisAccountingStandardsUpdatereplacethequantitative-basedrisksandrewardscalculationfordeterminingwhichreportingentity,ifany,hasacontrollingnancialinterestinavariableinterestentitywithanapproachfocusedonidentifyingwhichreportingentityhasthepowertodirecttheactivitiesofavariableinterestentitythatmostsignicantlyimpacttheentity'seconomicperformanceandhas(1)theobligationtoabsorblossesoftheentityor(2)therighttoreceivebenetsfromtheentity.
Anapproachthatisexpectedtobeprimarilyqualitativewillbemoreeffectiveforidentifyingwhichreportingentityhasacontrollingnancialinterestinavariableinterestentity.
TheamendmentsinthisUpdatealsorequireadditionaldisclosuresaboutareportingentity'sinvolvementinvariableinterestentities,whichwillenhancetheinformationprovidedtousersofnancialstatements.
TheCompanybelievestherewillbenomaterialimpactonitsconsolidatednancialstatementsuponadoptionofthisstandard.
F-224.
SegmentInformationInaccordancewithSohuGroup'sinternalnancialreportingstructure,theCompanyhasdeterminedthatthebusinesssegmentsthatconstituteitsprimaryreportingsegmentsarebrandadvertising,sponsoredsearch,onlinegameandwireless.
Priorto2009,theCompanydisclosedsegmentoperatingperformanceonlythroughthegrossprotslineitem,anddidnotallocateanyoperatingexpensesorassetstothosesegments,asmanagementdidnotusethisinformationtomeasuretheperformanceoftheoperatingsegments.
CommencingJanuary1,2009,thechiefoperatingdecisionmaker("CODM")beganreviewingcertainadditionalinformationfortheonlinegamesegment.
Accordingly,theCompanyhasadjustedtheonlinegamesegmentoperatingperformancemeasurementdisclosurestoincludeincomefromoperationsandthemainsegmentassetsfortheonlinegamesegment.
Fortheremainingsegments,theoperatingperformancemeasurementsareunchanged.
Consistentwithpriorperiods,someitems,suchasshare-basedcompensationexpense,operatingexpenses,otherincomeandexpense,andincometaxexpense,arenotreviewedbytheCODM.
Theseitemsaredisclosedinthefollowingsegmentinformationforreconciliationpurposesonly.
TheCompanyhasrestatedthepresentationofitssegmentsforpriorperiodstoconformtothecurrentpresentation,anditwillrestateallcomparableperiodshereafter.
Thefollowingtablespresentsummaryinformationbysegment(inthousands):YearEndedDecember31,2009SegmentsOtherThanOnlineGameBrandAdvertisingSponsoredSearchWirelessOthersSegmentsOtherThanOnlineGameTotalOnlineGameIntercompanyEliminationsConsolidatedRevenues(1)$197,180$8,552$60,809$1,220$267,761$267,585$(20,107)$515,239Segmentcostofrevenues(58,664)(10,344)(34,370)(1,687)(105,065)(17,194)13(122,246)Segmentgrossprot(loss)$138,516$(1,792)$26,439$(467)162,696250,391(20,094)392,993SBC(2)incostofrevenues(825)(324)—(1,149)Grossprot161,871250,067(20,094)391,844Operatingexpenses:Productdevelopment(28,270)(19,944)—(48,214)Salesandmarketing(73,058)(39,787)20,094(92,751)Generalandadministrative(16,583)(13,347)—(29,930)Amortizationofintangibleassets(383)(5)—(388)SBC(2)inoperatingexpenses(3,093)(13,077)—(16,170)Totaloperatingexpenses(121,387)(86,160)20,094(187,453)Operatingprot40,484163,907—204,391Otherincome(3)96,984158(96,800)342Interestincomeandexchangedifference1,7263,275—5,001Incometaxexpense(11,089)(22,656)—(33,745)Incomefromcontinuingoperations$128,105$144,684$(96,800)$175,989Note(1):Theintercompanyeliminationforsegmentrevenuesmainlyconsistsofthemarketingservicesprovidedbythebrandadvertisingsegment(banneradvertisementsetc.
)totheonlinegamesegment(conductedviaChangyou).
F-23Note(2):"SBC"standsforshare-basedcompensationexpense.
Note(3):Inthesecondquarterof2009,Changyoudeclaredadividenddistributionof$96.
8milliontoSohuGame.
BothChangyouandSohuGamearewithintheSohuGroup.
YearEndedDecember31,2008SegmentsOtherThanOnlineGameBrandAdvertisingSponsoredSearchWirelessOthersSegmentsOtherThanOnlineGameTotalOnlineGameIntercompanyEliminationsConsolidatedRevenues(1)$199,254$6,669$47,046$4,223$257,192$201,845$(29,986)$429,051Segmentcostofrevenues(58,243)(6,797)(24,538)(1,945)(91,523)(14,619)66(106,076)Segmentgrossprot(loss)$141,011$(128)$22,508$2,278165,669187,226(29,920)322,975SBC(2)incostofrevenues(1,224)(14)—(1,238)Grossprot164,445187,212(29,920)321,737Operatingexpenses:Productdevelopment(24,071)(18,893)—(42,964)Salesandmarketing(73,047)(38,907)28,159(83,795)Generalandadministrative(14,070)(8,649)1,761(20,958)Amortizationofintangibleassets(746)(50)—(796)SBC(2)inoperatingexpenses(4,049)(5,333)—(9,382)Totaloperatingexpenses(115,983)(71,832)29,920(157,895)Operatingprot48,462115,380—163,842Otherexpense(257)(278)(535)Interestincomeandexchangedifference3,298990—4,288Incometaxexpense(903)(8,106)—(9,009)Incomefromcontinuingoperations$50,600$107,986$—$158,586Note(1):Theintercompanyeliminationforsegmentrevenuesmainlyconsistsofthemarketingservicesprovidedbythebrandadvertisingsegment(banneradvertisementsetc.
)totheonlinegamesegment(conductedviaChangyou).
Note(2):"SBC"standsforshare-basedcompensationexpense.
F-24YearEndedDecember31,2007SegmentsOtherThanOnlineGameBrandAdvertisingSponsoredSearchWirelessOthersSegmentsOtherThanOnlineGameTotalOnlineGameIntercompanyEliminationsConsolidatedRevenues(1)$130,137$7,110$26,337$1,285$164,869$42,096$(18,031)$188,934Segmentcostofrevenues(37,160)(5,588)(12,334)(927)(56,009)(7,279)203(63,085)Segmentgrossprot$92,977$1,522$14,003$358108,86034,817(17,828)125,849SBC(2)incostofrevenues(1,640)(38)—(1,678)Grossprot107,22034,779(17,828)124,171Operatingexpenses:Productdevelopment(16,113)(6,525)—(22,638)Salesandmarketing(43,952)(19,841)17,828(45,965)Generalandadministrative(11,889)(2,767)—(14,656)Amortizationofintangibleassets(1,050)(43)—(1,093)SBC(2)inoperatingexpenses(6,703)(405)—(7,108)Totaloperatingexpenses(79,707)(29,581)17,828(91,460)Operatingprot27,5135,198—32,711Otherincome317570—887Interestincomeandexchangedifference2,810(17)—2,793Incometaxexpense(1,035)(452)—(1,487)Incomefromcontinuingoperations$29,605$5,299$—$34,904Note(1):Theintercompanyeliminationforsegmentrevenuesmainlyconsistsofthemarketingservicesprovidedbythebrandadvertisingsegment(banneradvertisementsetc.
)totheonlinegamesegment(conductedviaChangyou).
Note(2):"SBC"standsforshare-basedcompensationexpense.
AsofDecember31,2009SegmentsOtherThanOnlineGameTotalOnlineGameIntercompanyEliminationsConsolidatedCash$336,881$226,901$—$563,782Accountsreceivable,net43,2153,395—46,610Fixedassets,net65,91049,178—115,088Totalassets(1)544,942289,391(6,060)828,273Note(1):Theintercompanyeliminationforsegmentassetsismainlyresultedfromthemarketingservicesprovidedbythebrandadvertisingsegmenttotheonlinegamesegment(conductedviaChangyou).
AsofDecember31,2008SegmentsOtherThanOnlineGameTotalOnlineGameIntercompanyEliminationsConsolidatedCash$179,986$134,439$—$314,425Accountsreceivable,net35,8501,019—36,869Fixedassets,net66,9779,260—76,237Totalassets(1)355,947176,656(10,727)521,876Note(1):Theintercompanyeliminationforsegmentassetsismainlyresultedfromthemarketingservicesprovidedbythebrandadvertisingsegmenttotheonlinegamesegment(conductedviaChangyou).
F-255.
Share-basedCompensationExpenseBothSohu.
comInc.
andChangyou.
comLimitedhavestockincentiveplansforthegrantingofshareawards,includingordinaryshares,shareoptions,restrictedsharesandrestrictedshareunits,totheiremployeesanddirectors.
Share-basedcompensationexpenseisrecognizedascostsand/orexpensesintheconsolidatednancialstatementsbasedonthefairvaluesoftherelatedshareawardsontheirgrantdates.
Share-basedcompensationexpenseischargedtoshareholders'equitysectionintheconsolidatedbalancesheets.
SeeNote21—Sohu.
comInc.
Shareholders'Equity—StockIncentivePlan.
FortheyearsendedDecember31,2009,2008and2007,therewasnocapitalizedshare-basedcompensationexpense.
Share-basedcompensationexpenserecognizedincostsandexpensesforthoseshareawardswas(inthousands):YearEndedDecember31,Share-basedcompensationexpense200920082007Costofrevenues$1,149$1,238$1,678Productdevelopmentexpenses8,7296,7492,805Salesandmarketingexpenses7478961,541Generalandadministrativeexpenses6,6941,7372,762$17,319$10,620$8,786Share-basedcompensationexpenserecognizedfortheshareawardsgrantedbySohu.
comInc.
andChangyou.
comLimitedwas(inthousands):YearEndedDecember31,Share-basedcompensationexpense200920082007FortheshareawardsgrantedbySohu.
comInc.
$4,176$5,868$8,786FortheshareawardsgrantedbyChangyou.
comLimited*13,1434,752—$17,319$10,620$8,786*In2009,share-basedcompensationexpenserecordedfortheshareawardsgrantedbyChangyou.
comLimitedincluded$2.
6millionofexpensegeneratedbutnotrecognizedbeforethecompletionofChangyou'sinitialpublicofferingbecauseinitialvestingwasconditionedoncompletionoftheoffering.
6.
AdvertisingExpensesIncludedinthesalesandmarketingexpenses,advertisingexpensesgenerallyrepresenttheexpensesofpromotionstocreateorstimulateapositiveimageoftheCompanyoradesiretobuytheCompany'sproductsandservices.
Advertisingexpensesareexpensedasincurred.
FortheyearsendedDecember31,2009,2008and2007,advertisingexpensesrecognizedintheconsolidatedstatementsofoperationswere$61.
5million,$47.
4millionand$22.
5million,respectively.
F-267.
OtherIncome(Expense)ThefollowingtablesummarizestheCompany'sotherincome(expense)(inthousands):YearEndedDecember31,200920082007CharitabledonationforSichuanearthquake$—$(573)$—Gainfromdisposalofinterestinanassociate——561Receiptsoftaxrefundsandreversalofcertaintaxespreviouslyaccrued1611503Amortizationofofferingcostsforzerocouponconvertibleseniornotes——(248)Otherincomefromgovernmentgrant146——Otherincomefromwrite-offoflong-agedpayables*109——Shareofprotsfrominvestmentinanassociate——9Others712762$342$(535)$887*Theselong-agedpayableswerewrittenoffastheywereunlikelytoberequiredtobesettledinthefuture.
8.
DiscontinuanceofE-commerceOperationInordertofocusmoreontheCompany'scorebusinesses,onJune20,2006theCompanydiscontinueditsunprotablee-commercebusiness.
Asaresult,thee-commercebusinessisaccountedforasadiscontinuedoperationanditsstatementsofoperationsseparatethediscontinuedoperationforallperiodspresented.
FortheyearendedDecember31,2009,thegainfromthee-commerceoperationamountedto$446,000,mainlyfromthewrite-offoflong-agedpayableswhichwereunlikelytoberequiredtobesettledinthefuture.
FortheyearsendedDecember31,2008and2007,thelossfromthee-commerceoperationamountedtozeroand$20,000,respectively.
9.
BalanceSheetComponents(inthousands)AsofDecember31,20092008CashandcashequivalentsCash$254,912$190,002Timedepositswiththree-monthmaturitiesorless308,870124,423$563,782$314,425Accountsreceivable,netAccountsreceivable$47,982$38,988Allowancefordoubtfulaccounts:Balanceatbeginningofyear(2,119)(2,056)Additionalprovisionforbaddebt(1,548)(978)Write-offs1,905515Cashcollection390400Balanceatendofyear(1,372)(2,119)$46,610$36,869F-27AsofDecember31,20092008PrepaidandothercurrentassetsCorporateincometaxrefundreceivable$46$18,854DeferredexpensesinrelationtoinitialpublicofferingofChangyou—1,740Prepaidcontentandlicense1,7971,436Employeeadvances2,611973VATrefundreceivable1,001879Rentdeposit679778Prepaidprofessionalfees414465Prepaidadvertisingandpromotionfees1,127221Others3,1062,205$10,781$27,551Fixedassets,netComputerequipmentandhardware$70,911$60,435Ofcebuilding75,18440,325Leaseholdimprovements17,38211,899Investmentproperties—1,450Vehicles1,3401,213Ofcefurniture1,464985166,281116,307Accumulateddepreciation(51,193)(40,070)$115,088$76,237OtheraccruedliabilitiesContractdepositsfromcustomers$9,281$9,163Accruedprofessionalfees4,2123,658Others3,5422,882$17,035$15,703ReceiptsinadvanceanddeferredrevenueReceiptsinadvanceGeneratedfromonlinegamebusiness$21,889$15,415Generatedfromsponsoredsearchbusiness4,6793,584Generatedfrombrandadvertisingbusiness$1,5065,176Generatedfromwirelessandothersbusiness188373Totalreceiptsinadvance28,26224,548Deferredrevenue8,6826,898$36,944$31,44610.
FinancialInstrumentsThecarryingvalueoftheCompany'snancialinstruments,includingcashandcashequivalents,marketablesecurities,accountsreceivable,accountspayableandaccruedliabilities,approximatesthefairvaluebecauseoftheirgenerallyshortmaturities.
11.
RestrictedCashTomeettherequirementsundercertaincontentpurchaseandmarketingrightscontracts,theCompanymadedepositsof$2.
7millionand$4.
3million,respectively,intorestrictedbankaccountsasguaranteesfor2008and2007.
AsofDecember31,2009,alloftherestrictedcashhadbeenreleasedandthebalanceofrestrictedcashwaszero.
F-2812.
GoodwillThechangesinthecarryingvalueofgoodwillbysegmentareasfollows(inthousands):BrandAdvertisingSponsoredSearchOnlineGameWirelessTotalBalanceasofDecember31,2007Goodwill$50,119$7,477$183$15,439$73,218Accumulatedimpairmentlosses(17,676)17,676)32,4437,47718315,43955,542Transactionsin2008Foreigncurrencytranslationadjustment——13—13Inter-segmenttransfers196—(196)——ImpairmentlossesBalanceasofDecember31,2008$32,639$7,477$—$15,439$55,555BalanceasofDecember31,2008Goodwill$50,315$7,477$—$15,439$73,231Accumulatedimpairmentlosses(17,676)17,676)32,6397,477—15,43955,555Transactionsin2009ForeigncurrencytranslationadjustmentImpairmentlossesBalanceasofDecember31,2009$32,639$7,477$—$15,439$55,55513.
IntangibleAssets,NetThefollowingtablesummarizestheCompany'sintangibleassets,net(inthousands):AsofDecember31,2009AsofDecember31,2008GrossCarryingAmountAccumulatedAmortizationNetCarryingAmountGrossCarryingAmountAccumulatedAmortizationNetCarryingAmountComputersoftware$8,873$(6,527)$2,346$8,301$(5,498)$2,803Trademarksanddomainnames3,785(1,662)2,1233,785(1,397)2,388Developedtechnologies1,170(874)2961,169(750)419Marketingrightsandothers3,663(3,629)343,631(3,603)28Operatingrightsforlicensedgames3,536(402)3,134———Customerlists2,343(2,343)—2,343(2,327)16Others1,580(1,580)—1,580(1,580)—$24,950$(17,017)$7,933$20,809$(15,155)$5,654AsofDecember31,2009,estimatedamortizationexpensesforfutureperiodsareexpectedtobeasfollows:FortheyearendingDecember31,(inthousands)2010$1,87620111,75020121,35020139602014877Thereafter1,120Totalexpectedamortizationexpense$7,933F-2914.
ImpairmentforLong-LivedAssetsTheCompany'slong-livedassetsincludeintangibleassets,xedassetsandotherassets.
AsofDecember31,2009,theCompanywasnotawareoftheoccurrenceofanyeventorchangeofcircumstancesthatwouldresultinmaterialimpairmentlossesinlong-livedassetssodidnotrecognizeanyimpairmentlossforthelong-livedassets.
15.
IncomeTaxesSohu.
comInc.
andChangyou.
com(US)Inc.
(formerlyknownasAmazGameEntertainment(US)Inc.
)aresubjecttotaxesintheUnitedStates("U.
S.
").
SomeofthesubsidiariesintheCompanyaresubjecttotaxesinHongKong.
ThemajorityofthesubsidiariesandVIEsoftheCompanyareChina-basedandaresubjecttotaxesinthePRC.
TheseChina-basedsubsidiariesandVIEsconductsubstantiallyalloftheCompany'soperations,andgeneratemostoftheCompany'sincome.
FortheyearendedDecember31,2009,theCompanydidnothaveanyinterestandpenaltiesassociatedwithtaxpositionsnordidtheCompanyhaveanysignicantunrecognizeduncertaintaxpositionsasofDecember31,2009.
PRCCorporateIncomeTaxAdvertisingBusinessandWirelessBusinessEffectivefromJanuary1,2008,thecurrentPRCCorporateIncomeTaxLaw("CITLaw")imposesauniedincometaxrateof25%forbothdomesticandforeigninvestedenterprises.
UnderthecurrentCITLaw,NewTechnologyEnterprisescanenjoyapreferentialincometaxrateof15%.
Butafterathree-yearvalidationperiod,NewTechnologyEnterprisesneedtore-applyforthisqualication.
Underthepreviousincometaxlawsandregulations,NewTechnologyEnterprisesenjoyedafavorabletaxrateof15%andwereexemptedfromincometaxforthreeyearsbeginningwiththeirrstyearofoperations,andwereentitledtoa50%taxreductionto7.
5%forthesubsequentthreeyearsand15%thereafter.
ThecurrentCITLawprovidesgrandfatheringtreatmentforenterprisesthatwere(1)qualiedasNewTechnologyEnterprisesunderthepreviousPRCincometaxlaws,and(2)establishedbeforeMarch16,2007,iftheycontinuetomeetthecriteriaforNewTechnologyEnterprisesunderthecurrentCITLaw.
Thegrandfatheringprovisionallowstheseenterprisestocontinueenjoyingtheirunexpiredtaxholidaysprovidedbythepreviousincometaxlawsandregulations.
ThroughDecember31,2009,veChina-basedsubsidiariesandVIEsintheSohuGroupconductingadvertisingbusinessandwirelessbusinesshavequaliedas"NewTechnologyEnterprises"underthecurrentCITLaw.
TheseChina-basedsubsidiariesandVIEsare:SohuEra,SohuMedia,SogouTechnology,SohuInternetandSogouInformation.
Asaresult,forthescalyear2009,SohuEraandSohuInternetweresubjecttoa15%incometaxrate.
SohuMedia,SogouTechnologyandSogouInformationenjoyeda7.
5%incometaxrateduetotheirunexpiredtaxholidays.
In2009,thePRCtaxbureaucommunicatedtosomesubsidiarieswithintheSohuGroupthatcertainexpensesshouldnotbetreatedasdeductiblebeforeCorporateIncomeTax,althoughthecurrentCITLawissilentinthatregard.
Forsuchexpenses,theSohuGrouphadtreatedthemastaxdeductibleinpreviousperiods.
Thistreatmenthadbeencommunicatedtothetaxbureau,withouttheSohuGroup'sreceivinganyobjectionsorchallengeswithrespecttopriorPRCCorporateIncomeTaxlings.
Basedonthetaxbureau'scurrentinterpretation,theSohuGroupconcludedthatitwasmorelikelythannotthatsuchexpenseswouldnotbeallowedbythetaxbureauforincometaxdeduction.
Hence,theSohuGrouprecognizedincometaxexpenseof$1.
2millioninthesecondquarterof2009asaresultofthechangeinthetaxbureau'sposition.
Inaddition,inordertobeprudent,theSohuGroupwillnotreversethistreatmentunlessitreceivesawrittenclaricationissuedbythetaxauthoritythatthiskindofexpenseisdeductibleforincometaxpurposes.
F-30OnlineGameBusinessUnderthecurrentCITLaw,a"SoftwareEnterprise"canenjoyanincometaxexemptionfortwoyearsbeginningwithitsrstprotableyearanda50%taxreductiontoarateof12.
5%forthesubsequentthreeyears.
In2008,asChina-basedsubsidiaryandVIEofChangyou,AmazGameandGameasequaliedas"SoftwareEnterprises"underthecurrentCITLaw,andsoweresubjecttoa0%incometaxrateforthescalyear2008.
FortheyearendedDecember31,2009,theyweresubjecttoa50%reductiontoataxrateof12.
5%.
PRCWithholdingTaxonDividendsThecurrentCITLawimposesa10%withholdingincometaxfordividendsdistributedbyforeigninvestedenterprisestotheirimmediateholdingcompaniesoutsideChina.
AlowerwithholdingtaxratewillbeappliedifthereisataxtreatyarrangementbetweenmainlandChinaandthejurisdictionoftheforeignholdingcompany.
HoldingcompaniesinHongKong,forexample,willbesubjecttoa5%taxrate.
Inthefourthquarterof2008,AmazGamedeclaredadividendtoitsimmediateholdingcompanyinHongKongandawithholdingtaxofapproximately$5.
0millionwasaccruedbasedona5%withholdingtaxrate.
Thiswithholdingtaxwaspaidinthethirdquarterof2009.
AsofDecember31,2009,theCompanydidnotrecordanywithholdingtaxontheretainedearningsofitsforeigninvestedenterprisesinthePRC,sincetheCompanyintendstoreinvestitsearningstofurtherexpanditsbusinessinmainlandChina,anditsforeigninvestedenterprisesdonotintendtodeclaredividendstotheirimmediateforeignholdingcompanies.
IncomeTaxExpenseIncometaxexpensewas$33.
7millionfor2009,comparedto$9.
0millionand$1.
5millionfor2008and2007,respectively.
In2009,amongthe$33.
7millionincometaxexpense,$29.
8millionwasforChina-basedincomemainlyarosefromtheCompany'sonlinegamebusiness.
InaccordancewithU.
S.
GAAP,theCompanyrealized$3.
9millionofwindfalltaxbenetsfromexistingU.
S.
federalnetoperatinglosses("NOL")generatedfromexcesstaxdeductionsrelatedtoshare-basedawardswhichreduceditstaxespayablein2009.
Thisexcesstaxbenetwascorrespondinglychargedtotheshareholders'equitysectionintheconsolidatedbalancesheetsandpresentedasacashoutowfromoperatingactivitiesandacashinowfromnancingactivities.
Realizingthisbenetreducedtheamountoftaxespayableanddoesnototherwiseinvolvecashows.
ThecombinedeffectsoftheincometaxexemptionandreductionavailabletotheCompanyareasfollows(inthousands,exceptpersharedata):YearEndedDecember31,200920082007Taxholidayeffect$35,911$48,413$15,133Basicnetincomepershareeffect0.
941.
270.
41F-31ThefollowingisreconciliationbetweentheU.
S.
federalstatutoryrateandtheCompany'seffectivetaxrate:YearEndedDecember31,200920082007U.
S.
federalstatutoryrate:35%34%34%TaxdifferentialfromstatutoryrateapplicabletothesubsidiariesandtheVIEs(12%)(11%)(2%)EffectoftaxholidaysapplicabletothesubsidiariesandtheVIEs(17%)(29%)(41%)Effectofwithholdingtaxes—4%0%Changesinvaluationallowancefordeferredtaxassets7%6%14%Others3%1%(1%)16%5%4%SignicantcomponentsoftheCompany'sdeferredtaxassetsandliabilitiesconsistofthefollowing(inthousands):AsofDecember31,20092008Deferredtaxassets:Netoperatinglossfromoperations$7,448$5,957Netoperatinglossfromexerciseofshare-basedawards2,85718,388Share-basedcompensation2571,211Intangibleassetstransfer2,2462,403Accruedbonusandcommissions2,0842,146Fixedassetsrelated2,1141,786Totaldeferredtaxassets17,00631,891Less:Valuationallowance(15,569)(31,416)Netdeferredtaxassets$1,437$475DeferredtaxliabilitiesIntangibleassetsfromanacquisition$(172)$(539)Others(15)(18)Totaldeferredtaxliabilities$(187)$(557)AsofDecember31,2009,theCompanyhadU.
S.
NOLofapproximately$27.
7millionavailabletooffsetagainstfuturefederalincometaxliabilities,whichwasgeneratedfromexcesstaxdeductionsrelatedtoshare-basedawards.
TheU.
S.
NOLwillexpirebeginningin2020.
Intheforeseeablefuture,itismorelikelythannotthattheU.
S.
NOLwillnotbeutilized.
TheCompanydoesnotprovideforU.
S.
federalincometaxesortaxbenetsontheundistributedearningsorlossesofitsinternationalsubsidiariesorVIEsbecauseintheforeseeablefuturetheCompanydoesnothavetheintentiontorepatriatethoseundistributedearningsorlossestoU.
S.
whereitwouldbesubjecttoU.
S.
CorporateIncomeTax,exceptthat,undercertaincircumstances,theCompanymayrepatriatetotheU.
S.
incomethatwillbesubjecttoU.
S.
AlternativeMinimumTax.
AsofDecember31,2009and2008,thesecumulativeundistributedearningsareincludedinconsolidatedretainedearningsonthebalancesheetsandamountedto$409.
6millionand$279.
0million,respectively.
Anestimated$143.
4millionand$94.
9millioninU.
S.
incomeandforeignwithholdingtaxeswouldbedueiftheseearningswereremittedasdividends,afterpaymentofalldeferredtaxesasofDecember31,2009and2008.
F-3216.
ZeroCouponConvertibleSeniorNotesTheCompanycompletedaprivateplacementonJuly14,2003of$90millionprincipalamountofzerocouponconvertibleseniornotesdueJuly2023,whichresultedinnetproceedstotheCompanyofapproximately$87,350,000afterdeductionoftheinitialpurchaser'sdiscountof$2,250,000andofferingexpensesof$400,000.
ThenotesareaseniorunsecuredobligationoftheCompanyandrankequallyinrightofpaymentwithallofotherunsecuredandunsubordinatedindebtednessoftheCompany.
Thenotesdonotpayanyinterest,haveazeroyieldtomaturity,andareconvertibleintotheCompany'scommonstockataconversionpriceof$44.
76pershare,subjecttoadjustmentfordividends,distributions,andupontheoccurrenceofcertainotherevents.
Each$1,000principalofthenotesisinitiallyconvertibleinto22.
3414sharesofcommonstockoftheCompany.
Eachholderofthenoteswillhavetheright,attheholder'soption,torequiretheCompanytorepurchasealloranyportionoftheprincipalamountoftheholder'snotesonJuly14,in2007,2013and2018atapriceequalto100%oftheoutstandingprincipalamount.
TheCompanymayalsoredeemalloraportionofthenotesforcashatanytimeonorafterJuly14,2008at100%oftheprincipalamountofthenotesiftheclosingpriceofitscommonstockforeachofthe30consecutivetradingdayspriortosuchtimewasatleast130%oftheconversionpriceoratsuchtimeatleast90%oftheinitialaggregateprincipalamountofthenoteshavebeenconverted,repurchasedorredeemed.
Inaddition,uponachangeofcontrolevent,eachholderofthenoteshastherighttorequiretheCompanytorepurchasesomeorallofitsnotesatarepurchasepriceequalto100%oftheprincipalamountofthenotes.
FortheyearendedDecember31,2006,theCompanyearlyredeemedfromthemarketaportionofitszerocouponconvertibleseniornotesatadiscountfor$15,000,000inaggregatefacevalue,afterdeductingtherelatedportionofunamortizedofferingcost.
AsoftheendofthenoticationperiodassociatedwiththeJuly14,2007repurchasedate,noteholdershadexercisedtheirrighttorequiretheCompanytorepurchasesuchnotesinanaggregateprincipalamountof$58.
5million.
TheCompanyrepurchasedsuchnotesonJuly16,2007.
InNovember2007,themajorityofremainingnoteholderswith$1,250,000infaceamountofconvertiblenotesexercisedtheirrighttoconverttheirnotestotheCompany'scommonstockataconversionpriceof$44.
76pershare.
FortheyearendedDecember31,2008,theremaining$6,000ofzerocouponconvertibleseniornoteswereredeemed,thereforetheoutstandingbalancewaszeroasofDecember31,2008and2009.
17.
ChinaContributionPlanTheCompany'ssubsidiariesinChinaparticipateinagovernment-mandatedmulti-employerdenedcontributionplanpursuanttowhichcertainretirement,medicalandotherwelfarebenetsareprovidedtoemployees.
ChineselaborregulationsrequiretheCompany'ssubsidiariestopaytothelocallaborbureauamonthlycontributionatastatedcontributionratebasedonthemonthlybasiccompensationofqualiedemployees.
Therelevantlocallaborbureauisresponsibleformeetingallretirementbenetobligations;theCompanyhasnofurthercommitmentsbeyonditsmonthlycontribution.
FortheyearsendedDecember31,2009,2008and2007,theCompanycontributedatotalof$25.
7million,$17.
7millionand$11.
2million,respectively,tothesefunds.
18.
ProtAppropriationTheCompany'sChina-basedsubsidiariesandVIEsarerequiredtomakeappropriationstocertainnon-distributablereservefunds.
InaccordancewiththeChinaForeignInvestmentEnterpriseslaws,someoftheCompany'sChina-basedsubsidiaries,whicharecalledwhollyforeign-ownedenterprises("WFOEs"),havetomakeappropriationsfromtheirafter-taxprotasdeterminedunderGenerallyAcceptedAccountingPrinciplesinthePRC(the"after-tax-protunderPRCGAAP")tonon-distributablereservefunds,including(i)generalreservefund,(ii)enterpriseF-33expansionfund,and(iii)staffbonusandwelfarefund.
Eachyear,atleast10%oftheafter-tax-protunderPRCGAAPisrequiredtobesetasideasgeneralreservefunduntilsuchappropriationsforthefundequal50%ofthepaid-incapitaloftheapplicableentity.
TheappropriationfortheothertworeservefundsisattheCompany'sdiscretionasdeterminedbytheBoardofDirectorsofeachentity.
InaccordancewiththeChinaCompanyLaws,someoftheCompany'sChina-basedsubsidiaries,whicharecalleddomesticallyfundedenterprises,,aswellastheCompany'sVIEs,havetomakeappropriationsfromtheirafter-tax-protunderPRCGAAPtonon-distributablereservefunds,includingastatutorysurplusfundandadiscretionarysurplusfund.
Eachyear,atleast10%oftheafter-tax-protunderPRCGAAPisrequiredtobesetasideasstatutorysurplusfunduntilsuchappropriationsforthefundequal50%ofthepaid-incapitaloftheapplicableentity.
TheappropriationforthediscretionarysurplusfundisattheCompany'sdiscretionasdeterminedbytheBoardofDirectorsofeachentity.
Uponcertainregulatoryapprovalsandsubjecttocertainlimitations,thegeneralreservefundandthestatutorysurplusfundcanbeusedtooffsetprioryearlosses,ifany,andcanbeconvertedintopaid-incapitaloftheapplicableentity.
FortheyearsendedDecember31,2009,asthecumulativegeneralreservefundsandthestatutorysurplusfundsequaled50%oftheChina-basedsubsidiariesandVIEs'paid-incapital,noadditionalamountswereappropriatedforthem.
FortheyearendedDecember31,2008and2007,appropriationsforthegeneralreservefundsandstatutorysurplusfundstotaledthe$7.
1millionand$4.
4million,respectively.
FortheyearsendedDecember31,2009,2008and2007,theCompanyneitherusedanyoftheamountsinthetwofundsnorsetasideanyotherreservefunds.
19.
CommitmentsandContingenciesLawsandRegulationsTheChinesemarketinwhichtheSohuGroupoperatesposescertainmacro-economicandregulatoryrisksanduncertainties.
TheseuncertaintiesextendtotheabilitytooperateanInternetbusiness,andtoconductbrandadvertising,sponsoredsearch,onlinegameandwirelessandothersservicesinthePRC.
ThoughthePRChas,since1978,implementedawiderangeofmarket-orientedeconomicreforms,continuedreformsandprogresstowardsafullmarket-orientedeconomyareuncertain.
Inaddition,thetelecommunication,information,andmediaindustriesremainhighlyregulated.
Restrictionsarecurrentlyinplaceandareunclearwithrespecttowhichsegmentsoftheseindustriesforeign-ownedentities,liketheSohuGroup,mayoperate.
TheChinesegovernmentmayissuefromtimetotimenewlawsornewinterpretationsofexistinglawstoregulateareassuchastelecommunication,informationandmedia.
Regulatoryrisksalsoencompasstheinterpretationbythetaxauthoritiesofcurrenttaxlawsandregulations,includingtheapplicabilityofcertainpreferentialtaxtreatments.
ItslegalstructureandscopeofoperationsinChinacouldbesubjectedtorestrictionswhichcouldresultinseverelimitstotheabilitytoconductbusinessinthePRC.
TheSohuGroup'ssales,purchaseandexpensetransactionsaregenerallydenominatedinRMBandasignicantportionoftheSohuGroup'sassetsandliabilitiesaredenominatedinRMB.
TheRMBisnotfreelyconvertibleintoforeigncurrencies.
InChina,foreignexchangetransactionsarerequiredbylawtobetransactedonlybyauthorizednancialinstitutions.
RemittancesincurrenciesotherthanRMBbyitssubsidiariesinChinamayrequirecertainsupportingdocumentationinordertoaffecttheremittance.
F-34LitigationTheSohuGroupisapartytovariouslitigationmatterswhichitconsidersroutineandincidentaltoitsbusiness.
Managementdoesnotexpecttheresultsofanyoftheseactionstohaveamaterialadverseeffectonitsbusiness,resultsofoperationsornancialcondition.
InMarch2008,theSohuGroupwassuedbyfourmajorrecordcompanies,SonyBMG,Warner,UniversalandGoldLabel,whichallegedthattheSohuGroupprovidedmusicsearchlinksanddownloadservicesthatviolatedcopyrightstheyowned.
AsofDecember31,2009,thelawsuitswiththesefourrecordcompanieswerestillinprocess.
ContractualObligationOnNovember20,2009,theCompanyenteredintoanagreementtopurchaseanofcebuildingtobebuiltinBeijing,whichwillserveastheCompany'sheadquarters,forapurchasepriceofapproximately$110million,amongwhich$22millionhadbeenpaidinDecember2009.
Theremaining$88millionwouldbepaidininstallmentsasvariousstagesofthedevelopmentplansarecompleted.
Theconstructionisexpectedtobecompletedbyendof2012.
TheSohuGroupalsohassomecommitmentsrelatedtofutureminimumcontentandservicepurchases,operatingleaseobligations,andlicensefeesofgamesdevelopedbythird-partieswhicharepresentedinthefollowingtable(inthousands):AsofDecember31,ContentandservicepurchasesOperatingleaseobligationsLicensefeesofgamesdevelopedbythird-partiesTotalminimumpaymentsrequired2010$32,979$4,391$1,889$39,259201116,9383,77811720,83320121,4662,347—3,8132013622,370—2,4322014—2,261—2,261Thereafter————Totalminimumpaymentsrequired$51,445$15,147$2,006$68,59820.
VIEsandRelatedPartyTransactionsVIEsTosatisfyPRClawsandregulations,theSohuGroupconductscertainbusinessinthePRCviaitsVIEs.
TheseVIEsaredirectlyorindirectlyownedbyDr.
CharlesZhang("Dr.
Zhang"),theCompany'sChairman,ChiefExecutiveOfcerandamajorshareholder,andcertainemployeesoftheSohuGroup.
CapitalfortheVIEswasfundedbytheSohuGroupthroughloansprovidedtoDr.
Zhangandthoseemployees,andwasinitiallyrecordedasloanstorelatedparties.
TheseloansareeliminatedforaccountingpurposesagainstthecapitaloftheVIEsuponconsolidation.
UndercontractualagreementswiththeSohuGroup,Dr.
ZhangandotheremployeesoftheSohuGroupwhoareshareholdersoftheVIEsarerequiredtotransfertheirownershipintheseentitiestotheSohuGroup,ifpermittedbyPRClawsandregulations,or,ifnotsopermitted,todesigneesoftheSohuGroupatanytimetorepaytheloansoutstanding.
AllvotingrightsoftheVIEsareassignedtotheSohuGroup,andtheSohuGrouphastherighttodesignatealldirectorsandseniormanagementpersonneloftheVIEs.
Dr.
ZhangandtheotheremployeesoftheSohuGroupwhoareshareholdersoftheVIEshavepledgedtheirsharesintheVIEsascollateralfortheloans.
AsofDecember31,2009,theaggregateamountoftheseloanswas$11.
9million.
F-35TheCompanyconsolidatesallofitsVIEsinitsconsolidatednancialstatementsastheCompanyistheseVIE'sprimarybeneciary.
ThefollowingisasummaryofVIEswithintheSohuGroup:ForAdvertisingBusinessBrandAdvertisingBusinessa)SohuEntertainmentBeijingSohuEntertainmentCultureMediaCo.
,Ltd.
("SohuEntertainment",formerlyknownasBeijingHengdaYitongInternetTechnologyDevelopmentCo.
,Ltd.
,or"Hengda")wasincorporatedinthePRCin2002andengagesinentertainmentandadvertisingbusinessinthePRConbehalfoftheSohuGroup.
AsofDecember31,2009,theregisteredcapitalofSohuEntertainmentis$1.
2million.
XinWang(BelindaWang)andYeDeng,eachofwhomisanemployeeoftheSohuGroup,hold80%and20%interests,respectively,inthisentity.
b)FengYangTianLangBeijingFengYangTianLangAdvertisingCo.
,Ltd.
("FengYangTianLang")wasincorporatedinthePRCin2005andengagesinadvertisingservicesinthePRC.
AsofDecember31,2009,theregisteredcapitalofFengYangTianLangis$0.
2million.
BeijingSohuInternetInformationServiceCo.
,Ltd.
("SohuInternet")andBeijingCenturyHighTechInvestmentCo.
,Ltd.
("HighCentury")eachholdsa50%interestinthisentity.
SponsoredSearchBusinessc)TuXingTianXiaBeijingTuXingTianXiaInformationConsultancyCo.
,Ltd.
("TuXingTianXia")wasincorporatedinthePRCin1999andengagesinmappingservicesinthePRC.
AsofDecember31,2009,theregisteredcapitalofTuXingTianXiais$0.
2million.
HighCenturyandSohuInternethold56.
1%and43.
9%interests,respectively,inthisentity.
d)SogouInformationBeijingSogouInformationServiceCo.
,Ltd.
("SogouInformation")wasincorporatedinthePRCin2005andengagesinprovidingInternetinformationservicesinthePRC.
AsofDecember31,2009,theregisteredcapitalofSogouInformationis$2.
5million.
JingZhouandWeiLi,eachofwhomisanemployeeoftheSohuGroup,eachholdsa50%interestinthisentity.
ForOnlineGameBusinesse)GameaseBeijingGameaseAgeDigitalTechnologyCo.
,Ltd.
("Gamease")wasincorporatedinthePRCinAugust2007.
ItholdsthelicensesandapprovalstooperateonlinegamesinthePRC.
Gamease'sprimarybeneciaryisBeijingAmazGameAgeInternetTechnologyCo.
,Ltd.
("AmazGame"),whichisanindirectsubsidiaryofChangyouandSohu.
AsofDecember31,2009,theregisteredcapitalofGameaseis$1.
3million.
TaoWang,ChiefExecutiveOfcerofChangyou,andaChangyouemployeehold60%and40%interests,respectively,inthisentity.
F-36ForWirelessandOthersBusinessesf)SohuInternetSohuInternetwasincorporatedinthePRCin2003andengagesinInternetinformation,wirelessandadvertisingservicesinthePRConbehalfoftheSohuGroup.
AsofDecember31,2009,theregisteredcapitalofSohuInternetis$2.
4million.
HighCenturyandSohuEntertainmenthold75%and25%interests,respectively,inthisentity.
g)GoodFeelBeijingGoodFeelInformationTechnologyCo.
,Ltd.
("GoodFeel")wasincorporatedinthePRCin2001andengagesinvalue-addedtelecommunicationservicesinthePRC.
AsofDecember31,2009,theregisteredcapitalofGoodFeelis$1.
2million.
GuofengYueandJingZhou,eachofwhomisanemployeeoftheSohuGroup,hold58.
1%and41.
9%interests,respectively,inthisentity.
h)HighCenturyHighCenturywasincorporatedinthePRCin2001andengagesininvestmentholdinginthePRConbehalfoftheSohuGroup.
AsofDecember31,2009,theregisteredcapitalofHighCenturyis$4.
6million.
Dr.
ZhangandWeiLiwhoisanemployeeoftheSohuGroup,hold80%and20%interests,respectively,inthisentity.
i)21EastBeijingBeijing21EastCultureDevelopmentCo.
,Ltd.
("21EastBeijing")wasacquiredinOctober2006.
AsofDecember31,2009,theregisteredcapitalof21EastBeijingis$0.
1million.
HighCenturyandanemployeeoftheSohuGrouphold70%and30%interestsin21EastBeijing.
j)New21EastNew21EastArtDevelopment(Beijing)Co.
,Ltd.
("New21East")wasincorporatedinDecember2007.
AsofDecember31,2009,theregisteredcapitalofNew21Eastis$1.
4million.
HighCenturyandanemployeeoftheSohuGrouphold70%and30%interestsinNew21East.
AsofDecember31,2009and2008,theaboveVIEshaveaggregateaccumulatedprotsofapproximately$47.
6millionand$17.
1million,respectively,whichhavebeenreectedinSohu'sconsolidatednancialstatements.
RelatedPartyTransactionsThefollowingtablesummarizesrelatedpartytransactionsfortheyearsendedDecember31,2009,2008and2007,respectively(inthousands):YearEndedDecember31,NameorDescriptionofRelatedPartyDescriptionofTransactions200920082007AninvesteeoftheCompanyCostofrevenues$—$—$949ThisinvesteeceasedtobearelatedpartyoftheCompanystartingSeptember1,2007,whentheCompanydisposeditsequityinvestment.
Accordingly,sincethen,transactionswiththispartyarenotregardedasrelatedpartytransactions.
F-3721.
Sohu.
comInc.
Shareholders'EquitySummaryofSohu.
comInc.
'soutstandingshares(inthousands):NumberofOutstandingSharesasofDecember31,200920082007Commonstock:Balance,beginningofyear38,09537,71536,647Issuanceofcommonstock4058811,068Repurchaseofcommonstock(751)(501)—Balance,endofyear37,74938,09537,715(a)StockholderRightsPlanTheCompanyadoptedastockholderrightsplan(the"Plan")in2001.
ThePlanisdesignedtodetercoercivetakeovertactics,includingtheaccumulationofsharesintheopenmarketorthroughprivatetransactions,andtopreventanacquirerfromgainingcontroloftheCompanywithoutofferingafairandadequatepriceandtermstoalloftheCompany'sstockholders.
Ingeneral,thePlanvestsstockholdersofSohuwithrightstopurchasepreferredstockoftheCompanyatasubstantialdiscountfromthosesecurities'fairmarketvalueuponapersonorgroupacquiringwithouttheapprovaloftheBoardofDirectorsmorethan20%oftheoutstandingsharesofcommonstockoftheCompany.
AnypersonorgroupwhotriggersthepurchaserightdistributionbecomesineligibletoparticipateinthePlan,causingsubstantialdilutionofsuchpersonorgroup'sholdings.
TherightswillexpireonJuly25,2011.
(b)TreasuryStockFortheyearsendedDecember31,2009and2008,theCompanyrepurchased751,224and501,686sharesofitscommonstockfortotalconsiderationof$40millionand$20million,respectively.
FortheyearendedDecember31,2007,theCompanydidnotpurchaseanysharesofitscommonstock.
ThesharesrepurchasedbytheCompanyarenolongeroutstanding,andarebeingheldbytheCompanyastreasurystock.
Treasurystockisaccountedforunderthecostmethod.
(c)StockIncentivePlanBothSohu.
comInc.
andChangyou.
comLimitedhavestockincentiveplansforthegrantingofshareawards,includingordinaryshares,shareoptions,restrictedsharesandrestrictedshareunits,totheiremployeesanddirectors.
FortheyearsendedDecember31,2009,2008and2007,totalshare-basedcompensationexpenserecognizedwas$17.
3million,$10.
6million,and$8.
8million,respectively.
SeeNote5—Share-basedCompensationExpense.
1)Sohu.
comInc.
ShareAwardsSohu.
comInc.
's2000StockIncentivePlan(the"SohuStockIncentivePlan"),includingshareoptionsandrestrictedshareunits,providesfortheissuanceofupto9,500,000sharesofcommonstock.
Themaximumtermofanyissuedstockrightistenyearsfromthegrantdate.
ThisPlanwillexpireonJanuary24,2010.
Sohu.
comInc.
hasreserved9,500,000sharesofnewcommonstockforissuance.
AsofDecember31,2009,1,087,209shareswereavailableforgrantundertheSohuStockIncentivePlan.
FortheyearsendedDecember31,2009,2008and2007,totalshare-basedcompensationexpenserecognizedforawardsunderSohuStockIncentivePlanwas$4.
2million,$5.
8millionand$8.
8million,respectively.
F-38SummaryofOptionandRestrictedShareUnitActivityi)OptionactivityAsummaryofoptionsactivityundertheSohuStockIncentivePlanasofandfortheyearendedDecember31,2009ispresentedbelow:OptionsNumberofShares(inthousands)WeightedAverageExercisePriceWeightedAverageRemainingContractualLife(Years)AggregateIntrinsicValue(1)(inthousands)OutstandingatJanuary1,200979916.
725.
63$24,474Exercised(241)17.
12Forfeitedorexpired(3)16.
79OutstandingatDecember31,200955516.
554.
54$22,625VestedatDecember31,200955516.
554.
54$22,625ExercisableatDecember31,200955516.
554.
54$22,625Note(1):TheaggregateintrinsicvalueintheprecedingtablerepresentsthedifferencebetweenSohu.
comInc.
'sclosingstockpriceof$57.
28onDecember31,2009andtheexercisepriceofshareoptions.
ThetotalintrinsicvalueofshareoptionsexercisedfortheyearendedDecember31,2009was$9.
0million.
ThefollowingtablesummarizessignicantrangesofoutstandingandexercisableoptionsasofDecember31,2009:OptionsOutstandingasofDecember31,2009OptionsExercisableasofDecember31,2009RangeofExercisePriceNumberOutstanding(inthousands)WeightedAverageRemainingContractualLife(Years)WeightedAverageExercisePriceNumberExercisable(inthousands)WeightedAverageExercisePrice$0.
86–$2.
27402.
03$1.
3140$1.
31$3.
85–$7.
64473.
027.
63477.
63$8.
39383.
028.
39388.
39$13–$16.
84674.
5416.
126716.
12$17–$22.
863115.
3918.
3231118.
32$23.
17–$34.
51523.
8632.
265232.
26555555FortheyearsendedDecember31,2009,2008and2007,totalshare-basedcompensationexpenserecognizedforshareoptionsunderSohu'sStockIncentivePlanwas$0.
9million,$1.
3millionand$2.
7million,respectively.
AsofDecember31,2009,therewasnounrecognizedcompensationexpenseforoptionsbecausetherequisiteserviceperiodsfortheremainingoptionsexpiredin2009.
FortheyearsendedDecember31,2009,2008and2007,totalcashreceivedfromtheexerciseofshareoptionsamountedto$4.
1million,$13.
1millionand$10.
8million,respectively.
F-39ii)RestrictedshareunitactivityAsummaryofrestrictedshareunitsactivityundertheSohuStockIncentivePlanasofandfortheyearendedDecember31,2009ispresentedbelow:RestrictedShareUnitsNumberofUnits(inthousands)Weighted-AverageGrant-DateFairValueUnvestedatJanuary1,2009405$31.
35Granted1352.
56Vested(165)30.
02Forfeited(44)32.
71UnvestedatDecember31,200920933.
41Expectedtovestthereafter15633.
15FortheyearsendedDecember31,2009,2008and2007,totalshare-basedcompensationexpenserecognizedforrestrictedshareunitsunderSohu'sStockIncentivePlanwas$3.
3million,$4.
5millionand$6.
1million,respectively.
AsofDecember31,2009,therewas$1.
6millionofunrecognizedcompensationexpenserelatedtounvestedrestrictedshareunits.
Theexpenseisexpectedtoberecognizedoveraweightedaverageperiodof0.
8years.
2)ChangyouShareAwardsChangyou's2008ShareIncentivePlanOnDecember31,2008,Changyoureserved2,000,000ofitsordinaryshares,whichincluded1,774,000ClassBordinarysharesand226,000ClassAordinaryshares,forissuancetoitsexecutiveofcersandkeyemployeesasincentivecompensationunderits2008ShareIncentivePlan.
InMarch2009,the2,000,000reservedordinarysharesweresubjecttoaten-for-onesharespliteffectedbyChangyouandbecame20,000,000ordinaryshares.
ThroughDecember31,2009,underChangyou's2008ShareIncentivePlan,Changyouhasgranted9,000,000ClassBordinaryshares(including2,000,000ClassBrestrictedordinarysharesvestedinFebruary2009)and6,000,000ClassBrestrictedordinarysharestoTaoWangthroughProminenceand4,396,000ClassAandClassBrestrictedshareunits(settleablebyChangyou'sissuanceofClassAordinarysharesandClassBordinaryshares,respectively)toitsexecutiveofcersotherthanTaoWangandtoitskeyemployees.
SeeNote2—ChangyouTransactions.
FortheyearsendedDecember31,2009and2008,totalshare-basedcompensationexpenserecognizedforawardsunderChangyou's2008ShareIncentivePlanwas$13.
1millionand$4.
8million,respectively.
ShareAwardtoTaoWang,ChiefExecutiveOfcerofChangyouInJanuary2008,thedifferencebetweenthefairvalues("IncrementalFairValue"),ofthe700,000ordinarysharesand800,000restrictedordinarysharesgrantedtoTaoWangandhiscontingentrightinBeijingFireFoxwasaccountedforasshare-basedcompensationexpense.
The800,000restrictedordinarysharesweresubjecttoafour-yearvestingperiodcommencingonFebruary1,2008.
Inaddition,TaoWangwouldnotbeentitledtoparticipateinanydistributionsonChangyoushares,whetherornotvested,untiltheearlierofChangyou'scompletionofaninitialpublicofferingorFebruary2012,andinanyevententitlementtodistributionswouldbesubjecttovestingoftheshares.
F-40OnMarch16,2009,theordinarysharesdescribedabove,whichhadbeenissuedas700,000ClassBordinarysharesand800,000ClassBrestrictedordinarysharesinJanuary2009,became7,000,000ClassBordinarysharesand8,000,000ClassBrestrictedordinaryshares,respectively,asaresultofaten-for-onesharespliteffectedbyChangyouonthatdate.
Forthe700,000ordinaryshares,becausethetermsoftheissuanceoftheseordinaryshareshadbeenapprovedandwerecommunicatedtoandagreedwithTaoWangasofJanuary2,2008,thiswasconsideredthegrantdateunderU.
S.
GAAP,accordingly,theIncrementalFairValuewasdeterminedasofthatdate.
TheportionoftheIncrementalFairValuerelatedtotheseordinaryshares,equalto$1.
8million,wasrecognizedasshare-basedcompensationexpenseinproductdevelopmentexpensesforthethreemonthsendedMarch31,2008.
Forthe800,000restrictedordinaryshares,asaresultofthemodicationoftheirvestingtermsinApril2008,theportionoftheIncrementalFairValuerelatedtotheseshares,equalto$7.
0million,wasdeterminedinApril2008,andwasaccountedforasshare-basedcompensationexpenseoverthevestingperiodstartingfromthedateofthemodication,followingtheacceleratedbasisofattribution.
AsummaryoftheserestrictedordinarysharesactivityasofandfortheyearendedDecember31,2009ispresentedbelow.
Thesharesandtheirfairvaluepresentedinthefollowingformhavebeenrevisedonaretroactivebasistogiveeffecttotheten-for-onesharesplit.
ClassBRestrictedOrdinarySharesNumberofShares(inthousands)Weighted-AverageGrant-DateFairValueUnvestedatJanuary1,20098,000$1.
36Granted—Vested(2,000)1.
36UnvestedatDecember31,20096,0001.
36Expectedtovestthereafter6,0001.
36FortheyearsendedDecember31,2009and2008,share-basedcompensationexpenserecognizedfortheabove8,000,000ClassBrestrictedordinaryshareswas$2.
3millionand$3.
0million,respectively.
AsofDecember31,2009,therewas$1.
7millionofunrecognizedcompensationexpenserelatedtoaboveunvestedClassBrestrictedordinaryshares.
Thefairvalueoftheordinaryshareandrestrictedordinaryshareswasassessedusingtheincomeapproach/discountedcashowmethodwithadiscountforlackofmarketabilitygiventhatthesharesunderlyingtheawardwerenotpubliclytradedatthetimeofgrant,andwaspartlyreliedonareportpreparedbyaqualiedprofessionalappraiser.
ThisassessmentrequiredcomplexandsubjectivejudgmentsregardingChangyou'sprojectednancialandoperatingresults,itsuniquebusinessrisks,theliquidityofitsordinarysharesanditsoperatinghistoryandprospectsatthetimethegrantsweremade.
ShareAwardstoExecutiveOfcers(otherthanTaoWang)andCertainKeyEmployeesi)ShareAwardsGrantedbeforeChangyou'sInitialPublicOfferingInApril2008,ChangyouapprovedandcommunicatedtoexecutiveofcersotherthanTaoWangthegrantofanaggregateof180,000restrictedordinarysharesandtocertainkeyemployeesthegrantofanaggregateof94,000restrictedshareunitsofChangyou(settleableinordinarysharesuponvesting).
Theserestrictedordinarysharesandrestrictedshareunitsweresubjecttovestingoverafour-yearperiodcommencingonFebruary1,2008,withinitialvestingalsosubjecttothelistingofChangyou'sClassAordinarysharesinaninitialpublicofferingbyChangyou.
ThefairvalueoftheawardsatgrantdatewasrecognizedintheconsolidatedstatementofoperationsstartingfromApril2,2009,whenADSsrepresentingChangyou'sClassAordinaryshareswererstlistedontheNasdaqGlobalSelectMarket.
F-41OnJanuary15,2009,Changyouissued180,000ClassBrestrictedordinarysharestoexecutiveofcersotherthanTaoWangandgranted94,000ClassBrestrictedshareunitstocertainkeyemployees.
OnMarch13,2009,Changyouexchangedthe180,000ClassBrestrictedordinarysharesforClassBrestrictedshareunits(settleableinClassBordinaryshares),thatotherwisehavethesamevestingandothertermsasappliedtotheClassBrestrictedordinarysharesdescribedabove.
Includingtheexchange,ClassBrestrictedshareunitsgrantedtoexecutiveofcersotherthanTaoWangandcertainkeyemployeestotaled274,000.
OnMarch16,2009,theabove274,000ClassBrestrictedshareunitsbecame2,740,000ClassBrestrictedshareunitsasaresultoftheten-for-onesharespliteffectedonthatdate.
AsummaryoftheaboveClassBrestrictedshareunitsactivityasofandfortheyearendedDecember31,2009ispresentedbelow.
Thesharesandtheirfairvaluespresentedinthefollowingformhavebeenrevisedonaretroactivebasistogiveeffecttotheten-for-onesharesplit.
ClassBRestrictedShareUnitsNumberofUnits(inthousands)Weighted-AverageGrant-DateFairValueUnvestedatJanuary1,20092,740$1.
98Granted—Vested*(685)1.
98Forfeited—UnvestedatDecember31,20092,0551.
98Expectedtovestthereafter2,0551.
98*including75,000sharesnotsettledasofDecember31,2009.
FortheyearendedDecember31,2009,totalshare-basedcompensationexpenserecognizedfortheabove2,740,000ClassBrestrictedshareunitswas$4.
1million.
FortheyearendedDecember31,2008,theshare-basedcompensationexpensewaszerobecausesuchexpensebegantoberecognizedafterChangyou'sinitialpublicofferingasmentionedabove.
AsofDecember31,2009,therewas$1.
4millionofunrecognizedshare-basedcompensationexpenserelatedtoaboveunvestedClassBrestrictedshareunits.
ThemethodsChangyouusedtodeterminethefairvalueasoftheApril2008grantdateoftheseClassBrestrictedshareunitswerethesameasthemethodsusedforthesharesgrantedtoTaoWangasdescribedabove,withdifferentdiscountedratesapplied.
F-42ii)ShareAwardsGrantedafterChangyou'sInitialPublicOfferingOnApril21,2009,Changyougrantedanaggregateof1,200,000ClassArestrictedshareunits(settleableinClassAordinaryshares)toexecutiveofcersotherthanTaoWang.
TheseClassArestrictedshareunitsaresubjecttovestingoverafour-yearperiodcommencingonApril21,2009.
AsummaryoftheClassArestrictedshareunitsactivityasofandfortheyearendedDecember31,2009ispresentedbelow.
ClassARestrictedShareUnitsNumberofUnits(inthousands)Weighted-AverageGrant-DateFairValueUnvestedatJanuary1,2009—Granted1,200$12.
41Vested—Forfeited—UnvestedatDecember31,20091,20012.
41Expectedtovestthereafter1,20012.
41FortheyearendedDecember31,2009,totalshare-basedcompensationexpenserecognizedfortheabove1,200,000ClassArestrictedshareunitswas$5.
4million.
AsofDecember31,2009,therewas$9.
5millionofunrecognizedcompensationexpenserelatedtotheaboveunvestedClassArestrictedshareunits.
ThefairvalueofrestrictedshareunitsasoftheApril21,2009grantdatewasdeterminedbasedonChangyou'ssharepriceonthegrantdate.
ShareAwardstoOtherEmployeesOnFebruary17,2009,Changyougrantedanaggregateof45,600ClassArestrictedshareunits(settleableinClassAordinaryshares)tocertainofitsemployees.
Theserestrictedshareunitsaresubjecttovestingoverafour-yearperiodcommencinguponthecompletionofthelistingofChangyou'sClassAordinarysharesinaninitialpublicofferingbyChangyou.
ThegrantdatefairvalueoftheawardswasrecognizedinSohu'sconsolidatedstatementsofoperationsstartingfromApril2,2009,whenADSsrepresentingChangyou'sClassAordinaryshareswererstlistedontheNasdaqGlobalSelectMarket.
OnMarch16,2009,theabove45,600ClassArestrictedshareunitsbecame456,000ClassArestrictedshareunitsasaresultofaten-for-onesharespliteffectedonthatdate.
AsummaryoftheClassArestrictedshareunitsactivityasofandfortheyearendedDecember31,2009ispresentedbelow.
Thesharesandfairvaluepresentedinthefollowingformhavebeenrevisedonaretroactivebasistogiveeffecttotheten-for-onesharesplit.
ClassARestrictedShareUnitsNumberofUnits(inthousands)Weighted-AverageGrant-DateFairValueUnvestedatJanuary1,2009—Granted456$8.
00Vested—Forfeited(24)8.
00UnvestedatDecember31,20094328.
00Expectedtovestthereafter4108.
00FortheyearendedDecember31,2009,totalshare-basedcompensationexpenserecognizedfortheabove456,000ClassArestrictedshareunitswas$1.
4million.
AsofDecember31,2009,therewas$1.
9millionofunrecognizedshare-basedcompensationexpenserelatedtoaboveunvestedClassArestrictedshareunits.
F-43ThefairvalueoftheseClassArestrictedshareunitsasoftheFebruary17,2009grantdatewasdeterminedbasedonChangyou'sofferingpriceforitsinitialpublicoffering,whichwas$8.
00perClassAordinaryshare.
22.
NoncontrollingInterestFromJanuary1,2009,theCompanyrenameditsminorityinteresttononcontrollinginterestandreclassieditinitsconsolidatedbalancesheetsfromthemezzaninesectionbetweenliabilitiesandequitytoaseparatelineiteminequity.
TheCompanyalsoexpandeddisclosuresintheconsolidatednancialstatementstoclearlyidentifyanddistinguishtheinterestsofSohufromtheinterestsofthenoncontrollingownersofitssubsidiaries.
TheCompanyhasappliedthispresentationanddisclosurerequirementsretrospectivelyforallperiodspresentedforcomparability.
TheCompany'smajority-ownedsubsidiariesandVIEswhichareconsolidatedinSohu'sconsolidatednancialstatementsbutwithnoncontrollinginterestrecognizedareChangyouand21EastBeijing,New21Eastand21EastHongKong(collectively"21East").
Changyou,whichconductstheSohuGroup'sonlinegamebusiness,completeditsinitialpublicofferingontheNasdaqGlobalSelectMarketonApril7,2009.
21EastareentertainmentcompaniesinwhichtheCompanyholdsa70%economicinterest.
AsofDecember31,2009and2008,noncontrollinginterestintheconsolidatedbalancesheets,whichincludednoncontrollinginterestinChangyouandin21East,was$68.
0millionand$5.
1million,respectively.
FortheyearendedDecember31,2009,noncontrollinginterestintheconsolidatedstatementsofoperations,reectingnoncontrollinginterestinChangyouand21East,was$28.
6million,comparedwithnegative$51,000andnegative$47,000reectingnoncontrollinginterestin21East,fortheyearsendedDecember31,2008and2007.
Noncontrollinginterestintheconsolidatedbalancesheets(inthousands):AsofDecember31,20092008Changyou$67,691$4,75221East304396Total$67,995$5,148Noncontrollinginterestintheconsolidatedstatementsofoperations(inthousands):YearEndedDecember31,200920082007Changyou$28,694$—$—21East(92)(51)(47)Total$28,602$(51)$(47)(a)NoncontrollingInterestinChangyouNoncontrollingInterestintheConsolidatedBalanceSheetsAsofDecember31,2009and2008,noncontrollinginterestinChangyouinSohu'sconsolidatedbalancesheetswas$67.
7millionand$4.
8million,respectively.
AsofDecember31,2009,Sohurecognizednoncontrollinginterestinshareholders'equityinSohu'sconsolidatedbalancesheetstoreecttheinterestinChangyou'snetassetsattributabletoshareholdersotherthanSohu.
Thisnoncontrollinginterestconsistedofa26%economicinterestinChangyou'snetassetsandreectedthereclassicationofChangyou'sshare-basedcompensationexpensefromshareholders'additionalF-44paid-incapitaltononcontrollinginterest,asaforementionedinNote3—SummaryofSignicantAccountingPolicies—BasisofConsolidationandRecognitionofNoncontrollingInterest.
AsofDecember31,2008,Sohurecognizednoncontrollinginterestintheconsolidatedbalancesheetsconsistingoftheshare-basedcompensationexpenserelatedtoChangyou'sClassBordinarysharesgrantedtoTaoWangthroughtheshare-basedawardarrangement.
NoncontrollingInterestintheConsolidatedStatementsofOperationsFortheyearsendedDecember31,2009,Sohurecognized$28.
7millionnoncontrollinginterestinitsconsolidatedstatementsofoperationstoreectthe26%economicinterestinChangyouattributabletoshareholdersotherthanSohu.
FortheyearsendedDecember31,2008and2007,therewasnononcontrollinginterestrecognizedforChangyou.
(b)NoncontrollingInterestin21EastNoncontrollinginterestintheconsolidatednancialstatementsconsistedof30%noncontrollinginterestin21East.
AsofDecember31,2009and2008,noncontrollinginterestrelatedto21Eastintheconsolidatedbalancesheetswas$304,000and$396,000,respectively.
FortheyearsendedDecember31,2009,2008and2007,noncontrollinginterestrelatedto21Eastintheconsolidatedstatementsofoperationswasnegative$92,000,negative$51,000andnegative$47,000,respectively.
23.
NetIncomeperShareBasicnetincomepershareiscomputedusingtheweightedaveragenumberofcommonsharesoutstandingduringtheperiod.
Dilutednetincomepershareiscomputedusingtheweightedaveragenumberofcommonsharesand,ifdilutive,potentialcommonsharesoutstandingduringtheperiod.
Potentialcommonsharescomprisesharesissuableupontheexerciseofshare-basedawardsusingthetreasurystockmethodandsharesissuableupontheconversionofzerocouponconvertibleseniornotesusingtheif-convertedmethod.
Additionally,forpurposesofcalculatingdilutednetincomepershare,Sohu'sconsolidatednetincomeisadjustedforChangyou'snetincomemultipliedbythedifferencebetween:(a)thepercentageofthetotaleconomicinterestinChangyouheldbySohu,and(b)thepercentageoftheweightedaveragenumberofChangyousharesheldbySohutotheweightedaveragenumberofChangyouordinarysharesandsharesissuableupontheexerciseofshare-basedawards.
InthecalculationofSohu'sdilutednetincomepershare,allofChangyou'sexistingunvestedrestrictedshares,unvestedrestrictedshareunits,andvestedrestrictedshareunitsthathavenotyetbeensettledaretreatedasvestedandissuedbyChangyou.
Hence,Changyou'ssharenumberincreasesfromthebasicbasistothefullydilutedbasis,causingthepercentageandtheamountofChangyou'snetincomeattributabletoSohutodecrease.
Thisadjustmentispresentedas"incrementaldilutionfromChangyou"inthetablebelow.
F-45ThefollowingtablepresentsthecalculationofSohu'sbasicanddilutednetincomepershare(inthousands,exceptpersharedata)YearEndedDecember31,200920082007Numerator:NetincomefromcontinuingoperationsattributabletoSohu.
comInc.
$147,387$158,637$34,951Gain(Loss)fromdiscontinuede-commerceoperationsattributabletoSohu.
comInc.
446—(20)NetincomeattributabletoSohu.
comInc.
,basic147,833158,63734,931Effectofdilutivesecurities:IncrementaldilutionfromChangyou(8,561)——Amortizationofofferingcostsforzerocouponconvertibleseniornotes——248NetincomeattributabletoSohu.
comInc.
,diluted$139,272$158,637$35,179Denominator:Weightedaveragebasiccommonsharesoutstanding38,29438,16837,133Effectofdilutivesecurities:Shareoptionsandrestrictedshareunits6759491,135Zerocouponconvertibleseniornotes——651Weightedaveragedilutedcommonsharesoutstanding38,96939,11738,919BasicnetincomepershareattributabletoSohu.
comInc.
—Continuingoperations$3.
85$4.
16$0.
94—Discontinuede-commerceoperations0.
01—(0.
00)BasicnetincomepershareattributabletoSohu.
comInc.
$3.
86$4.
16$0.
94DilutednetincomepershareattributabletoSohu.
comInc.
—Continuingoperations$3.
56$4.
06$0.
90—Discontinuede-commerceoperations0.
01—(0.
00)DilutednetincomepershareattributabletoSohu.
comInc.
$3.
57$4.
06$0.
9024.
ConcentrationRisksBecauseitsoperationsaresubstantiallyconductedinthePRC,theSohuGroupissubjecttoPRC-relatedpolitical,economicandlegalrisks.
Besidestheserisks,theSohuGroupmayalsohavethefollowingconcentrationrisks.
OperationRiskFortheyearsendedDecember31,2009,2008and2007,therearenorevenuesfromclientsthatindividuallyrepresentgreaterthan10%ofthetotalrevenues.
FortheyearendedDecember31,2009,49%oftheSohuGroup'stotalrevenueand94%oftheSohuGroup'sonlinegamerevenuewasderivedfromasinglemassivelymulti-playeronlinerole-playinggamecalledTLBB,whichwaslaunchedinMay2007.
SubstantiallyalloftheSohuGroup'swirelessbusinessesrelyontwomajorthirdpartymobilenetworkoperatorsandtheirsubsidiariesforthebillingofandcollectionfrommobilephoneusers.
Iftheannualcontractswiththeseoperatorswerenotrenewedorwereterminated,theSohuGroup'swirelessbusinessandwirelessrevenuecouldbeadverselyaffected.
AsofDecember31,2009and2008,$8.
3millionand$9.
6millionofaccountsreceivablebalanceswereultimatelyduefrommobilenetworkoperators.
F-46CreditRiskFinancialinstrumentsthatpotentiallysubjecttheSohuGrouptosignicantconcentrationofcreditriskconsistprimarilyofcashandcashequivalents.
AsofDecember31,2009,approximately52%oftheSohuGroup'scashandcashequivalentswereheldin10nancialinstitutionsinChina.
TheremainingcashandcashequivalentswereheldbynancialinstitutionsinU.
S.
,SingaporeandHongKong.
Forthecreditriskrelatedtoaccountsreceivable,theSohuGroupperformsongoingcreditevaluationsofitscustomersand,ifnecessary,maintainsreservesforpotentialcreditlosses.
Historically,suchlosseshavebeenwithinmanagement'sexpectations.
25.
SubsequentEventsOnJanuary21,2010,theCompanygrantedapproximately727,000restrictedstockunitstoitsdirectors,ofcersandemployeesunderthe2000StockIncentivePlan.
TheplanthenexpiredonJanuary24,2010.
TheCompanyhasperformedanevaluationofsubsequenteventsthroughFebruary26,2010,whichisthedatethenancialstatementswereissued,withnoothereventsortransactionsneedingrecognitionordisclosurefound.
F-47SCHEDULEI—CONDENSEDFINANCIALINFORMATIONOFREGISTRANTSOHU.
COMINC.
CONDENSEDBALANCESHEETS(inthousands)AsofDecember31,20092008ASSETSCurrentassets:Cashandcashequivalents$2,635$20,853Prepaidandothercurrentassets283572Duefromsubsidiariesandvariableinterestentities3,952—Totalcurrentassets6,87021,425Interestsinsubsidiariesandvariableinterestentities606,390391,703Totalassets$613,260$413,128LIABILITIESANDSHAREHOLDERS'EQUITYCurrentliabilities:Accruedliabilities$3,479$3,252Duetosubsidiariesandvariableinterestentities—23,930Totalcurrentliabilities3,47927,182Shareholders'equity:Commonstock:$0.
001parvaluepershare(75,400authorized;37,749and38,095sharesissuedandoutstanding,respectively)4343Additionalpaid-incapital317,052201,196Treasurystock(5,389and4,638shares,respectively)(114,690)(74,683)Accumulatedothercomprehensiveincome21,50221,349Retainedearnings385,874238,041Totalshareholders'equity609,781385,946Totalliabilitiesandshareholders'equity$613,260$413,128F-48SOHU.
COMINC.
CONDENSEDSTATEMENTSOFOPERATIONS(inthousands)YearEndedDecember31,200920082007RevenuesCostofrevenues———Grossprot———Operatingexpenses:Generalandadministrative3,8353,3665,149Operatingloss(3,835)(3,366)(5,149)Equityinprotofsubsidiariesandvariableinterestentities154,616155,32833,395Otherexpense——(248)Interestincome1,2026,6756,941Incomebeforeincometaxexpense151,983158,63734,939Incometaxexpense4,150—8Netincome$147,833$158,637$34,931F-49SOHU.
COMINC.
CONDENSEDSTATEMENTSOFCASHFLOWS(inthousands)YearEndedDecember31,200920082007Cashowsfromoperatingactivities:Netincome$147,833$158,637$34,931Adjustmentstoreconcilenetincometonetcash(usedin)providedbyoperatingactivities:Equityinprotofsubsidiariesandvariableinterestentities(154,616)(155,328)(33,395)Excesstaxbenetsfromshare-basedpaymentarrangements(3,927)——Amortizationofotherassets——248Share-basedcompensationexpense8549521,590Changesincurrentassetsandliabilities:Due(from)tosubsidiariesandvariableinterestentities(27,882)(64,580)52,260Prepaidandothercurrentassets289(231)122Taxpayable4,152—7Accruedliabilities2(1,860)1,029Netcash(usedin)providedbyoperatingactivities(33,295)(62,410)56,792Cashowsfrominvestingactivities:Netcashinvestedinsubsidiaries(25,204)——Dividendreceived11,008——Proceedsfrommaturitiesofmarketabledebtsecurities——5,000Receiptsfromcollectionsofloanstoasubsidiary61,21349,841—Netcashprovidedbyinvestingactivities47,01749,8415,000Cashowsfromnancingactivities:Redemptionofzerocouponconvertibleseniornotes—(6)(58,524)Repurchaseofcommonstock(40,007)(19,997)—Issuanceofcommonstock4,14013,10310,785Excesstaxbenetsfromshare-basedpaymentarrangements3,927——Netcashusedinnancingactivities(31,940)(6,900)(47,739)Net(decrease)increaseincashandcashequivalent(18,218)(19,469)14,053Cashandcashequivalentsatbeginningofyear20,85340,32226,269Cashandcashequivalentsatendofyear$2,635$20,853$40,322F-50NOTESTOSCHEDULEI—CONDENSEDFINANCIALINFORMATIONOFSOHU.
COMINC.
1.
ThecondensednancialstatementsofSohu.
comInc.
(the"Company")havebeenpreparedinaccordancewithU.
S.
GAAP.
2.
TheCompanyrecordsitsinvestmentinsubsidiariesundertheequitymethod.
Suchinvestmentandlong-termloanstosubsidiariesarepresentedonthebalancesheetsasinterestsinsubsidiariesandVIEsandtheprotofthesubsidiariesispresentedasequityinprotofsubsidiariesandVIEsonthestatementofoperations.
ForVIEswheretheCompanyistheprimarybeneciary,theamountoftheCompany'sinvestmentisincludedonthebalancesheetsasinterestsinsubsidiariesandVIEsandtheprotorlossoftheVIEsisincludedinequityinprotofsubsidiariesandVIEsonthestatementofoperations.
CertaininformationandfootnotedisclosuresnormallyincludedinnancialstatementspreparedinaccordancewithaccountingprinciplesgenerallyacceptedinU.
S.
havebeencondensedoromitted.
ThefootnotedisclosurescontainsupplementalinformationrelatingtotheoperationsoftheCompanyand,assuch,thesestatementsshouldbereadinconjunctionwiththenotestotheConsolidatedFinancialStatementsoftheCompany.
3.
AsofDecember31,2009and2008,therewerenomaterialcontingencies,signicantprovisionsoflong-termobligations,mandatorydividendorredemptionrequirementsofredeemablestocksorguaranteesoftheCompany,exceptforthosewhichhavebeenseparatelydisclosedintheConsolidatedFinancialStatements,ifany.
4.
FortheyearendedDecember31,2009,therewas$11millionincashdividendspaidtotheCompanybyitsconsolidatedsubsidiaries.
FortheyearsendedDecember31,2008and2007,therewerenocashdividendspaidtotheCompanybyitsconsolidatedsubsidiaries,VIEsorassociate.
5.
Relatedpartytransactionsa)FortheyearendedDecember31,2009,$61.
2millionloanprincipaland$1.
1millionloaninterestwerereceivedfromtheCompany'ssubsidiariesandVIEsasloanrepayments.
AsofDecember312009,therewasnoloanbalanceoutstandingduefromitssubsidiariesandVIEs.
b)FortheyearendedDecember31,2008,$5.
3millionloaninterestwasprincipalizedata4.
8%interestrateperannum.
$49.
8millionwasreceivedfromtheCompany'ssubsidiariesandVIEsasloanrepayments.
AsofDecember31,2008,thelong-termloansduefromitssubsidiariesandVIEsboreaninterestrateof5.
05%perannumandthematuritydatesfortheseloanswereveyears.
FortheyearendedDecember31,2008,theinterestincomefromtheloanamountedto$5.
6million.
F-51EXHIBITINDEXExhibitNo.
Description3.
1(2)SixthAmendedandRestatedCerticateofIncorporationofSohu.
comInc.
asledwiththeDelawareSecretaryofStateonJuly17,2000.
3.
2(2)AmendedandRestatedBy-LawsofSohu.
comInc.
,effectiveJuly17,2000.
4.
1(3)RightsAgreement,datedasofJuly25,2001,betweenSohu.
comInc.
andTheBankofNewYork,asRightsAgent.
4.
2(6)Indenture,datedasofJuly14,2003,betweenSohu.
comInc.
andTheBankofNewYork.
10.
1(11)2000StockIncentivePlan,asamended.
10.
2(1)FormofStockOptionAgreement.
10.
3(1)FormofNon-Competition,CondentialInformationandWorkProductAgreementwiththeRegistrant'sExecutiveOfcers.
10.
4(1)LoanAgreementbetweenSohu.
comInc.
andCharlesZhang.
10.
5(1)LoanAgreementbetweenSohu.
comInc.
andJinmeiHe.
10.
6(4)LoanandSharePledgeAgreementdatedNovember19,2001amongSohu.
comInc.
,Dr.
CharlesZhangandLiWei.
10.
7(5)LoanandSharePledgeAgreement,datedJanuary23,2002,amongSohu.
comInc.
andLiWei.
10.
8(5)Shareholder'sAgreement,datedMarch16,2002,byandbetweenBeijingCenturyHi-TechInvestmentCo.
,Ltd.
andGuolianSecuritiesCo.
,Ltd.
(portionsofthisexhibithavebeenomittedpursuanttoarequestforcondentialtreatmentandhavebeenledseparatelywiththeSEC).
10.
9(7)LoanandSharePledgeAgreementbetweenSohu.
comInc.
andJinmeiHedatedJune9,2003.
10.
10(10)HostingServiceAgreementeffectiveJuly21,2003betweenBeijingSohuNewEraInformationTechnologyCo.
,Ltd.
,SalesOfceofBeijingCommunicationCorporationandBeijingSohuInternetInformationServiceCo.
,Ltd.
(portionsofthisexhibithavebeenomittedpursuanttoarequestforcondentialtreatmentandhavebeenledseparatelywiththeSEC).
10.
11(8)MobileDataServiceCooperationAgreementdatedMarch25,2003betweenChinaUnicomCo.
,Ltd.
andBeijingSohuOnlineNetworkInformationServiceCo.
,Ltd.
10.
12(14)HostingServiceAgreementAmongSohuInternet,SohuEraandChinaNetwork.
10.
13(14)HostingServiceAgreementbetweenSohuEraandChinaTelecom.
10.
14(13)ChinaMobileandMonternetWAPServiceProvidersCooperationAgreementdatedMay23,2003betweenChinaMobileCommunicationCorporationandBeijingG.
FeelTechnologyCo.
,Ltd.
10.
15(13)MonternetSMSCooperationAgreementdatedMay1,2004betweenBeijingMobileCommunicationCo.
,Ltd.
andBeijingSohuInternetInformationServicesCo.
,Ltd.
10.
16(13)ChinaMobileandMonternetWAPServiceProvidersCooperationAgreementdatedMay26,2003betweenChinaMobileCommunicationCorporationandBeijingSohuOnlineNetworkInformationServiceCo.
,Ltd.
10.
17(9)AgreementdatedSeptember1,2003betweenBeijingSohuNewEraTechnologyInformationCo.
,Ltd.
andSohuInternetInformationServicesCo.
,Ltd.
10.
18(12)PreliminaryAgreementamongBeijingSohuNewEraInformationTechnologyCo.
Ltd.
andVisionHuaqing(Beijing)DevelopmentCo.
Ltd.
(portionsofthisexhibithavebeenomittedpursuanttoarequestforcondentialtreatmentandhavebeenledseparatelywiththeSEC).
10.
19(12)LoanandSharePledgeAgreementbetweenSohu.
comInc.
andDengXiufeng.
F-5210.
20(12)LoanandSharePledgeAgreementbetweenSohu.
comInc.
andZhouJing.
10.
21(12)LoanandSharePledgeAgreementbetweenSohu.
comInc.
andXin(Belinda)Wang.
10.
22(15)HostingServiceAgreementAmongSohuInternet,SohuEraandChinaNetwork.
10.
23(15)HostingServiceAgreementBetweenSohuEraandChinaTelecom.
10.
24(16)EmploymentAgreement,effectiveasofMarch8,2007,byandbetweenSohu.
comInc.
andCarolYu.
10.
25(16)PurchasingAgreementofRealPropertyBetweenSohuNewEraandVisionHuaQing.
10.
26(17)EmploymentAgreement,effectiveasofJune1,2007,byandbetweenSohu.
comInc.
andXin(Belinda)Wang.
10.
27(18)UnderwritingAgreement,datedApril1,2009,forChangyou.
comLimited'sinitialpublicoffering.
10.
28(19)AgreementbetweenChangyou.
comLimitedandBeijingYinheWandaCo.
,Ltd.
forthepurchaseofanOfceTowerAatBeijingWestWandaPlaza,inBeijing,China.
10.
29(20)EmploymentAgreement,effectiveasofJanuary1,2009,byandbetweenSohu.
comInc.
andCharlesZhang.
10.
30(21)MasterTransactionAgreement,datedJanuary1,2009,byandbetweenSohu.
comInc.
andChangyou.
comLimited.
10.
31(21)Non-CompetitionAgreement,datedJanuary1,2009,byandbetweenSohu.
comInc.
andChangyou.
comLimited.
10.
32(21)MarketingServicesAgreement,datedJanuary1,2009,byandbetweenSohu.
comInc.
andChangyou.
comLimited.
10.
33(21)ProjectCooperationAgreement,datedNovember20,2009,byandbetweenBeijingRaycomRealEstateDevelopmentCo.
,Ltd.
andBeijingSohuNewMediaInformationTechnologyCo.
,Ltd.
14.
1(9)CodeofEthicsandConduct.
21.
1(21)Subsidiariesoftheregistrant.
23.
1(21)ConsentofIndependentRegisteredPublicAccountingFirm.
23.
2(21)ConsentofTransAsiaLawyers,PRCCounsel.
24.
1(21)PowerofAttorney(includedinsignaturepagetoForm10-K).
31.
1(21)Rule13a-14(a)/15d-14(a)CerticationofDr.
CharlesZhang.
31.
2(21)Rule13a-14(a)/15d-14(a)CerticationofCarolYu.
32.
1(21)Section1350CerticationofDr.
CharlesZhang.
32.
2(21)Section1350CerticationofCarolYu.
(1)Incorporatedhereinbyreferencetotheregistrant'sRegistrationStatementonFormS-1(FileNo.
333-96137).
(2)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonNovember14,2000.
(3)Incorporatedhereinbyreferencetotheregistrant'sRegistrationStatementonForm8-AledonJuly30,2001.
(4)Incorporatedhereinbyreferencetotheregistrant'sAnnualReportonForm10-KledonMarch15,2002.
(5)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonMay14,2002.
F-53(6)Incorporatedhereinbyreferencetotheregistrant'sCurrentReportonForm8-KledonJuly16,2003.
(7)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonAugust12,2003.
(8)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonNovember14,2003.
(9)Incorporatedhereinbyreferencetotheregistrant'sAnnualReportonForm10-KledonMarch2,2004.
(10)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-Q/AledonMarch26,2004.
(11)Incorporatedhereinbyreferencetotheregistrant'sRegistrationStatementonFormS-8ledonJune20,2005(FileNo.
333-125960).
(12)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonNovember9,2004.
(13)Incorporatedhereinbyreferencetotheregistrant'sAnnualReportonForm10-KledonMarch25,2005.
(14)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonMay2,2005.
(15)Incorporatedhereinbyreferencetotheregistrant'sAnnualReportonForm10-KledonMarch8,2007.
(16)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonMay8,2007.
(17)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonAugust6,2007.
(18)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonAugust7,2009.
(19)Incorporatedhereinbyreferencetotheregistrant'sQuarterlyReportonForm10-QledonNovember6,2009.
(20)Incorporatedhereinbyreferencetotheregistrant'sAnnualReportonForm10-KledonFebruary26,2009.
(21)Filedherewith.
F-54Exhibit21.
1SubsidiariesoftheregistrantDirectandIndirectSubsidiariesJurisdictionofOrganizationOwnershipSohu.
com(HongKong)Ltd.
HongKong100%Sohu.
comLimitedCaymanIslands100%BeijingSohuNewEraInformationTechnologyCo.
,Ltd.
People'sRepublicofChina100%BeijingSohuInteractiveSoftwareCo.
,Ltd.
People'sRepublicofChina100%KylieEnterprisesLimitedBritishVirginIslands100%AllHonestInternationalLimitedBritishVirginIslands100%Go2MapInc.
CaymanIslands100%Go2MapSoftware(Beijing)Co.
,Ltd.
People'sRepublicofChina100%Sohu.
com(Search)LimitedCaymanIslands100%SogouInc.
CaymanIslands100%Sogou(BVI)LimitedBritishVirginIslands100%SogouHongKongLimitedHongKong100%BeijingSogouTechnologyDevelopmentCo.
,Ltd.
People'sRepublicofChina100%BeijingSohuNewMediaInformationTechnologyCo.
,Ltd.
People'sRepublicofChina100%21EastEntertainmentLimitedHongKong70%BeijingSohuSoftwareTechnologyCo.
,Ltd.
People'sRepublicofChina100%BeijingFireFoxDigitalTechnologyCo.
,Ltd.
People'sRepublicofChina100%Sohu.
com(Game)LimitedCaymanIslands100%Changyou.
comLimitedCaymanIslands68%Changyou.
com(US)Inc.
UnitedStates68%Changyou.
com(UK)CompanyLimitedUnitedKingdom68%ChangyouMySdn.
BhdMalaysia68%Changyou.
com(HongKong)LimitedHongKong68%BeijingAmazGameAgeInternetTechnologyCo.
,Ltd.
People'sRepublicofChina68%Changyou.
comKoreaLimitedKorea68%Exhibit23.
1ConsentofIndependentRegisteredPublicAccountingFirmWeherebyconsenttotheincorporationbyreferenceintheRegistrationStatementonFormS-8(No.
333-61814,333-117412,333-125960)ofSohu.
comInc.
ofourreportdatedFebruary26,2010relatingtotheconsolidatednancialstatements,nancialstatementscheduleandtheeffectivenessofinternalcontrolovernancialreporting,whichappearsinthisForm10-K.
PricewaterhouseCoopersZhongTianCPAsLimitedCompanyBeijing,thePeople'sRepublicofChinaFebruary26,2010Exhibit23.
2ConsentofTransAsiaLawyers,PRCCounselFebruary26,2010Sohu.
comInc.
12/FSohu.
comInternetPlazaNo.
1UnitZhongguancunEastRoadHaidianDistrictBeijing100084People'sRepublicofChinaDearSirs,AnnualReportonForm10-KforYearEndedDecember31,2009Weherebyconsenttothereferencestoourrmundertheheading"GovernmentRegulationandLegalUncertainties"inthisAnnualReportonForm10-K.
Sincerely,/s/PhilipQuPhilipQuPartnerExhibit31.
1I,CharlesZhang,certifythat:1.
IhavereviewedthisannualreportonForm10-KofSohu.
comInc.
;2.
Basedonmyknowledge,thisreportdoesnotcontainanyuntruestatementofamaterialfactoromittostateamaterialfactnecessarytomakethestatementsmade,inlightofthecircumstancesunderwhichsuchstatementsweremade,notmisleadingwithrespecttotheperiodcoveredbythisreport;3.
Basedonmyknowledge,thenancialstatements,andothernancialinformationincludedinthisreport,fairlypresentinallmaterialrespectsthenancialcondition,resultsofoperationsandcashowsoftheregistrantasof,andfor,theperiodspresentedinthisreport;4.
Theregistrant'sothercertifyingofcersandIareresponsibleforestablishingandmaintainingdisclosurecontrolsandprocedures(asdenedinExchangeActRules13a-15(e)and15d-15(e))andinternalcontrolovernancialreporting(asdenedinExchangeActRules13a-15(f)and15d-15(f)fortheregistrantandhave:a)Designedsuchdisclosurecontrolsandprocedures,orcausedsuchdisclosurecontrolsandprocedurestobedesignedunderoursupervision,toensurethatmaterialinformationrelatingtotheregistrant,includingitsconsolidatedsubsidiaries,ismadeknowntousbyotherswithinthoseentities,particularlyduringtheperiodinwhichthisreportisbeingprepared;b)Designedsuchinternalcontrolovernancialreporting,orcausedsuchinternalcontrolovernancialreportingtobedesignedunderoursupervision,toprovidereasonableassuranceregardingthereliabilityofnancialreportingandthepreparationofnancialstatementsforexternalpurposesinaccordancewithgenerallyacceptedaccountingprinciples;c)Evaluatedtheeffectivenessoftheregistrant'sdisclosurecontrolsandproceduresandpresentedinthisreportourconclusionsabouttheeffectivenessofthedisclosurecontrolsandprocedures,asoftheendoftheperiodcoveredbythisreportbasedonsuchevaluation;andd)Disclosedinthisreportanychangeintheregistrant'sinternalcontrolovernancialreportingthatoccurredduringtheregistrant'smostrecentscalquarter(theregistrant'sfourthscalquarterinthecaseofanannualreport)thathasmateriallyaffected,orisreasonablylikelytomateriallyaffect,theregistrant'sinternalcontrolovernancialreporting;and5.
Theregistrant'sothercertifyingofcersandIhavedisclosed,basedonourmostrecentevaluationofinternalcontrolovernancialreporting,totheregistrant'sauditorsandtheauditcommitteeoftheregistrant'sboardofdirectors(orpersonsperformingtheequivalentfunction):a)Allsignicantdecienciesandmaterialweaknessesinthedesignoroperationofinternalcontrolovernancialreportingwhicharereasonablylikelytoadverselyaffecttheregistrant'sabilitytorecord,process,summarizeandreportnancialinformation;andb)Anyfraud,whetherornotmaterial,thatinvolvesmanagementorotheremployeeswhohaveasignicantroleintheregistrant'sinternalcontrolovernancialreporting.
Date:February26,2010/s/CharlesZhangCharlesZhang,ChiefExecutiveOfcerandChairmanoftheBoardofDirectorsExhibit31.
2I,CarolYu,certifythat:1.
IhavereviewedthisannualreportonForm10-KofSohu.
comInc.
;2.
Basedonmyknowledge,thisreportdoesnotcontainanyuntruestatementofamaterialfactoromittostateamaterialfactnecessarytomakethestatementsmade,inlightofthecircumstancesunderwhichsuchstatementsweremade,notmisleadingwithrespecttotheperiodcoveredbythisreport;3.
Basedonmyknowledge,thenancialstatements,andothernancialinformationincludedinthisreport,fairlypresentinallmaterialrespectsthenancialcondition,resultsofoperationsandcashowsoftheregistrantasof,andfor,theperiodspresentedinthisreport;4.
Theregistrant'sothercertifyingofcersandIareresponsibleforestablishingandmaintainingdisclosurecontrolsandprocedures(asdenedinExchangeActRules13a-15(e)and15d-15(e))andinternalcontrolovernancialreporting(asdenedinExchangeActRules13a-15(f)and15d-15(f)fortheregistrantandhave:a)Designedsuchdisclosurecontrolsandprocedures,orcausedsuchdisclosurecontrolsandprocedurestobedesignedunderoursupervision,toensurethatmaterialinformationrelatingtotheregistrant,includingitsconsolidatedsubsidiaries,ismadeknowntousbyotherswithinthoseentities,particularlyduringtheperiodinwhichthisreportisbeingprepared;b)Designedsuchinternalcontrolovernancialreporting,orcausedsuchinternalcontrolovernancialreportingtobedesignedunderoursupervision,toprovidereasonableassuranceregardingthereliabilityofnancialreportingandthepreparationofnancialstatementsforexternalpurposesinaccordancewithgenerallyacceptedaccountingprinciples;c)Evaluatedtheeffectivenessoftheregistrant'sdisclosurecontrolsandproceduresandpresentedinthisreportourconclusionsabouttheeffectivenessofthedisclosurecontrolsandprocedures,asoftheendoftheperiodcoveredbythisreportbasedonsuchevaluation;andd)Disclosedinthisreportanychangeintheregistrant'sinternalcontrolovernancialreportingthatoccurredduringtheregistrant'smostrecentscalquarter(theregistrant'sfourthscalquarterinthecaseofanannualreport)thathasmateriallyaffected,orisreasonablylikelytomateriallyaffect,theregistrant'sinternalcontrolovernancialreporting;and5.
Theregistrant'sothercertifyingofcersandIhavedisclosed,basedonourmostrecentevaluationofinternalcontrolovernancialreporting,totheregistrant'sauditorsandtheauditcommitteeoftheregistrant'sboardofdirectors(orpersonsperformingtheequivalentfunction):a)Allsignicantdecienciesandmaterialweaknessesinthedesignoroperationofinternalcontrolovernancialreportingwhicharereasonablylikelytoadverselyaffecttheregistrant'sabilitytorecord,process,summarizeandreportnancialinformation;andb)Anyfraud,whetherornotmaterial,thatinvolvesmanagementorotheremployeeswhohaveasignicantroleintheregistrant'sinternalcontrolovernancialreporting.
Date:February26,2010/s/CarolYuCarolYu,Co-PresidentandChiefFinancialOfcerExhibit32.
1SOHU.
COMINC.
CERTIFICATIONPURSUANTTO18U.
S.
C.
SECTION1350,ASADOPTEDPURSUANTTOSECTION906OFTHESARBANES-OXLEYACTOF2002InconnectionwiththeAnnualReportofSohu.
comInc.
(the"Company")onForm10-KforthescalyearendedDecember31,2009asledwiththeSecuritiesandExchangeCommissiononthedatehereof(the"Report"),I,CharlesZhang,ChiefExecutiveOfcerandChairmanoftheBoardofDirectorsoftheCompany,certify,pursuanttoU.
S.
C.
ss.
1350,asadoptedpursuanttoss.
906oftheSarbanes-OxleyActof2002,that:(1)TheReportfullycomplieswiththerequirementsofsection13(a)or15(d)oftheSecuritiesExchangeActof1934;and(2)TheinformationcontainedintheReportfairlypresents,inallmaterialrespects,thenancialconditionoftheCompanyasofDecember31,2009andresultsofoperationsoftheCompanyforthescalyearendedDecember31,2009.
/s/CharlesZhangCharlesZhang,ChiefExecutiveOfcerandChairmanoftheBoardofDirectorsFebruary26,2010Exhibit32.
2SOHU.
COMINC.
CERTIFICATIONPURSUANTTO18U.
S.
C.
SECTION1350,ASADOPTEDPURSUANTTOSECTION906OFTHESARBANES-OXLEYACTOF2002InconnectionwiththeAnnualReportofSohu.
comInc.
(the"Company")onForm10-KforthescalyearendedDecember31,2009asledwiththeSecuritiesandExchangeCommissiononthedatehereof(the"Report"),I,CarolYu,Co-PresidentandChiefFinancialOfceroftheCompany,certify,pursuanttoU.
S.
C.
ss.
1350,asadoptedpursuanttoss.
906oftheSarbanes-OxleyActof2002,that:(1)TheReportfullycomplieswiththerequirementsofsection13(a)or15(d)oftheSecuritiesExchangeActof1934;and(2)TheinformationcontainedintheReportfairlypresents,inallmaterialrespects,thenancialconditionoftheCompanyasofDecember31,2009andresultsofoperationsoftheCompanyforthescalyearendedDecember31,2009.
/s/CarolYuCarolYu,Co-PresidentandChiefFinancialOfcerFebruary26,2010CorporateOfcersDr.
CharlesZhangChairmanoftheBoardofDirectorsandChiefExecutiveOfcerBelindaWangCo-PresidentandChiefOperatingOfcerCarolYuCo-PresidentandChiefFinancialOfcerXiaochuanWangChiefTechnologyOfcerLumingChenVicePresidentGangFangVicePresidentofProductTaoWangVicePresidentofSohu.
comChiefExecutiveOfcerofChangyou.
comLinZhouVicePresidentofTechnologyWeiYuVicePresidentofMediaYeDengVicePresidentofEntertainmentMediaNon-ExecutiveMembersoftheBoardofDirectorsDr.
EdwardB.
RobertsMemberoftheCompensationandNominatingCommitteesProfessorofManagementofTechnology,MassachusettsInstituteofTechnology'sAlfredP.
SloanSchoolofManagementCharlesHuangMemberoftheAuditandNominatingCommitteesChairmanandCEO,NetbigEducationHoldingsLtd.
Dr.
DaveQiMemberoftheCompensation,AuditandNominatingCommitteesProfessorofAccountingandAssociateDean,theCheungKongGraduateSchoolofBusinessShiWangMemberoftheNominatingCommitteeChairman,ChinaVankeCo.
,Ltd.
Dr.
ZhonghanDengMemberoftheAuditandNominatingCommitteesChairmanandCEO,VimicroCorporation.
CorporateHeadquartersSohu.
comInc.
Sohu.
comInternetPlazaNo.
1UnitZhongguancunEastRoadHaidianDistrictBeijing100084People'sRepublicofChinaTel:(8610)62726666Fax:(8610)62722155www.
sohu.
comOtherOfcesSohu.
com—ShanghaiRoom1201-1205,ShuiOnPlaza333HuaiHaiZhongRoad,Shanghai200021People'sRepublicofChinaTel:(8621)23081600Fax:(8621)20381791Sohu.
com—GuangzhouRoom2003/04R&FCenter10HuaxiaRoadNewPearlRiverCityGuangzhou510623People'sRepublicofChinaTel:(8620)85115666Fax:(8620)85115601Sohu.
com—Fuzhou5/F,YifaBuilding111WusiRoadFuzhou350001People'sRepublicofChinaTel:(86591)87767088Fax:(86591)87810342Sohu.
com—HongKongRoom2010-2011,20/F,MillenniumCity2378KwunTongRoadKowloon,HongKongPeople'sRepublicofChinaTel:(852)28992278Fax:(852)23055968IndependentAccountantsPricewaterhouseCoopersZhongTianCPAsLimitedCompanyBeijingBranch26/FOfceTowerABeijingFortunePlaza7DongsanhuanZhongRoadChaoyangDistrictBeijing100020People'sRepublicofChinaLegalCounselGoulston&Storrs400AtlanticAvenueBoston,Massachusetts02110-3333UnitedStatesofAmericaTimothyB.
BancroftofGoulston&StorrsistheSecretaryofSohu.
com.
TransasiaSuite2218ChinaWorldOfce11JianguomenwaiAvenueBeijing100004,ChinaTransferAgentBNYMellonShareownerServicesPOBox358015Pittsburge,PA15252-80151-877-296-37111-201-680-6685(OutsidetheU.
S.
)1-800-231-5461(HearingImpaired—TDDPhone)1-201-680-6610(ForeignHearingImpared)E-MailAddress:shrrelations@bnymellon.
comTheBankofNewYork'sStockTransferWebsite:http://www.
bnymellon.
com/shareowner/isdSohu.
comInvestorRelations15/F,Sohu.
comInternetPlazaNo.
1UnitZhongguancunEastRoadHaidianDistrictBeijing100084People'sRepublicofChinaTel:(8610)62726596Fax:(8610)62726988Email:ir@contact.
sohu.
comIRwebpage:http://corp.
sohu.
com/corp.
shtmlAnnualStockholdersMeetingTheannualmeetingofstockholderswillbeheldatSohu.
com'sCorporateHeadquartersinBeijingonJune18,2010at10:00AM.
2010Sohu.
comInc.
Allrightsreserved.
Sohu.
comandSohu.
comlogoareregisteredtrademarksofBeijingSohuNewEraInformationTechnologyCo.
,Ltd.
.
Allothernamesaretrademarksand/orregisteredtrademarksoftheirrespectiveowners.
Oursuccessin2009wasfurthersupportedbytheinitialpublicofferingofourmassivelymulti-playeronlinerole-playinggames("MMORPG")subsidiary,Changyou.
com,onApril2,2009.
Despitechallengingmarketconditions,Changyou'sdebutwasoneofthemostsuccessfulIPOsoftheyearandwashonoredasthe"BestADREquityDeal/IPOof2009"byTheAssetmagazineintheir2009"TripleARegionalAwards.
"ThesuccessfulIPOprovidedChangyou,aleadingdeveloperandoperatorofonlinegamesinChina,withtheresourcesandplatformtofurtherexpanditsbusiness.
FollowingtheIPO,ChangyoucontinuedtodeliverrecordrevenuesandcontributedsignificantlytoSohu'sbottomlinein2009.
AsChangyou'smajorityshareholder,SohuwillbealongtermbeneficiaryofChangyou'sgrowthmomentumintheyearstocome.
OnlineGamesBusinessGoesPublic