|
SOHU COM INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge)
As used in this report, references to "us," "we," "our," "our company," "our
group," "Sohu" and "Sohu.com" are to Sohu.com Inc. and, except where the context
requires otherwise, our wholly-owned and majority-owned subsidiaries and
variable interest entities ("VIEs"), Sohu.com Limited, Sohu.com (Hong Kong)
Limited ("Sohu Hong Kong"), All Honest International Limited, Sohu.com (Game)
Limited ("Sohu Game"),Go2Map Inc., Sohu.com (Search) Limited, Sogou Inc., Sogou
(BVI) Limited, Sogou Hong Kong Limited, Vast Creation Advertising Media Services
Limited ("Vast Creation"), Fox Video Investment Holding Limited ("Video
Investment"), Fox Video Limited ("Sohu Video"), Fox Video (HK) Limited ("Video
HK"), Beijing Sohu New Era Information Technology Co., Ltd. ("Sohu Era"),
Beijing Sohu Software Technology Co., Ltd. ("New Software"), Beijing Fire Fox
Digital Technology Co., Ltd. ("Beijing Fire Fox", also known as Beijing Huohu
Digital Technology Co., Ltd., or "Huohu"), Beijing Sohu Interactive Software
Co., Ltd. ("Sohu Software"), Go2Map Software (Beijing) Co., Ltd. ("Go2Map
Software"), Beijing Sogou Technology Development Co., Ltd. ("Sogou Technology"),
Beijing Sogou Network Technology Co., Ltd ("Sogou Network"), Fox Information
Technology (Tianjin) Limited ("Video Tianjin"), Beijing Sohu New Media
Information Technology Co., Ltd. ("Sohu Media"), Beijing Focus Time Advertising
Media Co., Ltd. ("Focus Time"), Beijing Sohu New Momentum Information Technology
Co., Ltd. ("Sohu New Momentum"), Beijing Century High Tech Investment Co., Ltd.
("High Century"), Beijing Sohu Entertainment Culture Media Co., Ltd. ("Sohu
Entertainment", formerly known as Beijing Hengda Yitong Internet Technology
Development Co., Ltd., or "Hengda"), Beijing Sohu Internet Information Service
Co., Ltd. ("Sohu Internet"), Beijing GoodFeel Information Technology Co., Ltd.
("GoodFeel"), Beijing Tu Xing Tian Xia Information Consultancy Co., Ltd. ("Tu
Xing Tian Xia"), Beijing Sogou Information Service Co., Ltd. ("Sogou
Information"), Beijing 21 East Culture Development Co., Ltd. ("21 East
Beijing"), Beijing Sohu Donglin Advertising Co., Ltd.("Donglin"), Beijing Pilot
New Era Advertising Co., Ltd. ("Pilot New Era"), Beijing Focus Yiju Network
Information Technology Co., Ltd. ("Focus Yiju"), Beijing Yi He Jia Xun
Information Technology Co., Ltd. ("Yi He Jia Xun"), Beijing 17173 Network
Technology Co., Ltd. ("17173 Network"), Tianjin Jinhu Culture Development Co.,
Ltd. ("Tianjin Jinhu") and our independently-listed majority-owned subsidiary
Changyou.com Limited ("Changyou", formerly known as TL Age Limited) as well as
the following direct and indirect subsidiaries and VIEs of Changyou:
Changyou.com HK Limited ("Changyou HK", formerly known as TL Age Hong Kong
Limited), Changyou.com Webgame (HK) Limited ("Changyou HK Webgame"),
Changyou.com Gamepower (HK) Limited ("Changyou HK Gamepower"), ICE Entertainment
(HK) Limited ("ICE HK"), Changyou.com (US) Inc. (formerly known as AmazGame
Entertainment (US) Inc.), Changyou.com (UK) Company Limited ("Changyou UK"),
ChangyouMy Sdn. Bhd ("Changyou Malaysia"), Changyou.com Korea Limited ("Changyou
Korea"), Changyou.com India Private Limited ("Changyou India"), Changyou B L M
H ZMETLER T CARET L M TED RKET ("Changyou Turkey"), Kylie Enterprises
Limited, 7Road.com Limited ("7Road"), 7Road.com HK Limited ("7Road HK"), Beijing
AmazGame Age Internet Technology Co., Ltd. ("AmazGame"), Beijing Changyou
Gamespace Software Technology Co., Ltd. ("Gamespace"), ICE Information
Technology (Shanghai) Co., Ltd. ("ICE Information"), Beijing Yang Fan Jing He
Information Consulting Co., Ltd. ("Yang Fan Jing He"), Shanghai Jingmao Culture
Communication Co., Ltd. ("Shanghai Jingmao"), Shanghai Hejin Data Consulting
Co., Ltd. ("Shanghai Hejin"), Beijing Jingmao Film & Culture Communication Co.,
Ltd. ("Beijing Jingmao"), Beijing Gamease Age Digital Technology Co., Ltd.
("Gamease"), Beijing Guanyou Gamespace Digital Technology Co., Ltd. ("Guanyou
Gamespace"), and Shanghai ICE Information Technology Co., Ltd.("Shanghai ICE"),
Shenzhen 7Road Network Technologies Co., Ltd.("7Road Technology") , Shenzhen
7Road Technology Co., Ltd. ("Shenzhen 7Road"), and these references should be
interpreted accordingly. Unless otherwise specified, references to "China" or
"PRC" refer to the People's Republic of China and do not include the Hong Kong
Special Administrative Region, the Macau Special Administrative Region or
Taiwan. This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, including, without limitation, statements regarding our
expectations, beliefs, intentions or future strategies that are signified by the
words "expect", "anticipate", "intend" ,"believe", or similar language. All
forward-looking statements included in this document are based on information
available to us on the date hereof, and we assume no obligation to update any
such forward-looking statements. Our business and financial performance are
subject to substantial risks and uncertainties. Actual results could differ
materially from those projected in the forward-looking statements. In evaluating
our business, you should carefully consider the information set forth under the
heading "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for
the year ended December 31, 2011 filed with the Securities and Exchange
Commission ("SEC") on February 28, 2012, as updated by Part II Item 1A of this
report. Readers are cautioned not to place undue reliance on these
forward-looking statements.
OVERVIEW
Sohu (NASDAQ: SOHU) is a leading Chinese online media, search, gaming, community
and mobile service group. We operate one of the most comprehensive matrices of
Chinese language Web properties, and we developed and operate one of the most
popular massively multiplayer online games and two popular Web games in China.
Substantially all of our operations are conducted through our indirect
wholly-owned and majority-owned China-based subsidiaries and variable interest
entities (collectively the "Sohu Group").
-42---------------------------------------------------------------------------------
Table of Contents
Our businesses consist of the online advertising business, which consists of the
brand advertising business as well as the search and others business, the online
game business, the wireless business and the others business, among which online
advertising and online games are our core businesses.
Factors and Trends Affecting our Business
The Internet and Internet-related markets in China continued to evolve rapidly
during 2012. According to a semiannual report issued by the China Internet
Network Information Center ("CNNIC"), the total number of Internet users in
China had reached 538 million by the end of June 2012, an increase of
24.5 million from the end of 2011. The number of mobile Internet users in China
had reached 388 million by the end of June 2012, an increase of 32.7 million
from the end of 2011, and exceeding the 380 million desktop computer Internet
users as of June 2012. Mobile Internet is becoming the top channel for Internet
users to access Websites in China. We believe that this large and expanding user
base will continue to provide significant opportunities for our company to
expand our product offerings and to explore new revenue streams.
However, China's economy has been experiencing decelerating growth recently,
with the result that many large advertisers were cautious regarding their
spending on advertising in the face of this economy uncertainty. At the same
time, we have been facing fierce competition arising from existing and new
Internet companies, which have been seizing advertising market share. We have
noted that this macro-economic environment and increased competition has had
some adverse impact on our brand advertising business.
In China, online video is a popular Internet application, with over 350 million
users as of June 30, 2012 according to the semiannual report issued by CNNIC. We
expect that brand in the future will continue to allocate more advertising
dollars to online video in order to exploit this growing market, but we are
uncertain as to when such an increased allocation will occur, or how large it
might be. The market prices of online video content are becoming relatively
stable after a significant decline in prior months. During the third quarter of
2012, our strategic plan of building a dedicated sales team was well on track,
and our video direct account sales team was in place. Also, we set up a video
agency sales team during quarter. We are optimistic about the prospects of our
online video business, and expect this business to resume on a growth track
during the fourth quarter of 2012.
In the third quarter, our search and others business continued to grow, which
was attributable to the growth of pay-for-click services, as well as online
marketing services on Sogou Web Directory. We expect our search and others
business will sustain healthy revenue growth through the remainder of 2012.
We continue to be pleased with, and optimistic regarding, the growth and
profitability of our online games business. We believe that our strong
performance in the third quarter reflects the resilience of the online games
industry in China despite the weakening global macroeconomic environment and
economic slowdown in China, and that it also reflects the ongoing strength of
our online games content and our successful expansion into other fast-growing
segments of the industry, such as web games.
We believe, as discussed above, that there are significant opportunities to
explore new revenue streams related to the mobile Internet market. Our wireless
business faces a challenge in this regard, as we will need to catch up with our
peer competitors with respect to penetration of new mobile applications and
features.
Summary of Our Business
Online Advertising Business
Brand Advertising Business
Our brand advertising business offers various products and services (such as
free of charge premier content including video content, interactive community,
and other competitive Internet services) to our users, and provides advertising
services to advertisers on our matrices of Chinese language Web properties
consisting of:
• sohu.com, a leading mass portal and online media destination;
• focus.cn, a top real estate Website; and
• 17173.com, a leading game information portal. Since December 15, 2011,
17173.com has been owned and operated by our majority-owned subsidiary
Changyou.com Limited ("Changyou").
Our brand advertising business offers advertisements on our Web properties to
companies seeking to increase their brand awareness online.
-43---------------------------------------------------------------------------------
Table of Contents
Search and Others Business
Our search and others business, provided by our search subsidiary Sogou Inc.
("Sogou"), primarily offers customers pay-for-click services, as well as online
marketing services on Sogou Web Directory.
Online Game Business
Our online game business is conducted via Changyou, which is a leading online
game developer and operator in China. Changyou engages in the development,
operation and licensing of online games, including massively multiplayer online
games ("MMOGs") and Web games. Changyou developed and operates Tian Long Ba Bu
("TLBB"), which is one of the most popular MMOGs in China. Changyou's
majority-owned subsidiary 7Road.com Limited ("7Road") jointly operates DDTank
and Wartune (also known as "Shen Qu"), which are two popular Web games in China,
primarily through an extensive network of third-party game platforms in China
and overseas.
For the third quarter of 2012, more than 71% of the revenues of our online game
business were derived from TLBB. Changyou's online game revenues were $151.1
million, which represented 53% of our total revenues for the quarter. Net income
contributed by Changyou for the quarter was $77.4 million, which represented
150% of our total net income. We depend on Changyou for a significant portion of
our revenues, net income, and operating cash flow.
Wireless Business
Our wireless business offers mobile related services through different types of
wireless products to mobile phone users. The mobile related services consist of
the provision of content such as news, weather forecasts, chatting,
entertainment information, mobile games, mobile phone ringtones, logo downloads
and video content downloads. A majority of the content is purchased from third
party content providers. The wireless products mainly consist of short messaging
services ("SMS"), interactive voice response ("IVR"), mobile games and Ring Back
Tone ("RBT").
Others Business
Our others business primarily includes sub-licensing of licensed video content
to third parties, offering cinema advertisement slots to be shown in theaters
before the screening of movies, and offering Internet value-added services
("IVAS") with respect to Web games developed by third-party developers under
revenue sharing arrangements with third-party developers.
Business Restructuring
Initial Public Offering of Changyou
On April 7, 2009, Changyou completed its initial public offering on the NASDAQ
Global Select Market, trading under the symbol "CYOU." After Changyou's
offering, as we are Changyou's controlling shareholder, we continue to
consolidate Changyou in our consolidated financial statements, but recognize
noncontrolling interest reflecting shares held by shareholders other than us.
For the third quarter of 2012, approximately 32% of the economic interest in
Changyou was recognized as noncontrolling interest in our consolidated financial
statements.
On August 6, 2012, Changyou declared a special one-time cash dividend of $1.90
per Class A or Class B ordinary share, or $3.80 per American depositary share
("ADS") and a total of $201 million. On September 21, 2012, Changyou paid out
this special cash dividend, of which $136 million was paid to and received by
Sohu.
We have entered into agreements with Changyou with respect to various interim
and ongoing relationships between us, including a Master Transaction Agreement,
a Revised Non-Competition Agreement, and an Amended and Restated Marketing
Services Agreement. These agreements contain provisions which, among other
things, relate to the transfer of assets and assumption of liabilities of the
massively multiplayer online role-playing game ("MMORPG," which is a subset of
the MMOG category) business, provide cross-indemnification between us and
Changyou for liabilities arising from our respective businesses and mutually
limit us and Changyou from competing in certain aspects of each other's
businesses, and also include a number of ongoing commercial relationships.
Sogou Transactions
On October 22, 2010, Sogou sold 24.0 million, 14.4 million and 38.4 million,
respectively, of its newly-issued Series A Preferred Shares to Alibaba
Investment Limited ("Alibaba"), a private investment subsidiary of Alibaba Group
Holding Limited, China Web Search (HK) Limited ("China Web"), an investment
vehicle of Yunfeng Fund, LP, and Photon Group Limited ("Photon"), the investment
fund of Sohu's Chairman and Chief Executive Officer Dr. Charles Zhang, for $15
million, $9 million, and $24 million, respectively.
On June 29, 2012, Sohu purchased the 24.0 million Sogou Series A Preferred
Shares held by Alibaba for fixed cash consideration of $25.8 million. After the
purchase of these shares, we held 73% of the combined total of Sogou's
outstanding ordinary shares and Series A Preferred Shares. As we are Sogou's
controlling shareholder, we continue to consolidate Sogou in our consolidated
financial statements, but recognize noncontrolling interest reflecting shares
held by shareholders other than us.
-44---------------------------------------------------------------------------------
Table of Contents
17173 Transaction
On December 15, 2011, pursuant to an agreement entered into on November 29,
2011, we closed the sale to Changyou of certain assets associated with the
business of 17173.com (the "17173 Business"), a leading game information portal
in China, for fixed cash consideration of $162.5 million. In payment of part of
the consideration, Changyou.com HK Limited delivered to Sohu.com Limited a
promissory note in the amount of $16 million due on November 30, 2012. In
connection with this transaction, we and Changyou revised the Non-Competition
Agreement between us to provide our agreement not to compete with Changyou in
the 17173 Business for a period of five years following the closing of
Changyou's acquisition of the 17173 Business and to remove the prior prohibition
on Changyou's competing with us in the 17173 Business. After the closing of the
sale, we continued to consolidate the results of operations of the 17173
Business in our consolidated financial statements.
On November 29, 2011, we and Changyou entered into a services agreement and an
online links and advertising agreement pursuant to which we agreed to provide
links and advertising space and technical support to Changyou, including the
provision and maintenance of user log-in, information management and virtual
currency payment systems for the 17173 Business. The agreements provide for a
term of 25 years for the virtual currency payment system services, and an
initial term of three years for all the other relevant services and links and
advertising space, with aggregate fees payable by Changyou to us of
approximately $30 million. Under the agreements, Changyou may renew certain
rights for a subsequent term of 22 years, and may obtain a perpetual software
license in respect of the information management system and the user log-in
system following the expiration of the three-year term, subject to Changyou's
payment to us of additional fees of up to approximately $5 million in the
aggregate.
7Road Transactions
On May 11, 2011, Changyou, through its VIE Gamease, acquired 68.258% of the
equity interests of Shenzhen 7Road and began to consolidate Shenzhen 7Road's
financial statements on June 1, 2011. Effective June 26, 2012, Shenzhen 7Road
was reorganized into a Cayman Islands holding company structure where Changyou
holds a direct ownership interest in 7Road through Changyou's subsidiary
Changyou.com Webgame (HK) Limited, and Shenzhen 7Road is a VIE of 7Road. For
purposes of clarity, as the reorganization did not result in any change in the
ultimate beneficial ownership of Shenzhen 7Road's business, assets and results
of operations, when we discuss 7Road and Shenzhen 7Road in this report, we treat
the reorganization as if it had been effective upon Changyou's acquisition of
68.258% of the equity interests in Shenzhen 7Road.
On June 21, 2012, 7Road's Chief Executive Officer surrendered to 7Road, without
consideration, ordinary shares of 7Road representing 5.1% of the outstanding
ordinary shares of 7Road, in order to increase the number of ordinary shares
available for issuance as equity incentives to employees, directors and
consultants of 7Road without dilution of the other shareholders of 7Road. As a
result, the noncontrolling interest decreased to 28.074% of 7Road and Changyou's
interest in 7Road increased to 71.926%.
On September 26, 2012, 7Road submitted on a confidential basis to the SEC a
draft registration statement for a possible initial public offering ("IPO") of
ADSs representing ordinary shares of 7Road.
CRITICAL ACCOUNTING POLICIES AND MANAGEMENT ESTIMATES
Our discussion and analysis of our financial condition and results of operations
relates to our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("U.S. GAAP"). The preparation of these financial statements requires us
to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, we evaluate our estimates based on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We have identified below
the accounting policies that reflect our more significant estimates and
judgments, and those that we believe are the most critical to fully
understanding and evaluating our consolidated financial statements.
Basis of Consolidation
The consolidated financial statements include the accounts of Sohu and its
wholly-owned and majority-owned subsidiaries and variable interest entities
("VIEs"). All intercompany transactions are eliminated.
-45---------------------------------------------------------------------------------
Table of Contents
We have adopted the guidance of accounting for VIEs, which requires VIEs to be
consolidated by the primary beneficiary of the entity. Our management made
evaluations of the relationships between us and its VIEs and the economic
benefit flow of contractual arrangements with the VIEs. In connection with such
evaluation, management also took into account the fact that, as a result of such
contractual arrangements, the Sohu Group controls the shareholders' voting
interests in the VIEs. As a result of such evaluation, management concluded that
the Sohu Group is the primary beneficiary of its VIEs. As a result, we
consolidate all of its VIEs in its consolidated financial statements.
For majority-owned subsidiaries and VIEs, noncontrolling interest is recognized
to reflect the portion of their equity which is not attributable, directly or
indirectly, to the controlling shareholder.
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery
has occurred, the sales price is fixed or determinable, and collectability is
reasonably assured. The recognition of revenues involves certain management
judgments. The amount and timing of our revenues could be materially different
for any period if management made different judgments or utilized different
estimates.
Online Advertising Revenues
Online advertising revenues include revenues from brand advertising services as
well as search and others services.
For a barter transaction involving online advertising services, we recognize
revenue and expense at fair value only if the fair value of the advertising
services surrendered /received in the transaction is determinable. For our
advertising-for-advertising barter transactions, the fair value of the
advertising surrendered /received is not determinable, so no revenue from
advertising-for-advertising barter transactions is recognized.
Before September 1, 2012, our online advertising revenues were subject to PRC
business tax ("Business Tax"). Our online advertising revenues were recognized
after deducting agent rebates and applicable Business Tax and related
surcharges. Business Tax is imposed primarily on revenues from the provision of
taxable services and is calculated by multiplying the applicable tax rate by
gross revenue.
Effective September 1, 2012, the PRC Ministry of Finance and the State
Administration of Taxation launched a Business Tax to Value Added Tax
Transformation Pilot Program (the "Pilot Program") for certain industries in
eight regions, including Beijing and Tianjin. Value Added Tax ("VAT") payable on
goods sold or taxable labor services provided by a general VAT taxpayer for a
taxable period is the net balance of the output VAT for the period after
crediting the input VAT for the period. Hence, the amount of VAT payable does
not result directly from output VAT generated from goods sold or taxable labor
services provided. With the adoption of Pilot Program, our online advertising
revenues are subject to VAT. Our online advertising revenues are now recognized
after deducting agent rebates and net of VAT and related surcharges.
Brand Advertising Revenues
Business Model
Currently the brand advertising business has two main types of pricing models,
consisting of the Fixed Price Model and the Cost Per Impression ("CPM") pricing
model. We apply the Fixed Price Model for a majority of our brand advertising
revenues. Under the Fixed Price Model, a contract is signed to establish a fixed
price for the advertising services to be provided. Under the CPM pricing model,
the total contract amount for the advertising services is not fixed. Instead, a
fixed price for each qualifying display is stated. Advertisers using the CPM
pricing model pay us based on the number of qualifying displays of their
advertisements appear on our Websites, and we recognize as revenue the fees
charged to advertisers each time their advertisements are displayed on the
Websites, on the condition that each display meets certain selected criteria
imposed by advertisers. We provide advertisement placements to our advertisers
on our different Website channels and in different formats, which can include,
among other things, banners, links, logos, buttons, rich media, pre-roll and
post-roll video screens, pause video screens and content integration, as
specified in the contracts with the advertisers.
Revenue recognition and basis of revenue presentation
For brand advertising revenue recognition, prior to entering into contracts, we
make a credit assessment of the customer to assess the collectability of the
contract. For those contracts for which the collectability is determined to be
reasonably assured, we recognize revenue when all revenue recognition criteria
are met. For those contracts for which the collectability is determined not to
be reasonably assured, we recognize revenue only when the cash was received and
all other revenue recognition criteria are met.
In accordance with ASU No.2009 -13, which we adopted commencing January 1, 2011,
we treat advertising contracts with multiple deliverable elements as separate
units of accounting for revenue recognition purposes and to recognize revenue on
a periodic basis during the contract when each deliverable service is provided.
Since the contract price is for all deliverables, we allocate the arrangement
consideration to all deliverables at the inception of the arrangement on the
basis of their relative selling prices. Since the number of advertising
contracts that covered more than one quarter and the revenues from advertising
contracts that covered more than one quarter were immaterial compared to the
total advertising contracts, the impact of adoption of ASU 2009-13 to us is
immaterial.
-46-
--------------------------------------------------------------------------------
Table of Contents
We recognize gross revenue for the amount of fees we receive from our
advertisers. Determining whether revenue should be reported gross or net is
based on an assessment of various factors, the primary factor is whether we are
acting as the principal in offering services to the customer or we are acting as
an agent in the transaction. For the brand advertising business, we recognize
net revenue for the transactions where we act as an agent. Whether we are
serving as principal or agent in a transaction is judgmental in nature and is
determined by evaluating the terms of the arrangement.
Search and Others Revenues
Search and others services mainly include pay-for-click services, as well as
online marketing services on Sogou Web Directory.
Pay-for-click services
Pay-for-click services mainly consist of search query-based and contextual
online marketing services. Search query-based online marketing services are
keyword-based marketing services. Our auction-based system enables advertisers,
on a real time basis, to bid on keywords that trigger the display of their
Website links on Sogou search result pages. The display priority of advertiser
Website links is based on both the price bid on the keyword and the quality
factor of an advertiser's Website link for that search query. Revenue for
pay-for-click services is recognized on a per click basis when the users click
on the displayed links.
Contextual online marketing services enable our advertisers' promotional links
to be displayed on Sogou Website Alliance members' Websites where the links are
relevant to the subject and content of such Web pages.
Online marketing services on Sogou Web Directory
Online marketing services on Sogou Web Directory mainly consist of displaying
advertiser Website links on the Web pages of the Sogou Web Directory. The Sogou
Web Directory is a Chinese Web directory navigation site which serves as a key
access point to popular and preferred Websites and applications. Revenue for
online marketing services on Sogou Web Directory is normally recognized on a
straight-line basis over the contract period, provided our obligations under the
contract have been met and all revenue recognition criteria have been met.
Sogou Website Alliance
Both pay-for-click services and online marketing services on Sogou Web Directory
involve the Sogou Website Alliance. The Sogou Website Alliance is a program
through which we expand distribution of our advertisers' Website links or
advertisements by leveraging traffic on Sogou Website Alliance members'
Websites. Payments made to Sogou Website Alliance members are included in cost
of search and others revenues as traffic acquisition costs. We pay Sogou Website
Alliance members either based on revenue-sharing arrangements, under which we
pay a percentage of pay-for-click revenues generated from clicks by users of
their properties, or based on a pre-agreed unit price.
Basis of revenue presentation
We recognize gross revenue for the amount of fees we receive from our
advertisers. Determining whether revenue should be reported gross or net is
based on an assessment of various factors, the primary factor is whether we are
acting as the principal in offering services to the customer or we are acting as
an agent in the transaction. For pay-for-click services, we recognize gross
revenue, as we have the primary responsibility for fulfillment and
acceptability. As there is no revenue sharing for online marketing services on
Sogou Web Directory, there is no need to make a gross versus net judgment.
Whether we are serving as principal or agent in a transaction is judgmental in
nature and is determined by evaluating the terms of the arrangement.
Online Game Revenues
Our online game revenues are generated from MMOG operations revenues, Web game
revenues and overseas licensing revenues.
MMOG operations revenues
Revenues are recorded net of applicable Business Tax, discounts and rebates to
distributors.
-47-
--------------------------------------------------------------------------------
Table of Contents
Online game revenues from Changyou's current MMOG operations are earned by
providing online services to players pursuant to the item-based revenue model.
Under the item-based revenue model, the basic game play functions are free of
charge and players are charged for purchases of in-game virtual items. Online
game revenues are recognized over the estimated lives of the virtual items
purchased or as the virtual items are consumed. If different assumptions were
used in deriving the estimated lives of the virtual items, the timing of our
recording of the revenues would be impacted.
Game operations revenues are collected by Changyou's VIEs through the sale of
Changyou's prepaid cards, which it sells in both virtual and physical forms to
third-party distributors and players. Proceeds received from sales of prepaid
cards are initially recorded as receipts in advance from customers and, upon
activation or charge of the prepaid cards, are transferred from receipts in
advance from customers to deferred revenues. As Changyou does not have control
of, and generally does not know, the ultimate selling price of the prepaid cards
sold by distributors, net proceeds from distributors form the basis of revenue
recognition. Prepaid cards will expire two years after the date of card
production if they have never been activated. The proceeds from the expired game
cards are recognized as revenue upon expiration of cards. Once the prepaid cards
are activated and credited to a player's personal game account, they will not
expire as long as the personal game account remains active. Changyou is entitled
to suspend and close a player's personal game account if it has been inactive
for a period of 180 consecutive days. The unused balances in an inactive
player's personal game account are recognized as revenues when the account is
suspended and closed.
Web game revenue
We generated Web game revenues for the first time in 2011, upon Changyou's
acquisition of a majority interest in 7Road. 7Road's Web games are designed to
be operated under the item-based revenue model. 7Road primarily jointly operates
its games with third-party operators who offer the game to users in China and
other countries through their Websites or platforms.
7Road's joint operation arrangements with third parties provide for two revenue
streams, an initial fixed license fee and monthly joint operation revenue
sharing. Since 7Road is required to provide when-and-if-available upgrades to
the joint operators over the joint operation period, the initial license fee is
recognized ratably as revenue over the contract period. Since the third-party
operator is the party that signs the user agreement with its users and is
responsible for its users' experience on its Websites or platforms, 7Road does
not have the primary responsibility for fulfillment and acceptability of the
game services and is not considered a principal in the transactions with the
users, and therefore recognizes revenues on a net basis.
For arrangements where 7Road's games are hosted on third-party joint operator's
servers, revenues are recognized upon the conversion of the virtual currency of
the joint operator into 7Road's game coins or, if such operator does not have
its own virtual currency, upon payment by the game players for the purchase of
7Road's game coins through such joint operator's Website and game platform.
However, when 7Road also provides server hosting services to its joint operators
for its games, revenues are allocated to two separate elements, including
(i) the game and related service element and (ii) the hosting service element.
Revenues allocated to the game and related service element are recognized upon
conversion by game players of the joint operator's virtual currency into 7Road's
game coins or payment by game players for 7Road's game coins through such
operator's Website and game platform. Revenues allocated to the hosting service
element are recognized over the implicit service period during which 7Road is
obligated to provide access to the server for the game players to be able to
consume their virtual items. Accordingly, for consumable virtual items, revenues
are recognized when the virtual items are consumed or over the predetermined
period of use, or benefit period, and for perpetual virtual items revenues are
recognized over the estimated average period the game players play 7Road's
games.
Overseas licensing revenue
Changyou enters into licensing arrangements with overseas licensees to operate
its MMOGs in other countries or territories. These license agreements provide
two revenue streams, consisting of an initial license fee and a monthly
revenue-based royalty fee based on monthly revenue and sales from ancillary
products of the games. The initial license fee is based on both a fixed amount
and additional amounts receivable upon achieving certain sales targets. Since
Changyou is obligated to provide post-sales services such as technical support
and provision of updates and when-and-if-available upgrades to the licensees
during the license period, the initial license fee from the licensing
arrangement is recognized as revenue ratably over the license period. The fixed
amount of the initial license fee is recognized ratably over the remaining
license period from the launch of the game and the additional amount is
recognized ratably over the remaining license period from the date when such
additional amount is certain. The monthly revenue-based royalty fee is
recognized when relevant services are delivered, provided that collectability is
reasonably assured.
-48-
--------------------------------------------------------------------------------
Table of Contents
Wireless Revenues
Our wireless revenues are generated from the provision of mobile-related
services through different types of wireless products to mobile phone users. The
wireless products mainly consist of SMS, IVR, mobile games and RBT. In order to
deliver our products to mobile phone users, we sign contracts with China Mobile
Communications Corporation ("China Mobile"), China United Network Communication
Group Company Limited ("China Unicom"), China Telecom Corporation ("China
Telecom") and their subsidiaries, as well as other small mobile network
operators. We refer to these mobile network operators, collectively, as the
"China mobile network operators." The China mobile network operators charge
their users wireless service fees on a monthly or per message /download basis,
and pay us service fees after deducting the China mobile network operators'
share of the fees.
Wireless revenues are recognized in the month in which the service is performed,
provided that no significant obligations remain. For the amount of revenues to
be recognized, we rely on billing confirmations issued by the China mobile
network operators. If at the end of each reporting period, an operator has not
yet issued such billing confirmations, we estimate the amount of collectable
wireless service fees and recognize revenue. When we later receive billing
confirmations, we record a true-up accounting adjustment. For the three months
ended September 30, 2012, 70% of our estimated wireless revenues were confirmed
by billing confirmations received from the China mobile network operators.
Generally, (i) within 15 to 120 days after the end of each month, we receive
billing confirmations from the operators and (ii) within 30 to 180 days after
delivering billing confirmations, each operator remits the wireless service
fees, net of its service fees, to us.
Currently, a majority of our wireless revenues are recorded on a gross basis, as
we have the primary responsibility for fulfillment and acceptability of the
wireless services.
Others Revenues
Other revenues are primarily generated from sub-licensing of licensed video
content operated by Sohu, cinema advertisements operated by Changyou and IVAS
provided by Sogou with respect to Web games developed by third-party developers.
Revenue from sub-licensing of licensed video content
For licensed video content purchased with payment in cash on an exclusive basis,
we have rights to sub-license to other platforms. Revenue from sub-licensing of
licensed video content is recognized when the following criteria are met:
(1) Persuasive evidence of a sub-licensing arrangement exists;
(2) The content has been delivered or is available for immediate and
unconditional delivery;
(3) The sub-license period as indicated in the arrangement has begun and the
sub-licensee can begin its exploitation (exhibition); and
(4) The sub-licensing fee is fixed or determinable and collection of the
sub-licensing fee is reasonably assured.
Revenue from cinema advertisements
For cinema advertising revenues, a contract is signed with the advertiser to
establish a fixed price and specify advertising services to be provided. Based
on the contracts, we provide advertisement placements in advertising slots to be
shown in theatres before the screening of movies. The rights to place
advertisements in such advertising slots are granted under contracts with
different theatres and film production companies.
Revenue from cinema advertising is recognized when all the recognition criteria
are met. Depending on the terms of a customer contract, fees for services
performed can be recognized according to two principal methods, which are the
proportional performance method and the straight-line method. Under the
proportional performance method, fees are generally recognized based on a
percentage of the advertising slots actually delivered where the fee is earned
on a per-advertising slot placement basis. Under the straight-line method, fees
are recognized on a straight-line basis over the contract period when the fee is
not paid based on the number of advertising slots actually delivered.
Revenue from IVAS
We, through Sogou, offer Web games developed by third-party developers and
generate revenue from the provision of Internet value-added services, including
promotion, access maintenance and payment services to third-party developers.
The online games can be accessed and played by end users free of charge but the
end users may choose to purchase in-game merchandise to enhance their game
playing experience.
Under revenue sharing agreements signed with third-party developers, we collect
payments from the end users for items sold, keep a pre-agreed percentage of the
proceeds and remit the balance to the third-party developers. Revenue from IVAS
is recognized when our obligations under the agreements and all other revenue
recognition criteria have been met.
-49---------------------------------------------------------------------------------
Table of Contents
Share-based Compensation Expense
Sohu, Changyou, Sogou, Sohu Video and 7Road all have incentive plans for the
granting of share-based awards, including common stock /ordinary shares, share
options, restricted shares and restricted share units, to their executive
officers, management and employees. Share-based compensation expense is
recognized as costs and /or expenses in the consolidated statements of
comprehensive income based on the fair value of the related share-based awards
on their grant dates.
For Sohu share-based awards, in determining the fair value of share options
granted, the Black-Scholes valuation model is applied; in determining the fair
value of restricted share units granted, the public market price of the
underlying shares on the grant dates is applied.
For Changyou share-based awards, in determining the fair value of ordinary
shares, restricted shares and restricted share units granted in 2008, the income
approach /discounted cash flow method with a discount for lack of marketability
was applied, given that the shares underlying the awards were not publicly
traded at the time of grant. In determining the fair value of restricted share
units granted in 2009 before Changyou's initial public offering, the fair value
of the underlying shares was determined based on Changyou's offering price for
its initial public offering. In determining the fair value of restricted share
units granted after Changyou's initial public offering, the public market price
of the underlying shares on the grant dates is applied.
For Sogou share-based awards, in determining the fair value of share options
granted, the income approach /discounted cash flow method with a discount for
lack of marketability was applied, given that the shares underlying the awards
were not publicly traded at the time of grant.
On January 4, 2012, Sohu Video, the holding entity of Sohu's video division,
adopted a 2011 Share Incentive Plan which provided for the issuance of up to
25,000,000 ordinary shares of Sohu Video (amounting to 10% of the outstanding
Sohu Video shares on a fully-diluted basis) to management and key employees of
the video division and to Sohu management. As of September 30, 2012, grants of
options for the purchase of 15,352,200 of ordinary shares of Sohu Video had been
made and were effective under the plan. However, as of September 30, 2012, the
restructuring of Sohu's video division was still in process and certain
significant factors remained uncertain. For purposes of ASC 718, no grant date
is established until mutual understanding of the option awards' key terms and
conditions between Sohu Video and the recipients can be reached, and such mutual
understanding cannot be reached until the video division's restructuring plan
has been substantially fixed, so that the enterprise value of Sohu Video and
hence the fair value of the options is determinable and can be accounted for. As
of September 30, 2012, on the basis that the broader terms and conditions of the
option awards had neither been finalized nor mutually agreed with the
recipients, no grant of options had occurred for purposes of ASC 718 and hence
no share based compensation expense was recognized.
On July 10, 2012, 7Road adopted a 2012 Share Incentive Plan (the "7Road 2012
Share Incentive Plan"), which initially provided for the issuance of up
to 5,100,000 ordinary shares of 7Road (amounting to 5.1% of the outstanding
7Road shares on a fully-diluted basis) to selected directors, officers,
employees, consultants and advisors of 7Road. On November 2, 2012, 7Road's Board
of Directors and its shareholders approved an increase from 5,100,000 to
15,100,000 ordinary shares (amounting to 13.7% of the outstanding 7Road shares
on a fully-diluted basis) in the number of ordinary shares available for
issuance from time to time to selected directors, officers, employees,
consultants and advisors of 7Road under its 2012 Share Incentive Plan. As of
September 30, 2012, 2,546,250 restricted share units had been granted under the
plan. Such restricted share units will not be vested until 7Road's completion of
a firm commitment underwritten IPO of its shares resulting in a listing on an
internationally recognized exchange and the expiration of all underwriters'
lockup periods applicable to the IPO. The completion of a firm commitment IPO is
considered to be a performance condition of the awards. An IPO event is not
considered to be probable until it is completed. Under ASC718, compensation cost
should be accrued if it is probable that the performance condition will be
achieved and should not be accrued if it is not probable that the performance
condition will be achieved. As a result, no compensation expense will be
recognized relating to these restricted share units until the completion of an
IPO, and hence no share-based compensation expense was recognized for the
quarter ended September 30, 2012.
Share-based compensation expense for the ordinary shares granted is fully
recognized in the quarter during which these ordinary shares are granted. For
share options, restricted shares and restricted share units granted with respect
to Sohu shares and with respect to Changyou shares, compensation expense is
recognized on an accelerated basis over the requisite service period. For share
options granted with respect to Sogou shares, compensation expense is recognized
on a straight-line basis over the estimated period during which the service
period requirement and performance target will be met. The number of share-based
awards for which the service is not expected to be rendered over the requisite
period is estimated, and the related compensation expense is not recorded for
that number of awards.
The assumptions used in share-based compensation expense recognition represent
management's best estimates, but these estimates involve inherent uncertainties
and the application of management judgment. If factors change or different
assumptions are used, our share-based compensation expense could be materially
different for any period. Moreover, the estimates of fair value are not intended
to predict actual future events or the value that ultimately will be realized by
employees who receive equity awards, and subsequent events are not indicative of
the reasonableness of the original estimates of fair value made by us for
accounting purposes.
-50-
--------------------------------------------------------------------------------
Table of Contents
Taxation
Income Taxes
Income taxes are accounted for using an asset and liability approach which
requires the recognition of income taxes payable or refundable for the current
year and deferred tax liabilities and assets for the future tax consequences of
events that have been recognized in our financial statements or tax returns.
Deferred income taxes are determined based on the differences between the
accounting basis and the tax basis of assets and liabilities and are measured
using the currently enacted tax rates and laws. Deferred tax assets are reduced
by a valuation allowance, if based on available evidence, it is considered that
it is more likely than not that some portion of or all of the deferred tax
assets will not be realized. In making such determination, we consider factors
including future reversals of existing taxable temporary differences, future
profitability, and tax planning strategies. If events were to occur in the
future that would allow us to realize more of our deferred tax assets than the
presently recorded net amount, an adjustment would be made to the deferred tax
assets that would increase income for the period when those events occurred. If
events were to occur in the future that would require us to realize less of our
deferred tax assets than the presently recorded net amount, an adjustment would
be made to the valuation allowance against deferred tax assets that would
decrease income for the period when those events occurred. Significant
management judgment is required in determining income tax expense and deferred
tax assets and liabilities.
Our deferred tax assets are related to net operating losses and temporary
differences between accounting basis and tax basis for our China-based
subsidiaries and VIEs that are subject to corporate income tax in the PRC under
the PRC Corporate Income Tax Law.
Withholding tax
The PRC Corporate Income Tax Law (the "CIT Law") imposes a 10% withholding
income tax for dividends distributed by foreign invested enterprises to their
immediate holding companies outside mainland China. A lower withholding tax rate
will be applied if there is a tax treaty between mainland China and the
jurisdiction of the foreign holding company. A holding company in Hong Kong, for
example, will be subject to a 5% withholding tax rate under the Arrangement
Between the PRC and the Hong Kong Special Administrative Region on the Avoidance
of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on
Income and Capital (the "China-HK Tax Arrangement") if such holding company is
considered a non-PRC resident enterprise and holds at least 25% of the equity
interests in the PRC foreign invested enterprise distributing the dividends,
subject to approval of the PRC local tax authority. However, if the Hong Kong
holding company is not considered to be the beneficial owner of such dividends
under applicable PRC tax regulations, such dividend may remain subject to a
withholding tax rate of 10%.
In 2012, Changyou's Board of Directors determined to cause one of Changyou's PRC
subsidiaries to distribute all of its 2012 earnings to its overseas parent
company, Changyou.com HK Limited ("Changyou HK"). Based on an assessment
performed pursuant to requirements specified by PRC tax authorities, Changyou
concluded that it was more likely than not that such distribution would be
subject to 5% withholding tax. For the nine months ended September 30, 2012,
Changyou accrued deferred tax liabilities in the amount of $8.7 million for
withholding taxes associated with this distribution plan.
Uncertain Tax Positions
In order to assess uncertain tax positions, we apply a more likely than not
threshold and a two-step approach for tax position measurement and financial
statement recognition. For the two-step approach, the first step is to evaluate
the tax position for recognition by determining if the weight of available
evidence indicates that it is more likely than not that the position will be
sustained, including resolution of related appeals or litigation processes, if
any. The second step is to measure the tax benefit as the largest amount that is
more than 50% likely to be realized upon settlement.
Transition from PRC Business Tax to PRC Value Added Tax
Effective September 1, 2012, a pilot program for transition from the imposition
of Business Tax to the imposition of VAT for revenues from certain industries
was expanded from Shanghai to eight other cities and provinces in China,
including Beijing and Tianjin. Our brand advertising and search revenues are
subject to this program.
Business Tax had been imposed primarily on revenues from the provision of
taxable services, assignments of intangible assets and transfers of real estate.
Prior to the implementation of the pilot program, our Business Tax rate, which
varies depending upon the nature of the revenues being taxed, generally ranged
from 3% to 5%.
-51-
--------------------------------------------------------------------------------
Table of Contents
VAT payable on goods sold or taxable labor services provided by a general VAT
taxpayer for a taxable period is the net balance of the output VAT for the
period after crediting the input VAT for the period. Before the implementation
of the pilot program, we were mainly subject to a small amount of VAT for
revenues of Changyou's subsidiary 7Road that are deemed for PRC tax purposes to
be derived from the sale of software. VAT has been imposed on those 7Road
revenues at a rate of 17%, with a 14% immediate tax refund, resulting in a net
rate of 3%. With the implementation of the pilot program, in addition to the
revenues currently subject to VAT, our brand advertising and search revenues are
in the scope of the pilot program and are now subject to VAT at a rate of 6%.
Under ASC 605-45, the presentation of taxes on either a gross basis (included in
revenues and costs) or a net basis (excluded from revenues) is an accounting
policy decision determined by management. As VAT imposed on brand adverting and
search revenues and VAT imposed on 7Road's revenues from the sale of software
are considered as substantially different in nature, we determined that it is
reasonable to apply the guidance separately for these two types of VAT. The
basis for this determination is that VAT payable on brand advertising and search
revenues is the difference between the output VAT (at a rate of 6%) and
available input VAT amount (at the rate applicable to the supplier), which is a
component of our costs for providing the brand advertising and search services.
On the other hand, VAT payable by 7Road is in effect at 3% of the applicable
revenues from the sale of software, irrespective of the availability of any
input VAT, under preferential VAT treatment provided to 7Road by the local tax
bureau. In this regard, we believe the VAT payable by 7Road is more akin to a
sales tax than typical VAT. As a result, we adopted the net presentation method
for our brand advertising and search businesses both before and after the
implementation of the pilot program, and for the revenues of 7Road deemed to be
derived from the sale of software, we adopted the gross presentation method
before and after the implementation of the pilot program.
The implementation of the pilot program has not had a significant impact on our
consolidated statements of comprehensive income for the three and nine months
ended September 30, 2012.
Noncontrolling Interest
Noncontrolling interest is the portion of economic interest in Sohu's
majority-owned subsidiaries and VIEs which is not attributable, directly or
indirectly, to Sohu. Currently, the noncontrolling interest in our consolidated
financial statements mainly consists of noncontrolling interest for Changyou and
Sogou.
Noncontrolling Interest for Changyou
To reflect the economic interest in Changyou held by shareholders other than
Sohu ("noncontrolling shareholders"), Changyou's net income attributable to
these noncontrolling shareholders is recorded as noncontrolling interest in
Sohu's consolidated statements of comprehensive income, based on their share of
the economic interests in Changyou. Changyou's cumulative results of operations
attributable to these noncontrolling shareholders, along with changes in
shareholders' equity, adjustment for share-based compensation expense in
relation to those share-based awards which are unvested and vested but not yet
settled and adjustment for changes in Sohu's ownership in Changyou from Sohu's
purchase of Changyou ADSs representing Class A ordinary shares, are recorded as
noncontrolling interest in Sohu's consolidated balance sheets.
Noncontrolling Interest for Sogou
To reflect the economic interest in Sogou held by shareholders other than Sohu
("noncontrolling shareholders"), Sogou's net income /loss attributable to these
noncontrolling shareholders is recorded as noncontrolling interest in Sohu's
consolidated statements of comprehensive income. Sogou's cumulative results of
operations attributable to these noncontrolling shareholders, along with changes
in shareholders' equity /(deficit) and adjustment for share-based compensation
expense in relation to those share-based awards which are unvested and vested
but not yet settled and noncontrolling shareholders' investments in Series A
Preferred Shares are accounted for as a noncontrolling interest classified as
permanent equity in Sohu's consolidated balance sheets, as redemption of the
noncontrolling interest is solely within the control of Sohu. These treatments
are based on the terms governing investment by the noncontrolling shareholders
in the Series A Preferred Shares of Sogou (the "Sogou Series A Terms"), the
terms of Sogou's restructuring, and Sohu's purchase of Sogou Series A Preferred
Shares from Alibaba.
By virtue of these terms, as Sogou has been losing money after its
restructuring, the net losses have been and will be allocated in the following
order:
(i) net losses were allocated to ordinary shareholders until their basis in Sogou
decreased to zero;
(ii) additional net losses will be allocated to holders of Sogou Series A
Preferred Shares until their basis in Sogou decreases to zero; and
(iii) further net losses will be allocated between ordinary shareholders and
holders of Sogou Series A Preferred Shares based on their shareholding
percentage in Sogou.
-52-
--------------------------------------------------------------------------------
Table of Contents
Any subsequent net income from Sogou will be allocated in the following order:
(i) net income will be allocated between ordinary shareholders and holders of
Sogou Series A Preferred Shares based on their shareholding percentage in
Sogou until their basis in Sogou increases to zero;
(ii) additional net income will be allocated to holders of Sogou Series A
Preferred Shares to bring their basis back;
(iii) further net income will be allocated to ordinary shareholders to bring
their basis back; and
(iv) further net income will be allocated between ordinary shareholders and
holders of Sogou Series A Preferred Shares based on their shareholding
percentage in Sogou.
Net Income per Share
Basic net income per share is computed using the weighted average number of
common shares outstanding during the period. Diluted net income per share is
computed using the weighted average number of common shares and, if dilutive,
potential common shares outstanding during the period. Potential common shares
comprise shares issuable upon the exercise or settlement of share-based awards
using the treasury stock method. The dilutive effect of share-based awards with
performance requirements is not considered before the performance targets are
actually met. The computation of diluted net income per share does not assume
conversion, exercise, or contingent issuance of securities that would have an
anti-dilutive effect (i.e., an increase in earnings per share amounts or a
decrease in loss per share amounts) on net income per share. Additionally, for
purposes of calculating the numerator of diluted net income per share, the net
income attributable to Sohu is adjusted as follows:
(1) Changyou's net income attributable to Sohu is determined using the percentage
that the weighted average number of Changyou shares held by Sohu represents
of the weighted average number of Changyou ordinary shares and shares
issuable upon the exercise or settlement of share-based awards under the
treasury stock method, instead of by the percentage held by Sohu of the total
economic interest in Changyou, which is used for the calculation of basic net
income per share.
(2) Sogou's net income /(loss) attributable to Sohu is determined using the
percentage that the weighted average number of Sogou shares held by Sohu
represents of the weighted average number of Sogou ordinary shares and Series
A Preferred Shares, shares issuable upon the conversion of convertible
preferred shares under the if-converted method, and shares issuable upon the
exercise or settlement of share-based awards under the treasury stock method,
instead of by Sogou's net income /(loss) allocated to Sohu by virtue of the
Sogou Series A Terms, the terms of the restructuring and Sohu's purchase of
Sogou Series A Preferred Shares from Alibaba, which is used for the
calculation of basic net income per share.
Fair Value of Financial Instruments
Our financial instruments include cash equivalents, restricted time deposits,
short-term investments, accounts receivable, investments in debt securities,
prepaid and other current assets, accounts payable, short-term bank loans,
accrued liabilities, receipts in advance and deferred revenue, other short-term
liabilities and long-term bank loans. The carrying amount of accounts
receivable, prepaid and other current assets, accounts payable, receipts in
advance and deferred revenue, accrued liabilities and other short-term
liabilities approximates their fair value. Other financial instruments are
measured at their respective fair values. For fair value measurements, U.S. GAAP
establishes a three-tier hierarchy which prioritizes the inputs used in the
valuation methodologies in measuring fair value:
Level 1 - observable inputs that reflect quoted prices (unadjusted) for
identical assets or liabilities in active markets.
Level 2 - include other inputs that are directly or indirectly observable in the
market place.
Level 3 - unobservable inputs which are supported by little or no market
activity.
The fair value hierarchy also requires an entity to maximize the use of
observable inputs and minimize the use of unobservable inputs when measuring
fair value.
Cash Equivalents
Our cash equivalents mainly consist of time deposits placed with banks with an
original maturity of three months or less.
Restricted time deposits - Changyou offshore bridge loans from banks, secured by
time deposits
In the third quarter of 2012, Changyou drew down offshore bridge loans from
branches of certain banks for the purposes of expediting the payment of the
special one-time cash dividend to its shareholders and providing working capital
to support its overseas operations. All of these bridge loans were secured by an
equivalent or greater amount in RMB deposits by Changyou in the onshore branches
of such banks.
The offshore bridge loans from the branches of the lending banks are classified
as short-term bank loans or long-term bank loans based on their payment terms.
The RMB onshore deposits securing the offshore loans are treated as restricted
time deposits on our consolidated balance sheets. Restricted time deposits are
valued based on the prevailing interest rates in the market. The rates of
interest under the loan agreements with the lending banks were also determined
based on the prevailing interest rates in the market. We classify the valuation
techniques that use these inputs as Level 2 of fair value measurements of
offshore bridge loans from banks.
-53---------------------------------------------------------------------------------
Table of Contents
Short-term Investments
For investments in financial instruments with a variable interest rate indexed
to the performance of underlying assets, we elected the fair value method at the
date of initial recognition and carried these investments subsequently at fair
value. Changes in the fair value are reflected in the consolidated statements of
comprehensive income.
Accounts Receivable, Net
The carrying value of accounts receivable is reduced by an allowance that
reflects our best estimate of the amounts that will not be collected. We make
estimations of the collectability of accounts receivable. Many factors are
considered in estimating the general allowance, including but not limited to
reviewing delinquent accounts receivable, performing an aging analysis and a
customer credit analysis, and analyzing historical bad debt records and current
economic trends. Additional allowance for specific doubtful accounts might be
made if the financial conditions of our customers or the China mobile network
operators deteriorate or the China mobile network operators are unable to
collect fees from their end customers, resulting in their inability to make
payments due to us.
Investments in Debt Securities
We invest our excess cash in certain debt securities of high-quality corporate
issuers. We elected the fair value option to account for our investments in debt
securities at their initial recognition. Changes in the fair value are reflected
in the consolidated statements of comprehensive income as other income
/(expense). The fair value election was made to mitigate accounting mismatches
and to achieve operational simplifications.
Equity Investments
Investments in entities over which we do not have significant influence are
recorded as equity investments and are accounted for by the cost method.
Investments in entities over which we have significant influence but do not
control are also recorded as equity investments and are accounted for by the
equity method. Under the equity method, our share of the post-acquisition
profits or losses of the equity investment is recognized in our consolidated
statements of comprehensive income; and our share of post-acquisition movements
in equity investments is recognized in equity in our consolidated balance
sheets. Unrealized gains on transactions between us and our equity investees are
eliminated to the extent of the interest in the equity investments. Unrealized
losses are also eliminated unless the transaction provides evidence of an
impairment of the asset transferred. When our share of losses in an equity
investment equals or exceeds our interest in the equity investment, we do not
recognize further losses, unless we have incurred obligations or made payments
on behalf of the equity investee.
Long-Lived Assets
Long-lived assets include fixed assets, intangible assets and prepaid
non-current assets.
Fixed Assets
Fixed assets mainly comprise computer equipment and hardware, office building,
leasehold improvements, office furniture and vehicles. Fixed assets are recorded
at cost less accumulated depreciation with no residual value. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets.
Intangible Assets
Intangible assets mainly comprise customer lists, video content and license,
developed technologies, computer software purchased from unrelated third
parties, domain names and trademarks, marketing rights and others, as well as
operating rights for licensed games. Intangible assets are recorded at cost less
accumulated amortization with no residual value. Amortization of intangible
assets other than licensed video content is computed using the straight-line
method over their estimated useful lives. We amortize licensed video content
over the shorter of the term of the estimated period over which the benefits of
the license agreement will be enjoyed based on the trend of accumulation of
viewership or the applicable license period. Beginning in the third quarter of
2011, licensed video content is amortized on an accelerated basis based on the
viewership accumulation trend over the shorter of the term of the estimated
period over which the benefits of the license agreement will be enjoyed or the
applicable license period.
-54-
--------------------------------------------------------------------------------
Table of Contents
For exclusively licensed video content which we sub-licensed to similar
platforms in return for payment in cash, we allocate a portion of the video
content cost from cost of brand advertising revenues to sub-licensing cost. The
allocation is based on the revenues to be generated through sub-licensing. We
amortize sub-licensing cost using the individual-film-forecast-computation
method, which amortizes such costs in the same ratio that actual sub-licensing
revenue bears as of the current period end to the total of the actual revenue
earned and the estimated remaining unrecognized ultimate revenue.
Prepaid non-current Assets
Prepaid non-current assets primarily include prepayments for the office
buildings to be built as our and Changyou's headquarters before they are
recognized as fixed assets, prepayments for the technological infrastructure and
fitting-out of our office building before they are recognized as fixed assets,
and prepaid PRC income tax arising from the sale of the 17173 Business by us to
Changyou. Since the sale of the 17173 Business was between entities that are
included in our consolidated financial statements, it was considered an
"intra-entity transaction" and, under ASC 810-10, income taxes paid should be
deferred. Accordingly, we recorded income tax related to the sale of the 17173
Business as prepaid PRC income tax. The prepaid PRC income tax will be amortized
over the period of the weighted average remaining life of the 17173
Business-related assets sold to Changyou.
Impairment of Long-lived Assets
In accordance with ASC 360-10-35, we review the carrying values of long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying value of an asset may not be recoverable. Based on the existence of
one or more indicators of impairment, we measure any impairment of long-lived
assets using the projected discounted cash flow method at the asset group level.
The estimation of future cash flows requires significant management judgment
based on our historical results and anticipated results and is subject to many
factors. The discount rate that is commensurate with the risk inherent in our
business model is determined by our management. An impairment loss would be
recorded if we determined that the carrying value of long-lived assets may not
be recoverable. The impairment to be recognized is measured by the amount by
which the carrying values of the assets exceed the fair value of the assets.
We noted that prices for purchased video content decreased significantly in the
second quarter of 2012. We considered this is an indicator of impairment, and
accordingly we performed an impairment test for our purchased video content at
the asset group level. We divided purchased video content into seven asset
groups, consisting of TV series, Pay Channel, Overseas Content, Movies,
Animations, Variety shows, and Documentary films. We tested the recoverability
of the carrying values of these asset groups by comparing their carrying amounts
to the sum of the undiscounted cash flows expected to result from the use and
eventual disposition of the asset groups. If the carrying amount of an asset
group was determined to not be recoverable, an impairment loss was recognized,
measured by comparing the carrying value of the asset group to the asset group's
fair value. The fair values of the purchased video content were estimated using
the discounted cash flow method. The impairment losses were allocated only to
the purchased video content within the asset group, since the carrying amount of
other long-lived assets within the asset group was considered to be already
below their fair value.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the
identifiable assets and liabilities acquired as a result of our acquisitions of
interests in our subsidiaries and VIEs.
We test goodwill for impairment at the reporting unit level on an annual basis
as of October 1, and between annual tests when an event occurs or circumstances
change that could indicate that the asset might be impaired. Commencing in
September 2011, we adopted the Financial Accounting Standards Board ("FASB")
revised guidance on "Testing of Goodwill for Impairment." Under this guidance,
we have the option to choose whether we will apply the qualitative assessment
first and then the quantitative assessment, if necessary, or to apply the
quantitative assessment directly. For reporting units applying qualitative
assessment first, we start the goodwill impairment test by assessing qualitative
factors to determine whether it is more likely than not that the fair value of a
reporting unit is less than its carrying amount. If we determine that it is
more-likely-than-not the fair value of a reporting unit is less than its
carrying amount, the quantitative impairment test is mandatory. Otherwise, no
further testing is required. The quantitative impairment test consists of a
comparison of the fair value of goodwill with its carrying value. For reporting
units directly applying quantitative assessment, we perform the goodwill
impairment test by quantitatively comparing the fair values of those reporting
units to their carrying amounts.
Application of a goodwill impairment test requires significant management
judgment, including the identification of reporting units, assigning assets and
liabilities to reporting units, assigning goodwill to reporting units, and
determining the fair value of each reporting unit. The judgment in estimating
the fair value of reporting units includes estimating future cash flows,
determining appropriate discount rates and making other assumptions. Changes in
these estimates and assumptions could materially affect the determination of
fair value for each reporting unit.
-55---------------------------------------------------------------------------------
Table of Contents
Contingent Consideration
Our contingent consideration primarily consisted of contingent payments
generated from the acquisition of 7Road. The acquisition of 7Road includes a
contingent consideration arrangement that requires additional consideration to
be paid by Changyou based on the future financial performance of 7Road through
December 31, 2012. The fair value of the contingent consideration recognized on
the acquisition date was estimated using the income approach. As of
September 30, 2012, certain specified performance milestones in 2012 had been
achieved by 7Road based on its nine months' financial performance, and we
recorded consideration payable of $19.7 million in other accrued liabilities.
Changes in fair value of the contingent consideration were recognized in other
income /(expense). There are no indemnification assets involved.
Mezzanine Equity
On May 11, 2011, Changyou, through its VIE Gamease, acquired 68.258% of the
equity interests of Shenzhen 7Road and began to consolidate Shenzhen 7Road's
financial statements on June 1, 2011. Effective from June 26, 2012, Shenzhen
7Road was reorganized into a Cayman Islands holding company structure where
Changyou holds a direct ownership interest in 7Road through Changyou's
subsidiary Changyou.com Webgame (HK) Limited, and Shenzhen 7Road is a VIE of
7Road. For purposes of clarity, as the reorganization did not result in any
change in the ultimate beneficial ownership of Shenzhen 7Road's business, assets
and results of operations, when we discuss 7Road and Shenzhen 7Road in this
report, we treat the reorganization as if it had been effective upon Changyou's
acquisition of 68.258% of the equity interests in Shenzhen 7Road.
Mezzanine Equity consists of noncontrolling interest in 7Road and a put option
pursuant to which the noncontrolling shareholders will have the right to put
their equity interests in 7Road to Changyou at a pre-determined price if 7Road
achieves specified performance milestones in the coming three years and certain
circumstances occur. The put option will expire in 2014. Since the occurrence of
the sale is not solely within the control of Changyou, we classify the
noncontrolling interest as mezzanine equity instead of permanent equity in our
and Changyou's consolidated financial statements.
Under ASC subtopic 480-10, we calculate, on an accumulative basis from the
acquisition date, (i) the amount of accretion that would increase the balance of
noncontrolling interest to its estimated redemption value over the period from
the date of the Shenzhen 7Road acquisition to the earliest redemption date of
the noncontrolling interest in 7Road and (ii) the amount of net profit
attributable to noncontrolling shareholders of 7Road based on their ownership
percentage. The carrying value of the noncontrolling interest as mezzanine
equity will be adjusted by an accumulative amount equal to the higher of (i) and
(ii).
On June 21, 2012, 7Road's Chief Executive Officer surrendered to 7Road, without
consideration, ordinary shares of 7Road representing 5.1% of the outstanding
ordinary shares of 7Road, in order to increase the availability of ordinary
shares available for issuance as equity incentives to employees, directors and
consultants of 7Road without dilution of the other shareholders of 7Road. As a
result, the noncontrolling interest decreased to 28.074% of 7Road and Changyou's
interest in 7Road increased to 71.926%.
Under ASC subtopic 480-10, changes in a parent's ownership interest while the
parent retains control of its subsidiary are accounted for as equity
transactions, and do not impact net income or comprehensive income in the
consolidated financial statements. The variance of $6.8 million caused by
7Road's Chief Executive Officer's surrender of shares was recorded as a credit
to additional paid-in capital.
In the third quarter of 2012, Changyou's management estimated that, based on
7Road's performance in the nine months of 2012, 7Road will likely to exceed the
specified performance milestones set forth in the acquisition agreement, and
accordingly increased the estimated redemption value of the noncontrolling
interests in 7Road. The increase in the redemption value was recognized over the
period from the date of the 7Road acquisition to the earliest exercise date of
the put right as net income attributable to mezzanine-classified noncontrolling
interests.
Comprehensive Income
Comprehensive income is defined as the change in equity of a company during a
period from transactions and other events and circumstances excluding
transactions resulting from investments from owners and distributions to owners.
Accumulated other comprehensive income, as presented on our consolidated balance
sheets, includes a cumulative foreign currency translation adjustment.
Segment Reporting
Our segments are business units that offer different services and are reviewed
separately by the chief operating decision maker ("CODM"), or the decision
making group, in deciding how to allocate resources and in assessing
performance. Our CODM is the Chief Executive Officer. There are five segments in
the Sohu Group, consisting of brand advertising, Sogou (which mainly consists of
the search and related business), Changyou (which mainly consists of the online
game business), wireless and others.
-56---------------------------------------------------------------------------------
Table of Contents
Functional Currency and Foreign Currency Translation
Functional Currency
An entity's functional currency is the currency of the primary economic
environment in which it operates, normally that is the currency of the
environment in which the entity primarily generates and expends cash.
Management's judgment is essential to determine the functional currency by
assessing various indicators, such as cash flows, sales price and market,
expenses, financing and inter-company transactions and arrangements. The
functional currency of Sohu.com Inc. is the U.S. dollar. The functional currency
of our subsidiaries in the U.S., the Cayman Islands, the British Virgin Islands
and Hong Kong is the U.S. dollar. The functional currencies of our subsidiaries
and VIEs in the PRC, the United Kingdom, Malaysia and Korea are the national
currencies of those counties.
Foreign Currency Translation
Assets and liabilities of our China-based subsidiaries and VIEs, the United
Kingdom, Malaysia and Korea are translated into U.S. dollars, our reporting
currency, at the exchange rate in effect at the balance sheets date and revenues
and expenses are translated at the average exchange rates in effect during the
reporting period. Foreign currency translation adjustments are not included in
determining net income for the period but are accumulated in a separate
component of equity in our consolidated balance sheets.
Foreign currency transactions denominated in currencies other than the
functional currency are translated into the functional currency using the
exchange rates prevailing at the dates of the transactions. Monetary assets and
liabilities denominated in foreign currencies at the balance sheet date are
re-measured at the applicable rates of exchange in effect at that date. Gains
and losses resulting from foreign currency re-measurement are included in the
consolidated statements of comprehensive income.
RESULTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011
In 2011, we adjusted our business groupings from brand advertising business,
online game business, sponsored search business, and wireless and others
business to online advertising business (consists of the brand advertising
business as well as the search and others business), online game business,
wireless business and others business. To conform to current period
presentations, the relevant amounts for prior periods have been reclassified.
Commencing January 1, 2012, with the development of our business, we
reclassified certain expenses for our Search business and our video division.
Change in Presentation to Properly Reflect the Classification of Expenses of
Video Business
Prior to 2012, the video division was a relatively small operation in the Sohu
Group. It did not have clearly defined business departments because it was
highly dependent on the Sohu Group's resources to sustain its operation. The
video division's compensation and benefits expenses were recorded under cost of
revenues and were not allocated to individual operating expense categories, in
view of the fact that most of the employees in the video division provided
services related to the maintenance of content and resources that directly
contributed to video-related brand advertising revenues.
Commencing January 1, 2012, as the video division has grown significantly and
business departments have been defined through the restructuring process to
become more self-sustainable, compensation and benefits expenses have been
allocated to the respective business departments to properly reflect the
operating results of the video division. The video division's compensation and
benefits expenses were classified as cost of revenues, product development,
sales and marketing and general and administrative expenses, respectively, based
on the nature of the related employees' roles and responsibilities. To conform
to current period presentations, the relevant amounts for prior periods have
been changed accordingly. The change from cost of revenues to operating expenses
was not material to historical periods, and amounted to $1.4 million and $2.9
million for the three and the nine months ended September 30, 2011.
Reclassification of Expenses of Search and Others Business
To expand distribution of customers' sponsored links or advertisements, the
search and others business acquires traffic from third-party Websites. Most
traffic acquisition payments are made to Sogou's Website Alliance members.
Payments to Sogou's Website Alliance members are based on a portion of
pay-for-click revenues generated from clicks by users of their properties, and
are included in cost of revenues. A relatively small portion of traffic
acquisition payments to third-party Websites are based on pre-agreed unit prices
and the actual traffic volume they direct to our search and others business.
Prior to 2012, traffic acquisition payments based on pre-agreed unit price and
the actual traffic volume were recorded in sales and marketing expenses.
-57---------------------------------------------------------------------------------
Table of Contents
Commencing January 1, 2012, in order to enhance comparability with industry
peers, all traffic acquisition costs were recorded in cost of revenues. To
conform to current period presentations, the relevant amounts for prior periods
have been reclassified accordingly. Such reclassifications amounted to $2.0
million and $5.9 million for the three and the nine months ended September 30,
2011.
Revenues
The following table presents our revenues by revenue source and by proportion
for the periods indicated (in thousands, except percentages):
Three Months Ended September 30, Nine Months Ended September 30,
2012 vs 2012 vs
2012 2011 2011 2012 2011 2011
Revenues
Online advertising:
Brand advertising $ 77,874 27 % $ 76,572 33 % $ 1,302 $ 208,154 27 % $ 201,453 33 % $ 6,701
Search and others 35,284 12 % 18,410 8 % 16,874 85,684 11 % 40,002 7 % 45,682
Subtotal of online advertising revenues 113,158 39 % 94,982 41 % 18,176 293,838 38 % 241,455 40 % 52,383
Online game 151,093 54 % 115,798 50 % 35,295 415,711 54 % 312,259 52 % 103,452
Wireless 14,312 5 % 14,210 6 % 102 43,261 6 % 37,559 6 % 5,702
Others 6,815 2 % 7,870 3 % (1,055 ) 14,899 2 % 14,661 2 % 238
Total revenues $ 285,378 100 % $ 232,860 100 % $ 52,518 $ 767,709 100 % $ 605,934 100 % $ 161,775
Total revenues were $285.4 million and $767.7 million, respectively, for the
three and nine months ended September 30, 2012, compared to $232.9 million and
$605.9 million, respectively, for the corresponding periods in 2011. The
increase in total revenues from the three months ended September 30, 2011 to the
three months ended September 30, 2012 was $52.5 million, and the increase from
the nine months ended September 30, 2011 to the nine months ended September 30,
2012 was $161.8 million. The increases were mainly attributable to increases in
online game revenues and search and others revenues.
Online Advertising Revenues
Online advertising revenues were $113.2 million and $293.8 million,
respectively, for the three and nine months ended September 30, 2012, compared
to $95.0 million and $241.5 million, respectively, for the corresponding periods
in 2011. The increase in online advertising revenues from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $18.2
million, and the increase from the nine months ended September 30, 2011 to the
nine months ended September 30, 2012 was $52.3 million. The increases were
mainly attributable to increases in search and others revenues.
Brand Advertising Revenues
Brand advertising revenues were $77.9 million and $208.2 million, respectively,
for the three and nine months ended September 30, 2012, compared to $76.6
million and $201.5 million, respectively, for the corresponding periods in 2011.
The increase in brand advertising revenues from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $1.3
million, and the increase from the nine months ended September 30, 2011 to the
nine months ended September 30, 2012 was $6.7 million. The increases were mainly
attributable to increases in revenues from the sectors of fast-moving consumer
goods, online game and transportation.
We expect brand advertising revenues to increase modestly in the fourth quarter
of 2012, compared to the third quarter of 2012.
Search and Others Revenues
Search and others revenues were $35.3 million and $85.7 million, respectively,
for the three and nine months ended September 30, 2012, compared to $18.4
million and $40.0 million, respectively, for the corresponding periods in 2011.
The increase in search and others revenues from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $16.9
million, and the increase from the nine months ended September 30, 2011 to the
nine months ended September 30, 2012 was $45.7 million. The increases were
mainly due to increased traffic and improved monetization of traffic.
-58---------------------------------------------------------------------------------
Table of Contents
We expect search and others revenues to increase modestly in the fourth quarter
of 2012, compared to the third quarter of 2012.
Online Game Revenues
Online game revenues were $151.1 million and $415.7 million, respectively, for
the three and nine months ended September 30, 2012, compared to $115.8 million
and $312.3 million, respectively, for the corresponding periods in 2011. The
increase in online game revenues from the three months ended September 30, 2011
to the three months ended September 30, 2012 was $35.3 million, and the increase
from the nine months ended September 30, 2011 to the nine months ended
September 30, 2012 was $103.4 million.
The increases were mainly due to the ongoing popularity of Changyou's flagship
game TLBB, the increase in average revenue per active paying account for
Changyou's MMOGs, and the growth of Wartune in China. For the three months ended
September 30, 2012, average revenue per active paying account of Changyou's
MMOGs in China increased by 46% to RMB319, from RMB218 for the three months
ended September 30, 2011.
We expect online game revenues to increase in the fourth quarter of 2012,
compared to the third quarter of 2012.
Wireless Revenues
Wireless revenues were $14.3 million and $43.3 million, respectively, for the
three and nine months ended September 30, 2012, compared to $14.2 million and
$37.6 million, respectively, for the corresponding periods in 2011. The increase
in wireless revenues from the three months ended September 30, 2011 to the three
months ended September 30, 2012 was $0.1 million, and the increase from the nine
months ended September 30, 2011 to the nine months ended September 30, 2012 was
$5.7 million. The latter was mainly due to enhanced product distribution
programs.
We expect wireless revenues to decrease slightly for the fourth quarter of 2012,
compared to the third quarter of 2012.
Others Revenues
Revenues for other services were $6.8 million and $14.9 million, respectively,
for the three and nine months ended September 30, 2012, compared to $7.9 million
and $14.7 million, respectively, for the corresponding periods in 2011. The
decrease in other revenues from the three months ended September 30, 2011 to the
three months ended September 30, 2012 was $1.1 million. The decrease was mainly
due to decreased revenues from sub-licensing of licensed video content and
cinema advertisement business.
Costs and Expenses
Cost of Revenues
The following table presents our cost of revenues by source and by proportion
for the periods indicated (in thousands, except percentages):
Three Months Ended September 30, Nine Months Ended September 30,
2012 vs 2012 vs
2012 2011 2011 2012 2011 2011
Cost of revenues:
Online advertising:
Brand advertising $ 37,476 39 % $ 30,221 44 % $ 7,255 $ 125,331 45 % $ 76,942 46 % $ 48,389
Search and others 19,736 20 % 9,478 14 % 10,258 49,056 18 % 24,365 14 % 24,691
Subtotal of cost of online advertising revenues 57,212 59 % 39,699 58 % 17,513 174,387 63 % 101,307 60 % 73,080
Online game 21,026 22 % 14,578 22 % 6,448 55,735 20 % 33,496 20 % 22,239
Wireless 9,474 10 % 8,727 13 % 747 28,535 10 % 22,728 13 % 5,807
Others 9,037 9 % 4,469 7 % 4,568 17,458 7 % 11,359 7 % 6,099
Total cost of revenues $ 96,749 100 % $ 67,473 100 % $ 29,276 $ 276,115 100 % $ 168,890 100 % $ 107,225
-59-
--------------------------------------------------------------------------------
Table of Contents
Total cost of revenues was $96.7 million and $276.1 million, respectively, for
the three and nine months ended September 30, 2012, compared to $67.5million and
$168.9 million, respectively, for the corresponding periods in 2011. The
increase in cost of revenues from the three months ended September 30, 2011 to
the three months ended September 30, 2012 was $29.2 million, and the increase
from the nine months ended September 30, 2011 to the nine months ended
September 30, 2012 was $107.2 million. The increases were mainly attributable to
increases in cost of brand advertising revenues and cost of search and others
revenues.
Cost of Online Advertising Revenues
Cost of online advertising revenues was $57.2 million and $174.4 million,
respectively, for the three and nine months ended September 30, 2012, compared
to $39.7 million and $101.3 million, respectively, for the corresponding periods
in 2011. The increase in cost of online advertising revenues from the three
months ended September 30, 2011 to the three months ended September 30, 2012 was
$17.5 million, and the increase was mainly attributable to increase in cost of
search and others revenues. The increase from the nine months ended
September 30, 2011 to the nine months ended September 30, 2012 was $73.1
million, and the increase was mainly attributable to increase in cost of brand
advertising revenues.
Cost of Brand Advertising Revenues
Cost of brand advertising revenues mainly consists of content and license costs
(including amortization of licensed video content and impairment of purchased
video content), bandwidth leasing costs, salary and benefits expenses,
depreciation expenses and revenue sharing payments.
Cost of brand advertising revenues was $37.5 million and $125.3 million,
respectively, for the three and nine months ended September 30, 2012, compared
to $30.2 million and $76.9 million, respectively, for the corresponding periods
in 2011.
The increase in cost of brand advertising revenues from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $7.3
million. The increase mainly consisted of a 2.2 million increase in amortization
of licensed video content, a $2.0 million increase in bandwidth leasing costs,
and a $1.1 million increase in salary and benefits expenses.
The increase in cost of brand advertising revenues from the nine months ended
September 30, 2011 to the nine months ended September 30, 2012 was $48.4
million. The increase mainly consisted of a $15.6 million increase in
amortization of licensed video content, a $15.1 million increase in impairment
of purchased video content, an $8.8 million increase in bandwidth leasing costs,
and a $2.8 million increase in salary and benefits expenses.
Our brand advertising gross margin was 52% and 40%, respectively, for the three
and nine months ended September 30, 2012, as compared to 61% and 62%,
respectively, for the corresponding periods in 2011. The decrease in our brand
advertising gross margin for the three months ended September 30, 2012 was
mainly due to increase in content and bandwidth costs. The decrease for the nine
months ended September 30, 2012 was mainly due to increases in content and
bandwidth costs and the impairment of purchased video content.
Cost of Search and Others Revenues
Cost of search and others revenues mainly consists of traffic acquisition costs,
depreciation expenses, bandwidth leasing costs, as well as salary and benefits
expenses.
Cost of search and others revenues was $19.7 million and $49.1 million,
respectively, for the three and nine months ended September 30, 2012, compared
to $9.5 million and $24.4 million, respectively, for the corresponding periods
in 2011.
The increase in cost of search and others revenues from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $10.2
million. The increase mainly consisted of a $7.9 million increase in traffic
acquisition costs, a $1.3 million increase in depreciation expenses, a $0.6
million increase in salary and benefits expenses and a $0.4 million increase in
bandwidth leasing costs, along with increased traffic volume.
The increase in cost of search and others revenues from the nine months ended
September 30, 2011 to the nine months ended September 30, 2012 was $24.7
million. The increase mainly consisted of an $18.8 million increase in traffic
acquisition costs, a $3.1 million increase in depreciation expenses, a $1.5
million increase in salary and benefits expenses and a $1.2 million increase in
bandwidth leasing costs, along with increased traffic volume.
Our search and others gross margin was 44% and 43%, respectively, for the three
and nine months ended September 30, 2012, as compared to 49% and 39%,
respectively, for the corresponding periods in 2011. The decrease in our search
and others gross margin for the three months ended September 30, 2012 was mainly
due to higher traffic acquisition costs. The increase for the nine months ended
September 30, 2012 was mainly due to higher revenues from online marketing
services on Sogou Web Directory.
-60---------------------------------------------------------------------------------
Table of Contents
Cost of Online Game Revenues
Cost of online game revenues mainly consists of salary and benefits expenses,
bandwidth leasing costs, depreciation expenses, revenue-based royalty payments
to game developers, Business Tax and VAT arising from transactions between
Changyou's subsidiaries and its VIEs, and amortization of licensing fees.
Cost of online game revenues was $21.0 million and $55.7 million, respectively,
for the three and nine months ended September 30, 2012, compared to $14.6
million and $33.5 million, respectively, for the corresponding periods in 2011.
The increase in cost of online game revenues from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $6.4
million. The increase mainly consisted of a $3.0 million increase in salary and
benefits expenses, which was mainly attributable to increased headcount, a $1.7
million increase in depreciation and amortization expenses and a $0.6 million
increase in bandwidth leasing costs.
The increase from the nine months ended September 30, 2011 to the nine months
ended September 30, 2012 was $22.2 million. The increase mainly consisted of a
$7.4 million increase in salary and benefits expenses, which was mainly
attributable to increased headcount, a $5.9 million increase in depreciation and
amortization expenses and a $4.1 million increase in bandwidth leasing costs.
Our online game gross margin was 86% and 87%, respectively, for the three and
nine months ended September 30, 2012, as compared to 87% and 89%, respectively,
for the corresponding periods in 2011. The decreases in our online game gross
margin were mainly due to an increase in headcount and related salaries and
benefits expenses, as well as higher bandwidth and server costs as Changyou
operated a larger portfolio of online games.
Cost of Wireless Revenues
Cost of wireless revenues mainly consists of revenue sharing with partners,
collection charges and transmission fees paid to China mobile network operators,
bandwidth leasing costs and depreciation expenses.
Cost of wireless revenues was $9.5 million and $28.5 million, respectively, for
the three and nine months ended September 30, 2012, compared to $8.7 million and
$22.7 million, respectively, for the corresponding periods in 2011. The increase
in cost of wireless revenues from the three and nine months ended September 30,
2011 to the three and nine months ended September 30, 2012 was $0.8 million and
$5.8 million, respectively. The increases were mainly due to increased revenue
sharing with partners.
The collection charges and transmission fees vary between China mobile network
operators. The collection charges and transmission fees mainly included (i) a
gateway fee of $0.008 to $0.032 per message in the third quarter of 2012, and
$0.005 to $0.031 per message, depending on the volume of the monthly total
wireless messages, in the third quarter of 2011 and (ii) a collection fee of 15%
to 87% of total fees collected by China mobile network operators from mobile
phone users (with the residual paid to us) in both the third quarter of 2012 and
2011.
Our wireless gross margin was both 34% for the three and nine months ended
September 30, 2012, as compared to 39% for both of the corresponding periods in
2011. The decreases in our wireless gross margin were mainly due to increased
revenue sharing with partners.
Cost of Revenues for Other Services
Cost of revenues for other services mainly consists of payments to theatres and
film production companies for pre-film screening advertisement slots.
Cost of revenues for other services was $9.0 million and $17.5 million,
respectively, for the three and nine months ended September 30, 2012, compared
to $4.5 million and $11.4 million, respectively, for the corresponding periods
in 2011. The increase in cost of revenues for other services from the three
months ended September 30, 2011 to the three months ended September 30, 2012 was
$4.5 million, and the increase from the nine months ended September 30, 2011 to
the nine months ended September 30, 2012 was $6.1 million. The increases were
mainly due to long-lived assets impairment costs for our cinema advertisement
business.
-61-
--------------------------------------------------------------------------------
Table of Contents
Operating Expenses
The following table presents our operating expenses by nature and by proportion
for the periods indicated (in thousands, except percentages):
Three Months Ended September 30, Nine Months Ended September 30,
2012 vs 2012 vs
2012 2011 2011 2012 2011 2011
Operating expenses:
Product development $ 46,994 38 % $ 28,943 32 % $ 18,051 $ 128,927 39 % $ 78,005 34 % $ 50,922
Sales and marketing 58,250 47 % 47,150 51 % 11,100 145,903 43 % 112,275 48 % 33,628
General and administrative 19,666 15 % 15,686 17 % 3,980 54,968 17 % 41,000 18 % 13,968
Impairment of intangible
assets via acquisition of
businesses 0 0 % 0 0 % 0 2,906 1 % 0 0 % 2,906
Total operating expenses $ 124,910 100 % $ 91,779 100 % $ 33,131 $ 332,704 100 % $ 231,280 100 % $ 101,424
Total operating expenses were $124.9 million and $332.7 million, respectively,
for the three and nine months ended September 30, 2012, compared to $91.8
million and $231.3 million, respectively, for the corresponding periods in 2011.
The increase in operating expenses from the three months ended September 30,
2011 to the three months ended September 30, 2012 was $33.1 million, and the
increase from the nine months ended September 30, 2011 to the nine months ended
September 30, 2012 was $101.4 million. The increases were mainly attributable to
increases in product development expenses and sales and marketing expenses.
Product Development Expenses
Product development expenses mainly consist of personnel-related expenses
incurred for enhancement and maintenance of our Websites, and costs associated
with new product development and enhancement of existing products and services,
which mainly include the development costs of online games prior to the
establishment of technological feasibility and maintenance costs after the
online games are available for marketing.
Product development expenses were $47.0 million and $128.9 million,
respectively, for the three and nine months ended September 30, 2012, compared
to $28.9 million and $78.0 million, respectively, for the corresponding periods
in 2011.
The increase in product development expenses from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $18.1
million. The increase mainly consisted of a $14.7 million increase in salary and
benefits expenses, which was mainly attributable to increased headcount, and a
$1.0 million increase in travel expenses.
The increase in product development expenses from the nine months ended
September 30, 2011 to the nine months ended September 30, 2012 was $50.9
million. The increase mainly consisted of a $39.6 million increase in salary and
benefits expenses, which was mainly attributable to increased headcount, a $2.4
million increase in travel expenses, and a $2.2 million increase in professional
fees.
Sales and Marketing Expenses
Sales and marketing expenses mainly consist of advertising and promotional
expenditures, salary and benefits expenses, travel expenses, and facility
expenses.
Sales and marketing expenses were $58.3 million and $145.9 million,
respectively, for the three and nine months ended September 30, 2012, compared
to $47.2 million and $112.3 million, respectively, for the corresponding periods
in 2011.
The increase in sales and marketing expenses from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $11.1
million. The increase mainly consisted of a $7.9 million increase in salary and
benefits expenses, which was mainly attributable to increased headcount, a $1.4
million increase in travel expenses, and a $0.6 million increase in advertising
and promotional expenditures as a result of increased marketing and promotion
activities.
The increase in sales and marketing expenses from the nine months ended
September 30, 2011 to the nine months ended September 30, 2012 was $33.6
million. The increase mainly consisted of an $18.6 million increase in salary
and benefits expenses, which was mainly attributable to increased headcount, a
$7.6 million increase in advertising and promotional expenditures as a result of
increased marketing and promotion activities, and a $3.7 million increase in
travel expenses.
General and Administrative Expenses
General and administrative expenses mainly consist of salary and benefits
expenses, professional service fees, travel expenses, and facility expenses.
-62-
--------------------------------------------------------------------------------
Table of Contents
General and administrative expenses were $19.7 million and $55.0 million,
respectively, for the three and nine months ended September 30, 2012, compared
to $15.7 million and $41.0 million, respectively, for the corresponding periods
in 2011.
The increase in general and administrative expenses from the three months ended
September 30, 2011 to the three months ended September 30, 2012 was $4.0
million. The increase mainly consisted of a $1.7 million increase in salary and
benefits expenses, which was mainly attributable to increased headcount, a $1.1
million increase in professional service fees, and a $1.0 million increase in
travel expenses.
The increase in general and administrative expenses from the nine months ended
September 30, 2011 to the nine months ended September 30, 2012 was $14.0
million. The increase mainly consisted of a $6.0 million increase in salary and
benefits expenses, which was mainly attributable to increased headcount, a $3.6
million increase in bad debt expenses and a $2.2 million increase in
professional service fees.
Share-based Compensation Expense
Sohu, Changyou, Sogou, Sohu Video and 7Road all have incentive plans for the
granting of share-based awards, including common stock /ordinary shares, share
options, restricted shares and restricted share units, to their employees and
directors.
Share-based compensation expense was recognized in costs and/or expenses for the
three and nine months ended September 30, 2012 and September 30, 2011,
respectively, as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
Share-based compensation expense 2012 2011 2012 2011
Cost of revenues $ 232 $ 253 $ 426 $ 1,543
Product development expenses 1,316 1,633 4,019 4,826
Sales and marketing expenses 582 874 1,613 2,835
General and administrative expenses 1,713 1,617 4,144 4,857
$ 3,843 $ 4,377 $ 10,202 $ 14,061
Share-based compensation expense recognized for share awards of Sohu, Changyou,
Sogou, Sohu Video and 7Road, respectively, was as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
Share-based compensation expense 2012 2011 2012 2011
For Sohu share-based awards $ 1,440 $ 2,607 $ 4,621 $ 8,735
For Changyou share-based awards 750 1,172 2,769 4,210
For Sogou share-based awards 1,653 598 2,812 1,116
For Sohu Video share-based awards 0 - 0 -
For 7Road share-based awards 0 - 0 -
$ 3,843 $ 4,377 $ 10,202 $ 14,061
For Sohu share options, as of September 30, 2012 there was no unrecognized
compensation expense because the requisite service periods for the remaining
share options had ended by the end of 2009. For Sohu restricted share units, as
of September 30, 2012 there was $4.0 million of related unrecognized
compensation expense.
For Changyou share-based awards, as of September 30, 2012, there was $2.5
million of unrecognized compensation expense.
For Sogou share-based awards, as of September 30, 2012, there was $1.7 million
of unrecognized compensation expense.
For Sohu Video, no share-based compensation expense was recognized for the three
and the nine months ended September 30, 2012 with respect to Sohu Video share
option grants made during those nine months. This is because, under U.S. GAAP,
no grant of options had occurred, as no grant date had been established at this
stage.
-63-
--------------------------------------------------------------------------------
Table of Contents
For 7Road, no share-based compensation expense was recognized for the three and
the nine months ended September 30, 2012, as performance targets had not been
met.
Operating Profit
As a result of the foregoing, our operating profit was $63.7 million and $158.9
million, respectively, for the three and nine months ended September 30, 2012,
compared to $73.6 million and $205.8 million, respectively, for the
corresponding periods in 2011.
Other Income /(expense)
Other income was a negative $0.1 million and $3.3 million, respectively, for the
three and nine months ended September 30, 2012, compared to other income of $3.2
million and $5.2 million, respectively, for the corresponding periods in 2011.
The decreases were mainly due to changes in the fair value of consideration
payable to 7Road.
Interest Income
Interest income was $6.0 million and $19.7 million, respectively, for the three
and nine months ended September 30, 2012, compared to $4.3 million and $10.3
million, respectively, for the corresponding periods in 2011. The increases were
mainly due to increased cash balance and higher return on cash.
Income Tax Expense
Income tax expense was $18.7 million and $55.9 million, respectively, for the
three and nine months ended September 30, 2012, compared to $14.4 million and
$35.7 million, respectively, for the corresponding periods in 2011.
The increase in income tax expense from the three months ended September 30,
2011 to the three months ended September 30, 2012 was $4.3 million. The increase
from the nine months ended September 30, 2011 to the nine months ended
September 30, 2012 was $20.2 million. The increases were mainly due to an
increase in withholding tax and net income of Changyou, and an increase in the
applicable tax rates for the Sohu Group.
Net Income
For the three and nine months ended September 30, 2012, we had net income of
$51.5 million and $126.1 million, respectively, compared to $64.3 million and
$181.1 million, respectively, for the corresponding periods of 2011.
Net Income Attributable to Noncontrolling Interest
Net income attributable to noncontrolling interest was $21.1 million and $57.6
million, respectively, for the three and nine months ended September 30, 2012,
compared to $16.4 million and $43.7 million, respectively, for the corresponding
periods in 2011.
The increases in net income attributable to noncontrolling interest were mainly
due to increased net income of Changyou.
We expect the noncontrolling interest recognized for Changyou to increase in the
fourth quarter of 2012, compared to the third quarter of 2012, due to vesting of
share-based awards, as well as an increase in Changyou's net income.
We expect the noncontrolling interest recognized for Sogou to remain at a low
level.
Net Income attributable to Sohu.com Inc.
As a result of the foregoing, we had net income attributable to Sohu of $25.9
million and $61.8 million, respectively, for the three and nine months ended
September 30, 2012, compared to $46.8 million and $135.9 million, respectively,
for the corresponding periods in 2011.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are cash and cash equivalents, short-term
investments, investments in debt securities, as well as the cash flows generated
from our operations.
As of September 30, 2012, we had cash and cash equivalents, short-term
investments and investments in debt securities of approximately $894.3 million.
As of September 30, 2011, we had cash and cash equivalents, short-term
investments and investments in debt securities of approximately $808.4 million.
Cash equivalents primarily comprise time deposits.
-64---------------------------------------------------------------------------------
Table of Contents
In November 2009, we entered into an agreement to purchase a Beijing office
building to serve as our headquarters. The purchase price is approximately $127
million, of which $107 million had been paid as of September 30, 2012. In
December 2011, we also entered into an agreement for technological
infrastructure and fitting-out work for this office building. The contractual
amount is approximately $28 million, of which $16 million had been paid as of
September 30, 2012. These $107 million and $16 million payments have been
recognized as prepaid non-current assets in our consolidated balance sheets. The
remaining $20 million for the office building and $12 million for the
technological infrastructure and fitting-out work will be settled in
installments as various stages of the development plan are completed. This
office building and related technological infrastructure and fitting-out work
are in progress and are expected to be completed in 2013.
In August 2010, Changyou entered into an agreement to purchase a Beijing office
building to serve as its headquarters. The purchase price is approximately $157
million, of which $125 million had been paid as of September 30, 2012 and was
recognized as prepaid non-current assets in our consolidated balance sheets. The
remaining $32 million will be settled by early of 2013, when the office building
development is expected to be completed.
In the third quarter of 2012, Changyou drew down offshore bridge loans from
banks of $222 million, which were secured by the equivalent or greater amount of
RMB deposits in onshore branches of those banks, totaling RMB1.43 billion ($226
million).
As of September 30, 2012, the Sohu Group also had commitments for bandwidth
purchases in the amount of $25 million, commitments for video content purchases
in the amount of $19 million, commitments for operating leases in the amount of
$12 million and commitments for other content and service purchases in the
amount of $12 million.
We believe our current liquidity and capital resources are sufficient to meet
anticipated working capital needs (net cash used in operating activities),
commitments and capital expenditures over the next twelve months. We may,
however, require additional cash resources due to changes in business conditions
and other future developments, or changes in general economic conditions.
Cash Generating Ability
We believe we will continue to generate strong cash flow from our online brand
advertising business and online game business, which, along with our available
cash, will provide sufficient liquidity and financial flexibility.
Our cash flows were summarized below (in thousands):
Nine Months Ended
September 30,
2012 2011
Net cash provided by operating activities $ 279,781 $ 256,491
Net cash used in investing activities (346,743 ) (209,936 )
Net cash provided by /(used in) financing activities 110,433 (39,209 )
Effect of exchange rate change on cash and cash
equivalents (2,609 ) 21,688
Net increase in cash and cash equivalents 40,862 29,034
Cash and cash equivalents at beginning of period 732,607 678,389
Cash and cash equivalents at end of period $ 773,469 $ 707,423
Net Cash Provided by Operating Activities
For the nine months ended September 30, 2012, $279.8 million net cash provided
by operating activities was primarily attributable to our net income of $126.1
million, adjusted by non-cash items of depreciation and amortization of $76.7
million, impairment of purchased video content of $15.1 million, share-based
compensation expense of $10.2 million, impairment of intangible assets of $7.5
million, other miscellaneous non-cash expenses of $3.6 million, and an increase
in cash from working capital items of $48.2 million, and adjust out the
investment income from investments in debt securities of $4.1 million and excess
tax benefits of $3.5 million.
For the nine months ended September 30, 2011, $256.5 million net cash provided
by operating activities was primarily attributable to our net income of $181.1
million, adjusted by non-cash items of depreciation and amortization of $45.5
million, share-based compensation expense of $14.1 million, and an increase in
cash from working capital items of $19.4 million, offset by a decrease in cash
from change in the fair value of debt securities of $2.2 million and excess tax
benefits of $1.4 million.
In accordance with U.S. GAAP, the above excess tax benefits were presented as a
reduction in cash flows from operating activities and a cash inflow from
financing activities. Realizing these benefits reduces the amount of taxes
payable and does not otherwise affect cash flows.
-65---------------------------------------------------------------------------------
Table of Contents
Net Cash Used in Investing Activities
For the nine months ended September 30, 2012, $346.7 million net cash used in
investing activities was primarily attributable to $225.8 million restricted
time deposits used as collateral for offshore bridge loans from banks, $94.9
million used in acquiring fixed assets and intangible assets, $20.3 million used
in short-term investments, investment income from investments in debt securities
of $4.1 million described above under the heading "Net Cash Provided by
Operating Activities", and $1.6 million used in business acquisition and other
investment activities.
For the nine months ended September 30, 2011, $209.9 million net cash used in
investing activities was primarily attributable to $130.1 million used in
acquiring fixed assets and intangible assets including a $37 million payment for
Sohu's office building, and $79.8 million used in business acquisitions and
investing activities.
Net Cash Provided by /Used in Financing Activities
For the nine months ended September 30, 2012, $110.4 million net cash provided
by financing activities was primarily attributable to $222.4 million of offshore
bridge loans from banks, $3.5 million excess tax benefits described above under
the heading "Net Cash Provided by Operating Activities," and $1.3 million from
the exercise of share-based awards in a subsidiary, offset by $64.6 million used
for the portion of the Changyou dividend distributed to noncontrolling interest
shareholders, $25.8 million used for the purchase of Sogou Series A Preferred
Shares from Alibaba, $13.8 million used for the payment of contingent
consideration, and $12.6 million used for the repurchase of our common stock.
For the nine months ended September 30, 2011, $39.2 million net cash used in
financing activities was primarily attributable to $25.7 million used for the
purchase of 750,000 Changyou ADSs, and $16.6 million used for the repurchase of
our common stock, offset by $1.5 million from the issuance of common stock upon
the exercise of share options granted under our stock incentive plan, $1.4
million excess tax benefits mentioned above under the heading "Net Cash Provided
by Operating Activities," and $0.2 million in proceeds from noncontrolling
shareholders.
Restrictions on Cash Transfers to Sohu.com Inc.
To fund any cash requirements it may have, Sohu may need to rely on dividends
and other distributions on equity paid by Sohu.com Limited and Changyou, our
wholly-owned subsidiary and majority-owned subsidiary. Since substantially all
of our operations are conducted through our indirect wholly-owned and
majority-owned China-based subsidiaries and VIEs, Sohu.com Limited and Changyou
may need to rely on dividends, loans or advances made by our PRC subsidiaries.
For Sohu apart from Changyou, although the VIEs generate revenue and cash, due
to significant costs involved in these VIEs' operations, they generally have
minimal profit and cash balances, and their operating cash flow was negative for
the three and nine months ended September 30, 2012. However, substantially all
of Changyou's operations have conducted through Changyou's VIEs Gamease, Guanyou
Gamespace, Shanghai ICE and Shenzhen 7Road, which have generated all of our
online game revenues. Although Changyou's subsidiaries received a majority of
the VIEs' profits pursuant to the various contractual agreements between the
VIEs and the subsidiaries, significant cash balances remained in Changyou's VIEs
as of September 30, 2012.
As Changyou's VIEs are not owned by Changyou's subsidiaries, they are not able
to make dividend payments to Changyou's subsidiaries. Instead, each of AmazGame,
Gamespace, ICE Information and 7Road Technology, which are Changyou's
subsidiaries in China, has entered into a number of contracts with its
corresponding VIE to provide services to such VIE in return for cash payments.
In order for us to receive any dividends, loans or advances from Changyou's PRC
subsidiaries, or to distribute any dividends to our shareholders and ADS
holders, we will need to rely on these payments made from these VIEs to
Changyou's PRC subsidiaries. Depending on the nature of services provided by
Changyou's PRC subsidiaries to their corresponding VIEs, certain of these
payments are subject to PRC taxes, including Business Tax and VAT, which
effectively reduce the amount that a PRC subsidiary receives from its
corresponding VIE. In addition, the PRC government could impose restrictions on
such payments or change the tax rates applicable to such payments.
In addition, regulations in the PRC currently permit payment of dividends of a
PRC company only out of accumulated profits as determined in accordance with
accounting standards and regulations in China. Our China-based subsidiaries,
which are wholly foreign-owned enterprises ("WFOEs"), are also required to set
aside at least 10% of their after-tax profit based on PRC accounting standards
each year to their general reserves until the cumulative amount reaches 50% of
their paid-in capital. These reserves are not distributable as cash dividends,
or as loans or advances. These WFOEs may also allocate a portion of their
after-tax profits, at the discretion of their Boards of Directors, to their
staff welfare and bonus funds. Any amounts so allocated may not be distributed
to Changyou and /or to Sohu.com Limited and, accordingly, would not be available
for distribution to Sohu.
Also, under regulations of the State Administration of Foreign Exchange,
("SAFE"), the RMB is not convertible into foreign currencies for capital account
items, such as loans, repatriation of investments and investments outside of
China, unless prior approval of the SAFE is obtained and prior registration with
the SAFE is made.
-66-
--------------------------------------------------------------------------------
Table of Contents
With respect to PRC tax, certain dividends paid by WFOEs to their immediate Hong
Kong holding companies that meet tax authorities' requirements would be subject
to a withholding tax at the rate of 5%, which would reduce the amount of cash
available for distribution to Sohu. Any such dividends paid to Hong Kong holding
companies that did not meet the tax authorities' requirements would be subject
to a withholding tax at the rate of 10%, which would further reduce the amount
of cash available for distribution to Sohu.
With respect to U.S. tax, as Sohu Group has two listed companies, Sohu.com Inc.
and Changyou.com Limited, which are regarded as separate legal entities for U.S.
tax purposes, certain transactions between these two companies as well as
between their subsidiaries and VIEs might expose Sohu.com Inc. to 34% U.S.
Corporate Income Tax. In addition, certain transactions of Changyou and its
subsidiaries and VIEs (for example, investing in U.S. properties) might also
expose Sohu.com Inc. to the risk that these transactions will be treated as
taxable for U.S. tax purposes. Moreover, if Changyou pays dividends, Sohu.com
Inc., as one of the shareholders of Changyou, might be subject to U.S. tax at
34% for the dividends received or, under certain circumstances, when Sohu sells
Changyou ADSs originally held by Sohu at a price higher than its U.S. tax basis,
a portion of the proceeds will be subject to U.S. tax at 34%. Furthermore, any
dividends or any deemed dividends received by Sohu.com Inc. would be subject to
U.S. Tax at 34%.
We do not expect any of such restrictions or taxes to have a material impact on
our ability to meet our cash obligations.
Dividend Policy
On August 6, 2012, Changyou declared a special one-time cash dividend of $1.90
per Class A or Class B ordinary share, or $3.80 per ADS and a total of
$201 million. On September 21, 2012, Changyou paid out this special cash
dividend, of which $136 million was paid to and received by Sohu. Sohu does not
expect to pay any of such dividend to its shareholders in the foreseeable
future.
We do not expect Changyou to declare any additional dividends in the foreseeable
future. The Sohu Group intends to retain all available funds and any future
earnings for use in the operation and expansion of its own business, and does
not anticipate paying any cash dividends on Sohu.com Inc.'s common stock or
causing Changyou to pay any dividends, on Changyou.com Limited's ordinary
shares, including ordinary shares represented by Changyou.com Limited's ADSs,
for the foreseeable future.
Future cash dividends distributed by Sohu.com Inc. and Changyou.com Limited, if
any, will be declared at the discretion of their respective Boards of Directors
and will depend upon their future operations and earnings, capital requirements
and surplus, general financial condition, contractual restrictions and such
other factors as their respective Boards of Directors may deem relevant.
Holders of ADSs of Changyou.com Limited will be entitled to receive dividends,
subject to the terms of the deposit agreement, to the same extent as the holders
of Changyou.com Limited's ordinary shares, less the fees and expenses payable
under the deposit agreement. Cash dividends will be paid by the depositary to
holders of ADSs in U.S. dollars, subject to the terms of the deposit agreement.
Other distributions, if any, will be paid by the depositary to holders of ADSs
in any manner that the depositary deems equitable and practicable.
OFF-BALANCE SHEET COMMITMENTS AND ARRANGEMENTS
We have not entered into any financial guarantees or other commitments to
guarantee the payment obligations of third parties. We have not entered into any
derivative contracts that are indexed to our shares and classified as
shareholder's equity, or that are not reflected in our consolidated financial
statements. Furthermore, we do not have any retained or contingent interest in
assets transferred to an unconsolidated entity that serves as credit, liquidity
or market risk support to such entity. We do not have any variable interest in
any unconsolidated entity that provides financing, liquidity, market risk or
credit support to us or that engages in leasing, hedging or product development
services with us.
-67-
--------------------------------------------------------------------------------
Table of Contents
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2012, the FASB issued revised guidance on "Testing Indefinite-Lived
Intangible Assets for Impairment." The revised guidance applies to all entities,
both public and nonpublic, that have indefinite-lived intangible assets, other
than goodwill, reported in their financial statements. Under the revised
guidance, an entity has the option first to assess qualitative factors to
determine whether the existence of events and circumstances indicates that it is
more likely than not that the indefinite-lived intangible asset is impaired. If,
after assessing the totality of events and circumstances, an entity concludes
that it is not more likely than not that the indefinite-lived intangible asset
is impaired, then the entity is not required to take further action. However, if
an entity concludes otherwise, then it is required to determine the fair value
of the indefinite-lived intangible asset and perform a quantitative impairment
test by comparing the fair value with the carrying amount in accordance with
Subtopic 350-30. An entity also has the option to bypass a qualitative
assessment for any indefinite-lived intangible asset in any period and proceed
directly to performing the quantitative impairment test. An entity will be able
to resume performing the qualitative assessment in any subsequent period. In
conducting a qualitative assessment, an entity should consider the extent to
which relevant events and circumstances, both individually and in the aggregate,
could have affected the significant inputs used to determine the fair value of
the indefinite-lived intangible asset since the last assessment. An entity also
should consider whether there have been changes to the carrying amount of the
indefinite-lived intangible asset when evaluating whether it is more likely than
not that the indefinite-lived intangible asset is impaired. An entity should
consider positive and mitigating events and circumstances that could affect its
determination of whether it is more likely than not that the indefinite-lived
intangible asset is impaired. The amendments are effective for annual and
interim impairment tests performed for fiscal years beginning after
September 15, 2012. Early adoption is permitted, including for annual and
interim impairment tests performed as of a date before July 27, 2012, if a
public entity's financial statements for the most recent annual or interim
period have not yet been issued or, for nonpublic entities, have not yet been
made available for issuance. We are currently evaluating the impact on our
consolidated financial statements of adopting this guidance.
[ Back To middleeast.tmcnet.com.com's Homepage 's Homepage ]
|
Internet Telephony Magazine
Click here to read latest issue
CUSTOMER 
Cloud Computing Magazine
Click here to read latest issue
M2M Evolution Magazine
Call Center/CRM
Info Tech 
IP Communications 
Mobile 
Green 
Satellite 
Robotics 
