UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 20132014

OR

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                    TO

COMMISSION FILE NUMBER 0-30961

 

 

Sohu.com Inc.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

 

 

Delaware 98-0204667

(STATE OR OTHER JURISDICTION OF

INCORPORATION OR ORGANIZATION)

 

(I.R.S. EMPLOYER

IDENTIFICATION NUMBER)

Level 18, SOHU.com Media Plaza

Block 3, No. 2 Kexueyuan South Road, Haidian District

Beijing 100190

People’s Republic of China

(011) 8610-6272-6666

(Address, including zip code, of registrant’s principal executive offices

and registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x  Accelerated filer ¨
Non-accelerated filer ¨  Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Class

  

Outstanding at JuneSeptember 30, 20132014

Common stock, $.001 par value  38,292,91938,486,906

 

 

 


SOHU.COM INC.

Table of Contents

 

     PAGE 

PART I

 FINANCIAL INFORMATION  3

Item 1

 

Condensed Consolidated Financial Statements (unaudited)

   3  
 

Condensed Consolidated Balance Sheets as of September 30, 20132014 and December 31, 20122013

   3  
 

Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September  30, 20132014 and 20122013

   5  
 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 20132014 and 20122013

   7  
 

Condensed Consolidated Statements of Changes in Equity for the Nine Months Ended September  30, 20132014 and 20122013

   9  
 

Notes to Condensed Consolidated Financial Statements

   11  

Item 2

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   4550  

Item 3

 

Quantitative and Qualitative Disclosures about Market Risk

   7276  

Item 4

 

Controls and Procedures

   7377  

PART II

 

OTHER INFORMATION

Item 1

Legal Proceedings   7378  

Item 1A

1
 

Risk FactorsLegal Proceedings

   7478  

Item 21A

Risk Factors

  78
Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

   7478  

Item 3

 

Defaults Upon Senior Securities

   7478  

Item 4

 

Mine Safety Disclosures

   7479  

Item 5

 

Other Information

   7479  

Item 6

 

Exhibits

   7479  
 

Signatures

   7580  
 

Exhibit Index

   7681  

 

-2-


PART I – FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SOHU.COM INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

(In thousands, except par value)

 

  As of   As of 
  September 30,
2013
   December 31,
2012 (Revised)
   September 30,
2014
   December 31,
2013
 

ASSETS

        

Current assets:

        

Cash and cash equivalents

  $1,240,842    $833,535    $840,896    $1,287,288  

Restricted time deposits

   314,836     116,140     299,861     393,087  

Short-term investments

   24,369     54,901     209,508     2,827  

Investments in debt securities

   81,327     79,548     0     82,009  

Accounts receivable, net

   153,284     98,398     179,994     154,342  

Prepaid and other current assets

   95,501     55,761     123,060     132,002  
  

 

   

 

   

 

   

 

 

Total current assets

   1,910,159     1,238,283     1,653,319     2,051,555  
  

 

   

 

   

 

   

 

 

Fixed assets, net

   546,228     178,951     541,903     564,442  

Goodwill

   164,461     159,215     320,586     208,795  

Long-term investments, net

   25,638     3,726  

Intangible assets, net

   81,255     70,054     123,539     107,108  

Restricted time deposits

   60,151     130,699     143,825     40,961  

Prepaid non-current assets

   9,844     291,643     8,709     9,527  

Other assets

   16,249     13,792     34,351     12,601  
  

 

   

 

   

 

   

 

 

Total assets

  $2,788,347    $2,082,637    $2,851,870    $2,998,715  
  

 

   

 

   

 

   

 

 

LIABILITIES

        

Current liabilities:

        

Accounts payable (including accounts payable of consolidated variable interest entities (“VIEs”) without recourse to the Company of $11,067 and $6,958, respectively, as of September 30, 2013 and December 31, 2012)

  $96,171    $67,934  

Accrued liabilities (including accrued liabilities of consolidated VIEs without recourse to the Company of $51,937 and $53,034, respectively, as of September 30, 2013 and December 31, 2012)

   209,463     117,029  

Receipts in advance and deferred revenue (including receipts in advance and deferred revenue of consolidated VIEs without recourse to the Company of $64,765 and $54,150, respectively, as of September 30, 2013 and December 31, 2012)

   112,805     89,687  

Accrued salary and benefits (including accrued salary and benefits of consolidated VIEs without recourse to the Company of $2,985 and $4,940, respectively, as of September 30, 2013 and December 31, 2012)

   76,108     61,722  

Taxes payable (including taxes payable of consolidated VIEs without recourse to the Company of $14,091 and $14,191, respectively, as of September 30, 2013 and December 31, 2012)

   56,672     33,897  

Deferred tax liabilities (including deferred tax liabilities of consolidated VIEs without recourse to the Company of $3 and $83, respectively, as of September 30, 2013 and December 31, 2012)

   16,806     11,878  

Short-term bank loans (including short-term bank loans of consolidated VIEs without recourse to the Company of nil as of both September 30, 2013 and December 31, 2012)

   354,002     113,000  

Accounts payable (including accounts payable of consolidated variable interest entities (“VIEs”) without recourse to the Company of $3,102 and $16,167, respectively, as of September 30, 2014 and December 31, 2013)

  $135,966    $125,896  

Accrued liabilities (including accrued liabilities of consolidated VIEs without recourse to the Company of $85,463 and $79,041, respectively, as of September 30, 2014 and December 31, 2013)

   228,192     227,018  

Receipts in advance and deferred revenue (including receipts in advance and deferred revenue of consolidated VIEs without recourse to the Company of $41,743 and $60,140, respectively, as of September 30, 2014 and December 31, 2013)

   111,810     113,328  

Accrued salary and benefits (including accrued salary and benefits of consolidated VIEs without recourse to the Company of $3,395 and $3,241, respectively, as of September 30, 2014 and December 31, 2013)

   123,852     90,901  

Taxes payable (including taxes payable of consolidated VIEs without recourse to the Company of $11,088 and $7,616, respectively, as of September 30, 2014 and December 31, 2013)

   30,750     48,324  

Deferred tax liabilities (including deferred tax liabilities of consolidated VIEs without recourse to the Company of $3 as of both September 30, 2014 and December 31, 2013)

   21,500     18,813  

 

-3-


Other short-term liabilities (including other short-term liabilities of consolidated VIEs without recourse to the Company of $132,111 and $33,074, respectively, as of September 30, 2013 and December 31, 2012)

   63,298    63,352  

Contingent consideration (including contingent consideration of consolidated VIEs without recourse to the Company of nil as of both September 30, 2013 and December 31, 2012)

   0    76  

Short-term bank loans (including short-term bank loans of consolidated VIEs without recourse to the Company of nil as of both September 30, 2014 and December 31, 2013)

   0    410,331  

Other short-term liabilities (including other short-term liabilities of consolidated VIEs without recourse to the Company of $23,570 and $253,933, respectively, as of September 30, 2014 and December 31, 2013)

   91,736    79,798  

Contingent consideration (including contingent consideration of consolidated VIEs without recourse to the Company of $2,950 and nil, respectively, as of September 30, 2014 and December 31, 2013)

   2,950    0  
  

 

  

 

   

 

  

 

 

Total current liabilities

   985,325    558,575     746,756    1,114,409  
  

 

  

 

   

 

  

 

 

Long-term accounts payable (including long-term accounts payable of consolidated VIEs without recourse to the Company of $1,294 and nil, respectively, as of September 30, 2013 and December 31, 2012)

   7,333    12,684  

Long-term bank loans (including long-term bank loans of consolidated VIEs without recourse to the Company of nil as of both September 30, 2013 and December 31, 2012)

   0    126,353  

Deferred tax liabilities (including deferred tax liabilities of consolidated VIEs without recourse to the Company of $3,310 and $3,846, respectively, as of September 30, 2013 and December 31, 2012)

   7,350    7,998  

Long-term accounts payable (including long-term accounts payable of consolidated VIEs without recourse to the Company of $1,529 and $1,621, respectively, as of September 30, 2014 and December 31, 2013)

   5,211    6,252  

Long-term bank loans (including long-term bank loans of consolidated VIEs without recourse to the Company of nil as of both September 30, 2014 and December 31, 2013)

   370,000    0  

Long-term taxes payable (including long-term taxes payable of consolidated VIEs without recourse to the Company of nil as of both September 30, 2014 and December 31, 2013)

   24,820    24,835  

Deferred tax liabilities (including deferred tax liabilities of consolidated VIEs without recourse to the Company of $2,795 and $3,777, respectively, as of September 30, 2014 and December 31, 2013)

   10,685    12,337  

Contingent consideration (including contingent consideration of consolidated VIEs without recourse to the Company of $1,541 and $4,162, respectively, as of September 30, 2014 and December 31, 2013)

   1,839    4,162  
  

 

  

 

   

 

  

 

 

Total long-term liabilities

   14,683    147,035     412,555    47,586  
  

 

  

 

   

 

  

 

 

Total liabilities

   1,000,008    705,610     1,159,311    1,161,995  
  

 

  

 

   

 

  

 

 

Commitments and contingencies

      

MEZZANINE EQUITY

   0    61,810  

SHAREHOLDERS’ EQUITY

      

Sohu.com Inc. shareholders’ equity:

      

Common stock: $0.001 par value per share (75,400 shares authorized; 38,293 shares and 38,089 shares, respectively, issued and outstanding as of September 30, 2013 and December 31, 2012)

   44    44  

Common stock: $0.001 par value per share (75,400 shares authorized; 38,487 shares and 38,326 shares, respectively, issued and outstanding as of September 30, 2014 and December 31, 2013)

   44    44  

Additional paid-in capital

   594,812    378,311     652,627    601,633  

Treasury stock (5,889 shares as of September 30, 2013 and December 31, 2012)

   (143,858  (143,858

Treasury stock (5,889 shares as of September 30, 2014 and December 31, 2013)

   (143,858  (143,858

Accumulated other comprehensive income

   105,768    79,542     105,800    116,304  

Retained earnings

   749,748    770,184     605,500    752,582  
  

 

  

 

   

 

  

 

 

Total Sohu.com Inc. shareholders’ equity

   1,306,514    1,084,223     1,220,113    1,326,705  

Noncontrolling interest

   481,825    230,994     472,446    510,015  
  

 

  

 

   

 

  

 

 

Total shareholders’ equity

   1,788,339    1,315,217     1,692,559    1,836,720  
  

 

  

 

   

 

  

 

 

Total liabilities, mezzanine equity and shareholders’ equity

  $  2,788,347   $  2,082,637  

Total liabilities and shareholders’ equity

  $2,851,870   $2,998,715  
  

 

  

 

   

 

  

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

-4-


SOHU.COM INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

(In thousands, except per share data)

 

  Three Months Ended Nine Months Ended   Three Months Ended Nine Months Ended 
  September 30, September 30,   September 30, September 30, 
  2013 2012 2013 2012
(Revised)
   2014 2013 2014 2013 

Revenues:

          

Online advertising:

          

Brand advertising

  $124,780   $77,874   $305,208   $208,154    $148,823   $124,780   $393,334   $305,208  

Search and others

   52,305   35,284   134,528   85,684     98,437   52,305   247,810   134,528  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Subtotal of online advertising revenues

   177,085    113,158    439,736    293,838     247,260    177,085    641,144    439,736  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Online games

   161,494    150,263    497,210    412,187     150,338    161,494    467,603    497,210  

Mobile

   14,524    14,312    43,610    43,261  

Others

   15,220    7,645    34,267    18,423     32,817    29,744    87,134    77,877  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Total revenues

   368,323    285,378    1,014,823    767,709     430,415    368,323    1,195,881    1,014,823  

Cost of revenues:

          

Online advertising:

          

Brand advertising

   63,780    37,476    160,214    125,331     83,424    63,780    230,462    160,214  

Search and others

   26,785    19,736    72,075    49,056     46,375    26,785    118,532    72,075  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Subtotal of cost of online advertising revenues

   90,565    57,212    232,289    174,387     129,799    90,565    348,994    232,289  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Online games

   21,750    20,753    67,381    54,475     33,949    21,750    90,798    67,381  

Mobile

   8,108    9,474    26,342    28,535  

Others

   5,067    9,310    16,652    18,718     17,912    13,175    50,252    42,994  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Total cost of revenues

   125,490    96,749    342,664    276,115     181,660    125,490    490,044    342,664  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Gross profit

   242,833    188,629    672,159    491,594     248,755    242,833    705,837    672,159  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Operating expenses:

          

Product development

   70,551    46,994    185,731    128,927     107,971    70,551    327,911    185,731  

Sales and marketing

   90,728    58,250    221,129    145,903     131,742    90,728    410,702    221,129  

General and administrative

   29,365    19,666    77,726    54,968     49,730    29,365    138,330    77,726  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Impairment of intangible assets via acquisition of businesses

   0    0    0    2,906  
  

 

  

 

  

 

  

 

 

Total operating expenses

   190,644    124,910    484,586    332,704     289,443    190,644    876,943    484,586  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Operating profit

   52,189    63,719    187,573    158,890  

Operating profit /(loss)

   (40,688  52,189    (171,106  187,573  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Other income /(expense)

   1,533    (111  5,596    3,320  

Interest income

   7,595    5,974    19,794    19,692  

Other income

   896    1,533    5,340    5,596  

Net interest income

   7,468    7,595    24,704    19,794  

Exchange difference

   (1,305  667    (5,274  69     (610  (1,305  27    (5,274
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Income before income tax expense

   60,012    70,249    207,689    181,971  

Income tax expense

   18,923    18,727    55,192    55,881  

Income /(loss) before income tax benefit /(expense)

   (32,934  60,012    (141,035  207,689  

Income tax benefit /(expense)

   1,036    (18,923  2,562    (55,192
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Net income

   41,089    51,522    152,497    126,090  

Net income/(loss)

   (31,898  41,089    (138,473  152,497  

Less: Net income attributable to the mezzanine-classified noncontrolling interest
shareholders

   0    4,495    17,780    6,701     0    0    0    17,780  

Net income attributable to the noncontrolling interest shareholders

   22,855    21,146    70,426    57,618  

Net income /(loss) attributable to the noncontrolling interest shareholders

   (4,760  22,855    (19,138  70,426  

Deemed dividend to noncontrolling Sogou Series A Preferred shareholders

   0    82,423    27,747    82,423  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Dividend or deemed dividend to noncontrolling Sogou series A preferred shareholders

   82,423    0    82,423    14,219  

Net loss attributable to Sohu.com Inc.

  $(27,138 $(64,189 $(147,082 $(18,132
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

Net income /(loss) attributable to Sohu.com Inc.

  $(64,189 $25,881   $(18,132 $47,552  

Net income /(loss)

   (31,898  41,089    (138,473  152,497  

Other comprehensive income /(loss)

   (1,005  8,249    (14,084  33,481  
  

 

  

 

  

 

  

 

   

 

  

 

  

 

  

 

 

 

-5-


Net income

   41,089    51,522    152,497    126,090  

Other comprehensive income /(loss): Foreign currency translation adjustment, net of tax

   8,249    (3,447  33,481    (7,115
  

 

 

  

 

 

  

 

 

  

 

 

 

Comprehensive income

   49,338    48,075    185,978    118,975  
  

 

 

  

 

 

  

 

 

  

 

 

 

Less: Comprehensive income attributable to the mezzanine-classified
         noncontrolling interest shareholders

   0    4,495    17,780    6,701  

Comprehensive income attributable to noncontrolling interest shareholders

   24,749    20,540    77,681    56,510  

Dividend or deemed dividend to noncontrolling Sogou series A preferred shareholders

   82,423    0    82,423    14,219  
  

 

 

  

 

 

  

 

 

  

 

 

 

Comprehensive income /(loss) attributable to Sohu.com Inc.

  $(57,834 $23,040   $8,094   $41,545  
  

 

 

  

 

 

  

 

 

  

 

 

 

Basic net income /(loss) per share attributable to Sohu.com Inc.

  $(1.68 $0.68   $(0.47 $1.25  
  

 

 

  

 

 

  

 

 

  

 

 

 

Shares used in computing basic net income /(loss) per share attributable to Sohu.com Inc.

   38,288    38,022    38,239    38,036  
  

 

 

  

 

 

  

 

 

  

 

 

 

Diluted net income /(loss) per share attributable to Sohu.com Inc.

  $(1.69 $0.63   $(0.53 $1.06  
  

 

 

  

 

 

  

 

 

  

 

 

 

Shares used in computing diluted net income /(loss) per share attributable to Sohu.com Inc.

   38,522    38,344    38,481    38,392  
  

 

 

  

 

 

  

 

 

  

 

 

 

Comprehensive income /(loss)

   (32,903  49,338    (152,557  185,978  
  

 

 

  

 

 

  

 

 

  

 

 

 

Less: Comprehensive income attributable to the mezzanine-classified noncontrolling interest shareholders

   0    0    0    17,780  

Comprehensive income /(loss) attributable to noncontrolling interest shareholders

   (4,607  24,749    (22,718  77,681  

Deemed dividend to noncontrolling Sogou Series A Preferred shareholders

   0    82,423    27,747    82,423  
  

 

 

  

 

 

  

 

 

  

 

 

 

Comprehensive income /(loss) attributable to Sohu.com Inc.

  $(28,296 $(57,834 $(157,586 $8,094  
  

 

 

  

 

 

  

 

 

  

 

 

 

Basic net loss per share attributable to Sohu.com Inc.

  $(0.71 $(1.68 $(3.82 $(0.47
  

 

 

  

 

 

  

 

 

  

 

 

 

Shares used in computing basic net loss per share attributable to Sohu.com Inc.

   38,485    38,288    38,457    38,239  
  

 

 

  

 

 

  

 

 

  

 

 

 

Diluted net loss per share attributable to Sohu.com Inc.

  $(0.74 $(1.69 $(3.91 $(0.53
  

 

 

  

 

 

  

 

 

  

 

 

 

Shares used in computing diluted net loss per share attributable to Sohu.com Inc.

   38,485    38,522    38,457    38,481  
  

 

 

  

 

 

  

 

 

  

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

-6-


SOHU.COM INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(In thousands)

 

  Nine Months Ended September 30,   Nine Months Ended September 30, 
  2013 2012   2014 2013 

Cash flows from operating activities:

      

Net income

  $152,497   $126,090  

Net income /(loss)

  $(138,473 $152,497  

Adjustments to reconcile net income to net cash provided by operating activities:

      

Amortization of intangible assets and purchased video content in prepaid expense

   99,264   53,378  

Depreciation

   37,997   28,137     59,059   37,997  

Share-based compensation expense

   5,523   10,202     29,513   5,523  

Amortization of intangible assets and purchased video content in prepaid expense

   53,378   48,541  

Impairment of purchased video content

   0   15,101  

Impairment of other intangible assets

   1,504   7,522  

Provision /(Reversal) for allowance for doubtful accounts

   (134 3,538  

Excess tax benefits from share-based payment arrangements

   0   (3,492

Impairment of intangible assets

   1,457   1,504  

Reversal for allowance for doubtful accounts

   (2 (134

Investment income from investments in debt securities

   (4,143 (4,098   (1,370 (4,143

Change in fair value of put option

   (2,304 144  

Change in fair value of short-term investments

   (425 (2,292

Others

   (1,722 89     1,649   570  

Changes in assets and liabilities, net of acquisition:

      

Accounts receivable

   (49,920 (15,025   (25,759 (49,920

Prepaid and other assets

   (25,135 (4,042   32,825   (21,016

Accounts payable

   (4,194 11,921  

Receipts in advance and deferred revenue

   (941 12,578  

Taxes payable

   (17,463 870  

Deferred tax

   6,928   7,595     (21,727 2,809  

Accounts payable

   11,921   22,487  

Taxes payable

   870   (5,010

Accrued liabilities

   58,493   19,165  

Receipts in advance and deferred revenue

   12,578   4,809  

Other short-term liabilities

   14,751   18,172  

Accrued and other short-term liabilities

   83,676   73,100  
  

 

  

 

   

 

  

 

 

Net cash provided by operating activities

   275,386    279,781     94,785    275,386  

Cash flows from investing activities:

      

Proceeds from /(purchase of) short-term investments, net

   (206,662  32,856  

Acquisition of MoboTap (net of cash acquired)

   (86,539  0  

Purchase of intangible and other assets

   (98,706  (61,738

Purchase of fixed assets

   (73,440  (84,201

Purchase of long-term investments

   (24,609  0  

Cash paid related to restricted time deposits, net

   (13,554  (121,705

Purchase of noncontrolling interest in 7Road

   (76,010  0     0    (76,010

Purchase of fixed assets

   (84,201  (50,840

Purchase of intangible and other assets

   (61,738  (44,048

Cash paid related to restricted time deposits

   (121,705  (225,757

Proceeds /purchase of short-term investments, net

   32,856    (24,436

Other acquisitions, net of cash acquired

   0    (683

Other cash proceeds /(payments) related to investing activities

   1,783    (979

Proceeds received from debt securities at maturity

   82,009    0  

Other cash proceeds related to investing activities

   3,404    1,595  
  

 

  

 

   

 

  

 

 

Net cash used in investing activities

   (309,015  (346,743   (418,097  (309,203

Cash flows from financing activities:

      

Issuance of common stock

   964    240     516    964  

Issuance of Sogou series B preferred shares and Class B ordinary shares

   475,472    0  

Sohu’s purchase of Sogou Series A Preferred Shares from Alibaba

   0    (25,800

Repurchase of common stock

   0    (12,566

Issuance of Sogou Series B Preferred Shares and Class B Ordinary Shares

   0    475,472  

Repurchase of Changyou American depositary shares (“ADSs”)

   (9,048  0     0    (9,048

Portion of Changyou dividend distributed to noncontrolling interest shareholders

   0    (64,551

Portion of Sogou special dividend distributed to holders of Series A Preferred Shares other than Sohu

   (139,700  0  

Repurchase of Sogou Series A Preferred Shares from noncontrolling shareholders

   (47,285  0  

Repurchase of Sogou Class A Ordinary Shares from noncontrolling shareholders

   (24,591  0  

Proceeds of loans from offshore banks

   111,530    222,353     370,000    111,530  

Repayments of loans to offshore banks

   (410,194  0  

Exercise of share-based awards in subsidiary

   414    1,794  

 

-7-


Payment of contingent consideration

   (19,736  (13,806

Excess tax benefits from share-based payment arrangements

   0    3,492  

Exercise of share-based awards in subsidiary

   1,794    1,352  

Proceeds received from early exercise of share-based awards in subsidiary

   5,278    0  

Other cash payments related to financing activities

   (447  (281
  

 

 

  

 

 

 

Net cash provided by financing activities

   426,107    110,433  

Effect of exchange rate changes on cash and cash equivalents

   14,829    (2,609
  

 

 

  

 

 

 

Net increase in cash and cash equivalents

   407,307    40,862  

Cash and cash equivalents at beginning of period

   833,535    732,607  
  

 

 

  

 

 

 

Cash and cash equivalents at end of period

  $    1,240,842   $        773,469  
  

 

 

  

 

 

 

Supplemental cash flow disclosures:

   

Barter transactions

  $380   $451  

Supplemental schedule of non-cash investing activity:

   

Consideration payable for acquisition of Shi Ji Guang Su

   24,398    0  

Consideration payable for the purchase of noncontrolling interest in 7Road

   2,000    0  

Changes in government grant in prepaid and other current assets

   1,066    794  

Supplemental schedule of non-cash financing activity:

   

Transaction expenses payable for issuance of Sogou Series B Preferred Shares and Class B Ordinary Shares

   5,898    0  

Portion of Sogou special dividend distributed to holders of Series A Preferred Shares other than Sohu

   0    (139,700

Proceeds received from early exercise of share-based awards in subsidiary

   0    5,278  

Payment of contingent consideration

   (2,813  (19,736

Other cash payments related to financing activities

   (4,935  (259
  

 

 

  

 

 

 

Net cash provided by /(used in) financing activities

   (118,888  426,295  

Effect of exchange rate changes on cash and cash equivalents

   (4,192  14,829  
  

 

 

  

 

 

 

Net increase /(decrease) in cash and cash equivalents

   (446,392  407,307  

Cash and cash equivalents at beginning of period

   1,287,288    833,535  
  

 

 

  

 

 

 

Cash and cash equivalents at end of period

  $840,896   $1,240,842  
  

 

 

  

 

 

 

Supplemental cash flow disclosures:

   

Barter transactions

  $721   $380  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

-8-


SOHU.COM INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (unaudited)

Nine Months Ended September 30, 20132014

(In thousands)

 

     Sohu.com Inc. Shareholders’ Equity    
  Total  Common
Stock
  Additional
Paid-in
Capital
  Treasury
Stock
  Accumulated
Other
Comprehensive
Income
  Retained
Earnings
  Noncontrolling
Interest
 

Beginning balance

 $1,315,217   $44   $378,311   $(143,858 $79,542   $770,184   $230,994  

Issuance of common stock

  964    0    964    0    0    0    0  

Repurchase of Changyou ADSs

  (9,048  0    (6,116  0    0    0    (2,932

Share-based compensation expense

  5,464    0    (836  0    0    0    6,300  

Purchase of noncontrolling interest in 7Road

  2,257    0    1,517    0    0    0    740  

Consideration received for the issuance of Sogou shares to Tencent, net of transaction expenses

  470,662    0    146,798    0    0    0    323,864  

Direct tax impact of Sogou-Tencent Transactions

  (21,420  0    (21,420  0    0    0    0  

Special dividend paid to noncontrolling Sogou Series A Preferred Shareholders

  (139,700  0    86,335    0    0    (82,423  (143,612

Repurchase /put options for Sogou Series A preferred shares

  (6,048  0    (3,744  0    0    (2,304  0  

Settlement of share-based awards in subsidiary

  1,793    0    13,003    0    0    0    (11,210

Net income attributable to Sohu.com Inc. and noncontrolling interest shareholders

  134,717    0    0    0    0    64,291    70,426  

Foreign currency translation adjustment, net of tax

  33,481    0    0    0    26,226    0    7,255  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Ending balance

 $1,788,339   $44   $594,812   $(143,858 $105,768   $749,748   $481,825  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 
     Sohu.com Inc. Shareholders’ Equity    
  Total  Common
Stock
  Additional
Paid-in
Capital
  Treasury
Stock
  Accumulated
Other
Comprehensive
Income
  Retained
Earnings
  Noncontrolling
Interest
 

Beginning balance

 $1,836,720   $44   $601,633   $(143,858 $116,304   $752,582   $510,015  

Issuance of common stock

  516    0    516    0    0    0    0  

Repurchase of Sogou Series A Preferred Shares from noncontrolling shareholders

  (47,285  0    26,276    0    0    (27,747  (45,814

Repurchase of Sogou Class A Ordinary Shares from noncontrolling shareholders

  (24,591  0    0    0    0    0    (24,591

Exercise of right to repurchase from China Web

  1,584    0    1,584    0    0    0    0  

Purchase of equity interests of a VIE from a third party shareholder

  (809  0    11    0    0    0    (820

Share-based compensation expense

  29,485    0    13,048    0    0    0    16,437  

Settlement of share-based awards in subsidiary

  798    0    11,336    0    0    0    (10,538

Acquisition of MoboTap

  53,424    0    0    0    0    0    53,424  

Acquisition of noncontrolling interest in a subsidiary

  (4,726  0    (1,777  0    0    0    (2,949

Net income /(loss) attributable to Sohu.com Inc. and noncontrolling interest shareholders

  (138,473  0    0    0    0    (119,335  (19,138

Accumulated other comprehensive income /(loss)

  (14,084  0    0    0    (10,504  0    (3,580
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Ending balance

 $1,692,559   $44   $652,627   $(143,858 $105,800   $605,500   $472,446  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

-9-


SOHU.COM INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (unaudited and revised)(unaudited)

Nine Months Ended September 30, 20122013

(In thousands)

 

     Sohu.com Inc. Shareholders’ Equity    
  Total  Common
Stock
  Additional
Paid-in
Capital
  Treasury
Stock
  Accumulated
Other
Comprehensive
Income
  Retained
Earnings
  Noncontrolling
Interest
 

Beginning balance

 $1,219,071   $44   $366,210   $(131,292 $76,219   $697,244   $210,646  

Issuance of common stock

  240    0    240    0    0    0    0  

Repurchase of common stock

  (12,566  0    0    (12,566  0    0    0  

Share-based compensation expense

  10,202    0    4,555    0    0    0    5,647  

Settlement of share-based awards in subsidiary

  1,353    0    (7,477  0    0    0    8,830  

Portion of Changyou dividend attributable to noncontrolling interest shareholders

  (64,551  0    0    0    0    0    (64,551

Sohu’s purchase of Sogou Series A Preferred Shares from Alibaba

  (25,800  0    0    0    0    (14,219  (11,581

Changes in mezzanine equity of Changyou

  6,836    0    6,836    0    0    0    0  

Transaction cost for Sohu’s sale of the 17173 Business to Changyou

  118    0    118    0    0    0    0  

Deemed contribution from noncontrolling shareholders (related to Sohu’s sale of the 17173 Business to Changyou)

  0    0    171    0    0    0    (171

Excess tax benefits from share-based awards

  3,492    0    3,492    0    0    0    0  

Net income attributable to Sohu.com Inc. and noncontrolling interest shareholders

  119,389    0    0    0    0    61,771    57,618  

Foreign currency translation adjustment, net of tax

  (7,115  0    0    0    (6,007  0    (1,108
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Ending balance

 $1,250,669   $44   $374,145   $(143,858 $70,212   $744,796   $205,330  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 
     Sohu.com Inc. Shareholders’ Equity    
  Total  Common
Stock
  Additional
Paid-in
Capital
  Treasury
Stock
  Accumulated
Other
Comprehensive
Income
  Retained
Earnings
  Noncontrolling
Interest
 

Beginning balance

 $1,315,217   $44   $378,311   $(143,858 $79,542   $770,184   $230,994  

Issuance of common stock

  964    0    964    0    0    0    0  

Repurchase of Changyou ADSs

  (9,048  0    (6,116  0    0    0    (2,932

Share-based compensation expense

  5,464    0    (836  0    0    0    6,300  

Purchase of noncontrolling interest in 7Road

  2,257    0    1,517    0    0    0    740  

Consideration received for the issuance of Sogou shares to Tencent, net of transaction expenses

  470,662    0    146,798    0    0    0    323,864  

Direct tax impact of Sogou-Tencent Transactions

  (21,420  0    (21,420  0    0    0    0  

Special dividend paid to noncontrolling Sogou Series A Preferred shareholders

  (139,700  0    86,335    0    0    (82,423  (143,612

Repurchase /put options for Sogou Series A Preferred Shares

  (6,048  0    (3,744  0    0    (2,304  0  

Settlement of share-based awards in subsidiary

  1,793    0    13,003    0    0    0    (11,210

Net income /(loss) attributable to Sohu.com Inc. and noncontrolling interest shareholders

  134,717    0    0    0    0    64,291    70,426  

Accumulated other comprehensive income /(loss)

  33,481    0    0    0    26,226    0    7,255  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Ending balance

 $1,788,339   $44   $594,812   $(143,858 $105,768   $749,748   $481,825  
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

-10-


SOHU.COM INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. The Company and Basis of Presentation

Nature of Operations

Sohu.com Inc. (“Sohu” or the “Company”), a Delaware corporation organized in 1996, is a leading Chinese online media, search gaming, community and mobilegame service group providing comprehensive online products and services on PCs and mobile devices in the People’s Republic of China (the “PRC” or “China”). The core businesses of the Company, together with its wholly-owned and majority-owned subsidiaries and variable interest entities (collectively the “Sohu Group” or the “Group”), mainly offersare online advertising services, online game services and mobile services.

Online advertising and online games are the core businesses of the Sohu Group.games.

Online Advertising

The online advertising business consists of the brand advertising business as well as the search and others business.

Brand Advertising Business

The Sohu Group’s brand advertising business offers to its users, over its matrices of Chinese language online media content and services, various products and services across multiple Internet-enabled devices, such as PCs, mobile phones and tablets. It also offers advertisements on the Sohu Group’sGroup Web properties to companies seeking to increase their brand awareness online.

The majority of the Sohu Group’s products and services are provided on the following platforms:

Sohu.com, a leading mass portal and media destination;

Tv.sohu.com, a leading online video Website;

Focus.cn, a top real estate Website; and

17173.com, a leading game information portal.

Search and Others Business

The search and others business, provided by Sohu’s search subsidiary Sogou Inc. (“Sogou”), primarily offers customers pay-for-click services, as well as online marketing services on the Sogou Web Directory.

On September 16, 2013, pursuant to a Subscription Agreement entered into on that date by and among Sogou, THL A21 Limited, a British Virgin Islands company which is a wholly-owned subsidiary of Tencent Holdings Limited a Cayman Islands company (Tencent Holdings Limited together with its subsidiaries, Tencent”“Tencent”); Sohu’s wholly-owned subsidiary Sohu.com (Search) Limited, a Cayman Islands company (“Sohu Search”); and Photon Group Limited (“Photon”), the investment vehicle of the Sohu Group’ sGroup’s Chairman and Chief Executive Officer Dr. Charles Zhang, and a series of other contracts also entered into on that date between Sogou and Tencent, Tencent invested a net amount of $448 million in cash in Sogou and transferred its Soso search-related businesses and certain other assets to Sogou (collectively, the “Sogou-Tencent Transactions,” or the “Transactions”Transactions”).

On September 16, 2013, Sogou entered into (i) a Repurchase Option Agreement with Sohu Search, exercisable commencing March 16, 2014, granting to Sogou the right to purchase 24 million Series A Preferred Shares of Sogou held by Sohu Search for an aggregate purchase price of $78.8 million; (ii) a Repurchase Option Agreement with Photon, also exercisable commencing March 16, 2014, granting to Sogou the right to purchase 6.4 million Series A Preferred Shares of Sogou held by Photon for an aggregate purchase price of $21 million; and (iii) a Repurchase/Put Option Agreement with China Web Search (HK) Limited (“China Web”), an investment vehicle of Yunfeng Capital, granting to Sogou the right to purchase at any time from March 16, 2014 to July 31, 2014, and granting to China Web the right to put to Sogou at any time prior to July 31, 2014, 14.4 million Series A Preferred Shares of Sogou held by China Web for an aggregate purchase price of $47.3 million. Sogou expects to exercise its rights under each of these agreements when they first become exercisable.

On September 16, 2013, Sogou, Sohu Search, Photon, Mr. Xiaochuan Wang, four other members of Sogou’s management (collectively, the “Sohu Parties”) and Tencent entered into a Shareholders Agreement (the “Shareholders Agreement”). Under under which the Shareholders Agreement, the parties have agreed to vote their Sogou voting shares in all elections of directors to elect three designees of Sohu Search and two designees of Tencent.

On September 17, 2013, Sogou paid a special dividend to the three holders of Series A Preferred Shares of Sogou in anthe aggregate amount of $301 million, of which Sohu Search received $161 million, Photon received $43 million, and China Web received $97 million.

On December 2, 2013, Tencent invested $1.5 million in cash in Beijing Sogou Information Service Co., Ltd. (“Sogou Information”), a VIE of Sogou, as additional consideration in connection with the Sogou-Tencent Transactions.

-11-


On March 24, 2014, Sogou purchased from China Web, pursuant to the Repurchase/Put Option Agreement between Sogou and China Web, 14.4 million Series A Preferred Shares of Sogou, for an aggregate purchase price of $47.3 million.

In June 2014, Sogou repurchased approximately 4.2 million of its Class A Ordinary Shares from noncontrolling shareholders, some of whom are employees of the Group, for an aggregate purchase price of $41.6 million.

Pursuant to the Shareholders Agreement, Sohu will hold approximately 53.6%52% of the total voting power for the election of the Board of Directors of Sogou, assuming that the remaining repurchase options and the repurchase/put option are exercised, Tencent’s non-voting Class B Ordinary Shares are converted to voting shares, and all share options under the Sogou 2010 Share Incentive Plan and all share options under an arrangement providing for Sogou share-based awards to be available for grants to Sohu management and key employees (the “Management“Sohu Management Sogou Share Option Arrangement”) are granted and exercised. As Sohu is the controlling shareholder of Sogou, Sohu consolidates Sogou in the Sohu Group’s consolidated financial statements, and recognizes noncontrolling interest reflecting economic interests in Sogou held by shareholders other than Sohu.

-11-


Online Games

The online game business is conducted by Sohu’s majority-owned subsidiary Changyou.com Limited (“Changyou”). Changyou completed its initial public offering (“IPO”) on the NASDAQ Global Select Market under the symbol “CYOU” in 2009. As of September 30, 2013, Sohu held approximately 68% of the combined total of Changyou’s outstanding ordinary shares and controlled approximately 83% of the total voting power in Changyou. As Changyou’s controlling shareholder, Sohu consolidates Changyou in the Sohu Group’s consolidated financial statements but recognizes noncontrolling interest reflecting the economic interest in Changyou held by shareholders other than Sohu.

Theis a leading online game business consistsdeveloper and operator in China as measured by the popularity of its massively multiplayer online game (“MMOG”) Tian Long Ba Bu (“TLBB”) and its Web games DDTank and Wartune (also known as “Shen Qu”), which Changyou developed in-house. Changyou engages in the development, operation and licensing of massively multiplayer online games (“MMOGs”),for PCs and mobile devices. Changyou’s online games include MMOGs, which are interactive online games that may be played simultaneously by hundreds of thousands of game players, Web games, which are played over the Internet using a Web browser, and mobile games. Changyou currently operates several MMOGs in China, including the in-house developed Tian Long Ba Bu (“TLBB”), and developed, and primarily jointly operates with third-party joint operators, DDTank and Wartune (also known as “Shen Qu”),games, which are two popular Web games in China.played on mobile devices with an Internet connection.

Basis of Consolidation and Recognition of Noncontrolling Interest

The consolidated financial statements include the accounts of Sohu and its wholly-owned and majority-owned subsidiaries and consolidated VIEs. All intercompany transactions are eliminated.

VIE Consolidation

The Sohu Group adopted the guidance of accounting for VIEs, which requires VIEs to be consolidated by the primary beneficiary of the entity. For consolidated VIEs, management made evaluations of the relationships between the Sohu Group and the 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 Group controls the shareholders’ voting interests in these VIEs. As a result of such evaluation, management concluded that the Sohu Group is the primary beneficiary of its consolidated VIEs. The Sohu Group has one VIEthree VIEs that isare not consolidated, since the Group is not the primary beneficiary.

Noncontrolling Interest Recognition

Noncontrolling interests are recognized to reflect the portion of the equity of majority-owned subsidiaries and VIEs which is not attributable, directly or indirectly, to the controlling shareholders.

Basis of Presentation

These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements and related footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.2013.

The accompanying unaudited condensed consolidated interim financial statements reflect all normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of the results for the interim periods presented. Results for the nine months ended September 30, 20132014 are not necessarily indicative of the results expected for the full fiscal year or for any future period. Certain comparative figures have been reclassified to conform to the current presentation.

Historical accounting error regarding net income attributable to Sohu.com Inc. and basic and diluted net income per share attributable to Sohu.com Inc.

In the third quarter of 2013, as previously reported in an Amendment No. 1 to Current Report on Form 8-K/A that the Company filed with the SEC on September 20, 2013, management noted an accounting error in the Company’s Quarterly Report on Form 10-Q for the three months ended June 30, 2012 regarding net income attributable to Sohu.com Inc. and the calculation of basic and diluted net income per share attributable to Sohu.com Inc. In June 2012, Sohu had purchased from Alibaba Investments Limited (“Alibaba”), a private investment subsidiary of Alibaba Group Holding Limited, 24.0 million Series A Preferred Shares of Sogou for cash consideration of $25.8 million. UnderASC 260-10-S99-2, this transaction gave rise to a deemed dividend in the amount of $14.2 million, which was the difference between the consideration Sohu paid to Alibaba and the carrying amount of these 24.0 million Series A Preferred Shares in the Group’s consolidated financial statements. Accordingly, this amount of $14.2 million should have been subtracted from net income to arrive at net income available to common shareholders in the Group’s calculation of net income

 

-12-


per share. This deemed dividend was inappropriately accounted for when calculatingReclassification of Mobile Business to Others Business

Commencing in the net income attributablefirst quarter of 2014, the Group reclassified the mobile business to the others business, because the Group resultingdid not consider the mobile business to be significant enough to constitute a separately-disclosed revenue stream. The mobile business offers mobile-related services and mobile products, in an error incooperation with China mobile network operators, to mobile phone users and to China mobile network operators. Most the calculation of basic and diluted net income per share attributableGroup’s mobile revenues are contributed by services provided to Sohu.com Inc. There was a carry-forward effect of this accounting error to the net income attributable to Sohu.com Inc. and the net income per share calculationmobile phone users through products such as reported for the nine months ended September 30, 2012 in the Company’s Quarterly Report on Form 10-Q for the three months then ended (the “3rd Quarter 2012 10-Q”short messaging services (“SMS”), ring-back tones (“RBT”), and as reported for the year ended December 31, 2012 in the Company’s Annual Report on Form 10-K for the year then ended. In addition, there was a carry-forward effect of the error to the classification of retained earnings and additional paid-in capital in the Company’s Quarterly Report on Form 10-Q for the three months ended June 30, 2012, September 30, 2012, March 31, 2013 and June 30, 2013, and the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Management performed an assessment of the impact of this accounting error from both a quantitative and a qualitative perspective in accordance with the guidance contained inSAB 99, and concluded that the error was not material to the Group’s relevant historical financial statements taken as a whole. Therefore, management concluded that the relevant affected historical financial statements could continue to be relied upon but would be revised to correct the error.

Correction of the error in the Group’s consolidated statements of comprehensive income for the nine months ended September 30, 2012 included in this report resulted in a reduction of $14.2 million in the amount reported for net income attributable to Sohu.com Inc. (from $61.8 million to $47.6 million) and a reduction of $0.38 in the amounts reported for both basic net income per share and diluted net income per share attributable to Sohu.com Inc. (from $1.63 to $1.25 for basic net income per share, and from $1.44 to $1.06 for diluted net income per share), as compared to the corresponding amounts reported in the 3rd Quarter 2012 10-Q. Correction of the error in the Group’s consolidated balance sheets as of December 31, 2012 included in this report resulted in an increase of $14.2 million in additional paid-in capital (from $364.1 million to $378.3 million) and a reduction of $14.2 million in retained earnings (from $784.4 million to $770.2 million), as compared to the corresponding amounts reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Reclassification of revenues and costs related to Changyou Internet value-added servicesinteractive voice response (“IVAS”IVR”)

Commencing January 1, 2013, in order to provide a better foundation for understanding Changyou’s performance, both revenues and costs generated from the operation of third-party Web games by the 17173 business were reclassified from the online game business to IVAS in the others business.. To conform to current period presentations, the relevant amountscertain comparative figures for prior periods have been reclassified accordingly. Such reclassifications amounted to $0.8$14.5 million and $3.5$43.6 million, respectively, for revenues and $0.3$8.1 million and $1.3$26.3 million, respectively, for costs respectively, for the three months and nine months ended September 30, 2012.2013.

2. Segment Information

The Sohu Group’s segments are business units that offer different services and are reviewed separately by the chief operating decision maker (the “CODM”), or the decision making group, in deciding how to allocate resources and in assessing performance. The Group’s CODM is Sohu.com Inc.’s Chief Executive Officer. Some items, such as share-based compensation expense, operating expenses, other income and expense, and income tax benefit and expense, are not reviewed by the CODM. These items are disclosed in the segment information for reconciliation purposes only.

In connection with the reclassification of the mobile business to the others business, as the CODM no longer reviewed the mobile business as a separate segment, the Group reclassified the mobile segment to the others segment from the first quarter of 2014. There are fivefour reportable segments in the Group, consisting of brand advertising, Sogou (which mainly consists of the search and others business), Changyou (which mainly consists of the online game business), mobile and others.

Some items, such as share-based compensation expense, operating expenses, other income and expense, and income tax expense, are not reviewed by the CODM. These items are disclosed inothers business. The Group has restated the segment informationpresentation of its reportable segments for reconciliation purposes only.prior periods to conform to the current presentation.

The following tables present summary information by segment (in thousands):

 

                                                                                                                
   Three Months Ended September 30, 2013 
   Brand Advertising, Mobile and
Others
             
   Brand
Advertising
  Mobile  Others  Brand
Advertising,
Mobile and
Others
  Sogou  Changyou  Eliminations  Consolidated 

Revenues (1)

  $110,008   $14,524   $7,036   $131,568   $56,940   $183,068   $(3,253 $368,323  

Segment cost of revenues

   (60,512  (8,108  (71  (68,691  (26,687  (30,093  109    (125,362
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Segment gross profit /(loss)

  $49,496   $6,416   $6,965    62,877    30,253    152,975    (3,144  242,961  
  

 

 

  

 

 

  

 

 

      

SBC (2) in cost of revenues

      (59  (24  (45  0    (128
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Gross profit

      62,818    30,229    152,930    (3,144  242,833  
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

-13-


                                                                                                                

Operating expenses:

         

Product development

      (21,758  (17,700  (30,181  0    (69,639

Sales and marketing

      (54,748  (10,673  (28,092  3,144    (90,369

General and administrative

      (11,742  (2,952  (12,872  0    (27,566

SBC (2) in operating expenses

      (542  (5,389  (286  3,147    (3,070
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total operating expenses

      (88,790  (36,714  (71,431  6,291    (190,644
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating profit /(loss)

      (25,972  (6,485  81,499    3,147    52,189  

Other income /(expense) (3)

      162,372    (27  381    (161,193  1,533  

Interest income

      1,637    231    5,727    0    7,595  

Exchange difference

      (170  49    (1,184  0    (1,305

Income /(loss) before income tax expense

      137,867    (6,232  86,423    (158,046  60,012  
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Income tax expense

      (5,328  0    (13,595  0    (18,923
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net income

     $132,539   $(6,232 $72,828   $(158,046 $41,089  
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Note (1):  The elimination for segment revenues mainly consists of marketing services provided by the brand advertising segment (banner advertisements etc.) to the Changyou segment.

Note (2):  “SBC” stands for share-based compensation expense.

Note (3):  The elimination for other income is primarily for the portion paid to Sohu of a special dividend paid by Sogou to holders of its Series A Preferred Shares.

       

      

       

   Three Months Ended September 30, 2012 
   Brand Advertising, Mobile and
Others
             
   Brand
Advertising
  Mobile  Others  Brand
Advertising,
Mobile and
Others
  Sogou  Changyou  Eliminations  Consolidated 

Revenues (1)

  $68,217   $14,312   $2,935   $85,464   $37,295   $165,782   $(3,163 $285,378  

Segment cost of revenues

   (35,620  (9,474  (841  (45,935  (19,715  (30,908  41    (96,517
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Segment gross profit /(loss)

  $32,597   $4,838   $2,094    39,529    17,580    134,874    (3,122  188,861  
  

 

 

  

 

 

  

 

 

      

SBC (2) in cost of revenues

      (133  (21  (78  0    (232
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Gross profit

      39,396��   17,559    134,796    (3,122  188,629  
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating expenses:

         

Product development

      (16,916  (11,034  (17,728  0    (45,678

Sales and marketing

      (36,744  (7,693  (16,353  3,122    (57,668

General and administrative

      (8,842  (1,524  (7,587  0    (17,953

SBC (2) in operating expenses

      (1,030  (1,931  (715  65    (3,611
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total operating expenses

      (63,532  (22,182  (42,383  3,187    (124,910
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating profit /(loss)

      (24,136  (4,623  92,413    65    63,719  

Other income /(expense) (3)

      137,940    61    (1,787  (136,325  (111

Interest income

      2,297    73    3,604    0    5,974  

-14-


                                                                                                                

Exchange difference

      88    31    548    0    667  

Income /(loss) before income tax expense

      116,189    (4,458  94,778    (136,260  70,249  
     

 

  

 

  

 

  

 

  

 

 

Income tax expense

      (1,373  0    (17,354  0    (18,727
     

 

  

 

  

 

  

 

  

 

 

Net income

     $114,816   $(4,458 $77,424   $(136,260 $51,522  
     

 

  

 

  

 

  

 

  

 

 
 Three Months Ended September 30, 2014 

Note (1): The elimination for segment revenues mainly consists of marketing services provided by the brand advertising segment (banner advertisements etc.) to the Changyou segment.

Note (2): “SBC” stands for share-based compensation expense.

Note (3): The elimination for other income is primarily for the portion paid to Sohu of a special one-time cash dividend paid by Changyou to its shareholders.

       

      

       

 Brand Advertising and Others         
  Nine Months Ended September 30, 2013      Brand         
  Brand Advertising, Mobile and
Others
          Brand   Advertising         
  Brand
Advertising
 Mobile Others Brand
Advertising,
Mobile and
Others
 Sogou Changyou Eliminations Consolidated  Advertising Others and Others Sogou Changyou Eliminations Consolidated 

Revenues (1)

  $277,974   $43,610   $14,190   $335,774   $146,144   $543,024   $(10,119 $1,014,823   $135,301   $12,325   $147,626   $106,158   $180,819   $(4,188 $430,415  

Segment cost of revenues

   (151,105 (26,342 (2,180 (179,627 (71,972 (91,098 329   (342,368 (79,286 (5,831 (85,117 (46,463 (50,278 667   (181,191
  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Segment gross profit /(loss)

  $126,869   $17,268   $12,010    156,147    74,172    451,926    (9,790  672,455   $56,015   $6,494    62,509    59,695    130,541    (3,521  249,224  
  

 

  

 

  

 

       

 

  

 

      

SBC (2) in cost of revenues

      (197  (29  (70  0    (296    (218  (193  (58  0    (469
     

 

  

 

  

 

  

 

  

 

    

 

  

 

  

 

  

 

  

 

 

Gross profit

      155,950    74,143    451,856    (9,790  672,159      62,291    59,502    130,483    (3,521  248,755  
     

 

  

 

  

 

  

 

  

 

    

 

  

 

  

 

  

 

  

 

 

Operating expenses:

                

Product development

      (62,566  (45,131  (76,364  0    (184,061    (23,767  (26,113  (52,827  788    (101,919

Sales and marketing

      (142,581  (28,047  (59,559  9,790    (220,397    (57,470  (24,570  (52,930  4,165    (130,805

General and administrative

      (29,192  (7,020  (38,689  0    (74,901    (12,159  (3,208  (26,832  (189  (42,388

SBC (2) in operating expenses

      (1,701  (5,800  (875  3,149    (5,227    (922  (13,094  (456  141    (14,331
     

 

  

 

  

 

  

 

  

 

    

 

  

 

  

 

  

 

  

 

 

Total operating expenses

      (236,040  (85,998  (175,487  12,939    (484,586    (94,318  (66,985  (133,045  4,905    (289,443
     

 

  

 

  

 

  

 

  

 

    

 

  

 

  

 

  

 

  

 

 

Operating profit /(loss)

      (80,090  (11,855  276,369    3,149    187,573      (32,027  (7,483  (2,562  1,384    (40,688

Other income /(expense) (3)

      164,533    59    2,197    (161,193  5,596  

Interest income

      5,275    837    13,682    0    19,794  

Other income /(expense)

    1,860    (4  283    (1,243  896  

Net interest income

    1,966    860    4,642    0    7,468  

Exchange difference

      (752  196    (4,718  0    (5,274    (15  4    (599  0    (610

Income /(loss) before income tax expense

      88,966    (10,763  287,530    (158,044  207,689  

Income tax expense

      (11,079  (6  (44,107  0    (55,192

Income /(loss) before income tax benefit /(expense)

    (28,216  (6,623  1,764    141    (32,934
     

 

  

 

  

 

  

 

  

 

    

 

  

 

  

 

  

 

  

 

 

Net income

     $77,887   $(10,769 $243,423   $(158,044 $152,497  

Income tax benefit /(expense)

    1,327    0    (291  0    1,036  
     

 

  

 

  

 

  

 

  

 

    

 

  

 

  

 

  

 

  

 

 

Net income /(loss)

   $(26,889 $(6,623 $1,473   $141   $(31,898
   

 

  

 

  

 

  

 

  

 

 

 

Note (1):The elimination for segment revenues mainly consists of revenues from marketing services provided by the brand advertising segment (banner advertisements etc.) to the Changyou segment.
Note (2):“SBC” stands for share-based compensation expense.

-13-


  Three Months Ended September 30, 2013 
  Brand Advertising and Others             
        Brand             
  Brand     Advertising             
  Advertising  Others  and Others  Sogou  Changyou  Eliminations  Consolidated 

Revenues (1)

 $110,008   $21,560   $131,568   $56,940   $183,068   $(3,253 $368,323  

Segment cost of revenues

  (60,512  (8,179  (68,691  (26,687  (30,093  109    (125,362
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Segment gross profit /(loss)

 $49,496   $13,381    62,877    30,253    152,975    (3,144  242,961  
 

 

 

  

 

 

      

SBC (2) in cost of revenues

    (59  (24  (45  0    (128
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Gross profit

    62,818    30,229    152,930    (3,144  242,833  
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating expenses:

       

Product development

    (21,758  (17,700  (30,181  0    (69,639

Sales and marketing

    (54,748  (10,673  (28,092  3,144    (90,369

General and administrative

    (11,742  (2,952  (12,872  0    (27,566

SBC (2) in operating expenses

    (542  (5,389  (286  3,147    (3,070
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total operating expenses

    (88,790  (36,714  (71,431  6,291    (190,644
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating profit /(loss)

    (25,972  (6,485  81,499    3,147    52,189  

Other income /(expense) (3)

    162,372    (27  381    (161,193  1,533  

Net interest income

    1,637    231    5,727    0    7,595  

Exchange difference

    (170  49    (1,184  0    (1,305

Income /(loss) before income tax expense

    137,867    (6,232  86,423    (158,046  60,012  
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Income tax expense

    (5,328  (0  (13,595  0    (18,923
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net income /(loss)

   $132,539   $(6,232 $72,828   $(158,046 $41,089  
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Note (1):The elimination for segment revenues mainly consists of revenues from marketing services provided by the brand advertising segment (banner advertisements etc.) to the Changyou segment.
Note (2):“SBC” stands for share-based compensation expense.
Note (3):The elimination for other income is primarily for the portion paid to Sohu of a special dividend paid by Sogou to holders of its Series A Preferred Shares.

  Nine Months Ended September 30, 2014 
  Brand Advertising and Others          
        Brand             
  Brand     Advertising             
  Advertising  Others  and Others  Sogou  Changyou  Eliminations  Consolidated 

Revenues (1)

 $361,556   $39,139   $400,695   $267,081   $539,353   $(11,248 $1,195,881  

Segment cost of revenues

  (218,737  (19,880  (238,617  (118,152  (132,941  1,120    (488,590
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Segment gross profit /(loss)

 $142,819   $19,259    162,078    148,929    406,412    (10,128  707,291  
 

 

 

  

 

 

      

SBC (2) in cost of revenues

    (562  (706  (186  0    (1,454
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Gross profit

    161,516    148,223    406,226    (10,128  705,837  
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating expenses:

       

Product development

    (68,099  (75,582  (171,362  3,131    (311,912

Sales and marketing

    (165,408  (49,919  (202,890  11,266    (406,951

General and administrative

    (33,549  (8,395  (70,452  (533  (112,929

SBC (2) in operating expenses

    (8,437  (36,523  (1,093  902    (45,151
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total operating expenses

    (275,493  (170,419  (445,797  14,766    (876,943
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating profit /(loss)

    (113,977  (22,196  (39,571  4,638    (171,106

Other income /(expense)

    5,287    2,455    1,334    (3,736  5,340  

Net interest income

    6,515    1,714    16,475    0    24,704  

Exchange difference

    (103  (159  289    0    27  

Income /(loss) before income tax benefit/ (expense)

    (102,278  (18,186  (21,473  902    (141,035
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Income tax benefit/ (expense)

    (2,022  0    4,584    0    2,562  
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net income /(loss)

   $(104,300 $(18,186 $(16,889 $902   $(138,473
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

-14-


Note (1):The elimination for segment revenues mainly consists of revenues from marketing services provided by the brand advertising segment (banner advertisements etc.) to the Changyou segment.
Note (2):“SBC” stands for share-based compensation expense.

  Nine Months Ended September 30, 2013 
  Brand Advertising and Others             
        Brand             
  Brand     Advertising             
  Advertising  Others  and Others  Sogou  Changyou  Eliminations  Consolidated 

Revenues (1)

 $277,974   $57,800   $335,774   $146,144   $543,024   $(10,119 $1,014,823  

Segment cost of revenues

  (151,105  (28,522  (179,627  (71,972  (91,098  329    (342,368
 

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Segment gross profit /(loss)

 $126,869   $29,278    156,147    74,172    451,926    (9,790  672,455  
 

 

 

  

 

 

      

SBC (2) in cost of revenues

    (197  (29  (70  0    (296
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Gross profit

    155,950    74,143    451,856    (9,790  672,159  
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating expenses:

       

Product development

    (62,566  (45,131  (76,364  0    (184,061

Sales and marketing

    (142,581  (28,047  (59,559  9,790    (220,397

General and administrative

    (29,192  (7,020  (38,689  0    (74,901

SBC (2) in operating expenses

    (1,701  (5,800  (875  3,149    (5,227
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total operating expenses

    (236,040  (85,998  (175,487  12,939    (484,586
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating profit /(loss)

    (80,090  (11,855  276,369    3,149    187,573  

Other income /(expense) (3)

    164,533    59    2,197    (161,193  5,596  

Net interest income

    5,275    837    13,682    0    19,794  

Exchange difference

    (752  196    (4,718  0    (5,274

Income /(loss) before income tax expense

    88,966    (10,763  287,530    (158,044  207,689  
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Income tax expense

    (11,079  (6  (44,107  0    (55,192
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net income /(loss)

   $77,887   $(10,769 $243,423   $(158,044 $152,497  
   

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Note (1):The elimination for segment revenues mainly consists of revenues from marketing services provided by the brand advertising segment (banner advertisements etc.) to the Changyou segment.
Note (2):“SBC” stands for share-based compensation expense.
Note (3):The elimination for other income is primarily for the portion paid to Sohu of a special dividend paid by Sogou to holders of its Series A Preferred Shares.

 

-15-


                                                                                                                
   Nine Months Ended September 30, 2012 
   Brand Advertising, Mobile and
Others
             
   Brand
Advertising
  Mobile  Others  Brand
Advertising,
Mobile and
Others
  Sogou  Changyou  Eliminations  Consolidated 

Revenues (1)

  $188,117   $43,261   $6,210   $237,588   $90,470   $449,888   $(10,237 $767,709  

Segment cost of revenues

   (120,915  (28,535  (1,770  (151,220  (48,992  (75,700  223    (275,689
  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Segment gross profit /(loss)

  $67,202   $14,726   $4,440    86,368    41,478    374,188    (10,014  492,020  
  

 

 

  

 

 

  

 

 

      

SBC (2) in cost of revenues

      (117  (64  (245  0    (426
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Gross profit

      86,251    41,414    373,943    (10,014  491,594  
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating expenses:

         

Product development

      (46,400  (27,911  (50,597  0    (124,908

Sales and marketing

      (95,522  (18,277  (40,505  10,014    (144,290

General and administrative

      (23,543  (4,235  (23,046  0    (50,824

Impairment of intangible assets via acquisitions of businesses

      0    0    (2,906  0    (2,906

SBC (2) in operating expenses

      (3,538  (3,519  (2,784  65    (9,776
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Total operating expenses

      (169,003  (53,942  (119,838  10,079    (332,704
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Operating profit /(loss)

      (82,752  (12,528  254,105    65    158,890  

Other income /(expense) (3)

      140,495    60    (910  (136,325  3,320  

Interest income

      8,812    261    10,619    0    19,692  

Exchange difference

      188    58    (177  0    69  

Income /(loss) before income

tax expense

      66,743    (12,149  263,637    (136,260  181,971  

Income tax expense

      (6,187  0    (49,694  0    (55,881
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Net income

     $60,556   $(12,149 $213,943   $(136,260 $126,090  
     

 

 

  

 

 

  

 

 

  

 

 

  

 

 

 

Note (1):The intercompany elimination for segment revenues mainly consists of marketing services provided by the brand advertising segment (banner advertisements etc.) to the Changyou segment.
Note (2):“SBC” stands for share-based compensation expense.
Note (3):The elimination for other income is primarily for the portion paid to Sohu of a special one-time cash dividend paid by Changyou to its shareholders.

  As of September 30, 2013   As of September 30, 2014 
  Brand
Advertising,
Mobile and
Others
   Sogou   Changyou   Eliminations Consolidated   Brand
Advertising
and Others
   Sogou   Changyou   Eliminations Consolidated 

Cash and cash equivalents

  $502,934    $236,640    $501,268    $0   $1,240,842    $460,765    $202,826    $177,305    $0   $840,896  

Accounts receivable, net

   110,745     12,880     29,963     (304 153,284     124,964     12,420     42,702     (92 179,994  

Fixed assets, net

   249,956     61,965     234,307     0   546,228     252,777     44,512     244,614     0   541,903  

Total assets (1)

  $1,213,104    $333,464    $1,400,763    $(158,984 $2,788,347    $1,148,385    $279,651    $1,572,097    $(148,263 $2,851,870  

 

Note (1):The elimination for segment assets mainly consists of elimination of long-term investments in subsidiarysubsidiaries and associate companies.consolidated VIEs.

 

-16-


  As of December 31, 2012   As of December 31, 2013 
  Brand
Advertising,
Mobile and
Others
   Sogou   Changyou   Eliminations Consolidated   Brand
Advertising
and Others
   Sogou   Changyou   Eliminations Consolidated 

Cash and cash equivalents

  $433,777    $33,119    $366,639    $0   $833,535    $498,058    $240,746    $548,484    $0   $1,287,288  

Accounts receivable, net

   68,593     6,481     23,364     (40 98,398     102,823     15,705     35,996     (182 154,342  

Fixed assets, net

   70,262     43,861     64,828     0   178,951     257,307     60,461     246,674     0   564,442  

Total assets (1)

  $1,038,741    $87,537    $1,114,513    $(158,154 $2,082,637    $1,221,003    $350,256    $1,585,212    $(157,756 $2,998,715  

 

Note (1):The elimination for segment assets mainly consists of elimination of long-term investments in subsidiarysubsidiaries and associate companies.consolidated VIEs.

3. Share-Based Compensation Expense

Sohu, Changyou, Sogou, and Fox Video Limited (“Sohu Video”), have incentive plans, and prior to June 28, 2013 7Road.com Limited (“7Road”) all havehad an incentive plansplan, for the granting of share-based awards, including common stock /ordinaryor ordinary shares, share options, restricted shares and restricted share units, to their executive officers, management and employees.

Sohu, Changyou, and Sogou share-based awardsShare-based Awards

For Sohu, Changyou and Sogou, 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 Tencent restricted share units that Tencent had granted to employees who transferred to Sogou with the Soso search-related businesses, share-based compensation expense is recognized by Sogou in the consolidated statements of comprehensive income based on the then-current fair value at each reporting date. For Sogou Class A Ordinary Shares repurchased from employees of the Group in the second quarter of 2014, share-based compensation expense is recognized by the Sohu Group in the consolidated statements of comprehensive income in an amount equal to the excess of the repurchase price over the fair value at the repurchase date of the Sogou Class A Ordinary Shares that the Group repurchased. See Note 11 - Sohu.com Inc. Shareholders’ Equity.

Share-based compensation expense is charged to the shareholders’ equity or noncontrolling interest section in the consolidated balance sheets.

Sohu Video share-based awardsShare-based Awards

On January 4, 2012, Sohu Video, the holding entity of Sohu’s video division, adopted a 2011 Share Incentive Plan (the “Video 2011 Share Incentive Plan”) which provides 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, 2013,2014, grants of options for the purchase of 15,352,200 of16,368,200 ordinary shares of Sohu Video had been made, andof which options for the purchase of 4,972,800 ordinary shares were effective under the Video 2011 Share Incentive Plan.vested.

For purposes ofASC 718718-10-25, no grant date may be established until a mutual understanding ofcan be reached between Sohu Video and the recipients as to 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 enterprise value of Sohu Video and hence the fair value of the optionsawards is determinable and can be accounted for.

Management concluded that No grant date could be determined as of September 30, 2013 certain significant factors necessary to determine the fair value of Sohu’s video division remained uncertain. On the basis that2014, because the broader terms and conditions of the option awards had neither been finalized nor mutually agreed upon with the recipients, norecipients.

Under ASC 718-10-55, if the service inception date precedes the grant date for equity-classified awards, compensation expense should be accrued beginning on the service inception date and re-measured on each subsequent reporting date before the grant date, based on the estimated fair value of options occurredthe awards. The estimate of the awards’ fair value would be fixed in the period in which the grant date occurs, and cumulative compensation expense should be adjusted based on the fair value at the grant date. Management determined that the service inception date with respect to vested option awards for purposesthe purchase ofASC 718 4,972,800 shares had preceded the grant date.

-16-


For the three and hence nonine months ended September 30, 2014, negative $0.1 million and positive $4.1 million, respectively, of share-based compensation expense was recognized as costs and expenses in the consolidated statements of comprehensive income. The share-based compensation expense was recognized for vested awards based on the three months endeddifference between their re-measured fair value as of September 30, 2013.2014 and the fair value as of the previous reporting date.

7Road share-based awardsShare-based Awards

On July 10, 2012, 7Road adopted athe 2012 Share Incentive Plan (the “7Road 2012 Share Incentive Plan”), which initially provided for the issuance to selected directors, officers, employees, consultants and advisors of 7Road of up to 5,100,000 ordinary shares of 7Road (amounting to 5.1% of the then outstanding 7Road shares on a fully-diluted basis). 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 then outstanding 7Road shares on a fully-diluted basis) under the 7Road 2012 Share Incentive Plan.

On May 1, 2013, Changyou entered into an agreement with noncontrolling shareholders to acquire all of the outstanding ordinary shares of 7Road held by the noncontrolling shareholders. The acquisition closed on June 5, 2013.

On June 28, 2013, 7Road’s Board of Directors approved the cancellation of the 7Road 2012 Share Incentive Plan. 7Road concurrently offered to a total of 42 7Road employees holding an aggregate of 2,223,750 restricted share units which had been granted under the 7Road 2012 Share Incentive Plan the right to exchange their restricted share units for, at each employee’s election, in each case subject to the employee’s continued employment by 7Road, either (i) Scheme I: the right to a cash payment of up to an aggregate of $2.90 per restricted share unit exchanged, vesting and payable at the rate of 40%, 30% and 30%, respectively, on the first, second and third anniversaries of July 18, 2012, which is the date when the surrendered restricted share units were granted under the 7Road 2012 Share Incentive Plan, or (ii) Scheme II: the right to receive an annual cash bonus, over a seven-year period commencing July 1, 2013, based on the adjusted annual cumulative net income of 7Road. All restricted share units held by these 42 holders under the 7Road 2012 Share Incentive Plan as of June 28, 2013 were included in this exchange program.

-17-


As the original awards of restricted share units made under the 7Road 2012 Share Incentive Plan included as a vesting condition the completion of an IPO, which is not considered probable under it occurs, no share-based compensation expense was recognized for the fair value of the original awards. As of the date of the modification resulting from the exchange program, incremental compensation expense, which is not classified as share-based compensation expense, will be the fair values of the two new compensation schemes included in the exchange program.

For Scheme I, the modification resulted in total incremental compensation expense of $5.7 million, which will be recognized in the consolidated statements of comprehensive income ratably over the remaining vesting period of the awards for each tranche. For the three and nine months ended September 30, 2013, compensation expense of $0.4 million and $2.9 million, respectively, was recognized in the consolidated statements of comprehensive income. In the third quarter of 2013, 7Road paid $1.6 million in cash bonuses under Scheme I.

For Scheme II, the incremental compensation expense varies depending on 7Road’s financial performance. In the third quarter of 2013, 7Road granted to an additional 48 7Road employees the right to receive an annual cash bonus under Scheme II with the same terms as described above.

As the original awards of restricted share units made under the 7Road 2012 Share Incentive Plan included as a vesting condition the completion of an initial public offering (an “IPO”), which is not considered probable until it occurs, no share-based compensation expense was recognized for the fair value of the original awards. Incremental compensation expense, which is not classified as share-based compensation expense, is equal to the fair values of the two new compensation schemes included in the exchange program as of the date of the modification resulting from the exchange program.

For both the three and the nine months ended September 30, 2013,Scheme I, compensation expense of $0.3$3.9 million was recognized as of September 30, 2014 with respect to the modification, and $0.8 million will be recognized in the consolidated statements of comprehensive income.income ratably over the remaining vesting period of the awards. For Scheme II, the incremental compensation expense varies depending on 7Road’s financial performance.

Share-based compensation expense recognitionCompensation Expense Recognition

Share-based compensation expense was recognized in costs and /or expenses for the three and nine months ended September 30, 20132014 and 2012,2013, respectively, as follows (in thousands):

 

  Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
  2013   2012   2013   2012   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 

Share-based compensation expense

          2014   2013   2014   2013 

Cost of revenues

  $128    $232    $296    $426    $469    $128    $1,454    $296  

Product development expenses

   912     1,316     1,670     4,019     6,052     912     15,999     1,670  

Sales and marketing expenses

   359     582     732     1,613     937     359     3,751     732  

General and administrative expenses

   1,799     1,713     2,825     4,144     7,342     1,799     25,402     2,825  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
  $3,198    $3,843    $5,523    $10,202    $14,800    $3,198    $46,606    $5,523  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

-17-


Share-based compensation expense was recognized for share awards of Sohu, Changyou, Sogou and Sohu Video as follows (in thousands):

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
Share-based compensation expense  2014  2013   2014   2013 

For Sohu share-based awards

  $1,337   $730    $5,242    $2,313  

For Changyou share-based awards

   514    312     1,253     884  

For Sogou share-based awards (1)

   13,098    2,156     36,033     2,326  

For Sohu Video share-based awards

   (149  0     4,078     0  
  

 

 

  

 

 

   

 

 

   

 

 

 
  $14,800   $3,198    $46,606    $5,523  
  

 

 

  

 

 

   

 

 

   

 

 

 

Note (1):Includes compensation expense for Tencent restricted share units that Tencent had granted to employees who transferred to Sogou with the Soso search-related businesses, and compensation expense equal to the excess of the repurchase price paid to employees over the fair value at the repurchase date of the Sogou Class A Ordinary Shares that the Group repurchased.

There was no capitalized share-based compensation expense for the three and nine months ended September 30, 20132014 and 2012.2013.

Share-based4. Changyou Employee Incentive Plans

On February 8, 2014, Changyou’s Board of Directors approved three new employee incentive plans with terms of 10 years, effective January 1, 2014, under which Changyou may pay compensation to employees based on Changyou’s profits, or the profits of specified projects. Eligible employees will receive a cash award from the plans as a bonus based on the number of employee incentive instruments they hold in the plans.

Under two of these three plans, Changyou may pay compensation to employees based on Changyou’s profits. Changyou will distribute to eligible employees who participate in the plans up to 5% of Changyou’s annual adjusted net profits. Combined, these two plans will distribute up to 10% of Changyou’s annual adjusted net profits. Eligible employees will participate in these plans by paying an amount to purchase instruments that will entitle them, while they are employed by Changyou, to receive annual compensation under the plans. After four years of service to Changyou, employees who participate in either of these two plans will be entitled to sell their instruments to other employees at any time during their employment with Changyou at a price negotiated between the two employees, and by doing so would be compensated with the present value of their expected future cash bonuses for the remaining period of the incentive plans. Management concluded that compensation expense was recognizedassociated with these two plans should be accounted for share-based awardsby analogy to deferred compensation arrangements, and that the present value of Sohu, Changyouthe amounts forecasted to be distributed under the plans should be amortized over the first four years after the effective date of the plans, before the instruments are first allowed to be transferred to other employees; that the present value of future cash bonuses in the remaining period should be re-measured at each reporting date; that the gain or loss resulting from the re-measurement in the first four years should be amortized over the remaining portion of the four-year period; and Sogou as follows (in thousands):

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2013   2012   2013   2012 

Share-based compensation expense

        

For Sohu share-based awards

  $730    $1,440    $2,313    $4,621  

For Changyou share-based awards

   312     750     884     2,769  

For Sogou share-based awards

   2,156     1,653     2,326     2,812  
  

 

 

   

 

 

   

 

 

   

 

 

 
  $3,198    $3,843    $5,523    $10,202  
  

 

 

   

 

 

   

 

 

   

 

 

 

There was no share-basedthat the gain or loss after the four-year period should be booked immediately upon re-measurement at each reporting date after the four-year period. For the three and nine months ended September 30, 2014, compensation expense recognized for the share-based awards of Sohu Videothese two plans was $1.5 million and 7Road for any$4.3 million, respectively.

The third employee incentive plan is structured to allow eligible employees to receive up to 20% of the periods presentedannual adjusted net profits of projects that they work on. Unlike under the first two plans, certain of the incentive instruments to be issued under this plan will permit participating employees to sell the instruments to other employees at any time during their employment, and certain of the incentive instruments will not permit participating employees to sell their instruments to other employees. Management concluded that compensation expense in the above table.former case should be accounted for by analogy to deferred compensation arrangements, and accordingly should be accrued as of the effective date of the plan at the then present value of the amounts forecasted to be distributed under the plan; that the gain or loss resulting from the re-measurement of the cash bonus in the remaining period of the plan should be booked immediately upon re-measurement; and that compensation expense in the latter case should be recognized when the amount of relevant distributions under these plans is determined and Changyou’s obligations are established each year. For the three and nine months ended September 30, 2014, compensation expense recognized for this plan was $1.2 million and $27.9 million, respectively.

4.

-18-


5. Fair Value Measurements

Fair Value of Financial Instruments

The Sohu Group’s financial instruments include cash equivalents, restricted time deposits, short-term investments, investments in debt securities, accounts receivable, prepaid and other current assets, prepaid non-current assets, accounts payable, accrued liabilities, receipts in advance and deferred revenue, short-term bank loans, other short-term liabilities, long-term accounts payable and long-term bank loans, as well as the repurchase options and the repurchase/put option with respect to Sogou Series A Preferred Shares.

-18-


U.S. GAAP establishes a three-tier hierarchy to prioritize the inputs used in the valuation methodologies in measuring the fair value of financial instruments. This hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three-tier fair value hierarchy is:

Level 1 - 1—observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 - 2—include other inputs that are directly or indirectly observable in the market place.

Level 3 - 3—unobservable inputs which are supported by little or no market activity.

The following table sets forth the financial instruments, measured at fair value, by level within the fair value hierarchy as of September 30, 20132014 (in thousands):

 

      Fair value measurements at reporting date using       Fair value measurements at reporting date using 

Items

  As of
September 30,
2013
   Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
   Significant
Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   As of
September 30,
2014
   Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
   Significant
Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 

Cash equivalents

  $72,888    $0    $72,888    $0    $473,621    $0    $473,621    $0  

Restricted time deposits

   374,987     0     374,987     0     443,686     0     443,686     0  

Short-term investments

   24,369     0     24,369     0     209,508     0     209,508     0  

Investments in debt securities

   81,327     0     0     81,327  

Available-for-sale equity securities

   13,594     13,594     0     0  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total Assets

  $553,571    $0    $472,244    $81,327  

Total

  $1,140,409    $13,594    $1,126,815    $0  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Put option recognized as other short-term liability

  $6,192    $0    $0    $6,192  
  

 

   

 

   

 

   

 

 

The following table sets forth the financial instruments, measured at fair value, by level within the fair value hierarchy as of December 31, 20122013 (in thousands):

 

      Fair value measurements at reporting date using       Fair value measurements at reporting date using 

Items

  As of
December 31,
2012
   Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
   Significant
Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   As of
December 31,
2013
   Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
   Significant
Other
Observable Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 

Cash equivalents

  $291,945    $0    $291,945    $0    $359,289    $0    $359,289    $0  

Restricted time deposits

   246,839     0     246,839     0     434,048     0     434,048     0  

Short-term investments

   54,901     0     54,901     0     2,827     0     2,827     0  

Investments in debt securities

   79,548     0     0     79,548     82,009     0     0     82,009  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total

  $673,233    $0    $593,685    $79,548    $878,173    $0    $796,164    $82,009  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Put option recognized as other short-term liability

  $3,888    $0    $0    $3,888  
  

 

   

 

   

 

   

 

 

The following table sets forth the reconciliation of the fair value measurements using significant unobservable inputs (level 3) from December 31, 20122013 to September 30, 20132014 (in thousands):

 

   Fair Value Measurements Using
Significant Unobservable Inputs
(Level 3)
 
  Debt Securities   Put Option 

Beginning balance at December 31, 2012

  $79,548    $0  

Transactions:

    

Initial fair value of recognition

   0     6,048  

Fair value change

   0     144  

Currency translation adjustment

   1,779     0  
  

 

 

   

 

 

 

Ending balance at September 30, 2013

  $81,327    $6,192  
  

 

 

   

 

 

 
   Fair Value Measurements Using
Significant Unobservable Inputs

(Level 3)
 
  Investments in
Debt Securities
  Put Option 

Beginning balance at December 31, 2013

  $82,009   $3,888  

Transactions:

   

Initial recognition

   0    0  

Change in fair value

   0    (2,304

Currency translation adjustment

   (736  0  

Financial instruments matured /exercised

   (81,273  (1,584
  

 

 

  

 

 

 

Ending balance at September 30, 2014

  $0   $0  
  

 

 

  

 

 

 

 

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Cash equivalentsEquivalents

The Sohu Group’s cash equivalents mainly consist of time deposits placedand money market funds with banks with an original maturitymaturities of three months or less. The fair valuevalues of time deposits iscash equivalents are determined based on the pervasive interest rates in the market, which are also the interest rates as stated in the contracts with the banks.market. The Group classifies the valuation techniques that use the pervasive interest rates input as Level 2 of fair value measurements. Generally there are no quoted prices in active markets for identical time depositscash equivalents at the reporting date. In order to determine the fair value, the Group must use the discounted cash flow method and observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Restricted time depositsTime Deposits

Restricted time deposits are valued based on the prevailing interest rates in the market.market using the discounted cash flow method. The Sohu Group classifies the valuation techniques that use these inputs as Level 2 of fair value measurements.

Changyou loansLoans from offshore banks, securedOffshore Banks, Secured by time depositsTime Deposits

InCommencing in 2012, and 2013, Changyou drew down loans from offshore branches of certain banks for the purposes of expediting the payment of a special one-time cash dividend to its shareholders, providing working capital to support its overseas operations, and funding the acquisition of outstanding noncontrolling interests in 7Roadits acquisitions and providing capital to support its share repurchase program. These bank loans wereare secured by an equivalent or greater amount of RMB deposits by Changyou in the onshore branches of such banks. The loans from the offshore branches of the lending banks are classified as short-term bank loans or long-term bank loans based onaccording to their payment terms.

As of September 30, 2013,2014, the total amount of the bank loans was $354$370 million, all of which $252 million carried a floating rate of interest based on the London Inter-Bank Offered Rate (“LIBOR”). For the three and $102nine months ended September 30, 2014, interest income from the restricted time deposits securing the loans was $4.1 million carried a fixed rate of interest.and $12.0 million, respectively, and interest expense on the bank loans was $1.7 million and $4.6 million, respectively. For the three and nine months ended September 30, 2013, interest income from the restricted time deposits securing the loans was $2.9 million and $8.8 million, respectively, and interest expense on the bank loans was $2.3 million and $6.4 million, respectively. All of outstanding balances of the bank loans are repayable in 2014.

Collateral related to Sogou incentive shares trust arrangementsIncentive Shares Trust Arrangements

In February 2013, Sohu deposited $9 million in cash into restricted time deposit accounts at a bank as collateral for credit facilities provided by the bank to certain Sogou employees. The facilities were intended to fund the employees’ early exercise of Sogou share options and related PRC individual income tax. Sohu is not subject to any additional potential payments other than the restricted time deposit amounts, and believes that the fair value of its guarantee liability is immaterial.

Short-term investmentsInvestments

In accordance withASC 825, for investments in financial instruments with a variable interest rate indexed to performance of underlying assets, the Sohu Group elected the fair value method at the date of initial recognition and carried these investments at fair value. Changes in the fair value are reflected in the consolidated statements of comprehensive income as other income /(expense). To estimate fair value, the Group refers to the quoted rate of return provided by banks at the end of each period using the discounted cash flow method. The Group classifies the valuation techniques that use these inputs as Level 2 of fair value measurements.

As of September 30, 2013,2014, the Sohu Group’s investmentsinvestment in financial instruments were mainly held by 7Road and totaled approximately $24.4was $210 million. The investments areinvestment instruments were issued by commercial banks in China, withand have a variable interest rate indexed to performance of underlying assets. Since these investments’ maturity dates are within one year, they are classified as short-term investments. For the three and nine months ended September 30, 2014, the Sohu Group recorded in the consolidated statements of comprehensive income changes in the fair value of short-term investments in the amount of both $0.4 million. For the three and nine months ended September 30, 2013, the Group recorded in the consolidated statements of comprehensive income changechanges in the fair value of short-term investments in the amount of $0.8 million and $2.3 million, respectively. For

Available-for-Sale Equity Securities

Available-for-sale equity securities are valued using the threemarket approach based on the quoted prices in active markets at the reporting date. The Group classifies the valuation techniques that use these inputs as Level 1 of fair value measurements. On August 12, 2014, Sohu acquired approximately 6% of the total outstanding common shares of Keyeast Co., Ltd., a Korean-listed company, for a purchase price of $14.9 million. The Sohu Group classified this investment as available-for-sale equity securities under long-term investments, and nine months endedreported it at fair value. As of September 30, 2012, the Group recorded in the consolidated statements of comprehensive income change in2014, the fair value of short-term investmentsthe available-for-sale equity securities was $13.6 million. The unrealized loss representing the change in fair value of $1.3 million was recorded as a deduction from accumulated other comprehensive income in the amount of $0.4 million and $1.0 million, respectively.Sohu Group’s consolidated balance sheets.

 

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Investments in debt securitiesDebt Securities

In September 2010, Sohu purchased from a PRC-based company (the “Debtor”) a convertible debt security in the principal amount of $74.6 million (or RMB0.5 billion) with interest, payable quarterly in cash, of 3.8% per annum and an initial maturity of twelve months, subject to extension in Sohu’s sole discretion for additional sequential six-month periods. The Debtor’s obligations on the debt arewere secured by a pledge from the Debtor’s parent company of its entire equity interest in the Debtor. In September 2011, March 2012, September 2012, March 2013 and September 2013, SohuThe Company extended the maturity of the security, for sequential six-month periods, to March 2012, September 2012, March 2013, September 2013 and March 2014, respectively, withat an interest rate of 6.8% per annum.annum, for successive six-month periods through March 2014. Under the terms of the security, if Sohu continues to extend the maturity of the security to March 31, 2014, it will haveCompany had the option, exercisable on March 31, 2014, to convert the outstanding principal into fixed percentages of equity interests in two companies which are affiliates of the Debtor. On March 31, 2014, the Company neither extended the debt security nor exercised the option, and accordingly the $81.3 million (or RMB0.5 billion) principal amount of the security was repaid to the Company on that date.

For the three and nine months ended September 30, 2014, interest income generated from this debt security amounted to nil and $1.37 million, respectively. For the three and nine months ended September 30, 2013, interest income generated from this debt security amounted to $1.40 million and $4.14 million, respectively. For the three and nine months ended September 30, 2012, interest income generated from this debt security amounted to $1.37 million and $4.10 million, respectively.

The Sohu Group elected the fair value option to account for its investments in debt securities at their initial recognition. Changes in fair value were recognized in other income /(expense). For the three and nine months ended September 30, 20132014 and 2012,2013, there was no change in fair value. To estimate fair value, the Group used the income approach, which considers the estimated future return from the investment and the probabilities of getting these returns. The Group classifies the valuation techniques that use these inputs as Level 3 of fair value measurements.

Repurchase Options and Repurchase/Put Option for Sogou Series A Preferred Shares

As discussed in Note 1 - 1—The Company and Basis of Presentation, in September 2013, Sogou entered into Repurchase Option Agreements with Sohu Search and Photon, and a Repurchase/Put Option Agreement with China Web, with respect to Series A Preferred Shares of Sogou held by them. On March 24, 2014, Sogou expectspurchased from China Web, pursuant to exercise its rights to purchasethe Repurchase/Put Option Agreement between Sogou and China Web, 14.4 million Series A Preferred Shares under each of these agreements when they first become exercisable by Sogou, on March 16, 2014.for an aggregate purchase price of $47.3 million.

TheSogou’s repurchase options with Photon and the repurchase/put option for Sogou Series A Preferred SharesChina Web were initially recognized in additional paid-in capital in the Sohu Group’s consolidated balance sheets at fair value when the agreements were signed. The fair value of the put option will be revaluated quarterly until the option is exercised or expires unexercised. SubsequentAny subsequent changes in the fair values of the equity classified repurchase options were not and will not be recognized. On March 24, 2014, the repurchase option with China Web was exercised by Sogou. As of September 30, 2014, the remaining balance for the repurchase option with Photon in additional paid-in capital was $1.2 million, based on the fair value of the repurchase option on September 16, 2013.

China Web’s put option with Sogou was initially recognized untilin other short-term liabilities in the options are exercised. Sohu Group’s consolidated balance sheets at fair value when the agreement was signed. Subsequent changes in the fair value of the put option were recognized quarterly in other income /(expense) in the Sohu Group’s consolidated statements of comprehensive income. After Sogou’s repurchase of the Series A Preferred Shares from China Web on March 24, 2014, the other short-term liabilities recognized with respect to China Web were reversed to zero.

Management determined the fair values of thesethe repurchase options determinedwith Photon and China Web when the agreements were signed, and of the put option with China Web before Sogou exercised the repurchase option, using the binominal model, with a discount for lack of marketability, given that the repurchase options and the repurchase/put option were not publicly traded at the time of grant, andgrant. Management made the determination with the assistance of a qualified professional appraiser using management’s estimates and assumptions. We classifyThe Sohu Group classifies the valuation techniques that use these inputs as Level 3 of fair value measurements.

As of September 30, 2013, the Sohu Group recognized $6.2 million for the put option in other short-term liabilities. Any changes in the fair value of the put option were recognized in other income /(expense). For the three months ended September 30, 2013, fair value change of $144,000 for the put option was recognized in other expense in the consolidated statement of comprehensive income. As of September 30, 2013, the Sohu Group also recognized $3.7 million for the repurchase options in additional paid-in capital in equity, based on the fair value of the repurchase options on September 16, 2013.

Other financial instrumentsFinancial Instruments

The following are other financial instruments not measured at fair value in the consolidated balance sheets, but for which the fair value was estimated for disclosure purposes.

Short-term receivablesReceivables and payablesPayables

Accounts receivable and prepaid and other current assets are financial assets with carrying values that approximate fair value due to their short termshort-term nature. Short-term accounts payable, accrued liabilities, receipts in advance and deferred revenue, short-term bank loans and other short-term liabilities are financial liabilities with carrying values that approximate fair value due to their short term nature.

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For short-term bank loans, the rates of interest under the agreements with the lending banks were determined based on the prevailing interest rates in the market. The Sohu Group classifies the valuation techniques that use these inputs as Level 2 of fair value measurements. For other short-term receivables and payables, the Group estimated fair values using the discounted cash flow method, which is unobservable in the market. The Group classifies the valuation technique as Level 3 of fair value measurements.

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Prepaid non-current assetsNon-current Assets and long-term payablesLong-term Payables

Prepaid non-current assets are financial assets with carrying values that approximate fair value because the impact of applying a discount rate to the carrying values would be immaterial. Long-term accounts payable and long-term bank loans are financial liabilities with carrying values that approximate fair value due to the changeany changes in fair value, after considering the discount rate, being immaterial.

For long-term bank loans, the rates of interest under Changyou’s agreements with lending banks were determined based on the prevailing interest rates in the market. The Sohu Group classifies the valuation techniques that use these inputs as Level 2 of fair value measurements. For prepaid non-current assets and long-term accounts payable, the Group estimated fair values using the discounted cash flow method, which is unobservable in the market. The Sohu Group classifies the valuation technique as Level 3 of fair value measurements.

5. Fixed Assets

In May 2013, the office building Sohu purchased in 2009 was placed in service. Accordingly, in the same month, the Sohu Group recognized the office building’s original cost of $162 million as fixed assets. The original cost consists primarily of the purchase price and the costs of technological infrastructure and fitting-out work. Also in May 2013, the Group began recognizing depreciation expense based on the building’s useful life, which is approximately 41 years, on a straight-line basis.

For Changyou’s office building purchased in 2010, as of September 30, 2013, all of the $164 million purchase price had been paid and recognized as construction-in-process under fixed assets in the Sohu Group’s consolidated balance sheets, as the construction of the building had been completed and the technological infrastructure and fitting-out work was still in progress.

6. Goodwill

The changes in the carrying value of goodwill by segment are as follows (in thousands):

 

  Brand
Advertising
 Mobile Sogou   Changyou Total   Brand Advertising
and others
 Sogou Changyou Total 

Balance as of December 31, 2012

       

Balance as of December 31, 2013

     

Goodwill

  $42,093   $15,942   $2,047    $140,122   $200,204    $58,042   $6,290   $185,452   $249,784  

Accumulated impairment losses

   (19,846 (15,942 0     (5,201 (40,989   (35,788 0   (5,201 (40,989
  

 

  

 

  

 

   

 

  

 

   

 

  

 

  

 

  

 

 
  $22,247   $0   $2,047    $134,921   $159,215    $22,254   $6,290   $180,251   $208,795  
  

 

  

 

  

 

   

 

  

 

 

Transactions in 2013

       

Acquisition of Soso search-related businesses from Tencent

   0    0    2,405     0    2,405  

Transactions in 2014

     

Acquisition of MoboTap

   0    0    113,040    113,040  

Measurement period adjustment of goodwill for the acquisition of Soso search-related businesses from Tencent

   0    42    0    42  

Foreign currency translation adjustment

   6    0    48     2,787    2,841     (2  (58  (1,231  (1,291
  

 

  

 

  

 

   

 

  

 

   

 

  

 

  

 

  

 

 

Balance as of September 30, 2013

  $22,253   $0   $4,500    $137,708   $164,461  

Balance as of September 30, 2014

  $22,252   $6,274   $292,060   $320,586  
  

 

  

 

  

 

   

 

  

 

   

 

  

 

  

 

  

 

 

Balance as of September 30, 2013

       

Balance as of September 30, 2014

     

Goodwill

  $42,099   $15,942   $4,500    $142,909   $205,450    $58,040   $6,274   $297,261   $361,575  

Accumulated impairment losses

   (19,846  (15,942  0     (5,201  (40,989   (35,788  0    (5,201  (40,989
  

 

  

 

  

 

   

 

  

 

   

 

  

 

  

 

  

 

 
  $22,253   $0   $4,500    $137,708   $164,461    $22,252   $6,274   $292,060   $320,586  
  

 

  

 

  

 

   

 

  

 

 

7. Taxation

Sohu.com Inc. and Changyou.com (US) Inc. areis subject to income taxes in the United States (“U.S.”). income tax, and Changyou’s income that is from a U.S. source is generally subject to U.S. income tax. The majority of the subsidiaries and VIEs of the Sohu Group are based in mainland China and are subject to income taxes in the PRC. These China-based subsidiaries and VIEs conduct substantially all of the Sohu Group’s operations, and generate most of the Sohu Group’s income.income or losses.

The Sohu Group did not have any penalties or significant interest associated with tax positions for the three and nine months ended September 30, 2013,2014, nor did the Group have any significant unrecognized uncertain tax positions for the three and nine months ended September 30, 2013.2014.

PRC Corporate Income Tax

Related to High and New Technology Enterprises

The PRC Corporate Income Tax Law (the “CIT Law”) applies an income tax rate of 25% to all enterprises but grants preferential tax treatment to High and New Technology Enterprises (“NHTEs”HNTEs”). Under this preferential tax treatment, NHTEsHNTEs can enjoy a preferentialan income tax rate of 15% for three years, but need to re-apply after the end of the three-year period. The CIT Law went into effect on January 1, 2008.

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Within the Sohu Group, five enterprises, consisting of Beijing Sohu New Era Information Technology Co., Ltd. (“Sohu Era”), Beijing Sohu New Media Information Technology Co., Ltd. (“Sohu Media”), Beijing Sogou Technology Development Co., Ltd. (“Sogou Technology”), Changyou’s China-based subsidiary Beijing AmazGame Age Internet Technology Co., Ltd. (“AmazGame”) and Changyou’s China-based VIE Beijing Gamease Age Digital Technology Co., Ltd. (“Gamease”), qualified as NHTEs in 2008 and qualified upon re-application in 2011. Therefore, for these enterprises the income tax rate is 15% for 2013. These enterprises will need to re-apply for NHTE status in 2014.

Two additional enterprises, Beijing Sohu Internet Information Service Co., Ltd. (“Sohu Internet”) and Beijing Sogou Information Service Co., Ltd. (“Sogou Information”), qualified as NHTEs in 2009 and qualified upon re-application in 2012. Therefore, for these enterprises the income tax rate is 15% for 2013 and 2014. These enterprises will need to re-apply for NHTE status in 2015.

Related to Software Enterprises

UnderIn addition, the CIT Law and its implementing regulations provide that a Software Enterprise“Software Enterprise” can enjoy an income tax exemption for two years beginning with its first profitable year and a 50% tax reduction to a rate of 12.5% for the subsequent three years. An entity that qualifies as a “Key National Software Enterprise” can enjoy a further reduced preferential income tax rate of 10% for two years, but needs to re-apply after the end of the two-year period.

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Entities Qualified as HNTEs

As of September 30, 2013, 2014, the following entities were qualified as HNTEs and were entitled to an income tax rate of 15%, except that Beijing AmazGame Age Internet Technology Co., Ltd. (“AmazGame”) was entitled to an income tax rate of 10% because it was also qualified as a Key National Software Enterprise and was in an initial preferential period.

Corporate

Beijing Sohu Internet Information Service Co., Ltd. (“Sohu Internet”). Sohu Internet will need to re-apply for HNTE qualification in 2015.

For the Online Advertising Business

Brand Advertising Business

Beijing Sohu New Media Information Technology Co., Ltd. (“Sohu Media”). Sohu Media re-applied for HNTE qualification in the third quarter of 2014 and got approval in October, it is entitled to continue to enjoy the beneficial tax rate as HNTE for the year of 2014.

Search and Others Business

Beijing Sogou Technology Development Co., Ltd. (“Sogou Technology”). Sogou Technology re-applied for HNTE qualification in the third quarter of 2014 and got approval in October, it is entitled to continue to enjoy the beneficial tax rate as HNTE for the year of 2014.

Sogou Information. Sogou Information will need to re-apply for HNTE qualification in 2015.

For the Online Game Business

AmazGame. AmazGame re-applied for HNTE qualification in the third quarter of 2014. Pending approval of the re-application, it will be entitled to continue to enjoy the beneficial tax rate as if it had already qualified as HNTE for 2014.

Beijing Gamease Age Digital Technology Co., Ltd. (“Gamease”). Gamease re-applied for HNTE qualification in the third quarter of 2014. Pending approval of the re-application, it will be entitled to continue to enjoy the beneficial tax rate as if it had already qualified as HNTE for 2014.

Shenzhen 7Road Technology Co., LtdLtd. (“Shenzhen 7Road”). Shenzhen 7Road re-applied for HNTE qualification in the third quarter of 2014 and got approval in October, it is entitled to continue to enjoy the beneficial tax rate as HNTE for the year of 2014.

For the Others Business

Beijing Sohu New Era Information Technology Co., Ltd. (“Sohu Era”). Sohu Era re-applied for HNTE qualification in the third quarter of 2014. Pending approval of the re-application, it will be entitled to continue to enjoy the beneficial tax rate as if it had already qualified as HNTE for 2014.

Entities Qualified as Software Enterprises

For the Online Advertising Business—Brand Advertising Business

Beijing Sohu New Momentum Information Technology Co., Ltd. (“Sohu New Momentum”), which was in its first income tax exemption year as a Software Enterprise.

For the Online Game Business

AmazGame, which was qualified as a “Key National Software Enterprise” and enjoyed a preferential income tax rate of 10%. AmazGame will need to re-apply for Key National Software Enterprise qualification in 2015.

Shenzhen 7Road, which was also qualified as an HNTE and was entitled to an income tax rate of 15% since it had passed the three-year preferential period as a Software Enterprise.

Beijing Changyou Gamespace Software Technology Co., Ltd. (“Gamespace”), which was entitled to an income tax rate of 12.5%.

ICE Information Technology (Shanghai) Co., Ltd. (“ICE Information”), which was not subject to income tax, as it incurred losses.

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Shanghai ICE Information Technology Co., Ltd. (“Shanghai ICE”) and , which was entitled to an income tax rate of 12.5%.

Shenzhen 7Road Network Technologies Co., Ltd. (“7Road Technology”) were “Software Enterprises” entitled to the beneficial, which was in its second income tax treatment described above.

exemption year as a Software Enterprise.

PRC Withholding Tax on Dividends

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 arrangement 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 Betweenan arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance“Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital (the “China-HK Tax Arrangement”)Capital” 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 maywill remain subject to a withholding tax rate of 10%.

In order to fund the distribution of a dividend to shareholders of Sohu’s majority-owned subsidiary Changyou, Changyou’s Board of Directors determined to cause one of its PRC subsidiaries to declare and distribute a cash dividend of all of its 2012 stand alone earnings and half of its 2013 and 2014 stand alone earnings to its direct overseas parent company, Changyou HK. With the exception of that dividend, the Sohu Group does not intend to have any of its PRC subsidiaries distribute any undistributed profits of such subsidiaries to their direct overseas parent companies, but rather intends that such profits will be permanently reinvested by such subsidiaries for their PRC operations.

As of September 30, 2013,2014, Changyou had accrued deferred tax liabilities in the amount of $16.8$21.5 million for PRC withholding tax.

Transition from PRC BusinessValue-Added Tax to PRC Value Addedand Business Tax

Effective September 1, 2012, a Pilot Programpilot program (the “Pilot Program”) for transition from the imposition of PRC business tax (“Business Tax”) to the imposition of value addedvalue-added tax (“VAT”) for revenues from certain industries was expanded from Shanghai to eight other cities and provinces in China, including Beijing and Tianjin. Commencing August 1, 2013 the Pilot Program was expanded to all regions in the PRC. TheAll the Sohu Group’s brand advertising and search revenues areas well as certain online game revenues were 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, the Sohu Group’s Business Tax rate, which varies depending on the nature of the revenues being taxed, generally ranged from 3% to 5%.Program.

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 balance of VAT input. Before the implementation of the Pilot Program, the Sohu Group was 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, the Group’s brand advertising and search revenues are in the scope of the Pilot Program and are now subject to VAT at a rate of 6%.

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UnderASC 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’sas well as online game revenues from the sale of software are considered as substantially differentChangyou’s Web game operations that were not developed in nature, the Sohu Group 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 revenueshouse 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. Other online game revenues were not affected by the Pilot Program. Before and after the Pilot Program, revenues from MMOG operations are subject to a component5% Business Tax, and revenues of 7Road that deemed to be derived from the Group’s costs for providing the brand advertising and search services. On the other hand, thesale of software are subject to VAT. VAT payable by 7Road is in effect at 3%a rate of the applicable revenues from the sale of software,17%, with a 14% immediate tax refund irrespective of the availability of any input VAT, under preferential VAT treatment provided to 7Road by the local tax bureau. In this regard, the Group believes the VAT payable by 7Road is more akin toresulting in a sales tax than typical VAT. As a result, thenet rate of 3%.

The Group adopted the net presentation method for its brand advertising and search businesses both before and after the implementation of the Pilot Program, andProgram. The Group adopted the gross presentation method for the revenues of 7Road deemed to be derived from the sale of software the Group adopted the gross presentation methodboth before and after the implementation of the Pilot Program.

U.S. Corporate Income Tax

Sohu.com Inc. is a Delaware corporation that is subject to U.S. corporate income tax on its taxable income at a rate of 34% or 35%. Subject to certain limitations, the net operating losses (“NOLs”) of a corporation taxable in the U.S. that are carried forward from prior years may be used to offset the corporation’s taxable income. At the end of the 2012 taxable year, Sohu.com Inc. had no further NOLs available for offsetting any U.S. taxable income. Accordingly, toTo the extent that it has U.S. taxable income, in 2013, the Sohu Group will accrueaccrues U.S. corporate income tax in its consolidated statements of comprehensive income and makemakes estimated tax payments as and when required by U.S. law.

Other Provisions for TaxesUncertain Tax Positions

As described above,In order to assess uncertain tax positions, the Sohu Group applies 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 subject to various taxes in different jurisdictions, primarilyevaluate the US andtax position for recognition by determining if the PRC. Management reviews regularly the adequacyweight of the provisions for taxes as they relate to the income and transactions of the Group. In reviewing various equity transactions among companies in the Group, management determinedavailable evidence indicates that it is more likely than not that the transactions may result in additionalposition will be sustained, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax obligations under relevant tax rules. As a result of certain equity transactionsbenefit as the largest amount that took place during the quarter ended September 30, 2013, the Group has recognized directlyis more than 50% likely to equity a provision for tax in the amount of $21.4 million as of September 30, 2013.be realized upon settlement.

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8. Commitments and Contingencies

Unconditional Obligations

As of September 30, 2013,2014, the Sohu Group had commitments for bandwidth purchases in the amount of $44 million, commitments for operating leases in the amount of $28$62.9 million, commitments for video content purchases in the amount of $22$52.0 million, commitments for purchases of games developed by third-parties in the amount of $43.7 million, commitments for purchases of cinema advertisement slot rights in the amount of $40.1 million, commitments for operating leases in the amount of $39.7 million, and commitments for other content and service purchases in the amount of $16$22.9 million.

Litigation

The Sohu Group is a party to various litigation matters which it considers routine and incidental to its business. Management does not expect the results of any of these actions to have a material adverse effect on the Group’s business, results of operations, financial condition and cash flows.

In the first quarter of 2013, the Sohu Group settled lawsuits with four major record companies (Sony BMG, Warner, Universal and Gold Label) without any payment of damages. In these lawsuits, which were initiated against the Sohu Group in March 2008, these record companies had alleged that the Sohu Group provided music search links and download services that violated copyrights they owned.

PRC Law and Regulations

The Chinese market in which the Sohu Group operates poses certain macro-economic and regulatory risks and uncertainties. These uncertainties extend to the ability to operate an Internet business and to conduct brand advertising, search and others, online game, mobile and others services in the PRC. Though the PRC has, since 1978, implemented a wide range of market-oriented economic reforms, continued reforms and progress towards a full market-oriented economy are uncertain. In addition, the telecommunication, information, and media industries remain highly regulated. Restrictions are currently in place and are unclear with respect to which segments of these industries foreign-owned entities, like the Sohu Group, may operate. The Chinese government may issue from time to time new laws or new interpretations of existing laws to regulate areas such as telecommunication, information and media. Certain risks related to PRC law that could affect the Sohu Group’s VIE structure are discussed in Note 910 - VIEs.VIE.

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Regulatory risks also encompass interpretation by PRC tax authorities of current tax law, including the applicability of certain preferential tax treatments. The Sohu Group’s legal structure and scope of operations in China could be subject to restrictions, which could result in limits on its ability to conduct business in the PRC.

The Sohu Group’s sales, purchase and expense transactions are generally denominated in RMB and a significant portion of its assets and liabilities are denominated in RMB. The RMB is not freely convertible into foreign currencies. In China, foreign exchange transactions are required by law to be transacted only by authorized financial institutions. Remittances in currencies other than RMB by its subsidiaries in China may require certain supporting documentation in order to effect the remittance.

9. VIEsContingent Consideration

Contingent consideration consists of the fair value of potential payments related to two acquisitions made by Changyou.

Changyou’s acquisition of Beijing Doyo Internet Technology Co., Ltd. (“Doyo”), included a contingent consideration arrangement that requires additional consideration to be paid by Changyou based on the achievement of specified performance milestones by Doyo for the fiscal years 2013 through 2015. The range of the undiscounted amounts Changyou could pay under the contingent consideration agreement is between nil and $7.3 million. The fair value of the contingent consideration, in the amount of $4.8 million, was recognized on the acquisition date using the income approach /discounted cash flow method with a scenario analysis applied. There were no indemnification assets involved.

Changyou’s acquisition of the RaidCall business, included a contingent consideration arrangement that gives Changyou the right to acquire additional shares of TalkTalk Limited (“TalkTalk”) at no cost if specified conditions occur through the 2014 fiscal year. The range of the additional shares of TalkTalk that Changyou could acquire under the contingent consideration arrangement is between nil and 7.5% of the outstanding shares of TalkTalk on a post-issuance fully-diluted basis. The fair value of the contingent consideration recognized on the acquisition date was nil, as management determined that it is unlikely that the specified conditions will occur and that as a result the fair value and the financial impact on recognition of the noncontrolling interest was zero.

For the three and nine months ended September 30, 2014, based on management’s assessment, there were no changes in the estimated fair values of these contingent consideration arrangements.

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10. VIE

Background

PRC laws and regulations prohibit or restrict foreign ownership of companies that operate Internet information and content, Internet access, online games, mobile, value added telecommunications and certain other businesses in which the Sohu Group is engaged or could be deemed to be engaged. Consequently, the Sohu Group conducts certain of its operations and businesses in the PRC through its VIEs.

The Sohu Group consolidates in its consolidated financial statements all of the VIEs of which the Group is the primary beneficiary. The Sohu Group has one VIEthree VIEs that isare not consolidated in the Group’s consolidated financial statements because the Group is not the primary beneficiary.

VIEs Consolidated within the Sohu Group

The Sohu Group adopted the guidance of accounting for VIEs, which requires VIEs to be consolidated by the primary beneficiary of the entity. Management made evaluations of the relationships between the Sohu Group 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 contractual arrangements with its consolidated VIEs, the Sohu Group controls the shareholders’ voting interests in those VIEs. As a result of such evaluation, the management concluded that the Sohu Group is the primary beneficiary of the VIEs which the Group consolidates.

All of the consolidated VIEs are incorporated and operated in the PRC, and are directly or indirectly owned by Dr. Charles Zhang, Sohu’sthe Sohu Group’s Chairman and Chief Executive Officer, or other executive officers and employees of the Sohu Group identified below. Capital for the consolidated VIEs was funded by the Sohu Group through loans provided to Dr. Charles Zhang and those other executive officers and employees, and was initially recorded as loans to related parties. These loans are eliminated for accounting purposes against the capital of the VIEs upon consolidation.

Under contractual agreements with the Sohu Group, Dr. Charles Zhang and those other executive officers and employees of the Sohu Group who are shareholders of the consolidated VIEs are required to transfer their ownership in these entities to the Group, if permitted by PRC laws and regulations, or, if not so permitted, to designees of the Group at any time as requested by the Group to repay the loans outstanding. All voting rights of the consolidated VIEs are assigned to the Sohu Group, and the Group has the right to designate all directors and senior management personnel of the consolidated VIEs, and also has the obligation to absorb losses of the consolidated VIEs. Dr. Charles Zhang and those other executive officers and employees of the Sohu Group who are shareholders of the consolidated VIEs have pledged their shares in the consolidated VIEs as collateral for the loans. As of September 30, 2013,2014, the aggregate amount of these loans was $18.6$14.9 million.

Under its contractual arrangements with the consolidated VIEs, the Sohu Group has the power to direct activities of the VIEs, and can have assets transferred freely out of the VIEs without any restrictions. Therefore, the Group considers that there is no asset of a consolidated VIE that can be used only to settle obligations of the VIEs, except for registered capital and PRC statutory reserves of the VIEs. As of September 30, 2013,2014, the registered capital and PRC statutory reserves of the consolidated VIEs totaled $34.8$84.0 million. As all of the consolidated VIEs are incorporated as limited liability companies under the PRC Company Law, creditors of the consolidated VIEs do not have recourse to the general credit of the Sohu Group for any of the liabilities of the consolidated VIEs. Currently there is no contractual arrangement that could require the Sohu Group to provide additional financial support to the consolidated VIEs. As the Sohu Group is conducting certain business in the PRC mainly through the consolidated VIEs, the Group may provide such support on a discretionary basis in the future, which could expose the Group to a loss.

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The following is a summary of the consolidated VIEs within the Sohu Group:

Basic Information

Corporate

High Century

Beijing Century High Tech Investment Co., Ltd. (“High Century”) is a holding company which was incorporated in 2001. As of September 30, 2013,2014, the registered capital of High Century was $4.6 million and Dr. Charles Zhang and Wei Li held 80% and 20% interests, respectively, in this entity.

Sohu EntertainmentHeng Da Yi Tong

Beijing Heng Da Yi Tong Information Technology Co., Ltd. (“Heng Da Yi Tong”), formally known as “Beijing Sohu Entertainment Culture Media Co., Ltd. (“Sohu Entertainment”), was incorporated in 2002. As of September 30, 2013,2014, the registered capital of Sohu EntertainmentHeng Da Yi Tong was $1.2 million and Xin Wang (Belinda Wang), Sohu’s Co-PresidentDr. Charles Zhang and Chief Operating Officer, and Ye Deng, a Vice President of Sohu,Wei Li held 80% and 20% interests, respectively, in this entity.

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Sohu Internet

Sohu Internet was incorporated in 2003 and is engaged in the provision of mobile services.2003. As of September 30, 2013,2014, the registered capital of Sohu Internet was $1.6 million and High Century and Sohu EntertainmentHeng Da Yi Tong held 75% and 25% interests, respectively, in this entity.

SohuPay

SohuPay Science and Technology Co., Ltd. (“SohuPay”) was incorporated in January 2014. As of September 30, 2014, the registered capital of SohuPay was $16.4 million and Sohu Internet held 100% of the equity interests in this entity.

For the Online Advertising Business

Brand Advertising Business

Donglin

Beijing Sohu Donglin Advertising Co., Ltd. (“Donglin”) was incorporated in 2010 and is engaged in advertising services.2010. As of September 30, 2013,2014, the registered capital of Donglin was $1.5 million and High Century and Sohu Internet each held a 50% interest in this entity.

Pilot New Era

Beijing Pilot New Era Advertising Co., Ltd. (“Pilot New Era”) was incorporated in 2010 and is engaged in advertising services.2010. As of September 30, 2013,2014, the registered capital of Pilot New Era was $0.7 million and High Century and Sohu Internet each held a 50% interest in this entity.

Focus Yiju

Beijing Focus Yiju Network Information Technology Co., Ltd. (“Focus Yiju”) was acquired in 2011 and is engaged in advertising services.2011. As of September 30, 2013,2014, the registered capital of Focus Yiju was $1.6 million and High Century held a 100% interest in this entity.

Zhi Hui You

Beijing Zhi Hui You Information Technology Co., Ltd. (“Zhi Hui You”) was incorporated in 2011 as “Beijing 17173 Network Technology Co., Ltd.” and was renamed on December 14, 2012. Zhi Hui You is engaged in technology development and advertising services. As of September 30, 2013, the registered capital of Zhi Hui You was $1.6 million and Jing Zhou and a third party entity each held a 50% interestequity interests in this entity.

Tianjin Jinhu

Tianjin Jinhu Culture Development Co., Ltd. (“Tianjin Jinhu”) was incorporated in 2011 and is engaged in advertising services.2011. As of September 30, 2013,2014, the registered capital of Tianjin Jinhu was $0.5 million and Ye Deng and Chun LiuXuemei Zhang each held a 50% interest in this entity.

Focus Interactive

Beijing Focus Interactive Information Service Co., Ltd. (“Focus Interactive”) was incorporated in July 2014. As of September 30, 2014, the registered capital of Focus Interactive was $1.6 million and High Century held 100% of the equity interests in this entity.

Focus Technology

Beijing Focus Xin Gan Xian Information Technology Co., Ltd. (“Focus Technology”) was incorporated in August 2014. As of September 30, 2014, the registered capital of Focus Technology was $0.8 million and Focus Interactive held 100% of the equity interests in this entity.

Focus Real Estate

Beijing Focus Real Estate Agency Co., Ltd. (“Focus Real Estate”) was incorporated in August 2014. As of September 30, 2014, the registered capital of Focus Real Estate was $0.2 million and Focus Interactive held 100% of the equity interests in this entity.

Search and Others Business

Sogou Information

Sogou Information was incorporated in 2005. As of September 30, 2013,2014, the registered capital of Sogou Information was $2.5 million and Xiaochuan Wang, Sogou’s Chief Executive Officer, of Sogou,High Century and Xianxian Hao eachTencent held a 50% interest10%, 45% and 45% interests, respectively, in this entity.

 

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Shi Ji Guang Su

Shenzhen Shi Ji Guang Su Information Technology Co., Ltd. (“Shi Ji Guang Su”), which is engaged in Soso search-related businesses, was acquired in September 2013 as part of the Sogou-Tencent Transactions.2013. As of September 30, 2013,2014, the registered capital of Shi Ji Guang Su was $3.2 million and Sogou Information held a 100% interestof the equity interests in this entity.

For the Online Game Business

Gamease

Gamease was incorporated in 2007. As of September 30, 2013,2014, the registered capital of Gamease was $1.3 million and Tao Wang, Chief Executive Officer of Changyou, and Dewen Chen, President of Changyou, held 60% and 40% interests, respectively, in this entity.

Shanghai ICE

Shanghai ICE was acquired by Changyou in 2010. As of September 30, 2013,2014, the registered capital of Shanghai ICE was $1.2 million and Runa Pi and Rong Qi each held a 50% interest in this entity.

Guanyou Gamespace

Guanyou Gamespace was incorporated in 2010. As of September 30, 2013,2014, the registered capital of Guanyou Gamespace was $1.5 million and Tao Wang and Dewen Chen held 60% and 40% interests, respectively, in this entity.

Zhi Hui You

Beijing Zhi Hui You Information Technology Co., Ltd. (“Zhi Hui You”) was incorporated in 2011. Initially Jing Zhou, who is a Sohu employee, and a third party entity each held 50% of the equity interests in this entity. In the first quarter of 2014, Jing Zhou and the third party entity transferred all of their equity interests in Zhi Hui You to Changyou’s VIE Guanyou Gamespace. As of September 30, 2014, the registered capital of Zhi Hui You was $1.6 million and Guanyou Gamespace held 100% of the equity interests in this entity.

Shenzhen 7Road

68.258% of Shenzhen 7Road was acquired by Gamease in 2011. In the second quarter of 2012, in connection with a reorganization of Shenzhen 7Road to create a Cayman Islands holding company structure, Shenzhen 7Road became a VIE of 7Road, which is a Cayman Islands company of which approximately 71.926% was owned by Changyou. Shenzhen 7Road is controlled by Changyou, and Changyou is a primary beneficiary of Shenzhen 7Road, as a result of contractual arrangements among Shenzhen 7Road, 7Road Technology, which is a PRC-based indirect wholly-owned subsidiary of 7Road, and the shareholders of Shenzhen 7Road. On May 1, 2013, Gamease entered into an agreement to acquire all of the equity interests of Shenzhen 7Road heldwere acquired by the noncontrolling shareholders, representingGamease in 2011. The remaining 31.742% of the equity interests of Shenzhen 7Road. After closing7Road were acquired by Gamease on May 1, 2013. As of September 30, 2014, the acquisitionregistered capital of noncontrolling interests on June 5, 2013, ChangyouShenzhen 7Road was $1.5 million and Gamease held 100% of the outstanding shareequity interests in this entity.

Doyo

Doyo was acquired by Guanyou Gamespace in November 2013. As of September 30, 2014, the registered capital of 7RoadDoyo was $1.6 million and Guanyou Gamespace held 100% of the equity interests in this entity.

Changyou e-pay

Beijing Changyou e-pay Co., Ltd. (“Changyou e-pay”) was incorporated in 2013. As of September 30, 2014, the registered capital of Changyou e-pay was $16.4 million and Gamease held 100% of the equity interests in this entity.

Aishouxin

Beijing Changyou Aishouxin ecological technology Co., Ltd. (“Aishouxin”) was incorporated in May 2014. As of Shenzhen 7Road.September 30, 2014, the registered capital of Aishouxin was $2.4 million and Gamease held 100% of the equity interests in this entity.

Changyou Heguang

Fujian Changyou Heguang Electronic Technology Co., Ltd. (“Changyou Heguang”) was incorporated in September 2014. As of September 30, 2014, the registered capital of Changyou Heguang was $3.3 million and Gamease held 100% of the equity interests in this entity.

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Beijing Baina Information

Beijing Baina Information Technology Co., Ltd. (“Beijing Baina Information”) was acquired by Gamease in July 2014. As of September 30, 2014, the registered capital of Beijing Baina Information was $1.5 million and Gamease and a third-party individual held 60% and 40% interests, respectively, in this entity.

Wuhan Baina Information

Baina (Wuhan) Information Technology Co., Ltd. (“Wuhan Baina Information”) was acquired by Gamease in July 2014. As of September 30, 2014, the registered capital of Wuhan Baina Information was $3.0 million and Gamease and a third-party individual held 60% and 40% interests, respectively, in this entity.

Wuhan Xingyu

Wuhan Xingyu Technology Co., Ltd. (“Wuhan Xingyu”) was acquired by Gamease in July 2014. As of September 30, 2014, the registered capital of Wuhan Xingyu was $16,307 and Wuhan Baina Information held 100% of the equity interests in this entity.

Anzhuoxing

Beijing Anzhuoxing Technology Co., Ltd. (“Anzhuoxing”) was acquired by Gamease in July 2014. As of September 30, 2014, the registered capital of Anzhuoxing was $13,204 and Wuhan Baina Information held 100% of the equity interests in this entity.

Hualian Chuangke

Wuhan Hualian Chuangke Technology Co., Ltd. (“Hualian Chuangke”) was acquired by Gamease in July 2014. As of September 30, 2014, the registered capital of Hualian Chuangke was $0.1 million and Wuhan Baina Information held 100% of the equity interests in this entity.

For the MobileOthers Business

GoodFeel

Beijing GoodFeel Information Technology Co., Ltd. (“GoodFeel”) was acquired in 2004 and is engaged in value added telecommunication services.2004. As of September 30, 2013,2014, the registered capital of GoodFeel was $1.2 million and James Deng and Jing Zhou, held 58.1% and 41.9% interests, respectively, in this entity.

21 East Beijing

Beijing 21 East Culture Development Co., Ltd. (“21 East Beijing”) was acquired in 2006. As of September 30, 2013,2014, the registered capital of 21 East Beijing was $1.6 million and High Century held a 100% interestof the equity interests in this entity.

Yi He Jia Xun

Beijing Yi He Jia Xun Information Technology Co., Ltd. (“Yi He Jia Xun”) was acquired in September 2011. As of September 30, 2013,2014, the registered capital of Yi He Jia Xun was $2.1 million and Gang Fang and Yanfeng Lv each held a 50% interest in this entity.

 

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Financial Information

The following financial information of the Sohu Group’s consolidated VIEs is included in the accompanying consolidated financial statements (in thousands):

 

  As of   As of 
  September 30, 2013   December 31, 2012   September 30, 2014   December 31, 2013 

ASSETS:

        

Cash and cash equivalents

  $46,631    $62,638    $28,637    $112,316  

Short-term investments

   10,337     54,106     20,154     2,460  

Accounts receivable, net

   97,941     80,671     96,846     95,595  

Other current assets

   43,806     30,322  

Intercompany receivables due from subsidiaries

   260,930     109,728  

Prepaid and other current assets

   38,296     41,838  

Intercompany receivables due from the Company’s subsidiaries

   130,657     223,877  
  

 

   

 

   

 

   

 

 

Total current assets

   459,645     337,465     314,590     476,086  
  

 

   

 

   

 

   

 

 

Fixed assets, net

   9,976     8,190  

Goodwill

   128,949     126,516     139,874     139,478  

Prepaid and other non-current assets

   54,242     57,793  

Intangible assets, net

   34,778     35,135  

Other non-current assets

   77,626     61,550  
  

 

   

 

   

 

   

 

 

Total assets

  $642,836    $521,774    $576,844    $720,439  
  

 

   

 

   

 

   

 

 

LIABILITIES:

        

Accounts payable

  $11,067    $6,958    $3,102    $16,167  

Accrued and other short-term liabilities

   201,127     105,322     126,469     343,834  

Receipts in advance and deferred revenue

   64,765     54,150     41,743     60,140  

Intercompany payables due to subsidiaries

   30,962     36,446  

Intercompany payables due to the Company’s subsidiaries

   229,415     12,059  
  

 

   

 

   

 

   

 

 

Total current liabilities

   307,921     202,876     400,729     432,200  
  

 

   

 

   

 

   

 

 

Other long-term liabilities

   4,604     3,846  

Long-term liabilities

   5,865     9,560  
  

 

   

 

   

 

   

 

 

Total liabilities

  $312,525    $206,722    $406,594    $441,760  
  

 

   

 

   

 

   

 

 

 

  Three months ended September 30,   Nine months ended September 30,   Three months ended September 30,   Nine months ended September 30, 
  2013   2012   2013   2012   2014 2013   2014 2013 

Net revenue

  $259,362    $233,802    $759,948    $639,947    $262,280   $259,362    $767,529   $759,948  

Net income

  $5,425    $38,439    $198,853    $92,100  

Net income /(loss)

  $(16,862 $5,425    $(105,385 $25,297  
  

 

   

 

   

 

   

 

   

 

  

 

   

 

  

 

 

For the table below, consolidated VIEs under the Brand advertising, Sogou Mobile and Others segments are classified as Sohu’s VIEs, and consolidated VIEs under the Changyou segment are classified as Changyou’s VIEs.

Cash flows of Sohu’s VIEs

Cash flows of Sohu’s VIEs  Nine months ended September 30, 
   2013  2012 

Net cash provided by /(used in) operating activities

  $6,312   $(16,930

Net cash (used in) /provided by investing activities

   (574  143  

Net cash used in financing activities

  $0   $(474
  

 

 

  

 

 

 
Cash flows of Changyou’s VIEs  Nine months ended September 30, 
   2013  2012 

Net cash provided by operating activities

  $29,225   $41,843  

Net cash used in investing activities

   (51,434  (31,558

Net cash used in financing activities

  $0   $(13,105
  

 

 

  

 

 

 

   Nine months ended September 30, 
   2014  2013 

Net cash provided by operating activities

  $15,751   $6,312  

Net cash used in investing activities

   (2,795  (574

Net cash used in financing activities

  $0   $0  
  

 

 

  

 

 

 

Cash flows of Changyou’s VIEs

   Nine months ended September 30, 
   2014  2013 

Net cash provided by operating activities

  $16,970   $29,225  

Net cash used in investing activities

   (112,013  (51,434

Net cash used in financing activities

  $(793 $0  
  

 

 

  

 

 

 

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Summary of significant agreements currentlySignificant Agreements Currently in effectEffect

Agreements between consolidatedBetween Consolidated VIEs and Nominee Shareholders

Loan and equityshare pledge agreementsbetween Sohu Era and the respective shareholders of High Century and Sohu Entertainment:Heng Da Yi Tong: These loan agreements provide for loans to the shareholders of High Century and Sohu EntertainmentHeng Da Yi Tong for them to make contributions to the registered capital of High Century and Sohu EntertainmentHeng Da Yi Tong in exchange for the equity interests in High Century and Sohu Entertainment,Heng Da Yi Tong, and under these pledge agreements the shareholders pledge those equity interests to Sohu Era as security for the loans. The loan agreements include powers of attorney that give Sohu Era the power to appoint nominees to act on behalf of the shareholders of High Century and Sohu EntertainmentHeng Da Yi Tong in connection with all actions to be taken by High Century and Sohu Entertainment.Heng Da Yi Tong. Pursuant to the loan agreements, the shareholders executed in blank transfers of their equity interests in High Century and Sohu Entertainment,Heng Da Yi Tong, which transfers are held by the Sohu Group’s legal department and may be completed and effected at Sohu Era’s election.

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Loan and equityshare pledge agreements between Sogou TechTechnology and the shareholders of Sogou Information. TheseThe loan agreements provideagreement provides for loansa loan to Xiaochuan Wang, the shareholdersindividual shareholder of Sogou Information, for themto be used by him to make contributions to the registered capital of Sogou Information in exchange for thehis equity interestsinterest in Sogou Information, and under the pledge agreements the shareholders pledge those equity interests to Sogou Tech as security for the loans.Information. The loans areloan is interest free and arefree-and is repayable on demand, but the shareholders can onlyshareholder may repay the loansloan only by transferring to Sogou TechTechnology his equity interest in Sogou Information. Under the pledge agreement, all of the shareholders of Sogou Information pledge their equity interests to Sogou Technology to secure the performance of their obligations under the various VIE-related agreements. If any shareholder of Sogou Information breaches any of his or its obligations under any VIE-related agreements, Sogou Technology is entitled to exercise its right as the beneficiary under the share pledge agreement. The share pledge agreement terminates only after all of the obligations of the shareholders under the various VIE-related agreements are no longer in Sogou Information.effect.

Exclusive equity interest purchase right agreements between Sogou Tech,Technology, Sogou Information and the shareholders of Sogou Information. Pursuant to these agreements, Sogou TechTechnology and any third party designated by it have the right, exercisable at any time when it becomes legal to do so under PRC law, to purchase from the shareholders of Sogou Information all or any part of their equity interests at a purchase price equal to the shareholders’ initial contributions to registered capital.

Powers of Attorney executed by the shareholders of Sogou Information in favor of Sogou Tech with a term of 10 years, extendable at the request of Sogou Tech. These powers of attorney give Sogou Tech the right to appoint nominees to act on behalf of each of the two Sogou Information shareholders in connection with all actions to be taken by Sogou Information.

Business operation agreementamong Sogou Tech,Technology, Sogou Information and the shareholders of Sogou Information. The agreement sets forth the right of Sogou TechTechnology to control the actions of the shareholders of Sogou Information. The agreement has a term of 10 years, renewable at the request of Sogou Tech.Technology.

Powers of Attorney executed by the shareholders of Sogou Information in favor of Sogou Technology with a term of 10 years, extendable at the request of Sogou Technology. These powers of attorney give Sogou Technology the right to appoint nominees to act on behalf of each of the three Sogou Information shareholders in connection with all actions to be taken by Sogou Information.

Loan and share pledge agreementsbetween Sohu Era and the respective shareholders of GoodFeel: These loan agreements provide for loans to the shareholders of GoodFeel for them to make contributions to the registered capital of GoodFeel in exchange for the equity interests in GoodFeel, and under these pledge agreements the shareholders pledge those equity interests to Sohu Era as security for the loans. The loan agreements include powers of attorney that give Sohu Era the power to appoint nominees to act on behalf of the shareholders of GoodFeel in connection with all actions to be taken by GoodFeel. Pursuant to the loan agreements, the shareholders executed in blank transfers of their equity interests in GoodFeel, which transfers are held by the Sohu Group’s legal department and may be completed and effected at Sohu Era’s election.

Loan and share pledge agreements between Sohu Era and the shareholders of Yi He Jia Xun. The loan agreement provides for loans to the individual shareholders of Yi He Jia Xun, to be used by them to make contributions to the registered capital of Yi He Jia Xun in exchange for the equity interest in Yi He Jia Xun. The loans are interest free-and are repayable on demand, but the shareholders may repay the loans only by transferring to Sohu Era their equity interest in Yi He Jia Xun. Under the pledge agreements, all of the shareholders of Yi He Jia Xun pledge their equity interests to Sohu Era to secure the performance of their obligations under the various VIE-related agreements. If any shareholder of Yi He Jia Xun breaches any of his or its obligations under any VIE-related agreements, Sohu Era is entitled to exercise its right as the beneficiary under the share pledge agreement. The share pledge agreement terminates only after all of the obligations of the shareholders under the various VIE-related agreements are no longer in effect.

Exclusive equity interest purchase right agreements between Sohu Era, Yi He Jia Xun and the shareholders of Yi He Jia Xun. Pursuant to these agreements, Sohu Era and any third party designated by it have the right, exercisable at any time when it becomes legal to do so under PRC law, to purchase from the shareholders of Yi He Jia Xun all or any part of their equity interests at a purchase price equal to the shareholders’ initial contributions to registered capital.

Business operation agreementamong Sohu Era, Yi He Jia Xun and the shareholders of Yi He Jia Xun. The agreement sets forth the right of Sohu Era to control the actions of the shareholders of Yi He Jia Xun. The agreement has a term of 10 years, renewable at the request of Sohu Era.

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Powers of Attorney executed by the shareholders of Yi He Jia Xun in favor of Sohu Era with a term of 10 years, extendable at the request of Sohu Era. These powers of attorney give Sohu Era the right to appoint nominees to act on behalf of each of the two Yi He Jia Xun shareholders in connection with all actions to be taken by Yi He Jia Xun.

Loan agreements and equity pledge agreements between AmazGame and the shareholders of Gamease and between Gamespace and the shareholders of Guanyou Gamespace. The loan agreements provide for loans to the shareholders of Gamease and Guanyou Gamespace, respectively, for them to make contributions to the registered capital of Gamease and Guanyou Gamespace in exchange for the equity interests in Gamease and Guanyou Gamespace, respectively. Under the equity pledge agreements the shareholders of Gamease and Guanyou Gamespace, respectively, pledge to AmazGame and Gamespace, respectively, their equity interests in Gamease and Guanyou Gamespace, respectively, to secure the performance of their obligations under the loan agreements and Gamease’s and Guanyou Gamespace’s obligations to AmazGame and Gamespace under their business agreements. The loans are interest free and are repayable on demand, but the shareholders can only repay the loans by transferring to AmazGame and Gamespace, respectively, their equity interests in Gamease and Guanyou Gamespace.

Equity interest purchase right agreements between AmazGame and the shareholders of Gamease and between Gamespace and the shareholders of Guanyou Gamespace. Pursuant to these agreements, AmazGame and Gamespace, respectively, have the right, and any third party designated by them has the right, exercisable at any time during the terms of the agreements, if and when it becomes legal to do so under PRC law, to purchase from the shareholders of Gamease and Guanyou Gamespace, respectively, all or any part of their equity interests at a purchase price equal to their initial contributions to the registered capital.capital of Gamease and Guanyou Gamespace or the proportional amount of such initial contribution in the case of a partial purchase of such equity interests.

Business operation agreementsamong AmazGame, Gamease and the shareholders of Gamease and among Gamespace, Guanyou Gamespace and the shareholders of Guanyou Gamespace. These agreements set forth the rights of AmazGame and Gamespace, respectively, to control the actions of the shareholders of Gamease and Guanyou Gamespace, respectively. The agreements have a term of 10 years.

Powers of attorney executed by the shareholders of Gamease in favor of AmazGame and the shareholders of Guanyou Gamespace in favor of Gamespace, with a term of 10 years. These powers of attorney give AmazGame and Gamespace, respectively, the exclusive right to appoint nominees to act on behalf of the shareholders in connection with all actions to be taken by Gamease and Guanyou Gamespace, respectively.

Business operation agreements between AmazGame and the shareholders of Gamease and between Gamespace and the shareholders of Guanyou Gamespace. This agreement sets forth the right of AmazGame and Gamespace, respectively, to control the actions of the shareholders of Gamease and Guanyou Gamespace, respectively. The agreements have a term of 10 years.

Call option agreement among ICE Information, Shanghai ICE and Shanghai ICE shareholders. This agreement provides to ICE Information and any third party designated by ICE Information the right, exercisable at any time during the terms of the agreements, if and when it becomes legal to do so under PRC law, to purchase from the shareholders all or any part of their shares in Shanghai ICE or purchase from Shanghai ICE all or part of its assets or business at the lowest purchase price permissible under PRC law. The agreement is terminable only if ICE Information is dissolved.

Share pledge agreementamong ICE Information, Shanghai ICE and the shareholders of Shanghai ICE. Under this agreement the shareholders pledge to ICE Information their equity interests in Shanghai ICE to secure the performance of their obligations under the call option agreement described above and Shanghai ICE’s obligations to ICE Information under their business agreements.agreements described below.

Business operation agreementamong ICE Information, Shanghai ICE and the shareholders of Shanghai ICE. This agreement sets forth the right of ICE Information to control the actions of the shareholders of Shanghai ICE. The agreement is terminable only if ICE Information is dissolved.

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EquityAmended and restated equity interest purchase right agreementamong 7Road Technology, Shenzhen 7Road and Gamease, which is Shenzhen 7Road’s sole shareholder. Under this agreement, 7Road Technology and any third-party designated by 7Road Technology have the right, exercisable at any time during the term of the agreements,agreement, if and when it is legal to do so under PRC law, to purchase from Gamease all or any part of its shares in Shenzhen 7Road at a nominal purchase price. This agreement has a term of 10 years, is renewable by 7Road Technology for such term as it may determine and is terminable early onlyby 7Road Technology by notice to the other parties at any time when, under PRC law as then in effect, 7Road Technology cannot exercise its purchase right, and is also terminable if Shenzhen 7Road’s or 7Road Technology’s existence is terminated, by mutual agreement of the parties or upon the written request of 7Road Technology. Neither Gamease nor Shenzhen 7Road has any power to terminate the agreement.

Equity interest pledge agreementamong 7Road Technology, Shenzhen 7Road and Gamease. Under this agreement, Gamease agreed to pledge to 7Road Technology its equity interests in Shenzhen 7Road to secure the performance of its obligations and Shenzhen 7Road’s obligations under the various VIE-related agreements. If Gamease or Shenzhen 7Road breaches its obligations under any VIE-related agreements, 7Road Technology is entitled to exercise its rights as the beneficiary under the Equity Interest Pledge Agreement. This agreement terminates only after all of the obligations of Gamease and of Shenzhen 7Road under the various VIE-related agreements are no longer in effect.

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Business operation agreementamong 7Road Technology, Shenzhen 7Road and Gamease. This agreement grants to 7Road Technology the right to control the actions of Shenzhen 7Road and the actions of Gamease in its capacity as the shareholder of Shenzhen 7Road. This agreement has a term of 10 years, is renewable by 7Road Technology for such term as it may determine and is terminable early if the existence of Shenzhen 7Road or 7Road Technology is terminated, by mutual agreement of the parties or upon the written request of 7Road Technology.

Power of attorneyexecuted by Gamease in favor of 7Road Technology. This power of attorney gives 7Road Technology the exclusive right to appoint designees to act on behalf of Gamease in connection with all actions to be taken by Shenzhen 7Road requiring shareholder approval.

Business Arrangements betweenBetween Subsidiaries and consolidatedConsolidated VIEs

Business cooperationExclusive technology consulting and service agreementbetween Sohu Era and Sohu Internet. Pursuant to this agreement Sohu Era provideshas the exclusive right to provide technical consultation content purchasing and other related services to Sohu Internet, in exchange for a percentage of the gross income of Sohu Internet. The agreement has an initial term of two years, and is renewable at the request of Sohu Era.

Exclusive technology consulting and service agreementbetween GoodFeel and Sohu Era. Pursuant to this agreement Sohu Era has the exclusive right to provide technical consultation and Sohu Internetother related services to GoodFeel in exchange for a fee. The agreement has a term of one year,two years, and is renewable at the request of Sohu Era.

Exclusive technology consulting and service agreementbetween Yi He Jia Xun and Sohu Era. Pursuant to this agreement Sohu Era has the exclusive right to provide technical consultation and other related services to Yi He Jia Xun in exchange for a fee. The agreement has a term of ten years, and is renewable at the request of Sohu Era.

Business cooperation agreement between Sogou TechTechnology and Sogou Information. Pursuant to this agreement, Sogou Information provides the Internet information serviceservices to Sogou Tech’sTechnology’s customers in exchange for a certain amount of service fee withpayable to Sogou Information. The agreement has a term of 10 years, and is renewable at the request of Sogou Tech.Technology.

Exclusive technology consulting and service agreementbetween Sogou TechTechnology and Sogou Information. Pursuant to this agreement Sogou TechTechnology has the exclusive right to provide technical consultation and other related services to Sogou Information in exchange for a certain amount of service fee, withfee. The agreement has a term of 10 years and is renewable at the request of Sogou Tech.Technology.

Technology support and utilization agreements between AmazGame and Gamease and between Gamespace and Guanyou Gamespace. Pursuant to these agreements, AmazGame and Gamespace, respectively, have the exclusive right to provide certain product development and application services and technology support to Gamease and Guanyou Gamespace, respectively, for a fee equal to a predetermined percentage, subject to adjustment by AmazGame or Gamespace at any time, of Gamease’s and Guanyou Gamespace’s respective revenues. These agreements will be terminated only when AmazGame and Gamespace are dissolved.

Services and maintenance agreementsbetween AmazGame and Gamease between Gamespace and Guanyou Gamespace. Pursuant to these agreements, AmazGame and Gamespace, respectively, provide marketing, staffing, business operation and maintenance services to Gamease and Guanyou Gamespace, respectively, in exchange for a fee equal to the cost of providing such services plus a predetermined margin. These agreements will be terminated only when AmazGame and Gamespace are dissolved.

Exclusive business cooperation agreement between ICE Information and Shanghai ICE. This agreement sets forth the exclusive right of ICE Information to provide business support and technical services to Shanghai ICE. The agreement will be terminated only when ICE Information is dissolved.

Exclusive technology consulting and services agreement between ICE Information and Shanghai ICE. This agreement provides to ICE Information the exclusive right to provide technical consultation and other related services to Shanghai ICE in exchange for a fee equal to the balance of Shanghai ICE’s gross income after deduction of related costs and expenses. The agreement will be terminated only when ICE Information is dissolved.

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Technology development and utilization agreement between 7Road Technology and Shenzhen 7Road. Under this agreement, 7Road Technology has the exclusive right to provide product development and application services and technology support to Shenzhen 7Road for a fee based on Shenzhen 7Road’s revenues, which fee can be adjusted by 7Road Technology at any time in its sole discretion. The fee is eliminated upon consolidation. This agreement will terminate if the existence of 7Road Technology or Shenzhen 7Road is terminated, by mutual agreement of the parties or upon failure to perform due to a force majeure event.

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Services and maintenance agreementbetween 7Road Technology and Shenzhen 7Road. Pursuant to this agreement, 7Road Technology provides marketing and maintenance services to Shenzhen 7Road in exchange for a fee equal to the cost of providing such services plus a predetermined margin. This agreement will terminate if the existence of 7Road Technology or Shenzhen 7Road is terminated, by mutual agreement of the parties or upon failure to perform due to a force majeure event.

Certain of the contractual arrangements described above between the VIEs and the related wholly-owned subsidiaries of the Sohu Group are silent regarding renewals. However, because the VIEs are controlled by the Sohu Group through powers of attorney granted to the Sohu Group by the shareholders of the VIEs, the contractual arrangements can be, and are expected to be, renewed at the subsidiaries’ election.

VIE-Related Risks

It is possible that the Sohu Group’s operation of certain of its operations and businesses through VIEs could be found by PRC authorities to be in violation of PRC laws and regulations prohibiting or restricting foreign ownership of companies that engage in such operations and businesses. If such a finding were made, regulatory authorities with jurisdiction over the licensing and operation of such operations businesses would have broad discretion in dealing with such a violation, including levying fines, confiscating the Group’s income, revoking the business or operating licenses of the affected businesses, requiring the Group to restructure its ownership structure or operations, or requiring the Group to discontinue all or any portion of its operations. Any of these actions could cause significant disruption to the Group’s business operations, and have a materially adverse impact on the Group’s cash flows, financial position and operating performance. The Group’s management considers the possibility of such a finding by PRC regulatory authorities to be remote.

In addition, it is possible that the contracts with the Sohu Group, the Sohu Group’s VIEs and shareholders of its VIEs would not be enforceable in China if PRC government authorities or courts were to find that such contracts contravene PRC laws and regulations or are otherwise not enforceable for public policy reasons. In the event that the Sohu Group was unable to enforce these contractual arrangements, the Group would not be able to exert effective control over the affected VIEs. Consequently, such VIE’s results of operations, assets and liabilities would not be included in the Sohu Group’s consolidated financial statements. If such were the case, the Group’s cash flows, financial position and operating performance would be materially adversely affected. The Sohu Group’s contractual arrangements with respect to its consolidated VIEs are approved and in place. The management believes that such contracts are enforceable, and considers the possibility remote that PRC regulatory authorities with jurisdiction over the Sohu Group’s operations and contractual relationships would find the contracts to be unenforceable.

The Sohu Group’s operations and businesses rely on the operations and businesses of its VIEs, which hold certain recognized and unrecognized revenue-producing assets. The recognized revenue-producing assets include goodwill and intangible assets acquired through business acquisitions. Goodwill primarily represents the expected synergies from combining an acquired business with the Group. Intangible assets acquired through business acquisitions mainly consist of customer relationships, non-compete agreements, user bases, copyrights, trademarks and developed technologies. Unrecognized revenue-producing assets mainly consist of licenses and intellectual property. Licenses include operations licenses, such as internet information service licenses and licenses for providing content. Intellectual property developed by Sohu mainly consists of patents, copyrights, trademarks, and domain names. The Group’s operations and businesses may be adversely impacted if the Group loses the ability to use and enjoy assets held by these VIEs.

VIEVIEs Not Consolidated within the Sohu Group

In December 2012,As of September 30, 2014, Sohu had three VIEs which were not consolidated within the Sohu Group acquired, for a price of $1.6 million, a 25% equity interest in a VIE to support the Group’s brand advertising business.Group. Since the Sohu Group neither controlshas the power to direct these VIEs’ activities that will significantly impact their economic performance nor has the obligation to absorb losses of, or the right to receive benefits from, these VIEs that could potentially be significant influence over this VIE,to these VIEs, the Group is not the primary beneficiary and, accordingly, the Group recognizes the investmentinvestments under the equity method.method or the cost method according to the share percentage the Group holds. In assessing itsthe maximum exposure to a loss on the investmentinvestments compared to the cost of its investment, the Sohu Group determined that it did not have further obligations exceeding the cost of the investmentinvestments and that there were no terms of the investment arrangementarrangements that could require the Sohu Group to provide further financial support to the VIE.VIEs.

10.11. Sohu.com Inc. Shareholders’ Equity

Takeover Defense

Sohu intends to adopt appropriate defensive measures in the future on a case by case basis as and to the extent that Sohu’s Board of Directors determines that such measures are necessary or advisable to protect Sohu stockholder value in the face of any coercive takeover threats or to prevent an acquirer from gaining control of Sohu without offering fair and adequate price and terms.

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Treasury Stock

Treasury stock consists of shares repurchased by Sohu that are no longer outstanding and are held by Sohu. Treasury stock is accounted for under the cost method.

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On July 27, 2013, Changyou’s Board of Directors authorized a share repurchase program of up to $100 million ofFor the outstanding ADSs of Changyou over a two-year period from July 27, 2013 to July 26, 2015. As ofthree and nine months ended September 30, 2014 and 2013, Changyou had repurchased 305,800the Company did not repurchase any shares of its ADSs, representing 611,600 ordinary shares under the share repurchase program at an aggregate cost of approximately $9.1 million.common stock.

Stock Incentive Plan

Sohu, Changyou, Sogou, and Sohu Video and 7Road all have incentive plans, and prior to June 28, 2013 7Road had an incentive plan, for the granting of share-based awards, including common stock /ordinaryor ordinary shares, share options, restricted shares and restricted share units, to their directors, executive officers, and employees.

1) Sohu.com Inc. Share-based Awards

Sohu’s 2000 Stock Incentive Plan

Sohu’s 2000 Stock Incentive Plan (the “Sohu 2000 Stock Incentive Plan”) provided for the issuance of up to 9,500,000 shares of common stock, including those issued pursuant to the exercise of share options and upon vesting and settlement of restricted share units. Most of these awards vest over a period of four years. The maximum term of any issued stock right under the Sohu 2000 Stock Incentive Plan is ten years from the grant date. The Sohu 2000 Stock Incentive Plan expired on January 24, 2010. As of the expiration date, 9,128,724 shares of common stock had been issued or were subject to issuance upon the vesting and exercise of share options or the vesting and settlement of restricted share units granted under the plan. A new plan (the “Sohu 2010 Stock Incentive Plan”) was adopted by Sohu’s shareholders on July 2, 2010.

For the three and nine months ended September 30, 2014, total share-based compensation expense recognized for awards under the Sohu 2000 Stock Incentive Plan was nil and $1.4 million, respectively. For the three and nine months ended September 30, 2013, total share-based compensation expense recognized for awards under the Sohu 2000 Stock Incentive Plan was $0.5 million and $1.7 million, respectively. For the three and nine months ended September 30, 2012, total share-based compensation expense recognized for awards under the Sohu 2000 Stock Incentive Plan was $1.2 million and $3.9 million, respectively.

i) Summary of share option activity

A summary of share option activity under the Sohu 2000 Stock Incentive Plan as of and for the nine months ended September 30, 20132014 is presented below:

 

          Weighted     
   Number  Weighted   Average   Aggregate 
   Of  Average   Remaining   Intrinsic 
   Shares  Exercise   Contractual   Value (1) 

Options

  (in thousands)  Price   Life (Years)   (in thousands) 

Outstanding at January 1, 2013

   242   $19.36     1.91    $6,781  

Exercised

   (63  15.06      

Forfeited or expired

   (1  9.07      
  

 

 

      

Outstanding at September 30, 2013

   178    20.91     1.43     10,336  
  

 

 

      

Vested at September 30, 2013

   178    20.91     1.43     10,336  
  

 

 

      

Exercisable at September 30, 2013

   178    20.91     1.43     10,336  
  

 

 

      

Options

  Number
Of
Shares
(in thousands)
  Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Life (Years)
   Aggregate
Intrinsic
Value (1)
(in thousands)
 

Outstanding at January 1, 2014

   147   $18.87     1.39    $7,958  

Exercised

   (28  18.31      

Forfeited or expired

   (2  16.81      
  

 

 

      

Outstanding at September 30, 2014

   117    19.04     0.68     3,643  
  

 

 

      

Vested at September 30, 2014

   117    19.04     0.68     3,643  
  

 

 

      

Exercisable at September 30, 2014

   117    19.04     0.68     3,643  
  

 

 

      

 

Note (1):The aggregate intrinsic value in the preceding table represents the difference between Sohu’s closing stock price of $78.83$50.23 on September 30, 20132014 and the exercise price of share options. The total intrinsic value of share options exercised for the nine months ended September 30, 20132014 was $2.3$1.6 million.

No options have been granted under Sohu’s 2000 Stock Incentive Plan since 2006. For the three and nine months ended September 30, 20132014 and 2012,2013, no compensation expense was recognized for share options because the requisite service periods for share options had ended by the end of 2009.

For the three and nine months ended September 30, 2014, total cash received from the exercise of share options amounted to $0.1 million and $0.5 million, respectively. For the three and nine months ended September 30, 2013, total cash received from the exercise of share options amounted to $0.1 million and $1.0 million, respectively. For the three and nine months ended September 30, 2012, total cash received from the exercise of share options amounted to $101,000 and $240,000, respectively.

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ii) Summary of restricted share unit activity

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A summary of restricted share unit activity under the Sohu 2000 Stock Incentive Plan as of and for the nine months ended September 30, 20132014 is presented below:

 

  Number of Weighted-Average 
  Units Grant-Date 

Restricted Share Units

  (in thousands) Fair Value   Number of
Units

(in thousands)
 Weighted-Average
Grant-Date

Fair Value
 

Unvested at January 1, 2013

   255   $61.27  

Unvested at January 1, 2014

   123   $61.27  

Granted

   0      0   

Vested

   (127 61.27     (121 61.27  

Forfeited

   (4 61.27     (2 61.27  
  

 

    

 

  

Unvested at September 30, 2013

   124    61.27  

Unvested at September 30, 2014

   0   
  

 

    

 

  

Expected to vest thereafter

   93    61.27     0   
  

 

    

 

  

For the three and nine months ended September 30, 2014, total share-based compensation expense recognized for restricted share units was nil and $1.4 million, respectively. For the three and nine months ended September 30, 2013, total share-based compensation expense recognized for restricted share units was $0.5 million and $1.7 million, respectively. For

There was no unrecognized compensation expense for restricted share units as of September 30, 2014, because all remaining unvested restricted shares units vested in the first quarter of 2014. The total fair value on their respective vesting dates of restricted share units that vested during the three and nine months ended September 30, 2012, total share-based compensation expense recognized for restricted share units2014 was $1.2nil and $9.3 million, and $3.9 million, respectively.

As of September 30, 2013, there was $0.6 million of unrecognized compensation expense related to unvested restricted share units. The expense is expected to be recognized over a weighted average period of 0.29 years. The total fair value on their respective vesting dates of restricted share units vested during the three and nine months ended September 30, 2013 was nil and $6.2 million, respectively. The total fair value on their respective vesting dates of restricted share units vested during the three and nine months ended September 30, 2012 was nil and $8.9 million, respectively.

Sohu’s 2010 Stock Incentive Plan

On July 2, 2010, SohuSohu’s shareholders adopted the Sohu 2010 Stock Incentive Plan, which provides for the issuance of up to 1,500,000 shares of common stock, including thoseshares issued pursuant to the vesting and settlement of restricted share units and pursuant to the exercise of share options. The maximum term of any issued stock right granted under the Sohu 2010 Stock Incentive Plan is ten years from the grant date. The Sohu 2010 Stock Incentive Plan will expire on July 1, 2020. As of September 30, 2013, 1,455,4222014, 1,306,513 shares were available for grant under the Sohu 2010 Stock Incentive Plan.

A summary of restricted share unit activity under the Sohu 2010 Stock Incentive Plan as of and for the nine months ended September 30, 20132014 is presented below:

 

  Number of Weighted-Average 
  Units Grant-Date 

Restricted Share Units

  (in thousands) Fair Value   Number of
Units

(in thousands)
 Weighted-Average
Grant-Date

Fair Value
 

Unvested at January 1, 2013

   5   $70.88  

Unvested at January 1, 2014

   123   $84.82  

Granted

   14   48.75     36   67.57  

Vested

   (7 48.75     (4 72.92  

Forfeited

   (2 70.88     (9 81.33  
  

 

    

 

  

Unvested at September 30, 2013

   10    55.84  

Unvested at September 30, 2014

   146    81.08  
  

 

    

 

  

Expected to vest thereafter

   9    54.41     108    52.25  
  

 

    

 

  

For the three and nine months ended September 30, 2014, total share-based compensation expense recognized for restricted share units was $1.3 million and $3.8 million, respectively. For the three and nine months ended September 30, 2013, total share-based compensation expense recognized for restricted share units was $0.2 million and $0.6 million, respectively. For the three and nine months ended September 30, 2012, total share-based compensation expense recognized for restricted share units was $0.2 million and $0.6 million, respectively.

As of September 30, 2013,2014, there was $0.3$4.9 million of unrecognized compensation expense related to unvested restricted share units. The expense is expected to be recognized over a weighted average period of 0.41.16 years. The total fair value on their respective vesting dates of restricted share units that vested was $0.2 million during both the three months and the nine months ended September 30, 2014. The total fair value on their respective vesting dates of restricted share units vested during both the three months and the nine months ended September 30, 2013 was $0.4 million. The total fair value on their respective vesting dates of restricted share units vested during both the three months and the nine months ended September 30, 2012 was $0.25 million.

 

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2) Changyou.com Limited Share-based Awards

Changyou’s 2008 Share Incentive Plan

Changyou’s 2008 Share Incentive Plan (the “Changyou 2008 Share Incentive Plan”) originally provided for the issuance of up to 2,000,000 ordinary shares, including thoseordinary shares issued pursuant to the exercise of share options and upon vesting and settlement of restricted share units. InThe 2,000,000 reserved shares became 20,000,000 ordinary shares in March 2009 the 2,000,000 reserved ordinary shares were subject towhen Changyou effected a ten-for-one share split effected by Changyou and became 20,000,000of its ordinary shares. Most of thesethe awards granted under the Changyou 2008 Share Incentive Plan vest over a period of four years. The maximum term of any issued share right granted under the Changyou 2008 Share Incentive Plan is ten years from the grant date. The Changyou 2008 Share Incentive Plan will expire in August 2018.

As ofThrough September 30, 2013,2014, Changyou had granted under the Changyou 2008 Share Incentive Plan 15,000,000 ordinary shares to its chief executive officer Tao Wang, through Prominence Investments Ltd. (“Prominence”) and 4,781,552 restricted share units to certain of its executive officers other than Tao Wang, and to certain of its other employees. Prominence, which is an entity that may deemed under applicable rules of the Securities and Exchange Commission to be beneficially owned by Tao Wang. As of September 30, 2014, Changyou had also granted under the Changyou 2008 Share Incentive Plan restricted share units, settleable upon vesting by the issuance of an aggregate of 4,983,552 ordinary shares, to its executive officers other than Tao Wang, and certain other Changyou employees.

For the three and nine months ended September 30, 2014, total share-based compensation expense recognized for awards under the Changyou 2008 Share Incentive Plan was $0.5 million and $1.2 million, respectively. For the three and nine months ended September 30, 2013, total share-based compensation expense recognized for awards under the Changyou 2008 Share Incentive Plan was $0.3 million and $0.9 million, respectively. For the three and nine months ended September 30, 2012, total share-based compensation expense recognized for awards under the Changyou 2008 Share Incentive Plan was $0.8 million and $2.8 million, respectively.

Share-based Awards Granted before Changyou’s IPO

All of the restricted ordinary shares and restricted share units granted before Changyou’s Initial Public Offering

For Changyou restricted ordinary shares granted to Tao WangIPO became vested in 2012 and to its executive officers other than Tao Wang before Changyou’s IPO,2013, respectively. Hence there washas been no share-based compensation expense recognized for either the three months or the nine months ended September 30, 2013, as these awards were fully vested in 2012. For the three and nine months ended September 30, 2012, total share-based compensation expense recognized for the abovewith respect to such restricted ordinary shares was nil and $72,000, respectively.

For Changyou restricted share units granted to certain of its other employees before Changyou’s IPO, there was no share-based compensation expense recognized for the three months ended September 30, 2013, as these awards were fully vested in the first half of 2013. The fair value of these restricted share units as of the grant date was determined based on Changyou’s offering price for its IPO, which was $8.00 per ordinary share.

A summary of activity for the restricted share units as of and for the nine months ended September 30, 2013 is presented below:

Restricted Share Units

  Number of
Units
(in thousands)
  Weighted-Average
Grant-Date
Fair Value
 

Unvested at January 1, 2013

   81   $8.00  

Granted

   0   

Vested

   (81  8.00  

Forfeited

   0   
  

 

 

  

Unvested at September 30, 2013

   0   
  

 

 

  

Expected to vest thereafter

   0   
  

 

 

  

For the three and nine months ended September 30, 2013, total share-based compensation expense recognized for the above restricted share units was nil and negative $0.3 million, respectively. The negative $0.3 million resulted from Changyou’s true-up of the shared-based compensation expense for forfeited restricted share units in the first quarter of 2013. For the three and nine months ended September 30, 2012, total share-based compensation expense recognized for the above restricted share units was $50,000 and $0.2 million, respectively.

As of September 30, 2013, there was no unrecognized share-based compensation expense related to the unvested restricted share units. The total fair value of restricted share units vested to Changyou’s other employees onsince their respective full vesting dates during the three and nine months ended September 30, 2013 was nil and $1.1 million, respectively. The total fair value of restricted share units vested to Changyou’s other employees on their respective vesting dates during the three and nine months ended September 30, 2012 was nil and $1.2 million, respectively.dates.

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Share-based Awards grantedGranted after Changyou’s Initial Public OfferingIPO

As ofThrough September 30, 2013,2014, in addition to the share-based awards granted before Changyou’s IPO, Changyou had granted restricted share units, settleable upon vesting with the issuance of an aggregate of 1,585,552 restricted share units (settleable in1,787,552 ordinary shares)shares, to certain of its executive officers other than Tao Wang and to certain of its other employees. These restricted share units are subject to vesting over a four-year period commencing on their grant dates. Share-based compensation expense for such restricted share units is recognized on an accelerated basis over the requisite service period. The fair value of restricted share units was determined based on the market price of Changyou’s ADSsAmerican depositary shares on the grant date.

A summary of activity for these restricted share units as of and for the nine months ended September 30, 20132014 is presented below:

 

Restricted Share Units

  Number of
Units
(in thousands)
 Weighted-Average
Grant-Date
Fair Value
   Number of
Units
(in thousands)
 Weighted-Average
Grant-Date

Fair Value
 

Unvested at January 1, 2013

   526   $13.30  

Unvested at January 1, 2014

   218   $14.46  

Granted

   36   14.57     160   13.80  

Vested

   (320 12.70     (29 16.32  

Forfeited

   (12 12.88     (5 17.19  
  

 

    

 

  

Unvested at September 30, 2013

   230    14.35  

Unvested at September 30, 2014

   344    13.96  
  

 

    

 

  

Expected to vest thereafter

   213    14.38     331    13.97  
  

 

    

 

  

For the three and nine months ended September 30, 2014, total share-based compensation expense recognized for the above restricted share units was $0.5 million and $1.2 million, respectively. For the three and nine months ended September 30, 2013, total share-based compensation expense recognized for the above restricted share units was $0.3 million and $1.2 million, respectively. For the three and nine months ended September 30, 2012, total share-based compensation expense recognized for the above restricted share units was $0.7 million and $2.5 million, respectively.

As of September 30, 2013,2014, there was $1.0$2.2 million of unrecognized compensation expense related to the unvested restricted share units. The expense is expected to be recognized over a weighted average period of 0.871.15 years. The total fair value of these restricted share units vested during the three and nine months ended September 30, 2014 was nil and $0.44 million, respectively. The total fair value of these restricted share units vested during the three and nine months ended September 30, 2013 was nil and $4.7 million, respectively. The total fair value

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Changyou 2014 Share Incentive Plan

On June 25, 2014, Changyou reserved 2,000,000 of these restrictedits Class A ordinary shares under the Changyou.com Limited 2014 Share Incentive Plan (the “Changyou 2014 Share Incentive Plan”) for the purpose of making share units vested during the threeincentive awards to its executive officers and nine months endedemployees. As of September 30, 2012 was nil and $4.0 million, respectively.2014, Changyou had not made any awards under the Changyou 2014 Share Incentive Plan.

3) Sogou Inc. Share-based Awards

Sogou 2010 Share Incentive Plan

OnSogou adopted a share incentive plan on October 20, 2010. The number of Sogou ordinary shares issuable under the plan was 41,500,000 after an amendment that was effective August 22, 2014 (as amended, the “Sogou 2010 Sogou adoptedShare Incentive Plan”). Awards of share rights may be granted under the Sogou 2010 Share Incentive Plan (the “Sogou 2010 Share Incentive Plan”). On June 18, 2013, the Sogou 2010 Share Incentive Plan was amended to provide for the issuance of up to 36,000,000 ordinary shares of Sogou to management and key employees of Sogou and of any present or future parents or subsidiaries or variable interest entities of Sogou. The maximum term of any issued share right granted under the amended Sogou 2010 Share Incentive Plan is ten years from the grant date. The amended Sogou 2010 Share Incentive Plan will expire on October 19, 2020. As of September 30, 2013,2014, Sogou had issuedgranted options for the purchase of 35,436,37537,829,113 ordinary shares.shares under the 2010 Sogou Share Incentive Plan.

Of the 35,436,375 issued sharegranted options 23,206,375 sharefor the purchase of 37,829,113 shares, options for the purchase of 25,319,113 shares will become vested and exercisable in four equal installments, with each installment vesting upon a service period requirement for management and key employees being met, as well as Sogou’s achievement of performance targets for the corresponding period. The performance target for each installment will be set at the beginning of each vesting period; therefore,period. Accordingly, for purposes of recognition of share-based compensation expense, each installment is considered to be granted atas of that date. As of September 30, 2013,2014, performance targets had been set for 15,790,400 share options and, accordingly, those optionsfor the purchase of 21,885,713 shares, subject to vesting upon service period requirements for management and key employees being met and Sogou’s achievement of performance targets and, accordingly, such options were considered granted for purposes of recognition of share-based compensation expense. As of September 30, 2013, 10,040,650 share2014, options for the purchase of 15,733,513 shares had become vested and exercisable because both the service period and the performance requirements had been met, and a portion of such vested options, options for the vestedpurchase of 15,276,505 shares had been exercised.

8,270,000Of the granted share options, options for the purchase of 8,550,000 shares will become vested and exercisable in four or five equal installments, with (i) the first installment vesting upon Sogou’s completion of an initial public offeringIPO of its ordinary shares (“Sogou’s IPO”) and the expiration of all underwriters’ lockup periods applicable to theSogou’s IPO, and (ii) each of the three or four subsequent installments vesting on the first, second, third and, if applicable, fourth anniversary dates, respectively, of the closing of Sogou’s IPO.

The remaining 3,960,000granted share options, for the purchase of 3,960,000 Sogou ordinary shares, will become vested and exercisable in four equal installments, with (i) the first installment vesting upon the first anniversary of the occurrence of either of the following events (“Event”): (a) completion of Sogou’s IPO; (b) the consolidation of Sogou with or the acquisition of Sogou by another person or entity in a sale of all or substantially all of its assets or shares, and (ii) each of the three subsequent installments vesting on the second, third and fourth anniversary dates, respectively, of the occurrence of an Event. If there has not been an Event within 24 months fromafter June 15, 2013, (the “Vesting Cessation Date”), all installments of these remaining options for the remainingpurchase of 3,960,000 share optionsSogou ordinary shares will cease to vest.

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All installments of options for the 8,270,000purchase of 8,550,000 shares that are subject to vesting upon completion of Sogou’s IPO and options for the purchase of 3,960,000 share optionsshares that are subject to vesting upon the completion of Sogou’s IPO or an Event were considered granted upon the issuance of the options. The completion of a firm commitment IPO or such an Event is considered to be a performance condition of the awards. An IPO event or such another Event is not considered to be probable until it is completed. UnderASC 718, 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 related to these options until the completion of an IPO or the occurrence of an Event, and hence no share-based compensation expense was recognized for the three and nine months ended September 30, 20132014 for the 8,270,000 andoptions for the purchase of 8,550,000 shares that are subject to vesting upon completion of Sogou’s IPO or for the options for the purchase of 3,960,000 share optionsshares that are subject to vesting upon the completion of Sogou’s IPO or an Event.

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A summary of share option activity under the amended Sogou 2010 Stock Incentive Plan as of and for the nine months ended September 30, 20132014 is presented below:

 

        Weighted 
  Number Weighted   Average 
  Of Average   Remaining 
  Shares Exercise   Contractual 

Options

  (in thousands) Price   Life (Years)   Number Of
Shares
(in thousands)
 Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Life (Years)
 

Outstanding at January 1, 2013

   6,345   $0.001    

Outstanding at January 1, 2014

   17,953   $0.251    

Granted

   17,076   0.264       6,578   0.001    

Exercised

   (5,339 0.001       (5,242 0.001    

Forfeited or expired

   (96 0.001       (170 0.001    
  

 

      

 

    

Outstanding at September 30, 2013

   17,986    0.251     8.90  

Outstanding at September 30, 2014

   19,119    0.236     7.99  
  

 

      

 

    

Vested at September 30, 2013 and expected to vest thereafter

   5,641     

Vested at September 30, 2014 and expected to vest thereafter

   6,120     
  

 

      

 

    

Exercisable at September 30, 2013

   6     

Exercisable at September 30, 2014

   457     
  

 

      

 

    

For the three and nine months ended September 30, 2014, total share-based compensation expense recognized for share options under the Sogou 2010 Share Incentive Plan was $9.8 million and $10.7 million, respectively. For the three and nine months ended September 30, 2013, total share-based compensation expense recognized for share options under the amended Sogou 2010 Share Incentive Plan was $1.7 million and $1.8 million, respectively. For the three and nine months ended September 30, 2012, total share-based compensation expense recognized for share options under the Sogou 2010 Share Incentive Plan was $1.4 million and $2.4 million, respectively.

As of September 30, 2013,2014, there was $2.0$23.9 million of unrecognized compensation expense related to the unvested share options. The expense is expected to be recognized over a weighted average period of 0.270.26 years.

The fair value of the ordinary shares of Sogou was assessed using the income approach /discounted cash flow method, with a discount for lack of marketability, given that the shares underlying the award were not publicly traded at the time of grant, and was determined with the assistance of a qualified professional appraiser using management’s estimates and assumptions. This assessment required complex and subjective judgments regarding Sogou’s projected financial and operating results, its unique business risks, the liquidity of its ordinary shares and its operating history and prospects at the time the grants were made.

The fair value of the options granted to Sogou management and key employees was estimated on the date of grant using the Binomial option - pricing model (the “BP Model”) with the following assumptions used:

 

Granted to Employees

  

2013

2014

Average risk-free interest rate

  2.10%~2.87%2.62%-3.05%

Exercise multiple

  2~3

Expected forfeiture rate (Post-vesting)(post-vesting)

  1.3%0%~6.0%12%

Weighted average expected option life

  107.37

Volatility rate

  47.00%~49.00%52%-54%

Dividend yield

  0%

Fair value

  0.675.85

Sogou estimated the risk freerisk-free rate based on the yield to maturitymarket yields of China Sovereign bonds denominated in United States dollarsU.S. Treasury securities with an estimated country-risk differential as of the valuation date. An exercise multiple was estimated as the ratio of the fair value of the shares over the exercise price as of the time the option is exercised, based on consideration of research studies regarding exercise patterns based on historical statistical data. In Sogou’s valuation analysis, a multiple of two was applied for employees and a multiple of three was applied for management. Sogou estimated the forfeiture rate to be 1.3%0% or 1% for Sogou management’s share options granted as of September 30, 20132014 and 6.0%12% for Sogou employees’ share options granted as of September 30, 2013.2014. The life of the share options is the contract life of the option. Based on the option agreement, the contract life of the option is 10 years. The expected volatility at the valuation date was estimated based on the historical volatility of comparable companies for the period before the grant date with length commensurate with the expected term of the options. Sogou has no history or expectation of paying dividends on its ordinary shares. Accordingly, the dividend yield is estimated to be 0%.

 

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Share-based Awards to Sohu managementManagement

Under the Sohu Management Sogou Share Option Arrangement, which was approved by the Boardboards of Directorsdirectors of Sohu and Sogou in March 2011, Sohu has the right to provide to Sohu management and key employees the opportunity to purchase from Sohu up to 12,000,000 ordinary shares of Sogou at a fixed exercise price of $0.625 per share. Of these 12,000,000 ordinary shares, 8,800,000 are Sogou ordinary shares previously held by Sohu and 3,200,000 are Sogou ordinary shares that were newly-issued on April 14, 2011 by Sogou to Sohu at a price of $0.625 per share, or a total of $2 million. As of September 30, 2013,2014, Sohu had issuedgranted options for the purchase of 11,378,50010,763,000 Sogou ordinary shares to Sohu management and key employees under this arrangement.the Sohu Management Sogou Share Option Arrangement.

Of the 11,378,500 issued sharegranted options 8,978,500 sharefor the purchase of 10,763,000 shares, options for the purchase of 8,363,000 shares will become vested and exercisable in four equal installments, with each installment vesting upon a service period requirement for management and key employees being met, as well as Sogou’s achievement of performance targets for the corresponding period. The performance target for each installment will be set at the beginning of each vesting period; therefore,period. Accordingly, for purposes of recognition of share-based compensation expense, each installment is considered to be granted atas of that date. As of September 30, 2013,2014, performance targets had been set for 6,585,750 share options and, accordingly, those optionsfor the purchase of 8,208,000 shares vesting upon service period requirements for management and key employees being met and Sogou’s achievement of performance targets and, accordingly, such share options were considered granted. As of September 30, 2013, 5,105,500 share2014, options for the purchase of 6,585,750 shares had become vested and exercisable because both the service period and the performance requirements had been met, and allvested options for the purchase of the vested6,378,500 shares had been exercised.

The remaining options for the purchase of 2,400,000 share optionsshares will become vested and exercisable in five equal installments, with (i) the first installment vesting upon Sogou’s IPO and the expiration of all underwriters’ lockup periods applicable to the IPO, and (ii) each of the four subsequent installments vesting on the first, second, third and fourth anniversary dates, respectively, of the closing of Sogou’s IPO. All installments of the options for the purchase of 2,400,000 share optionsshares that are subject to vesting upon the completion of Sogou’s IPO were considered granted upon the issuance of the options. 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. UnderASC 718, 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 related to these options until the completion of an IPO, and hence no share-based compensation expense was recognized for the three and nine months ended September 30, 2013,2014 for these options for the purchase of 2,400,000 share options that are subject to vesting upon the completion of Sogou’s IPO.shares.

A summary of share option activity as of and for the nine months ended September 30, 20132014 is presented below:

 

        Weighted 
  Number Weighted   Average 
  Of Average   Remaining 
  Shares Exercise   Contractual 

Options

  (in thousands) Price   Life (Years)   Number
Of
Shares
(in thousands)
 Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Life (Years)
 

Outstanding at January 1, 2013

   2,178   $ 0.625    

Outstanding at January 1, 2014

   3,880   $0.625    

Granted

   4,638   0.625       1,623   0.625    

Exercised

   (2,936 0.625       (1,273 0.625    

Forfeited or expired

   0        0     
  

 

      

 

    

Outstanding at September 30, 2013

   3,880    0.625     8.74  

Outstanding at September 30, 2014

   4,230    0.625     7.68  
  

 

      

 

    

Vested at September 30, 2013 and expected to vest thereafter

   1,475     

Vested at September 30, 2014 and expected to vest thereafter

   1,696     
  

 

      

 

    

Exercisable at September 30, 2013

   0     

Exercisable at September 30, 2014

   207     
  

 

      

 

    

For the three months and the nine months ended September 30, 2014, total share-based compensation expense recognized for share options under the Sohu Management Sogou Share Option Arrangement was $2.3 million and $3.6 million, respectively. For both the three months and the nine months ended September 30, 2013, total share-based compensation expense recognized for share options under the Management Share Option Arrangement was $0.5 million and $0.5 million, respectively. For the three months and the nine months ended September 30, 2012, total share-based compensation expense recognized for share options under the Management Share Option Arrangement was $200,000 and $382,000, respectively.million.

As of September 30, 2013,2014, there was $0.3$5.5 million of unrecognized compensation expense related to the unvested Sogou share options. The expense is expected to be recognized over a weighted average period of 0.25 years.

 

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The method used to determine the fair value of share options granted to Sohu management and key employees was the same as the method used for the share options granted to Sogou’s management and key employees as described above, except for the assumptions used in the BP Model as presented below:

 

Granted to Employees

  

2013

2014

Average risk-free interest rate

  2.10%~2.87%2.62%-2.93%

Exercise multiple

  2~3

Expected forfeiture rate (Post-vesting)(post-vesting)

 0%-8%

Weighted average expected option life

  106.79

Volatility rate

  47.00%-48.00%52%-54%

Dividend yield

  0%

Fair value

  0.27-0.385.23

Option Modification

In the first and second quarter of 2013, a portion of the share options granted under the amended Sogou 2010 Share Incentive Plan and the Sohu Management Sogou Share Option Arrangement were exercised early, and the resulting Sogou ordinary shares were transferred to a trusttrusts with the original option grantees as beneficiaries. The trusttrusts will distribute the shares to those beneficiaries in installments based on the vesting requirements under the original option agreements. Although thisthese trust arrangementarrangements caused a modification of the terms of these share options, the modification was not considered substantive; thereforesubstantive. Accordingly, no incremental fair value related to these shares resulted from the modification, and the remaining share-based compensation expense for these shares will continue to be recognized over the original remaining vesting period.

As of September 30, 2013, 19,245,000 share2014, options for the purchase of 15,320,000 shares granted under the amended Sogou 2010 Share Incentive Plan and 1,225,000 share options for the purchase of 612,500 shares granted under the Sohu Management Sogou Share Option Arrangement, or options for the purchase of a total of 20,470,00015,932,500 shares, had been exercised early but had not been distributed to the beneficiaries of the trusts. All of the early-exercised shares that were distributed to those beneficiaries by the trusts in accordance with the vesting requirements under the original option agreements have been included in the disclosures under the headings “Sogou 2010 Share Incentive Plan” and “Share-based Awards to Sohu Management” above.

Tencent Share-based Awards Granted to Employees Who Transferred to Sogou with Soso Search-related Businesses

Certain persons who became Sogou employees when Tencent’s Soso search-related businesses were transferred to Sogou on September 16, 2013 had been granted restricted share options,units under Tencent’s share award arrangements prior to the transfer of the businesses to Sogou. These Tencent restricted share units will continue to vest under the original Tencent share award arrangements provided the transferred employees continue to be employed by Sogou during the requisite service period. After the transfer of the Soso search-related businesses to Sogou, Sogou applied the guidance inASC 505-50 to measure the related compensation expense, based on the then-current fair value at each reporting date, which is deemed to have been incurred by Tencent as an investor on Sogou’s behalf. To determine the then-current fair value of the Tencent restricted share units granted to these employees, the public market price of the underlying shares at each reporting date was applied. Because Sogou is not required to reimburse Tencent for such share-based compensation expense, the related amount was recorded by Sogou as a capital contribution from Tencent.

As of September 30, 2014, unvested Tencent restricted share unit awards held by these employees provided for the issuance of up to 428,300 ordinary shares of Tencent, taking into consideration a five-for-one split of Tencent’s shares that became effective in May 2014. Share-based compensation expense of $1.0 million and $4.6 million, respectively, related to these Tencent restricted share units was recognized in the Group’s consolidated statements of comprehensive income for the three and nine months ended September 30, 2014. As of September 30, 2014, there was $3.4 million of unrecognized compensation expense related to these unvested restricted share units. This amount is expected to be recognized over a weighted average period of 2.84 years.

Sogou Share Repurchase Transaction

In June 2014, Sogou repurchased approximately 4.2 million of its Class A Ordinary Shares from noncontrolling shareholders, some of whom were exercised early.employees of the Group, for an aggregate repurchase price of $41.6 million, which exceeded the fair value of the ordinary shares. UnderASC 718, the excess of the repurchase price over the fair value of the equity instruments repurchased from employees should be recognized as additional compensation expense. Therefore, in the second quarter of 2014, approximately $17.0 million of share-based compensation expense was recognized in the Sohu Group’s statements of comprehensive income as share-based compensation expense in connection with the repurchases.

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4) Sohu Video Share-based Awards

On January 4, 2012, Sohu Video adopted the Video 2011 Share Incentive Plan, under which 25,000,000 ordinary shares of Sohu Video are reserved for the purpose of making share incentive awards to management and key employees of the video division and to Sohu management. The maximum term of any share incentive award granted under the Video 2011 Share Incentive Plan is ten years from the grant date. The Video 2011 Share Incentive Plan will expire on January 3, 2021. As of September 30, 2014, grants of options for the purchase of 16,368,200 ordinary shares of Sohu Video had been made under the Video 2011 Share Incentive Plan, and options for the purchase of 4,972,800 ordinary shares were vested.

For the three months and the nine months ended September 30, 2014, total share-based compensation expense recognized for vested options under the Video 2011 Share Incentive Plan was negative $0.1 million and positive $ 4.1 million, respectively.

The method used to determine the fair value of share options granted was the same as the method used for the share options granted to Sogou’s management and key employees as described above, except for the assumptions used in the BP Model as presented below:

Assumptions Adopted

2014

Average risk-free interest rate

2.81%

Exercise multiple

2.8

Expected forfeiture rate (post-vesting)

10%

Weighted average expected option life

7.3

Volatility rate

61%

Dividend yield

0%

Fair value

0.82

5) 7Road Share-based Awards

See Note 3 - 3—Share-Based Compensation Expense.

11.12. Business Transactions

Sogou Transactions

Sogou-Tencent Transactions

On October 22, 2010, Sogou issued and sold 24.0 million, 14.4 million and 38.4 million, respectively, of its newly-issued Series A Preferred Shares to Alibaba Investments Limited (“Alibaba”), China Web and Photon for $15 million, $9 million, and $24 million, respectively. On June 29, 2012, Sohu purchased Alibaba’s 24.0 million Sogou Series A Preferred Shares for a purchase price of $25.8 million.

On September 16, 2013, Sogou entered into a series of agreements with Tencent, Sohu Search and Photon pursuant to which Sogou issued Series B Preferred Shares and Class B Ordinary Shares to Tencent for a net amount of $448 million in cash and Tencent transferred its Soso search-related businesses and certain other assets to Sogou. Also on that date, Sogou entered into Repurchase Option Agreements with Sohu Search and Photon, and a Repurchase/Put Option Agreement with China Web, with respect to all of the Series A Preferred Shares of Sogou held by Sohu Search and China Web, and a portion of the Series A Preferred Shares of Sogou held by Photon. On September 17, 2013, Sogou paid a special dividend to the three holders of Series A Preferred Shares of Sogou in anthe aggregate amount of $301 million, of which Sohu Search received $161 million, Photon received $43 million, and China Web received $97 million. See Note 1 - The CompanyOn December 2, 2013, Tencent invested $1.5 million in cash in Sogou’s VIE Sogou Information, as additional consideration for the Sogou-Tencent Transactions, in return for a 45% equity interest in Sogou Information. Through a share pledge agreement and Basisan exclusive equity interest purchase right agreement between Tencent and Sogou Technology, and similar agreements between the other two shareholders of Presentation.Sogou Information, Sogou Technology controls all shareholder voting rights in Sogou Information, has the power to direct the activities of Sogou Information, and is the primary beneficiary of Sogou Information, and Tencent and the other two shareholders of Sogou Information act as Sohu Technology’s nominees.

On March 24, 2014, Sogou purchased from China Web, pursuant to the Repurchase/Put Option Agreement between Sogou and China Web, 14.4 million Series A Preferred Shares of Sogou, for an aggregate purchase price of $47.3 million.

In June 2014, Sogou repurchased approximately 4.2 million of its Class A Ordinary Shares from noncontrolling shareholders, some of whom are employees of the Group, for an aggregate purchase price of $41.6 million.

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Sohu’s Shareholding in Sogou

As of September 30, 2013,2014, Sogou had outstanding a combined total of 370,771,658357,445,588 ordinary shares and preferred shares, consisting of shares held as follows:

 

(i)Sohu: 134,107,750 Class A Ordinary Shares and 24,000,000 Series A Preferred Shares. Of the Class A Ordinary Shares, 6,907,750 shares are subject to purchase under options held by Sohu management and key employees. All of the 24,000,000 Series A Preferred Shares are subject to repurchase by Sogou commencing March 16, 2014;

132,834,750 Class A Ordinary Shares and 24,000,000 Series A Preferred Shares. Of the Class A Ordinary Shares, 5,634,750 shares are subject to purchase from Sohu under options held by Sohu management and key employees. All of the 24,000,000 Series A Preferred Shares are subject to repurchase by Sogou commencing March 16, 2014;

 

(ii)Photon: 38,400,000 Series A Preferred Shares, of which 6,400,000 are subject to repurchase by Sogou commencing March 16, 2014;

38,400,000 Series A Preferred Shares, of which 6,400,000 are subject to repurchase by Sogou commencing March 16, 2014;

 

(iii)China Web: 14,400,000 Series A Preferred Shares, all of which are subject to China Web’s right to put the shares to Sogou at any time prior to July 31, 2014 and all of which are subject to repurchase by Sogou at any time from March 16, 2014 to July 31, 2014;Tencent:

6,757,875 Class A Ordinary Shares, 65,431,579 Series B Preferred Shares and 79,368,421 non-voting Class B Ordinary Shares; and

 

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(iv)Tencent: 79,368,421 non-voting Class B Ordinary Shares and 65,431,579 Series B Preferred Shares; and

(v)CertainVarious employees of Sogou and Sohu: 15,063,90810,652,963 Class A Ordinary Shares.

AsSince Sohu controls the election of the Board of Directors of Sogou, Sohu is Sogou’s controlling shareholder,shareholder. Therefore, Sohu consolidates Sogou in the Sohu Group’s consolidated financial statements, and recognizes noncontrolling interest reflecting economic interests in Sogou held by shareholders other than Sohu.

As of September 30, 2013, a portion of Sogou options granted to Sogou and Sohu top management and key employees were still unvested and were settable upon the achievement of different vesting conditions. Because no ordinary shares will be issued with respect to share options granted by Sogou until they are vested and exercised, the share options granted by Sogou that have not vested and vested share options that have not yet been exercised are not included as outstanding shares of Sogou and have no impact on the Sohu Group’s basic net income per share. Unvested share options with the performance targets achieved and vested share options that have not yet been exercised do, however, have a dilutive impact on the Sohu Group’s dilutive net income per share. See Note 15 - 16—Net Income /(Loss) per Share.

Terms of Sogou Preferred Shares of Sogou

In connection with the Sogou-Tencent Transactions, Sogou’s shareholders adopted a Fifth Amended and Restated Memorandum of Association and Second Amended and Restated Articles of Association (together, the “Revised Sogou Memorandum and Articles”), which became effective on September 16, 2013. The following is a summary of some of the key terms of the Sogou Series A Preferred Shares and Series B Preferred Shares (collectively, the “Preferred“Sogou Preferred Shares”) under the Revised Sogou Memorandum and Articles.

Dividend Rights

Sogou may not declare or pay dividends on its Class A Ordinary Shares or Class B Ordinary Shares (collectively, “Ordinary Shares”) unless the holders of the Sogou Preferred Shares then outstanding first receive a dividend on each outstanding Preferred Share in an amount at least equal to the sum of (i) the dividends that would have been payable to the holder of such Preferred Share if such share had been converted into Ordinary Shares, at the then-applicable conversion rate, immediately prior to the record date for such dividend, and (ii) all accrued and unpaid Accruing Dividends. “Accruing Dividends” are calculated from the date of issuance of the Series A Preferred Shares at the rate per annum of $0.0375 per Series A Preferred Share and from the date of issuance of the Series B Preferred Shares at the rate per annum of $0.411 per Series B Preferred Share.

Liquidation Rights

In the event of any “Liquidation Event,” such as the liquidation, dissolution or winding up of Sogou, a merger or consolidation of Sogou resulting in a change of control, the sale of substantially all of Sogou’s assets or similar events, the holders of Series B Preferred Shares are entitled to receive an amount per share equal to the greater of (i) $6.847 plus any unpaid Accruing Dividends or (ii) such amount per share as would have been payable if the Series B Preferred Shares had been converted into Ordinary Shares prior the Liquidation Event, and holders of Series A Preferred Shares are entitled to receive, after payment to the holders of the Series B Preferred Shares but before any payment to holders of Ordinary Shares, an amount equal to the greater of (i) 1.3 times their original investment in the Series A Preferred Shares plus all accrued but unpaid Accruing Dividends or (ii) such amount per share as would be payable if the Series A Preferred Shares had been converted into Ordinary Shares immediately prior to the Liquidation Event.

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Redemption Rights

The Sogou Preferred Shares are not redeemable at the option of the holders.

Conversion Rights

Each Sogou Preferred Share is convertible, at the option of the holder, at any time, and without the payment of additional consideration by the holder. Each Sogou Preferred Share is convertible into such number of Class A Ordinary Shares as is determined, in the case of Series A Preferred Shares, by dividing $0.625 by the then-effective conversion price for Series A Preferred Shares, which is initially $0.625, and, in the case of Series B Preferred Shares, by dividing $7.267 by the then-effective conversion price for Series B Preferred Shares, which is initially $7.267. The conversion prices of the Sogou Preferred Shares are subject to adjustment on a weighted average basis upon the issuance of additional equity shares, or securities convertible into equity shares, at a price per share less than $0.625, in the case of Series A Preferred Shares, or less than $7.267, in the case of Series B Preferred Shares, subject to certain customary exceptions, such as shares issued pursuant to the amended Sogou 2010 Share Incentive Plan. Each Sogou Preferred Share will be automatically converted into Class A Ordinary Shares of Sogou upon the closing of a qualified initial public offeringIPO of Sogou based on the then-effective conversion ratio of such Sogou Preferred Share, which is currently one-for-one for both Series A Preferred Shares and Series B Preferred Shares.

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Voting Rights

Each holder of Sogou Preferred Shares is entitled to cast the number of votes equal to the number of Class A Ordinary Shares into which the Sogou Preferred Shares held by such holder are then convertible.

Other Rights

The holders of Sogou Preferred Shares have various other rights typical of preferred share investments.

Terms of Sogou Class A Ordinary Shares and Class B Ordinary Shares of Sogou

The Class A Ordinary Shares and Class B Ordinary Shares have rights identical to those of the Class A Ordinary Shares,rights, except that Class B Ordinary Shares do not have voting rights unless the holders of at least a majority of the then outstanding Class B Ordinary Shares elect, by written notice to Sogou, to convert them into shares with voting rights.

7RoadChangyou Share Repurchase Transactions

On May 1,July 27, 2013, Changyou’s Board of Directors authorized a share repurchase program of up to $100 million of the outstanding ADSs of Changyou over a two-year period from July 27, 2013 to July 26, 2015. During the nine months ended September 30, 2014, Changyou did not repurchase any of its ADSs under the share repurchase program.

13. Business Combination

On July 16, 2014, Changyou, through a wholly-owned subsidiary, entered into an investment agreement with MoboTap Inc. (“MoboTap”), a Cayman Islands company which is the mobile technology developer behind the Dolphin Browser, MoboTap’s subsidiaries and variable interest entities, and MoboTap’s shareholders pursuant to acquire allwhich Changyou agreed to purchase from existing shareholders of MoboTap shares of MoboTap representing 51% of the ordinary sharesequity interests in MoboTap on a fully-diluted basis for approximately $91 million in cash. In addition, Changyou has the right to purchase up to 10% of 7Road held bythe equity interests in MoboTap from the noncontrolling shareholders, at a price of 20% below the IPO price, before a qualified IPO of MoboTap. If MoboTap achieves specified performance milestones for 2016 and certain other conditions specified in the shareholder agreement, including the completion of an IPO, are not met, the noncontrolling shareholders of MoboTap will have a one-time right to put to Changyou shares of MoboTap held by them, representing 28.074%up to 15% of the outstanding share capitalequity interests in MoboTap, for an aggregate price of 7Road, for aggregate cash consideration of approximately $78up to $53 million. The acquisition closed on June 5, 2013. Effective with the closing, 7Road became an indirect wholly-owned subsidiary of Changyou, and Changyou’s VIE Gamease became the sole shareholder of 7Road’s VIE Shenzhen 7Road. As of September 30, 2013, Changyou had paid $76 million of the total cash consideration. The remaining $2 million will be settled in June 2014.

12. Business Combination

On September 16, 2013, as part of the Sogou-Tencent Transactions, Sogou acquired from certain subsidiaries of Tencent, Shi Ji Guang Su, which conducts Soso search-related businesses, and other related assets, for cash consideration of approximately $27.6 million (the “Shi Ji Guang Su Acquisition”). As of September 30, 2013, Sogou had paid $3.3 million of the consideration. The remaining amount will be settled prior to March 16, 2014. The Sohu Group began to consolidate Shi Ji Guang Su’sMoboTap’s financial statements commencing September 16, 2013.with the acquisition.

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On the acquisition date, the allocation of the consideration of the assets acquired and liabilities assumed based on their fair valuevalues was as follows (in thousands):

 

   As of September 16, 2013 

Cash

  $3,249  

Receivables

   7,967  

Fixed assets acquired

   21,964  

Goodwill

   2,405  

Identifiable intangible assets acquired

   5,686  

Liabilities

   (13,653
  

 

 

 

Total

  $27,618  
  

 

 

 
   As of July 31, 2014 

Cash consideration

  $90,830  
  

 

 

 

Repurchase option

   793  

Identifiable intangible assets acquired

   27,000  

Goodwill

   113,040  

Other assets

   6,714  

Put option

   (298

Liabilities assumed

   (2,995

Noncontrolling interest

   (53,424
  

 

 

 

Total

  $90,830  
  

 

 

 

The fixed assets acquired in the Shi Ji Guang Su Acquisition consist primarily of computer equipment and hardware. The identifiable intangible assets represent the Dolphin Browser user base, technology and trademark, the useful lives of which were 2.4 years, 5.4 years and 10.4 years, respectively. The acquired inuser base was valued with the Shi Ji Guang Su Acquisition consist primarily of developed technologies, trademarkscost approach, and domain names. These identifiable intangible assetsthe acquired technology and trademark were valued usingwith the income approach. The excessGoodwill of $113 million primarily represents the purchase price over identifiable tangibleexpected synergies from combining the operations of Changyou and intangible assets acquired and identifiable liabilities assumed was recorded asMoboTap, which are complementary to each other. In accordance withASC 350, goodwill which is not amortized but is tested for impairment.impairment and is not deductible for tax purposes. As of September 30, 2014, no measurement period adjustment had been recorded.

Based on an assessment of the acquired company’sMoboTap’s financial performance, the acquired companyMoboTap is not considered material to the Sohu Group. Thus the Sohu Group’s management concluded that the presentation of pro forma financial information with respect to the results of operations of the Sohu Group including the acquired companyMoboTap is not necessary. As the Dolphin Browser serves as an important entrance point for Changyou to accumulate traffic from users of mobile devices, which is complementary to Changyou’s game business, MoboTap will be reported under the online game segment.

13.14. Mezzanine Equity

Mezzanine Equity consistsconsisted of the noncontrolling interest in 7Road and a put option pursuant to which the former noncontrolling shareholders would have had the right to put their ordinary shares in 7Road to Changyou at a pre-determined price if 7Road had achieved specified performance milestones before the expiration of the put option and 7Road did not complete an IPO on NASDAQ, the NYSENew York Stock Exchange (the “NYSE”) or the HKEX.Stock Exchange of Hong Kong (the “HKEX”). The put option was due to expire in 2014. Since the occurrence of the sale was not solely within the control of Changyou, the noncontrolling interest was classified as mezzanine equity instead of permanent equity in the Sohu Group’s and Changyou’s consolidated financial statements.

-40-


UnderASC 480-10, the Sohu Group calculates,calculated, 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 iswas adjusted by an accumulative amount equal to the higher of (i) and (ii).

On May 1, 2013, Changyou entered into an agreement to acquire all of the ordinary shares of 7Road held by the noncontrolling shareholders. The acquisition closed on June 5, 2013. UnderASC 810-10, changes in2013, and 7Road has been a parent’s ownershipwholly-owned subsidiary of Changyou since then. As the put option held by the owners of the noncontrolling 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. Followinglapsed upon the closing of theChangyou’s acquisition $2.4 million, representing the excess of the amount of the mezzanine-classified noncontrolling interesttheir shares in 7Road, overthere was no associated accretion and no mezzanine equity during and after the purchase price asthird quarter of the closing date, was recorded in the Sohu Group’s equity accounts.2013.

For the three and nine months ended September 30, 2013, accretion charges of nil and $17.8 million, respectively, compared to $4.5 million and $6.7 million, respectively, for the three and nine months ended September 30, 2012, were recorded in the Sohu Group’s statements of comprehensive income as net income attributable to the mezzanine-classified noncontrolling interest shareholders of 7Road. There was no associated accretion in 2014, as no mezzanine equity existed after Changyou’s acquisition on June 5, 2013 of all of the ordinary shares of 7Road held by the noncontrolling shareholders.

14.15. Noncontrolling Interest

The primary majority-owned subsidiaries and VIEs of the Sohu Group which are consolidated in its consolidated financial statements but with noncontrolling interest recognized are Changyou and Sogou.

-45-


Noncontrolling Interest for Changyou

As Sohu is Changyou’s controlling shareholder, Changyou’s financial results have been consolidated with those of Sohu for all periods presented. To reflect the economic interest in Changyou held by shareholders other than Sohu (the “Changyou noncontrolling shareholders”), Changyou’s net income /(loss) attributable to the Changyou noncontrolling shareholders is recorded as noncontrolling interest in the Sohu Group’s consolidated statements of comprehensive income, based on their share of the economic interest in Changyou. Changyou’s cumulative results of operations attributable to the Changyou 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, are recorded as noncontrolling interest in the Sohu Group’s consolidated balance sheets.

Noncontrolling Interest for Sogou

AsSince Sohu controls the election of the Board of Directors of Sogou, Sohu is Sogou’s controlling shareholder,shareholder. Therefore, Sogou’s financial results have been consolidated with those of Sohu for all periods presented. To reflect the economic interest in Sogou held by shareholders other than Sohu (the “Sogou noncontrolling shareholders”), Sogou’s net income /(loss) attributable to the Sogou noncontrolling shareholders is recorded as noncontrolling interest in the Sohu Group’s consolidated statements of comprehensive income. Sogou’s cumulative results of operations attributable to the Sogou 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 the Sogou noncontrolling shareholders’ original investments in Series A Preferred Shares, Series BSogou Preferred Shares and Class B Ordinary Shares are accounted for as a noncontrolling interest classified as permanent equity in the Sohu Group’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, and on the terms of the classes of Sogou shares held, by the Sogou noncontrolling shareholders in the Preferred Shares of Sogou (the “Terms of Preferred Shares of Sogou”), the terms of Sogou’s restructuring in 2010, Sohu’s purchase of Sogou Series A Preferred Shares from Alibaba, and the terms of Class B Ordinary Shares of Sogou.

By virtue of these terms, as Sogou has been losing money since its restructuring in 2010, the netSogou’s losses have been and will be allocated in the following order:

 

(i)net losses were allocated to holders of Sogou Class A Ordinary Shares and the holder of Sogou Class B Ordinary Shares until their basis in Sogou decreased to zero;

 

(ii)additional net losses were allocated to holders of Sogou Series A Preferred Shares until their basis in Sogou decreased to zero;

 

(iii)additional net losses will be allocated to the holder of Sogou Series B Preferred Shares until its basis in Sogou decreases to zero; and

 

(iv)further net losses will be allocated between Sohu and noncontrolling shareholders based on their shareholding percentage in Sogou.

-41-


Any subsequentNet income from Sogou has been, and future net income from Sogou will be, allocated in the following order:

 

(i)net income will be allocated between Sohu and noncontrolling shareholders based on their shareholding percentage in Sogou until their basis in Sogou increases to zero;

 

(ii)additional net income will be allocated to the holder of Sogou Series B Preferred Shares to bring its basis back;

 

(iii)additional net income will be allocated to holders of Sogou Series A Preferred Shares to bring their basis back;

 

(iv)further net income will be allocated to holders of Sogou Class A Ordinary Shares and the holder of Sogou Class B Ordinary Shares to bring their basis back; and

 

(v)further net income will be allocated between Sohu and noncontrolling shareholders based on their shareholding percentage in Sogou.

Noncontrolling Interest in the Consolidated Balance Sheets

As of September 30, 20132014 and December 31, 2012,2013, noncontrolling interest in the consolidated balance sheets was $481.8$472.4 million and $231.0$510.0 million, respectively.

 

  As of   As of 
  September 30, 2013
(in thousands)
   December 31, 2012
(in thousands)
   September 30, 2014
(in thousands)
   December 31, 2013
(in thousands)
 

Changyou

  $279,065    $203,995    $351,703    $307,898  

Sogou

   200,314     24,645     120,743     199,059  

Others

   2,446     2,354     0     3,058  
  

 

   

 

   

 

   

 

 

Total

  $481,825    $230,994    $472,446    $510,015  
  

 

   

 

   

 

   

 

 

-46-


Noncontrolling Interest of Changyou

As of September 30, 20132014 and December 31, 2012,2013, the noncontrolling interest of Changyou of $279.1 million and $204.0 million, respectively, was recognized in the Sohu Group’s consolidated balance sheets, representing as of both dates a 32% economic interest in Changyou’s net assets held by shareholders other than Sohu and reflecting the reclassification of Changyou’s share-based compensation expense from shareholders’ additional paid-in capital to noncontrolling interest.

Noncontrolling Interest of Sogou

As of September 30, 20132014 and December 31, 2012,2013, the noncontrolling interest of Sogou of $200.3 million and $24.6 million, respectively, was recognized in the Sohu Group’s consolidated balance sheets, representing Sogou’s cumulative results of operations attributable to shareholders other than Sohu, Sogou’s share-based compensation expense, and the investments of shareholders other than Sohu in Series A Preferred Shares, Series B Preferred Shares and Class B Ordinary Shares of Sogou, and the adjustment of the investment basis of shareholders other than Sohu due to the special dividend paid to holders of Series A Preferred Shares of Sogou on September 17, 2013. The increase from December 31, 2012 to September 30, 2013, was mainly due to the net impactrepurchase of Tencent’s investment in Sogou on September 16, 2013, and the adjustment of the investment basis of shareholders other than Sohu due to the special dividend paid to holders of Series A Preferred Shares from China Web on March 24, 2014, and Sogou’s repurchase of Sogou on September 17, 2013.Class A Ordinary Shares from noncontrolling shareholders in June 2014.

Noncontrolling Interest in the Consolidated Statements of Comprehensive Income

For the three and nine months ended September 30, 2013,2014, net incomeloss attributable to the noncontrolling interestsinterest in the consolidated statements of comprehensive income was $22.9$4.8 million and $70.4$19.1 million, respectively, compared with $21.1net income attributable to noncontrolling interest of $22.9 million and $57.6$70.4 million, respectively, for the three months and nine months ended September 30, 2012.2013.

 

   Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
   2013  2012  2013  2012 

Changyou

  $23,596   $23,410   $73,486   $65,425  

Sogou

   (1,143  (2,232  (3,109  (7,780

Others

   402    (32  49    (27
  

 

 

  

 

 

  

 

 

  

 

 

 

Total

  $22,855   $21,146   $70,426   $57,618  
  

 

 

  

 

 

  

 

 

  

 

 

 

-42-


   Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
   2014  2013  2014  2013 

Changyou

  $(783 $23,596   $(7,191 $73,486  

Sogou

   (3,977  (1,143  (12,712  (3,109

Others

   0    402    765    49  
  

 

 

  

 

 

  

 

 

  

 

 

 

Total

  $(4,760 $22,855   $(19,138 $70,426  
  

 

 

  

 

 

  

 

 

  

 

 

 

Noncontrolling Interest of Changyou

For the three months ended September 30, 2014 and 2013, net loss and 2012, $23.6 million and $23.4 million, respectively, in net income, respectively, attributable to the noncontrolling interest of Changyou, representing the 32% economic interest in Changyou attributable to shareholders other than Sohu for both periods, was recognized in the Sohu Group’s consolidated statements of comprehensive income, representing a 32% economic interest in Changyou attributable to shareholders other than Sohu.income.

Noncontrolling Interest of Sogou

For the three months ended September 30, 20132014 and 2012, $1.1 million and $2.2 million, respectively, in2013, net loss attributable to the noncontrolling interest of Sogou was recognized in the Sohu Group’s consolidated statements of comprehensive income, representing Sogou’s net loss attributable to shareholders other than Sohu.

15.16. Net Income /(Loss) per Share

Basic net income /(loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income /(loss) 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 /(loss) 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 /(loss) per share. For the three and nine months ended September 30, 2014, 99,000 and 114,000, respectively, common shares potentially issuable upon the exercise or settlement of share-based awards using the treasury stock method were anti-dilutive and excluded from the denominator for calculation of diluted net loss per share.

-47-


Additionally, for purposes of calculating the numerator of diluted net income /(loss) per share, the net income /(loss) attributable to the Sohu Group is adjusted as follows:follows. The adjustment will not be made if there is an anti-dilutive effect.

 

(1)Changyou’s net income /(loss) attributable to the Sohu Group 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 ofand not by using the percentage held by Sohu of the total economic interest in Changyou, which is used for the calculation of basic net income per share.

For the third quarter of 2013, the percentage used for the calculation of basic and dilutive net income per share was 67.6% and 67.2%, respectively. In the calculation of the Sohu Group’s diluted net income /(loss) per share, assuming a dilutive effect, all of Changyou’s existing unvested restricted share units, and vested restricted share units that have not yet been settled, are treated as vested and settled by Changyou under the treasury stock method, causing the percentage of the weighted average number of shares held by Sohu in Changyou to decrease from 67.6% to 67.2%.decrease. As a result, Changyou’s net income /(loss) attributable to the Sohu Group on a diluted basis decreased accordingly. The effect of this calculation is presented as “incremental dilution from Changyou” in the table below. Assuming an anti-dilutive effect, all of these Changyou restricted share units are excluded from the calculation of the Sohu Group’s diluted net income /(loss) per share. As a result, Changyou’s net income /(loss) attributable to the Sohu Group on a diluted basis equals the number used for the calculation of the Sohu Group’s basic net income /(loss) per share.

For the three months ended September 30, 2014, all of these Changyou restricted share units had a dilutive effect, and therefore were included in the calculation of the Sohu Group’s diluted net loss per share. This impact is presented as “incremental dilution from Changyou” in the table below.

For the nine months ended September 30, 2014, all of these Changyou restricted share units had an anti-dilutive effect, and therefore were excluded in the calculation of the Sohu Group’s diluted net loss per share, and “incremental dilution from Changyou” in the table below was zero.

 

(2)Sogou’s net income /(loss) attributable to the Sohu Group 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, Series A Preferred Shares Series B Preferredand Ordinary 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 ofand is not determined by allocating Sogou’s net income /(loss) allocated to the Sohu Group by virtue ofusing the Terms of Preferred Shares of Sogou, the terms of Sogou’s restructuring in 2010, Sohu’s purchase of Sogou Series A Preferred Shares from Alibaba, and the terms of Class B Ordinary Shares of Sogou, which is usedmethodology for the calculation of basic net income per share./(loss) attributable to the Sogou noncontrolling shareholders discussed in Note 15—Noncontrolling Interest.

In the calculation of the Sohu Group’s basicdiluted net income per share, Sogou’s net income /(loss) attributable to the Group is determined according to the Terms of Preferred Shares of Sogou, the terms of Sogou’s restructuring in 2010, Sohu’s purchase of Sogou Series A Preferred Shares from Alibaba, and the terms of Class B Ordinary Shares of Sogou. For the third quarter of 2013, in the calculation of the Sohu Group’s diluted net income per share, assuming a dilutive effect, the percentage of 63%the Sohu Group’s shareholding in Sogou was calculated by treating convertible preferred shares issued by Sogou as having been converted at the beginning of the period and unvested share options with the performance targets achieved as well as vested but unexercised share options as having been exercised during the period. The dilutive effect of share-based awards with a performance requirement was not considered before the performance targets were actually met. The above differenceeffect of this calculation is presented as “incremental dilution from Sogou” in the table below. Assuming an anti-dilutive effect, all of these Sogou shares and share options are excluded from the calculation of the Sohu Group’s diluted income /(loss) per share. As a result, Sogou’s net income /(loss) attributable to the Sohu Group on a diluted basis equals the number used for the calculation of the Sohu Group’s basic net income /(loss) per share.

For the three and nine months ended September 30, 2014, all of these Sogou shares and share options had a dilutive effect, and therefore were included in the calculation of the Sohu Group’s diluted net loss per share. This impact is presented as “incremental dilution from Sogou” in the table below.

As discussed in Note 1 - 1—The Company and Basis of Presentation, on June 29, 2012, SohuMarch 24, 2014 Sogou purchased 24from China Web 14.4 million Sogou Series A Preferred Shares from Alibaba, and thisof Sogou for an aggregate purchase price of $47.3 million. The transaction gave rise to a deemed dividend amounting to $14.2$27.7 million, which was deemed to have been contributed by Sohu, as a holder of ordinary shares of Sogou, for the difference between the price SohuSogou paid to AlibabaChina Web for the Series A Preferred Shares and the carrying amount of these 24.014.4 million Series A Preferred Shares in the Group’s consolidated financial statements. This deemed dividend has been subtracted from the Netnet income attributable to Sohu.com Inc. for the nine months ended September 30, 20122014 in the table below to revise the historical inappropriate treatment when calculating the basic and diluted net incomeloss per share attributable to Sohu.com Inc.

 

-43--48-


The portion of the special dividend paid by Sogou on September 17, 2013 to holders of Series A Preferred Shares of Sogou other than Sohu, in the amount of $139.7 million, is a payment to noncontrolling preferred shareholders, of which Sohu, as a holder of ordinary shares of Sogou, is deemed to have contributed $82.4 million. This $82.4 million has also been subtracted from the Net income attributable to Sohu.com Inc. for the three months and nine months ended September 30, 2013 to arrive at net income available to ordinary shareholders in the calculation of net income per share attributable to Sohu.com Inc.

The following table presents the calculation of the Sohu Group’s basic and diluted net incomeloss per share (in thousands, except per share data).

 

   Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
   2013  2012  2013  2012 

Numerator:

     

Net income /(loss) attributable to Sohu.com Inc., basic (after subtracting the dividend or deemed dividend to noncontrolling Sogou series A preferred shareholders)

  $(64,189 $25,881   $(18,132 $47,552  
  

 

 

  

 

 

  

 

 

  

 

 

 

Effect of dilutive securities:

     

Incremental dilution from Changyou

   (297  (510  (723  (1,945

Incremental dilution from Sogou

   (535  (1,356  (1,673  (4,813
  

 

 

  

 

 

  

 

 

  

 

 

 

Net income /(loss) attributable to Sohu.com Inc., diluted

  $(65,021 $24,015   $(20,528 $40,794  
  

 

 

  

 

 

  

 

 

  

 

 

 

Denominator:

     

Weighted average basic common shares outstanding

   38,288    38,022    38,239    38,036  

Effect of dilutive securities:

     

Share options and restricted share units

   234    322    242    356  
  

 

 

  

 

 

  

 

 

  

 

 

 

Weighted average diluted common shares outstanding

   38,522    38,344    38,481    38,392  
  

 

 

  

 

 

  

 

 

  

 

 

 

Basic net income /(loss) per share attributable to Sohu.com Inc.

  $(1.68 $0.68   $(0.47 $1.25  
  

 

 

  

 

 

  

 

 

  

 

 

 

Diluted net income /(loss) per share attributable to Sohu.com Inc.

  $(1.69 $0.63   $(0.53 $1.06  
  

 

 

  

 

 

  

 

 

  

 

 

 

16. Subsequent Events

From October 1, 2013 to November 8, 2013, Changyou repurchased an additional 284,700 of its ADSs, representing 569,400 ordinary shares, at an aggregate cost of approximately $8.2 million, under Changyou’s ADSs repurchase program discussed above.

   Three Months Ended
September 30,
  Nine Months Ended
September 30,
 
   2014  2013  2014  2013 

Numerator:

     

Net loss attributable to Sohu.com Inc., basic (after subtracting the deemed dividend to noncontrolling Sogou Series A Preferred shareholders)

  $(27,138 $(64,189 $(147,082 $(18,132
  

 

 

  

 

 

  

 

 

  

 

 

 

Effect of dilutive securities:

     

Incremental dilution from Changyou

   (5  (297  0    (723

Incremental dilution from Sogou

   (1,259  (535  (3,429  (1,673
  

 

 

  

 

 

  

 

 

  

 

 

 

Net loss attributable to Sohu.com Inc., diluted

  $(28,402 $(65,021 $(150,511 $(20,528
  

 

 

  

 

 

  

 

 

  

 

 

 

Denominator:

   

Weighted average basic common shares outstanding

   38,485    38,288    38,457    38,239  

Effect of dilutive securities:

   

Share options and restricted share units

   0    234    0    242  
  

 

 

  

 

 

  

 

 

  

 

 

 

Weighted average diluted common shares outstanding

   38,485    38,522    38,457    38,481  
  

 

 

  

 

 

  

 

 

  

 

 

 

Basic net loss per share attributable to Sohu.com Inc.

  $(0.71 $(1.68 $(3.82 $(0.47
  

 

 

  

 

 

  

 

 

  

 

 

 

Diluted net loss per share attributable to Sohu.com Inc.

  $(0.74 $(1.69 $(3.91 $(0.53
  

 

 

  

 

 

  

 

 

  

 

 

 

17. Recently Issued Accounting Pronouncements

None.The FASB issuedReporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which changes the threshold for reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as a disposal that “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. Entities may “early adopt” the guidance for new disposals. The Group is currently evaluating the impact on its consolidated financial statements of adopting this guidance.

On May 28, 2014, the FASB and IASB issued their long-awaited converged standard on the recognition of revenue from contracts with customers. The standard will improve the financial reporting of revenue and improve comparability of the top line in financial statements globally. The FASB is amending the FASBAccounting Standards Codification and creating a new Topic 606,Revenue from Contracts with Customers, to supersede the revenue recognition requirements in Topic 605,Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. Additionally, the amendments supersede some cost guidance included in Subtopic 605-35,Revenue Recognition—Construction-Type and Production-Type Contracts. For a public entity, the amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The Group is currently evaluating the impact on its consolidated financial statements of adopting this guidance.

In June 2014, underASC 718, Compensation—Stock Compensation, the FASB issuedAccounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. These amendments apply to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target could be achieved and still be eligible to vest in the award if and when the performance target is achieved. For all entities, the amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The Group is currently evaluating the impact on its consolidated financial statements of adopting this guidance.

In August 2014, the FASB issuedPresentation of Financial Statements – Going Concern. This standard requires management to evaluate for each annual and interim reporting period whether it is probable that the reporting entity will not be able to meet its obligations as they become due within one year after the date that the financial statements are issued. If the entity is in such a position, the standard provides for certain disclosures depending on whether or not the entity will be able to successfully mitigate its going concern status. This guidance is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. Early application is permitted. The Company does not anticipate that this adoption will have a significant impact on its financial position, results of operations, or cash flows.

 

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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

As used in this report, references to “us,” “we,” “our,” “our company,” “our Group,” the “Group,” “Sohu,” the “Sohu Group,” 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 (“Sohu Search”), Sogou Inc. (“Sogou”), 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”), Focus Investment Holding Limited (“Focus Investment”), Sohu Focus Limited (“Sohu Focus”), Sohu Focus (HK) Limited (“Focus 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 Heng Da Yi Tong Information Technology Co., Ltd. (“Heng Da Yi Tong”, formerly known as Beijing Sohu Entertainment Culture Media Co., Ltd. (“Sohu Entertainment,” formerly known as Beijing Hengda Yitong Internet Technology Development Co., Ltd., or “Hengda”“Sohu Entertainment”), Beijing Sohu Internet Information Service Co., Ltd. (“Sohu Internet”), Beijing GoodFeel Information Technology Co., Ltd. (“GoodFeel”), 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”), SohuPay Science and Technology Co., Ltd. (“SohuPay”), Beijing Yi He Jia Xun Information Technology Co., Ltd. (“Yi He Jia Xun”), Beijing Zhi Hui You Information Technology Co., Ltd. (“Zhi Hui You”), Tianjin Jinhu Culture Development Co., Ltd. (“Tianjin Jinhu”), Shenzhen Shi Ji Guang Su Information Technology Co., Ltd. (“Shi Ji Guang Su”), Beijing Intelligence World Network Technology Co., Ltd. (“Intelligence World”), SendCloud Technology Co., Ltd., Beijing Focus Interactive Information Service Co., Ltd. (“Focus Interactive”), Beijing Focus Xin Gan Xian Information Technology Co., Ltd. (“Focus Technology”), Beijing Focus Real Estate Agency Co., Ltd. (“Focus Real Estate”) 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 Webgames (HK) Limited (“Changyou HK Webgames”), Changyou.com Gamepower (HK) Limited (“Changyou HK Gamepower”), ICE Entertainment (HK) Limited (“ICE HK”), Changyou.com Gamestar (HK) Limited (“Changyou HK Gamestar”), Changyou.com (US) LLC. (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 BİLİŞİM HİZMETLERİ TİCARET LİMİTED ŞİRKETİ (“Changyou Turkey”), Kylie Enterprises Limited, Mobogarden Enterprises Limited, Heroic Vision Holdings Limited (“Heroic”), TalkTalk Limited (“TalkTalk”), RaidCall (HK) Limited (“RaidCall HK”), 7Road.com Limited (“7Road”), 7Road.com HK Limited (“7Road HK”), Changyou.com (TH) Limited (“Changyou Thai”), Changyou.com Rus Limited (“Changyou Rus”), PT.CHANGYOU TECHNOLOGY INDONESIA (“Changyou Indonesia”), Changyou Middle East FZ-LLC (“Changyou AUE”), Changyou.com Technology Brazil Desenvolvimento De Programas LTDA (“Changyou Brazil”), Greative Digital Limited, Glory Loop Limited, MoboTap Inc. (“MoboTap”) (a Cayman Islands company), MoboTap Inc. Limited, MoboTap Inc. (a Delaware corporation), Dolphin Browser Inc., Muse Entertainment Limited, Dstore Technology Limited, 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 Changyou RaidCall Internet Technology Co., Ltd. (“RaidCall”), 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 Changyou 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”), andBeijing Doyo Internet Technology Co., Ltd. (“Doyo Internet”), Beijing Zhi Hui You Information Technology Co., Ltd. (“Zhi Hui You”), Shanghai ICE Information Technology Co., Ltd.(“ (“Shanghai ICE”), Shenzhen 7Road Network Technologies Co., Ltd.(“ (“7Road Technology”), Shenzhen 7Road Technology Co., Ltd. (“Shenzhen 7Road”), Beijing Changyou e-pay Co. Ltd. (“Changyou e-pay”), Beijing Changyou Aishouxin Ecological Technology Co., Ltd. (“Aishouxin Ecological Technology”), Shenzhen Brilliant Imagination Technologies Co., Ltd., Fujian Changyou Heguang Electronic Technology Co., Ltd., Beijing Baina Information Technology Co., Ltd., Baina Zhiyuan (Beijing) Technology Co., Ltd., Beijing Anzhuoxing Technology Co., Ltd., Baina Zhiyuan (Chengdu) Technology Co., Ltd., Chengdu Xingyu Technology Co., Ltd., Baina (Wuhan) Information Technology Co., Ltd., Wuhan Xingyu Technology Co., Ltd., and Wuhan Hualian Chuangke Technology Co., Ltd., 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,“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, 20122013 filed with the Securities and Exchange Commission (“SEC”) on February 28, 2013,2014, as updated by Part II Item 1A of this report. Readers are cautioned not to place undue reliance on these forward-looking statements.

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OVERVIEW

Sohu (NASDAQ: SOHU) is a leading Chinese online media, search, gaming, communitygame and service group providing comprehensive online products and services on PCs and mobile service group.devices. We operate one of the most comprehensive matrices of Chinese language content and services, and we developed and operate in China one of the most popular Chinese search engines, one of the most popular massively multiplayer online games (“MMOGs”) and two popular Web games in China. Substantially allgames. Most of our operations are conducted through our indirect wholly-owned and majority-owned China-based subsidiaries and variable interest entities (collectively the “Sohu Group” or “the Group”(“VIEs”).

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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 mobile business and the others business, of which online advertising and online games are our core businesses.

Factors and Trends Affecting our Business

The InternetWith the accelerated shift in user activities from desktop computers (“PCs”) to mobile devices and Internet-related marketsan increase in China continued to evolve rapidly during 2013. According to a semiannual report issued by the China Internet Network Information Center (“CNNIC”), the total number of Internet users, in China had reached 591 million by June 30, 2013, an increasethe third quarter, the usage of 26.6 million from the end of 2012. The CNNIC also reported that the numbervarious kinds of mobile Internet services continued to accelerate at a fast pace as the mobile penetration rate grew. At Sohu, we focused our efforts on developing a portfolio of leading mobile products, across our business lines, that we believed our users like. Our key products continued to gain traction in terms of traffic. For example, as of September 30, 2014, mobile video views of our video programs and mobile search queries on Sogou had increased by approximately 169% and 88%, respectively, compared to the beginning of 2014. The monetization of growing mobile traffic is also progressing well, as advertiser customers have begun to increase their budgets allocated to this area.

Online video is one of the top Internet services in China, had reached 464 million by June 30, 2013,and Sohu Video is a leading video service provider. We noted an increase of 43.8 millionaccelerating trend away from the end of 2012, exceeding the 411 million desktop computer Internet users as of June 30, 2013,television toward streaming video, which is an indication that mobile Internet is becomingimportant specifically to Sohu’s online video business, as advertising dollars shift from television to online video. In the top channel for Internet users to consume online content and services in China. We believe that this large and expandingthird quarter, we saw continuous user base will continueexpansion and increased advertising revenues generated on our video platforms. In the meantime, as competition intensified, the major players stepped up their content spending to provide significant opportunitiesattract viewers. The average licensing fee of premium content grew significantly as compared to expand our product offerings and to explore newthe same period of 2013. As a result, despite solid revenue streams.

In China, online video is a top Internet application, with over 389 million users as of June 30, 2013, according to CNNIC. We expect that brand advertisers will continue to allocate more advertising dollars to online video in order to exploit this growing market. To better employ market opportunities, we set up a dedicated advertising sales force forgrowth, our online video business in 2012. For the first three quarters of 2013, the online video advertising revenues grew 123% compared with the same period of 2012.continued to incur operating losses. We expect tothat the industry-wide unfavorable cost structure will continue to operateovershadow the profitability outlook for the entire industry, including us, in the near term. However, we remain optimistic about the long-term prospects of the online video business, aswhich is a significant unit within Sohu’s brand advertising business.strategic key business line for Sohu. As such, we will continue to invest in content in order to maintain our leading position in the industry.

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 the Sogou Web Directory. On September 16, 2013, we entered into a strategic cooperation with Tencent Holdings Limited a Cayman Islands company (Tencent Holdings Limited together with its subsidiaries, “Tencent”), wherebyin connection with which Tencent invested in our search subsidiary Sogou. We believe that this strategic cooperation will reinforce and strengthenhas reinforced Sogou as a leader in the large and fast-growing China market for search and Internet services, particularly for the mobile platform. In the online search sector, Sogou is one of the top three PC search players in China, and we have demonstrated strengthened competitiveness in mobile search. In the third quarter of 2014, with our consistent efforts to improve search quality and user experience, overall search traffic continued to grow quickly. In particular, mobile search traffic increased by approximately 20% compared to the prior quarter. In the third quarter of 2014, aggregate paid clicks and cost-per-click continued to grow, which improved mobile monetization. We expect our search and others business to sustain healthy revenue growth through the remainder of 2013.2014.

OurFor our online gamegames business achieved our expectations in the third quarter, as we continue to release content updates in the form of expansion packs for our games on a regular basis, which we believe helps to extend the popularity of our games in China. We developed and currently operate three popular games in China, includingconducted by Changyou, Tian Long Ba Bu (“TLBB”), DDTankwhich we developed and Wartune (also known as “Shen Qu”). In addition, we own the leading game information portalcurrently operate in China, 17173.com, whichcontinues to account for a majority of our online game revenues. Our two popular web games, Wartune and DDTank, have entered into a relatively mature phase and their revenues are trending down. Licensed games that we operate, such as Huan Xiang Shen Yu, have become the new growth points of our online games revenues. We expect to launch a number of new MMOGs, Web games and mobile games in the fourth quarter of 2014 to diversify our offering of games and revenues. With more Internet users playing games across multiple devices on PCs and mobile devices, in order to capture new business opportunities arising from this trend and strengthen our capabilities to distribute and promote games across various devices, Changyou is oneinvesting heavily in the development and marketing of new software applications. Such investment has led to a decline in Changyou’s profitability. In the third quarter of 2014, total average monthly active users of Changyou’s platform channels were 275 million. Changyou will continue its investment for the rest of the major online mediumsyear.

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In November 2014, Mr. Tao Wang resigned as Changyou’s Chief Executive Officer for advertising gamespersonal reasons. Changyou’s Board of Directors appointed Ms. Carol Yu, President and Chief Financial Officer of Sohu.com Inc., and Mr. Dewen Chen, Changyou’s President, to be Co-Chief Executive Officers. Ms. Yu will maintain her position as President and Chief Financial Officer of Sohu in China.addition to her new role with Changyou. Mr. Wang will continue to serve as a member of the Board of Directors of Changyou.

Summary of Our Business

Online Advertising Business

Brand Advertising Business

Our brand advertising business offers to our users, over our matrices of Chinese language Webonline media content and services, various products and services (such as free of charge content, including news, video, interactive community, and other competitive Internet services) across multiple Internet-enabled devices, such as PCs, mobile phones and tablets. It also offers advertisements on Sohu Group Web properties to companies seeking to increase their brand awareness online.

The majority of our products and services are provided on the following platforms:

 

Sohu.com, a leading mass portal and media destination;

 

Tv.sohu.com, a leading online video Website;

Focus.cn, a top real estate Website; and

 

17173.com, a leading game information portal. Since December 15, 2011, 17173.com has been owned

For the three and operated bynine months ended September 30, 2014, brand advertising revenues were $148.8 million and $393.3 million, respectively, which represented 35% and 33%, respectively, of our majority-owned subsidiary Changyou.total revenues, of which $16.7 million and $40.7 million, respectively, was attributable to 17173.com.

Search and Others Business

Our search and others business, providedoperated by our search subsidiary Sogou, primarily offers customers pay-for-click services, as well as online marketing services on the Sogou Web Directory. Pay-for-click services enable our advertisers’ promotional links to be displayed on Sogou search result pages and Sogou Website Alliance members’ Websites where the links are relevant to the subject and content of such Web pages. Both pay-for-click services and online marketing services on the Sogou Web Directory expand distribution of our advertisers’ Website links and advertisements by leveraging traffic on Sogou Website Alliance members’ Websites.

For the three and nine months ended September 30, 2014, our search and others revenues were $98.4 million and $247.8 million, respectively, which represented 23%and 21%, respectively, of our total revenues.

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Online Game Business

Our online game business is conducted viaby our majority-owned subsidiary Changyou. Changyou is a leading online game developer and operator in China.China as measured by the popularity of its MMOG TLBB and its Web games DDTank and Wartune, which Changyou completed an initial public offering on the NASDAQ Global Select Market under the symbol “CYOU” in 2009. As Changyou’s controlling shareholder, Sohu consolidates Changyou in the Sohu Group’s consolidated financial statements but recognizes noncontrolling interest reflecting the economic interest in Changyou held by shareholders other than Sohu.

developed in-house. Changyou engages in the development, operation and licensing of online games including massively multiplayerfor PCs and mobile devices. Changyou’s online games (“MMOGs”),include MMOGs, which are interactive online games that may be played simultaneously by hundreds of thousands of game players, Web games, which are played over the Internet using a Web browser, and mobile games. Changyou developed and operates TLBB, which is one of the most popular MMOGs in China, and developed, and primarily jointly operates with third-party joint operators, DDTank and Wartune,games, which are two popular Web games in China. played on mobile devices with an Internet connection.

For the third quarter of 2013, more than 67% of the revenues of Changyou’s online game business were derived from TLBB.

We depend on Changyou for a significant portion ofthree and nine months ended September 30, 2014, our revenues, net income, and operating cash flow. For the third quarter of 2013, Changyou’s online game revenues were $161.5$150.3 million and $467.6 million, respectively, which represented 44%35% and 39%, respectively, of our total revenues. Net income contributed by Changyou for the quarter was $72.8 million, which represented 177% of our total net income.

Mobile Business

Our mobile business offers mobile related services through different types of mobile products to mobile phone users. The mobile products mainly consist of short messaging services (“SMS”), Ring Back Tone (“RBT”), mobile video, mobile games, and interactive voice response (“IVR”). A majority of the content is purchased from third party content providers.

Others Business

Our others business revenues are primarily generated primarily from our business of offering Internet value-added services (“IVAS”) with respect to the operation of Web games developed by third-party developers under revenue-sharing arrangementsand services provided to software application users; offering mobile-related services and mobile products, in cooperation with the developers,China mobile network operators, to mobile phone users and to China mobile network operators; and offering cinema advertisement slots for advertisements to be shown in theaterscinemas before the screening of movies, and sub-licensing of licensed video content to third parties.movies.

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Business Transactions

Sogou Transactions

On October 22, 2010, Sogou issued and 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 Capital, and Photon Group Limited (“Photon”), the investment vehicle of Sohu Group’s Chairman and Chief Executive Officer Dr. Charles Zhang, for $15 million, $9 million, and $24 million, respectively. On June 29, 2012, Sohu purchased Alibaba’s 24.0 million Sogou Series A Preferred Shares for a purchase price of $25.8 million.

On September 16, 2013, pursuant to a Subscription Agreement entered into on that date by and among Sogou, Tencent, Sohu Search, and Photon, and a series of other contracts also entered into on that date between Sogou and Tencent, Tencent invested a net amount of $448 million in cash in Sogou and transferred its Soso search-related businesses and certain other assets to Sogou (collectively, the “Sogou-Tencent Transactions,” or the “Transactions”Transactions”).

On September 16, 2013, Sogou entered into (i) a Repurchase Option Agreement with Sohu Search, exercisable commencing March 16, 2014, granting to Sogou the right to purchase 24 million Series A Preferred Shares of Sogou held by Sohu Search for an aggregate purchase price of $78.8 million; (ii) a Repurchase Option Agreement with Photon, also exercisable commencing March 16, 2014, granting to Sogou the right to purchase 6.4 million Series A Preferred Shares of Sogou held by Photon for an aggregate purchase price of $21 million; and (iii) a Repurchase/Put Option Agreement with China Web, granting to Sogou the right to purchase at any time from March 16, 2014 to July 31, 2014, and granting to China Web the right to put to Sogou at any time prior to July 31, 2014, 14.4 million Series A Preferred Shares of Sogou held by China Web for an aggregate purchase price of $47.3 million. Sogou expects to exercise its rights under each of these agreements when they first become exercisable.

On September 16, 2013, Sogou, Sohu Search, Photon, Mr. Xiaochuan Wang, four other members of Sogou’s management (collectively, the “Sohu Parties”) and Tencent entered into a Shareholders Agreement (the “Shareholders Agreement”). Under under which the Shareholders Agreement, the parties have agreed to vote their Sogou voting shares in all elections of directors to elect three designees of Sohu Search and two designees of Tencent.

On September 17, 2013, Sogou paid a special dividend to the three holders of Series A Preferred Shares of Sogou in anthe aggregate amount of $301 million, of which Sohu Search received $161 million, Photon received $43 million, and China Web received $97 million.

On December 2, 2013, Tencent invested $1.5 million in cash in Sogou Information, which is a VIE of Sogou, as additional consideration in connection with the Sogou-Tencent Transactions.

On March 24, 2014, Sogou purchased from China Web, pursuant to the Repurchase/Put Option Agreement between Sogou and China Web, 14.4 million Series A Preferred Shares of Sogou, for an aggregate purchase price of $47.3 million.

-47-In June 2014, Sogou repurchased approximately 4.2 million of its Class A Ordinary Shares from noncontrolling shareholders, some of whom are our employees, for an aggregate purchase price of $41.6 million.


Pursuant to the Shareholders Agreement, Sohu will hold approximately 53.6%52% of the total voting power for the election of the Board of Directors of Sogou, assuming that the remaining repurchase options and the repurchase/put option are exercised, Tencent’s non-voting Class B Ordinary Shares are converted to voting shares, and all share options under the Sogou 2010 Share Incentive Plan and all share options under an arrangement providing for Sogou share-based awards to be available for grants to Sohu management and key employees (the “Management Share Option Arrangement”) are granted and exercised. As Sohu is the controlling shareholder of Sogou, we consolidate Sogou in the Sohu Group’s consolidated financial statements, and recognize noncontrolling interest reflecting economic interests in Sogou held by shareholders other than Sohu.

7Road TransactionsAcquisition of MoboTap

On May 1, 2013,July 16, 2014, Changyou, through a wholly-owned subsidiary, entered into an investment agreement with MoboTap, which is the mobile technology developer behind the Dolphin Browser, MoboTap’s subsidiaries and variable interest entities, and MoboTap’s shareholders pursuant to acquire allwhich Changyou agreed to purchase from existing shareholders of MoboTap shares of MoboTap representing 51% of the ordinaryequity interests in MoboTap on a fully-diluted basis for approximately $91 million in cash.

Changyou and MoboTap also entered into a subscription agreement pursuant to which Changyou purchased $30 million in principal amount of a zero-coupon convertible bond issued by MoboTap that is due in five years. Changyou has the option, exercisable at any time when the bond is outstanding, to convert all or any part of the unpaid principal into shares of 7Road heldMoboTap at a conversion price that would result in Changyou’s interest in MoboTap increasing to 60% on a fully-diluted basis, measured as of the closing date under the investment agreement, if the option is exercised in full.

The noncontrolling shareholders of MoboTap, who are the founders of MoboTap, and MoboTap also entered into a shareholder agreement pursuant to which Changyou has the right to designate three of the five directors of MoboTap, including the chairman of the board; any proposed transfers of equity interests in MoboTap by the noncontrolling shareholders representing 28.074%or Changyou are subject to approval of Changyou or the noncontrolling shareholders, as applicable; and Changyou is entitled to customary pre-emptive rights with respect to any new issuance of equity interests in MoboTap. In addition, Changyou has the right to purchase up to 10% of the outstanding share capitalequity interests in MoboTap from the noncontrolling shareholders, at a price of 7Road,20% below the initial public offering (“IPO”) price, before a qualified IPO of MoboTap. If MoboTap achieves specified performance milestones for 2016 and certain other conditions specified in the shareholder agreement, including the completion of an IPO, are not met, the noncontrolling shareholders of MoboTap will have a one-time right to put to Changyou shares of MoboTap held by them, representing up to 15% of the equity interests in MoboTap, for an aggregate cash considerationprice of approximately $78up to $53 million. The acquisition closed on June 5, 2013. EffectiveSohu Group began to consolidate MoboTap’s financial statements commencing with the closing, 7Road became an indirect wholly-owned subsidiary of Changyou, and Changyou’s VIE Gamease became the sole shareholder of 7Road’s VIE Shenzhen 7Road. As of September 30, 2013, Changyou had paid $76 million of the total cash consideration. The remaining $2 million will be settled in June 2014.acquisition.

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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, costs and expenses, and related disclosures. On an on-going 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. Identified below are 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

Our consolidated financial statements include the accounts of Sohu.com Inc. and its direct and indirect wholly-owned and majority-owned subsidiaries and consolidated VIEs. All intercompany transactions are eliminated.

VIE Consolidation

Our Group adopted the guidance of accounting for VIEs, which requires VIEs to be consolidated by the primary beneficiary of the entity. For our consolidated VIEs, management made evaluations of the relationships between us and our 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, we control the shareholders’ voting interests in these VIEs. As a result of such evaluation, management concluded that we are the primary beneficiary of our consolidated VIEs. Our Group has one VIEthree VIEs that isare not consolidated, since we are not the primary beneficiary.

Noncontrolling Interest Recognition

Noncontrolling interests are recognized to reflect the portion of the equity of majority-owned subsidiaries and VIEs which is not attributable, directly or indirectly, to the controlling shareholder. Currently, the noncontrolling interests in our consolidated financial statements primarily consist of noncontrolling interests for Changyou and Sogou.

Noncontrolling Interest for Changyou

As of September 30, 2013,2014, Sohu held approximately 68% of the combined total of Changyou’s outstanding ordinary shares and controlled approximately 83% of the total voting power in Changyou. As Sohu is Changyou’s controlling shareholder, we consolidate Changyou in our consolidated financial statements, but recognize noncontrolling interest reflecting the economic interest in Changyou held by shareholders other than Sohu.

To reflect the economic interest in Changyou held by shareholders other than Sohu (“Changyou noncontrolling shareholders”), Changyou’s net income /(loss) attributable to the Changyou noncontrolling shareholders is recorded as noncontrolling interest in Sohu’s consolidated statements of comprehensive income, based on their share of the economic interest in Changyou. Changyou’s cumulative results of operations attributable to the Changyou 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, are recorded as noncontrolling interest in our consolidated balance sheets.

 

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Noncontrolling Interest for Sogou

AsSince Sohu controls the election of the Board of Directors of Sogou, Sohu is Sogou’s controlling shareholder,shareholder. Therefore we consolidate Sogou in the Sohu Group’s consolidated financial statements, and recognize noncontrolling interest reflecting economic interests in Sogou held by shareholders other than Sohu. To reflect the economic interest in Sogou held by shareholders other than Sohu (the “Sogou noncontrolling shareholders”), Sogou’s net income /(loss) attributable to the Sogou noncontrolling shareholders is recorded as noncontrolling interest in the Sohu Group’s consolidated statements of comprehensive income. Sogou’s cumulative results of operations attributable to the Sogou 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 the Sogou noncontrolling shareholders’ original investments in Series A Preferred Shares, Series BSogou Preferred Shares and Class B Ordinary Shares are accounted for as a noncontrolling interest classified as permanent equity in the Sohu Group’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, and on the terms of the classes of Sogou shares held by the Sogou noncontrolling shareholders in the Preferred Shares of Sogou (the “Terms of Preferred Shares of Sogou”), the terms of Sogou’s restructuring in 2010, Sohu’s purchase of Sogou Series A Preferred Shares from Alibaba, and the terms of Class B Ordinary Shares of Sogou.

By virtue of these terms, as Sogou has been losing money since its restructuring in 2010, the netSogou’s losses have been and will be allocated in the following order:

 

(i)net losses were allocated to holders of Sogou Class A Ordinary Shares and the holder of Sogou Class B Ordinary Shares until their basis in Sogou decreased to zero;

 

(ii)additional net losses were allocated to holders of Sogou Series A Preferred Shares until their basis in Sogou decreased to zero;

 

(iii)additional net losses will be allocated to the holder of Sogou Series B Preferred Shares until its basis in Sogou decreases to zero; and

 

(iv)further net losses will be allocated between Sohu and noncontrolling shareholders based on their shareholding percentage in Sogou.

Any subsequentNet income from Sogou has been, and future net income from Sogou will be, allocated in the following order:

 

(i)net income will be allocated between Sohu and noncontrolling shareholders based on their shareholding percentage in Sogou until their basis in Sogou increases to zero;

 

(ii)additional net income will be allocated to the holder of Sogou Series B Preferred Shares to bring its basis back;

 

(iii)additional net income will be allocated to holders of Sogou Series A Preferred Shares to bring their basis back;

 

(iv)further net income will be allocated to holders of Sogou Class A Ordinary Shares and the holder of Sogou Class B Ordinary Shares to bring their basis back; and

 

(v)further net income will be allocated between Sohu and noncontrolling shareholders based on their shareholding percentage in Sogou.

Segment Reporting

Our Group’s segments are business units that offer different services and are reviewed separately by the chief operating decision maker (the “CODM”), or the decision making group, in deciding how to allocate resources and in assessing performance. The CODM is Sohu.com Inc.’s Chief Executive Officer. There are five segments in our Group, consisting of brand advertising, Sogou (which mainly consists of the search and others business), Changyou (which mainly consists of the online game business), mobile and others.

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Historical accounting error regarding net income attributable to Sohu.com Inc. and basic and diluted net income per share attributable to Sohu.com Inc.

In the third quarter of 2013, as previously reported in an Amendment No. 1 to Current Report on Form 8-K/A that we filed with the SEC on September 20, 2013, management noted an accounting error in the Group’s Quarterly Report on Form 10-Q for the three months ended June 30, 2012 regarding net income attributable to Sohu.com Inc. and the calculation of basic and diluted net income per share attributable to Sohu.com Inc. In June 2012, Sohu had purchased from Alibaba 24.0 million Series A Preferred Shares of Sogou for cash consideration of $25.8 million. UnderASC 260-10-S99-2, this transaction gave rise to a deemed dividend in the amount of $14.2 million, which was the difference between the consideration Sohu paid to Alibaba and the carrying amount of these 24.0 million Series A Preferred Shares in the Group’s consolidated financial statements. Accordingly, this amount of $14.2 million should have been subtracted from net income to arrive at net income available to common shareholders in the Group’s calculation of net income per share. This deemed dividend was inappropriately accounted for when calculating the net income attributable to the Group, resulting in an error in the calculation of basic and diluted net income per share attributable to Sohu.com Inc. There was a carry-forward effect of this accounting error to the net income attributable to Sohu.com Inc. and the net income per share calculation as reported for the nine months ended September 30, 2012 in the Group’s Quarterly Report on Form 10-Q for the three months then ended (the “3rd Quarter 2012 10-Q”), and as reported for the year ended December 31, 2012 in the Group’s Annual Report on Form 10-K for the year then ended. In addition, there was a carry-forward effect of the error to the classification of retained earnings and additional paid-in capital in the Group’s Quarterly Report on Form 10-Q for the three months ended June 30, 2012, September 30, 2012, March 31, 2013 and June 30, 2013, and the Group’s Annual Report on Form 10-K for the year ended December 31, 2012.

Management performed an assessment of the impact of this accounting error from both a quantitative and a qualitative perspective in accordance with the guidance contained inSAB 99, and concluded that the error was not material to the Group’s relevant historical financial statements taken as a whole. Therefore, management concluded that the relevant affected historical financial statements could continue to be relied upon but would be revised to correct the error.

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.

UnderASC 845, barterBarter trade transactions in which physical goods or services (other than advertising services) are received in exchange for advertising services should beare recorded based on the fair values of the goods and/orand services received. For our online advertising-for-online advertising barter transactions, no revenue or expense is recognized because the fair value of neither the advertising surrendered nor the advertising received is determinable.

Online Advertising Revenues

Online advertising revenues include revenues from brand advertising services as well as search and others services.

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 whether we are acting as an agent in the transaction. 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. Our revenues from online advertising services are recognized on a gross basis, as we have the primary responsibility for fulfillment and acceptability. These revenues are recognized after deducting agent rebates paid to advertising agencies and applicable taxesnet of value-added tax (“VAT”) and related surcharges.

Before September 1, 2012, our online advertising revenues were subject to PRC business tax (“Business Tax”). 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. Before September 1, 2012, our online advertising revenues were recognized after deducting agent rebates and applicable Business Tax and related surcharges. Effective September 1, 2012, the PRC Ministry of Finance and the State Administration of Taxation launched a Business Tax to Value Added Tax (“VAT”) Transformation Pilot Program (“Pilot Program”) for certain industries in eight regions, including Beijing and Tianjin. Commencing August 1, 2013, the Pilot Program expanded to all regions in the PRC. 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 balance of VAT input. 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 the 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.

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Brand Advertising Revenues

Business Model

Currently the brand advertising business has two main types of pricing models, consisting of the Fixed Price ModelThrough PCs and the Cost Per Impression (“CPM”) pricing model. 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, but the unit price for each qualifying display is fixed. A qualifying display is defined as the appearance of an advertisement, where the advertisement meets criteria specified in the contract with the advertiser. Advertising fees are charged to the advertisers based on the unit prices and the number of qualifying displays. Wemobile devices, we provide advertisement placements to our advertisers on different Website channels and in different formats, which include, among other things, banners, links, logos, buttons, full screen, pre-roll, mid-roll, post-roll video screens, and mid-rollpause video screens, as well as pause video screens.loading page ads and news feed ads on our News App.

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Currently we have three main types of pricing models, consisting of the Fixed Price model, the Cost Per Impression (“CPM”) model, and the E-commerce model.

Fixed Price model

Under the Fixed Price model, a contract is signed to establish a fixed price for the advertising services to be provided.

CPM model

Under the CPM model, the unit price for each qualifying display is fixed, but there is no overall fixed price for the advertising services stated in the contract with the advertiser. A qualifying display is defined as the appearance of an advertisement, where the advertisement meets criteria specified in the contract. Advertising fees are charged to the advertisers based on the unit prices and the number of qualifying displays.

E-commerce model

Our e-commerce revenues are primarily generated from selling membership cards to potential home buyers. The membership card allows a buyer to purchase specified properties from real estate developers at a discount greater than the price that we charge for the card. Membership fees are refundable until the potential home buyer uses the discounts to purchase properties. We recognize such e-commerce revenues upon obtaining confirmation that the membership card has been redeemed to purchase a property.

Revenue recognitionRecognition

For brand advertising revenue recognition, prior to entering into contracts, we make a credit assessment of the customer. For contracts for which collectability is determined to be reasonably assured, we recognize revenue when all revenue recognition criteria are met. Otherwise,In other cases, we only recognize revenue when the cash is received and all other revenue recognition criteria are met.

In accordance withASU No.2009 -13No. 2009-13, 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.

Search and Others Revenues

Search and others services mainly include pay-for-click services, as well as online marketing services on the Sogou Web Directory.

Pay-for-click Services

Pay-for-click services are services that enable our advertisers’ promotional links to be displayed on Sogou search result pages and Sogou Website Alliance members’ Websites where the links are relevant to the subject and content of such Web pages. For pay-for-click services, we introduce Internet users to our advertisers through our auction-based pay-for-click systems and charge advertisers on a per-click basis when the users click on the displayed links. Revenue for pay-for-click services is recognized on a per-click basis when the users click on the displayed links.

Online Marketing Services on the Sogou Web Directory

Online marketing services on the 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 the 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 the Sogou Web Directory expand distribution of advertisers’ Website links or advertisements by leveraging traffic on Sogou Website Alliance members’ Websites. We recognize gross revenue for the amount of fees we receive from advertisers.advertisers, as we have the primary responsibility for fulfillment and acceptability. Payments made to Sogou Website Alliance members are included in cost of search and others revenues as traffic acquisition costs. 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. 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. We pay Sogou Website Alliance members based on either revenue-sharing arrangements, under which we pay a percentage of pay-for-click revenues generated from clicks by users of their properties, or on a pre-agreed unit price.

 

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Online Game Revenues

Our online game revenues are generated from MMOG operationsoperation revenues, Web game revenues and overseas licensing revenues.

MMOG operations revenuesOperations Revenues

Revenues are recorded net ofafter deducting applicable Business Tax, discounts and rebates to distributors.

Online game revenues from Changyou’s current MMOG operationsoperation of MMOGs 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 revenueGame Revenue

Changyou began generating Web game revenue after its acquisition of a controlling interest in 7Road in May 2011. Through December 31, 2011, 7Road’s revenues wereRevenues from Web games are derived entirelymainly from revenue-sharing payments from third-party joint operators of itsChangyou’s games and license fees from certain of these joint operators. Beginning in the year ended December 31, 2012, 7Road also derives revenues from direct operation of Wartune on its own Website for the game, which was launched in May 2012. TheWeb games developed by 7Road are operated primarily under the item-based revenue model, in which game players can access the games free of charge, but may purchase consumable virtual items, including those with a predetermined expiration time, or perpetual virtual items, such as certain costumes that stay bound to a game player throughoutitems. Although the life of the game. In certain of its joint operation arrangements, 7Road provides its games and related services to a third-party joint operator at no upfront fee. In these arrangements, 7Road is entitled to a single stream of revenue-sharing payments from the joint operator when game players convert the joint operator’s virtual currency into 7Road’s game coins or purchase its game coins directly through such operator’s Websites or game platform. Certain of the joint operators pay 7Road license fees for the exclusive right to operate its games in specified geographic areas or upon achievement of certain performance milestones from the joint operators’ operation of the games. Certain of the joint operators also pay 7Road license fees for the right to be among a selected few who will have the initial right ahead of other operators to jointly operate 7Road’s games in China during a specified period after their launch.

When 7Road’s games are jointly operated through the Websites or platforms of third-party joint operators, theWeb games may be hosted either on the third-party operators’ servers or on servers that 7RoadChangyou owns or leases from Internet data centers. In its arrangements with third-party joint operators, 7Road views the third-party joint operators as its customers andcenters, Changyou does not view 7Roaditself as the primary obligor with respect to operation of these Web games, as itChangyou does not have the primary responsibility for fulfillment and acceptability of the game services. For 7Road’s direct operation of its Web game Wartune through its Website for the game, 7Road is obligated to provide on-going services to the game players, and such obligation is not deemed to be inconsequential and perfunctory after game players purchase its game coins directly through its Website for Wartune. Therefore, 7Road’sAccordingly, Changyou recognizes these revenues from direct operation of Wartune on its Website for the game are first recorded by 7Road as deferred revenues and subsequently recognized as revenues over the service period during which 7Road is obligated to provide services to the game players to enable them to consume their virtual items.

PRC tax authorities have determined that all of 7Road’s game revenues from the joint operation of its games within China, which are generated through Shenzhen 7Road, are subject to 17% PRC VAT, and that Shenzhen 7Road, as a “Software Enterprise,” is entitled to a 14% VAT refund immediately upon the filing of its VAT returns, with the result that 7Road’s net effective PRC VAT rate is 3%. 7Road presents PRC VAT on a grossnet basis by which VAT at the rateaccording to its share of 17% is included in revenues, and 7Road’s net effective PRC VAT rate of 3% is included in cost of revenues, because Shenzhen 7Road’s 17% VAT obligation and its entitlement to a 14% VAT refund are one integrated preferential VAT policy.revenues.

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Overseas licensing revenueLicensing Revenue

Changyou enters into licensing arrangements with overseas licenseesthird-party operators to operate its MMOGs in other countries orand regions. These licenselicensing 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 ofrelated to the games. The initial license fee is based on both a fixed amount and additional amounts receivable upon the games’ achieving certain sales targets. Since Changyou is obligated to provide post-salespost-sale 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.

Mobile Revenues

Our mobile revenues are generated from the provision of mobile-related services through different types of mobile products to mobile phone users. The mobile products mainly consist of SMS, RBT, mobile video, mobile games, and IVR. In order to deliver our products to mobile phone users, we sign contracts with China Mobile Communications Corporation, China United Network Communication Group Company Limited, China Telecom Corporation and their subsidiaries and other small mobile network operators (collectively, the “China mobile network operators”). We obtain fees from the China mobile network operators, which charge users on a monthly or per message /download basis for mobile services we provide. After the receipt of service fees from China mobile network operators, we make payments to third-party mobile service alliance and content providers based on revenue-sharing arrangements.

Mobile revenues are recognized on gross or net basis, determined by evaluating the terms of the arrangement to determine whether we are serving as principal or agent in a transaction. To determine the amount of revenues to be recognized in the month in which the service is performed, provided that no significant obligations remain, 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 mobile 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, 2013, 70% of our estimated mobile 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 mobile service fees, net of its service fees, to us.

Others Revenues

Others revenues are primarily generated from our business of offering IVAS with respect to the operation of Web games developed by third-party developers under revenue-sharing arrangementsand services provided to software application users; offering mobile-related services and mobile products, in cooperation with the developers,China mobile network operators, to mobile phone users and to China mobile network operators; and offering cinema advertisement slots for advertisements to be shown in theaterscinemas before the screening of movies, and sub-licensing of licensed video content to third parties.movies.

Revenues from IVAS

Our IVAS revenues are currently derived from our operation of Web games and services we provide to users of our software applications. We offer Web games, developed by third-party developersincluding licensed and generate revenues from the provision of IVAS, including promotion, access maintenance andself-developed games on our Websites, collect payment services, to third-party developers. Under revenue-sharing agreements that we sign with third-party developers, we collect payments from the end users, keepand pay a pre-agreed percentage of the proceeds to third-party developers for the licensed games. We provide online music and remit the balanceentertainment services to the third-party developers.users of our software applications, such as RaidCall. We also provide download services for APPS and games for mobile devices. Revenues from IVAS are recognized when our obligations under the agreements and all other revenue recognition criteria have been met.

Revenues from cinema advertisementsMobile Products

For cinema advertisingMost of our mobile revenues are contributed by services provided to mobile phone users through products such as short messaging services (“SMS”), ring-back tones (“RBT”), and interactive voice response (“IVR”). We obtain fees for these services from the China mobile network operators, which charge users on a contractmonthly or per message /download basis for mobile services we provide, and we make payments to third-party mobile service alliance members and content providers based on revenue-sharing arrangements. Such revenues are recognized on either a gross or a net basis, which is signed withdetermined by evaluating the advertiserterms of the arrangement to establishdetermine whether we are serving as principal or agent in a fixed price and specify the advertising services to be provided. Pursuant to the contracts, wetransaction.

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Revenues from Cinema Advertisements

We provide advertisement placements in advertising slots to be shown in theatrescinemas before the screening of movies. When all the recognition criteria are met, revenues from cinema advertising are recognized under either the proportional performance method or the straight-line method, depending on the terms of the customer contract. Under the proportional performance method, revenues are generally recognized based on a percentage of the advertising slots actually delivered. Under the straight-line method, revenues are recognizeddelivered or on a straight-line basis over the contract period.

Revenues from sub-licensing of licensed video content

For licensed video content purchased on an exclusive basis, we have rights to sub-license to other platforms. Revenues from sub-licensing of licensed video content are recognized when the content is available for immediate and unconditional delivery under an existing sub-licensing arrangement, the sub-license period has begun and the sub-licensing fee is fixed or determinable and collection of the sub-licensing fee is reasonably assured.

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Share-based Compensation Expense

Sohu, Changyou, Sogou, and Sohu Video and 7Road all have incentive plans, and prior to June 28, 2013 7Road had an incentive plan, for the granting of share-based awards, including common stock /ordinaryor ordinary shares, share options, restricted shares and restricted share units, to their executive officers, management and employees.

Share-basedFor share-based awards for which a grant date has occurred, 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 share-based awards for which the service inception date precedes the grant date, share-based compensation expense is recognized as costs and expenses in the consolidated statements of comprehensive income beginning on the service inception date and is re-measured on each subsequent reporting date before the grant date, based on the estimated fair value of the related share-based awards. Share-based compensation expense is charged to the shareholders’ equity or noncontrolling interest section in the consolidated balance sheets. 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.

Sohu, Changyou, and Sogou share-based awardsShare-based Awards

For Sohu share-based awards, inIn determining the fair value of share options granted by Sohu as share-based awards, 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, inIn determining the fair value of ordinary shares restricted shares and restricted share units granted by Changyou as share-based awards 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, inIn determining the fair value of share options granted by Sogou as share-based awards, 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. Certain persons who became Sogou employees when Tencent’s Soso search-related businesses were transferred to Sogou on September 16, 2013 had been granted restricted share units under Tencent’s share award arrangements prior to the transfer of the businesses to Sogou. These Tencent restricted share units will continue to vest under the original Tencent share award arrangements provided the transferred employees continue to be employed by Sogou during the requisite service period. After the transfer of the Soso search-related businesses to Sogou, Sogou applied the guidance in ASC 505-50 to measure the related compensation expense, based on the then-current fair value at each reporting date, which is deemed to have been incurred by Tencent as an investor on Sogou’s behalf. To determine the then-current fair value of the Tencent restricted share units granted to these employees, the public market price of the underlying shares at each reporting date was applied. Because Sogou is not required to reimburse Tencent for such share-based compensation expense, the related amount was recorded by Sogou as a capital contribution from Tencent.

Share-based compensation expense for ordinary shares granted is fully recognized in the quarter during which the ordinary shares are granted. For share options, restricted shares and restricted share units granted with respect to Sohu shares and 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. For Tencent restricted share units that Tencent had granted to employees who transferred to Sogou with the Soso search-related businesses, compensation expense is recognized by Sogou on an accelerated basis over the requisite service period, and the fair value of the share-based compensation is re-measured at each reporting date until a measurement date occurs. For Sogou Class A Ordinary Shares repurchased from our employees in the second quarter of 2014, share-based compensation expense is recognized by the Sohu Group in the consolidated statements of comprehensive income in an amount equal to the excess of the repurchase price over the fair value at the repurchase date of the Sogou Class A Ordinary Shares that we repurchased. The number of share-based awards for which the service is not expected to be rendered over the requisite period is estimated, and the relatedno compensation expense is not recorded for thatthe number of awards.awards so estimated.

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Sohu Video share-based awardsShare-based Awards

On January 4, 2012, Sohu Video, the holding entity of Sohu’s video division, adopted a 2011 Share Incentive Plan (the “Video 2011 Share Incentive Plan”) which provides 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, 2013,2014, grants of options for the purchase of 15,352,200 of16,368,200 ordinary shares of Sohu Video had been made, andof which options for the purchase of 4,972,800 ordinary shares were effective under the Video 2011 Share Incentive Plan.vested.

For purposes ofASC 718718-10-25, no grant date may be established until a mutual understanding ofcan be reached between Sohu Video and the recipients as to 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 enterprise value of Sohu Video and hence the fair value of the optionsawards is determinable and can be accounted for.

Management concluded that No grant date could be determined as of September 30, 2013 certain significant factors necessary to determine the fair value of Sohu’s video division remained uncertain. On the basis that2014, because the broader terms and conditions of the option awards had neither been finalized nor mutually agreed upon with the recipients, norecipients.

UnderASC 718-10-55, if the service inception date precedes the grant of options occurreddate for purposes ofASC 718 and hence no share-basedequity-classified awards, compensation expense was recognizedshould be accrued beginning on the service inception date and re-measured on each subsequent reporting date before the grant date, based on the estimated fair value of the awards. The estimate of the awards’ fair value would be fixed in the period in which the grant date occurs, and cumulative compensation expense should be adjusted based on the fair value at the grant date. Management determined that the service inception date with respect to vested option awards for the three months ended September 30, 2013.purchase of 4,972,800 shares had preceded the grant date.

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7Road share-based awardsShare-based Awards

On July 10, 2012, 7Road adopted athe 2012 Share Incentive Plan (the “7Road 2012 Share Incentive Plan”), which initially provided for the issuance to selected directors, officers, employees, consultants and advisors of 7Road of up to 5,100,000 ordinary shares of 7Road (amounting to 5.1% of the then outstanding 7Road shares on a fully-diluted basis). 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 then outstanding 7Road shares on a fully-diluted basis) under the 7Road 2012 Share Incentive Plan.

On May 1, 2013, Changyou entered into an agreement with noncontrolling shareholders to acquire all of the outstanding ordinary shares of 7Road held by the noncontrolling shareholders. The acquisition closed on June 5, 2013.

On June 28, 2013, 7Road’s Board of Directors approved the cancellation of the 7Road 2012 Share Incentive Plan. 7Road concurrently offered to a total of 42 7Road employees holding an aggregate of 2,223,750 restricted share units which had been granted under the 7Road 2012 Share Incentive Plan the right to exchange their restricted share units for, at each employee’s election, in each case subject to the employee’s continued employment by 7Road, either (i) Scheme I: the right to a cash payment of up to an aggregate of $2.90 per restricted share unit exchanged, vesting and payable at the rate of 40%, 30% and 30%, respectively, on the first, second and third anniversaries of July 18, 2012, which is the date when the surrendered restricted share units were granted under the 7Road 2012 Share Incentive Plan, or (ii) Scheme II: the right to receive an annual cash bonus, over a seven-year period commencing July 1, 2013, based on the adjusted annual cumulative net income of 7Road. All restricted share units held by these 42 holders under the 7Road 2012 Share Incentive Plan as of June 28, 2013 were included in this exchange program.

In the third quarter of 2013, 7Road granted to an additional 48 7Road employees the right to receive an annual cash bonus under Scheme II with the same terms as described above.

As the original awards of restricted share units made under the 7Road 2012 Share Incentive Plan included as a vesting condition the completion of an initial public offering, which is not considered probable underuntil it occurs, no share-based compensation expense was recognized for the fair value of the original awards. As of the date of the modification resulting from the exchange program, incrementalIncremental compensation expense, which is not classified as share-based compensation expense, will beis equal to the fair values of the two new compensation schemes included in the exchange program as of the date of the modification resulting from the exchange program.

For Scheme I, the modification resulted in total incremental compensation expense of $5.7$3.9 million whichwas recognized as of September 30, 2014 with respect to the modification, and $0.8 million will be recognized in the consolidated statements of comprehensive income ratably over the remaining vesting period of the awards for each tranche. For the three and nine months ended September 30, 2013, compensation expense of $0.4 million and $2.9 million, respectively, was recognized in the consolidated statements of comprehensive income. In the third quarter of 2013, 7Road paid $1.6 million in cash bonuses under Scheme I.

awards. For Scheme II, the incremental compensation expense varies depending on 7Road’s financial performance. In

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Changyou Employee Incentive Plans

On February 8, 2014, Changyou’s Board of Directors approved three new employee incentive plans with terms of 10 years, effective January 1, 2014, under which Changyou may pay compensation to employees based on Changyou’s profits, or the third quarterprofits of 2013, 7Road grantedspecified projects. Eligible employees will receive a cash award from the plans as a bonus based on the number of employee incentive instruments they hold in the plans.

Under two of these three plans, Changyou may pay compensation to employees based on Changyou’s profits. Changyou will distribute to eligible employees who participate in the plans up to 5% of Changyou’s annual adjusted net profits. Combined, these two plans will distribute up to 10% of Changyou’s annual adjusted net profits. Eligible employees will participate in these plans by paying an additional 48 7Road employees the rightamount to purchase instruments that will entitle them, while they are employed by Changyou, to receive an annual cash bonuscompensation under Scheme IIthe plans. After four years of service to Changyou, employees who participate in either of these two plans will be entitled to sell their instruments to other employees at any time during their employment with Changyou at a price negotiated between the two employees, and by doing so would be compensated with the same terms as described above.present value of their expected future cash bonuses for the remaining period of the incentive plans. Management concluded that compensation expense associated with these two plans should be accounted for by analogy to deferred compensation arrangements, and that the present value of the amounts forecasted to be distributed under the plans should be amortized over the first four years after the effective date of the plans, before the instruments are first allowed to be transferred to other employees; that the present value of future cash bonuses in the remaining period should be re-measured at each reporting date; that the gain or loss resulting from the re-measurement in the first four years should be amortized over the remaining portion of the four-year period; and that the gain or loss after the four-year period should be booked immediately upon re-measurement at each reporting date after the four-year period. For both the three and the nine months ended September 30, 2013,2014, compensation expense recognized for these two plans was $1.5 million and $4.3 million, respectively.

The third employee incentive plan is structured to allow eligible employees to receive up to 20% of $0.3 million was recognizedthe annual adjusted net profits of projects that they work on. Unlike under the first two plans, certain of the incentive instruments to be issued under this plan will permit participating employees to sell the instruments to other employees at any time during their employment, and certain of the incentive instruments will not permit participating employees to sell their instruments to other employees. Management concluded that compensation expense in the consolidated statementsformer case should be accounted for by analogy to deferred compensation arrangements, and accordingly should be accrued as of comprehensive income.the effective date of the plan at the then present value of the amounts forecasted to be distributed under the plan; that the gain or loss resulting from the re-measurement of the cash bonus in the remaining period of the plan should be booked immediately upon re-measurement; and that compensation expense in the latter case should be recognized when the amount of relevant distributions under these plans is determined and Changyou’s obligations are established each year. For the three and nine months ended September 30, 2014, compensation expense recognized for this plan was $1.2 million and $27.9 million, respectively.

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 relate to net operating losses and temporary differences between accounting basis and tax basis for our China-based subsidiaries and VIEs, which are subject to corporate income tax in the PRC under the PRC Corporate Income Tax Law (the “CIT Law”).

 

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PRC Withholding Tax on Dividends

The CIT Law imposes a 10% withholding income tax foron dividends distributed by foreign invested enterprises to their immediate holding companies outside mainland China. A lower withholding tax rate willmay 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 Betweenan arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance“Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, (the “China-HK Tax Arrangement”)Capital”, 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 maywill remain subject to a withholding tax rate of 10%.

Changyou’s Board of Directors determined to cause one of Changyou’s PRC subsidiaries to distribute all of its 2012 earnings and a portion of its 2013 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. As of September 30, 2013, Changyou had accrued deferred tax liabilities in the amount of $16.8 million for withholding taxes associated with this distribution plan.

Transition from PRC Business Tax to PRC Value Added Tax and Business Tax

Effective September 1, 2012, the Pilot Programa pilot program (the “Pilot Program”) for transition from the imposition of PRC business tax (“Business TaxTax”) 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. Commencing August 1, 2013 the Pilot Program was expanded to all regions in the PRC. Our brand advertising and search revenues areas well as certain online game revenues were 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%.Pilot Program.

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 balance of VAT input. 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 7Road revenues, our brand advertising and search revenues are now subject to VAT at a rate of 6%.

UnderASC 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’sas well as online game revenues from the sale of software are considered as substantially different in nature, we determinedChangyou’s Web game operations 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 revenueswere not developed in-house 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. Other online game revenues were not affected by the Pilot Program. Before and after the Pilot Program, revenues from MMOG operations are subject to a component5% Business Tax, and revenues of our costs for providing7Road that deemed to be derived from the brand advertising and search services. On the other hand,sale of software are subject to VAT. VAT payable by 7Road is in effect at 3%a rate of the applicable revenues from the sale of software,17%, with a 14% immediate tax refund 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 toresulting in a sales tax than typical VAT. As a result, wenet rate of 3%.

We adopted the net presentation method for our brand advertising and search businesses both before and after the implementation of the Pilot Program, andProgram. We adopted the gross presentation method for the revenues of 7Road deemed to be derived from the sale of software we adopted the gross presentation methodboth before and after the implementation of the Pilot Program.

U.S. Corporate Income Tax

Sohu.com Inc. is a Delaware corporation that is subject to U.S. corporate income tax on its taxable income at a rate of 34% or 35%. Subject to certain limitations, the net operating losses (“NOLs”) of a corporation taxable in the U.S. that are carried forward from prior years may be used to offset the corporation’s taxable income. As of the end of the 2012 taxable year, Sohu.com Inc. had no further NOLs available for offsetting any U.S. taxable income. Accordingly, toTo the extent that Sohu.com Inc. has U.S. taxable income, in 2013, we will accrue U.S. corporate income tax in our consolidated statements of comprehensive income and make estimated tax payments as and when required by U.S. law.

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Other Provisions for Taxes

As described above, the Group is subject to various taxes in different jurisdictions, primarily the US and the PRC. Management reviews regularly the adequacy of the provisions for taxes as they relate to the income and transactions of the Group. In reviewing various equity transactions among companies in the Group, management determined that the transactions may result in additional tax obligations under relevant tax rules. As a result of certain equity transactions that took place during the quarter ended September 30, 2013, the Group has recognized directly to equity a provision for tax in the amount of $21.4 million as of September 30, 2013.

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. As discussed above, the Sohu Group recognized $21.4 million tax payable as of September 30, 2013 for an uncertain tax position arising from certain equity transactions that may be considered by PRC tax authorities to have resulted in taxable income.

Net Income /(Loss) per Share

Basic net income /(loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income /(loss) 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 /(loss) 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 /(loss) per share. Additionally, for purposes of calculating the numerator of diluted net income /(loss) per share, the net income /(loss) attributable to the Sohu Group is adjusted as follows:follows. The adjustment will not be made if there is an anti-dilutive effect.

 

(1)Changyou’s net income /(loss) attributable to the Sohu Group 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 ofand not by using the percentage held by Sohu of the total economic interest in Changyou, which is used for the calculation of basic net income per share.

In the calculation of the Sohu Group’s diluted net income /(loss) per share, assuming a dilutive effect, all of Changyou’s existing unvested restricted share units, and vested restricted share units that have not yet been settled, are treated as vested and settled by Changyou under the treasury stock method, causing the percentage of the weighted average number of shares held by Sohu in Changyou to decrease. As a result, Changyou’s net income /(loss) attributable to the Sohu Group on a diluted basis decreased accordingly. Assuming an anti-dilutive effect, all of these Changyou restricted share units are excluded from the calculation of the Sohu Group’s diluted net income /(loss) per share. As a result, Changyou’s net income /(loss) attributable to the Sohu Group on a diluted basis equals the number used for the calculation of the Sohu Group’s basic net income /(loss) per share.

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(2)Sogou’s net income /(loss) attributable to the Sohu Group 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, Series A Preferred Shares Series B Preferredand Ordinary 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 ofand is not determined by allocating Sogou’s net income /(loss) allocated to the Sohu Group by virtue ofusing the Terms of Preferred Shares of Sogou, the terms of Sogou’s restructuring in 2010, Sohu’s purchase of Sogou Series A Preferred Shares from Alibaba, and the terms of Class B Ordinary Shares of Sogou, which is usedmethodology for the calculation of basic net income per share./(loss) attributable to the Sogou noncontrolling shareholders.

In the calculation of the Sohu Group’s diluted net income /(loss) per share, assuming a dilutive effect, the percentage of the Sohu Group’s shareholding in Sogou was calculated by treating convertible preferred shares issued by Sogou as having been converted at the beginning of the period and unvested share options with the performance targets achieved as well as vested but unexercised share options as having been exercised during the period. The dilutive effect of share-based awards with a performance requirement was not considered before the performance targets were actually met. Assuming an anti-dilutive effect, all of these Sogou shares and share options are excluded from the calculation of the Sohu Group’s diluted income /(loss) per share. As a result, Sogou’s net income /(loss) attributable to the Sohu Group on a diluted basis equals the number used for the calculation of the Sohu Group’s basic net income /(loss) per share.

Fair Value of Financial Instruments

U.S. GAAP establishes a three-tier hierarchy to prioritize the inputs used in the valuation methodologies in measuring the fair value of financial instruments. This hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three-tier fair value hierarchy is:

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.

Our financial instruments include cash equivalents, restricted time deposits, short-term investments, investments in debt securities, accounts receivable, prepaid and other current assets, prepaid non-current assets, accounts payable, accrued liabilities, receipts in advance and deferred revenue, short-term bank loans, other short-term liabilities, long-term accounts payable and long-term bank loans, as well as the repurchase options and the repurchase/put option with respect to Sogou Series A Preferred Shares.

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Cash Equivalents

Our cash equivalents mainly consist of time deposits placedand money market funds with banks with an original maturitymaturities of three months or less.

Restricted time depositsTime Deposits

Restricted time deposits are valued based on the prevailing interest rates in the market.market using the discounted cash flow method.

Changyou loansLoans from offshore banks, securedOffshore Banks, Secured by time depositsTime Deposits

As of September 30, 20132014 we had, through Changyou, loans from offshore banks. These loans arebanks secured by RMB deposits in onshore branches of those banks. The loans from the offshore branches of the lending banks are classified as short-term bank loans or long-term bank loans based on their repayment period. The rates of interest under the loan agreements with the lending banks were determined based on the prevailing interest rates in the market. The RMB onshore deposits securing the offshore loans are treated as restricted time deposits on our consolidated balance sheets.

Collateral related to Sogou incentive shares trust arrangementsIncentive Shares Trust Arrangements

In February 2013, we deposited $9 million in cash into restricted time deposit accounts at a bank as collateral for credit facilities provided by the bank to certain Sogou employees. The facilities were intended to fund the employees’ early exercise of Sogou share options and related PRC individual income tax. We are not subject to any additional potential payments other than the restricted time deposit amounts, and believe that the fair value of our guarantee liability is immaterial.

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 valuevalues are reflected in the consolidated statements of comprehensive income.

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 simplicity.

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 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.

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Available-for-Sale Securities

Investments in debt securities and equity securities that have readily determinable fair values not classified as trading securities or as held-to-maturity securities are classified as available-for-sale securities. Available-for-sale securities are reported at fair value, with unrealized gains or losses recorded in other comprehensive income or losses in the consolidated balance sheets. Realized gains or losses are included in the consolidated statements of comprehensive income during the period in which the gain or loss is realized. An impairment loss on the available-for-sale securities is recognized in the consolidated statements of comprehensive income when the decline in value is determined to be other-than-temporary.

On August 12, 2014, Sohu acquired approximately 6% of the total outstanding common shares of Keyeast Co. Ltd., a Korean-listed company, for a purchase price of $14.9 million. We classified this investment as available-for-sale equity securities and reported it at fair value.

Equity Investments

Investments in entities are recorded as equity investments. For entities over which we do not have significant influence, are recorded as equity investments and are accounted for by the cost method. Investments inmethod is applied; for entities over which we havecan exercise significant influence but do not control are also recorded asown a majority equity investments and are accounted for byinterest or control, the equity method. Undermethod is applied. For cost method investments, we carry the investment at historical cost after the date of investment. For equity method investments, we adjust the carrying amount of an investment and recognize investment income or loss for our share of the post-acquisition profitsearnings or lossesloss of the equity investment is recognized in our consolidated statementsinvestee after the date 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.investment.

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Repurchase Options and Repurchase/Put Option for Sogou Series A Preferred Shares

As discussed in “Business Transactions-SogouTransactions - Sogou Transactions,” in September 2013 Sogou entered into Repurchase Option Agreements with Sohu Search and Photon, and a Repurchase/Put Option Agreement with China Web, with respect to Series A Preferred Shares of Sogou held by them. On March 24, 2014, Sogou expectspurchased from China Web, pursuant to exercise its rights to purchase itsthe Repurchase/Put Option Agreement between Sogou and China Web, 14.4 million Series A Preferred Shares under each of these agreements when they first become exercisable by Sogou, on March 16, 2014.for an aggregate purchase price of $47.3 million.

TheSogou’s repurchase options with Photon and the repurchase/put option for Sogou Series A Preferred SharesChina Web were initially recognized in additional paid-in capital in the Sohu Group’s consolidated balance sheets at fair value when the agreements were signed. The fair value of the put option will be revaluated quarterly until the option is exercised or expires unexercised. SubsequentAny subsequent changes in the fair values of the equity classified repurchase options were not and will not be recognized. On March 24, 2014, the repurchase option with China Web was exercised by Sogou. As of September 30, 2014, the remaining balance for the repurchase option with Photon in additional paid-in capital was $1.2 million, based on the fair value of the repurchase option on September 16, 2013.

China Web’s put option with Sogou was initially recognized untilin other short-term liabilities in the options are exercised. Sohu Group’s consolidated balance sheets at fair value when the agreement was signed. Subsequent changes in the fair value of the put option were recognized quarterly in other income /(expense) in the Sohu Group’s consolidated statements of comprehensive income. After Sogou’s repurchase of the Series A Preferred Shares from China Web on March 24, 2014, the other short-term liabilities recognized with respect to China Web were reversed to zero.

Management determined the fair values of thesethe repurchase options determinedwith Photon and China Web when the agreements were signed, and of the put option with China Web before Sogou exercised the repurchase option, using the binominal model, with a discount for lack of marketability, given that the repurchase options and the repurchase/put option were not publicly traded at the time of grant, andgrant. Management made the determination with the assistance of a qualified professional appraiser using management’s estimates and assumptions. We classify the valuation techniques that use these inputs as Level 3 of fair value measurements.

Long-Lived Assets

Long-lived assets include fixed assets, intangible assets and prepaid non-current assets.

Fixed Assets

Fixed assets mainly comprise office buildings, building improvements, leasehold improvements, vehicles, office furniture, and computer equipment and hardware. 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.

In May 2013, the office building Sohu purchased in 2009 was placed in service. Accordingly, in the same month, we recognized the office building’s original cost of $162 million as fixed assets. The original cost consists primarily of the purchase price and the costs of technological infrastructure and fitting-out work. Also in May 2013, we began recognizing depreciation expense based on the building’s useful life, which is approximately 41 years, on a straight-line basis.

For Changyou’s office building purchased in 2010, as of September 30, 2013, all of the $164 million purchase price had been paid and recognized as construction-in-process under fixed assets in our consolidated balance sheets, as the construction of the building had been completed and the technological infrastructure and fitting-out work was still in progress.

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Expenditure for maintenance and repairs is expensed as incurred.

The gain or loss on the disposal of fixed assets is the difference between the net sales proceeds and the lower of the carrying value or fair value less cost to sell the relevant assets and is recognized in operating expenses in the consolidated statements of comprehensive income.

Intangible Assets

Intangible assets mainly comprise video content and license, customer lists, developed technologies, domain names and trademarks, operating rights for licensed games and computer software purchased from unrelated third parties domain names and trademarks, and operating rights for licensed games.or acquired from business combinations. 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 Commencing in the thirdfirst quarter of 2011, licensed video content is amortized on2014, in order to match the current trend in viewership accumulation, we adopted an accelerated basis based on the viewership accumulation trend over the shorteramortization pattern for certain of the term of the estimated period over which the benefits of the license contract will be enjoyed or the applicable license period. For exclusively licensedour purchased 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.content.

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Prepaid non-currentNon-current Assets

Prepaid non-current assets primarily include prepaid PRC income tax arising from the sale of certain assets associated with the 17173 Business by Sohu to Changyou. 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 withASC 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.

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 consolidated VIEs. If the initial accounting for a business combination is incomplete by the end of the reporting period in which the combination occurs, we report in our financial statements provisional amounts for the items for which the accounting is incomplete. If a measurement period adjustment is identified, we recognize the adjustment as part of the acquisition accounting. We increase or decrease the provisional amounts of identifiable assets or liabilities by means of increases or decreases in goodwill for measurement period adjustments.

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 a 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 the 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.

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Contingent Consideration

Contingent consideration consists of the fair value of potential payments related to two acquisitions made by Changyou.

Changyou’s acquisition of Beijing Doyo Internet Technology Co., Ltd. (“Doyo”), included a contingent consideration arrangement that requires additional consideration to be paid by Changyou based on the achievement of specified performance milestones by Doyo for the fiscal years 2013 through 2015. The fair value of the contingent consideration was recognized on the date of the acquisition with the income approach applied. There were no indemnification assets involved.

Changyou’s acquisition of the RaidCall business, included a contingent consideration arrangement that gives Changyou the right to acquire additional shares of TalkTalk Limited (“TalkTalk”) at no cost if specified conditions occur through the 2014 fiscal year. The fair value of the right, which was nil, was recognized as contingent consideration on the date of the acquisition.

Mezzanine Equity

Our Mezzanine Equity consistsconsisted of the noncontrolling interest in 7Road and a put option pursuant to which the former noncontrolling shareholders would have had the right to put their ordinary shares in 7Road to Changyou at a pre-determined price if 7Road had achieved specified performance milestones before the expiration of the put option and 7Road did not complete an initial public offeringIPO on NASDAQ, the NYSENew York Stock Exchange (the “NYSE”) or the HKEX.Stock Exchange of Hong Kong (the “HKEX”). The put option was due to expire in 2014. Since the occurrence of the sale was not solely within the control of Changyou, we classify the noncontrolling interest was classified as mezzanine equity instead of permanent equity in ourthe Sohu Group’s and Changyou’s consolidated financial statements.

UnderASC 480-10, we calculate,calculated, 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 iswas adjusted by an accumulative amount equal to the higher of (i) and (ii).

On May 1, 2013, Changyou entered into an agreement to acquire all of the ordinary shares of 7Road held by the noncontrolling shareholders. The acquisition closed on June 5, 2013. UnderASC 810-10, changes in2013, and 7Road has been a parent’s ownershipwholly-owned subsidiary of Changyou since then. As the put option held by the owners of the noncontrolling 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. Followinglapsed upon the closing of theChangyou’s acquisition $2.4 million, representing the excess of the amount of the mezzanine-classified noncontrolling interesttheir shares in 7Road, overthere was no associated accretion and no mezzanine equity during and after the purchase price asthird quarter of the closing date, was recorded in our equity accounts.

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For the three and nine months ended September 30, 2013, accretion charges of nil and $17.8 million, respectively, compared to $4.5 million and $6.7 million, respectively, for the three and nine months ended September 30, 2012, were recorded in our statements of comprehensive income as net income attributable to the mezzanine-classified noncontrolling interest shareholders of 7Road.2013.

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.

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 Koreaother countries are the national currencies of those counties.counties, rather than the U.S. dollar.

Foreign Currency Translation

Assets and liabilities of our China-based subsidiaries and VIEs whose functional currencies are not the United Kingdom, Malaysia and KoreaU.S. dollar are translated into U.S. dollars, our reporting currency, at the exchange rate in effect at the balance sheetssheet 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.

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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.

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RESULTS OF OPERATIONS

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 20132014 AND 2012

Historical accounting error regarding net income attributable to Sohu.com Inc. and basic and diluted net income per share attributable to Sohu.com Inc.

As discussed above under the heading “Critical Accounting Policies and Management Estimates”, in the third quarter of 2013 management noted an accounting error in the Group’s Quarterly Report on Form 10-Q for the three months ended June 30, 2012 regarding net income attributable to Sohu.com Inc. and the calculation of basic and diluted net income per share attributable to Sohu.com Inc. After considering both the quantitative and qualitative aspects, the management concluded that the error was not material to the Group’s relevant historical financial statements taken as a whole so there was no need to restate the Group’s affected historical financial statements, but that relevant corrected financial information and related disclosures would be presented in this report and the Group’s future filings as applicable. Correction of the error in the Group’s consolidated statements of comprehensive income for the nine months ended September 30, 2012 included in this report resulted in a reduction of $14.2 million in the amount reported for net income attributable to Sohu.com Inc. (from $61.8 million to $47.6 million) and a reduction of $0.38 in the amounts reported for both basic net income per share and diluted net income per share attributable to Sohu.com Inc. (from $1.63 to $1.25 for basic net income per share, and from $1.44 to $1.06 for diluted net income per share), as compared to the corresponding amounts reported in the Group’s 3rd Quarter 2012 10-Q. Correction of the error in the Group’s consolidated balance sheets as of December 31, 2012 included in this report resulted in an increase of $14.2 million in additional paid-in capital (from $364.1 million to $378.3 million) and a reduction of $14.2 million in retained earnings (from $784.4 million to $770.2 million), as compared to the corresponding amounts reported in the Group’s Annual Report on Form 10-K for the year ended December 31, 2012.

Reclassification of revenuesMobile Business and costs related to Changyou IVASMobile Segment

Commencing January 1, 2013, in orderthe first quarter of 2014, we reclassified the mobile business and mobile segment to provide a better foundation for understanding Changyou’s performance, both revenuesthe others business and costs generated from the operation of third-party Web games byothers segment, respectively, because we did not consider the 17173 business were reclassified from the online gamemobile business to IVASbe significant enough to constitute a separate business and the CODM no longer reviewed the mobile business as a separate segment. The mobile business offers mobile-related services and mobile products, in the others business.cooperation with China mobile network operators, to mobile phone users and to China mobile network operators. Most of our mobile revenues are contributed by services provided to mobile phone users through products such as SMS, RBT, and IVR. To conform to current period presentations, the relevant amounts for prior periods have been reclassified accordingly. Such reclassifications amounted to $0.8$14.5 million and $3.5$43.2 million, respectively, for revenues and $0.3$8.1 million and $1.3$26.3 million, respectively, for costs respectively, for the three and nine months ended September 30, 2012.2013.

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,  Three Months Ended September 30, Nine Months Ended September 30, 
 2013   2012   2013 vs
2012
 2013   2012   2013 vs
2012
  2014   2013   2014 vs
2013
 2014   2013   2014 vs
2013
 

Revenues

                    

Online advertising:

                    

Brand advertising

 $124,780   34 $77,874   27 $46,906   $305,208   30 $208,154   27 $97,054   $148,823   35 $124,780   34 $24,043   $393,334   33 $305,208   30 $88,126  

Search and others

 52,305   14 35,284   12 17,021   134,528   13 85,684   11 48,844   98,437   22 52,305   14 46,132   247,810   21 134,528   13 113,282  
 

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

 

Subtotal of online advertising revenues

  177,085    48  113,158    39  63,927    439,736    43  293,838    38  145,898    247,260    57  177,085    48  70,175    641,144    54  439,736    43  201,408  
 

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

 

Online game

  161,494    44  150,263    53  11,231    497,210    49  412,187    54  85,023    150,338    35  161,494    44  (11,156  467,603    39  497,210    49  (29,607

Mobile

  14,524    4  14,312    5  212    43,610    4  43,261    6  349  

Others

  15,220    4  7,645    3  7,575    34,267    4  18,423    2  15,844    32,817    8  29,744    8  3,073    87,134    7  77,877    8  9,257  
 

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

 

Total revenues

 $368,323    100 $285,378    100 $82,945   $1,014,823    100 $767,709    100 $247,114   $430,415    100 $368,323    100 $62,092   $1,195,881    100 $1,014,823    100 $181,058  
 

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

 

Total revenues were $368.3$430.4 million and $1,014.8 million,$1.2 billion, respectively, for the three and nine months ended September 30, 2013,2014, compared to $285.4$368.3 million and $767.7 million,$1.0 billion, respectively, for the corresponding periods in 2012.2013. The increase in total revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $82.9$62.1 million, and the increase from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $247.1$181.1 million. The increases were mainly attributable to increases in online advertising revenues, andwhich were offset in part by decreases in online game revenues.

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Online Advertising Revenues

Online advertising revenues were $177.1$247.3 million and $439.7$641.1 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $113.2$177.1 million and $293.8$439.7 million, respectively, for the corresponding periods in 2012.2013. The increase in online advertising revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $63.9$70.2 million, and the increase from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $145.9$201.4 million. The increases were mainly attributable to increases in brand advertising revenues and search and others revenues.

Brand Advertising Revenues

Brand advertising revenues were $124.8$148.8 million and $305.2$393.3 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $77.9$124.8 million and $208.2$305.2 million, respectively, for the corresponding periods in 2012.2013. The increase in brand advertising revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $46.9$24.0 million, and the increase from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $97.1$88.1 million. The increases were mainly attributable to increases in revenues from the online video and real estate businesses.

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Revenues from the online video business increased $14.2 million and $46.8 million, respectively, for the three months and nine months ended September 30, 2014, compared to the corresponding periods in 2013. The increase was driven by our strategy of providing high-quality differentiated content and increasing the base of daily unique visitors and daily video views, which in turn resulted in higher revenues and also attracted larger numbers of advertisers. The average daily unique visitors and average daily video views for our online video business increased 48% and 128%, respectively, for the month of September 2014, compared to the month of September 2013. The number of advertisers on our online video sites increased to 306 as of September 30, 2014 from 188 as of September 30, 2013. Revenues from the real estate business.business increased $3.7 million and $15.6 million, respectively, for the three months and nine months ended September 30, 2014, compared to the corresponding periods in 2013. This increase was mainly driven by our subscription membership services and our brand advertising services. The quicker growth of our subscription membership services offered to prospective purchasers of real estate was a result of business expansion through cooperation with property developers. The number of property developers with which we had cooperation arrangements increased to 593 as of September 30, 2014 from 262 as of September 30, 2013.

We expect brand advertising revenues to be flatstable in the fourth quarter of 2013,2014, compared to the third quarter of 2013.2014.

Search and Others Revenues

Search and others revenues were $52.3$98.4 million and $134.5$247.8 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $35.3$52.3 million and $85.7$134.5 million, respectively, for the corresponding periods in 2012.2013. The increase in search and others revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $17.0$46.1 million, and the increase from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $48.8$113.3 million. The increases wereincrease was mainly contributed by pay-for-click services,services. The revenue growth of pay-for-click service was principally attributable to an increase in the number of paid clicks and a higher average cost-per-click, as well as online marketing services onpaid clicks increased by approximately 83% and 53%, respectively, and average cost-per-click increased by approximately 19% and 29%, respectively, for the Sogou Web Directory, both as a result of improved monetization of traffic.three and nine months ended September 30, 2014 compared to the corresponding periods in 2013.

We expect search and others revenues to increase in the fourth quarter of 2013,2014, compared to the third quarter of 2013.2014.

Online Game Revenues

Online game revenues were $161.5$150.3 million and $497.2$467.6 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $150.3$161.5 million and $412.2$497.2 million, respectively, for the corresponding periods in 2012.2013. The increasedecrease in online game revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $11.2 million, and the increasedecrease from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $85.0$29.6 million. The increases weredecrease was mainly due to decreased revenues from Changyou’s Web games Wartune and DDTank in China, which have reached a relatively mature phase in their operation, and decreased revenues from Changyou’s flagship MMOG, TLBB, following the growth in revenue of Wartune, TLBB, andstrategic decision to reduce the new MMOG Dou Po Cang Qiong.game’s difficulty.

We expect online game revenues to increasebe stable in the fourth quarter of 2013,2014, compared to the third quarter of 2013.2014.

MobileOthers Revenues

Mobile revenuesRevenues for other services were $14.5$32.8 million and $43.6$87.1 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $14.3$29.7 million and $43.3$77.9 million, respectively, for the corresponding periods in 2012. The increase in mobile revenues from the three months ended September 30, 2012 to the three months ended September 30, 2013 was $0.2 million, and the increase from the nine months ended September 30, 2012 to the nine months ended September 30, 2013 was $0.3 million.

We expect mobile revenues to be decrease in the fourth quarter of 2013, compared to the third quarter of 2013.

Others Revenues

Revenues for other services were $15.2 million and $34.3 million, respectively, for the three and nine months ended September 30, 2013, compared to $7.6 million and $18.4 million, respectively, for the corresponding periods in 2012. The increase in others revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $7.6$3.1 million, and the increase from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $15.8$9.3 million. The increases wereincrease was mainly due to increased revenues from IVAS and the cinema advertisement business.advertising.

 

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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,  Three Months Ended September 30, Nine Months Ended September 30, 
 2013   2012   2013 vs
2012
 2013   2012   2013 vs
2012
  2014   2013   2014 vs
2013
 2014   2013   2014 vs
2013
 

Cost of revenues:

                    

Online advertising:

                    

Brand advertising

 $63,780   51 $37,476   39 $26,304   $160,214   47 $125,331   45 $34,883   $83,424   46 $63,780   51 $19,644   $230,462   47 $160,214   47 $70,248  

Search and others

 26,785   21 19,736   20 7,049   72,075   21 49,056   18 23,019   46,375   26 26,785   21 19,590   118,532   24 72,075   21 46,457  
 

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

 

Subtotal of cost of online advertising revenues

  90,565    72  57,212    59  33,353    232,289    68  174,387    63  57,902    129,799    72  90,565    72  39,234    348,994    71  232,289    68  116,705  
 

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

 

Online game

  21,750    17  20,753    21  997    67,381    20  54,475    20  12,906    33,949    19  21,750    17  12,199    90,798    19  67,381    20  23,417  

Mobile

  8,108    7  9,474    10  (1,366  26,342    8  28,535    10  (2,193

Others

  5,067    4  9,310    10  (4,243  16,652    4  18,718    7  (2,066  17,912    9  13,175    11  4,737    50,252    10  42,994    12  7,258  
 

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

 

Total cost of revenues

 $125,490    100 $96,749    100 $28,741   $342,664    100 $276,115    100 $66,549   $181,660    100 $125,490    100 $56,170   $490,044    100 $342,664    100 $147,380  
 

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

  

 

   

 

   

 

 

Total cost of revenues was $125.5$181.7 million and $342.7$490.0 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $96.7$125.5 million and $276.1$342.7 million, respectively, for the corresponding periods in 2012.2013. The increase in cost of revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $28.7$56.2 million, and the increase from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $66.5$147.4 million. The increases wereincrease was mainly attributable to increases in cost of online advertising revenues and cost of online game revenues.

Cost of Online Advertising Revenues

Cost of online advertising revenues was $90.6$129.8 million and $232.3$349.0 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $57.2$90.6 million and $174.4$232.3 million, respectively, for the corresponding periods in 2012.2013. The increase in cost of online advertising revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $33.4$39.2 million, and the increase from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $57.9$116.7 million. The increases wereincrease was mainly attributable to increases in cost of brand advertising revenues.

Cost of Brand Advertising Revenues

Cost of brand advertising revenues mainly consists of content and license costs, bandwidth leasing costs, salary and benefits expenses,expense, and depreciation expenses.expense.

Cost of brand advertising revenues was $63.8$83.4 million and $160.2$230.5 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $37.5$63.8 million and $125.3$160.2 million, respectively, for the corresponding periods in 2012.2013.

The increase in cost of brand advertising revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $26.3$19.6 million. The increase mainly consisted of a $12.3an $11.8 million increase in amortization of content and license costs, an $8.1and a $4.4 million increase in bandwidth leasing costs, a $3.3 million increase in salary and benefits expenses, and a $1.1 million increase in depreciation expenses.costs.

The increase in cost of brand advertising revenues from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $34.9$70.2 million. The increase mainly consisted of a $21.2$38.8 million increase in amortization of content and license costs, an $11.1a $20.9 million increase in bandwidth leasing costs, a $3.4 million increase in salary and benefits expenses, an $11.0 million increase in bandwidth leasing costs,expense, and a $3.1$3.3 million increase in depreciation expenses, offset by a $15.3 million impairment of purchased video content in the second quarter of 2012.expense.

Our brand advertising gross margin was 49%44% and 48%41%, respectively, for the three and nine months ended September 30, 2013,2014, as compared to 52%49% and 40%48%, respectively, for the corresponding periods in 2012.2013. The decrease in our brand advertising gross margin from 52% to 49% for the three months ended September 30, 2013 was mainly due to the increase in content and license costs and in bandwidth leasing costs. The increase from 40% to 48% for the nine months ended September 30, 2013 was mainly due to a $15.3 million impairment of purchased video content that we recognized in the second quarter of 2012, and relatively slower growth in the rate of brand advertising costs compared with the growth in revenues.

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Cost of Search and Others Revenues

Cost of search and others revenues mainly consists of traffic acquisition costs, bandwidth leasing costs, and depreciation expenses,expense, as well as salary and benefits expenses.expense.

Cost of search and others revenues was $26.8were $46.4 million and $72.1$118.5 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $19.7$26.8 million and $49.1$72.1 million, respectively, for the corresponding periods in 2012.2013.

The increase in cost of search and others revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $7.0$19.6 million. The increase mainly consisted of a $2.8$14.0 million increase in traffic acquisition costs, a $2.4$2.7 million increase in depreciation expense, and a $2.7 million increase in bandwidth leasing costs, and a 1.3 million increase in depreciation expenses.costs.

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The increase in cost of search and others revenues from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $23.0$46.5 million. The increase mainly consisted of a $13.1$27.3 million increase in traffic acquisition costs, a $5.0$9.6 million increase in depreciation expense, and an $8.4 million increase in bandwidth leasing costs, and a $3.8 million increase in depreciation expenses.costs.

Our search and others gross margin was 49%53% and 46%52%, respectively, for the three and nine months ended September 30, 2013,2014, as compared to 44%49% and 43%46%, respectively, for the corresponding periods in 2012.2013. The increase in our search and others gross margin was mainly due to higher revenues from the improved monetization of traffic,increased paid clicks and a higher average cost-per-click, as well as traffic acquisition costs and bandwidth costs constituting a lower percentage of search and others revenues.

Cost of Online Game Revenues

Cost of online game revenues mainly consists of salary and benefits expenses, depreciation and amortization expenses, bandwidth leasing costs, Business Tax and VAT arising from transactions between Changyou’s subsidiaries and its VIEs, andexpense, revenue-based royalty payments to game developers.developers, bandwidth leasing costs, and depreciation and amortization expense.

Cost of online game revenues was $21.8$33.9 million and $67.4$90.8 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $20.8$21.8 million and $54.5$67.4 million, respectively, for the corresponding periods in 2012.2013.

The increase in cost of online game revenues from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $1.0$12.2 million. The increase mainly consisted ofincluded a $1.0 million increase in Business Tax and 7Road VAT, a $0.8$4.7 million increase in revenue-based royalty payments to game developers, and a $0.5$3.9 million increase in salary and benefits expenses, offset byexpense, and a $1.1$1.5 million decreaseincrease in bandwidth leasing costs.

The increase in cost of online game revenues from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $12.9$23.4 million. The increase mainly consisted ofincluded a $6.0$7.9 million increase in revenue-based royalty payments to game developers, and a $7.5 million increase in salary and benefits expenses, a $3.7 million increase in Business Tax and 7Road VAT, and a $1.5 million increase in bandwidth leasing costs.expense.

Our online game gross margin was 87%77% and 86%81%, respectively, for the three and nine months ended September 30, 2013,2014, as compared to 86%87% and 87%86%, respectively, for the corresponding periods in 2012.

Cost of Mobile Revenues

Cost of mobile revenues mainly consists of revenue-sharing payments (which include payments to third party mobile service alliances and content providers), collection charges and transmission fees paid to China mobile network operators, bandwidth leasing costs and depreciation expenses.

Cost of mobile revenues was $8.1 million and $26.3 million, respectively, for the three and nine months ended September 30, 2013, compared to $9.5 million and $28.5 million, respectively, for the corresponding periods in 2012. The decrease in cost of mobile revenues from the three and nine months ended September 30, 2012 to the three and nine months ended September 30, 2013 was $1.4 million and $2.2 million, respectively.2013. The decreases were mainly due to decreased revenue-sharing payments.

The collection charges and transmission fees varied between China mobile network operators. The collection charges and transmission fees mainly include (i) a gateway fee of $0.008 to $0.032 per message in both the third quarter of 2013 and 2012, depending on the volume of the monthly total mobile messages, 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 2013 and 2012.

Our mobile gross margin was 44% and 40%, respectively, for the three and nine months ended September 30, 2013, as compared to 34% for both the three and the nine months ended September 30, 2012. The increases in our mobileonline game gross margin were mainly due to decreased collection chargesadditional costs of licensed MMO and revenue-sharing payments.mobile games that were launched in the third quarter of 2014.

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Cost of Revenues for Other Services

Cost of revenues for other services mainly consists of revenue-sharing payments related to the IVAS business, revenue-sharing payments paid to China mobile network operators, and payments to theatres and film production companies for pre-film screening advertisement slots, revenue-sharing payments related to IVAS business, and amortization of sub-licensing cost.slots.

Cost of revenues for other services was $5.1$17.9 million and $16.7$50.3 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $9.3$13.2 million and $18.7$43.0 million, respectively, for the corresponding periods in 2012.2013. The decreaseincrease in cost of revenues for other services from the three and nine months ended September 30, 20122013 to the three and nine months ended September 30, 20132014 was $4.2$4.7 million and $2.1$7.3 million, respectively. The decreasesincreases were mainly due to decreasedrevenue-sharing payments forrelated to the cinema advertisementIVAS business.

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,   Three Months Ended September 30,   Nine Months Ended September 30, 
 2013   2012   2013 vs
2012
 2013   2012   2013 vs
2012
   2014     2013     2014 vs
2013
   2014     2013     2014 vs
2013
 

Operating expenses:

                          

Product development

 $70,551   37 $46,994   38 $23,557   $185,731   38 $128,927   39 $56,804    $107,971     37 $70,551     37 $37,420    $327,911     37 $185,731     38 $142,180  

Sales and marketing

 90,728   48 58,250   47 32,478   221,129   46 145,903   43 75,226     131,742     46 90,728     48 41,014     410,702     47 221,129     46 189,573  

General and administrative

 29,365   15 19,666   15 9,699   77,726   16 54,968   17 22,758     49,730     17 29,365     15 20,365     138,330     16 77,726     16 60,604  

Impairment of intangible assets via acquisition of businesses

 0   0 0   0 0   0   0 2,906   1 (2,906
 

 

   

 

   

 

  

 

   

 

   

 

   

 

    

 

    

 

   

 

    

 

    

 

 

Total operating expenses

 $190,644    100 $124,910    100 $65,734   $484,586    100 $332,704    100 $151,882    $289,443     100 $190,644     100 $98,799    $876,943     100 $484,586     100 $392,357  
 

 

   

 

   

 

  

 

   

 

   

 

   

 

    

 

    

 

   

 

    

 

    

 

 

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Total operating expenses were $190.6$289.4 million and $484.6$876.9 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $124.9$190.6 million and $332.7$484.6 million, respectively, for the corresponding periods in 2012.2013. The increase in operating expenses from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $65.7$98.8 million, and the increase from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $151.9$392.4 million. The increases wereincrease was mainly due to increases in sales and marketing expenses and product development 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 maintenance, as well as 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 $70.6$108.0 million and $185.7$327.9 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $47.0$70.6 million and $128.9$185.7 million, respectively, for the corresponding periods in 2012.2013.

The increase in product development expenses from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $23.6$37.4 million. The increase mainly consisted of a $16.7$28.6 million increase in salary and benefits expenses,expense, which was mainly attributable to an increase in the number of employeesincreased headcount and increased average compensation, and a $1.9$3.7 million increase in office expenses.content and license expenses, and a $3.0 million increase in depreciation expense.

The increase in product development expenses from the nine months ended September 30, 20122013 to the nine months ended September 30, 2013 was $56.8$142.2 million. The increase mainly consisted of a $47.5$73.6 million increase in salary and benefits expenses,expense, which was mainly attributable to an increase in the number of employeesincreased headcount and increased average compensation, a $3.0$30.2 million increase in officecompensation expense related to Changyou’s three new employee incentive plans, most of which was recognized in the first quarter of 2014, a $9.3 million increase in content and license expenses, a $8.3 million increase in share-based compensation expense, a $7.0 million increase in depreciation expense, and a $2.0$4.6 million increase in professional fees, offset by a $2.3 million decrease in share-based compensation expense.service expenses.

Sales and Marketing Expenses

Sales and marketing expenses mainly consist of advertising and promotional expenditures, salary and benefits expenses,expense, travel expenses, and facility expenses.

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Sales and marketing expenses were $90.7$131.7 million and $221.1$410.7 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $58.3$90.7 million and $145.9$221.1 million, respectively, for the corresponding periods in 2012.2013.

The increase in sales and marketing expenses from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $32.5$41.0 million. The increase mainly consisted of a $19.6$28.4 million increase in advertising and promotional expenditures, particularlywhich primarily resulted from higher advertising costs for the promotion activities relatingof mobile applications as part of Changyou’s initiative to our mobile products in our brand advertisingdevelop its platform business, and online games businesses, a $9.6$10.7 million increase in salary and benefits expenses, which was mainly attributable to an increase in the number of employees and increased average compensation, and a $1.8 million increase in travel expenses.expense.

The increase in sales and marketing expenses from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $75.2$189.6 million. The increase mainly consisted of a $40.3$144.5 million increase in advertising and promotional expenditures, which primarily resulted from higher advertising costs for the promotion of mobile applications as part of Changyou’s initiative to develop its platform business, a $27.8$32.5 million increase in salary and benefits expenses,expense, which was mainly attributable to an increase in the number of employeesincreased headcount and increased average compensation, and a $5.2$4.0 million increase in travel expenses, and a $2.2 million increase in facility expenses.

General and Administrative Expenses

General and administrative expenses mainly consist of salary and benefits expenses,expense, professional service fees, travelexpenses, facility expenses and facilitytravel expenses.

General and administrative expenses were $29.4$49.7 million and $77.7$138.3 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $19.7$29.4 million and $55.0$77.7 million, respectively, for the corresponding periods in 2012.2013.

The increase in general and administrative expenses from the three months ended September 30, 20122013 to the three months ended September 30, 20132014 was $9.7$20.4 million. The increase mainly consisted of a $5.7$16.8 million increase in salary and benefits expenses,expense, which was mainly attributable to an increased number of employeesheadcount and increased average compensation, and a $2.1$2.6 million increase in professional service fees,facility and a $0.7 million increase in traveloffice expenses.

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The increase in general and administrative expenses from the nine months ended September 30, 20122013 to the nine months ended September 30, 20132014 was $22.8$60.6 million. The increase mainly consisted of a $14.4$31.7 million increase in salary and benefits expenses,expense, which was mainly attributable to an increased number of employeesheadcount and increased average compensation, an $8.3a $16.2 million increase in professional service fees, andshare-based compensation expense, a $3.0$4.0 million increase in travelfacility expenses, offset by a $3.7 million decrease in bad debt expense, and a $1.3$3.2 million decreaseincrease in share-based compensationdepreciation expense.

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/orand expenses for the three and nine months ended September 30, 20132014 and September 30, 2012,2013, respectively, as follows (in thousands):

 

  Three Months Ended
September 30,
   Nine Months Ended
September 30,
   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
Share-based compensation expense  2013   2012   2013   2012   2014   2013   2014   2013 

Cost of revenues

  $128    $232    $296    $426    $469    $128    $1,454    $296  

Product development expenses

   912     1,316     1,670     4,019     6,052     912     15,999     1,670  

Sales and marketing expenses

   359     582     732     1,613     937     359     3,751     732  

General and administrative expenses

   1,799     1,713     2,825     4,144     7,342     1,799     25,402     2,825  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 
  $3,198    $3,843    $5,523    $10,202    $14,800    $3,198    $46,606    $5,523  
  

 

   

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Share-based compensation expense recognized for share awards of Sohu, Changyou, Sogou and Sogou,Sohu Video was as follows (in thousands):

 

  Three Months Ended
September 30,
   Nine Months Ended
September 30,
   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
Share-based compensation expense  2013   2012   2013   2012   2014 2013   2014   2013 

For Sohu share-based awards

  $730    $1,440    $2,313    $4,621    $1,337   $730    $5,242    $2,313  

For Changyou share-based awards

   312     750     884     2,769     514   312     1,253     884  

For Sogou share-based awards(1)

   2,156     1,653     2,326     2,812     13,098   2,156     36,033     2,326  

For Sohu Video share-based awards

   (149 0     4,078     0  
  

 

   

 

   

 

   

 

   

 

  

 

   

 

   

 

 
  $3,198    $3,843    $5,523    $10,202    $14,800   $3,198    $46,606    $5,523  
  

 

   

 

   

 

   

 

   

 

  

 

   

 

   

 

 

Note (1): Includes compensation expense for Tencent restricted share units that Tencent had granted to employees who transferred to Sogou with the Soso search-related businesses, and compensation expense equal to the excess of the repurchase price paid to employees over the fair value at the repurchase date of the Sogou Class A Ordinary Shares that we repurchased.

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For Sohu share options, asAs of September 30, 2013 there2014, unrecognized share-based compensation expense for Sohu, Changyou and Sogou share-based awards was noas follows (in thousands):

Unrecognized share-based compensation expense  As of September 30, 2014 

For Sohu share-based awards

  $4,927  

For Changyou share-based awards

   2,224  

For Sogou share-based awards (2)

   32,795  
  

 

 

 
  $39,946  
  

 

 

 

Note (2): Includes the 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, 2013 there was $0.9 million of unrecognized compensation expense.

For Changyou share-based awards, as of September 30, 2013, there was $1.0 million of unrecognized compensation expense.

For Sogou share-based awards, as of September 30, 2013, there was $2.3 million of unrecognized compensation expense.

There was no share-based compensation expense recognized for the share-based awards of Sohu Video and 7Road for any of the periods presented in the above table.employees who transferred from Tencent with Soso search-related businesses.

Operating Profit /(Loss)

As a resultFor the three and nine months ended September 30, 2014, we had an operating loss of the foregoing, our$40.7 million and $171.1 million, respectively, compared to an operating profit wasof $52.2 million and $187.6 million, respectively, for the corresponding periods in 2013. These changes from operating profit to operating loss of $92.9 million and $358.7 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $63.7 million and $158.9 million, respectively, for the corresponding periods in 2012.2013, were mainly due to Changyou. Changyou’s operating loss resulted primarily from higher advertising costs for the promotion of software applications for mobile devices as part of Changyou’s initiative to develop its platform business, increased salary and benefits expense and higher licensing fees associated with new games to be launched later this year.

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Other Income /(expense)

Other income was $1.5$0.9 million and $5.6$5.3 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to other income of negative $0.1$1.5 million and $3.3$5.6 million, respectively, for the corresponding periods in 2012.2013.

Net Interest Income

InterestNet interest income was $7.6$7.5 million and $19.8$24.7 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $6.0$7.6 million and $19.7$19.8 million, respectively, for the corresponding periods in 2012.2013.

Income Tax ExpenseBenefit /(Expense)

Income tax expensebenefit was $18.9$1.0 million and $55.2$2.6 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $18.7income tax expense of $18.9 million and $55.9$55.2 million, respectively, for the corresponding periods in 2012.2013. The income tax benefit in the third quarter of 2014 consisted of a net $1.3 million tax benefit recognized by Sohu businesses other than Changyou, offset by $0.3 million of income tax expense recognized by Changyou.

Net Income /(Loss)

For the three and nine months ended September 30, 2013,2014, we had net loss of $31.9 million and $138.5 million, respectively, compared to net income of $41.1 million and $152.5 million, respectively, compared to $51.5 million and $126.1 million, respectively, for the corresponding periods of 2012.in 2013.

Net Income /(Loss) Attributable to Noncontrolling Interest

Net incomeloss attributable to noncontrolling interest was $22.9$4.8 million and $70.4$19.1 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to $21.1net income attributable to noncontrolling interest of $22.9 million and $57.6$70.4 million, respectively, for the corresponding periods in 2012.2013.

The increase in net income attributableDeemed Dividend to Noncontrolling Sogou Series A Preferred Shareholders

Deemed dividend to noncontrolling interest fromSogou Series A Preferred shareholders was nil and $27.7 million for the three and nine months ended September 30, 20122014, compared to $82.4 million for both the three months ended September 30, 2013 was $1.8 million, of which $1.1 million and $0.2 million were contributed by Sogou and Changyou, respectively. The increase from the nine months ended September 30, 20122013.

For the nine months ended September 30, 2014, the deemed dividend resulted from Sogou’s repurchase of 14.4 million Sogou Series A Preferred Shares from China Web, and was deemed to have been contributed by Sohu, as a holder of ordinary shares of Sogou, in an amount equal to the proportionate difference between the price Sogou paid to China Web for the Series A Preferred Shares and the carrying amount of these 14.4 million Series A Preferred Shares in our consolidated financial statements.

For both the three months and the nine months ended September 30, 2013, was $12.8 million, of which $8.1 million and $4.7 million were contributed by Changyou and Sogou, respectively.

We expect the noncontrolling interest recognized for Changyou to decrease in the fourth quarter of 2013, compared to the third quarter of 2013.

Net Income Attributable to Sohu.com Inc.

Sohu’s purchase of 24.0 million Sogou Series A Preferred Shares from Alibaba on June 29, 2012 gave rise to a deemed dividend in the amount of $14.2 million, which was the difference between the purchase price Sohu paid to Alibaba and the carrying amount of Alibaba’s net investment balance in the Group’s consolidated financial statements. This deemed dividend has been subtractedresulted from the Net income attributable to Sohu.com Inc. for the nine months ended September 30, 2012.

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The portion of the special dividend paid by Sogou on September 17, 2013 to holders of Series A Preferred Shares of Sogou other than Sohu, in the amount of $139.7 million, is a payment to noncontrolling preferred shareholders, of which Sohu, as a holder of ordinary shares of Sogou, is deemed to have contributed $82.4 million. This $82.4 million has also been subtracted from the

Net income attributableLoss Attributable to Sohu.com Inc. for the three months and nine months ended September 30, 2013 to arrive at net income available to ordinary shareholders in the calculation of net income per share attributable to Sohu.com Inc.

As a result of the foregoing, we had a net loss attributable to SohuSohu.com Inc. of $64.2$27.1 million and $18.1$147.1 million, respectively, for the three and nine months ended September 30, 2013,2014, compared to net incomeloss attributable to SohuSohu.com Inc. of $25.9$64.2 million and $47.6$18.1 million, respectively, for the corresponding periods in 2012.2013.

LIQUIDITY AND CAPITAL RESOURCES

Resources Analysis

Liquidity Sources and Balance

Our principal sources of liquidity are cash and cash equivalents, short-term investments, investments in debt securities, as well as theand cash flows generated from our operations. Cash equivalents primarily comprise time deposits. deposits and money market funds. Short-term investments comprise investment instruments issued by commercial banks in China, with a variable interest rate indexed to performance of underlying assets and the maturity dates within one year.

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As of September 30, 2013,2014, we had cash and cash equivalents of approximately $840.9 million, and short-term investments of $209.5 million. Of our cash and investmentscash equivalents, $354.7 million was held in debt securitiesfinancial institutions inside Mainland China and $486.2 million was held in financial institutions outside of approximately $1,347 million.Mainland China. Our VIEs held $28.6 million of our cash and cash equivalents and $812.3 million was held outside of our VIEs. In addition, as of September 30, 2013,2014, we had, $375 million cash in the form of restricted time deposits, of which $366 million consisted of RMB deposits in onshore banks related tothrough Changyou, loans to Changyou from offshore banks in the principal amount of $354$370.0 million.

In September 2013, Sogou received an investment from Tencent These loans were secured by RMB deposits in onshore branches of $448 million and paid a special dividend to holders of its Series A Preferred Sharesthose banks in the total amount of $301 million, of which $139.7 million was paid to shareholders other than Sohu.

Asas of September 30, 2013, Sohu Group had commitments for bandwidth purchases in the amount2014 of $44$434.4 million, commitments for operating leases in the amount of $28 million, commitments for video content purchases in the amount of $22 millionwhich deposits are recognized as restricted time deposits. See Item 3 ‘Quantitative and commitments for other content and service purchases in the amount of $16 million.

On July 27, 2013, Changyou’s Board of Directors authorized a share repurchase program of up to $100 million of the outstanding American depositary shares (“ADSs”) of Changyou over a two-year period from July 27, 2013 to July 26, 2015. As of September 30, 2013, Changyou had repurchased 305,800 of its ADSs, representing 611,600 ordinary shares, under the share repurchase program at an aggregate cost of approximately $9.1 million.Qualitative Disclosure About Market Risk - Foreign Currency Exchange Rate Risk’.

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, and investment activities 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.

Commitments

As of September 30, 2014, we also had commitments for bandwidth purchases in the amount of $62.9 million, commitments for video content purchases in the amount of $52.0 million, commitments for purchases of games developed by third-parties in the amount of $43.7 million, commitments for purchases of cinema advertisement slot rights in the amount of $40.1 million, commitments for operating leases in the amount of $39.7 million, and commitments for other content and service purchases in the amount of $22.9 million.

Significant Cash Related Activities

On March 24, 2014, Sogou purchased from China Web, pursuant to the Repurchase /Put Option Agreement between Sogou and China Web, 14.4 million Series A Preferred Shares of Sogou, for an aggregate purchase price of $47.3 million.

In June 2014, Sogou repurchased approximately 4.2 million of its Class A Ordinary Shares from noncontrolling shareholders, some of whom are our employees, for an aggregate purchase price of $41.6 million.

On July 16, 2014, Changyou, through a wholly-owned subsidiary, entered into an investment agreement with MoboTap and its subsidiaries and VIEs, and MoboTap’s shareholders to purchase 51% of the equity interests in MoboTap on a fully-diluted basis for approximately $91 million in cash. Changyou also entered into a subscription agreement with MoboTap to purchase $30 million in principal amount of a zero-coupon convertible bond issued by MoboTap that will be due in five years.

Cash Generating Ability

We believe we will continue to generate strong cash flow from 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,   Nine Months Ended September 30, 
  2013 2012   2014 2013 

Net cash provided by operating activities

  $275,386   $279,781    $94,785   $275,386  

Net cash used in investing activities

   (309,015 (346,743   (418,097 (309,203

Net cash provided by financing activities

   426,107   110,433  

Net cash provided by /(used in) financing activities

   (118,888 426,295  

Effect of exchange rate change on cash and cash equivalents

   14,829   (2,609   (4,192 14,829  
  

 

  

 

   

 

  

 

 

Net increase in cash and cash equivalents

   407,307    40,862  

Net increase /(decrease) in cash and cash equivalents

   (446,392  407,307  

Cash and cash equivalents at beginning of period

   833,535    732,607     1,287,288    833,535  
  

 

  

 

   

 

  

 

 

Cash and cash equivalents at end of period

  $1,240,842   $773,469    $840,896   $1,240,842  
  

 

  

 

   

 

  

 

 

Net Cash Provided by Operating Activities

For the nine months ended September 30, 2014, $94.8 million net cash provided by operating activities was primarily attributable to our net loss of $138.5 million, adjusted by non-cash items of depreciation and amortization of $158.3 million, share-based compensation expense of $29.5 million, other non-cash items of $3.2 million, and an increase in cash from working capital items of $46.4 million, offset by a non-cash item of change in fair value of put option of $2.3 million, income from investments in debt securities of $1.4 million, and change in fair value of short-term investments of $0.4 million.

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For the nine months ended September 30, 2013, $275.4 million net cash provided by operating activities was primarily attributable to our net income of $152.5 million, adjusted by non-cash items of depreciation and amortization of $91.4 million, share-based compensation expense of $5.5 million, impairment of other intangible assets of $1.5 million, other non-cash items of $0.4 million, and an increase in cash from working capital items of $30.5 million, offset by a non-cash item of investment income from investments in debt securities of $4.1 million and miscellaneous expenseschange in fair value of $1.9short-term investments of $2.3 million.

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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, offset by investment income from investments in debt securities of $4.1 million and excess tax benefits of $3.5 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.

Net Cash Used in Investing Activities

For the nine months ended September 30, 2014, $418.1 million net cash used in investing activities was primarily attributable to purchase of short-term investments of $206.7 million, purchase of fixed assets and intangible assets of $172.1 million, acquisition of MoboTap (net of cash acquired) of $86.5 million, purchase of long-term investments of $24.6 million, and cash paid related to restricted time deposits of $13.6 million as collateral for Changyou loans from offshore banks, offset by proceeds received from debt securities at maturity of $82.0 million, and proceeds from other investing activities of $3.4 million.

For the nine months ended September 30, 2013, $309.0$309.2 million net cash used in investing activities was primarily attributable to $145.9 million used to acquire fixed assets and intangible assets (including a $3.2 million payment for thean office building acquired by Sohu and a $35.0 million payment for thean office building acquired by Changyou), $112.7 million in restricted time deposits used as collateral for Changyou loans from offshore banks, $76.0 million used in the purchase of the noncontrolling interest in 7Road, $9.0 million in restricted time deposits used as collateral for credit facilities provided by banks to certain Sogou employees and $2.4$2.6 million used for investments related to other investing activities, offset by receivedmatured short-term investments of $32.9 million and investment income from investments in debt securities of $4.1 million.

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 loans from offshore banks, $94.9 million used in acquiring fixed assets and intangible assets, $20.3 million used in short-term investments, $4.1 million used in investment income from investments in debt securities, and $1.6 million used in business acquisition and other investment activities.

Net Cash Provided by /(Used in) Financing Activities

For the nine months ended September 30, 2014, $118.9 million net cash used in financing activities was primarily attributable to Changyou’s repayment of $410.2 million loans to offshore banks, $47.3 million used in Sogou’s repurchase of Series A Preferred Shares of Sogou from China Web, $24.6 million used in Sogou’s repurchase of its Class A Ordinary Shares from its noncontrolling shareholders, $2.8 million used in payment of contingent consideration by Changyou, and $4.9 million used in investing activities, offset by proceeds of loans from offshore banks of $370 million, and $0.9 million received from the exercise of share-based awards.

For the nine months ended September 30, 2013, $426.1$426.3 million net cash provided by financing activities was primarily attributable to $475.5 million in cash received from Tencent in connection with the “Sogou-Tencent Transactions,”Tencent’s investment in and business collaboration with Sogou, $111.5 million proceeds of Changyou loans from offshore banks, $5.3$8.0 million in proceeds received from early exercise of share-based awards in Sogou, $1.8 million from the exercise of share-based awards, in Sogou, and $1.0 million from the issuance of common stock upon the exercise of share options granted under our stock incentive plan, offset by $139.7 million used for the Sogoua dividend distributed by Sogou to holders of Sogou Series A Preferred Shares other than Sohu Search, $19.7 million used for contingent consideration paid by Changyou to 7Road’s noncontrolling shareholders, $9.1$9.0 million used for the repurchase of ADSs of Changyou and $0.5$0.3 million used for other cash payments related to 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 loans from offshore banks, $3.5 million excess tax benefits, 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.

Restrictions and Limitations on Cash Available to Sohu.com Inc.

To fund any cash requirements it may have, Sohu.com Inc. may need to rely on dividends and other distributions on equity paid by our wholly-owned subsidiary Sohu.com Limited or our majority-owned subsidiary Changyou.com Limited. 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.com Limited may need to rely on dividends, loans or advances made by our PRC subsidiaries in order to make dividends and other distributions to us.

The ability of Sohu.com Limited and Changyou.com Limited to receive dividends and distributions from our China-based subsidiaries and VIEs, and the amount of cash available for distribution to, and use by, Sohu.com Inc., are subject to certain restrictions and limitations related to PRC law, our VIE structure and U.S. corporate income tax. We do not expect any of such restrictions or taxes to have a material impact on our ability to meet our cash obligations.

PRC profit appropriation, withholding taxProfit Appropriation, Withholding Tax on dividendsDividends and regulationRegulation of foreign currency exchangeForeign Currency Exchange

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”) under PRC law, are also required to set aside each year to their general reserves at least 10% of their after-tax profit based on PRC accounting standards, until the cumulative amount reaches 50% of their paid-in capital. These reserves may not be distributed as cash dividends, or as loans or advances. Our 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 Sohu.com Limited or Changyou.com Limited and, accordingly, would not be available for distribution to Sohu.com Inc.

 

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The PRC CIT Law generally imposes a 10% withholding tax on dividends distributed by WFOEs to their immediate holding companies outside mainland China, provided that a lower rate may apply under tax treaties between mainland China and other jurisdictions. For example, withholding tax for dividends to a holding company in Hong Kong may, under certain circumstances, be 5% rather than 10%. As of September 30, 2013,2014, we had accrued deferred tax liabilities in the amount of $16.8$21.5 million for withholding taxes associated with dividends paid by Changyou’s mainland China-based WFOEs to Changyou’s Hong Kong subsidiary.

Under regulations of the PRC 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 mainland China, unless prior approval of the SAFE is obtained and prior registration with the SAFE is made.

PRC restrictions relatedRestrictions Related to ourOur VIE structureStructure

While generally our VIEs generate revenues and cash, almost allmost of our VIEs with the exception of those related to Changyou’s online game business, incurincurred deficits as a result of significant costs involved in their operations and had negative operating cash flow for the three and nine months ended September 30, 2013.2014.

Substantially all of Changyou’s operations are conducted through its VIEs, which generate most of Changyou’s online game revenues. Although Changyou’s subsidiaries received or absorbed a majority of the VIEs’ profits or losses pursuant to contractual agreements between the VIEs and Changyou’s PRC subsidiaries providing for payments to the subsidiaries in return for services provided to the VIEs by the PRC subsidiaries, significant cash balances remained in Changyou’s VIEs as of September 30, 2013.2014. As Changyou’s VIEs are not owned by Changyou’s PRC subsidiaries, the VIEs are not able to make dividend payments to the subsidiaries. Therefore, in order for Sohu.com Inc. or our subsidiaries outside of mainland China to receive any dividends, loans or advances from Changyou’s PRC subsidiaries, we will need to rely on these contractual payments made by Changyou’s 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 will subject to PRC taxes, including Business Tax and VAT, which will effectively reduce the amount that the 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.

U.S. corporate income taxCorporate Income Tax

Sohu.com Inc. is a Delaware corporation and is subject to corporate income tax in the United States. Although in the past Sohu.com Inc. has been able to use NOLs to offset a portion of its U.S. taxable income, at the end of its 2012 taxable year it had no further NOLs available for offsetting any U.S. taxable income. The majority of our subsidiaries and VIEs are based in China and are subject to income taxes in the PRC. These China-based subsidiaries and VIEs conduct substantially all of our operations and, as a result, we generate most of our consolidated income or losses in China. The amount of cash derived from our operations that can be used to buy back our shares of common stock in the market, paid as dividends to Sohu.com Inc.’s shareholders or used for other corporate purposes of Sohu.com Inc. may be limited by the imposition of U.S. corporate income tax on Sohu.com Inc.’s income.

In accordance with U.S. GAAP, we do not provide for U.S. federal income taxes or tax benefits on the undistributed earnings or losses of our non-U.S. subsidiaries or consolidated VIEs because, for the foreseeable future, we do not have the intention to repatriate those undistributed earnings or losses to the U.S. However, certain activities conducted in the PRC may give rise to U.S. corporate income tax, even if there are no distributions to Sohu.com Inc. U.S. corporate income taxes would be imposed on Sohu.com Inc. when its subsidiaries that are controlled foreign corporations (“CFCs”) generate income that is subject to Subpart F of the U.S. Internal Revenue Code (“Subpart F”). Passive income, such as rents, royalties, interest and dividends, is among the types of income subject to taxation under Subpart F. Any income taxable under Subpart F is taxable in the U.S. at federal corporate income tax rates of 34% or 35%. Subpart F income also includes certain income from intercompany transactions between Sohu.com Inc.’s non-U.S. subsidiaries and VIEs and Changyou’s non-U.S. subsidiaries and VIEs, or where Sohu.com Inc.‘s’s non-U.S. subsidiaries or VIEs make an “investment in U.S. property,” such as holding the stock in, or making a loan to, a U.S. corporation. Under a temporary provision of the U.S. tax code commonly referred to as the CFC look-through rule, Sohu.com Inc. has not had to treat dividends received by its CFC subsidiaries as Subpart F income includible in Sohu.com Inc.’s taxable income in the U.S. The CFC look-through rule, which is currently scheduled to expire for taxable years beginning after December 31, 2013, has been extended several times by the U.S. Congress. Unless further extended, the CFC look-through rule will be available for Sohu.com Inc.’s CFC subsidiaries and their VIEs only through their taxable years ending November 30, 2014.

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Dividend Policy

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, or causing Sogou to pay any dividends on Sogou.com Inc.’s ordinary shares and preferred shares, for the foreseeable future. Future cash dividends distributed by Sohu.com Inc. and, Changyou.com Limited, or Sogou.com Inc., 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.

In September 2013, Sogou distributed a special dividend to holders of its Series A Preferred Shares in the amount of $301 million, of which Sohu received $161 million, Photon received $43 million, and China Web received $97 million. The Sohu Group does not expect to pay any of such dividend to its shareholders in the foreseeable future.

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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, except for a $9 million restricted time deposit acting as collateral for credit facilities provided by a bank to certain Sogou employees. We are not subject to any additional potential payments other than the restricted time deposit amount, and believe that the fair value of our guarantee liability is immaterial. 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.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

None.The FASB issuedReporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which changes the threshold for reporting discontinued operations and adds new disclosures. The new guidance defines a discontinued operation as a disposal that “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The standard is required to be adopted by public business entities in annual periods beginning on or after December 15, 2014, and interim periods within those annual periods. Entities may “early adopt” the guidance for new disposals. We are currently evaluating the impact on our consolidated financial statements of adopting this guidance.

On May 28, 2014, the FASB and IASB issued their long-awaited converged standard on the recognition of revenue from contracts with customers. The standard will improve the financial reporting of revenue and improve comparability of the top line in financial statements globally. The FASB is amending the FASBAccounting Standards Codification and creating a new Topic 606,Revenue from Contracts with Customers, to supersede the revenue recognition requirements in Topic 605,Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. Additionally, the amendments supersede some cost guidance included in Subtopic 605-35,Revenue Recognition—Construction-Type and Production-Type Contracts. For a public entity, the amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. We are currently evaluating the impact on its consolidated financial statements of adopting this guidance.

In June 2014, underASC 718, Compensation—Stock Compensation, the FASB issuedAccounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. These amendments apply to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target could be achieved and still be eligible to vest in the award if and when the performance target is achieved. For all entities, the amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. We are currently evaluating the impact on our consolidated financial statements of adopting this guidance.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

FOREIGN CURRENCY EXCHANGE RATE RISK

While our reporting currency is the U.S. dollar, to date the majority of our revenues and costs are denominated in RMB and a significant portion of our assets and liabilities are denominated in RMB. As a result, we are exposed to foreign exchange risk as our revenues and results of operations may be affected by fluctuations in the exchange rate between the U.S. dollar and the RMB. If the RMB depreciates against the U.S. dollar, the value of our RMB revenues and assets as expressed in our U.S. dollar financial statements will decline. We do not hold any derivative or other financial instruments that expose us to substantial market risk.

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The RMB is currently freely convertible under the “current account,” which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account,” which includes foreign direct investment. In addition, commencing on July 21, 2005, China reformed its exchange rate regime by changing to a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Under the managed floating exchange rate regime, the RMB is no longer pegged to the U.S. dollar. The exchange rate of the RMB against the U.S. dollar was adjusted to RMB8.11 per U.S. dollar as of July 21, 2005, representing an appreciation of about 2%. The People’s Bank of China will announce the closing prices of foreign currencies such as the U.S. dollar traded against the RMB in the inter-bank foreign exchange market after the closing of the market on each business day, and will make such prices the central parity for trading against the RMB on the following business day. On May 19, 2007, the People’s Bank of China announced a policy to expand the maximum daily floating range of RMB trading prices against the U.S. dollar in the inter-bank spot foreign exchange market from 0.3% to 0.5%. While the international reactions to the RMB revaluation and widening of the RMB’s daily trading band have generally been positive, with the increased floating range of the RMB’s value against foreign currencies, the RMB may appreciate or depreciate significantly in value against the U.S. dollar or other foreign currencies in the long term, depending on the fluctuation of the basket of currencies against which it is currently valued.

On June 19, 2010, the People’s Bank of China announced that it has decided to proceed further with the reform of the RMB exchange rate regime to enhance the flexibility of the RMB exchange rate and that emphasis would be placed on reflecting market supply and demand with reference to a basket of currencies. While so indicating its intention to make the RMB’s exchange rate more flexible, the People’s Bank of China ruled out any sharp fluctuations in the currency or a one-off adjustment. AsOn April 16, 2012, the People’s Bank of China announced a resultpolicy to expand the maximum daily floating range of RMB trading prices against the announcement,U.S. dollar in the inter-bank spot foreign exchange market from 0.5% to 1%. On March 17, 2014, the People’s Bank of China announced a policy to further expand the maximum daily floating range of RMB has appreciated significantly. In early November 2013,trading prices against the center point ofU.S. dollar in the currency’s official trading band hit 6.1452, representing appreciation of more than 11.1% since June 19, 2010.inter-bank spot foreign exchange market to 2%. In the long term, the RMB may appreciate or depreciate more significantly in value against the U.S. dollar or other foreign currencies, depending on the market supply and demand with reference to a basket of currencies.

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To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure. Accordingly, we may incur economic losses in the future due to foreign exchange rate fluctuations, which could have a negative impact on our financial condition and results of operations.

The following table sets forth a summary of our foreign currency sensitive financial instruments as of September 30, 2013,2014, which consisted of cash and cash equivalents, restricted time deposits, short-term investments, investments in debt securities, accounts receivable, prepaid and other current assets, available-for-sale securities, current liabilities, long-term accounts payable and long-term bank loans. These financial instruments are recorded at their fair value.

 

  Denominated in (in thousands)       Denominated in (in thousands)     
  US$   RMB   HK$   Others   Total   US$   RMB   HK$   Others   Total 

Cash and cash equivalents

   565,952     670,613     3,329     948     1,240,842     458,531     375,891     1,448     5,026     840,896  

Restricted time deposits

   9,240     365,747     0     0     374,987     9,305     434,381     0     0     443,686  

Short-term investments

   0     24,369     0     0     24,369     0     209,508     0     0     209,508  

Investments in debt securities

   0     81,327     0     0     81,327  

Accounts Receivable

   1,435     151,480     33     336     153,284  

Accounts receivable

   1,866     177,831     6     291     179,994  

Prepaid and other current assets

   1,092     93,684     40     685     95,501     2,940     117,899     1,279     942     123,060  

Available-for-sale securities

   15,550     0     0     0     15,550  

Current liabilities

   301,673     678,340     1     5,311     985,325     12,115     734,641     0     0     746,756  

Long-term accounts payable

   0     7,333     0     0     7,333     0     5,211     0     0     5,211  

Long-term bank loans

   0     0     0     0     0     370,000     0     0     0     370,000  

INTEREST RATE RISK

The basic objectives of our investment program are to protect the invested funds from excessive risk and to provide for liquidity that is sufficient to meet operating and investment cash requirements. Under the investment policy, our excess cash is invested in high-quality securities which are limited as to length of time to maturity and the amount of credit exposure.

Our exposure to interest rate risk primarily relates to the interest income generated from excess cash invested in demand deposits, and debt securities, and interest expense generated from loans to Changyou from offshore banks. We have not used derivative financial instruments in our investment portfolio in order to reduce this risk. We have not been exposed nor do we anticipate being exposed to material risks due to changes in interest rates.

INFLATION RATE RISK

According to the National Bureau of Statistics of China, the consumer price index grew 3.1%2.1% in the first nine months ofended September 30, 2014, compared to the growth rate for the corresponding period in 2013. While this rate of inflation represents a decline compared to the rate for the previous quarter,declined, there may be further increased inflation in the future, which could have a material adverse effect on our business.

ITEM 4. CONTROLS AND PROCEDURES

Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this quarterly report (the “Evaluation Date”), have concluded that as of the Evaluation Date our disclosure controls and procedures were effective and designed to ensure that all material information relating to Sohu required to be included in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and to ensure that information required to be disclosed is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

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During the period covered by this quarterly report, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

There have been no material developments in the legal proceedings reported in our Annual Report on Form 10-K for the year ended December 31, 20122013 filed with the SEC on February 28, 2013.2014.

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ITEM 1A. RISK FACTORS

ThereA notice issued on September 2014 by the State Administration of Press, Publication, Radio, Film and Television (“SAPPRFT”) could have an adverse effect on the results of operations and prospects of our online video business.

On September 2, 2014, the SAPPRFT issued a Notice on Further Strengthening the Administration of Online Foreign Audiovisual Content (the “September 2014 SAPPRFT Notice”), which requires that operators of audiovisual Websites obtain from the SAPPRFT a Film Public Screening Permit, TV Drama Distribution Permit, or TV Animation Distribution Permit for all foreign films and TV dramas before they are transmitted via the Internet in China. The September 2014 SAPPRFT Notice further stipulates that before any foreign films or TV dramas for transmission exclusively via the Internet are purchased after the promulgation of the September 2014 SAPPRFT Notice, operators of audiovisual Websites must declare their annual purchasing plans with the SAPPRFT before the end of the year preceding the year of the intended broadcast and obtain the SAPPRFT’s approval. The September 2014 SAPPRFT Notice also states that the number of foreign films and TV dramas to be purchased by an operator and transmitted via its Website in a single year may not exceed 30% of the total amount of the Chinese films and TV dramas purchased and transmitted by the same Website in the previous year.

We rely heavily on foreign films and TV dramas to attract users and advertisers to our online video Website and, accordingly, the promulgation of the September 2014 SAPPRFT Notice could have an adverse impact on our online video business. We believe that the September 2014 SAPPRFT Notice requirement of a minimum ratio of domestic video content to foreign-sourced content will have the effect of requiring that we purchase more domestic video content in order to maintain our existing position and reputation as one of the leading providers of online foreign films and TV dramas in China. As competing operators in China will also be required to maintain such a minimum ratio, the September 2014 SAPPRFT Notice is also likely to have the effect of driving up the price for Chinese films and TV dramas, which would cause our expenses for video content to increase, as we will be required to both increase the amount of domestic content that we purchase and pay higher prices for the domestic content that we purchase. If, on the other hand, we respond to the minimum ratio requirement of the September 2014 SAPPRFT Notice by reducing our purchases of foreign films and TV dramas, our attraction to users and traffic on or online video Website could be reduced, resulting in a decrease in our advertising revenues.

With the exception of the foregoing, there are no material changes or updates to the risk factors previously disclosed in Part I, Item 1A of our Annual Report on
Form 10-K for the year ended December 31, 20122013 filed with the SEC on February 28, 2013.2014.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Use of ProceedsUSE OF PROCEEDS

On July 17, 2000, Sohu completed an underwritten initial public offering of its common stock pursuant to a Registration Statement on Form S-1 (SEC file No. 333-96137), which became effective on July 10, 2000. Public trading of the common stock offered in the initial public offering commenced on July 12, 2000. Sohu sold an aggregate of 4,600,000 shares of common stock in the offering at a price to the public of $13 per share, resulting in gross proceeds of $59.8 million. Sohu’s net proceeds, after deduction of the underwriting discount of $4.2 million and other offering expenses of $3.2 million, were approximately $52.4 million. All shares sold in the offering were sold by Sohu.

During the nine months ended September 30, 2013,2014, Sohu did not use any proceeds from the offering. The remaining net proceeds from the offering have been invested in cash and cash equivalents. The use of the proceeds from the offering does not represent a material change in the use of proceeds described in the prospectus contained in the Registration Statement on Form S-1 described above.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Please see the ExhibitExhibits Index attached hereto.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: November 8, 20137, 2014

 

SOHU.COM INC.
By: 

/s/ Carol Yu

 Carol Yu
 Co-PresidentPresident and Chief Financial Officer

 

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Sohu.com Inc.

Quarterly Report on Form 10-Q for Quarter Ended September 30, 20132014

EXHIBITS INDEX

 

10.1  English Translation of Convertible Bond Subscription Agreement, dated SeptemberJuly 16, 2013 among Sogou Inc, Sohu Search, Photon2014, between MoboTap Inc. and THL A21Glory Loop Limited.
10.2  Shareholders’English Translation of Investment Agreement, dated September 16, 2013July 31, 2014, among Sogou Inc, Sohu Search, Photon, THL A21Glory Loop Limited, Sogou ManagementBeijing Gamease Age Internet Technology Co., Ltd, Baina, Forest, Matrix, Sequoia, Qualcomm, Yongzhi Yang, Tiefeng Liu, Youyang Xie, Na Zeng, Zhou Yu and Management Trusts.Sen Li, MoboTap Inc. (Cayman Islands), MoboTap Inc. Limited, MoboTap Inc.(US), Dolphin Browser Inc., Muse Entertainment Limited, Dstore Technology Limited, Baina Zhiyuan (Chengdu) Technology Co., Ltd., Baina Zhiyuan (Beijing) Technology Co., Ltd, Beijing Baina Information Technology Co., Ltd, Baina (Wuhan) Information Technology Co., Ltd, Chengdu Xingyu Science and Technology Co., Ltd, Wuhan Xingyu Science and Technology Co., Ltd, Wuhan Hualian Chuangke Science and Technology Co., Ltd, Beijing Anzhuoxing Science and Technology Co., Ltd and Shanghai Andepurui Network Science and Technology Co., Ltd. (Portions of this exhibit have been omitted pursuant to a request for confidential treatment, and the omitted information has been filed separately with the Securities and Exchange Commission)
10.3  5th Restated Memorandum and 2nd Restated ArticlesEnglish Translation of Association of Sogou Inc. adopted on September 16, 2013.
10.4VotingShareholder Agreement, dated September 16, 2013July 31, 2014, among Sogou Inc, Sohu Search, Photon, Sogou ManagementGlory Loop Limited, Beijing Gamease Age Internet Technology Co., Ltd, Baina Inc., Yongzhi Yang, MoboTap Inc. (Cayman Islands), MoboTap Inc. Limited, MoboTap Inc. (US), Baina Zhiyuan (Chengdu) Technology Co., Ltd, Baina Zhiyuan (Beijing) Technology Co., Ltd, Beijing Baina Information Technology Co., Ltd, Baina (Wuhan) Information Technology Co., Ltd, Chengdu Xingyu Science and Management Trusts.
10.5Termination Agreement dated September 16, 2013 among Sogou Inc, China Web, PhotonTechnology Co., Ltd, Wuhan Xingyu Science and Sohu Search regarding AmendedTechnology Co., Ltd, Wuhan Hualian Chuangke Science and Restated Investors’ Rights Agreement AmendedTechnology Co., Ltd and Restated RightBeijing Anzhuoxing Science and Technology Co., Ltd. (Portions of First Refusalthis exhibit have been omitted pursuant to a request for confidential treatment, and Co-Sale Agreement both dated June 29, 2013.
10.6Repurchase Option Agreement dated September 16, 2013 between Sogou Incthe omitted information has been filed separately with the Securities and Sohu Search.
10.7Repurchase Option Agreement dated September 16, 2013 between Sogou Inc and China Web.
10.8Repurchase Option Agreement dated September 16, 2013 between Sogou Inc and Photon.
10.9Equity Transfer Contract dated September 16, 2013 between Tencent Computer System Company Limited and Sogou Information.Exchange Commission)
31.1  Rule 13a-14(a)/15d-14(a) Certification of Charles Zhang
31.2  Rule 13a-14(a)/15d-14(a) Certification of Carol Yu
32.1  Section 1350 Certification of Charles Zhang
32.2  Section 1350 Certification of Carol Yu
101  Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of September 30, 20132014 and December 31, 2012;2013; (ii) Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 20132014 and 2012;2013; (iii) Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 20132014 and 2012;2013; (iv) Condensed Consolidated Statements of Changes in Equity for the Nine Months Ended September 30, 20132014 and 2012;2013; and (v) Notes to Condensed Consolidated Financial Statements, tagged using four different levels of detail.

 

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