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TMCNet:  SOHU COM INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[February 28, 2013]

SOHU COM INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) OVERVIEW Sohu (NASDAQ: SOHU) is a leading Chinese online media, search, gaming, community and mobile service group. We operate one of the most comprehensive matrices of Chinese language content and services, and we developed and operate one of the most popular massively multiplayer online games and two popular Web games in China. Substantially all of our operations are conducted through our indirect wholly-owned and majority-owned China-based subsidiaries and variable interest entities (collectively the "Sohu Group").



Our businesses consist of the online advertising business, which consists of the brand advertising business as well as the search and others business, the online game business, the wireless business and the others business, among which online advertising and online games are our core businesses.

Factors and Trends Affecting our Business The Internet and Internet-related markets in China continued to evolve rapidly during 2012. According to an annual report issued by the China Internet Network Information Center ("CNNIC"), the total number of Internet users in China had reached 564 million by the end of December 2012, an increase of 50.9 million from the end of 2011. The number of mobile Internet users in China had reached 420 million by the end of December 2012, an increase of 64.4 million from the end of 2011, and exceeding the 398 million desktop computer Internet users as of December 2012. Mobile Internet became the top channel for Internet users to access Websites in China in 2012. We believe that this large and expanding user base will continue to provide significant opportunities for our company to expand our product offerings and to explore new revenue streams. That being said, our brand advertising business in 2012 was impacted by macro-economy conditions as the slowdown in China's economic growth reduced the spending of some large advertisers. These adverse factors resulted in a deceleration in revenue growth for our brand advertising business.

In China, online video is a popular Internet application, with over 370 million users as of December 31, 2012, according to an annual report issued by 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 made a strategic decision in early 2012 to set up a dedicated sales force for our online video business. In the fourth quarter of 2012, we completed the establishment of our dedicated video sales team and the transition was smooth. We expect this business to reaccelerate in 2013.

81-------------------------------------------------------------------------------- Table of Contents During the year of 2012, 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. We expect our search and others business will sustain healthy revenue growth through the year of 2013.

We continue to be pleased with and optimistic regarding the growth and profitability of our online games business. We believe that our strong performance in 2012 reflects the resilience of the Chinese online games industry despite the weakening global macroeconomic environment and economic slowdown in China. We also believe that it reflects the ongoing strength of our online games content and our successful transition from a dominant player in the massively multi-player online gaming business to a broad spectrum gaming company responding to fast-growing segments of the industry and new technologies and platforms.

Summary of Our Business For the year ended December 31, 2012, our total revenues increased by 25% to $1,067.2 million and gross margin decreased from 72% to 65%. Our online advertising business generated revenues of $414.6 million with 21% annual growth, representing 39% of total revenues. Our online game business generated revenues of $574.7 million with 32% annual growth, representing 54% of total revenues. Net income contributed by the online game business was $293.6 million, which represented 166% of our total net income. In 2012, our net income before deducting the noncontrolling interest was $177.2 million, compared to $228.3 million in 2011. In 2012, our net income after deducting the noncontrolling interest was $87.2 million, compared to $162.7 million in 2011. Diluted net income per share attributable to Sohu.com Inc was $2.03 in 2012, compared to $3.93 in 2011.

For the details of our business and business restructuring, please see Item 1 Business Overview.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our discussion and analysis of our financial condition and results of operations relates to our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an 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 and Recognition of Noncontrolling Interest The consolidated financial statements include the accounts of Sohu and its wholly-owned and majority-owned subsidiaries and the consolidated variable interest entities ("VIEs"). All intercompany transactions are eliminated.

We have adopted the guidance of accounting for VIEs, which requires VIEs to be consolidated by the primary beneficiary of the entity. For the consolidated VIEs, our 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, the Sohu 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. We have one VIE that is not consolidated by us since we are not the primary beneficiary.

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 To reflect the economic interest in Changyou held by shareholders other than Sohu ("noncontrolling shareholders"), Changyou's net income attributable to these noncontrolling shareholders is recorded as noncontrolling interest in Sohu's consolidated statements of comprehensive income, based on their share of the economic interests in Changyou. Changyou's cumulative results of operations attributable to these noncontrolling shareholders, along with changes in shareholders' equity, adjustment for share-based compensation expense in relation to those share-based awards which are unvested and vested but not yet settled and adjustment for changes in Sohu's ownership in Changyou from Sohu's purchase of Changyou ADSs representing Class A ordinary shares, are recorded as noncontrolling interest in Sohu's consolidated balance sheets.

82-------------------------------------------------------------------------------- Table of Contents Noncontrolling Interest for Sogou To reflect the economic interest in Sogou held by shareholders other than Sohu ("noncontrolling shareholders"), Sogou's net income /loss attributable to these noncontrolling shareholders is recorded as noncontrolling interest in Sohu's consolidated statements of comprehensive income. Sogou's cumulative results of operations attributable to these noncontrolling shareholders, along with changes in shareholders' equity /(deficit) and adjustment for share-based compensation expense in relation to those share-based awards which are unvested and vested but not yet settled and noncontrolling shareholders' investments in Series A Preferred Shares are accounted for as a noncontrolling interest classified as permanent equity in Sohu's consolidated balance sheets, as redemption of the noncontrolling interest is solely within the control of Sohu. These treatments are based on the terms governing investment by the noncontrolling shareholders in the Series A Preferred Shares of Sogou (the "Sogou Series A Terms"), the terms of Sogou's restructuring, and Sohu's purchase of Sogou Series A Preferred Shares from Alibaba.

By virtue of these terms, as Sogou has been losing money since its restructuring, the net losses have been and will be allocated in the following order: (i) net losses were allocated to ordinary shareholders until their basis in Sogou decreased to zero; (ii) additional net losses will be allocated to holders of Sogou Series A Preferred Shares until their basis in Sogou decreases to zero; and (iii) further net losses will be allocated between ordinary shareholders and holders of Sogou Series A Preferred Shares based on their shareholding percentage in Sogou.

Any subsequent net income from Sogou will be allocated in the following order: (i) net income will be allocated between ordinary shareholders and holders of Sogou Series A Preferred Shares based on their shareholding percentage in Sogou until their basis in Sogou increases to zero; (ii) additional net income will be allocated to holders of Sogou Series A Preferred Shares to bring their basis back; (iii) further net income will be allocated to ordinary shareholders to bring their basis back; and (iv) further net income will be allocated between ordinary shareholders and holders of Sogou Series A Preferred Shares based on their shareholding percentage in Sogou.

Segment Reporting Our segments are business units that offer different services and are reviewed separately by the chief operating decision maker ("CODM"), or the decision making group, in deciding how to allocate resources and in assessing performance. Our CODM is the Chief Executive Officer. There are five segments in the Sohu Group, consisting of brand advertising, Sogou (which mainly consists of the search and others business), Changyou (which mainly consists of the online game business), wireless and others.

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.

Under ASC 845, barter trade transactions from which physical goods or services (other than advertising services) are received in exchange for advertising services should be recorded based on the fair values of the goods and/or services received. For a barter transaction involving online advertising services, we recognize revenue and expense at fair value only if the fair value of the advertising services surrendered /received in the transaction is determinable. For our advertising-for-advertising barter transactions, the fair value of the advertising surrendered /received is not determinable, so no revenue from advertising-for-advertising barter transactions is recognized.

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 taxes and /or related surcharges.

83 -------------------------------------------------------------------------------- Table of Contents Before September 1, 2012, our online advertising revenues were subject to PRC business tax, ("Business Tax"). Our online advertising revenues were recognized after deducting agent rebates and applicable Business Tax and related surcharges. Business Tax is imposed primarily on revenues from the provision of taxable services and is calculated by multiplying the applicable tax rate by gross revenue. Effective September 1, 2012, the PRC Ministry of Finance and the State Administration of Taxation launched a Business Tax to Value Added Tax ("VAT") Transformation Pilot Program, ("the Pilot Program"), for certain industries in eight regions, including Beijing and Tianjin. VAT payable on goods sold or taxable labor services provided by a general VAT taxpayer for a taxable period is the net balance of the output VAT for the period after crediting the input VAT for the period. Hence, the amount of VAT payable does not result directly from output VAT generated from goods sold or taxable labor services provided. With the adoption of 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.

Brand Advertising Revenues Business Model Currently the brand advertising business has two main types of pricing models, consisting of the Fixed Price Model and the Cost Per Impression ("CPM") pricing model. Under the Fixed Price Model, a contract is signed to establish a fixed price for the advertising services to be provided. Under the CPM pricing model, the total contract amount for the advertising services is not fixed. Instead, a fixed price for each qualifying display is stated. Advertisers using the CPM pricing model pay us based on the number of qualifying displays of their advertisements appearing on our Websites, and we recognize as revenue the fees charged to advertisers each time their advertisements are displayed on the Websites, on the condition that each display meets certain selected criteria imposed by advertisers. We provide advertisement placements to our advertisers on our different Website channels and in different formats, which can include, among other things, banners, links, logos, buttons, full screen, pre-roll, post-roll, and mid-roll video screens, as well as pause video screens.

Revenue Recognition For brand advertising revenue recognition, prior to entering into contracts, we make a credit assessment of the customer to assess the collectability of the contract. For those contracts for which the collectability is determined to be reasonably assured, we recognize revenue when all revenue recognition criteria are met. For those contracts for which the collectability is determined not to be reasonably assured, we recognize revenue only when the cash was received and all other revenue recognition criteria are met.

Before 2011, since almost all of the elements were delivered within one calendar quarter, we treated all elements of advertising contracts as one single unit of accounting for revenue recognition purposes. Commencing January 1, 2011, in accordance with ASU No.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.

Since the number of advertising contracts that covered more than one quarter and the revenues from advertising contracts that covered more than one quarter were immaterial compared to the total advertising contracts, the impact of adoption of ASU 2009-13 to us is immaterial.

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.

84 -------------------------------------------------------------------------------- Table of Contents Sogou Website Alliance Both pay-for-click services and online marketing services on the Sogou Web Directory expand distribution of its advertisers' Website links or advertisements by leveraging traffic on Sogou Website Alliance members' Websites. We recognize gross revenue for the amount of fees it receives from its advertisers. 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 it pays a percentage of pay-for-click revenues generated from clicks by users of their properties, or on a pre-agreed unit price.

Online Game Revenues Our online game revenues are generated from MMOG operations revenues, Web game revenues and overseas licensing revenues.

MMOG operations revenues Revenues are recorded net of applicable Business Tax, discounts and rebates to distributors.

Online game revenues from Changyou's current MMOG operations are earned by providing online services to players pursuant to the item-based revenue model.

Under the item-based revenue model, the basic game play functions are free of charge and players are charged for purchases of in-game virtual items. Online game revenues are recognized over the estimated lives of the virtual items purchased or as the virtual items are consumed. If different assumptions were used in deriving the estimated lives of the virtual items, the timing of our recording of the revenues would be impacted.

Game operations revenues are collected by Changyou's VIEs through the sale of Changyou's prepaid cards, which it sells in both virtual and physical forms to third-party distributors and players. Proceeds received from sales of prepaid cards are initially recorded as receipts in advance from customers and, upon activation or charge of the prepaid cards, are transferred from receipts in advance from customers to deferred revenues. As Changyou does not have control of, and generally does not know, the ultimate selling price of the prepaid cards sold by distributors, net proceeds from distributors form the basis of revenue recognition. Prepaid cards will expire two years after the date of card production if they have never been activated. The proceeds from the expired game cards are recognized as revenue upon expiration of cards. Once the prepaid cards are activated and credited to a player's personal game account, they will not expire as long as the personal game account remains active. Changyou is entitled to suspend and close a player's personal game account if it has been inactive for a period of 180 consecutive days. The unused balances in an inactive player's personal game account are recognized as revenues when the account is suspended and closed.

Web game revenue 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 were derived entirely from revenue-sharing payments from third-party joint operators of its 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. The 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 throughout 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, the games may be hosted either on the third-party operators' servers or on servers that 7Road 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 and does not view 7Road as the primary obligor, as it 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's revenues from direct operation of Wartune on its Website for the game are first recorded by 7Road as deferred revenues and subsequently recognized as revenue over the service period during which 7Road is obligated to provide services to the game players to enable them to consume their virtual items.

85-------------------------------------------------------------------------------- Table of Contents 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 gross basis, by which VAT at the rate 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.

Overseas licensing revenue Changyou enters into licensing arrangements with overseas licensees to operate its MMOGs in other countries or regions. These license agreements provide two revenue streams, consisting of an initial license fee and a monthly revenue-based royalty fee based on monthly revenue and sales from ancillary products of the games. The initial license fee is based on both a fixed amount and additional amounts receivable upon the games' achieving certain sales targets. Since Changyou is obligated to provide post-sales services such as technical support and provision of updates and when-and-if-available upgrades to the licensees during the license period, the initial license fee from the licensing arrangement is recognized as revenue ratably over the license period.

The fixed amount of the initial license fee is recognized ratably over the remaining license period from the launch of the game and the additional amount is recognized ratably over the remaining license period from the date when such additional amount is certain. The monthly revenue-based royalty fee is recognized when relevant services are delivered, provided that collectability is reasonably assured.

Wireless Revenues Our wireless revenues are generated from the provision of mobile-related services through different types of wireless products to mobile phone users. The wireless products mainly consist of SMS, IVR, mobile games and RBT. In order to deliver our products to mobile phone users, we sign contracts with China Mobile Communications Corporation, China 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 wireless services we provide. After the receipt of service fees from China mobile network operators, we make payments to third party wireless service alliance and content providers based on revenue-sharing arrangements.

Currently, a majority of our wireless revenues are recorded on a gross basis, as we have the primary responsibility for fulfillment and acceptability of the wireless services.

Wireless revenues are recognized in the month in which the service is performed, provided that no significant obligations remain. For the amount of revenues to be recognized, we rely on billing confirmations issued by the China mobile network operators. If at the end of each reporting period, an operator has not yet issued such billing confirmations, we estimate the amount of collectable wireless service fees and recognize revenue. When we later receive billing confirmations, we record a true-up accounting adjustment. For the three months ended December 31, 2012, 66% of our estimated wireless revenues were confirmed by billing confirmations received from the China mobile network operators.

Generally, (i) within 15 to 120 days after the end of each month, we receive billing confirmations from the operators and (ii) within 30 to 180 days after delivering billing confirmations, each operator remits the wireless service fees, net of its service fees, to us.

Others Revenues Others revenues are primarily generated from sub-licensing of licensed video content operated by Sohu, IVAS provided by Sogou with respect to Web games developed by third-party developers, and cinema advertising services provided by Changyou.

Revenues from sub-licensing of licensed video content For licensed video content purchased on an exclusive basis with payment in cash, 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.

Revenues from IVAS Sogou offers Web games developed by third-party developers and generate revenues from the provision of IVAS, including promotion, access maintenance and payment services, to third-party developers. The Web games can be accessed and played by end users free of charge, but the end users may choose to purchase in-game merchandise to enhance their game playing experience. We sign revenue-sharing agreements with third-party developers. Under these revenue-sharing agreements, we collect payments from the end users for items sold, keep a pre-agreed percentage of the proceeds and remit the balance to the third-party developers.

Revenues from IVAS are recognized on a net basis, when our obligations under the agreements and all other revenue recognition criteria have been met.

86-------------------------------------------------------------------------------- Table of Contents Revenues from cinema advertisements For cinema advertising revenues, a contract is signed with the advertiser to establish a fixed price and specify advertising services to be provided. Based on the contracts, Changyou provides advertisement placements in advertising slots to be shown in theatres before the screening of movies. Revenues from cinema advertising are recognized when all the recognition criteria are met.

Depending on the terms of a customer contract, fees for services performed can be recognized according to two principal methods, consisting of the proportional performance method and the straight-line method. Under the proportional performance method, fees are generally recognized based on a percentage of the advertising slots actually delivered where the fee is earned on a per-advertising slot placement basis. Under the straight-line method, fees are recognized on a straight-line basis over the contract period when the fee is not paid based on the number of advertising slots actually delivered.

Cost of Revenues Cost of Online Advertising Revenues Cost of online advertising revenues includes cost of revenues from brand advertising services as well as cost of search and others services.

Cost of Brand Advertising Revenues Cost of brand advertising revenues mainly consists of content and license costs (including amortization of licensed video content and impairment of purchased video content), bandwidth leasing costs, depreciation expenses, and salary and benefits expenses.

Cost of Search and Others Revenues Cost of search and others revenues mainly consists of traffic acquisition costs, bandwidth leasing costs, depreciation expenses, and salary and benefits expenses. Traffic acquisition costs represent payments made to Sogou Website Alliance members. We pay Sogou Website Alliance members based either on revenue-sharing arrangements or on a pre-agreed unit price. Under the revenue-sharing arrangements, we pay a percentage of pay-for-click revenues generated from clicks by users of the Website Alliance members' properties.

Cost of Online Game Revenues Cost of online game revenues mainly consists of salary and benefits expenses, bandwidth leasing charges, depreciation expenses, revenue-based royalty payments to game developers, Business Tax and VAT arising from transactions between Changyou's subsidiaries and its VIEs.

Cost of Wireless Revenues Cost of wireless revenues mainly consists of revenue-sharing payments, which include payments to third party wireless service alliances and content providers, collection charges and transmission fees paid to China mobile network operators, bandwidth leasing costs and depreciation expenses.

Cost of Revenues for Other Services Cost of revenues for other services mainly consists of payments to theatres and film production companies for pre-film screening advertisement slots, charges for impairment of intangible assets and amortization of sub-licensing cost.

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. During the years ended December 31, 2012, 2011 and 2010, no product development expenses were capitalized.

Sales and Marketing Expenses Sales and marketing expenses mainly consist of advertising and promotional expenditures, salary and benefits expenses, travel expenses, and facility expenses.

General and Administrative Expenses General and administrative expenses mainly consist of salary and benefits expenses, professional service fees, travel expenses, and facility expenses.

87 -------------------------------------------------------------------------------- Table of Contents Share-based Compensation Expense Sohu, Changyou, Sogou, Fox Video Limited ("Sohu Video") and 7Road all have incentive plans for the granting of share-based awards, including common stock /ordinary shares, share options, restricted shares and restricted share units, to their executive officers, management and employees.

Share-based compensation expense is recognized as costs and /or expenses in the consolidated statements of comprehensive income based on the fair value of the related share-based awards on their grant dates. 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.

Share-based Compensation Expense related to Sohu, Changyou, and Sogou Share-based Awards For Sohu share-based awards, in determining the fair value of share options granted, the Black-Scholes valuation model is applied; in determining the fair value of restricted share units granted, the public market price of the underlying shares on the grant dates is applied.

For Changyou share-based awards, in determining the fair value of ordinary shares, restricted shares and restricted share units granted in 2008, the income approach /discounted cash flow method with a discount for lack of marketability was applied, given that the shares underlying the awards were not publicly traded at the time of grant. In determining the fair value of restricted share units granted in 2009 before Changyou's initial public offering, the fair value of the underlying shares was determined based on Changyou's offering price for its initial public offering. In determining the fair value of restricted share units granted after Changyou's initial public offering, the public market price of the underlying shares on the grant dates is applied.

For Sogou share-based awards, in determining the fair value of share options granted, the income approach /discounted cash flow method with a discount for lack of marketability was applied, given that the shares underlying the awards were not publicly traded at the time of grant.

Share-based compensation expense for the ordinary shares granted is fully recognized in the quarter during which these ordinary shares are granted. For share options, restricted shares and restricted share units granted with respect to Sohu shares and with respect to Changyou shares, compensation expense is recognized on an accelerated basis over the requisite service period. For share options granted with respect to Sogou shares, compensation expense is recognized on a straight-line basis over the estimated period during which the service period requirement and performance target will be met. The number of share-based awards for which the service is not expected to be rendered over the requisite period is estimated, and the related compensation expense is not recorded for that number of awards.

Sohu Video Share-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 December 31, 2012, grants of options for the purchase of 15,352,200 of ordinary shares of Sohu Video had been made and were effective under the plan. However, as of December 31, 2012, the restructuring of Sohu's video division was still in process and certain significant factors remained uncertain. For purposes of ASC 718, no grant date is established until mutual understanding of the option awards' key terms and conditions between Sohu Video and the recipients can be reached, and such mutual understanding cannot be reached until the video division's restructuring plan has been substantially fixed, so that the enterprise value of Sohu Video and hence the fair value of the options is determinable and can be accounted for. As a result, on the basis that the broader terms and conditions of the option awards had neither been finalized nor mutually agreed with the recipients, no grant of options occurred for purposes of ASC 718 and hence no share-based compensation expense was recognized for the year ended December 31, 2012.

88-------------------------------------------------------------------------------- Table of Contents 7Road Share-based Awards On July 10, 2012, 7Road adopted a 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. As of December 31, 2012, 2,546,250 restricted share units had been granted under the plan. Such restricted share units will not be vested until 7Road's completion of a firm commitment underwritten initial public offering (the "IPO") of its shares resulting in a listing on an internationally recognized exchange and the expiration of all underwriters' lockup periods applicable to the IPO. The completion of a firm commitment IPO is considered to be a performance condition of the awards. An IPO event is not considered to be probable until it is completed. Under ASC 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 relating to these restricted share units until the completion of an IPO, and hence no share-based compensation expense was recognized for the year ended December 31, 2012.

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").

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 between mainland China and the jurisdiction of the foreign holding company. A holding company in Hong Kong, for example, will be subject to a 5% withholding tax rate under the Arrangement Between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital, (the "China-HK Tax Arrangement"), if such holding company is considered a non-PRC resident enterprise and holds at least 25% of the equity interests in the PRC foreign invested enterprise distributing the dividends, subject to approval of the PRC local tax authority. However, if the Hong Kong holding company is not considered to be the beneficial owner of such dividends under applicable PRC tax regulations, such dividend may remain subject to a withholding tax rate of 10%.

Uncertain Tax Positions In order to assess uncertain tax positions, we apply a more likely than not threshold and a two-step approach for tax position measurement and financial statement recognition. For the two-step approach, the first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely to be realized upon settlement.

Transition from PRC Business Tax to PRC Value Added Tax Effective September 1, 2012, the Pilot Program, for transition from the imposition of Business Tax to the imposition of VAT for revenues from certain industries was expanded from Shanghai to eight other cities and provinces in China, including Beijing and Tianjin. Our brand advertising and search revenues are subject to this program.

89 -------------------------------------------------------------------------------- Table of Contents 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%.

VAT payable on goods sold or taxable labor services provided by a general VAT taxpayer for a taxable period is the net balance of the output VAT for the period after crediting the input VAT for the period. Before the implementation of the Pilot Program, we were mainly subject to a small amount of VAT for revenues of Changyou's subsidiary 7Road that are deemed for PRC tax purposes to be derived from the sale of software. VAT has been imposed on those 7Road revenues at a rate of 17%, with a 14% immediate tax refund, resulting in a net rate of 3%. With the implementation of the Pilot Program, in addition to the 7Road revenues, our brand advertising and search revenues are now subject to VAT at a rate of 6%.

Under ASC 605-45, the presentation of taxes on either a gross basis (included in revenues and costs) or a net basis (excluded from revenues) is an accounting policy decision determined by management. As VAT imposed on brand adverting and search revenues and VAT imposed on 7Road's revenues from the sale of software are considered as substantially different in nature, we determined that it is reasonable to apply the guidance separately for these two types of VAT. The basis for this determination is that VAT payable on brand advertising and search revenues is the difference between the output VAT (at a rate of 6%) and available input VAT amount (at the rate applicable to the supplier), which is a component of our costs for providing the brand advertising and search services.

On the other hand, VAT payable by 7Road is in effect at 3% of the applicable revenues from the sale of software, irrespective of the availability of any input VAT, under preferential VAT treatment provided to 7Road by the local tax bureau. In this regard, we believe the VAT payable by 7Road is more akin to a sales tax than typical VAT. As a result, we adopted the net presentation method for our brand advertising and search businesses both before and after the implementation of the Pilot Program, and for the revenues of 7Road deemed to be derived from the sale of software, we adopted the gross presentation method before and after the implementation of the Pilot Program.

The implementation of the Pilot Program has not had a significant impact on our consolidated statements of comprehensive income for the year ended December 31, 2012.

Net Income per Share Basic net income per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares comprise shares issuable upon the exercise or settlement of share-based awards.

Potential common shares are accounted for in the computation of diluted earnings per share using the treasury stock method. The dilutive effect of share-based awards with performance requirements is not considered before the performance targets are actually met. The computation of diluted net income per share does not assume conversion, exercise, or contingent issuance of securities that would have an anti-dilutive effect (i.e., an increase in earnings per share amounts or a decrease in loss per share amounts) on net income per share. Additionally, for purposes of calculating the numerator of diluted net income per share, the net income attributable to Sohu is adjusted as follows: (1) Changyou's net income attributable to Sohu is determined using the percentage that the weighted average number of Changyou shares held by Sohu represents of the weighted average number of Changyou ordinary shares and shares issuable upon the exercise or settlement of share-based awards under the treasury stock method, instead of by the percentage held by Sohu of the total economic interest in Changyou, which is used for the calculation of basic net income per share.

(2) Sogou's net income /(loss) attributable to Sohu is determined using the percentage that the weighted average number of Sogou shares held by Sohu represents of the weighted average number of Sogou ordinary shares and Series A Preferred Shares, shares issuable upon the conversion of convertible preferred shares under the if-converted method, and shares issuable upon the exercise or settlement of share-based awards under the treasury stock method, instead of by Sogou's net income /(loss) allocated to Sohu by virtue of the Sogou Series A Terms, the terms of the restructuring and Sohu's purchase of Sogou Series A Preferred Shares from Alibaba, which is used for the calculation of basic net income per share.

Fair Value of Financial Instruments U.S. GAAP establishes a three-tier hierarchy to prioritize the inputs used in the valuation methodologies in measuring 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, accounts receivable, investments in debt securities, prepaid and other current assets, prepaid non-current assets, accounts payable, short-term bank loans, accrued liabilities, receipts in advance and deferred revenue, other short-term liabilities, long-term accounts payable and long-term bank loans.

90 -------------------------------------------------------------------------------- Table of Contents Cash Equivalents Our cash equivalents mainly consist of time deposits placed with banks with an original maturity of three months or less.

Restricted time deposits-Changyou bridge loans from offshore banks, secured by time deposits The bridge 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. Restricted time deposits are valued based on the prevailing interest rates in the market.

Short-term Investments For investments in financial instruments with a variable interest rate indexed to the performance of underlying assets, we elected the fair value method at the date of initial recognition and carried these investments subsequently at fair value. Changes in the fair value are reflected in the consolidated statements of comprehensive income.

Accounts Receivable, Net The carrying value of accounts receivable is reduced by an allowance that reflects our best estimate of the amounts that will not be collected. We make estimations of the collectability of accounts receivable. Many factors are considered in estimating the general allowance, including reviewing delinquent accounts receivable, performing an aging analysis and a customer credit analysis, and analyzing historical bad debt records and current economic trends.

Additional allowance for specific doubtful accounts might be made if the financial conditions of our customers or the China mobile network operators deteriorate or the China mobile network operators are unable to collect fees from their end customers, resulting in their inability to make payments due to us.

Investments in Debt Securities We invest our excess cash in certain debt securities of high-quality corporate issuers. We elected the fair value option to account for our investments in debt securities at their initial recognition. Changes in the fair value are reflected in the consolidated statements of comprehensive income as other income /(expense). The fair value election was made to mitigate accounting mismatches and to achieve operational simplifications.

Equity Investments Investments in entities over which we do not have significant influence are recorded as equity investments and are accounted for by the cost method.

Investments in entities over which we have significant influence but do not control are also recorded as equity investments and are accounted for by the equity method. Under the equity method, our share of the post-acquisition profits or losses of the equity investment is recognized in our consolidated statements of comprehensive income; and our share of post-acquisition movements in equity investments is recognized in equity in our consolidated balance sheets. Unrealized gains on transactions between us and our equity investees are eliminated to the extent of the interest in the equity investments. Unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. When our share of losses in an equity investment equals or exceeds our interest in the equity investment, we do not recognize further losses, unless we have incurred obligations or made payments on behalf of the equity investee.

Long-Lived Assets Long-lived assets include fixed assets, intangible assets and prepaid non-current assets.

Fixed Assets Fixed assets mainly comprise office building, 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 listed below.

Fixed Assets Estimated Useful Lives (years) Office building 47 Leasehold improvements Lesser of term of the lease or the estimated useful lives of the assets Vehicles 4-10 Office furniture 5 Computer equipment and hardware 4 91 -------------------------------------------------------------------------------- Table of Contents 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, computer software purchased from unrelated third parties, domain names and trademarks, and operating rights for licensed games.

Intangible assets are recorded at cost less accumulated amortization with no residual value. Amortization of intangible assets other than licensed video content is computed using the straight-line method over their estimated useful lives.

We amortize licensed video content over the shorter of the term of the estimated period over which the benefits of the license agreement will be enjoyed based on the trend of accumulation of viewership or the applicable license period.

Beginning in the third quarter of 2011, licensed video content is amortized on an accelerated basis based on the viewership accumulation trend over the shorter of the term of the estimated period over which the benefits of the license contract will be enjoyed or the applicable license period. For exclusively licensed video content which we sub-licensed to similar platforms in return for payment in cash, we allocate a portion of the video content cost from cost of brand advertising revenues to sub-licensing cost. The allocation is based on the revenues to be generated through sub-licensing. We amortize sub-licensing cost using the individual-film-forecast-computation method, which amortizes such costs in the same ratio that actual sub-licensing revenue bears as of the current period end to the total of the actual revenue earned and the estimated remaining unrecognized ultimate revenue.

Prepaid non-current Assets Prepaid non-current assets primarily include prepayments for the office buildings to be built as our and Changyou's headquarters before they are recognized as fixed assets, prepayments for the technological infrastructure and fitting-out of our office building before they are recognized as fixed assets, and prepaid PRC income tax arising from the sale of certain assets associated with the business of 17173.com (the "17173 Business") by us to Changyou. Since the sale of the 17173 Business was between entities that are included in our consolidated financial statements, it was considered an "intra-entity transaction" and, under ASC 810-10, income taxes paid should be deferred.

Accordingly, we recorded income tax related to the sale of the 17173 Business as prepaid PRC income tax. The prepaid PRC income tax will be amortized over the period of the weighted average remaining life of the 17173 Business-related assets sold to Changyou.

Impairment of Long-lived Assets In accordance with ASC 360-10-35, we review the carrying values of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Based on the existence of one or more indicators of impairment, we measure any impairment of long-lived assets using the projected discounted cash flow method at the asset group level.

The estimation of future cash flows requires significant management judgment based on our historical results and anticipated results and is subject to many factors. The discount rate that is commensurate with the risk inherent in our business model is determined by our management. An impairment loss would be recorded if we determined that the carrying value of long-lived assets may not be recoverable. The impairment to be recognized is measured by the amount by which the carrying values of the assets exceed the fair value of the assets.

We noted that prices for purchased video content decreased significantly in the second quarter of 2012. We considered this is an indicator of impairment, and accordingly we performed an impairment test for our purchased video content at the asset group level. We divided purchased video content into seven asset groups, consisting of TV series, Pay Channel, Overseas Content, Movies, Animations, Variety shows, and Documentary films. We tested the recoverability of the carrying values of these asset groups by comparing their carrying amounts to the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset groups. If the carrying amount of an asset group was determined to not be recoverable, an impairment loss was recognized, measured by comparing the carrying value of the asset group to the asset group's fair value. The fair values of the purchased video content were estimated using the discounted cash flow method. The impairment losses were allocated only to the purchased video content within the asset group, since the carrying amount of other long-lived assets within the asset group was considered to be already below their fair value. We did not note any indicators in the second half year of 2012 that would result in any further impairment of long-lived assets related to video content.

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.

92-------------------------------------------------------------------------------- Table of Contents 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.

Contingent Consideration The agreement for Changyou's acquisition of a majority interest in 7Road includes a contingent consideration arrangement that requires additional consideration to be paid by Changyou based on the financial performance of 7Road through December 31, 2012. The range of the undiscounted amounts Changyou could pay under the contingent consideration agreement is between $nil and $32.76 million. Fair value of the contingent consideration of $28.05 million was recognized on the date of the acquisition, with the income approach applied.

There were no indemnification assets involved. As of the end of 2012, 7Road had exceeded the financial performance milestones, as a result of which changes in the fair value of the contingent consideration of $2.2 million were recognized in other income /(expense) for the year ended December 31, 2012.

Mezzanine Equity On May 11, 2011, Changyou, through its VIE Gamease, acquired 68.258% of the equity interests of Shenzhen 7Road Technology Co., Ltd ("Shenzhen 7Road") and began to consolidate Shenzhen 7Road's financial statements on June 1, 2011.

Our Mezzanine Equity consists of noncontrolling interest in 7Road and a put option pursuant to which the noncontrolling shareholders will have the right to put their equity interests in 7Road to Changyou at a pre-determined price if 7Road achieves specified performance milestones before the expiry of the put option and 7Road does not complete an initial public offering on NASDAQ, NYSE or HKEX. The put option will expire in 2014. Since the occurrence of the sale is not solely within the control of Changyou, we classify the noncontrolling interest as mezzanine equity instead of permanent equity in our and Changyou's consolidated financial statements.

Under ASC 480-10, we calculate, on an accumulative basis from the acquisition date, (i) the amount of accretion that would increase the balance of noncontrolling interest to its estimated redemption value over the period from the date of the Shenzhen 7Road acquisition to the earliest redemption date of the noncontrolling interest in 7Road and (ii) the amount of net profit attributable to noncontrolling shareholders of 7Road based on their ownership percentage. The carrying value of the noncontrolling interest as mezzanine equity will be adjusted by an accumulative amount equal to the higher of (i) and (ii).

On June 21, 2012, 7Road's Chief Executive Officer surrendered to 7Road, without consideration, ordinary shares of 7Road representing 5.1% of the then outstanding ordinary shares of 7Road, with the intention that these shares would be added to the shares reserved by 7Road for grants of equity incentive awards under the 7Road 2012 Share Incentive Plan without dilution of the other shareholders of 7Road. As a result, the noncontrolling interest decreased to 28.074% of 7Road and Changyou's interest in 7Road increased to 71.926%.

Under ASC 480-10, changes in a parent's ownership interest while the parent retains control of its subsidiary are accounted for as equity transactions, and do not impact net income or comprehensive income in the consolidated financial statements. The variance of $6.8 million caused by 7Road's Chief Executive Officer's surrender of shares was recorded as credit to additional paid-in capital.

For the year ended December 31, 2012, 7Road had exceeded the specified performance milestones set forth in the acquisition agreement for Changyou's acquisition of a majority interest in 7Road, and accordingly the estimated redemption value of the noncontrolling interests in 7Road increased. The increase in the redemption value was recognized over the period from the date of management's increased estimate to the earliest exercise date of the put right as an increase in net income attributable to mezzanine-classified noncontrolling interests.

93 -------------------------------------------------------------------------------- Table of Contents 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 Korea are the national currencies of those counties.

Foreign Currency Translation Assets and liabilities of our China-based subsidiaries and VIEs, the United Kingdom, Malaysia and Korea are translated into U.S. dollars, our reporting currency, at the exchange rate in effect at the balance sheets date and revenues and expenses are translated at the average exchange rates in effect during the reporting period. Foreign currency translation adjustments are not included in determining net income for the period but are accumulated in a separate component of equity in our consolidated balance sheets.

Foreign currency transactions denominated in currencies other than the functional currency are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are re-measured at the applicable rates of exchange in effect at that date. Gains and losses resulting from foreign currency re-measurement are included in the consolidated statements of comprehensive income.

RESULTS OF OPERATIONS In 2010, we adjusted our business groupings from advertising business, online game business, and wireless and others business to brand advertising business, online game business, sponsored search business, and wireless and others business. Accordingly, we adjusted our presentation based on the new classification for the years prior to 2010 to conform to the current year classification.

In 2011, we adjusted our business groupings from brand advertising business, online game business, sponsored search business, and wireless and others business to online advertising business (consisting of the brand advertising business as well as the search and others business), online game business, wireless business and others business. To conform to current period presentations, the relevant amounts for prior periods have been reclassified.

Commencing January 1, 2012, with the development of our business, we reclassified certain expenses for our search and others business and our video division.

Reclassification of Expenses of Search and Others Business To expand distribution of customers' sponsored links or advertisements, the search and others business acquires traffic from third-party Websites. Most traffic acquisition payments are made to Sogou's Website Alliance members.

Payments to Sogou's Website Alliance members are based on a portion of pay-for-click revenues generated from clicks by users of their properties, and are included in cost of revenues. A relatively small portion of traffic acquisition payments to third-party Websites are based on pre-agreed unit prices and the actual traffic volume they direct to our search and others business.

Prior to 2012, traffic acquisition payments based on pre-agreed unit price and the actual traffic volume were recorded in sales and marketing expenses.

Commencing January 1, 2012, in order to enhance comparability with industry peers, all traffic acquisition costs were recorded in cost of revenues. To conform to current period presentations, the relevant amounts for prior periods have been reclassified accordingly. Such reclassifications amounted to $8.7 million and $4.2 million, respectively, for the years ended December 31, 2011 and 2010.

94 -------------------------------------------------------------------------------- Table of Contents Change in Presentation to Properly Reflect the Classification of Expenses of Video Division Prior to 2012, the video division was a relatively small operation in the Sohu Group. It did not have clearly defined business departments because it was highly dependent on the Sohu Group's resources to sustain its operation. The video division's compensation and benefits expenses were recorded under cost of revenues and were not allocated to individual operating expense categories, in view of the fact that most of the employees in the video division provided services related to the maintenance of content and resources that directly contributed to video-related brand advertising revenues.

Commencing January 1, 2012, as the video division has grown significantly and business departments have been defined through the restructuring process to become more self-sustainable, compensation and benefits expenses have been allocated to the respective business departments to properly reflect the operating results of the video division. The video division's compensation and benefits expenses were classified as cost of revenues, product development, sales and marketing and general and administrative expenses, respectively, based on the nature of the related employees' roles and responsibilities. To conform to current period presentations, the relevant amounts for prior periods have been changed accordingly. The change from cost of revenues to operating expenses was not material to historical periods, and amounted to $5.0 million and $ nil, respectively, for the years ended December 31, 2011 and 2010.

Revenues The following table presents our revenues by revenue source and by proportion for the periods indicated (in thousands, except percentages): Year ended December 31, 2012 2011 2010 12 VS 11 11 VS 10 Revenues: Online advertising: Brand advertising $ 290,205 27 % $ 279,189 33 % $ 211,821 35 % $ 11,016 $ 67,368 Search and others 124,389 12 % 62,981 7 % 18,649 3 % 61,408 44,332 Subtotal of online advertising revenues 414,594 39 % 342,170 40 % 230,470 38 % 72,424 111,700 Online game 574,653 54 % 435,508 51 % 327,151 53 % 139,145 108,357 Wireless 55,893 5 % 52,015 6 % 52,320 9 % 3,878 (305 ) Others 22,061 2 % 22,394 3 % 2,836 0 % (333 ) 19,558 Total revenues $ 1,067,201 100 % $ 852,087 100 % $ 612,777 100 % $ 215,114 $ 239,310 Total revenues were $1,067.2 million for 2012, compared to $852.1 million and $612.8 million, respectively, for 2011 and 2010. The year-on-year increase in total revenues for 2012 and 2011 was $215.1 million and $239.3 million, respectively. The increase was mainly attributable to increases in online game revenues and online advertising revenues.

Online Advertising Revenues Online advertising revenues were $414.6 million for 2012, compared to $342.2 million and $230.5 million, respectively, for 2011 and 2010. The year-on-year increase in online advertising revenues for 2012 and 2011 was $72.4 million and $111.7 million, respectively. The increase was mainly attributable to increases in search and others revenues.

Brand Advertising Revenues Brand advertising revenues were $290.2 million for 2012, compared to $279.2 million and $211.8 million, respectively, for 2011 and 2010. The year-on-year increase in brand advertising revenues for 2012 was $11 million. The increase was mainly attributable to increases in revenues from the sectors of fast-moving consumer goods, online game and transportation. The year-on-year increase in brand advertising revenues for 2011 was $67.4 million. The increase was mainly attributable to increases in revenues from the real estate industry, as we expanded our estate sales network in 2011, from the IT-related industry, where advertising demand was strong, and from an increase in advertising related to our online video business. Sales to our five largest advertisers comprised approximately 10% of total brand advertising revenues for 2012, compared to 11% for both 2011 and 2010.

The value of brand advertising services provided by our brand advertising segment to the Changyou segment was approximately $14 million for 2012, compared to $11 million for both 2011 and 2010. No revenues and /or expenses were recognized in Sohu's consolidated statements of comprehensive income as all intercompany transactions were eliminated.

As of December 31, 2012, 2011 and 2010, we recorded $15.4 million, $6.5 million and $7.8 million, respectively, of receipts in advance from advertisers.

We expect brand advertising revenues to increase modestly in 2013 compared to 2012.

95 -------------------------------------------------------------------------------- Table of Contents Search and Others Revenues Search and others revenues were $124.4 million for 2012, compared to $63.0 million and $18.6 million, respectively, for 2011 and 2010. Search and others services mainly include pay-for-click services, as well as online marketing services on the Sogou Web Directory. Revenues from pay-for-click services accounted for approximately 73% of the total search and others revenues for 2012, compared to 75% and 84%, respectively, for 2011 and 2010. Revenues from online marketing services on the Sogou Web Directory accounted for approximately 23% of the total search and others revenues for 2012, compared to 8% for 2011.

The year-on-year increase in search and others revenues for 2012 was $61.4 million, mainly contributed by pay-for-click services, as well as online marketing services on the Sogou Web Directory, both as a result of increased traffic and improved monetization of traffic. The year-on-year increase in search and others revenues for 2011 was $44.4 million, mainly contributed by pay-for-click services, as well as newly-launched online marketing services on the Sogou Web Directory, both as a result of increased traffic and improved monetization of traffic.

We expect search and others revenues to increase in 2013 compared to 2012.

Online Game Revenues Online game revenues include revenues from MMOG operations revenues, Web game revenues and overseas licensing revenues.

Online Game revenues were $574.7 million for 2012, compared to $435.5 million and $327.1 million, respectively, for 2011 and 2010. The year-on-year increase in online game revenues for 2012 was $139.2 million, mainly due to the ongoing popularity of Changyou's flagship game TLBB and Wartune in China in 2012 and a full year's revenue contribution from 7Road. The year-on-year increase in online game revenues for 2011 was $108.4 million, mainly due to the ongoing popularity of TLBB and overall increases in active paying accounts for Changyou's MMOGs, revenue contribution from 7Road, and revenue contribution from the newly launched DMD. For the three months ended December 31, 2012, average revenue per active paying account of Changyou's MMOGs in China increased by 60% to RMB353, from RMB221 for the three months ended December 31, 2011.

We expect online game revenues to increase in 2013 compared to 2012.

Wireless Revenues Wireless revenues were $55.9 million for 2012, compared to $52.0 million and $52.3 million, respectively, for 2011 and 2010. We expect wireless revenues to decrease slightly in 2013 compared to 2012.

Others Revenues Revenues for other services were $22.1 million for 2012, compared to $22.4 million and $2.8 million, respectively, for 2011 and 2010. The year-on-year increase for 2011 in other revenues mainly arose from sub-licensing of licensed video content and increases in revenues in the cinema advertisement business.

Costs and Expenses Cost of Revenues The following table presents our cost of revenues by source and by proportion for the periods indicated (in thousands, except percentages): Year ended December 31, 2012 2011 2010 12 VS 11 11 VS 10 Cost of revenues: Online advertising: Brand advertising $ 161,195 44 % $ 107,391 45 % $ 86,684 53 % $ 53,804 $ 20,707 Search and others 70,628 19 % 35,144 14 % 18,434 11 % 35,484 16,710 Subtotal of cost of online advertising revenues 231,823 63 % 142,535 59 % 105,118 64 % 89,288 37,417 Online game 77,859 21 % 49,837 21 % 29,852 18 % 28,022 19,985 Wireless 36,893 10 % 31,882 13 % 28,041 17 % 5,011 3,841 Others 23,083 6 % 16,093 7 % 1,487 1 % 6,990 14,606 Total cost of revenues $ 369,658 100 % $ 240,347 100 % $ 164,498 100 % $ 129,311 $ 75,849 Total cost of revenues was $369.7 million for 2012, compared to $240.3 million and $164.5 million, respectively, for 2011 and 2010. The year-on-year increase in total cost of revenues for 2012 and 2011 was $129.4 million and $75.8 million, respectively. The increase was mainly attributable to increases in cost of online advertising revenues and cost of online game revenues.

96-------------------------------------------------------------------------------- Table of Contents Cost of Online Advertising Revenues Cost of online advertising revenues was $231.8 million for 2012, compared to $142.5 million and $105.1 million, respectively, for 2011 and 2010. The year-on-year increase in cost of online advertising revenues for 2012 and 2011 was $89.3 million and $37.4 million, respectively. The increase 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 (including amortization of licensed video content and impairment of purchased video content), bandwidth leasing costs, depreciation expenses, and salary and benefits expenses.

Cost of brand advertising revenues was $161.2 million for 2012, compared to $107.4 million and $86.7 million, respectively, for 2011 and 2010.

The year-on-year increase in cost of brand advertising revenues for 2012 was $53.8 million. This increase mainly consisted of a $13.9 million increase in amortization of licensed video content, a $15.1 million increase in impairment of purchased video content, an $10.6 million increase in bandwidth leasing costs, and a $4.1 million increase in salary and benefits expenses.

The year-on-year increase in cost of brand advertising revenues for 2011 was $20.7 million, primarily attributable to investment in our online video business. This increase mainly consisted of a $15.4 million increase attributable to accelerated amortization of licensed video content, which was in effect in the second half of 2011, a $9.6 million increase in bandwidth leasing cost, and a $1.8 million increase in facility expenses, offset by a $3.8 million decrease in salary and benefits expenses, and a $2.9 million decrease in share-based compensation expense.

Our brand advertising gross margin was 44% for 2012, compared to 62% and 59%, respectively, for 2011 and 2010. The year-on-year decrease in our brand advertising gross margin for 2012 was due to increases in content and bandwidth costs and the impairment of purchased video content. The year-on-year increase in our brand advertising gross margin for 2011 was due to the growth in cost of brand advertising revenues having been slower than the increase in brand advertising revenues.

Cost of Search and Others Revenues Cost of search and others revenues mainly consists of traffic acquisition costs, bandwidth leasing costs, depreciation expenses, as well as salary and benefits expenses.

Cost of search and others revenues was $70.6 million for 2012, compared to $35.1 million and $18.4 million, respectively, for 2011 and 2010.

The year-on-year increase in cost of search and others revenues for 2012 was $35.5 million. The increase mainly consisted of a $26.9 million increase in traffic acquisition costs, a $4.3 million increase in depreciation expenses, a $2.2 million increase in salary and benefits expenses and a $1.9 million increase in bandwidth leasing costs, along with increased traffic volume.

The year-on-year increase in cost of search and others revenues for 2011 was $16.7 million. The increase mainly consisted of a $12.6 million increase in traffic acquisition costs, a $2.6 million increase in bandwidth leasing costs and a $1.3 million increase in depreciation expenses, along with increased traffic volume.

Our search and others gross margin was 43% for 2012, compared to 44% and 1%, respectively, for 2011 and 2010. The year-on-year increase in our search and others gross margin for 2011 was due to higher revenues from the improved monetization of traffic and online marketing services newly launched on the Sogou Web Directory.

Cost of Online Game Revenues Cost of online game revenues mainly consists of salary and benefits expenses, bandwidth leasing charges, depreciation expenses, revenue-based royalty payments to game developers, Business Tax and VAT arising from transactions between Changyou's subsidiaries and its VIEs.

Cost of online game revenues was $77.8 million for 2012, compared to $49.8 million and $29.9 million, respectively, for 2011 and 2010.

The year-on-year increase in cost of online game revenues for 2012 was $28 million. The increase mainly consisted of a $10.6 million increase in salary and benefits expenses as a result of increased headcount, a $4.6 million increase in bandwidth leasing costs and a $4.0 million increase in depreciation expenses.

97 -------------------------------------------------------------------------------- Table of Contents The year-on-year increase in cost of online game revenues for 2011 was $19.9 million. The increase mainly consisted of a $6.6 million increase in bandwidth leasing costs, a $5.2 million increase in salary and benefits expenses as a result of increased headcount, a $3.9 million increase in revenue-based royalty payments to game developers, a $2.1 million increase in depreciation expenses and amortization of licensing fees.

Our online game gross margin was 86%, 89% and 91%, respectively, for 2012, 2011 and 2010. The year-on-year decrease in our online game gross margin for 2012 was mainly due to an increase in salaries and benefits expenses as a result of increased headcount, higher bandwidth costs incurred for Wartune and higher expenses related to licensed games in 2012. The year-on-year decrease in our online game gross margin for 2011 was mainly due to higher bandwidth leasing costs and server depreciation associated with the operation of our games in 2011 and an increase in salaries and benefits.

Cost of Wireless Revenues Cost of wireless revenues mainly consists of revenue-sharing payments, which include payments to third party wireless service alliances and content providers, collection charges and transmission fees paid to China mobile network operators, bandwidth leasing costs and depreciation expenses.

Cost of wireless revenues was $36.9 million for 2012, compared to $31.9 million and $28.0 million, respectively, for 2011 and 2010. The year-on-year increase in cost of wireless revenues for 2012 and 2011was $5 million and $3.9million, respectively. The increases were mainly due to increased revenue-sharing payments.

The collection charges and transmission fees varied between China mobile network operators. The collection charges and transmission fees mainly included (i) a gateway fee of $0.008 to $0.032 per message in 2012, $0.008 to $0.032 per message in 2011 and $0.003 to $0.03 per message in 2010 , depending on the volume of the monthly total wireless 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 2012, compared to 15% to 87% in 2011 and 0% to 87% in 2010.

Our wireless gross margin was 34% for 2012, compared to 39% and 46%, respectively, for 2011 and 2010. The year-on-year decrease in our wireless gross margin for 2012 was mainly due to an increase in the rate of revenue-sharing with partners. The year-on-year decrease in our wireless gross margin for 2011 was due to a product mix change and increased revenue-sharing payments.

Cost of Revenues for Other Services Cost of revenues for other services mainly consists of payments to theatres and film production companies for pre-film screening advertisement slots, charges for impairment of intangible assets and amortization of sub-licensing cost.

Cost of revenues for other services was $23.1 million for 2012, compared to $16.1 million and $1.5 million, respectively, for 2011 and 2010. The year-on-year increase in cost of revenues for other services for 2012 was $7 million. The increases were mainly due to intangible assets impairment costs for our cinema advertisement business. The year-on-year increase in cost of revenues for other services for 2011 was $14.6 million. The increase mainly consisted of a $13.8 million in cost for our cinema advertisement business.

Operating Expenses The following table presents our operating expenses by nature and by proportion for the periods indicated (in thousands, except percentages): Year ended December 31, 2012 2011 2010 12 VS 11 11 VS 10 Operating expenses: Product development $ 181,359 38 % $ 112,617 31 % $ 75,638 35 % $ 68,742 $ 36,979 Sales and marketing 214,736 45 % 158,187 44 % 101,215 46 % 56,549 56,972 General and administrative 75,243 16 % 59,126 17 % 40,895 19 % 16,117 18,231 Goodwill impairment and impairment of intangibles via acquisition of businesses 2,906 1 % 27,511 8 % 0 (24,605 ) 27,511 Total operating expenses $ 474,244 100 % $ 357,441 100 % $ 217,748 100 % $ 116,803 $ 139,693 Total operating expenses were $474.2 million for 2012, compared to $357.4 million and $217.7 million, respectively, for 2011 and 2010.

98-------------------------------------------------------------------------------- Table of Contents The year-on-year increase in total operating expenses for 2012 and 2011 was $116.8 million and $139.7 million, respectively. The increase in total operating expenses was mainly due to increases in product development expenses, sales and marketing expenses, and general and administrative 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 $181.4 million for 2012, compared to $112.6 million and $75.6 million, respectively, for 2011 and 2010.

The year-on-year increase in product development expenses for 2012 was $68.8 million. The increase mainly consisted of a $53.8 million increase in salary and benefits expenses, which was mainly attributable to increased headcount, a $5.4 million increase in facility expenses, a $3.5 million increase in content and license fees, a $3.0 million increase in travel expenses, and a $2.6 million increase in professional fees.

The year-on-year increase in product development expenses for 2011 was $37.0 million. The increase mainly consisted of a $33.4 million increase in salary and benefits expenses as a result of increased headcount and higher salaries and a $2.1 million increase in depreciation and amortization expenses.

Sales and Marketing Expenses Sales and marketing expenses mainly consist of advertising and promotional expenditures, salary and benefits expenses, travel expenses, and facility expenses.

Sales and marketing expenses were $214.7 million for 2012, compared to $158.2 million and $101.2 million, respectively, for 2011 and 2010.

The year-on-year increase in sales and marketing expenses for 2012 was $56.5 million. The increase mainly consisted of a $26.2 million increase in salary and benefits expenses, which was mainly attributable to increased headcount, a $21.3 million increase in advertising and promotional expenditures as a result of increased marketing and promotion activities, a $4.7 million increase in facility expenses, and a $4.3 million increase in travel expenses.

The year-on-year increase in sales and marketing expenses for 2011 was $57 million. The increase mainly consisted of a $27.1 million increase in advertising and promotional expenditures as a result of increased promotion activities, a $21.7 million increase in salary and benefits expenses as a result of increased headcount and higher salaries, a $4.4 million increase in travel expenses and a $2.1 million increase in facility expenses.

General and Administrative Expenses General and administrative expenses mainly consist of salary and benefits expenses, professional service fees, travel expenses, and facility expenses.

General and administrative expenses were $75.2 million for 2012, compared to $59.1 million and $40.9 million, respectively, for 2011 and 2010.

The year-on-year increase in general and administrative expenses for 2012 was $16.1 million. The increase mainly consisted of an $8.7 million increase in salary and benefits expenses, which was mainly attributable to increased headcount, a $2.6 million increase in professional service fees, a $2.2 million increase in travel expenses, and a $2.0 million increase in bad debt expenses.

The year-on-year increase in general and administrative expenses for 2011 was $18.2 million. The increase mainly consisted of an $8.1 million increase in salary and benefits expenses as a result of increased headcount and higher salaries, a $3.1 million increase in professional service fees, a $2.0 million increase in facility expenses and a $1.9 million increase in bad debt expenses.

Goodwill Impairment and Impairment of Intangibles via Acquisition of Businesses We recognized a $2.9 million impairment loss for intangibles via acquisition of businesses in 2012. This $2.9 million was for the Changyou segment for intangible assets from acquired businesses.

99-------------------------------------------------------------------------------- Table of Contents We recognized $23.3 million of goodwill impairment losses in 2011. Of this $23.3 million, $2.2 million was for the Focus Yiju reporting unit, $15.9 million was for the Wireless reporting unit, and $5.2 million was for the Shanghai Jingmao reporting unit.

We also recognized a $4.2 million impairment loss for intangibles via acquisition of businesses in 2011. Of this $4.2 million, $3.4 million was for the Focus Yiju reporting unit, $0.6 million was for the Wireless reporting unit, and $0.2 million was for the Shanghai Jingmao reporting unit.

Share-based Compensation Expense Sohu, Changyou Sogou, Sohu Video and 7Road all have incentive plans for the granting of share-based awards, including common stock /ordinary shares, share options, restricted shares and restricted share units, to their employees and directors.

Share-based compensation expense was recognized in costs and/or expenses for the years ended December 31, 2012, 2011 and 2010 as follows (in thousands): Year Ended December 31, Share-based compensation expense 2012 2011 2010 Cost of revenues $ 648 $ 2,010 $ 5,000 Product development expenses 5,210 6,461 9,692 Sales and marketing expenses 2,149 3,694 5,027 General and administrative expenses 5,959 6,487 7,772 $ 13,966 $ 18,652 $ 27,491 Share-based compensation expense recognized for share awards of Sohu, Changyou, Sogou, Sohu Video and 7Road, was as follows (in thousands): Year Ended December 31, Share-based compensation expense 2012 2011 2010 For Sohu share-based awards $ 6,052 $ 11,325 $ 19,000 For Changyou share-based awards 3,366 5,546 8,491 For Sogou share-based awards 4,548 1,781 0 For Sohu Video share-based awards 0 - - For 7Road share-based awards 0 - - $ 13,966 $ 18,652 $ 27,491 For Sohu share options, as of December 31, 2012 there was no unrecognized compensation expense because the requisite service periods for the remaining share options had ended by the end of 2009. For Sohu restricted share units, as of December 31, 2012 there was $2.5 million of related unrecognized compensation expense.

For Changyou share-based awards, as of December 31, 2012, there was $1.9 million of unrecognized compensation expense.

For Sogou share-based awards, as of December 31, 2012, there was $0.04 million of unrecognized compensation expense.

No share-based compensation expense was recognized for the year ended December 31, 2012 with respect to Sohu Video share option grants made during the year. This is because under U.S. GAAP no grant of options had occurred, as no grant date had been established at this stage.

For 7Road, no share-based compensation expense was recognized for the year ended December 31, 2012, as performance targets had not been met.

Operating Profit As a result of the foregoing, our operating profit was $223.3 million for 2012, compared to $254.3 million and $230.5 million, respectively for 2011 and 2010.

Other Income /(Expense) Other income was $5.4 million for 2012, compared to $9.8 million other income and $790,000 other expense, respectively, for 2011 and 2010.

100-------------------------------------------------------------------------------- Table of Contents The decrease in other income in 2012 was mainly due to a $2.2 million change in the fair value of consideration payable for Changyou's acquisition of a majority interest in 7Road and a $2.2 million reversal of contingent consideration for Focus Yiju in 2011.

The increase in other income in 2011 was mainly due to income of $3.2 million from a change in the fair value of debt securities and income of $2.2 million from reversal of contingent consideration for Focus Yiju.

Interest Income Interest income was $25.3 million for 2012, compared to $15.8 million and $5.9 million, respectively, for 2011 and 2010.

Income Tax Expense Income tax expense was $76.2 million for 2012, compared to $46.6 million and $36.0 million, respectively, for 2011 and 2010. The year-on-year increase in income tax expense was $29.6 million and $10.6 million, respectively for 2012 and 2011.

The increase in income tax expense in 2012 was mainly due to an increase in withholding tax and an increase in profit of Changyou, and an increase in the applicable tax rates for the Sohu Group.

The increase in income tax expense in 2011 was mainly due to an increase in profit of Changyou.

Net Income As a result of the foregoing, we had net income of $177.2 million for 2012, compared to $228.3 million and $198.2 million, respectively, for 2011 and 2010.

Net Income Attributable to Noncontrolling Interest Net income attributable to noncontrolling interest was $78.8 million for 2012, compared to $63.0 million and $49.6 million, respectively, for 2011 and 2010.

The year-on-year increase in net income attributable to noncontrolling interest for 2012 and 2011 was $15.8 million and $13.4 million, respectively. The increase was mainly due to increased net income of Changyou.

We expect the noncontrolling interest recognized for Changyou to increase in 2013 compared with 2012, due to vesting of share-based awards, as well as an increase in Changyou's net income.

We expect the noncontrolling interest recognized for Sogou to remain at a low level in 2013.

Net Income attributable to Sohu.com Inc.

As a result of the foregoing, we had net income attributable to Sohu of $87.2 million for 2012, compared to $162.7 million and $148.6 million, respectively, for 2011 and 2010.

QUARTERLY RESULTS OF OPERATIONS In 2011, we adjusted our business grouping from brand advertising business, online game business, sponsored search business, and wireless and others business to online advertising business, online game business, wireless business and others business. Accordingly, we adjusted our presentation based on the new classification for the years prior to 2011 to conform to the current year classification.

In 2012, with the development of our business, we reclassified certain expenses for our search and others business and our video division. Certain comparative figures have been reclassified to conform to the current presentation.

101-------------------------------------------------------------------------------- Table of Contents The following table sets forth, for the periods presented, our unaudited quarterly results of operations for the eight quarters ended December 31, 2012.

The data have been derived from our consolidated financial statements and, in our management's opinion, they have been prepared on substantially the same basis as the audited consolidated financial statements and include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the financial results for the periods presented. This information should be read in conjunction with the annual consolidated financial statements included elsewhere in this Form 10-K. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period.

Three Months Ended Dec. 31, Sep. 30, Jun. 30, Mar. 31, Dec. 31, Sep. 30, Jun. 30, Mar. 31, 2012 2012 2012 2012 2011 2011 2011 2011 (Unaudited, in thousands, except per share data) Revenues: Online advertising: Brand advertising $ 82,051 $ 77,874 $ 69,312 $ 60,968 $ 77,736 $ 76,572 $ 67,728 $ 57,153 Search and others 38,705 35,284 28,763 21,637 22,979 18,410 13,613 7,979 Subtotal of online advertising revenues 120,756 113,158 98,075 82,605 100,715 94,982 81,341 65,132 Online games 158,942 151,093 137,172 127,446 123,249 115,798 101,531 94,930 Wireless 12,632 14,312 15,598 13,351 14,456 14,210 11,645 11,704 Others 7,162 6,815 4,882 3,202 7,733 7,870 4,188 2,603 Total revenues 299,492 285,378 255,727 226,604 246,153 232,860 198,705 174,369 Cost of revenues: Online advertising: Brand advertising 35,864 37,476 50,963 36,892 30,449 30,221 24,937 21,784 Search and others 21,572 19,736 16,192 13,128 10,779 9,478 8,222 6,665 Subtotal of cost of online advertising revenues 57,436 57,212 67,155 50,020 41,228 39,699 33,159 28,449 Online games 22,124 21,026 18,301 16,408 16,341 14,578 9,950 8,968 Wireless 8,358 9,474 10,208 8,853 9,154 8,727 7,109 6,892 Others 5,625 9,037 4,180 4,241 4,734 4,469 4,220 2,670 Total cost of revenues 93,543 96,749 99,844 79,522 71,457 67,473 54, 438 46,979 Gross profit 205,949 188,629 155,883 147,082 174,696 165,387 144,267 127,390 Operating expenses: Product development 52,432 46,994 43,340 38,593 34,612 28,943 25,839 23,223 Sales and marketing 68,833 58,250 48,999 38,654 45,912 47,150 36,492 28,633 General and administrative 20,275 19,666 17,508 17,794 18,126 15,686 13,148 12,166 Goodwill impairment and impairment of intangibles via acquisition of businesses 0 0 2,906 0 27,511 0 0 0 Total operating expenses 141,540 124,910 112,753 95,041 126,161 91,779 75,479 64,022 Operating profit 64,409 63,719 43,130 52,041 48,535 73,608 68,788 63,368 Other income/(expense) 2,102 (111 ) 1,818 1,613 4,561 3,249 1,479 510 Interest income 5,585 5,974 7,223 6,495 5,488 4,314 3,279 2,719 Exchange difference (704 ) 667 45 (643 ) (499 ) (2,420 ) (1,658 ) (426 ) Income before income tax expense 71,392 70,249 52,216 59,506 58,085 78,751 71,888 66,171 Income tax expense 20,290 18,727 18,467 18,687 10,828 14,441 10,281 11,002 Net income 51,102 51,522 33,749 40,819 47,257 64,310 61,607 55,169 Less: Net income attributable to the mezzanine classified noncontrolling interest shareholders 4,495 4,495 1,095 1,111 1,105 1,092 361 0 Net income attributable to the noncontrolling interest shareholders 21,219 21,146 19,872 16,600 19,295 16,406 16,981 10,362 Net income attributable to Sohu.com Inc. $ 25,388 $ 25,881 $ 12,782 $ 23,108 $ 26,857 $ 46,812 $ 44,265 $ 44,807 102 -------------------------------------------------------------------------------- Table of Contents Basic net income per share attributable to Sohu.com Inc. $ 0.67 $ 0.68 $ 0.34 $ 0.61 $ 0.71 $ 1.22 $ 1.16 $ 1.17 Shares used in computing basic net income per share attributable to Sohu.com Inc. 38,046 38,022 38,002 38,084 38,076 38,298 38,295 38,193 Diluted net income per share attributable to Sohu.com Inc. $ 0.60 $ 0.63 $ 0.28 $ 0.53 $ 0.65 $ 1.17 $ 1.10 $ 1.01 Shares used in computing diluted net income per share attributable to Sohu.com Inc. 38,393 38,344 38,347 38,485 38,574 38,844 38,860 38,767 LIQUIDITY AND CAPITAL RESOURCES Resources Analysis Our principal sources of liquidity are cash and cash equivalents, short-term investments, investments in debt securities, as well as the cash flows generated from our operations. Cash equivalents primarily comprise time deposits.

As of December 31, 2012, we had cash and cash equivalents, short-term investments and investments in debt securities of approximately $968.0 million.

In addition, as of December 31, 2012 we had, through Changyou, bridge loans from offshore banks in the principal amount of $239 million. These bridge loans are secured by RMB deposits in onshore branches of those banks in the total amount of $247 million.

As of December 31, 2011, we had cash and cash equivalents, short-term investments, and investment in debt securities of approximately $830 million.

As of December 31, 2010, we had cash and cash equivalents and investment in debt securities of approximately $754 million.

On August 29, 2011, our Board of Directors authorized a combined share purchase program of up to $100 million of the outstanding shares of our common stock, and/or outstanding ADSs of Changyou over a one-year period from September 1, 2011 to August 31, 2012. As of the expiration of the program on August 31, 2012, we had repurchased 500,000 shares of our common stock, and we also had purchased 750,000 Changyou ADSs, representing 1,500,000 Class A ordinary shares, for consideration of $25.7 million. The total consideration paid under the combined share purchase program was $54.9 million.

In November 2009, we entered into an agreement to purchase a Beijing office building to serve as our headquarters. The purchase price is approximately $128 million, of which $125 million had been paid as of December 31, 2012. In December 2011, we also entered into an agreement for technological infrastructure and fitting-out work for this office building. The contractual amount is approximately $28 million, of which $21 million had been paid as of December 31, 2012. These $125 million and $21 million payments have been recognized as prepaid non-current assets in our consolidated balance sheets. The remaining $3 million for the office building and $7 million for the technological infrastructure and fitting-out work will be settled in installments as various stages of the development plan are completed. This office building and related technological infrastructure and fitting-out work are in progress and are expected to be completed in 2013.

In August 2010, Changyou entered into an agreement to purchase a Beijing office building to serve as its headquarters. The purchase price is approximately $159 million, of which $126 million had been paid as of December 31, 2012 and was recognized as prepaid non-current assets in our consolidated balance sheets. In February 2013, Changyou paid out $16 million and the remaining $17 million will be settled in the first half of 2013, when the office building is expected to be completed and accepted by Changyou.

We believe our current liquidity and capital resources are sufficient to meet anticipated working capital needs (net cash used in operating activities), commitments and capital expenditures over the next twelve months. We may, however, require additional cash resources due to changes in business conditions and other future developments, or changes in general economic conditions.

Cash Generating Ability We believe we will continue to generate strong cash flow from online game business, which, along with our available cash, will provide sufficient liquidity and financial flexibility.

103-------------------------------------------------------------------------------- Table of Contents Our cash flows were summarized below (in thousands): Year Ended December 31, 2012 2011 2010Net cash provided by operating activities $ 402,587 $ 370,453 $ 284,424 Net cash used in investing activities (432,595 ) (305,781 ) (229,814 ) Net cash provided by /(used in) financing activities 128,717 (36,759 ) 49,017 Effect of exchange rate change on cash and cash equivalents 2,219 26,305 10,980 Net increase in cash and cash equivalents 100,928 54,218 114,607 Cash and cash equivalents at beginning of year 732,607 678,389 563,782 Cash and cash equivalents at end of year $ 833,535 $ 732,607 $ 678,389 Net Cash Provided by Operating Activities For 2012, $402.6 million net cash provided by operating activities was primarily attributable to our net income of $177.2 million, adjusted by non-cash items of depreciation and amortization of $101.8 million, impairment of purchased video content of $15.1 million, share-based compensation expense of $14.0 million, impairment of intangible assets of $8.6 million, other miscellaneous non-cash expenses of $2.4 million, and an increase in cash from working capital items of $94.6 million, offset by excess tax benefits of $5.6 million and income from investments in debt securities of $5.5 million.

For 2011, $370.5 million net cash provided by operating activities was primarily attributable to our net income of $228.3 million, adjusted by non-cash items of depreciation and amortization of $69.8 million, goodwill impairment and impairment of intangibles via acquisition of businesses of $27.5 million, share-based compensation expense of $18.7 million, impairment of other intangible assets of $1.1 million, other miscellaneous non-cash expense of $1.3 million, and an increase in cash from working capital items of $30.4 million, offset by income from investments in debt securities of $3.6 million and excess tax benefits of $3.0 million.

For 2010, $284.4 million net cash provided by operating activities was primarily attributable to our net income of $198.2 million, adjusted by non-cash items of share-based compensation expense of $27.5 million, depreciation and amortization of $23.4 million, impairment of other intangible assets of $2.9 million, loss from equity investment of $1.7 million and other miscellaneous non-cash expense of $1.6 million, and an increase in cash from working capital items of $30.3 million, offset by excess tax benefits of $1.2 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 2012, $432.6 million net cash used in investing activities was primarily attributable to $244.8 million restricted time deposits used as collateral for bridge loans from offshore banks, $154.5 million used in acquiring fixed assets and intangible assets, $35.8 million used in short-term investments, and $3.0 million used in business acquisition and other investment activities, offset by income from investments in debt securities of $5.5 million described above under the heading "Net Cash Provided by Operating Activities".

For 2011, $305.8 million net cash used in investing activities was primarily attributable to $233.1 million used in acquiring fixed assets, intangible assets and prepaid non-current assets, and $72.7 million used in business acquisition and investing activities. Of the $233.1 million, $37.9 million was for our office building, $62.8 million was for Changyou's office building, and $16 million was for technological infrastructure and fitting-out work for our office building.

For 2010, $229.8 million net cash used in investing activities was primarily attributable to $141.0 million used in acquiring fixed assets and prepaid non-current assets, including $44 million for our office building and $60 million for Changyou's office building, $74.6 million of investment in debt securities and $14.2 million used in business acquisitions and investing activities.

Net Cash Provided by /(Used in) Financing Activities For 2012, $128.7 million net cash provided by financing activities was primarily attributable to $239.4 million of bridge loans from offshore banks, $5.6 million excess tax benefits described above under the heading "Net Cash Provided by Operating Activities," $1.4 million from the exercise of share-based awards in a subsidiary, and $0.8 million from the issuance of common stock upon the exercise of share options granted under our stock incentive plan, 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, $12.6 million used for the repurchase of our common stock, and $1.7 million in payments for other financing activities.

104-------------------------------------------------------------------------------- Table of Contents For 2011, $36.8 million net cash used in financing activities was primarily attributable to $25.7 million used for the purchase of 750,000 Changyou ADSs, representing 1,500,000 Class A ordinary shares, and $16.6 million used for the repurchase of our common stock, offset by a $1.6 million from the issuance of common stock upon the exercise of share options granted under our stock incentive plan, $3.0 million excess tax benefits mentioned above in "Net Cash Provided by Operating Activities", and $0.9 million in proceeds from noncontrolling shareholders.

For 2010, $49.0 million net cash provided by financing activities was primarily attributable to $48.0 million from the sale of Sogou's newly-issued Series A Preferred Shares to Alibaba, China Web and Photon, $2.1 million from the issuance of common stock upon the exercise of share options granted under our stock incentive plan, $1.2 million excess tax benefits mentioned in above "Net Cash Provided by Operating Activities" and $0.7 million proceeds from other financing activities, offset by repayment of a $3.0 million loan by one of Sohu's subsidiaries to a third party.

Restrictions on Cash Transfers 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 Sohu.com Limited and Changyou.com Limited, our wholly-owned subsidiary and majority-owned subsidiary.

Since substantially all of our operations are conducted through our indirect wholly-owned and majority-owned China-based subsidiaries and VIEs, Sohu.com Limited and Changyou.com Limited may need to rely on dividends, loans or advances made by our PRC subsidiaries. In 2012, Changyou's Board of Directors decided to cause one of Changyou's PRC subsidiaries to distribute all of its 2012 earnings to its overseas parent company, Changyou HK. On September 21, 2012, Changyou paid out a special cash dividend of $201 million, with $136 million paid to and received by Sohu. In the $136 million, $128 million was paid to and received by Sohu.com Limited and $8 million was paid to and received by Sohu.com Inc.

The cash transfers to Sohu.com Inc. are subject to certain restrictions, such as the PRC company's profit appropriation required by the PRC law, the PRC foreign currency exchange regulations, PRC tax and US tax regulations, as well as the restrictions related to our VIE structures. However, 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 tax on dividends and foreign currency exchange regulation Regulations in the PRC currently permit payment of dividends of a PRC company only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Our China-based subsidiaries, which are wholly foreign-owned enterprises ("WFOEs"), are also required to set aside at least 10% of their after-tax profit based on PRC accounting standards each year to their general reserves until the cumulative amount reaches 50% of their paid-in capital. These reserves are not distributable as cash dividends, or as loans or advances. These WFOEs may also allocate a portion of their after-tax profits, at the discretion of their Boards of Directors, to their staff welfare and bonus funds. Any amounts so allocated may not be distributed to Sohu.com Limited and /or Changyou.com Limited, accordingly, would not be available for distribution to Sohu.com Inc.

The PRC Corporate Income Tax Law imposes a 10% withholding income tax for dividends distributed by WFOEs 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 Between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital (the "China-HK Tax Arrangement") if such holding company is considered a non-PRC resident enterprise and holds at least 25% of the equity interests in the PRC foreign invested enterprise distributing the dividends, subject to approval of the PRC local tax authority. However, if the Hong Kong holding company is not considered to be the beneficial owner of such dividends under applicable PRC tax regulations, such dividend may remain subject to a withholding tax rate of 10%.

For the aforementioned distribution plan in which one of Changyou's PRC subsidiaries would distribute dividend to Changyou HK, based on an assessment performed pursuant to requirements specified by PRC tax authorities, Changyou concluded that it was more likely than not that such distribution would be subject to 5% withholding tax. For the year ended December 31, 2012, Changyou accrued deferred tax liabilities in the amount of $11.9 million for withholding taxes associated with this dividend distribution plan.

Under regulations of the State Administration of Foreign Exchange ("SAFE") in China, the RMB is not convertible into foreign currencies for capital account items, such as loans, repatriation of investments and investments outside of China, unless prior approval of the SAFE is obtained and prior registration with the SAFE is made.

U.S. tax regulation Sohu.com Inc. is a Delaware corporation and its income is subject to income taxes in the United States ("U.S.") at a rate of up to 35%. As Sohu.com Inc. has no substantial operations and earns little income in the United States, its taxable income is near negligible and so is its U.S. income tax due. Sohu.com Inc. is also subject to U.S. income tax on any deemed dividends from its non-U.S. subsidiaries, as discussed below.

105-------------------------------------------------------------------------------- Table of Contents The majority of the subsidiaries and VIEs of the Sohu.com Inc. 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. Non-U.S. companies, such as Sohu.com Inc.'s non-U.S. subsidiaries and VIEs, are generally not subject to U.S. income taxes unless they conduct a trade or business in the United States themselves. However, if a controlled foreign corporation ("CFC"), such as the non-U.S. subsidiaries and VIEs of Sohu.com Inc., with respect to a U.S.

shareholder, such as Sohu.com Inc., earns certain passive and certain related party income, called "Subpart F income," such income is deemed as a dividend to Sohu.com Inc., subject to U.S. income tax even though no actual dividend is paid to Sohu.com Inc. Subpart F income includes interest income from third parties earned by Sohu.com Inc.'s CFCs. Hence, the interest income earned by Sohu's and Changyou's China-based subsidiaries and VIEs is Subpart F income, includible in Sohu.com Inc.'s taxable income. Moreover, Sohu.com Limited and Changyou.com Limited are regarded as separate entities for U.S. tax purposes, and certain transactions between Sohu.com Limited and Changyou.com Limited. as well as between their subsidiaries and VIEs may generate related party income, another type of Subpart F income, includible in Sohu.com Inc.'s taxable income. In addition, certain transactions between Changyou.com Limited, its non-U.S.

subsidiaries and VIEs on the one hand and Changyou.com Inc. (U.S.) on the other could constitute a CFC's investment in U.S. property, also giving rise to deemed dividends to Sohu.com Inc., includible in Sohu.com Inc.'s taxable income. If Changyou.com Limited pays dividends to its shareholders, including Sohu, such dividends are generally Subpart F income, includible in Sohu.com Inc.'s taxable income unless an exception applies. Under one such exception, the "CFC Look-through Rule," the special cash dividend Sohu received from Changyou in September 2012 should not be includible in Sohu.com Inc.'s taxable income. Under certain circumstances, when Sohu sells Changyou ADSs originally held by Sohu at a price higher than its U.S. tax basis, a portion of the proceeds could be Subpart F income, subjecting Sohu.com Inc. to U.S. tax at 34% or 35%.

As most of the income earned by the non-U.S. subsidiaries and VIEs of Sohu.com Inc. is not Subpart F income, Sohu.com Inc. is only required to include in its taxable income a small amount of its non-U.S. subsidiaries' income that is Subpart F income. As Sohu.com Inc. has net operating loss exceeding such Subpart F income, Sohu.com Inc. does not owe much U.S. tax. Subpart F income once includible in Sohu.com Inc.'s taxable income becomes previously taxed income ("PTI") and actual dividends made out of PTI will not be taxed a second time.

Moreover, according to ASC 740-30, Sohu.com Inc. does not provide for U.S.

federal income taxes or tax benefits on the undistributed earnings or losses of its international subsidiaries or consolidated VIEs because in the foreseeable future Sohu.com Inc. does not have the intention to repatriate those undistributed earnings or losses to U.S. where it would be subject to U.S.

Corporate Income Tax, except that, under certain circumstances, Sohu.com Inc.

may repatriate to the U.S. income that will be subject to U.S. Alternative Minimum Tax. For detailed dividend policy please refer to the section below.

Restriction related to VIE structure For Sohu except for Changyou, although the VIEs generate revenue and cash, due to significant costs involved in their operations, almost all the VIEs are incur deficits, and their operating cash flow was negative for the year ended December 31, 2012.

Substantially all of Changyou's operations are conducted through Changyou's VIEs, which generated all of Changyou's online game revenues. Although Changyou's subsidiaries received a majority of the VIEs' profits pursuant to the various contractual agreements between the VIEs and the subsidiaries, significant cash balances remained in Changyou's VIEs as of December 31, 2012.As Changyou's VIEs are not owned by Changyou's subsidiaries, they are not able to make dividend payments to Changyou's subsidiaries. Instead, Changyou's PRC subsidiaries have entered into a number of contracts with its corresponding VIE to provide services to such VIE in return for cash payments. In order for Sohu.com Inc. and /or Changyou.com Limited to receive any dividends, loans or advances from Changyou's PRC subsidiaries, or to distribute any dividends to Sohu.com Inc.' shareholders and /or Changyou.com Limited's ADS holders, we will need to rely on these payments made from these VIEs to Changyou's PRC subsidiaries. Depending on the nature of services provided by Changyou's PRC subsidiaries to their corresponding VIEs, certain of these payments are subject to PRC taxes, including Business Tax and VAT, which effectively reduce the amount that a PRC subsidiary receives from its corresponding VIE. In addition, the PRC government could impose restrictions on such payments or change the tax rates applicable to such payments.

Dividend Policy On August 6, 2012, Changyou declared a special one-time cash dividend of $1.90 per Class A or Class B ordinary share, or $3.80 per ADS and a total of $201 million. On September 21, 2012, Changyou paid out this special cash dividend, of which $136 million was paid to and received by Sohu.

The Sohu Group intends to retain all available funds and any future earnings for use in the operation and expansion of its own business, and does not anticipate paying any cash dividends on Sohu.com Inc.'s common stock or causing Changyou to pay any dividends, on Changyou.com Limited's ordinary shares, including ordinary shares represented by Changyou.com Limited's ADSs, for the foreseeable future.

Future cash dividends distributed by Sohu.com Inc. and Changyou.com Limited, if any, will be declared at the discretion of their respective Boards of Directors and will depend upon their future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and such other factors as their respective Boards of Directors may deem relevant.

106-------------------------------------------------------------------------------- Table of Contents Holders of ADSs of Changyou.com Limited will be entitled to receive dividends, subject to the terms of the deposit agreement, to the same extent as the holders of Changyou.com Limited's ordinary shares, less the fees and expenses payable under the deposit agreement. Cash dividends will be paid by the depositary to holders of ADSs in U.S. dollars, subject to the terms of the deposit agreement.

Other distributions, if any, will be paid by the depositary to holders of ADSs in any manner that the depositary deems equitable and practicable.

UNCONDITIONAL OBLIGATIONS The following table sets forth our unconditional obligations as of December 31, 2012 (in thousands): Payment Due by Period Total Payments Unconditional Obligations 2013 2014 2015 2016 2017 Thereafter Required Content and service purchases -video 46,870 2,217 0 0 0 0 49,087 Bandwidth purchases 30,360 3,127 448 286 95 0 34,316 Operating lease obligation 18,840 10,079 1,773 0 0 0 30,692 Purchases of office building and related technological infrastructures and fitting-out work 35,722 2,561 869 0 0 0 39,152 Content and service purchases -others 16,481 1,553 418 1 0 0 18,453 Others 15,861 2,474 315 0 0 0 18,650 Total Payments Required 164,134 22,011 3,823 287 95 0 190,350 Operating Lease Obligation We have entered into various operating lease agreements for certain of our and Changyou's offices, land and data centers with original lease periods expiring between 2013 and 2017. We recognize rental expense under such leases on a straight-line basis over the lease terms.

Purchases of Office Building and Related Technological Infrastructure and Fitting-out Work In November 2009, we entered into an agreement to purchase a Beijing office building to serve as our headquarters. The purchase price is approximately $128 million, of which $125 million had been paid as of December 31, 2012. In December 2011, we also entered into an agreement for technological infrastructure and fitting-out work for this office building. The contractual amount is approximately $28 million, of which $21 million had been paid as of December 31, 2012. These $125 million and $21 million payments have been recognized as prepaid non-current assets in our consolidated balance sheets. The remaining $3 million for the office building and $7 million for the technological infrastructure and fitting-out work will be settled in installments as various stages of the development plan are completed. This office building and related technological infrastructure and fitting-out work are in progress and are expected to be completed in 2013.

In August 2010, Changyou entered into an agreement to purchase a Beijing office building to serve as its headquarters. The purchase price is approximately $159 million, of which $126 million had been paid as of December 31, 2012 and was recognized as prepaid non-current assets in our consolidated balance sheets. In February 2013, Changyou paid out $16 million and the remaining $17 million will be settled in the first half of 2013, when the office building is expected to be completed and accepted by Changyou.

OTHER LONG-TERM LIABILITIES As a result of our adoption of Accounting Standard Codification 740 "Income Taxes" (ASC 740), during 2009, we recorded unrecognized tax benefit of $3.1 million and recognized related long-term tax payable, as ASC 740 specifies that tax positions for which the timing of the ultimate resolution is uncertain should be recognized as long-term liabilities. The situation is unchanged as of December 31, 2012. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes. As a result, this amount is not included in the table above.

OFF-BALANCE SHEET COMMITMENTS AND ARRANGEMENTS We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholder's equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or that engages in leasing, hedging or product development services with us.

107 -------------------------------------------------------------------------------- Table of Contents IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In July 2012, the FASB issued revised guidance on "Testing Indefinite-Lived Intangible Assets for Impairment." The revised guidance applies to all entities, both public and nonpublic, that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. Under the revised guidance, an entity has the option first to assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite-lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform a quantitative impairment test by comparing the fair value with the carrying amount in accordance with Subtopic 350-30. An entity also has the option to bypass a qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. In conducting a qualitative assessment, an entity should consider the extent to which relevant events and circumstances, both individually and in the aggregate, could have affected the significant inputs used to determine the fair value of the indefinite-lived intangible asset since the last assessment. An entity also should consider whether there have been changes to the carrying amount of the indefinite-lived intangible asset when evaluating whether it is more likely than not that the indefinite-lived intangible asset is impaired. An entity should consider positive and mitigating events and circumstances that could affect its determination of whether it is more likely than not that the indefinite-lived intangible asset is impaired. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012, if a public entity's financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. We are currently evaluating the impact on our consolidated financial statements of adopting this guidance.

In February 2013, the FASB issued revised guidance on "Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." The revised guidance does not change the current requirements for reporting net income or other comprehensive income in financial statements.

However, the revised guidance requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The revised guidance is effective prospectively for reporting periods beginning after December 15, 2012 for public entities. The revised guidance will not have a material effect on us.

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