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Article by DailyStocks_admin    (06-03-08 09:08 AM)

The Daily China Business Stock for 06/03/2008 is SOHU

BUSINESS OVERVIEW

Overview

Sohu is one of the premier Internet media companies in China, providing millions of Chinese consumers with their daily source of information, entertainment and communication. We have built one of the most comprehensive matrices of Chinese language Web properties consisting of:
-www.sohu.com , a leading mass portal and online media destination;
-www.sogou.com , an interactive proprietary search engine with an expanded database capacity of more than ten billion retrieved web pages;
-www.17173.com , a leading games information portal;
-www.focus.cn , a top real estate Website;
-www.chinaren.com , a leading online alumni club;
-www.go2map.com , one of the leading online mapping service providers; and
-www.goodfeel.com.cn , a wireless value-added services provider.

Sohu corporate services consist of brand advertising on its matrix of Websites as well as paid listing and bid listing on its in-house developed search directory and engines. Sohu also offers two types of consumer services, which includes online game and wireless. The company operates two massively multi-player online role-playing games (or MMORPG games), namely Tian Long Ba Bu (or TLBB) and Blade Online (or BO), and a casual game platform. Sohu also offers wireless value-added services such as news, information, music, ringtone and picture content sent over mobile phones.

We were incorporated in Delaware in August 1996 as Internet Technologies China Incorporated, and launched our original Website, itc.com.cn, in January 1997. During 1997, we developed the Sohu online directory and search engine and related technology infrastructure, and also focused on recruiting personnel, raising capital and aggregating content to attract and retain users. In February 1998, we re-launched our Website under the domain name Sohu.com and, in September 1999, we renamed our company Sohu.com Inc. On October 18, 2000, we completed the acquisition of ChinaRen, the leading youth community Website in China. On
November 24, 2003, we completed the acquisition of Kylie Enterprises Limited, the owner of 17173.com, a Website providing information about multiplayer online games in China. On November 25, 2003, we completed the acquisition of All Honest International Limited, the owner of Focus.cn, a Website providing information about real estate in Beijing and Shanghai. On May 31, 2004, we completed the acquisition of Marvel Hero Limited and Goodfeel, a leading provider of value-added mobile data services for Wireless Application Protocol, or WAP, in China. On May 31, 2005, we completed the acquisition of Go2Map Inc. (and its affiliate, Tu Xing Tian Xia), one of the leading online mapping service providers in China. On November 1, 2006, we completed the acquisition of 21 East HK and its subsidiary 21 East Beijing, an entertainment provider in China. Through our acquisition and successful integration of these companies, we have built one of the most comprehensive networks of Web properties in China.

Substantially all of our operations are conducted through our indirect wholly owned PRC subsidiaries, Sohu Era, Sohu Media, Sohu Software, Sogou Technology, Go2Map Software and AmazGame Age and our VIEs, High Century, Sohu Entertainment, Sohu Internet, Goodfeel, Huohu, Tu Xing Tian Xia, Feng Yang Tian Lang, Sogou Information, 21 East Beijing, Gamease Age and New 21 East. Since our inception, our business model has expanded to include other major business lines, including brand advertising, sponsored search, online game, wireless services and other businesses.

We derive revenues from the sale of brand advertising, sponsored search, online game and wireless services.

In 2000, we started the e-commerce business, selling consumer products through store.sohu.com. We discontinued the e-commerce business on June 20, 2006 in order to focus on profitable segments. In 2001, we began to provide wireless services for mobile phone users through sms.sohu.com. We then expanded our wireless services to include short messaging services, or SMS, Ring Back Tone, or RBT, WAP, multimedia messaging services, or MMS and interactive voice response, or IVR. In 2003, we launched our first licensed multiplayer online game, Knight Online (or KO). Because the license to KO expired in November 2006, we discontinued the operation of the game since then. In 2004, we launched our second multiplayer online game, BO. In May 2007, we launched our first self-developed multiplayer online game, TLBB. In August 2004, developed from the existing directory search capabilities, we introduced our new, all-inclusive, proprietary search engine under the brand name Sogou through Sogou.com. On January 1, 2007, we announced the launch of Sogou version 3.0, which offers further enhanced updating speeds, shortened search times and more accurate search results, based on an expanded database capacity of more than ten billion retrieved web pages.

Official Internet Content Service Sponsor for Beijing 2008 Olympic Games

In November 2005, we were selected as the official sponsor of Internet Content Services (or ICS) for the Beijing 2008 Olympic Games. Under the sponsorship agreement we entered into with the Beijing Organizing Committee for the Games of the XXIX Olympiad (or BOCOG), we provided exclusive services to BOCOG to construct, operate and host the official BOCOG Website, www.beijing2008.com, for this historic event.

Our Web Properties

We have matrices of seven Web properties, with Sohu.com being the Website attracting the highest level of Internet traffic. On all of our Websites, we offer basic content to our users on a free of charge basis.

Mass Portal—Sohu.com

Sohu.com’s portal consists of sophisticated Chinese language Web navigational capabilities, 35 main content channels, Web-based communication and community services and short messaging services. Each of our interest-specific main channels contains multi-level sub-channels that cover a comprehensive range of topics, including news, business and finance, entertainment, sports, information technology, automobile, real estate, and women. We also offer free Web-based e-mail services. Our portal attracts consumers and merchants alike because it is designed to meet the specific needs and interests of Internet users in China. Key features of our portal include proprietary Web navigational capabilities that reflect particular cultural characteristics and viewing habits of PRC Internet users.

Proprietary Search Engine—Sogou.com

Sogou, which means “Search Dog”, is Sohu’s proprietary search engine launched in August 2004. Sogou performs interactive searches of billions of Web pages using advanced algorithms. The user is taken through a fast and convenient interactive process to arrive at the most relevant selection of the integrated Website and page search results. On February 25, 2005, we launched our upgraded search engine Sogou 2.0 with an expanded breadth of one billion Chinese language indexed web pages, higher updating speed and shorter search time. In November 2005, we announced the launch of Sogou version 2.5, a further upgrade for our proprietary search engine. This upgraded Sogou 2.5 was more sophisticated with advanced spider technology and more intelligent in terms of crawling, selecting and ranking capabilities so as to provide more relevant, accurate and up-to-date Web search results. On January 1, 2007, we announced the launch of Sogou 3.0, a newly upgraded version for our intelligent search engine. This new version of Sogou can provide our users with higher updating speeds, shortened search times and more accurate search results based on an expanded database capacity of more than ten billion retrieved pages. We will continue to integrate Sogou 3.0 with the content strength of our comprehensive Internet platform and our community based product offering, which will enable us to obtain knowledge of our users’ online habits and interests, in order to optimize the overall search experience for our users.

Vertical Sites

17173.com

The Sohu games portal www.17173.com was launched in 2000 as the first online games portal in China and was acquired by Sohu in November 2003. 17173.com is a leading online destination for game players seeking information on games and feedback from other players on the site’s message boards. With over 100 game zones and millions of registered users supported by alliances with over thousands of Internet cafés, 17173.com is one of the largest online games information and community Websites in China. The games portal www.17173.com is widely recognized as a market leader among the games Websites in China, with strong expertise in running the Website, building a game community and developing relationships with advertising clients in the online games industry.

Focus.cn

Focus.cn is one of the leading real estate Websites in China. Focus.cn attracts many users who are homeowners with high incomes and real estate professionals. Launched in 1999, Focus.cn has developed into what we believe is one of the most influential Websites serving the Beijing market. The Focus.cn platform serves as a basis for regional expansion in other key urban areas where Internet penetration is highest in China. As of December 31, 2007, the Website has successfully rolled out into 28 cities. Focus has also been enriching its content and has diversified from residential properties to commercial properties, as well as other auxiliary industries, such as home decoration, furniture and fixtures.

Chinaren.com

We acquired ChinaRen in October 2000. ChinaRen is the largest online youth community in China, with over eighty million registered users as of December 31, 2007. Schools and universities in China generally do not have alumni offices to cater to the needs of former students to organize their classes into long-term communities. As in other Asian societies, Chinese people hold strong ties of friendship and loyalty with their fellow alumni, which form the basis of their personal and professional relationship networks. ChinaRen has leveraged a critical mass of loyal users to create one of the leading online alumni networks in China.

Go2Map.com

Go2Map is one of the leading online mapping services providers in China founded in 1999. Go2Map mapping information platform enables online mapping services through different Internet/Intranet platforms, mobile phones, call centers and PDAs. Go2Map’s database covers points of interests in more than 307 cities across China, which has enabled it to develop multiple business applications, including sales of software and map information resources. Go2Map also provides Web surfers a free online mapping inquiry system in large Chinese cities. We acquired Go2Map in May 2005 and Go2Map’s expertise in professional location-based information had enhanced our search engine capabilities as well as online Website content.

Goodfeel.com.cn

Goodfeel is a leading WAP service provider in China, offering various WAP services including ring tone and picture downloads. Goodfeel.com was founded in November 2001 and was acquired by us in May 2004. Goodfeel has since been integrated with our WAP business. We believe it is important for Sohu to maintain a presence on the wireless side, and more specifically in WAP, in anticipation of the launch of the third generation of mobile networks in China in the near future and the burgeoning market that it will bring.

Our Products and Services

Products and Services for Businesses

Brand Advertising

In brand advertising, we enjoy a strong competitive position as one of the top portals in China. We provide brand advertising services across our matrices of Web properties. Our offerings enable advertisers to post their advertisements in different forms, including textual, rich media and graphic advertisements, and in different locations on the Sohu matrix of Web properties. Our brand advertising products include but are not limited to banners, links, logos, buttons and stream advertisements placed on our Websites and sponsorships that typically focus on a particular event or a particular Website area. We charge advertisers daily or hourly rates for banners, links, logos, buttons and stream advertisements. Sponsorship contracts for a particular area of a Website or for a particular event may require fixed payments over the contract period. Our standard advertising charges vary depending on the terms of the contract and the advertisement’s location within our Website. Discounts from standard rates are typically provided for higher-volume, longer-term advertising contracts, and may be provided for promotional purposes.

We rely on both direct sales by our internal sales force and sales by advertising agents for advertising on our Websites. During the year ended December 31, 2007, approximately 1,070 companies advertised on our Websites. Our customers include multinational companies that have significant operations in Chinese markets, many of which are Fortune 500 companies, as well as numerous Chinese domestic companies, which are mainly large or medium size companies. We plan to continue focusing on multinational and Chinese domestic companies as our key advertisers. In 2007, our five largest advertisers accounted for approximately 14% of total brand advertising revenues. Sohu has entered into agreements with each of these advertisers. Most of these agreements have terms of less than 12 months.

The focus of our marketing strategy is to generate brand and product awareness for Sohu.com in China with advertisers, Internet users and the general public. During the year ended December 31, 2007, we spent approximately $22.5 million in advertising expenses. As a pioneer of the PRC Internet industry, we have been able to generate substantial public awareness of Sohu in China.

As of December 31, 2007, we had obligations to provide, and advertisers had obligations to purchase, advertising services under existing contracts in the amount of $2.3 million, of which $1.8 million of services were required to be provided during the year ended December 31, 2008.

Sponsored Search

We offer a series of sponsored search offerings, aiming at small and medium sized enterprises that pay fees to list on our search results, in our directory. Through our sponsored search services, we provide advertisers a cost-effective way to deliver advertisement to targeted customers by displaying advertisements in response to user actions, such as a keyword search. We offer both paid listing and bid listing on our search engine and online directory, as well as listings in our classified advertisement section. For paid listing, advertisers pay fixed lump-sum fees based on priority and keywords within a certain period. For bid listing, advertisers pay us according to a cost per click bidding price set by the advertisers.

We market our paid search services through the use of approximately 200 distribution agents as well as our internal sales force. We also have a Website Alliance network with more than 6,000 members, whereby our bid listing advertisers could choose to also post their links in different Websites of the Website Alliance members so as to increase the chance of click-through.

In 2007, we had more than 51,400 customers for our sponsored search business.

Products and Services for Users

We provide an array of products and services to our users through our Web properties, including aggregated content, communication and community, search and directory, online game and wireless services.

Aggregated Content

We also are a leading aggregator of content, and provide content on a variety of topics. We organize our content around 35 main channels on the Sohu portal. Each main channel contains numerous sub-channels and features news, commentaries and various utilities and solutions relating to a specific topic. We also have regional Websites in three different cities in China. As of December 31, 2007, we had over 1,600 content partners, which enables us to provide a wide range of content offerings. Our content partners are leading Chinese language media and information providers in a variety of fields with coverage of major cities in China. Our arrangements with content partners are normally short-term and non-exclusive. In addition, we have established exclusive partnership/sponsorships with some of our important content partners and sponsors, including the Beijing 2008 Olympic Games, Team China, China Interactive Sports and NBA. Such exclusive content partnerships or sponsorships enable us to differentiate our brand advertising offering from other brands and to improve and strengthen our brand.

All of our channels, including co-branded third party content on our portal, are defined by the following features, that together constitute the distinct Sohu “look and feel”: the Sohu.com logo, the “Search Fox” mascot that displays different postures in different channels, the navigation bar, the color combination, the size and type of the Chinese characters, the spacing of the characters used in our directories and the reporting style. Below are descriptions of some of our main channels: Online Games

In 2007, we operated two MMORPG games, namely TLBB and BO.

TLBB

TLBB is our first in-house developed MMORPG game with development work started in late 2004. It is a 2.5D martial art game based on a famous novel “Eight Demigods” written by Louis Cha. The game appeals to players of all levels and offers high quality graphics and in-game communities. In the interactive in-game communities, the players can complete series activities, such as making friends, getting married, learning life skills or completing other preset tasks. To enhance the game experience, users can buy in-game virtual items, such as power enabled medicine, costumes, weapon by purchasing Sohu prepaid cards and charge the amount to their accounts. TLBB was commercially launched in May 2007 and solidified its success during the subsequent months during the year of 2007. As of December 31, 2007, TLBB has been ranked in the top five MMORPG games in the Chinese market. The success of TLBB in China has enabled us to license the game overseas. In August 2007, we licensed TLBB to an operator in Vietnam. In December 2007, we also licensed it to operators in Hong Kong and Taiwan. As of December 31, 2007, TLBB had more than 23 million registered users in China.

BO

In 2004, we launched BO, which was co-developed with a Beijing-based game studio. In December 2006, we launched Blade Hero Online, which is the upgraded version of BO.

In 2007, both games are free-to-play games and generate revenue through sale of in-game virtual items. Under this item-based model, players play a game on a free of charge basis and with the ability to purchase in-game premium features. The item-based model allows us to make frequent adjustments to meet the changing demands of players in order to enhance game interaction and create a better game community. In addition, the item-based model offers flexible ways to generate revenues, including attracting more users, increasing the number of active paying accounts and growing average quarterly revenue per active paying account (or ARPU). Online game revenues are collected through sale of our prepaid cards, which we sell in both virtual and physical form, to third party distributors and retailers.

Pipeline

In August 2007, we obtained rights to develop the game “The Duke of Mount Deer”, another famous novel written by Mr. Louis Cha, author of TLBB. This will be a 2.5D cartoon style MMORPG game and is now under development. In December 2007, we licensed a new MMORPG game, “The Legend of the Ancient World,” from a local studio. This will be a 2.5D MMORPG game and is now under development.

Casual Game

In addition to MMORPG games, we also operate a casual game platform on our portal, which mainly consists of 40 casual games, such as chess, board games, card games and puzzle games. In 2007, no revenue was generated from this casual game platform.

Wireless Services

We operate as a service provider to China’s leading mobile network operators, offering a wide range of wireless products focused on entertainment, information and communications. These products are available to end users via a broad choice of technologies, such as SMS, RBT, WAP, MMS, and IVR services. We provide wireless services mainly pursuant to our cooperation arrangements with all of the four Chinese mobile network operators and their provincial subsidiaries.

We offer a variety of products and services to our users by utilizing the content of our portals to create fee-based services. Users can purchase our wireless services through our Websites or through mobile phones and pay for such services on a monthly subscription basis or per-message basis. Users may subscribe to receive news, alerts and other information, download ring tones and logos and alumni clubs, participate in dating and friends matching as well as play games, and order other mobile related content. Pursuant to our cooperation arrangement with mobile network operators, the monthly service fees charged on users range from $0.065 to $4.037 per month and single message fees range from $0.006 to $0.538 per message. For the year ended December 31, 2007, approximately 59% of our SMS revenues was derived from consumers who subscribe for monthly services. We do not directly bill and collect fees from users. Instead, we rely on mobile network operators to bill and collect our service fees. After collecting service fees from users on behalf of Sohu, mobile network operators will deduct a percentage of such revenue as gateway fees and service fees before paying the balance to us. Such percentages normally ranges from 15%-60% based on contract rates.

Competition

The Internet and Internet-related markets in China are relatively new and rapidly evolving. There are many companies in the domestic and international markets that distribute online content, value-added telecommunications services targeting Chinese users. We now are facing more intense competition from both domestic and international competitors for providing content and services over the Internet, including brand advertising, content, community tools, search engines, web directories, online games and wireless services. For example, there are a number of existing or new PRC Internet portals, including those controlled or sponsored by private and PRC government entities. As an Internet portal, we compete with these portals, including but not limited to Sina, Tencent and Netease, and vertical sites, such as PColine and SouFun. Our search engine faces intense competition from software and other Internet products and services incorporating search and retrieval capabilities, such as Baidu, Google, Yahoo! China and SoSo. We compete with other pure-play online games developers and operators including but not limited to Shanda, The9, Perfect World, Giant Interactive, Netdragon and Kingsoft; and pure-play wireless services providers, such as Tom Online, KongZhong, Linktone and Hurray!. In addition, we compete with operators of global leading Websites or Internet service providers, including Yahoo!, Microsoft/MSN and AOL, currently offer, and could expand, their online products and services targeting China. These sites and companies compete with us for visitor traffic, advertising dollars, Internet services, game players spending, wireless services and potential partners.

In the PRC Internet market, competition is intense and is expected to increase significantly in the future because there are no substantial barriers to entry in our market. Our competitors may have certain competitive advantages over us in terms of:
-substantially greater financial and technical resources;
-more extensive and well developed marketing and sales networks;
-better access to original content and information;
-greater global brand recognition among consumers; and
-larger customer bases.

We compete with other portals in China primarily on the following basis:
-technological advancements;
-attractiveness of products;
-brand recognition;
-volume of traffic and users;
-quality of our Websites and content;
-strategic relationships;
-quality of our services;
-effectiveness of sales and marketing efforts;
-talented staff; and
-price.

Our existing competitors may in the future achieve greater market acceptance and gain additional market share. It is also possible that new competitors may emerge and acquire significant market share. We believe the rapid increase in China’s online population will draw more attention from these multinational players to the PRC Internet market. We also compete with traditional forms of media — such as newspapers, magazines, radio and television — for advertisers, advertising revenues and content. Some of these traditional media have extended their businesses into the Internet market such as CCTV.com and XinHuaNet. Accordingly, we will face more intense competition with traditional media companies in both their traditional media, and in the Internet-related markets.

CEO BACKGROUND

Dr. Roberts is the David Sarnoff Professor of Management of Technology at Massachusetts Institute of Technology’s Alfred P. Sloan School of Management. He chaired MIT’s research and educational programs in the management of technological innovation from 1967 to 1993. He also founded and chairs the MIT Entrepreneurship Center. Dr. Roberts is currently a director of Medical Information Technology, Inc. He has authored over 160 articles and eleven books, a recent one being Entrepreneurs in High Technology (Oxford University Press, 1991). Dr. Roberts received four degrees from M.I.T., including a Ph.D in 1962.

Dr. Deng is the Chief Executive Officer and Chairman of the Board of Directors of Vimicro Corporation (NASDAQ: VIMC), which he co-founded in 1999. Dr. Deng received a Ph.D. in Electrical Engineering and Computer Sciences, a M.S. degree in Economics and a M.S. degree in Physics from the University of California, Berkeley. After graduation from Berkeley, Dr. Deng worked as a research scientist for International Business Machines Corporation at the T.J. Watson Research Center in Yorktown Heights, New York.

Dr. Zhang is our Founder and has been Chairman of our Board and Chief Executive Officer since August 1996. Dr. Zhang also served as President from August 1996 until July 2004. Prior to founding Sohu, Dr. Zhang worked for Internet Securities Inc. and helped establish its China operations. Prior to that, he worked as Massachusetts Institute of Technology’s liaison officer with China. Dr. Zhang has a Ph.D in experimental physics from Massachusetts Institute of Technology and a Bachelor of Science degree from Tsinghua University in Beijing. Dr. Zhang is a native of the People’s Republic of China.

Mr. Huang is the Founder, Chief Executive Officer and Chairman of Netbig Education Holdings Ltd., a leading education enterprise in China. Prior to founding Netbig in 1999, Mr. Huang worked as Executive Director and Head of Asia Securitization Group of Deutsche Bank, New York and Hong Kong, as well as Senior Vice President of Prudential Securities Inc., New York. He holds an M.S. degree in Computer Science from MIT and a B.S. degree from the University of Science and Technology of China. Mr. Huang is also a Chartered Financial Analyst.

Dr. Qi is a Professor of Accounting and the Associate Dean of the Cheung Kong Graduate School of Business. He began teaching at the Cheung Kong Graduate School of Business in 2002 and was the founding Director of the Executive MBA program. Before joining the Cheung Kong Graduate School of Business, Dr. Qi was an Associate Professor at the School of Accounting of the Chinese University of Hong Kong. Dr. Qi has published many articles and research essays on accounting, financial reporting, capital market and other related topics. He has a Ph.D. in accounting from the Eli Broad Graduate School of management of Michigan State University, a Master of Business Administration from the University of Hawaii at Manoa, and a Bachelor of Science and a Bachelor of Arts from Fudan University. Dr. Qi is currently a member of the American Accounting Association.

Mr. Wang is the Chairman of China Vanke Co., Ltd., of which Mr. Wang was Chairman and General Manager from 1991 to 1999. He founded the Shenzhen Exhibition Center of Modern Science and Education Equipment in 1984, which is the predecessor to China Vanke Co., Ltd. Mr. Wang is the Executive Manager of the China Real Estate Association and is Deputy Director of the City Housing Development Council of the China Real Estate Association.


MANAGEMENT DISCUSSION FROM LATEST 10K

OVERVIEW

We are a leading online media, search, online game and mobile value-added services company providing comprehensive online products and services to consumers and businesses in China, through our comprehensive matrices of web properties, consisting of the mass portal and leading online media destination www.sohu.com; the interactive search engine www.sogou.com; the leading games information portal www.17173.com; one of the top real estate Websites www.focus.cn; the leading online alumni club www.chinaren.com; a leading online mapping service Website www.go2map.com and the wireless value-added services provider www.goodfeel.com.cn. We offer our user community very broad choices regarding information, entertainment, communication, online game and wireless services. We derive revenue primarily through the sale of brand advertising, sponsored search, online game and wireless services. We also sponsor major events to further enhance our viewership and create a positive branding impact.

We were incorporated in the state of Delaware in August 1996 as Internet Technologies China Incorporated, and launched our original Website, itc.com.cn, in January 1997. During 1997, we developed the Sohu online directory, search engine and related technology infrastructure, and also focused on recruiting personnel, raising capital and aggregating content to attract and retain users. In February 1998, we re-launched our Website under the domain name sohu.com. In September 1999, we re-named our company Sohu.com Inc. Our business operations are conducted primarily through our indirect wholly owned subsidiaries, Sohu Era, Sohu Media, Sohu Software, Sogou Technology, Go2Map Software and AmazGame Age and our VIEs, High Century, Sohu Entertainment, Sohu Internet, Goodfeel, Huohu, Tu Xing Tian Xia, Feng Yang Tian Lang, Sogou Information, 21 East Beijing, Gamease Age and New 21 East.

On May 31, 2005, we completed the acquisition of all of the outstanding capital stock of Go2Map Inc., and all of the registered share capital of Tu Xing Tian Xia, a company incorporated in the PRC which was an affiliate of Go2Map Inc (collectively “Go2Map”). Go2Map is one of the leading online mapping service providers in China. Revenues of $919,000 and $1.2 million, costs and expenses of $3.6 million and $2.8 million for the year ended December 31, 2007 and 2006, respectively.

We incurred significant net losses from our inception in August 1996 through the quarter ended June 30, 2002. These losses were funded with private placements of convertible preferred stock and our initial public offering. As of December 31, 2007, we had retained earnings of $79.4 million. However, we intend to continue spending on content enhancements, research and development, technology, infrastructure, marketing and brand development. As a result, net losses could occur in the future. We anticipate funding such losses in excess of our retained earnings, if any, with cash flows from operating activities and the remaining proceeds from our initial public offering.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. 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. We believe accounting for brand advertising and sponsored search revenues, accounting for online game revenues, accounting for wireless revenues and cost of revenues, gross versus net basis of revenue recognition, determination of functional currencies, allowance for doubtful accounts, assessment of impairment for goodwill, intangible assets, fixed assets and other assets, determination of share-based compensation expense, and valuation allowance against deferred tax assets, represent critical accounting policies that reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

Advertising Revenues

Advertising revenues include revenue from brand advertising and sponsored search services, after deducting agent rebates and applicable business tax. No revenues from advertising-for-advertisi ng barter transactions were recognized.

Brand advertising contracts establish the fixed price and advertising services to be provided. Pursuant to brand advertising contracts, we provide advertisement placements on various Website channels and in different formats, including but not limited to banners, links, logos, buttons, rich media and content integration. Revenue is recognized ratably over the period the advertising is provided and, as such, we consider the services to have been delivered. We treat all elements of advertising contracts as a single unit of accounting for revenue recognition purposes. Based upon our credit assessments of our customers prior to entering into contracts, we determine if collectibility is reasonably assured. In situations where collectibility is not deemed to be reasonably assured, we recognize revenue upon payment from the customers.

Sponsorship contracts may include services similar to those in our brand advertising contracts, are generally for larger dollar amounts and for a longer period of time, may allow advertisers to sponsor a particular area on our Websites, may include brand affiliation services and/or a larger volume of services, and may require some exclusivity or premiere placements. Sponsorship advertisement revenues are normally recognized on a straight-line basis over the contract period, provided we are meeting our obligations under the contract.

Pursuant to sponsored search contracts, which are normally for relatively small dollar amounts and are with small and medium sized enterprises, sponsored search services mainly include priority placements in our search directory and pay-for-click services consisting of displaying the text-based links of our advertisers on our Websites and our Website Alliance network. We normally provide priority placements services for a fixed fee over the service period of the contracts. Revenues on priority placements are normally recognized on a straight-line basis over the contract period provided we are meeting our obligation under the contract. Pay-for-click services of displaying the text-based links to our advertisers’ Websites are charged on a cost per click basis, so that an advertiser pays us only when a user clicks on the displayed link. The priority of the display of text-based links is based on the bidding price of different advertisers. Revenues from the pay-for-click services are recognized as the users click on the links.

Material differences could result in the amount and timing of our advertising revenue for any period if management made different judgments or utilized different estimates.

Non-Advertising Revenues

Non-advertising revenues include revenues principally from online game and wireless services.

Online game revenues are collected through sale of our prepaid cards, which we sell in both virtual and physical form, to third party distributors and retailers. Prior to December 2006, we operated our MMORPG games under a time-based model. Under this model, the proceeds from sale of prepaid cards from distributors or retailers are deferred when received and revenue is recognized based upon the actual usage of time units by the end users. In December 2006, we changed the revenue model from time-based to item-based. Under the new item-based model, players play a game on a free of charge basis and with the ability to purchase in-game premium features. Proceeds from sale of prepaid cards are deferred when received and revenue is recognized over the estimated lives of the premium features purchased or as the premium features are consumed. While we have adopted the new item-based model for our online games for a relatively short operation history, we considered the average period that players typically play our games and other player behavior patterns to arrive at our best estimates for the lives of these in-game features. However, if different assumptions were used and resulted in a different estimate of the average period, it may impact the timing that we record our revenues.

Wireless revenues are derived from providing SMS, RBT, WAP, MMS and IVR, mainly consisting of news, weather forecast, chatting, entertainment information, ring tones, and logo downloads and various other mobile related products provided to mobile phone users. Wireless service fees are charged on a monthly or per message/download basis. Wireless revenues and cost of revenues are recognized in the month in which the service is performed, provided no significant obligations remain. We rely on mobile network operators in China to bill mobile phone users for wireless service fees. In order to meet ownership requirements under PRC law which restrict or prohibit wholly foreign owned enterprises from providing Internet information and value-added telecommunication services such as wireless, we rely on Sohu Internet and Goodfeel to contract with the mobile network operators. Generally, (i) within 15 to 120 days after the end of each month, Sohu Internet or Goodfeel receives statements from each of the operators confirming the amount of wireless service charges billed to that operator’s mobile phone users and (ii) within 30 to 180 days after delivering monthly statements, each operator remits the wireless service fees, net of its service fees, for the month to Sohu Internet or Goodfeel. In order to recognize revenue and be paid for services provided, we rely on billing confirmations from the mobile network operators as to the actual amount of services they have billed to their mobile customers. We are unable to collect certain wireless services fees from an operator in certain circumstances due to technical issues with the operator’s network. This is referred to as the “failure rate”, which can vary from operator to operator. Recently, the time lag in receiving monthly statements from one of the mobile network operators has increased. At the end of each reporting period, where an operator has not provided Sohu Internet or Goodfeel with the monthly statements for any month confirming the amount of wireless service charges billed to that operator’s mobile phone users for the month, we, using information generated from our own internal system and historical data, make estimates of the failure rate and collectable wireless service fees and accrues revenue accordingly. The quarterly historical differences in our estimated revenue which was recorded in the financial statements compared to the actual revenue have ranged from an underestimation of $538,000 (gross margin underestimate of $286,000) to an overestimation of $340,000 (gross margin overestimate of $171,000) since 2002 when wireless revenues began representing a significant portion of our total revenues. We believe we have the ability to make a reasonable estimate. However, differences between the actual failure rate and bad debt rate per an operator’s statement and our internal estimates could result in material differences in the amount and timing of our revenue and cost of non-advertising revenue for any period. For the three months ended December 31, 2007, 69.9% of our estimated wireless revenues were confirmed by the monthly statements received from the mobile network operators.

Our management must determine whether to record our wireless revenues using the gross or net method of reporting. Determining whether revenue should be reported gross or net is based on an assessment of various factors, principally whether we are acting as the principal in offering services to the customer or whether we are acting as an agent in the transaction. To the extent we are acting as a principal in a transaction, we report as revenue the payments received on a gross basis, and reports as costs of revenue the amounts attributable to services provided by mobile network operators and other vendors. To the extent we are acting as an agent in a transaction, we report on a net basis reporting as revenue the payments received less commission and other payments to third parties. The determination of whether we are serving as principal or agent in a transaction is judgmental in nature and based on an evaluation of the terms of an arrangement.

Based on our assessment, the majority of our wireless revenues are recorded on a gross basis. We have primary responsibility for fulfillment and acceptability of the wireless services. The content and nature of the wireless services are designed and developed by us (either independently or with third parties) and originate from our Websites, our links located on third parties’ Websites, or one of our dedicated phone numbers. The mobile network operators that we contract with to deliver these services to the end customers are not involved in the design or development of the services that are provided by us. The end customer purchases the wireless content, community access or value-added services, such as news, weather forecast, chatting, entertainment information, ring tones, and logo downloads and various other mobile related products provided to mobile phone users. The end customer receives identical services from us regardless of which mobile network operator is used to deliver the message. In addition, we provide customer services to the end customers directly and we could be requested by the mobile network operators to assume the credit risk if the operators are not able to collect fees from the end customers. We have determined that in addition to the indicators of gross reporting, there are also certain indicators of net reporting, including the fact that the mobile network operators set maximum prices that we can charge and that the mobile network operators also have the right to set requirements and procedures associated with using their platform. However, we have determined that the gross revenue reporting indicators are stronger, because we are the primary obligor, adds value to the products, has inventory risk related to content and products, and has reasonable pricing latitude.

To the extent revenues are recorded gross, any commissions or other payments to third parties are recorded as costs or expenses so that the net amount (gross revenues, less costs and expenses) flows through to operating income. Accordingly, the impact on operating income is the same whether we record the revenue on a gross or net basis.

Functional Currency

Our functional currency is the US Dollar. The functional currency of our subsidiaries and VIEs in China is RMB. 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 it primarily generates and expends cash. Management’s judgment is essential in determination of the functional currency by assessing various indicators, such as cash flows, sales price and market, expenses, financing and inter-company transactions and arrangements. Assets and liabilities of the China subsidiaries and VIEs are translated into US Dollar, our reporting currency, at the exchange rate in effect at the balance sheet date. Foreign currency translation adjustments are not included in determining net income for the period but are accumulated in a separate component of consolidated equity on the balance sheet. The accumulated foreign currency translation adjustment as of December 31, 2007 and December 31, 2006 was a gain of $11.9 million and $5.2 million, respectively.

Allowance for Doubtful Accounts Receivable

Our management must make estimates of the collectibility of our accounts receivable. Management specifically analyzes accounts receivable, historical bad debts, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. Our accounts receivable balance was $29.1 million, net of allowance for doubtful accounts of $2.1 million as of December 31, 2007. If the financial condition of Sohu’s customers or mobile network operators were to deteriorate, resulting in their inability to make payments, or the mobile network operators requested that we assume additional bad debts as a result of the operators’ inability to collect fees from end customers, additional allowance might be required.

Impairment on Long-Lived Assets

Our long-lived assets include goodwill, intangible assets, fixed assets and other assets. We test goodwill for impairment at the reporting unit level (operating segment) on an annual basis, and between annual tests when an event occurs or circumstances change that could more likely than not reduce the fair value of goodwill below its carrying value. Application of a goodwill impairment test requires 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. Significant judgments required to estimate the fair value of reporting units include 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. Any impairment losses recorded in the future could have a material adverse impact on our financial condition and results of operations. As of December 31, 2007, we did not believe that any event or change of circumstances had occurred that would result in material impairment losses in goodwill.

In respect of our intangible assets, which mainly comprise domain names, trademarks, customer lists and computer software purchased from unrelated third parties, we amortize the costs over their expected future economic lives. Fixed assets comprise office buildings, investment properties, computer equipment and hardware, office furniture, vehicles and leasehold improvements, and are depreciated over the estimated useful lives of the assets on a straight-line basis. Other assets mainly include prepaid content fees and rental deposits. We amortize the content fees over the terms of the contracts. Management’s judgment is required in the assessment of the economic lives of intangible assets and useful lives of the fixed assets and other assets. Based on the existence of one or more indicators of impairment, we measure any impairment of intangible assets, fixed assets and other assets based on a projected discounted cash flow method using a discount rate determined by our management which is commensurate with the risk inherent in our business model. An impairment charge would be recorded if we determined that the carrying value of intangible assets, fixed assets or other assets may not be recoverable. Our estimates of future cash flows require significant judgment based on our historical results and anticipated results and are subject to many factors. As of December 31, 2007, we were not aware of any indication of impairment of our intangible assets, fixed assets and other assets.

Share-Based Compensation

Effective from January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (or SFAS 123(R)), which requires all share-based payments to employees and directors, including grants of stock options and restricted stock units, to be recognized in the financial statements based on their grant date fair values.

As of January 1, 2006, we adopted SFAS 123(R) using the modified prospective method. The fair value of the options granted before January 1, 2006 is determined based on the Black-Scholes valuation model, which is consistent with the valuation techniques utilized when we prepared pro forma information under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (or SFAS 123). Restricted stock units are measured based on the fair market values of the underlying stock on the dates of grant. Fair value of the share-based awards is recognized as share-based compensation cost over the requisite service period, net of estimated forfeitures on an accelerated basis under SFAS 123(R).

The determination of the fair value of share-based awards and related share-based compensation expense requires input of subjective assumptions, including but not limited to the valuation model adopted, risk-free interest rates, expected life of the share-based awards, stock price volatility, and expected forfeiture rate. The selection of an appropriate valuation technique or model depends on the substantive characteristics of the instrument being valued. Risk-free interest rates are decided based on the yield to maturity of US government bonds as at respective dates of grant of options. Expected life is the number of years that we estimate, based primarily on the history, using “plain-vanilla” method, that options will be outstanding prior to settlement. Volatility is measured using historical daily price changes of our stock over the respective expected life of the option. Forfeiture rate is estimated based on historical forfeiture pattern and adjusted in accordance with our expectation for the future.

Our input assumptions were based on historical experience, with consideration to developing expectations about the future. The assumptions used in calculating the fair value of share-based awards and related share-based compensation represent management’s best estimations, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change or we utilize different assumptions, our share-based compensation expense could be materially different for any period.

RESULTS OF OPERATIONS

Year Ended December 31, 2007 compared to Year Ended December 31, 2006

In order to focus on our core business of online advertising, on June 20, 2006, we discontinued our unprofitable e-commerce business. As a result of the discontinuation of this business, the e-commerce business is accounted for as a discontinued operation. Accordingly, our statements of operations separate the discontinued operation for all periods presented.

Revenues

Total revenues were $188.9 million and $134.2 million for the years ended December 31, 2007 and 2006, respectively.

Advertising Revenues

Advertising revenues are derived principally from brand advertising and sponsored search.

Advertising revenues were $119.2 million and $91.8 million, or 63% and 68% of total revenues for the years ended December 31, 2007 and 2006, respectively. For the year ended December 31, 2007, advertising revenues consisted of revenues from brand advertising of $112.1 million, and revenues from sponsored search of $7.1 million. For the year ended December 31, 2006, advertising revenues consisted of revenues from brand advertising of $79.0 million, and revenues from sponsored search of $12.8 million.

Brand advertising. Brand advertising revenues increased by $33.1 million to $112.1 million for the year ended December 31, 2007 as compared to $79.0 million for the year ended December 31, 2006. The increase of revenues in 2007 was attributable to increase of number of advertisers and increase of price. The increase of $33.1 million from 2006 to 2007 consisted of: (i) a $17.1 million increase from advertisers who advertised with us during the year ended December 31, 2007 but did not advertise on our Websites during the year ended December 31, 2006; (ii) a $37.5 million increase in revenues from the advertisers who advertised with us in 2006 and continued to do so in 2007; and (iii) a $21.5 million decrease in revenues as some of the advertisers who advertised with us during the year ended December 31, 2006 did not advertise on our Websites during the year ended December 31, 2007. We had approximately 1,070 advertisers in 2007 as compared to 850 advertisers in 2006. Sales to our five largest advertisers comprised both 14% of total brand advertising revenues for the years ended December 31, 2007 and 2006, respectively. No single advertiser accounted for more than 10% of total brand advertising revenues for the years ended December 31, 2007 and 2006. Our advertising customers consisted primarily of companies within automobile, real estate, online games, information technology, financial services and fast moving consumer goods industries. The fastest growing sectors for brand advertising were online games, fast moving consumer goods and financial services industries in 2007. As of December 31, 2007 and 2006, we had $1.4 million and $2.2 million of receipts in advance from advertisers, respectively. We have not recorded any revenue from advertising-for-advertisi ng barter transactions.

For the years ended December 31, 2007 and 2006, we recorded brand advertising revenues of approximately $962,000 and $42,000, respectively, from Fujian Tian Qing Digital Co., Ltd. (or Fujian Tian Qing), formerly known as NetDragon Websoft Inc., in connection with its advertisements on our 17173.com Website. Those advertising services are provided pursuant to a three-year advertising framework agreement that expired in November 2006 and has been extended to November 2009. Fujian Tian Qing was the owner of 17173.com Website prior to our acquisition of 17173.com from them.

Sponsored search. Sponsored search services revenue decreased by $5.7 million to $7.1 million for the year ended December 31, 2007 as compared to $12.8 million for the year ended December 31, 2006. Sponsored search services primarily include priority placements in our search directory and pay-for-click services of displaying the text-based links of our advertisers on our Websites and our Website Alliance network. Revenues from pay-for-click services accounted for approximately 32% of the total sponsored search revenues in 2007 as compared to 28% in 2006. The decrease in sponsored search revenues mainly resulted from our efforts to further strengthen our anti-fraudulent click-through mechanism starting from second half of 2006 which resulted in a decrease in average click-through rates. We believe the improved anti-fraudulent click-through mechanism will provide benefits to our sponsored search business in the long run.

Non-advertising Revenues

Non-advertising revenues are derived principally from online game, wireless and other services.

Non-advertising revenues were $69.7 million and $42.5 million, or 37% and 32% of total revenues for the years ended December 31, 2007 and 2006, respectively.

For the year ended December 31, 2007, non-advertising revenues consisted of revenues from online game of $42.1 million, from wireless of $26.3 million and from other services of $1.3 million. For the year ended December 31, 2006, non-advertising revenues consisted of revenues from online game of $8.5 million, from wireless of $32.6 million and from other services of $1.4 million.

Online game. Our online game revenues are mainly derived from two game titles, TLBB and BO. TLBB is our first in-house developed online game launched on May 9, 2007. BO was licensed from a local independent game development studio and launched in October 2004.

For the year ended December 31, 2007, online game revenues increased by $33.6 million to $42.1 million as compared to $8.5 million for the year ended December 31, 2006. This was primarily due to the commercial launch of TLBB in May 2007, with total revenue of $35.2 million in 2007, representing 84% of total online game revenues. As of December 31, 2007, the total registered users of TLBB had reached 23 million. In 2007, peak concurrent users of TLBB had exceeded 500,000.

The success of TLBB in China has enabled us to license the game in the overseas market. In August 2007, we licensed TLBB to an operator in Vietnam. For the year ended December 31, 2007, we recorded revenues of $345,000 for the license fees and usage-based royalties from this arrangement.

Online game revenues are collected through sale of our prepaid cards, which we sell in both virtual and physical form, to third party distributors and retailers. We account for proceeds from sale of prepaid game cards from distributors or retailers as receipts in advance from distributors in our consolidated balance sheet, prior to their registration to specific game accounts. Once a prepaid game card is registered to a specific game account, we account for related amounts as deferred revenues. As of December 31, 2007, we had receipts in advance from distributors of $6.5 million and deferred revenues of $2.0 million, as compared with $0.7 million and $0.3 million, respectively, as of December 31, 2006.

Wireless. Our wireless revenues include SMS, RBT, WAP, MMS and IVR services. Because of restrictions on foreign companies operating in the PRC telecommunications industry, we have used our VIEs to contract on our behalf with PRC mobile network operators who provide the gateway for sending messages and collect our fees from customers. Our VIEs collect the fees from the operators and we then transfer the fees to our subsidiaries on a periodic basis. There was no material impact in 2007 on our revenues or margins from our reliance on these related party arrangements. Our wireless services include news, weather forecast, chatting, entertainment information, ring tone, and logo downloads and various other related products provided to mobile phone users. Most of our services are charged on a monthly or per message/download basis. For the year ended December 31, 2007, we ordinarily charged monthly fees ranging from approximately $0.065 to $4.037 and per message/download fees ranging from approximately $0.006 to $0.538.

For the year ended December 31, 2007, our wireless revenues decreased by $6.3 million to $26.3 million as compared to $32.6 million for the year ended December 31, 2006, primarily due to decreases of $5.7 million in SMS revenues and $4.6 million in WAP revenues and MMS revenues. This decrease was partially offset by an increase of $4.0 million in RBT revenues and IVR revenues. The decrease in SMS revenues was primarily due to the ongoing negative impact of policies such as double confirmation, billing reminders and details of promotion adopted by SPs issued by mobile network operators starting from July 2006. The decrease in WAP revenues was primarily due to the continuing negative impact of operational policy changes, which include limitations on promotion activities for WAP products and the sending of fee reminders to WAP service users, implemented by a mobile network operator in late 2006. The increase in RBT and IVR revenue in 2007 was because of our continued market development effort and product diversification.

Others . Our other services mainly consist of office space rental income, sales of software to third parties, provision of applications service provider (or ASP) services and construction of websites. For the years ended December 31, 2007 and 2006, revenues for other services were $1.3 million and $1.4 million, respectively.

COSTS AND EXPENSES

Prior to 2007, most of the costs and expenses of the game department were related to product development and research. Accordingly, we recorded all such costs and expenses in product development expenses in the statements of operations. In 2007, in order to better present operating results and to enhance comparability with industry peers, we reclassify expenses in relation to game operations, mainly salary and benefits of game masters, from product development expenses to cost of online game revenues. To conform with current period presentations, the relevant amounts for prior periods have been reclassified. Such reclassification amounted to $1.3 million for the year ended December 31, 2006.

Cost of Revenues

Total cost of revenues was $64.8 million and $48.4 million for the years ended December 31, 2007 and 2006, respectively.

Cost of Advertising Revenues

Cost of advertising revenues increased by $15.9 million to $44.4 million for the year ended December 31, 2007 as compared to $28.5 million for the year ended December 31, 2006.

Brand advertising. Cost of brand advertising revenues includes personnel costs and personnel overhead relating to our editorial center, content purchases, payments to our business partners, relevant depreciation of servers and computer equipment and bandwidth leasing costs. Cost of brand advertising revenues was $38.7 million and $23.2 million for the years ended December 31, 2007 and 2006, respectively. The increase of $15.5 million consisted of a $4.7 million increase in content purchases, a $3.9 million increase in personnel expense, a $2.6 million increase in payments to our business partners, a $2.1 million increase in bandwidth leasing cost to our expanded business, a $1.4 million increase in depreciation expense and a $0.8 million increase in other costs. Our brand advertising gross margin for the years ended December 31, 2007 and 2006 was 65% and 71%, respectively. The decrease was mainly because of increased spending on content purchases, increase in headcount, bandwidth leasing costs and server depreciation costs.

Sponsored search. Cost of sponsored search revenues consists primarily of relevant depreciation of servers and computer equipment, bandwidth leasing costs, payments to our Website Alliance, personnel costs and data collection cost. Cost of sponsored search revenues was $5.6 million for the year ended December 31, 2007 as compared to $5.2 million for the year ended December 31, 2006. The increase in cost of sponsored search revenues resulted from an increase of $1.0 million in relevant depreciation and bandwidth leasing costs, which was offset by a $580,000 decrease in payment to Website alliances. Our sponsored search gross margin for the years ended December 31, 2007 and 2006 was 21% and 59%, respectively. The decrease was mainly due to lower revenue and higher server depreciation and bandwidth leasing costs in relation to the launch of Sogou 3.0 in late 2006.

Cost of Non-advertising Revenues

Cost of non-advertising revenues was $20.4 million and $19.9 million for the years ended December 31, 2007 and 2006, respectively.

Online game. Cost of online game revenues primarily consists of personnel costs relating to the operation of the games, bandwidth leasing costs, revenue sharing with the game developer of BO and depreciation of servers and computer equipment. Cost of online game revenues was $7.1 million for the year ended December 31, 2007 as compared to $3.9 million for the year ended December 31, 2006. The increase in cost of online game revenues was mainly due to increased server depreciation and bandwidth leasing costs due to the launch of TLBB, and increase of personnel costs relating to operation of TLBB. Our online game gross margins were 83% for the year ended December 31, 2007 as compared to 54% for the year ended December 31, 2006. The increase primarily represents contribution from TLBB.

Wireless. Cost of wireless revenues mainly consists of collection and wireless transmission charges paid to mobile network operators, expenses related to complaints based on allegations of breaches of certain provisions of our agreements with mobile network operators, fees or royalties paid to third party providers for promotion services and content associated with our wireless services, payments to third party wireless service alliances, relevant depreciation of servers and computer equipment and bandwidth leasing costs. Cost of wireless revenues decreased by $3.1 million to $12.3 million for the year ended December 31, 2007, as compared to $15.4 million for the year ended December 31, 2006. The decrease in cost of wireless revenues resulted from a decrease of $5.2 million in collection charges, transmission charges and expenses related to penalties paid to mobile network operators; the decrease was partially offset by an increase of $2.1 million paid to third party wireless service alliances and content or service providers. The collection and transmission charges vary between mobile network operators and include a gateway fee of $0.003 to $0.027 per message, depending on the volume of the monthly total wireless messages, and a collection fee of 15% to 60% of total fees collected by mobile network operators from mobile phone users (with the residual paid to us) in the year of 2007. Our wireless gross margins were both 53% for the years ended December 31, 2007 and 2006.

Others. Cost of revenues for other services, was $939,000 and $570,000 for the years ended December 31, 2007 and 2006, respectively. Cost of revenues for other services mainly consists of personnel and other expenses in connection with sales of software, provision of ASP services and construction of websites.

Product Development Expenses

Product development expenses increased by $7.7 million to $25.4 million for the year ended December 31, 2007, as compared to $17.7 million for the year ended December 31, 2006. The increase was primarily due to a $4.9 million increase in personnel expenses resulting from an increase in headcount, salaries and bonuses, a $2.2 million increase in license fee, and a $1.0 million increase in share-based compensation expense under SFAS 123(R), which was offset by a $400,000 decrease in other expenses.

Sales and Marketing Expenses

Sales and marketing expenses increased by $19.0 million to $47.5 million for the year ended December 31, 2007, as compared to $28.5 million for the year ended December 31, 2006. The increase primarily consisted of a $13.7 million increase in advertising and promotion expenses, which included the relevant expenses associated with our exclusive Olympic sponsorship in the Internet Content Services category, investment in corporate branding, marketing expenses for Sohu 3.0 and TLBB, a $4.0 million increase in personnel expenses resulting from an increase in headcount, salaries and sales commission, and a $1.3 million increase in other expenses.

General and Administrative Expenses

General and administrative expenses increased by $4.3 million to $17.4 million for the year ended December 31, 2007, as compared to $13.1 million for the year ended December 31, 2006. The increase was primarily due to a $1.7 million increase in personnel expenses, a $1.0 million increase in professional fee, a $900,000 increase in share-based compensation expense under SFAS 123(R), and a $700,000 increase in other expenses.

Amortization of Intangible Assets

Amortization of intangible assets was $1.1 million and $2.0 million for the years ended December 31, 2007 and 2006, respectively, which were mainly related to the acquisitions of the 17173.com, Focus.cn, Goodfeel and Go2Map.

Operating Profit

As a result of the foregoing, our operating profit increased by $8.1 million to $32.7 million for the year ended December 31, 2007, as compared to $24.6 million for the year ended December 31, 2006. The operating profit for the years ended December 31, 2007 and 2006 included $8.8 million and $6.9 million, respectively, for share-based compensation expense recorded under SFAS 123(R).

Other Income

For the year ended December 31, 2007, other income of $887,000 mainly consisted of $561,000 gain from disposal of interest in an associate. In addition, we have also recorded approximately $503,000 of certain tax refund. This was offset by the amortization of $248,000 of the offering costs of our zero coupon convertible senior notes issued in July 2003. For the year ended December 31, 2006, other income of $477,000 mainly consisted of $793,000 of gains from early redemption of zero coupon convertible senior notes with face value of $15.0 million and our share of profits of $151,000 from our investment in an associate. This was offset by the amortization of $537,000 of the offering costs of our zero coupon convertible senior notes issued in July 2003.

Interest Income

Interest income includes net interest income and foreign currency exchange gains. For the year ended December 31, 2007, interest income was $2.8 million as compared to $3.2 million for the year ended December 31, 2006. The decrease was mainly due to the repayment of our convertible notes of $58.5 million in July, which decreased the average cash balance for the year.

Income Tax Expense

For the year ended December 31, 2007, income tax expense was $1.5 million as compared to $1.6 million for the year ended December 31, 2006.

Most of our income is earned by our China-based subsidiaries and VIEs. Prior to January 1, 2008, our subsidiaries in China were governed by the Income Tax Law of the People’s Republic of China concerning Foreign Investment Enterprises and Foreign Enterprises and local income tax laws (the previous income tax laws and rules). Pursuant to the previous income tax laws and rules, wholly-owned foreign enterprises were subject to tax at a statutory rate of 33% (30% state income tax plus 3% local income tax), or 15% for certain technology enterprises, on PRC taxable income. Our China-based subsidiaries and VIEs, Sohu Era, Sohu Media, Sogou Technology, AmazGame Age, Sohu Internet, Sogou Information and Gamease Age, enjoyed tax benefits which were available to new technology enterprises beginning with their first year of operations. Under the previous income tax laws and rules, new technology enterprises could enjoy a favorable tax rate of 15% and were exempted from income tax for three years beginning with their first year of operations, and were entitled to a 50% tax reduction to 7.5% for the subsequent three years and 15% thereafter. For the year ended December 31, 2007, Sohu Era and Sohu Internet were subject to 7.5%, while Sohu Media, Sogou Technology, AmazGame Age, Sogou Information and Gamease Age, were exempted from income tax.

In March 2007, the Chinese government enacted the Corporate Income Tax Law, and promulgated related regulations, which were effective January 1, 2008. The Corporate Income Tax Law, among other things, imposes a unified income tax rate of 25% for both domestic and foreign invested enterprises. New technology enterprises will still enjoy a favorable tax rate of 15%, but the qualifying criteria for a new technology enterprise under the Corporate Income Tax Law have not been released yet. The previous income tax laws and rules, which stipulated income tax rates for domestic and foreign invested enterprises at different rates, expired upon the effectiveness of the Corporate Income Tax Law.

The Corporate Income Tax Law provides a five-year transitional period for those entities established before March 16, 2007, which enjoyed a favorable income tax rate of less than 25% under the previous income tax laws and rules, to gradually change their rates to 25%. In addition, the Corporate Income Tax Law provides grandfather treatment for companies qualified as new technology enterprises under the previous income tax laws and rules and established before March 16, 2007 if they continue in the period after January 1, 2008 to meet the criteria for new technology enterprises under the previous income tax laws and rules. The grandfather provision allows these enterprises to continue to enjoy their unexpired tax holiday under the previous income tax laws and rules.

The Corporate Income Tax Law also imposes a 10% withholding income tax for dividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous income tax laws and rules. 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. Holding companies in Hong Kong, for example, will be subject to a 5% rate. Most of our China-based subsidiaries, Sohu Era, Sohu Media, Sohu Software, Sogou Technology, Go2Map Software and AmazGame Age are invested by immediate foreign holding companies in Hong Kong, except for Sogou Technology. All of these foreign invested enterprises will be subject to the withholding tax on January 1, 2008. Since we intend to reinvest our earnings to further expand our businesses in mainland China, our foreign invested enterprises do not intend to declare dividends to their immediate foreign holding companies in the foreseeable future. Accordingly, as of December 31, 2007, we have not recorded any withholding tax on the retained earnings of our foreign invested enterprises in China.

Currently, there are divergent views on how the Corporate Income Tax Law will be implemented. The Company’s ultimate applicable effective tax rate in 2008 and beyond will depend on many factors, including but not limited to whether certain of its legal entities will obtain an approval of their new technology enterprise status under the Corporate Income Tax Law, whether they can continue to enjoy the unexpired tax holidays and how the withholding tax on dividends will be applied. If any of Sohu Era, Sohu Media, Sogou Technology, AmazGame Age, Sohu Internet, Sogou Information and Gamease Age cannot obtain an approval on their new technology enterprise status under the Corporate Income Tax Law and/or cannot continue to enjoy the unexpired tax holidays or if the withholding tax on dividends is applied in a manner different from our understanding, our effective tax rate will be increased significantly.

Income earned in the United States, where Sohu.com Inc. is incorporated, is subject to taxation at 34% or 35%. For the foreseeable future, we anticipate the major source of income earned in the United States and subject to United States taxation to be interest income. If dividends are paid by our China or other non-U.S. subsidiaries to Sohu.com Inc., the dividends would be taxed at Sohu.com Inc.’s rate of taxation, which is 34% or 35% (as reduced by any applicable “deemed-paid” foreign tax credits for foreign income taxes paid by such subsidiaries). For the foreseeable future, we do not intend for the China or other non-U.S. subsidiaries to pay dividends to Sohu.com Inc.

Minority Interests

On October 31, 2006, we completed the acquisition of a 70% interest in 21 East HK and 21 East Beijing (collectively “21 East”), an entertainment company. The acquisition had been accounted for as a purchase business combination and the results of operations from the acquisition date have been included in our consolidated financial statements, resulting in minority interests of $47,000 and $7,000 for the years ended December 31, 2007 and 2006, respectively.

Net Income from Continuing Operations

For the year ended December 31, 2007, income from continuing operations was $35.0 million, as compared to $26.7 million for the year ended December 31, 2006.

Loss from Discontinued E-commerce Operations

On June 20, 2006, we discontinued our e-commerce business. For the year ended December 31, 2007, loss from discontinued e-commerce operations was $20,000, as compared to $841,000 for the year ended December 31, 2006.

Net Income

As a result of the foregoing, we had net income of $34.9 million for the year ended December 31, 2007, as compared to net income of $25.9 million for the year ended December 31, 2006. The net income for the years ended December 31, 2007 and 2006 included $8.8 million and $6.9 million of share-based compensation expense recorded under SFAS 123(R).

MANAGEMENT DISCUSSION FOR LATEST QUARTER

RESULTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2008 AND 2007


REVENUES


Total revenues were $84.8 million and $33.1 million for the three months ended March 31, 2008 and 2007, respectively.


Advertising Revenues


Advertising revenues are derived principally from brand advertising and sponsored search.


Advertising revenues were $34.8 million and $25.6 million, or 41% and 77% of total revenues for the three months ended March 31, 2008 and 2007, respectively. For the three months ended March 31, 2008, advertising revenues consisted of revenues from brand advertising of $33.2 million, and revenues from sponsored search of $1.6 million. For the three months ended March 31, 2007, advertising revenues consisted of revenues from brand advertising of $23.5 million, and revenues from sponsored search of $2.1 million.


Brand advertising. Brand advertising revenues increased by $9.7 million to $33.2 million for the three months ended March 31, 2008 as compared to $23.5 million for the three months ended March 31, 2007. The increase of $9.7 million from 2007 to 2008 consisted of: (i) a $12.3 million increase from advertisers who advertised with us during the three months ended March 31, 2008 but did not advertise on our Website during the three months ended March 31, 2007; (ii) a $4.8 million increase in revenues from the advertisers who advertised with us in the three months ended March 31, 2007 and continued to do so in the three months ended March 31, 2008; and (iii) a $7.4 million decrease in revenues as some of the advertisers who advertised with us during the three months ended March 31, 2007 did not advertise on our Website channels during the three months ended March 31, 2008. No single customer accounted for more than 10% of total brand advertising revenues for each of the three months ended March 31, 2008 and 2007. As of March 31, 2008 and 2007, we had $1.8 million and $1.9 million of receipt in advance from advertisers, respectively. We have not recorded any revenue from advertising-for-advertisi ng barter transactions.


For the three months ended March 31, 2008 and 2007, we recorded brand advertising revenues of approximately $443,000 and $267,000, respectively, from Fujian Tian Qing Digital Co., Ltd. (or Fujian Tian Qing), formerly known as NetDragon Websoft Inc., in connection with its advertisements on our 17173.com Website. Those advertising services are provided pursuant to a three-year advertising framework agreement expiring in November 2006 and has been extended to November 2009. Fujian Tian Qing was the owner of 17173.com Website prior to our acquisition of 17173.com from them.


We expect brand advertising revenues to increase in the second quarter of 2008 as compared to the first quarter of 2008.


Sponsored search. Sponsored search revenues decreased by $0.5 million to $1.6 million for the three months ended March 31, 2008 as compared to $2.1 million for the three months ended March 31, 2007. Sponsored search services primarily include priority placements in our search directory and pay-for-click services of displaying the text-based links of our advertisers on our Websites and our Website Alliance network. Revenues from pay-for-click services accounted for approximately 36% of the total sponsored search revenues in the first quarter of 2008 as compared to 28% in the first quarter of 2007. The decrease in sponsored search revenues mainly resulted from our continued efforts to strengthen our anti-fraudulent click-through mechanism which resulted in a decrease in average click-through rates.


Non-advertising Revenues

Non-advertising revenues are derived principally from online game, wireless and other services.


Non-advertising revenues were $50.1 million and $7.5 million, or 59% and 23% of total revenues for the three months ended March 31, 2008 and 2007, respectively.


For the three months ended March 31, 2008, non-advertising revenues consisted of revenues from online game of $41.0 million, from wireless of $8.6 million and from other services of $0.5 million. For the three months ended March 31, 2007, non-advertising revenues consisted of revenues from online game of $1.6 million, from wireless of $5.6 million and from other services of $0.3 million.


Online game. Our online game revenues are mainly derived from two game titles, Tian Long Ba Bu (or TLBB) and Blade Online (or BO). TLBB is our first in-house developed online game launched on May 9, 2007. BO was licensed from a local independent game development studio and launched in October 2004.


For the three months ended March 31, 2008, online game revenues increased by $39.4 million to $41.0 million as compared to $1.6 million for the three months ended March 31, 2007. This was primarily due to the commercial launch of TLBB in May 2007, with total revenue of $38.9 million in the three months ended March 31, 2008, representing 95% of total online game revenues. As of March 31, 2008, the total registered users of TLBB had reached 28 million and peak concurrent users of TLBB had reached 592,000.

The success of TLBB in China has enabled us to license the game in the overseas market. In August 2007, we licensed TLBB to an operator in Vietnam. For the three months ended March 31, 2008, we recorded revenue of $381,000 for the license fees and usage-based royalties from this arrangement.


Online game revenues are collected through sale of our prepaid cards, which we sell in both virtual and physical form, to third party distributors and retailers. We account for proceeds from sale of prepaid game cards from distributors or retailers as receipts in advance from distributors in our consolidated balance sheet, prior to their registration to specific game accounts. Once a prepaid game card is registered to a specific game account, we account for related amounts as deferred revenues. As of March 31, 2008, we had receipts in advance from distributors of $8.9 million and deferred revenues of $2.4 million, as compared with $0.6 million and $0.2 million, respectively, as of March 31, 2007.

We expected online game revenue to increase in the second quarter of 2008 as compared to the first quarter of 2008.


Wireless. Our wireless revenues include SMS, RBT, WAP, MMS and IVR services. Our wireless services include news, weather forecast, chatting, entertainment information, music, ring tone, and logo downloads and various other related products provided to mobile phone users. Most of our services are charged on a monthly or per message/download basis. For the three months ended March 31, 2008, we normally charged monthly fees ranging from $0.070 to $4.187 and per message/download fee ranging from approximately $0.007 to $0.558.


For the three months ended March 31, 2008, our wireless revenues increased by $3.0 million to $8.6 million as compared to $5.6 million for the three months ended March 31, 2007, primarily due to an increase of $1.1 million in SMS revenues and an increase of $2.1 million in RBT, MMS and IVR revenues. This increase was partially offset by a decrease of $0.2 million in WAP revenues. The increase in SMS, MMS and IVR revenue was primarily due to successful product distribution programs, and the increase in RBT revenue was because of our continued market development effort and product diversification.


Assuming that there are no further regulatory changes, we expect wireless revenues to increase in the second quarter of 2008 as compared to the first quarter of 2008.


Others . Other services mainly consist of sales of software to third parties, provision of applications service provider (or ASP) services, office space rental income and construction of websites. For the three months ended March 31, 2008 and 2007, revenues for other services were $506,000 and $280,000, respectively.


COSTS AND EXPENSES


In the quarters prior to April 1, 2007, most of the costs and expenses of the game department were related to product development and research. Accordingly, we recorded all such costs and expenses in product development expenses in the statements of operations. Beginning April 1, 2007, in order to better present operating results and to enhance comparability with industry peers, we reclassify expenses in relation to game operations, mainly salary and benefits of game masters, from product development expenses to cost of online game revenues. To conform with current period presentations, the relevant amounts for prior periods have been reclassified. Such reclassification amounted to $275,000 for the three months ended March 31, 2007.


Cost of Revenues


Total cost of revenues was $20.3 million and $13.3 million for the three months ended March 31, 2008 and 2007, respectively.


Cost of Advertising Revenues


Cost of advertising revenues increased by $3.1 million to $12.8 million for the three months ended March 31, 2008 as compared to $9.7 million for the three months ended March 31, 2007.


Brand advertising. Cost of brand advertising revenues includes personnel costs and personnel overhead relating to our editorial center, content purchases, payments to our business partners, relevant depreciation of servers and computer equipment and bandwidth leasing costs. Cost of brand advertising revenues was $11.3 million and $8.1 million for the three months ended March 31, 2008 and 2007, respectively. The increase of $3.2 million consisted of a $1.2 million increase in personnel expense, a $0.7 million increase in content purchases, a $0.5 million increase in bandwidth leasing costs due to increased traffic of our Websites, a $0.3 million increase in servers depreciation expense, a $0.2 million increase in payments to our business partners, and a $0.3 million increase in other costs. Our brand advertising gross margins for the three months ended March 31, 2008 and 2007 were 66% and 65%, respectively.


Sponsored search. Cost of sponsored search revenues consisted primarily of relevant depreciation of servers and computer equipment, payments to our Website Alliance, bandwidth leasing costs, personnel cost and data collection cost. Cost of sponsored search revenues was $1.5 million for the three months ended March 31, 2008 as compared to $1.6 million for the three months ended March 31, 2007. Our sponsored search gross margin for the years ended March 31, 2008 and 2007 was 6% and 24%, respectively. The decrease was primarily due to higher bandwidth leasing costs to support the increased traffic and a smaller scale of sponsored search revenue.

CONF CALL

Brandi Piacente
Thank you for joining Sohu.com to discuss our first quarter results. On the call today are Chairman and Chief Executive Officer, Dr. Charles Zhang; Co-President and Chief Marketing Officer, Belinda Wang; Co-President and Chief Financial Officer, Carol Yu; Chief Operating Officer, Gong Yu; and Vice President of Online Game Business, Wang Tao.
Before management begins their prepared remarks, I would like to read you the Safe Harbor statement in connection with today’s conference call. Except for the historical information contained herein, the matters discussed in this call are forward-looking statements. These statements are based on current plans, estimates, and projections and therefore you should not place undue reliance on them.
Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements.
Potential risks and uncertainties include, but are not limited to, Sohu's historical and possible future losses, limited operating history, uncertain regulatory landscape in the People’s Republic of China, fluctuations in quarterly operating results, and the company’s reliance on online advertising sales, online game revenues, and mobile phone related wireless revenue for its revenues.
Further information regarding these and other risks are included in Sohu's annual report on Form 10-K and other filings with the Securities and Exchange Commission.
Now, let me turn the call over to Dr. Charles Zhang, Chairman and CEO. Charles.
Dr. Charles Zhang
Thank you, Brandi. Hello, everyone. Welcome to Sohu's first quarter financial results conference call. I am right now actually at the base camp of Mount Everest at 5100 meters high, participating and leading a team reporting about the torch relay on the Mount Everest area, so I will speak really slowly because of having 60% of the oxygen of ground level.
We are thrilled to report another excellent quarter, the first quarter of 2008, with the third consecutive in which we reported record total revenue, record revenues in each category, as well as record non-GAAP net income. Let me first begin by giving you some highlights of our financial results.
For the first quarter of 2008, our total revenue grew by 30% quarter-on-quarter, reaching $84.8 million. Brand advertising revenue once again excelled, reaching $33.2 million, representing a 3% quarter-on-quarter growth and 41% year-on-year increase. Online game revenue reached $41 million, up 71% quarter-on-quarter. Non-GAAP net income increased by 48% quarter-on-quarter to $25.1 million.
All of those milestones exceeded our first quarter guidance and most of them exceeded our expectations by a rather wide margin. We believe that these results are made possible only by our long-term strategic vision on the Chinese Internet space, such as our elite position at the official Internet content sponsor of Beijing 2008 Olympic Games and by our continued cutting edge advantage in our technological development, such as our in-house developed online game Tian Long Ba Bu.
Now I will begin by discussing Sohu's major achievement. First, Beijing 2008 Olympic Games -- as the Olympic torch was lit in Athens on March 24th, momentum of Chinese Internet users and advertisers reached a new peak. As the sole official Internet content sponsor of the Beijing 2008 Olympic Games, Sohu continued to provide first-hand and authoritative Olympic reporting, which has further distanced us from the rest of the competition. Sohu has been further solidifying its position as the portal of choice for the Olympics for both the Internet users and advertisers in China.
Using the Olympic Torch Relay as an example, by invitation from the Greek Olympic Committee, which is a huge honor, I personally led a team of 25 editors and reporters to Athens, the largest team among all the Chinese, to attend and report on the torch lighting ceremony and handover of the Olympic Games.
With Sohu's privileged role, we were able to conduct various exclusive video interviews with famous torchbearers and the prominent government officials and as the only Internet media allowed to travel on the same private aircraft worldwide with the Olympic Flame, we were able to have a distinct advantage and provide a first-hand coverage of the torch relay, which put us in the leadership position reporting on a high profile international event.
When [inaudible] from the commencement of the torch relay 370 Sohu produced articles and pictures have been referenced in 140 publications and our pictures and video clips were used extensively by 40 television stations, including CCTV, Beijing TV, and Shanghai Media Group. We expect to further demonstrate and expand our leadership position with the upcoming torch relay at Mount Everest.
After kicking off the relay, average daily page views of our Olympic channel tripled from previous levels. In addition, we are pleased to see the acceleration of advertisers starting from the Olympic torch relay, as reflected in our second quarter guidance. In a few moments, Belinda will provide you with more color on this.
We believe that the opportunities surrounding the Olympics, coupled with Sohu's Olympic strategy, will enable us to gain market share of Internet users, further enhance Sohu's value, and become the destination for advertisers to carry out their online marketing campaigns.
During the run-up to the Olympic Games, we will invest about $14.5 million to carry our a massive branding and marketing program, including TVs and outdoors, in 27 major cities in China that will host the torch relay, as well as hospitality programs for our VIP advertisers and partners. We believe this will further broaden people’s awareness of Sohu as the portal of choice for the Olympic Games.
Among such expenses, approximately $4.5 million and $10 million will be charged to income statements in the second and third quarter, respectively. None of them will become recurring in 2009.
Secondly -- hold on just one second. Belinda will provide you a business review of our brand advertising business in a few moments but first, let me briefly discuss our online game business and technology initiatives.
Online game revenues increased by 71% quarter-on-quarter and reached $41 million in the first quarter of 2008. Tian Long Ba Bu continues to outperform and reach a new high as we saw first quarter revenues grow by 77% quarter-on-quarter, reaching $39 million, once again above our expectations.
In the first quarter, due to our effective marketing campaigns and the launch of a new expansion pack on January 16th, we managed to grow Tian Long Ba Bu registered accounts by 22% sequentially from $23 million to $28 million, despite the first quarter being a seasonally weak quarter for Internet usage and the fact that Tian Long Ba Bu had entered into its fourth quarter of operations.
We’ve also been successful in converting non-paying accounts into paying accounts through in-game activities. For the first quarter, quarterly active paying accounts increased by 26% quarter-on-quarter from 1.1 million to 1.39 million.
While maintaining the stability of our in-game ecosystem, we launched certain virtual items to further enhance user stickiness and game effectiveness. These items were well-accepted by our users. Hence, quarterly average revenue per account increased by 35% quarter-on-quarter from RMB147 to RMB199. We are also glad to report that peak concurrent users, PCU, to Tian Long Ba Bu has exceeded 600,000 since early April and we plan to launch our next expansion pack around late June.
Despite the first quarter’s strong revenue growth, we are still targeting 5% to 10% sequential revenue growth for the second quarter of 2008, given our planned promotional efforts during the quarter. We expect that growth to come from both increasing users and [op] value.
Development progress on our second in-house developed RPG game, Duke of Mountain Deer, is on track. Overall, we are pleased with the development quality thus far and continue to target closed beta testing by the end of 2008.
I wish to emphasize the substantial synergies between our portal and the online game business. On one hand, our game business brings to Sohu revenues, profitability, and most importantly, new users. On the other hand, Sohu websites matrix, in particular 17173.com, the number one online game information portal in China, is a significant advertising resource. Most importantly, 17173.com provides valuable insight for games development by utilizing the comprehensive gamer experience. We have been able to leverage their advice during the development stage of our online games, which largely enhances our success potential. This is an unmatched advantage in the industry.
My third topic pertains to Sohu's innovative products, which continued to demonstrate our thought leadership and attract users and have allowed us to achieve great success in the development of major and groundbreaking technology products and initiatives. For example, with Sohu blogs, we have been continuously upgrading our blogs to [gear up] a community based [inaudible] space. In March, Sohu launched a new function named [inaudible]. This new functionality allows the Sohu blog users to receive real-time updates to his or her space friends, as friends make changes to their blogs.
A traditional blogs user could write articles, uploading pictures and videos but essentially operating on a standalone basis. On the upgraded Sohu blogs, users become automatically connected to their friends through their blogs, where users can get timely updates about their friends’ movement.
Our continuous enhancement of Sohu blogs has been well-received by our users, especially by the young [consuming] generation, and we believe more and more bloggers are converting their Sohu blogs into their personalized portal space.
Thank you for your attention. Now I would like to turn the call to Belinda Wang, Co-President and Chief Marketing Officer of Sohu.com, for a brief discussion of progress in the brand advertising business. Belinda.
Belinda Wang
Thank you, Charles. We continue to be excited about the robust trend driving the strong momentum of the Chinese online advertising market. Despite a generally weak season in the industry for the first quarter of the year, we were able to achieve yet another record in terms of brand advertising revenues. We can squarely attribute this result to the continued shifting of advertising from offline to online and robust momentum in the advertiser spending as the 2008 Beijing Olympic Games are only about 100 days away.
For the first quarter, the top three industries in brand advertising were automobile, online games, and the real estate, the same as in the previous quarter. The fastest growing sectors during the first quarter was online games, which continued to experience strong momentum, posting 170% increase over last year’s levels due to strong trends of the online game business in China.
With the Olympic Games drawing close, as Charles mentioned, we are pleased with the acceleration on the advertiser spending starting from the torch relay as reflected in our second quarter guidance. Based on the signed [inaudible] contracts and the deals in final negotiations in 2008 for Olympic partners, sponsors, and suppliers, we expect that they will increase their spending by 50% to 100% year-on-year with Sohu. This is even more impressive considering that those partners, sponsors, and suppliers had already extended their ad spending with Sohu by 74% year-on-year in 2007.
Historically, we normally adjust the price semi-annually and our last price increase was in October 2007. Starting in April 2008, we increased our average prices by 38% sequentially from the last price increase, which will be effective for three months to June, 2008. We have not seen much push-back from clients so far.
Looking ahead at the full year of 2008, we expect brand advertising revenue to grow by 40% to 45% year-on-year.
With that, I would now like to turn the call to Gong Yu, Chief Operating Officer, for the review of website operations.
Dr. Gong Yu
Thank you, Belinda. As Sohu continues to leverage opportunities surrounding the Olympics our premier content offerings and the news reporting capabilities have been highly recognized by many well-known entrepreneurs and thought leaders in China. The impact and the reach of our online reporting capabilities across China are well-respected by the industry and have further positioned Sohu as one of the most powerful online media sources in China.
We have worked continuously to provide premier content and innovative products to our users. As a result, during the quarter we saw unique visitors increase 41% year-on-year, which again represents the strong attraction we have to Internet users. We are confident that with our continuous efforts, we will further attract users to Sohu, especially during the 2008 Beijing Olympic Games on the [kipson] and Sohu platform.
With that, I would like to turn the call to Carol, Co-President and Chief Financial Officer, for a review of Sohu's financial results. Carol.
Carol Yu
Thank you, Gong Yu and hello, everyone. I will now provide the review of the financial results for the first quarter of 2008.

One, revenues -- starting with top line results, total revenues hit a record of $84.8 million, representing an increase of 30% sequentially and 156% year-on-year. Not only did each of the revenue categories exceed our expectations but also passed all-time records.
One, advertising -- total advertising revenues reached $34.8 million, as we achieved a sequential increase of 3% and a year-on-year increase of 36%.
Brand advertising -- brand advertising revenues totaled $33.2 million, representing 3% sequential increase and a year-on-year increase of 41%.
Sponsored search revenues were $1.6 million, representing a 5% sequential increase and a 23% decline year-on-year. The year-on-year decline was mainly due to the strengthening of the anti-fraudulent click policy, based on more sophisticated algorithms.
Two, non-advertising revenues -- non-ad revenues totaled $50.1 million, representing an increase of 58% sequentially and a five-fold increase year-on-year. Online games revenues were $41 million, an increase of 71% quarter-on-quarter and 24 times year-on-year, due to the strong performance of TLBB. For the first quarter, revenues from TLBB and Blade Online were $38.9 million and $2.1 million respectively.
Wireless revenues were $8.6 million, a quarter-on-quarter increase of 17% and year-on-year increase of 54%. Sohu is well-positioned to minimize risk associated with the wireless sector, as it now represents only 10% of our total revenue.
Two, gross margins -- as you may know, under SFAS-123R, share-based compensation expenses are charged to the quarter’s revenue and operating expenses. Total share-based compensation expense for the first quarter of 2008 was $3.5 million. As we believe excluding the share-based compensation expense from our non-GAAP financial measure of net income makes a more meaningful comparison of Sohu operation results and improves investors’ understanding of Sohu's performance, we use non-GAAP measures in this discussion to explain margin, comp, and expense items.
Non-GAAP gross margin for the first quarter was 76%, compared with 72% in the previous quarter and 61% in the first quarter of 2007. Gross margin expansion was primarily due to contribution from TLBB.
Non-GAAP advertising gross margin was 64% in the first quarter, flat with the previous quarter and with the same period last year. Brand advertising non-GAAP gross margin for the first quarter was 67%, flat with the previous quarter and the same period last year.
Sponsored search non-GAAP gross margin for the first quarter was 6%, down from 12% in the previous quarter and 25% in the same period last year. The year-on-year decrease was primarily due to higher bandwidth costs to support the increased traffic and the smaller scale of search revenue.
Non-advertising non-GAAP gross margin was 85% for the first quarter, up from 79% from the previous quarter and 52% in the first quarter of last year. Online games non-GAAP gross margin for the first quarter was 92%, up from 88% in the previous quarter and 47% in the same period last year. The increase correlates to the increase in revenue from TLBB.
Wireless non-GAAP gross margin for the first quarter was 54%, down from 56% in the previous quarter and up from 53% in the same period last year.
Three, operating expenses -- for the first quarter, Sohu's non-GAAP operating expenses totaled $30.8 million, up 3% from the $30 million for the previous quarter and 125% year-on-year. The year-on-year increase was primarily due to continued investments in product development, marketing expenses for Sohu branding and on TLBB, and as well as an increase in bonuses to reward employees for their contribution to the good results.
Four, operating margin -- non-GAAP operating profit margin was 40% for the first quarter, up from 26% in the previous quarter and 20% in the same period last year.
Five, income tax expense -- income tax expense for the first quarter was $9.2 million, compared to $0.7 million in the previous quarter and $0.3 million for the same period last year.
On January 1, 2008, the newly introduce corporate income tax laws, which unifies the statutory income tax rate of enterprises in China to 25%, became effective. On April 14, 2008, relevant government regulatory authorities released qualification criteria application procedures and assessment processes for new technology enterprises which will be entitled to a favorable statutory tax rate of 15%. Solicitation of actual application has not yet commenced, however. In addition, there are still divergent views as to whether there will be any pre-conditions for allowing grandfather treatment for the unexpired tax holiday of new technology enterprises previously qualified under the old laws as of December 31, 2007.
Due to uncertainties on A, whether any of Sohu's major operating entities in China will eventually be approved for new technology enterprise status and B, whether these entities will be able to enjoy grandfather treatment for their unexpired tax holidays unconditionally, hence for the first quarter of 2008 Sohu has accounted for its income tax based on the statutory tax rate of 25%, assuming that it will not enjoy any of the preferential tax treatment mentioned above.
Sohu will account for lower tax charges in future quarters even when confirmation is received from the Chinese Tax Authority that any of these operating entities is entitled to be taxed at preferential rates.
Six, net income -- non-GAAP net income for the first quarter reached a record high of $25.1 million, or $0.64 per fully diluted share. Non-GAAP net income increased by 48% sequentially and 261% year-on-year.
Seven, net margin -- non-GAAP net margin for the first quarter was 30%. Compared with 26% in the previous quarter and 21% in the first quarter of 2007.
Eight, balance sheet -- as of March 31, 2008, our net accounts receivable balance was $36.2 million, an increase of $9.1 million as compared to $27.1 million last quarter. Our DSO for the first quarter was 37 days compared to 37 days for the previous quarter. First quarter brand advertising DSO was 69 days compared to 53 days for the previous quarter. As of March 31, 2008, our bad debt provision totaled $2 million, compared to $2.1 million as of December 31, 2007, reflecting our stringent revenue recognition and credit extension policies.
Finally, turning to our business outlook, for the second quarter of 2008 Sohu expects: one, total revenues to be between $93 million to $96 million, with advertising revenues of $40 million to $41 million and non-ad revenues of $53 million to $55 million; two, brand advertising revenues of $38.5 million to $39.5 million; three, online games revenues of $43 million to $45 million; four, we estimate non-GAAP fully diluted earnings per share to be between $0.72 and $0.75, assuming statutory income tax rate for our major operating entities in China to be 25%; and lastly, assuming no new grants of share-based awards, we estimate share-based compensation expense to be between $2 million to $2.5 million. The impact of this expense is expected to reduce fully diluted earnings per share under U.S. GAAP by about $0.05 to $0.06.
In conclusion, Sohu's outstanding results for the first quarter were driven largely by our focus on innovation, the execution of strategic deals, and our desire to grow our market share and to be the leading Internet company in China.
With the Olympic Games just around the corner, there are many exciting developments we hope to be sharing with you over the near-term.

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