Sohu.com (SOHU)

i) Advertising

Cost of advertising revenues consists of compensation and related overhead costs for employees, depreciation expenses, fees for bandwidth leasing charges, content and services. Royalties paid to content providers are expensed as incurred and included as cost of revenues. Contracts with content providers generally range from one to three years in duration and may be terminated by either party upon notice.

i) Advertising

Cost of advertising revenues consists of compensation and related overhead costs for employees, depreciation expenses, fees for bandwidth leasing charges, content and services. Royalties paid to content providers are expensed as incurred and included as cost of revenues. Contracts with content providers generally range from one to three years in duration and may be terminated by either party upon notice.

i) Advertising

Cost of advertising revenues consists of compensation and related overhead costs for employees, depreciation expenses, fees for bandwidth leasing charges, content and services. Royalties paid to content providers are expensed as incurred and included as cost of revenues. Contracts with content providers generally range from one to three years in duration and may be terminated by either party upon notice.

Advertising

Overall, we experienced a healthy quarter in advertising. Advertising revenues for the first quarter were $20.1 million dollars, down 1% quarter on quarter and up 35% year on year, exceeding our guidance.

Brand advertising revenues were $16.7 million dollars, representing a sequential decline of 1% and year on year increase of 38%. Sponsored search accounted for $3.4 million dollars, representing a sequential increase of 1% and year on year increase of 26%.

In brand advertising, revenues were primarily driven by heavy spending sectors such as automobile, information technology and real estate. We are pleased to see increased monetization of our new products. Revenue from Chinaren and new community based products such as BBS, blogs and picture gallery increased by around 60% sequentially. There has been growing momentum in the more recent quarters and expect this to continue going forward.

At Sohu, we are always looking for new and innovative ways to attract more users to our sites and extend the power of the Sohu brand. During the first quarter, we made significant re-investments to add to our content offerings and also improve our products, adding more differentiated content in the form of streaming video.

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In connection with this, I would also like to highlight:

As we move closer to the Beijing 2008 Olympics, we have increased our interaction with the Olympics partnership and sponsorship community of potential advertisers, especially surrounding the recent winter Olympics in Turin. We also provided extensive coverage of the event on our Sports Channel.

In a quest to further enhance our sports content, we have been investing aggressively and smartly to provide premier and differentiated content of the upcoming World Cup event.

In March, we were chosen by SMGBB.cn, a subsidiary of Shanghai Media Group, to be an exclusive portal partner in delivering exclusive 2006 World Cup broadband internet video content to Chinese internet users and football fans.

In addition, earlier this week, we announced a partnership with Sony BMG which allows Sohu.com to be able to exclusively offer a full range of music and video products of the 2006 World Cup official music via online and wireless capabilities.

We view both these relationships as Sohu’s further commitment to providing the best and most exclusive content to its growing user base and also a testament to Sohu’s leading global brand presence capable of providing well sought after content for extremely high profile international events.

Similar to our expectation that the impact of the Olympics will become more fully magnified as the Beijing 2008 Olympics approaches, we expect the World Cup to be an important revenue contributor in the late second quarter and early third quarter when the event takes place.

With more than 1000 content partners and unique products, Sohu’s combined family of web sites continues to rank No. 1 in page views amongst ALL Chinese Internet portal companies, according to Alexa.com. As of March 2006, Sohu family traffic was 102% of our major competitor, in terms of page views. Traffic of our portal site, sohu.com, represented 72% of that of our major competitor. We also continue to have higher stickiness with approximately 11 page views per user vs. our competitor’s 10.

As an integral part of our strategy, we have focused on developing our community based products, such as Chinaren alumni club, BBS, picture gallery and blogs. This has proven to be successful as traffic to these products has increased nicely since the launch of these products. We will continue to invest and broaden our new product portfolio, such as photo albums, in order to grow on an already existing solid base and to increasingly monetize these products going forward.

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In sponsored search, the 1% sequential growth and 26% year on year growth was driven by continued improvements to the Sogou search product itself and a more concentrated effort in marketing and promoting the Sogou brand.

We have followed the successful launch of Sogou 2.5 in November 2005 with additional product and feature enhancements. We launched a new picture search capability in February 2006 and added an improved seamless map search function in March 2006, both of which will further enhance the overall search experience.

In addition, our innovative Sogou marketing campaign, such as Sogou Supergirl Contest and our national “Spokesdog” Search continues to generate buzz throughout China. Both of these events are cost effective and creative marketing initiatives to promote the Sogou brand in the most meaningful way to reach the mass Chinese online population. We strive to make Sogou the search engine of choice, custom-tailored to the needs of the Chinese community.

With continuous product improvements combined with an effective marketing campaign, Sogou has continued to experience robust traffic growth in the first quarter, increasing over 50% from the previous quarter according to our internal statistics.

Overall, we remain confident that there will be strong growth for our core advertising business over the next few years. The branding effect from the Olympic sponsorship and other high profile international events such as the World Cup will have an increasingly significant impact on our ability to attract more advertisers as the overall online advertising market in China grows. We will also continue to focus on developing and fine-tuning our search product given the increasingly competitive search environment in order to best position Sogou as one of the leading search engines in China.

For the full fiscal year 2006, we remain confident in reaching our full year advertising revenue growth target of 25% year-on-year as we see continued healthy growth in brand advertising and sponsored search.

Turning to our wireless business, while our focus remains on our core advertising business, we have been pleased to see a continued pickup in our wireless business, with 10% sequential and 34% year-on-year growth in the first quarter to $8.0 million dollars. This represents the fifth consecutive quarter of growth in our wireless business which has been achieved entirely through organic means with NO substantial increase in promotional expenses or reinvestment.

During the next quarter, we will be able to leverage our content partnerships such as with Sony BMG to allow us to offer a full range of music and video products of the 2006 World Cup official music via wireless services which will contribute more to our Ring Back Tone and WAP revenues. We will also be working more closely with China Mobile to jointly promote our efforts in integrated marketing of RBT and WAP services for the World Cup official music. Through these partnerships, we believe we will be able to more effectively promote Sohu’s World Cup music products to China’s broad mobile user population.

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In early April, one of the mobile network operators issued a new policy applicable for all SPs, in which it set price ceilings for SMS monthly fees or per message subscription fees. This became effective on April 17, 2006 and will likely reduce our SMS revenue from this mobile network operator. However, for the second quarter 2006, we expect the negative impact of this new policy on SMS revenue to be offset by positive contributions resulting from the World Cup event.

As we have previously stated, we believe it is important for Sohu to maintain a presence on the wireless side, and more specifically in WAP, in anticipation of the imminent launch of 3G mobile network in China and the burgeoning market that it will bring. Our WAP portal launched in December 2005 continues to see strong sequential traffic growth of 30% in the first quarter.

We will continue to capitalize on Sohu’s comprehensive content strength from our portal and family of websites so that we can take full advantage of complementary wireless revenue opportunities. In short, our business divisions are well-aligned and well-positioned to achieve our growth objectives.

With that, I would now like to turn the call over to our CFO, Carol Yu, for a financial review.

i) Advertising

Advertising cost of revenues consists of compensation and related overhead costs for employees, depreciation expenses, fees for bandwidth leasing charges, content and services. Royalties paid to content providers are expensed as incurred and included as cost of revenues. Contracts with content providers generally range from one to two years in duration and may be terminated by either party upon notice.

Advertising

Overall, we have seen a healthy fourth quarter and 2005 fiscal year in the advertising business. Advertising revenues for the fourth quarter were $20.3 million, up 8% quarter on quarter, which exceeded our guidance. For the full fiscal year 2005, advertising revenues grew 27% year over year, also exceeding our guidance of 20% to 25% year over year growth.

Brand advertising revenues were $16.9 million dollars and sponsored search accounted for $3.4 million dollars, a sequential increase of 8% and 7% respectively in a traditionally weak quarter and a year-on-year increase of 28% and 27% respectively. I’d like to give an overview of brand advertising first.

In brand advertising, the 8% sequential revenue growth was primarily due to heavy advertising spending sectors such as information technology, automobile and real estate. On the other hand, sectors that have experienced the fastest growth for the quarter have been financial services, travel and health care.

More specifically, there are two very important underlying factors which are at the core of our brand advertising strength and strong future growth outlook.

The fourth quarter was the first quarter of constructing, operating and hosting the official Beijing 2008 Olympics website. The website, beijing2008.com is now up and running in three languages – Chinese, English and French.

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We are very excited about our role in the Olympics and this has been felt throughout the entire organization at Sohu. This is a point of extreme pride for myself and all Sohu employees.

Our Olympics sponsorship role is also an important recognition by the Chinese government that Sohu is THE premier Internet portal company and has enhanced our overall relationship with government agencies.

The overriding impact is the increased Sohu brand awareness and we have already seen the effect of Sohu’s branding power coming through from Fortune 1000 advertisers. In Q4, 2005, we already began signing new Olympic-related deals with Fortune 1000 advertisers, such as Lenovo and Audi China. We expect the impact to become even more magnified as the Beijing 2008 Olympics approaches.

Sohu has more than 1000 content partners and has unique products such as Chinaren alumni club, and new products such as BBS, picture gallery and blogs. Traffic of our community-based products (i.e. BBS and picture gallery) has been increasing at a monthly rate of over 10% during Q4 2005.

As a result, Sohu’s combined family of web sites has achieved the No. 1 ranking of page views amongst ALL Chinese Internet portal companies, according to Alexa.com, and Sohu has widened its lead against its major competitor. Based on Alexa.com, as of mid January 2006, Sohu family traffic was more than 120% of our major competitor, in terms of page views. Turning to our portal site, sohu.com, we have narrowed the gap quite significantly compared to our major competitor just in the past few months with Sohu traffic on the rise, from representing 72% of that of our major competitor at the end of September 2005 to 87% as of mid January 2006. We have also been pleased to have higher stickiness with 12-13 page views per user vs. our competitor’s, 10-11. We would like to again emphasize, despite the above payoff in investment, Sohu has been able to maintain a higher gross margin of 74% vs. our competitor’s 68%.

In addition, we have also seen increased monetization of our new products. In Q4 2005, revenue from Chinaren and those new products such as BBS and picture bar increased by over 60% sequentially. Although this was off a relatively small base, we expect this area to continue to gain momentum going forward.

In sponsored search, the 7% sequential growth was driven by a significant increase in bid-listing revenues which accounted for 30% of our total sponsored search revenue compared with 23% in the third quarter. This shift in revenue mix was mainly due to the expansion of our web site alliance network and a growing acceptance of the ‘pay-for-click’ concept in China.

In late November, 2005, we also successfully launched Sogou 2.5 which increased the search database to two billion retrieved pages and 800 million indexed pages. In addition, Sogou 2.5 is a more intelligent version in terms of crawling, selecting and ranking the search results, thus providing users with more relevant, accurate and up-to-date

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web pages. Sogou 2.5 improves analysis capability to more effectively minimize dead and repetitive links. According to our internal data, Sogou traffic in the fourth quarter grew close to 40% compared with the third quarter and we believe this does not yet fully reflect the Sogou 2.5 upgrade as the new product did not fully ramp up until the end of December.

In addition, we continue to look for new and innovative ways to promote the Sogou brand via Sogou Supergirl contest and our national “spokesdog” search. The “spokesdog” search event has sparked great interest especially given that this year, 2006, is the Year of the Dog. It is important for us to brand Sogou as the search engine of choice custom-tailored to the needs of the Chinese community.

We remain confident that there will be strong growth for our advertising business over the next few years. The branding effect from the Olympic sponsorship will continue to have a significant impact on our ability to drive our advertising business going forward. We will also continue to focus on developing and fine-tuning our search product given the increasingly competitive search environment in order to position Sogou as one of the leading search engines in China.

For 2006, we are targeting full year advertising revenues to grow 25% year-on-year as we see continued healthy growth in brand advertising and more significant contribution from sponsored search advertising.

Turning to our wireless business, while our focus remains on our core advertising business, we have been happy to see a continuing steady recovery in our wireless business, with 7% sequential growth and 55% year-on-year growth in the fourth quarter to $7.2 million dollars. In addition, the growth of our wireless business was achieved with NO substantial increase in promotional expenses or revenue sharing percentage change. We are pleased that our wireless business has become increasingly stable in fiscal 2005.

We firmly believe it is important for Sohu to maintain a presence on the wireless side, and more specifically in WAP, in anticipation of the imminent launch of 3G mobile network in China (3G licenses are expected to be awarded this year and commercialization of the technology by 2007) and the burgeoning market that it will bring. With this in mind, we recently launched our WAP portal, a WAP version of our existing portal in a simplified format, in December 2005 and have seen traffic increase 80% in the subsequent two months. We have been able to capitalize on Sohu’s broad content strength from our portal and family of web sites. We believe that we will be able to continue to leverage our content strength in this area.

I would now like to turn the call over to our CFO, Carol Yu, for a financial review.

i) Advertising

Advertising cost of revenues consists of compensation and related overhead costs for employees, depreciation expenses, fees for bandwidth leasing charges, content and services. Royalties paid to content providers are expensed as incurred and included as cost of revenues. Contracts with content providers generally range from three to twelve months in duration and may be terminated by either party upon notice.