Sohu.com (SOHU)

6. SHARE-BASED COMPENSATION EXPENSE

The Company has accounted for share-based compensation expense under the provisions of SFAS 123(R), Share-Based Payment, Staff Accounting Bulletin 107(“SAB 107”) and based on their grant date fair values.

Estimates of fair value are not intended to predict actual future events or the value that ultimately will be realized by employees who receive equity awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by the Company under SFAS 123(R).

Share-based compensation expense included in costs and expenses includes (in thousands):

Share-based Compensation Expense

Share-based compensation expense included in costs and expenses includes (in thousands):

Share-based compensation expenses included in our financial statements include expenses related to share-based awards of Sohu.com Inc. and Changyou.

1) Sohu.com Inc. Share Awards

The total share-based compensation expenses related to Sohu.com Inc. share awards recognized in the consolidated income statements during the three months ended March 31, 2009 and 2008 were $2.3 million and $3.5 million, respectively. As of March 31, 2009, there was $4.0 million of unrecognized compensation expense related to unvested options and restricted stock units.

2) Changyou Share Awards

The total share-based compensation expenses related to Changyou share awards recognized in the consolidated income statements during the three months ended March 31, 2009 and 2008 were $0.7 million and $1.8 million, respectively. Share-based compensation expenses during the both period was recorded in production development. As of March 31, 2009, there was $3.3 million of

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unrecognized compensation expense related to unvested Class B restricted share units granted to Tao Wang and $9.1 million related to unvested Class A and B restricted share units granted to other executive officer and key employees, respectively.

Share-based Compensation Expense

Share-based compensation expense included in costs and expenses includes (in thousands):

Share-based compensation expenses included in our financial statements include expenses related to share-based awards of Sohu.com Inc, and Changyou, a subsidiary set up to own and operate our online game business.

1) Sohu.com Inc Share Awards

Our 2000 Stock Incentive Plan provides for the issuance of up to 9,500,000 shares of Sohu.com Inc.’s common stock. As of December 31, 2008, 1,053,059 shares were available for grant under the plan. The total share-based compensation in related to Sohu.com Inc. share awards recognized in the consolidated income statements during the years ended December 31, 2008, 2007 and 2006 were $5.8 million, $8.8 million and $6.9 million, respectively. As of December 31, 2008, there was $4.6 million of unrecognized compensation expense related to unvested options and restricted stock units.

2) Changyou Share Awards

In March 2005, Sohu formed an indirect subsidiary, Beijing Fire Fox, to carry out game development, and granted to an employee a contingent right to receive a payment equal to 25% of the value of Beijing Fire Fox upon the occurrence of certain events. As the substance of this arrangement is similar to the grant of an option, this arrangement was accounted for as share-based compensation under APB 25. The amount of compensation to be recorded is based upon the intrinsic value on the grant date, which was determined based on its fair market value. As of the date of grant, the intrinsic value was determined to be zero. We later agreed with the employee that his contingent right in Beijing Fire Fox would be modified to provide to the employee an equity interest in Changyou, a subsidiary set up to own and operate our online game business, in lieu of the contingent right.

In January 2008, Sohu communicated to and agreed with the employee that the equity interest granted to him consisted of 700,000 ordinary shares and 800,000 restricted shares in Changyou, which represent approximately 7% and 8% of the fully diluted equity interest of Changyou. The restricted shares included, as a condition of vesting, the completion of an initial public offering by Changyou on an internationally recognized stock exchange, and also were subject to a vesting schedule. In addition, the employee will not be entitled to participate in any distributions by Changyou, on his ordinary shares and restricted shares, until the earlier of its completion of an initial public offering or February 2012. In April 2008, Changyou modified the vesting conditions of the restricted shares to provide for vesting over a four-year period commencing on February 1, 2008, with no condition that an initial public offering be completed.

The difference between the fair values, or the Incremental Fair Value, of the 700,000 ordinary shares and 800,000 restricted shares granted to the employee and his contingent right in Beijing Fire Fox was accounted for as share-based compensation. Because the terms of the issuance of the ordinary shares and restricted shares had been approved and were communicated to and agreed with the employee as of January 2, 2008, this was considered the grant date under US GAAP and, accordingly, the Incremental Fair Value was determined as of that date. The portion of the Incremental Fair Value related to the 700,000 ordinary shares, equal to $1.8 million, was recognized as share-based compensation expense in product development expenses for the three months ended March 31, 2008. As result of the modification of the vesting terms of the 800,000 restricted shares in April 2008, the portion of the Incremental Fair Value related to those shares, equal to $7.0 million, was determined as of that date and is accounted for as share-based compensation over the vesting period starting from the date of the modification, following the accelerated basis of attribution. Share based compensation expense relating to the 800,000 restricted shares for the year ended December 31, 2008 was $3.0 million and recognized in product development expenses. The Incremental Fair Values were determined using the discounted cash flow method.

In April 2008, Sohu approved and communicated to other employees of Changyou the grants of an aggregate of 180,000 restricted shares and 94,000 restricted share units of Changyou, which are settleable in Changyou’s ordinary shares upon vesting. These restricted shares and restricted share units are subject to vesting over a four-year period commencing February 1, 2008 and are subject to a completion of an initial public offering of Changyou. The grant date fair value of the awards will be recognized in the consolidated statement of operations starting from the date when those vesting conditions become probable.

The total share-based compensation in related to Changyou share awards recognized in the consolidated income statements during the years ended December 31, 2008, 2007 and 2006 were $4.8 million, nil and nil, respectively. As of December 31, 2008, there was $9.4 million of unrecognized compensation cost related to unvested restricted shares and restricted share units of Changyou granted to the aforementioned employees of Changyou.

We determined the fair values of the ordinary shares of one of our subsidiaries, Changyou, as of the January 2008 and April 2008 grant dates, relying in part on a report prepared by a qualified professional appraiser, and determining the fair value required us to make complex and subjective judgments regarding its projected financial and operating results, its unique business risks, the liquidity of its ordinary shares and its operating history and prospects at the time the grants were made.

Because at the time of the grants our MMORPG business was at a different stage of its product life cycle than that of the publicly-listed companies in the online game industry, we concluded that a market comparison approach would not have been meaningful in determining the fair value of Changyou’s ordinary shares. As a result, we and the professional appraiser used the income approach/discounted cash flow method to derive the fair values. We applied the discounted cash flow, or DCF, analysis based on its projected cash flow using management’s best estimate as of the respective valuation dates. The projected cash flow estimate included, among other things, an analysis of projected revenue growth, gross margins, effective tax rates, capital expenditures and working capital requirements. The income approach involves applying appropriate discount rates, based on earnings forecasts, to estimated cash flows. The assumptions we used in deriving the fair value of its ordinary shares were consistent with the assumptions used in developing our online game business plan, which included no material changes in the existing political, legal, fiscal and economic conditions in China; our ability to recruit and retain competent management, key personnel and technical staff to support our ongoing operations; and no material deviation in industry trends and market conditions from economic forecasts. These assumptions are inherently uncertain and subjective. The discount rates reflect the risks our management perceived as being associated with achieving the forecasts and are based on our estimated cost of capital, which was derived by using the capital asset pricing model, after taking into account systemic risks and company-specific risks. The capital asset pricing model is a model for pricing securities that adds an assumed risk premium rate of return to an assumed risk-free rate of return. Using this method, we determined the appropriate discount rates to be 22% as of the January 2008 valuation date and 23% as of the April 2008 valuation date.

We also applied a discount for lack of marketability, or DLOM, to reflect the fact that, at the time of the grants, Changyou was a closely-held company and there was no public market for its ordinary shares. To determine the discount for lack of marketability, we and the professional appraiser used the Black-Scholes option pricing model. Pursuant to the Black-Scholes option pricing model, we used the cost of a put option, which can be used to hedge the price change before a privately held share can be sold, as the basis to determine the discount for lack of marketability. Based on the foregoing analysis, we used a DLOM of 19% to discount the value of Changyou ordinary share as of the January 2008 and April 2008 valuation dates. Because there was no evidence to indicate that there would be a disproportionate return between majority and minority shareholders, we did not apply a minority discount.

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Share-based Compensation Expense

FACE="Times New Roman" SIZE="2">Share-based compensation expense included in costs and expenses includes (in thousands):

Share-based compensation expenses included in our financial statements include expenses related to share-based
awards of Sohu.com Inc, and Changyou, a subsidiary set up to own and operate our online game business.

1) Sohu.com Inc Share Awards

5. SHARE-BASED COMPENSATION EXPENSE

The Company’s 2000 Stock Incentive Plan, including stock options and restricted stock units, provides for the issuance of up to 9,500,000 shares of common stock. The maximum term of any issued stock right is ten years from the grant date.

The Company has reserved 9,500,000 shares of new common stock for issuance under the Company’s 2000 Stock Incentive Plan. As of March 31, 2008, 1,067,926 shares were available for grant under the plan.

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A summary of option activity under the Company’s 2000 Stock Incentive Plan as of March 31, 2008, and changes during the three month period then ended, is presented below:

The aggregate intrinsic value in the preceding table represents the total intrinsic value based on the Company’s closing stock price of $45.13 as of March 31, 2008.

The total intrinsic value of options exercised during the three month period ended March 31, 2008 was $708,000.

A summary of restricted stock unit activity under the Company’s 2000 Stock Incentive Plan as of March 31, 2008, and changes during the three month period ended, is presented below:

As of March 31, 2008, there was $0.9 million of total unrecognized compensation cost related to options for which services had not been provided. That cost is expected to be recognized over a weighted average period of 0.64 years. The total fair value of options expensed during the three months ended March 31, 2008 and 2007 was $0.6 million and $1.0 million, respectively.

As of March 31, 2008, there was $5.1 million of total unrecognized compensation cost related to unvested restricted stock units. That cost is expected to be recognized over a weighted average period of 1.03 years. Total fair value of restricted stock units expensed during the three months ended March 31, 2008 and 2007 was $1.1 million and $1.5 million, respectively.

There were no capitalized share-based compensation costs during the three months ended March 31, 2008 and 2007.

During three months ended March 31, 2008 and 2007, total cash received from the exercise of stock options amounted to $0.5 million and $1.4 million, respectively.

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For the three months ended March 31, 2008, the Company granted equity based awards with a fair value of $3.8 million in one of our subsidiaries. The fair value of the equity based awards was determined using the discounted cash flow method and the guideline companies method. A portion of these awards was vested immediately and the related fair value of $1.8 million was charged to the income statement at the date of grant. In April 2008, the board of directors modified the vesting conditions of the remaining unvested awards. The modification consisted primarily of removing provisions for vesting of the awards upon certain future events. As a consequence, the awards are exercisable over a four-year period commencing the date of grant. The fair value of the remaining equity based awards will be recognized starting from the date when the board of directors approved the modification of the vesting conditions. 

6. SHARE-BASED COMPENSATION EXPENSE

The Company’s 2000 Stock Incentive Plan, including stock options and restricted stock units, provides for the issuance of up to 9,500,000 shares of common stock. The maximum term of any issued stock right is ten years from the grant date.

The Company has reserved 9,500,000 shares of new common stock for issuance under the Company’s 2000 Stock Incentive Plan. As of September 30, 2007, 1,048,984 shares were available for grant under the plan.

A summary of option activity under the Company’s 2000 Stock Incentive Plan as of September 30, 2007, and changes during the nine month period then ended, is presented below:

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The aggregate intrinsic value in the preceding table represents the total intrinsic value based on the Company’s closing stock price of $37.71 as of September 28, 2007.

The total intrinsic value of options exercised during the nine month period ended September 30, 2007 was $13.7 million.

A summary of restricted stock unit activity under the Company’s 2000 Stock Incentive Plan as of September 30, 2007, and changes during the nine month period then ended, is presented below:

As of September 30, 2007, there was $1.8 million of total unrecognized compensation cost related to options for which services had not been provided, net of forecasted forfeitures. Such cost is expected to be recognized over a weighted average period of 0.8 year. Total fair value of options expensed during the three months ended September 30, 2007 and 2006 was $0.6 million and $1.1 million, respectively.

As of September 30, 2007, there was $7.1 million of total unrecognized compensation cost related to unvested restricted stock units, net of forecasted forfeitures. Such cost is expected to be recognized over a weighted average period of 1.2 years. Total fair value of restricted stock units expensed during the three months ended September 30, 2007 and 2006 was $1.4 million and $0.8 million, respectively.

There were no capitalized share-based compensation costs during the three and nine months ended September 30, 2007 and 2006.

During the three months ended September 30, 2007 and 2006, total cash received from the exercise of stock options amounted to $4.3 million and $1.3 million, respectively.