<PAGE>
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-96137
4,600,000 Shares
Sohu.com Inc.
[LOGO OF SOHU.COM]
Common Stock
------------
We are offering 2,300,000 shares of our common stock in the United States
and Canada through a syndicate of U.S. underwriters, and 2,300,000 shares
outside the United States and Canada through a syndicate of international
managers. The offering price and the underwriting discount and commission for
the two offerings are identical.
Prior to this offering, there has been no public market for our common
stock. Our common stock has been approved for quotation on The Nasdaq Stock
Market's National Market under the symbol "SOHU".
The U.S. underwriters and international managers have an option to purchase
on a pro rata basis up to 690,000 additional shares to cover over-allotments.
Investing in our common stock involves risks. See "Risk Factors" on page 7.
<TABLE>
<CAPTION>
Underwriting
Price to Discounts and Proceeds to
Public Commissions Sohu.com
----------- ------------- -----------
<S> <C> <C> <C>
Per Share................................... $ 13.00 $ 0.91 $ 12.09
Total....................................... $59,800,000 $4,186,000 $55,614,000
</TABLE>
Delivery of the shares of common stock will be made on or about July 17,
2000.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if
this prospectus is truthful or complete. Any representation to the contrary is
a criminal offense.
Credit Suisse First Boston
Credit Suisse First Boston
BOCI Asia Limited
Donaldson, Lufkin & Jenrette
The date of this prospectus is July 12, 2000.
<PAGE>
[Inside front cover --
(1) Top half -- Heading "A Leading Internet Portal in China" followed by a
screen shot of the Sohu.com home page, which is in the Chinese language,
together with English annotations.
(2) Bottom half -- Heading "Offering Context, Content, Community & Commerce"
followed by screen shots of the Sohu online directory, the Sohu News
channel, the Sohu chat room and the Sohu shopping channel.
(3) Background -- The tail of the "Search Fox".]
<PAGE>
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary.................. 1
Risk Factors........................ 7
Enforceability of Civil
Liabilities........................ 24
Cautionary Notice Regarding Forward-
Looking Statements................. 24
Use of Proceeds..................... 25
Dividend Policy..................... 25
Capitalization...................... 26
Dilution............................ 28
Exchange Rate Information........... 29
Selected Consolidated Financial
Data............................... 30
Corporate Restructuring............. 33
Management's Discussion and Analysis
of Financial Condition and Results
of Operations...................... 36
</TABLE>
<TABLE>
<CAPTION>
Page
----
<S> <C>
Business......................... 47
Regulation of the PRC Internet
Industry........................ 62
Management....................... 66
Principal Shareholders........... 76
Related Party Transactions....... 78
Shares Eligible for Future Sale.. 82
Description of Capital Stock..... 84
Taxation......................... 88
Underwriting..................... 91
Notice to Canadian Residents..... 95
Validity of Common Stock......... 96
Experts.......................... 96
Where You Can Find More
Information..................... 96
Index to Financial Statements.... F-1
</TABLE>
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Dealer Prospectus Delivery Obligation
Until August 6, 2000 (25 days after the commencement of this offering), all
dealers that effect transactions in these securities, whether or not
participating in this offering, may be required to deliver a prospectus. This
is in addition to the dealers' obligation to deliver a prospectus when acting
as an underwriter and with respect to their unsold allotments or subscriptions.
<PAGE>
PROSPECTUS SUMMARY
This summary highlights selected information from this prospectus and does
not contain all of the information that may be important to you. You should
read the entire prospectus carefully in evaluating an investment in our shares.
Sohu.com Inc.
Our Business
We are a leading Internet portal in China in terms of brand recognition,
page views and registered users. As of June 24, 2000, we averaged in excess of
16.3 million page views per day during June 2000. In addition, as of June 24,
2000, we had over 3.1 million registered e-mail users. Our portal consists of
the following:
. sophisticated Chinese language Web navigational and search capabilities;
. twelve main content channels;
. Web-based communications and community services; and
. a platform for e-commerce services.
We are a pioneer of the Internet industry in China, having introduced the
first Chinese language online directory and search engine. We have exclusively
targeted the PRC Internet market since our inception. All of our products and
services are designed to meet the specific interests and needs of Internet
users in China. As of May 31, 2000, our online directory contained over 270,000
Chinese language Web listings. We offer Internet users a proprietary Chinese
language search and a co-branded English language search. Furthermore, we have
contractual relationships with over 85 Chinese language media and information
providers. Each of our main content channels contains multi-level sub-channels
that cover a comprehensive range of topics, including news, business,
entertainment, sports and career. We also promote user affinity to Sohu by
providing free Chinese language e-mail, online bulletin boards, chat rooms and
instant messaging. We began offering limited e-commerce services on a trial
basis in 1999.
As a leading Internet portal in China, we are well positioned to capitalize
on the emergence of the Web as a new advertising medium and commerce platform
in China. We believe that by providing a well tuned and highly relevant
navigational context and comprehensive range of China-specific content, we
provide advertisers and merchants with targeted access to a large audience with
highly desirable demographic profiles.
Corporate Structure
Under current PRC regulations, foreign companies such as Sohu.com Inc. may
not own or operate telecommunications businesses in China, which may include
the operation of Internet content provision businesses. Our wholly owned PRC
subsidiary, Sohu ITC Information Technology (Beijing) Co., Ltd., or Beijing
ITC, does not have a license to provide Internet content and information
services. As a result, we recently restructured our operations. As part of this
restructuring, our content-related operations were transferred to Beijing Sohu
Online Network Information Services, Ltd., or Beijing Sohu, a PRC company that
has received approval to develop Internet content and information services.
Beijing Sohu is 80% owned by Charles Zhang, our founder, President and Chief
Executive Officer, and 20% owned by He Jinmei, an executive officer of Beijing
ITC, both of whom are PRC nationals. After the restructuring, Beijing ITC
continues to operate our online advertising, e-commerce applications, directory
and search engine and other businesses described in this prospectus, while
Beijing Sohu provides and develops content for use by Beijing ITC on our Web
site for a monthly fee. See "Corporate Restructuring".
1
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Our Market Opportunity
Internet use in China has grown rapidly in recent years and is expected to
significantly outpace growth in worldwide Internet use over the next several
years. According to International Data Corporation, or IDC, between January 1,
1999 and December 31, 1999, the number of PRC Internet users increased from
approximately 2.4 million to 3.8 million. In addition, IDC projects that the
number of Internet users in China will grow to approximately 25.2 million in
2003.
As Internet use becomes more pervasive in China, and as the PRC online
population continues to develop and expand, the opportunities for online
advertising and commerce will also expand.
Zenith Media estimates that advertising expenditures for television,
newspapers, magazines and other traditional media in China totaled over $4.1
billion in 1999. In addition, Forrester Research estimates that the aggregate
online advertising market in China in 1999 was only $8.0 million. As the number
of Internet users increases, we believe that online advertising will capture an
increasing percentage of the overall PRC advertising market. Zenith Media has
estimated that in 2002 China's overall advertising market will be $6.1 billion,
while Forrester Research has estimated that China's online advertising market
will be $100 million in 2002 and $440 million in 2004. Similarly, the volume of
e-commerce transactions in China is expected to increase significantly as the
online population expands. According to IDC, total e-commerce revenue in China
is expected to grow from approximately $43.0 million in 1999 to approximately
$11.7 billion in 2004.
Our Strategy
Our objective is to strengthen our position as a leading Internet portal in
China. In order to accomplish this objective, we plan to:
. maintain and extend our brand recognition;
. increase the number of visitors to our portal and the duration of each
visit;
. increase online advertising revenues and develop an e-commerce business;
and
. acquire complementary assets, technologies and businesses.
Recent Developments
On January 29, 2000, we sold a total of 1,347,991 shares of our Series D
preferred stock to an affiliate of Pacific Century Cyberworks Limited, an
affiliate of Legend Holdings Limited and Hikari Tsushin, Inc. for an aggregate
of approximately $20.0 million. On February 2, 2000, we sold an additional
673,998 shares of Series D preferred stock to an affiliate of Pacific Century
Cyberworks Limited for approximately $10.0 million. All of the Series D
preferred stock will, under the terms of the preferred stock, be mandatorily
converted into an equal number of shares of common stock upon the consummation
of this offering.
On March 1, 2000, we entered into a one-year non-exclusive agreement with an
affiliate of Nokia Corporation, under which we are Nokia's preferred partner in
China for the co-development of wireless access protocol, or WAP, mobile
Internet services, as well as short message services, or SMS. We are currently
Nokia's only content partner for WAP and SMS services in China, and are
responsible for aggregating content, such as stock quotes, news, e-mail and
advertising, and tailoring it for mobile telephone users. We commenced
providing content for this WAP service on April 27, 2000.
In May 2000, we, together with an affiliate of Nokia Corporation, entered
into six-month cooperation memoranda of understanding, or MOUs, with eight PRC
provincial wireless telecommunications operators. Under the terms of these
MOUs, we will be responsible for identifying and developing content for new WAP
applications and services.
2
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In May 2000, the State Administration of Industry and Commerce, or SAIC,
selected a number of Internet companies in the PRC to participate in a one-year
online advertising trial program. The SAIC is expected to formulate online
advertising regulations based on the information gathered during the trial
program. We were selected as one of the Internet companies that will
participate in the trial program. We also obtained a one-year advertising
business permit from SAIC on May 18, 2000.
On July 12, 2000, Dr. Charles Zhang, our founder, President and Chief
Executive Officer, agreed with Pacific Century Cyberworks Limited, an affiliate
of one of the holders of our Series D preferred stock, to procure Sohu.com Inc.
to purchase within a period of three years not less than $6.0 million of
services, including but not limited to, broadband, web distribution,
advertising, consultancy services and such other services, from Pacific Century
Cyberworks Limited and its affiliated group companies at their then current
fees and charges.
Our History
We were incorporated in Delaware in August 1996 as Internet Technologies
China Incorporated, and launched our original Web site, 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 Web site under sohu.com. In September 1999,
we re-named our company Sohu.com Inc. Substantially all of our operations are
conducted through Beijing ITC, our wholly owned PRC subsidiary. In May 2000, as
a result of regulatory developments in the Internet industry in China, we
restructured our operations. See "Corporate Restructuring".
Our principal executive offices are located at 7 Jianguomen Nei Avenue,
Suite 1519, Tower 2, Bright China Chang An Building, Beijing 100005, People's
Republic of China and our telephone number is 86-10-6510-2160. In addition, we
maintain offices in Shanghai and Guangzhou. Our Internet address is
www.sohu.com. The information on our Web site is not a part of this prospectus.
------------
As used in this prospectus, references to "us", "we", "our", "our company",
"Sohu.com" and "Sohu" are to Sohu.com Inc., our subsidiary Beijing ITC, and our
affiliate Beijing Sohu, and these references should be interpreted accordingly.
Except where the context requires otherwise, these references include all of
our subsidiaries. Unless otherwise specified, references to "China" or "PRC"
refer to the People's Republic of China and do not include the Hong Kong
Special Administrative Region, the Macau Special Administrative Region or
Taiwan.
Unless otherwise indicated, all references in this prospectus to the number
of outstanding shares of our common stock:
. give effect to the mandatory conversion of the Series A, B, B-1, C and D
preferred stock into common stock upon the consummation of this
offering;
. give effect to a five-for-one stock split which became effective on
October 15, 1999;
. give effect to a 2.6-for-one stock split which became effective on June
22, 2000; and
. do not include the number of shares that we will issue if the U.S.
underwriters and international managers exercise their over-allotment
option.
As used in this prospectus, "U.S. Dollar", "dollar" or "$" means the lawful
currency of the United States of America, and "Renminbi" or "RMB" means the
lawful currency of the PRC.
------------
3
<PAGE>
The Offering
This offering consists of the U.S. offering and the international offering,
each of which is described below. A total of 4,600,000 shares will be offered
(plus 690,000 shares subject to the U.S. underwriters' and international
managers' overallotment option).
U.S. offering............. An offering in the United States and Canada of
2,300,000 shares.
International offering.... An offering outside the United States and Canada of
2,300,000 shares at the same time as the U.S.
offering.
Common stock to be
outstanding after this
offering................. 31,224,216 shares or 31,914,216 shares if the U.S.
underwriters and international managers exercise
their over-allotment option in full. Excluded are
stock options and warrants outstanding to purchase
an aggregate of 1,616,654 shares of our common
stock at a weighted average exercise price of $2.95
per share and stock options to purchase up to
598,000 additional shares of our common stock,
which we intend to grant prior to the closing of
this offering at an exercise price equal to the
public offering price.
Use of proceeds........... We intend to use a portion of the net proceeds of
this offering to fund capital expenditures,
consisting primarily of additions to our networking
and computer infrastructure. In addition, we intend
to use a portion of the net proceeds for sales and
marketing activities. The remainder of the net
proceeds will be used for general corporate
purposes. We may also use a portion of the net
proceeds for possible acquisitions or investments
although we do not currently have any agreements or
understandings to make any acquisitions or
investments. See "Use of Proceeds".
------------
You should rely only on the information contained in this document or to
which we have referred you. We have not authorized anyone to provide you with
information that is different. This document may only be used where it is legal
to sell these securities. The information in this document may only be accurate
on the date of this document.
------------
4
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Summary Consolidated Financial Data
The following summary consolidated financial data have been derived from our
(1) audited consolidated financial statements for the years ended December 31,
1997, 1998 and 1999, (2) our unaudited consolidated financial statements for
the three-months periods ended March 31, 1999 and 2000 and (3) our unaudited
consolidated pro forma balance sheet as of March 31, 2000, all of which are set
forth in our consolidated financial statements included elsewhere in this
prospectus. The information below should be read in conjunction with "Selected
Consolidated Financial Data", "Management's Discussion and Analysis of
Financial Condition and Results of Operations", our audited consolidated
financial statements and the related notes and our unaudited consolidated
financial statements and the related notes, all of which are included in this
prospectus. Our consolidated financial statements are presented in accordance
with United States generally accepted accounting principles. Basic and diluted
pro forma net loss per share in 1999 is computed using the weighted average
number of shares of common stock outstanding, including the pro forma effects
of the mandatory conversion of the Series A, B, B-1 and C preferred stock into
common stock upon the consummation of this offering. Basic and diluted pro
forma net loss per share for the three months ended March 31, 2000 is computed
using the weighted average number of shares of common stock outstanding,
including the pro forma effects of the mandatory conversion of the Series A, B,
B-1, C and D preferred stock into common stock upon the consummation of this
offering. For a description of the pro forma financial effects of our
restructuring, see "Corporate Restructuring -- Pro Forma Effects of Corporate
Restructuring".
<TABLE>
<CAPTION>
Three Months ended
Year ended December 31, March 31,
--------------------------------- ---------------------
1997 1998 1999 1999 2000
--------- --------- ----------- --------- ----------
(in thousands, except for per share
and share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $ 78 $ 472 $ 1,617 $ 233 $ 842
Total costs and
expenses............... (238) (1,082) (5,077) (516) (3,409)
Operating loss.......... (160) (610) (3,460) (283) (2,567)
Net loss................ (160) (615) (3,449) (276) (2,536)
Net loss attributable to
common stockholders.... (160) (859) (4,366) (390) (4,095)
Basic and diluted net
loss per share
attributable to common
stockholders........... $ (0.02) $ (0.09) $ (0.47) $ (0.04) $ (0.43)
Shares used in computing
basic and diluted net
loss per share......... 9,100,000 9,224,000 9,328,000 9,265,000 9,416,000
Basic and diluted pro
forma net loss per
share attributable to
common stockholders.... $ (0.16) $ (0.10)
Shares used in computing
basic and diluted
pro forma net loss per
share ................. 21,615,000 25,950,000
</TABLE>
5
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The following table is a summary of our consolidated balance sheet as of
March 31, 2000:
. on an actual basis;
. on a pro forma basis to give effect to the mandatory conversion of all
outstanding Series A, B, B-1, C and D preferred stock into common stock
upon the closing of this offering; and
. on a pro forma as adjusted basis to reflect the mandatory conversion of
all the preferred stock and the sale of 4,600,000 shares of common stock
offered at the initial public offering price of $13.00 per share, after
deducting estimated underwriting discounts and commissions and offering
expenses.
<TABLE>
<CAPTION>
As of March 31, 2000
----------------------------
Pro Pro forma
Actual Forma as adjusted
------- ------- -----------
(in thousands)
<S> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents........................ $33,106 $33,106 $87,120
Working capital.................................. 28,801 28,801 82,815
Total assets..................................... 38,111 38,111 91,144
Total liabilities................................ 5,322 5,322 5,322
Mandatorily redeemable convertible preferred
stock........................................... 41,721 -- --
Total shareholders' equity (deficit)............. (8,932) 32,789 85,822
</TABLE>
6
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RISK FACTORS
This offering involves a high degree of risk. You should carefully consider
the risks described below and the other information in this prospectus,
including our consolidated financial statements and the related notes, before
making an investment decision.
Risks relating to Sohu.com
We have incurred net losses since inception and anticipate that losses will
continue.
We were incorporated in Delaware in August 1996, and launched our original
Web site in January 1997. In February 1998, we re-launched our Web site under
www.Sohu.com. We have incurred significant net losses since inception and had
an accumulated deficit of approximately $9.5 million as of March 31, 2000. We
anticipate that we will continue to incur substantial net losses due to a high
level of planned operating and capital expenditures, including increased sales
and marketing costs, additional personnel hires, and greater levels of product
development. Our net losses will increase in the future and we may never
achieve or sustain profitability.
We have a limited operating history, which may make it difficult for you to
evaluate our business.
We began offering products and services under the www.Sohu.com Web site in
February 1998. Accordingly, we have a limited operating history upon which you
can evaluate our business. In addition, our senior management and employees
have worked together at our company for only a relatively short period of time.
As an early stage company in the new and rapidly evolving PRC Internet market,
we face numerous risks and uncertainties. Some of these risks relate to our
ability to:
. increase our online advertising revenues and successfully build an e-
commerce business, given the early stage of development of the PRC
Internet industry;
. continue to attract a larger audience to our portal by expanding the
type and technical sophistication of the content and services we offer;
and
. maintain our current, and develop new, strategic relationships to
increase our revenue streams as well as product and service offerings;
If we are unsuccessful in addressing these risks, our business, financial
condition and results of operations will be materially and adversely affected.
PRC Internet laws and regulations are unclear and will likely change in the
near future. If we are found to be in violation of current or future PRC laws
or regulations, we could be subject to severe penalties.
We conduct our Internet business solely in the PRC through our wholly owned
subsidiary, Sohu ITC Information Technology (Beijing ) Co., Ltd., or Beijing
ITC. Beijing ITC is a wholly foreign owned enterprise, or a WFOE, under PRC
law. We are a Delaware corporation and a foreign person under PRC law.
Accordingly, our Internet business is 100% foreign-owned. In addition, pursuant
to our recent restructuring, we transferred certain of our assets and
operations to Beijing Sohu Online Network Information Services, Ltd., or
Beijing Sohu, a PRC company that is 80% owned by our chief executive officer.
We do not have any ownership interest in Beijing Sohu.
The PRC has recently begun to regulate its Internet sector by making
pronouncements or enacting regulations regarding the legality of foreign
investment in the PRC Internet sector, the existence and enforcement of content
restrictions on the Internet and the availability of securities offerings by
companies operating in the PRC Internet sector. In the opinion of TransAsia
lawyers, our PRC counsel, the ownership structures of Sohu, Beijing ITC and
Beijing Sohu, both currently and giving effect to this offering, and the
7
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businesses and operations of Sohu, Beijing ITC and Beijing Sohu as described in
this prospectus comply with all existing PRC laws, rules and regulations, and
no further PRC governmental approvals are required for such ownership
structures, businesses, operations or this offering. There are, however,
substantial uncertainties regarding the interpretation of current PRC Internet
laws and regulations. In addition, there will likely be new PRC Internet laws
and regulations adopted in the near future. Accordingly, we cannot assure you
whether the PRC government may ultimately take a contrary view to the opinion
of our PRC counsel.
Issues, risks and uncertainties relating to PRC government regulation of the
PRC Internet sector include the following:
. A prohibition of foreign investment in businesses providing value-added
telecommunication services, including computer information services or
electronic mail box services, may be applied to Internet businesses such
as ours. Some officials of the PRC Ministry of Information, or MII, have
taken the position that foreign investment in the Internet sector is
prohibited.
. The MII has also stated recently that it intends to adopt new laws or
regulations governing foreign investment in the PRC Internet sector in
the near future. If these new laws or regulations are inconsistent with
our restructuring, our business will be severely impaired.
. Under the agreement reached in November 1999 between the PRC and the
United States concerning the United States' support of PRC's entry into
the World Trade Organization, or WTO, foreign investment in PRC Internet
services will be liberalized to allow for 30% foreign ownership in key
telecommunication services, including PRC Internet ventures, for the
first year after China's entry into the WTO, 49% in the second year and
50% thereafter. However, the implementation of this agreement is still
subject to various conditions, including approval by the U.S. Congress
and the PRC National People's Congress, and the agreement also faces
opposition in the United States from various parties, including trade
unions, environmentalists and human rights organizations.
. The MII has also stated recently that the activities of Internet content
providers are also subject to regulation by various PRC government
authorities, depending on the specific activities conducted by the
Internet content provider. Various government authorities have stated
publicly that they are in the process of preparing new laws and
regulations that will govern these activities. The areas of regulation
may include online advertising and online news reporting. In addition,
the new laws and regulations may require various PRC government
approvals for securities offerings by companies engaged in the Internet
sector in the PRC.
The interpretation and application of existing PRC laws and regulations, the
stated positions of the MII and the possible new laws or regulations have
created substantial uncertainties regarding the legality of existing and future
foreign investments in, and the businesses and activities of, PRC Internet
companies, including us.
Accordingly, it is possible that the relevant PRC authorities could, at any
time, assert that any portion or all of our, Beijing ITC's or Beijing Sohu's
existing or future ownership structure and businesses, or this offering,
violates existing or future PRC laws, regulations or policies. It is also
possible that the new laws or regulations governing the PRC Internet sector
that may be adopted in the future will prohibit or restrict foreign investment
in, or other aspects of, any of our, Beijing ITC's or Beijing Sohu's current or
proposed businesses and operations or require governmental approvals for this
offering. In addition, these new laws and regulations may be retroactively
applied to us, Beijing ITC or Beijing Sohu.
If we, Beijing ITC or Beijing Sohu are found to be in violation of any
existing or future PRC laws or regulations, the relevant PRC authorities would
have broad discretion in dealing with such violation, including, without
limitation, the following:
. levying fines;
. confiscating our, Beijing ITC's or Beijing Sohu's income;
8
<PAGE>
. revoking our, Beijing ITC's or Beijing Sohu's business license;
. shutting down our, Beijing ITC's or Beijing Sohu's servers and/or
blocking our Web sites;
. restricting or prohibiting our use of the proceeds of this offering to
finance our business and operations in China;
. requiring us, Beijing ITC or Beijing Sohu to restructure our ownership
structure or operations; and
. requiring us, Beijing ITC or Beijing Sohu to discontinue any portion or
all of our Internet business.
Any of these actions could cause our business, financial condition and
results of operations to suffer and the price of our common stock to decline.
We have attempted to comply with restrictions on foreign investment in the
PRC Internet sector imposed by the PRC government by transferring our
content-related assets and operations to, and entering into agreements with,
Beijing Sohu, a PRC company controlled by our President and Chief Executive
Officer. If the PRC government finds that these agreements do not comply with
the relevant foreign investment restrictions, our business in the PRC will be
adversely affected.
Because the PRC government restricts foreign investment in Internet-related
businesses, we have restructured our Internet operations by having Beijing Sohu
acquire appropriate government approvals to conduct our content-related
operations. In addition, we have transferred our content-related assets and
operations to Beijing Sohu. See "Related Party Transactions". The legal
uncertainties associated with PRC government regulations and our restructuring
may be summarized as follows:
. whether the PRC government may view our restructuring as being in
compliance with their laws and regulations;
. whether the PRC government may impose additional regulatory requirements
with which we or Beijing Sohu may not be in compliance; and
. whether the PRC government will permit Beijing Sohu to acquire future
licenses necessary in order to conduct operations in the PRC.
Although we restructured our operations based upon the advice of the MII, we
cannot be sure that our restructured operations and activities will be viewed
by PRC regulatory authorities as in compliance with applicable PRC laws and
regulations. Our business will be adversely affected if our business license is
revoked as a result of non-compliance. In addition, we cannot be sure that we
and Beijing Sohu will be able to obtain all of the licenses we or Beijing Sohu
may need in the future or that future changes in PRC government policies
affecting the provision of information services, including the provision of
online services and Internet access, will not impose additional regulatory
requirements on us or Beijing Sohu or our service providers or otherwise harm
our business.
We depend upon contractual arrangements with Beijing Sohu for the success of
our business and these arrangements may not be as effective in providing
operational control as direct ownership of these businesses and may be
difficult to enforce.
Because we conduct our Internet business only in the PRC, and because we are
restricted by the PRC government from owning Internet content operations in the
PRC, we are dependent on Beijing Sohu, in which we have no ownership interest,
to provide such services through contractual agreements between the parties.
This arrangement may not be as effective in providing control over our Internet
content operations as direct ownership of these businesses. For example,
Beijing Sohu could fail to take actions required for our business, such as
entering into content development contracts with potential content suppliers or
failing to maintain the necessary permit for the content servers. If Beijing
Sohu fails to perform its obligations under these agreements, we would
potentially have to rely on legal remedies under PRC law, which we cannot be
sure would be effective or sufficient.
9
<PAGE>
Beijing Sohu is controlled by Charles Zhang, our chief executive officer. As
a result, our contractual relationships with Beijing Sohu could be viewed as
entrenching his management position or transferring certain value to him,
especially if any conflict arises with him.
Even if we are in compliance with PRC governmental regulations relating to
licensing and foreign investment prohibitions, the PRC government may prevent
us from distributing, and we may be subject to liability for, content that it
believes is inappropriate.
China has enacted regulations governing Internet access and the distribution
of news and other information. In the past, the PRC government has stopped the
distribution of information over the Internet that it believes to violate PRC
law, including content that is obscene, incites violence, endangers national
security, is contrary to the national interest or is defamatory. In addition,
we may not publish certain news items, such as news relating to national
security, without permission from the PRC government. Furthermore, the Ministry
of Public Security has the authority to cause any local Internet service
provider to block any Web site maintained outside the PRC at its sole
discretion. Even if we comply with PRC governmental regulations relating to
licensing and foreign investment prohibitions, if the PRC government were to
take any action to limit or prohibit the distribution of information through
our network or to limit or regulate any current or future content or services
available to users on our network, our business would be harmed.
We are also subject to potential liability for content on our Web sites that
is deemed inappropriate and for any unlawful actions of our subscribers and
other users of our systems under regulations promulgated by the MII.
Furthermore, we are required to delete content that clearly violates the
laws of the PRC and report content that we suspect may violate PRC law. It is
difficult to determine the type of content that may result in liability for us,
and if we are wrong, we may be prevented from operating our Web sites.
We may have to register our encryption software with PRC regulatory
authorities, and if they request that we change our encryption software, our
business operations will be disrupted as we develop or license replacement
software.
Pursuant to the Regulations for the Administration of Commercial Encryption
promulgated at the end of 1999, foreign and domestic PRC companies operating in
the PRC are required to register and disclose to PRC regulatory authorities the
commercial encryption products they use. Because these regulations have just
recently been adopted and because they do not specify what constitutes
encryption products, we are unsure as to whether or how they apply to us and
the encryption software we utilize. We may be required to register, or apply
for permits with the relevant PRC regulatory authorities for, our current or
future encryption software. If PRC regulatory authorities request that we
change our encryption software, we may have to develop or license replacement
software, which could disrupt our business operations. In addition, we may be
subject to potential liability for using software that is subsequently deemed
to be illegal by the relevant PRC regulatory authorities. These potential
liabilities might include, without limitation, fines, product confiscation and
criminal sanctions. We cannot assure you that our business, financial condition
and results of operations will not be materially and adversely affected by the
application of these regulations.
We depend on online advertising for substantially all of our revenues.
We derive substantially all of our revenues from the sale of online
advertising on our Web sites. For 1998, 1999 and the three months ended March
31, 2000, online advertising revenues represented approximately 75%, 88% and
94%, respectively, of our total revenues. In addition, our business plan is
heavily dependent on the anticipated expansion of online advertising in China
and the growth of our revenue is heavily dependent on online advertising.
The online advertising market in China is new and relatively small.
According to Forrester Research, the dollar amount of the online advertising
market in China in 1999 was approximately $8.0 million. According to
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Zenith Media's estimate, the dollar amount of the total advertising market in
China was over $4.1 billion in 1999. Our ability to generate and maintain
significant online advertising revenues in China will depend, among other
things, on:
. the development of a large base of users possessing demographic
characteristics attractive to advertisers;
. downward pressure on online advertising prices;
. the development of independent and reliable means of verifying traffic;
and
. the effectiveness of our advertising delivery, tracking and reporting
systems.
The development of Web software that blocks Internet advertisements before
they appear on a user's screen may hinder the growth of online advertising. The
expansion of ad blocking on the Internet may decrease our revenues because when
an ad is blocked, it is not downloaded from our ad server. As a result, such
advertisements will not be tracked as a delivered advertisement. In addition,
advertisers may choose not to advertise on the Internet or on our portal
because of the use by third parties of Internet advertisement blocking
software. The use of Web software that blocks Internet advertisements may
materially and adversely affect our business, financial condition and results
of operations.
In addition, an element of our strategy is to diversify our revenue stream
by entering into more Web site sponsorship arrangements and by introducing e-
commerce services and generating e-commerce revenue. We cannot assure you that
we will be successful in implementing this strategy.
Accordingly, we cannot assure you that we will be successful in generating
significant future online advertising revenue or in diversifying our revenue
stream, and the failure to do so would have a material adverse effect on our
business, online advertising revenue and profitability.
Our operating results are likely to fluctuate significantly and may differ
from market expectations.
Our annual and quarterly operating results have varied significantly in the
past, and may vary significantly in the future, due to a number of factors,
many of which are beyond our control. As a result, we believe that year-to-year
and quarter-to-quarter comparisons of our operating results are not a good
indication of our future performance. It is likely that in some future quarter,
our operating results may be below the expectations of public market analysts
and investors. In this event, the trading price of our common stock may fall.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Quarterly Results of Operations".
We will not be able to attract visitors, advertisers and e-commerce merchants
if we do not maintain and develop the Sohu brand.
Maintaining and further developing the Sohu brand is critical to our ability
to expand our user base and our revenues. We believe that the importance of
brand recognition will increase as the number of Internet users in China grows.
In order to attract and retain Internet users, advertisers and e-commerce
partners, we intend to increase substantially our expenditures for creating and
maintaining brand loyalty. If our revenues do not increase proportionately, our
results of operations and liquidity will suffer.
Our success in promoting and enhancing the Sohu brand, as well as our
ability to remain competitive, will also depend on our success in offering high
quality content, features and functionality. If we fail to promote our brand
successfully or if visitors to our portal or advertisers do not perceive our
content and services to be of high quality, we may not be able to continue
growing our business and attracting visitors, advertisers and e-commerce
partners. This could have a material and adverse effect on our business,
financial condition and results of operations.
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We may need additional capital and we may not be able to obtain it.
Our capital requirements are difficult to plan in our rapidly changing
industry. We currently expect that we will need capital to fund additions to
our portal and computer infrastructure, including any acquisitions of
complementary assets, technologies or businesses we may pursue, as well as the
expansion of our sales and marketing activities. We believe that our current
cash and cash equivalents, cash flow from operations, proceeds from the sale
of Series D preferred stock in January and February 2000 and the proceeds from
this offering will be sufficient to meet our anticipated needs, including
working capital and capital expenditures, for at least the next twelve months.
However, future market or other developments may cause us to require
additional funds.
Our ability to obtain additional financing in the future is subject to a
variety of uncertainties, including:
. investors' perceptions of and appetite for Internet-related securities;
. conditions in the U.S. and other capital markets in which we may seek to
raise financing;
. our future results of operations, financial condition and cash flows;
. the amount of capital that other PRC entities may seek to raise in
foreign capital markets;
. PRC governmental regulation of foreign investment in Internet companies;
. economic, political and other conditions in the PRC; and
. PRC governmental policies relating to foreign currency borrowings.
Our inability to raise additional funds on terms favorable to us, or at
all, may have a material adverse effect on our business, financial condition
and results of operations. For example, we may be required to scale back our
planned expenditures, which could adversely affect our growth prospects. For
more information on our capital and financing requirements, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources".
If we fail to establish and maintain relationships with content providers, e-
commerce merchants and technology providers, we may not be able to attract
and retain users.
We rely on a number of third party relationships to attract traffic and
provide content in order to make our portal more attractive to users and
advertisers. Third parties providing content to our portal include CNET, Dow
Jones & Company, Inc. and Xinhua News Agency. Moreover, some content providers
have recently increased the fees they charge us for their content. This trend
could increase our expenses and could adversely affect our ability to obtain
quality content at an economically acceptable cost. Most of these arrangements
are short-term and may be terminated at the convenience of the other party. In
addition, much of the third party content provided to our portal is also
available from other sources or may be provided to other Internet companies.
If other Internet companies present the same or similar content in a superior
manner, it would adversely affect our visitor traffic.
Similarly, we have focused, and will continue to focus, on establishing
relationships with leading e-commerce merchants and technology and
infrastructure providers. Our business depends significantly on these
relationships and the licenses that the technology providers have granted to
us. Our competitors may seek to establish the same relationships as we have,
which may adversely affect us. We may not be able to maintain these
relationships or replace them on commercially attractive terms.
We depend on key personnel and our business may be severely disrupted if we
lose the services of our key executives.
Our future success is heavily dependent upon the continued service of our
key executives, particularly Dr. Charles Zhang, who is the founder, President
and Chief Executive Officer of our company and the founder and President of
Beijing Sohu. We rely on his expertise in our business operations and on his
personal relationships with our shareholders, the relevant regulatory
authorities, our customers and suppliers and Beijing Sohu. If one or more of
our key executives were unable or unwilling to continue in their present
positions, we
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may not be able to easily replace them, our business may be severely disrupted,
financial condition and results of operations may be materially and adversely
affected. In addition, if any of these key executives joins a competitor or
forms a competing company, we may lose customers and suppliers and incur
additional expenses to recruit and train personnel. Each of our executive
officers has entered into a confidentiality, non-competition and non-
solicitation agreement with us. These officers also have employment agreements
with Beijing ITC, our PRC operating subsidiary, which contain substantially
similar confidentiality and non-competition undertakings. However, the degree
of protection afforded to an employer pursuant to confidentiality and non-
competition undertakings governed by PRC law may be more limited when compared
to the degree of protection afforded under the laws of other jurisdictions. We
do not maintain key-man life insurance for any of our key executives.
Rapid growth and a rapidly changing operating environment strain our limited
resources.
We have limited operational, administrative and financial resources, which
may be inadequate to sustain the growth we want to achieve. As our audience and
their Internet use increase, as the demands of our audience and the needs of
our customers change and as the volume of online advertising and e-commerce
activities increases, we will need to increase our investment in our network
infrastructure, facilities and other areas of operations. If we are unable to
manage our growth and expansion effectively, the quality of our services could
deteriorate and our business may suffer. Our future success will depend on,
among other things, our ability to:
. adapt our services and maintain and improve the quality of our services;
. continue training, motivating and retaining our existing employees and
attracting and integrating new employees; and
. developing and improving our operational, financial, accounting and
other internal systems and controls.
Our advertising pricing model, which is based on charging a fixed fee to
display advertisements for a specified time period, may not be profitable.
There are currently no industry standard pricing models used to sell
advertising on the Internet. This makes it difficult to project our future
advertising rates and revenues. The models we adopt may prove not to be
profitable. Substantially all of our advertising revenues in 1999 were derived
from charging a fixed fee to display an advertisement over a given time period.
To the extent that minimum guaranteed impression levels are not met, we are
required to provide additional impressions after the contract term and we
accordingly defer the related revenue. The failure of our advertising pricing
model could have a material adverse effect on our business, financial condition
and results of operations.
We may not be able to track the delivery of advertisements through our
portal, which may make us less attractive to potential advertisers.
It is important to advertisers that we accurately measure the demographics
of our user base and the delivery of advertisements through our portal.
Companies may choose not to advertise on our portal or may pay less for
advertising if they do not perceive our ability to track and measure the
demographics of our users or the delivery of advertisements to be reliable. We
depend on third parties to provide us with some of these measurement services.
If they are unable to provide these services in the future, we would need to
perform these services ourselves or obtain these service from other providers.
This could cause us to incur additional costs or cause interruptions or
slowdowns in our business during the time we are replacing these services. We
are currently implementing additional systems designed to collect information
on our users. We cannot assure you, however, that we can implement these
systems successfully.
The loss of one of our significant advertisers would reduce our advertising
revenues as well as materially and adversely affect our financial conditions
and results of operations.
We depend on a small group of advertisers for a significant portion of our
total revenues. For 1999, two of our advertisers, one of which is a
shareholder, each accounted for more than 10% of our total revenues. In
addition, our five largest advertisers accounted for approximately 34% of our
total revenues. In the three
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months ended March 31, 2000, two advertisers each accounted for more than 8% of
our total revenues and our top five advertisers accounted for approximately 34%
of our total revenues. We anticipate that we will continue to rely on a
relatively small number of significant advertisers for a majority of our total
revenues for the foreseeable future. Our business, financial condition and
results of operations would be materially and adversely affected by the loss of
one or more of our significant advertisers or a decrease in the volume of
advertising by any of these advertisers.
During January 2000, we entered into multi-year advertising agreements with
affiliates of Pacific Century Cyberworks, Legend Holdings Limited and Hikari
Tsushin, Inc. We also sold shares of our Series D preferred stock to these
entities or their affiliates in January and February 2000. We expect to derive
significant revenues from these advertising agreements. The loss of any of
these agreements or a decrease in the volume of advertising by any of these
advertisers would have a material adverse effect on our business, financial
condition and results of operations.
Our strategy of acquiring complementary assets, technologies and businesses
may fail and may result in equity or earnings dilution.
As a component of our growth strategy, we have acquired and intend to
actively identify and acquire assets, technologies and businesses that are
complementary to our existing portal business. Our acquisitions could result in
the use of substantial amounts of cash, potentially dilutive issuances of
equity securities, significant amortization expenses related to goodwill and
other intangible assets and exposure to undisclosed or potential liabilities of
acquired companies, each of which could materially and adversely affect our
business, financial condition and results of operations. Moreover the resources
expended in identifying and consummating acquisitions may be significant.
Furthermore, any acquisitions we decide to pursue may be subject to the
approval of the relevant PRC governmental authorities, as well as any
applicable PRC rules and regulations.
We rely on dividends and other distributions on equity paid by our wholly-
owned operating subsidiary to fund any cash requirements we may have.
We are a holding company with no operating assets other than the shares of
Beijing ITC, our wholly- owned subsidiary in the PRC that owns and conducts our
entire Internet business. We rely on dividends and other distributions on
equity paid by Beijing ITC for our cash requirements, including the funds
necessary to service any debt we may incur. If Beijing ITC incurs debt on its
own behalf in the future, the instruments governing the debt may restrict
Beijing ITC's ability to pay dividends or make other distributions to us. In
addition, PRC legal restrictions permit payment of dividends by Beijing ITC
only out of its net income, if any, determined in accordance with PRC
accounting standards and regulations. Under PRC law, Beijing ITC is also
required to set aside a portion of its net income each year to fund certain
reserve funds. These reserves are not distributable as cash dividends. See note
5 to our consolidated financial statements included in this prospectus.
Beijing ITC has been in a loss-making position since its inception and will
continue to make losses in the foreseeable future. Therefore, we have not
received any dividends or other distributions from Beijing ITC in the past and
do not expect any dividends in the foreseeable future.
Until the China Trademark Office issues the actual trademark registration
certificates, we do not have exclusive rights over the mark "Sohu.com".
China's trademark law adopts a "first-to-file" system for obtaining
trademark rights. As a result, the first applicant to file an application for
registration of a mark will preempt all other applicants. Prior use of an
unregistered mark is generally irrelevant except for "well-known" marks. We
have registered the domain name "Sohu.com" with Network Solutions and the
domain name "Sohu.com.cn" with China Internet Network Information Center, a
domain name registration service in China, and have full legal rights over
these domain names. We have also filed trademark applications for the mark
"Sohu.com" in Chinese and English with the China Trademark Office. However,
until actual registration certificates are issued by the China Trademark
Office, we do not have exclusive rights over the mark "Sohu.com".
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We have applied for registration of the "Sohu.com" mark in the United
States. We have also applied for registration of the "Sohu.com" mark in Hong
Kong and Taiwan, and plan to apply for registration in Malaysia and Singapore.
Completion of all of these applications is subject to prior rights in the
relevant jurisdictions. Any rejection of such applications may adversely affect
our legal rights over the mark "Sohu.com" in those countries and regions.
Unauthorized use of our intellectual property by third parties, and the
expenses incurred in protecting our intellectual property rights, may
adversely affect our business.
We regard our copyrights, service marks, trademarks, trade secrets and other
intellectual property as critical to our success. Unauthorized use of our
intellectual property by third parties may adversely affect our business and
reputation. We rely on trademark and copyright law, trade secret protection and
confidentiality agreements with our employees, customers, business partners and
others to protect our intellectual property rights. Despite our precautions, it
may be possible for third parties to obtain and use our intellectual property
without authorization. Furthermore, the validity, enforceability and scope of
protection of intellectual property in Internet-related industries is uncertain
and still evolving. In particular, the laws of the PRC and certain other
countries are uncertain or do not protect intellectual property rights to the
same extent as do the laws of the United States. Moreover, litigation may be
necessary in the future to enforce our intellectual property rights, to protect
our trade secrets or to determine the validity and scope of the proprietary
rights of others. Future litigation could result in substantial costs and
diversion of our resources, and could have a material adverse effect on our
business, financial condition and results of operations.
We may be subject to intellectual property infringement claims, which may
force us to incur substantial legal expenses and, if determined adversely
against us, materially disrupt our business.
We cannot be certain that our products and services do not or will not
infringe valid patents, copyrights or other intellectual property rights held
by third parties. We have in the past been, and may in the future be, subject
to legal proceedings and claims from time to time relating to the intellectual
property of others in the ordinary course of our business. In particular, if we
are found to have violated the intellectual property rights of others, we may
be enjoined from using such intellectual property, and we may incur licensing
fees or be forced to develop alternatives. We may incur substantial expenses in
defending against these third party infringement claims, regardless of their
merit. Successful infringement claims against us may result in substantial
monetary liability or may materially disrupt the conduct of our business.
We may be subject to, and may expend significant resources in defending
against, claims based on the content and services we provide over our portal.
As our services may be used to download and distribute information to
others, there is a risk that claims may be made against us for defamation,
negligence, copyright or trademark infringement or other claims based on the
nature and content of such information. Furthermore, we could be subject to
claims for the online activities of our visitors and incur significant costs in
their defense. In the past, claims based on the nature and content of
information that was posted online by visitors have been made in the United
States against companies that provide online services. We do not carry any
liability insurance against such risks.
We could be exposed to liability for the selection of listings that may be
accessible through our portal or through content and materials that our
visitors may post in classifieds, message boards, chat rooms or other
interactive services. If any information provided through our services contains
errors, third parties may make claims against us for losses incurred in
reliance on the information. We also offer Web-based e-mail services, which
expose us to potential liabilities or claims resulting from:
. unsolicited e-mail;
. lost or misdirected messages;
. illegal or fraudulent use of e-mail; or
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. interruptions or delays in e-mail service.
Investigating and defending these claims may be expensive, even if they do
not result in liability.
Risks relating to our markets
We rely on online advertising sales for a significant portion of our future
revenues, but the Internet has not been proven as a widely accepted medium
for advertising.
We expect to derive most of our revenue for the foreseeable future from
Internet advertising, and to a lesser extent, from e-commerce. If the Internet
is not accepted as a medium for advertising, our ability to generate revenues
will be adversely affected.
The acceptance of the Internet as a medium for advertising depends on the
development of a measurement standard. No standards have been widely accepted
for the measurement of the effectiveness of Internet advertising. Industry-wide
standards may not develop sufficiently to support the Internet as an effective
advertising medium. If these standards do not develop, advertisers may choose
not to advertise on the Internet in general or through our portals or search
engines. This would have a material adverse effect on our business, financial
condition and results of operations.
Many of our current and potential advertising and e-commerce customers have
only limited experience using the Internet for advertising or commerce
purposes, and may not be willing to fully embrace the products and services
we offer, which would adversely affect our future revenues and business
expansion.
The online advertising and e-commerce markets are new and rapidly evolving,
particularly in China. As a result, many of our current and potential
advertising and e-commerce customers have limited experience using the Internet
for advertising or commerce purposes and historically have not devoted a
significant portion of their advertising and sales budgets to Internet-based
advertising and e-commerce. Moreover, customers that have invested substantial
resources in other methods of conducting business may be reluctant to adopt a
new strategy that may limit or compete with their existing efforts. In
addition, companies may choose not to advertise or sell their products on our
portal if they do not perceive our online advertising and e-commerce platform
to be effective or our audience demographics to be desirable. The failure to
successfully address these risks or execute our business strategy would
significantly reduce our profitability and materially and adversely affect our
financial condition and results of operations.
We face intense competition which could reduce our market share and adversely
affect our financial performance.
The PRC Internet market is characterized by an increasing number of entrants
because, among other reasons, the barriers to entry are relatively low. The
market for Internet services and products, particularly Internet search and
retrieval services and Internet advertising, is intensely competitive. In
addition, the Internet industry is relatively new and constantly evolving and,
as a result, our competitors may better position themselves to compete in this
market as it matures.
There are many companies that provide or may provide Web sites and online
destinations targeted at Internet users in China. Some of our major competitors
in China are major United States Internet companies, such as Yahoo! Inc. In
addition, we may face competition from existing or new domestic PRC Internet
companies that are either affiliated with large corporations such as American
Online and Softbank Corporation, or controlled or sponsored by PRC government
entities. These competitors may have certain advantages over us, including:
. substantially greater financial and technical resources;
. more extensive and well developed marketing and sales networks;
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. better access to original content;
. greater global brand recognition among consumers; and
. larger customer bases.
With these advantages, our competitors may be better able to:
. develop, market and sell their products and services;
. adapt more quickly to new and changing technologies; and
. more easily obtain new customers.
We can provide no assurance that we will be able to compete successfully
against our current or future competitors.
The telecommunications infrastructure in China, which is not as well
developed as in the United States, may limit our growth.
The telecommunications infrastructure in China is not well developed. In
particular, we depend on the Chinese government and state-owned enterprises to
establish and maintain a reliable Internet and telecommunications
infrastructure to reach a broader base of Internet users in China. We cannot
assure you that the Internet infrastructure in China will support the demands
associated with continued growth. If the necessary infrastructure standards or
protocols or complementary products, services or facilities are not developed
on a timely basis or at all by the Chinese government and state-owned
enterprises, our business, financial condition and results of operations could
be materially and adversely affected.
We depend on ChinaNet, China Telecom and the Beijing Telecom Administration
for telecommunications services, and any interruption in these services may
result in severe disruptions to our business.
Although private Internet service providers exist in China, almost all
access to the Internet is maintained through ChinaNet, currently owned by China
Telecom, under the administrative control and regulatory supervision of China's
Ministry of Information Industry. In addition, local networks connect to the
Internet through a government-owned international gateway. This international
gateway is the only channel through which a domestic Chinese user can connect
to the international Internet network. We rely on this infrastructure and China
Telecom to provide data communications capacity primarily through local
telecommunications lines. Although the government has announced aggressive
plans to develop the national information infrastructure, we cannot assure you
that this infrastructure will be developed or that the Internet infrastructure
in China will be able to support the continued growth of Internet usage. In
addition, we will have no access to alternative networks and services, on a
timely basis if at all, in the event of any infrastructure disruption or
failure.
We cannot assure you that we will be able to lease additional bandwidth from
the Beijing Telecom Administration on acceptable terms or on a timely basis or
at all. In addition, we will have no means of getting access to alternative
networks and services, on a timely basis or at all, in the event of any
disruption or failure of the network.
If we are unseccessful in addressing these risks, our business may be
severely disrupted.
High cost of Internet access may limit the growth of the Internet in China
and impede our growth.
Access to the Internet in China remains relatively expensive, and may make
it less likely for users to access and transact business over the Internet.
Unfavorable rate developments could further decrease our visitor traffic and
our ability to derive revenues from transactions over the Internet. This could
have a material adverse effect on our business, financial condition and results
of operations.
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The acceptance of the Internet as a commerce platform in China depends on the
resolution of problems relating to fulfillment and electronic payment.
Our future growth of revenues depends in part on the anticipated expansion
of e-commerce activities in China. As China currently does not have a reliable
nationwide product distribution network, the fulfillment of goods purchased
over the Internet will continue to be a factor constraining the growth of e-
commerce. An additional barrier to the development of e-commerce in China is
the lack of reliable payment systems. In particular, the use of credit cards or
other viable means of electronic payment in sales transactions is not as well
developed in China as in some other countries, such as the United States.
Various government entities and businesses are working to resolve these
fulfillment and payment problems, but these problems are expected to continue
to hinder the acceptance and growth of the Internet as a commerce platform in
China, which could in turn adversely affect our business, financial condition
and results of operations.
Risks Related to the Internet and Our Technology Infrastructure
To the extent we are unable to scale our systems accordingly to meet the
rapidly increasing PRC Internet population, we will be unable to expand our
user base and increase our attractiveness to advertisers and merchants.
China is one of the world's fastest growing Internet markets. According to
International Data Corporation, the number of Internet users in China was 3.8
million in 1999 and is projected to grow to approximately 25.2 million in 2003.
As Web page volume and traffic increase, we cannot assure you that we will be
able to scale our systems proportionately. To the extent we do not successfully
address our capacity constraints, our operations may be severely disrupted, and
we may not be able to expand our user base and increase our attractiveness to
advertisers and merchants.
Unexpected network interruptions caused by system failures may result in
reduced visitor traffic, reduced revenue and harm to our reputation.
Our portal operations are dependent upon Web browsers, Internet service
providers, content providers and other Web site operators in China, which have
experienced significant system failures and system outages in the past. Our
users have in the past experienced difficulties due to system failures
unrelated to our systems and services. Any system failure or inadequacy that
causes interruptions in the availability of our services, or increases the
response time of our services, as a result of increased traffic or otherwise,
could reduce our user satisfaction, future traffic and our attractiveness to
users and advertisers.
Our operations are vulnerable to natural disasters and other events, as we
only have limited backup systems and do not maintain any backup servers
outside of China.
We have limited backup systems and have experienced system failures and
electrical outages from time to time in the past, which have disrupted our
operations. All of our servers and routers are currently hosted in a single
location within the premises of Beijing Telecom Administration. We do not
maintain any back up servers outside Beijing. We do not have a disaster
recovery plan in the event of damage from fire, floods, typhoons, earthquakes,
power loss, telecommunications failures, break-ins and similar events. If any
of the foregoing occur, we may experience a complete system shut-down. We do
not carry any business interruption insurance. To improve the performance and
to prevent disruption of our services, we may have to make substantial
investments to deploy additional servers or one or more copies of our Web sites
to mirror our online resources. Although we carry property insurance with low
coverage limits, our coverage may not be adequate to compensate us for all
losses, particularly with respect to loss of business and reputation, that may
occur.
Concerns about security of e-commerce transactions and confidentiality of
information on the Internet may increase our costs, reduce the use of our
portal and impede our growth.
A significant barrier to e-commerce and confidential communications over the
Internet has been the need for security. Internet usage could decline if any
well-publicized compromise of security occurred. We may incur
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significant costs to protect against the threat of security breaches or to
alleviate problems caused by these breaches. If unauthorized persons are able
to penetrate our network security, they could misappropriate proprietary
information or cause interruptions in our services. As a result, we may be
required to expend capital and resources to protect against or to alleviate
these problems. Security breaches could have a material adverse effect on our
business, financial condition and results of operations.
Our network operations may be vulnerable to hacking, viruses and other
disruptions, which may make our products and services less attractive and
reliable.
Internet usage could decline if any well publicized compromise of security
occurs. "Hacking" involves efforts to gain unauthorized access to information
or systems or to cause intentional malfunctions or loss or corruption of data,
software, hardware or other computer equipment. Hackers, if successful, could
misappropriate proprietary information or cause disruptions in our service. We
may be required to expend capital and other resources to protect our Web site
against hackers. We cannot assure you that any measures we may take will be
effective. Security breaches could have a material adverse effect on our
business. In addition, the inadvertent transmission of computer viruses could
expose us to a material risk of loss or litigation and possible liability, as
well as materially damage our reputation and decrease our user traffic.
Political, Economic and Regulatory Risks
Regulation and censorship of information distribution in China may adversely
affect our business.
China has enacted regulations governing Internet access and the distribution
of news and other information. Furthermore, the Propaganda Department of the
Chinese Communist Party has been given the responsibility to censor news
published in China to ensure, supervise and control proper political ideology.
In addition, the Ministry of Information Industry has published implementing
regulations that subject online information providers to potential liability
for content included on their portals and the actions of subscribers and others
using their systems, including liability for violation of PRC laws prohibiting
the distribution of content deemed to be socially destabilizing. Because many
PRC laws, regulations and legal requirements with regard to the Internet are
relatively new and untested, their interpretation and enforcement may involve
significant uncertainty. In addition, the PRC legal system is a civil law
system in which decided legal cases have limited binding force as legal
precedents. As a result, in many cases it is difficult to determine the type of
content that may result in liability for a Web site operator.
Periodically, the Ministry of Public Security has stopped the distribution
over the Internet of information which it believes to be socially
destabilizing. The Ministry of Public Security has the authority to cause any
local Internet service provider to block any Web site maintained outside China
at its sole discretion. If the PRC government were to take any action to limit
or eliminate the distribution of information through our portal or to limit or
regulate any current or future applications available to users of our portal,
such action could have a material adverse effect on our business, financial
condition and results of operations.
The State Secrecy Bureau, which is directly responsible for the protection
of state secrets of all PRC government and Chinese Communist Party
organizations, is authorized to block any Web site it deems to be leaking state
secrets or failing to meet the relevant regulations relating to the protection
of state secrets in the distribution of online information. Under the
applicable regulations, we may be held liable for any content transmitted on
our portal. Furthermore, where the transmitted content clearly violates the
laws of the PRC, we will be required to delete it. Moreover, where the
transmitted content is considered suspicious, we are required to report such
content. We must also undergo computer security inspections, and if we fail to
implement the relevant safeguards against security breaches, we may be shut
down. In addition, under recently adopted regulations, Internet companies which
provide bulletin board systems, chat rooms or similar services, such as our
company, must apply for the approval of the State Secrecy Bureau. As the
implementing rules of these new regulations have not been issued, however, we
do not know how or when we will be expected to comply. We cannot assure you
that our business, financial condition and results of operations will not be
materially and adversely affected by the application of these regulations.
19
<PAGE>
Political and economic policies of the PRC government could affect our
business.
All of our business, assets and operations are located in China and all of
our revenues are derived from our operations in China. Accordingly, our
business, financial condition and results of operations are affected to a
significant degree by economic, political and legal developments in China.
Changes in political, economic and social conditions in China, adjustments in
PRC government policies or changes in laws and regulations could adversely
affect our business, financial condition and results of operations.
The economy of China differs from the economies of most countries belonging
to the Organization for Economic Cooperation and Development in a number of
respects, including:
. structure;
. level of government involvement;
. level of development;
. level of capital reinvestment;
. growth rate;
. control of foreign exchange; and
. methods of allocating resources.
Since 1949, China has been primarily a planned economy subject to a system
of macroeconomic management. Although the Chinese government still owns a
significant portion of the productive assets in China, economic reform policies
since the late 1970s have emphasized decentralization, autonomous enterprises
and the utilization of market mechanisms. Although we believe that economic
reform and the macroeconomic measures adopted by the Chinese government have
had a positive effect on economic development in China, we cannot predict what
effects these measures may have on our business or results of operations.
The PRC legal system embodies uncertainties which could limit the legal
protections available to us and you.
The PRC legal system is a civil law system based on written statutes. Unlike
common law systems, it is a system in which decided legal cases have little
precedential value. In 1979, the PRC government began to promulgate a
comprehensive system of laws and regulations governing economic matters in
general. The overall effect of legislation over the past 20 years has
significantly enhanced the protections afforded to various forms of foreign
investment in mainland China. Our PRC operating subsidiary, Beijing ITC, is a
wholly- foreign owned enterprise, or WFOE, which is an enterprise incorporated
in mainland China and wholly-owned by foreign investors. Beijing ITC is subject
to laws and regulations applicable to foreign investment in mainland China in
general and laws and regulations applicable to WFOEs in particular. However,
these laws, regulations and legal requirements are relatively recent, and their
interpretation and enforcement involve uncertainties. These uncertainties could
limit the legal protections available to us and other foreign investors,
including you. In addition, we cannot predict the effect of future developments
in the PRC legal system, particularly with regard to the Internet, including
the promulgation of new laws, changes to existing laws or the interpretation or
enforcement thereof, or the preemption of local regulations by national laws.
Restrictions on currency exchange may limit our ability to utilize our
revenues effectively.
Substantially all of our revenues and operating expenses are denominated in
Renminbi. The Renminbi is currently freely convertible under the "current
account", which includes dividends, trade and service-related foreign exchange
transactions, but not under the "capital account", which includes foreign
direct investment.
Currently, Beijing ITC may purchase foreign exchange for settlement of
"current account transactions", including payment of dividends, without the
approval of the State Administration for Foreign Exchange, or SAFE. Beijing ITC
may also retain foreign exchange in its current account (subject to a ceiling
approved by
20
<PAGE>
the SAFE) to satisfy foreign exchange liabilities or to pay dividends. However,
we cannot assure you that the relevant PRC governmental authorities will not
limit or eliminate our ability to purchase and retain foreign currencies in the
future.
Since a significant amount of our future revenues will be in the form of
Renminbi, the existing and any future restrictions on currency exchange may
limit our ability to utilize revenue generated in Renminbi to fund our business
activities outside China, if any, or expenditures denominated in foreign
currencies.
Foreign exchange transactions under the capital account are still subject to
limitations and require approvals from the SAFE. This could affect Beijing
ITC's ability to obtain foreign exchange through debt or equity financing,
including by means of loans or capital contributions from us.
We may suffer currency exchange losses if the Renminbi depreciates relative
to the U.S. Dollar.
Our reporting currency is the U.S. Dollar. However, substantially all of our
assets and revenues are denominated in Renminbi. Our assets and revenues as
expressed in our U.S. Dollar financial statements will decline in value if the
Renminbi depreciates relative to the U.S. Dollar. Any such depreciation could
adversely affect the market price of our common stock. Very limited hedging
transactions are available in China to reduce our exposure to exchange rate
fluctuations. To date, we have not entered into any hedging transactions in an
effort to reduce our exposure to foreign currency exchange risk. While we may
decide to enter into hedging transactions in the future, the availability and
effectiveness of these hedges may be limited and we may not be able to
successfully hedge our exposure at all. In addition, our currency exchange
losses may be magnified by PRC exchange control regulations that restrict our
ability to convert Renminbi into U.S. Dollars.
Risks Related to this Offering
An active trading market for our shares may not develop and the trading price
for our shares may fluctuate significantly.
Prior to this offering, there has been no public market for our shares. If
an active public market for our shares does not develop after this offering,
the market price and liquidity of our shares may be adversely affected. Our
common stock has been approved for quotation on The Nasdaq Stock Market's
National Market. We can provide no assurances that a liquid public market for
our shares will develop.
The initial public offering price for our shares has been determined by
negotiation between us and the U.S. underwriters and international managers
based upon several factors and we can provide no assurance that the price at
which the shares are traded after this offering will not decline below the
initial offering price.
In addition, The Nasdaq Stock Market's National Market has from time to time
experienced significant price and volume fluctuations that have affected the
market prices for the securities of technology companies, particularly Internet
companies. As a result, investors in our shares may experience a decrease in
the value of their shares regardless of our operating performance or prospects.
In the past, following periods of volatility in the market price of a company's
securities, shareholders have often instituted securities class action
litigation against that company. If we were involved in a class action suit, it
could divert the attention of senior management, and, if adversely determined,
have a material adverse effect on our business, financial condition and results
of operations.
The sale or availability for sale of substantial amounts of our common stock
could adversely affect its market price.
Sales of substantial amounts of our common stock in the public market after
the completion of this offering, or the perception that these sales could
occur, could adversely affect the market price of our common stock and could
materially impair our future ability to raise capital through offerings of our
common stock.
21
<PAGE>
There will be 31,224,216 shares of common stock outstanding immediately after
this offering, or 31,914,216 shares if the U.S. underwriters and international
managers exercise their over-allotment option in full. In addition, as of May
31, 2000, there were outstanding options and warrants to purchase 1,616,654
shares, including options and warrants to purchase 543,670 shares that are
immediately exercisable. All of the shares sold in this offering will be freely
tradeable without restriction or further registration under the Securities Act,
unless held by our "affiliates" as that term is defined in Rule 144 under the
Securities Act. The 28,240,870 shares of common stock outstanding prior to this
offering (assuming the conversion of all outstanding convertible preferred
stock into common stock and the exercise of all outstanding options and
warrants to acquire common stock) are "restricted securities" as defined in
Rule 144 and may not be sold in the absence of registration other than in
accordance with Rule 144 or Rule 701 under the Securities Act or another
exemption from registration.
In connection with this offering, we, our executive officers and directors
and most of our preferred shareholders have agreed not to sell any shares of
common stock for 180 days after the date of this prospectus without the U.S.
underwriters' consent. However, the U.S. underwriters may release these shares
from these restrictions at any time. We cannot predict what effect, if any,
market sales of shares held by our significant shareholders or any other
shareholder or the availability of these shares for future sale will have on
the market price of our common stock. See "Shares Eligible for Future Sale" for
a more detailed description of the restrictions on selling shares of our common
stock after this offering.
A number of our shareholders are parties to an agreement with us that
provides these shareholders with the right to require us to register the sale
of shares owned by them. These rights cover more than 50% of our issued and
outstanding common stock prior to this offering (assuming the conversion of all
outstanding shares of preferred stock into common stock and the exercise of all
outstanding options and warrants to acquire common stock) and will also cover
any additional shares obtained by these shareholders from time to time.
Registration of these shares of our common stock would permit the sale of these
shares without regard to the restrictions of Rule 144. Under the terms of this
agreement, we do not have any obligation to register for sale with the
Securities and Exchange Commission any shares of common stock held by these
shareholders if, within the six month period preceding the date of the request
for registration, we have already effected a registration under the Securities
Act pursuant to a request by these shareholders or in which these shareholders
had an opportunity to participate. For a further discussion of these
registration rights, see "Description of Capital Stock -- Registration Rights."
We are controlled by a small group of our existing shareholders, whose
interests may differ from other shareholders.
Our three largest shareholders currently beneficially own approximately 67%
of our outstanding shares (assuming the conversion of all outstanding shares of
preferred stock into common stock and the exercise of all outstanding options
and warrants to acquire common stock), and following this offering will
beneficially own approximately 58% of the outstanding shares, or 57% if the
U.S. underwriters and international managers exercise their over-allotment
option in full. Accordingly, they will have significant influence in
determining the outcome of any corporate transaction or other matter submitted
to the shareholders for approval, including mergers, consolidations and the
sale of all or substantially all of our assets, election of directors and other
significant corporate actions. They will also have the power to prevent or
cause a change in control. In addition, without the consent of these
shareholders, we could be prevented from entering into transactions that could
be beneficial to us. The interests of these shareholders may differ from the
interests of the other shareholders.
Holders of approximately 76% of the outstanding shares of our common stock
immediately following this offering (assuming the conversion of all outstanding
shares of preferred stock into common stock and the exercise of all outstanding
options and warrants to acquire common stock) are parties to an agreement under
which they have agreed to vote together in favor of their nominees to our board
of directors. As a result of their voting power, they will have the ability to
cause their nominees to be elected. See "Related Party Transactions" and
"Principal Shareholders" for more information regarding the share ownership of
our officers, directors and significant shareholders.
22
<PAGE>
Because the initial public offering price is substantially higher than the
pro forma net tangible book value per share, you will incur immediate and
substantial dilution.
If you purchase common stock in this offering, you will pay more for your
shares than the amount paid by existing shareholders for their shares. As a
result, you will experience immediate and substantial dilution of approximately
$10.27 per share (assuming the conversion of all outstanding convertible
preferred stock into common stock and no exercise of outstanding options or
warrants to acquire common stock), representing the difference between our pro
forma net tangible book value per share as of March 31, 2000, after giving
effect to this offering at the initial public offering price of $13.00 per
share. In addition, you may experience further dilution to the extent that
shares of our common stock are issued upon the exercise of stock options or
warrants. Substantially all of the shares issuable upon the exercise of
currently outstanding stock options or warrants will be issued at a purchase
price less than the public offering price per share in this offering. See
"Dilution" for a more complete description of how the value of your investment
in our common stock will be diluted upon the completion of this offering.
Anti-takeover provisions of the Delaware General Corporation Law and our
certificate of incorporation could delay or deter a change in control.
Amendments we intend to make to our certificate of incorporation and our
bylaws prior to the consummation of this offering, as well as various
provisions of the Delaware General Corporation Law, may make it more difficult
to effect a change in control of our company. The existence of these provisions
may adversely affect the price of our common stock, discourage third parties
from making a bid for our company or reduce any premiums paid to our
shareholders for their common stock. For example, we intend to amend our
certificate of incorporation to authorize our board of directors to issue
"blank check" preferred stock and to attach special rights and preferences to
this preferred stock. The issuance of this preferred stock may make it more
difficult for a third party to acquire control of us. We also intend to amend
our certificate of incorporation to provide for the division of the board of
directors into two classes as nearly equal in size as possible with staggered
two-year terms. This classification of the board of directors could have the
effect of making it more difficult for a third party to acquire our company, or
of discouraging a third party from acquiring control of our company. See
"Description of Capital Stock -- Preferred Stock," and "Description of Capital
Stock -- Anti-Takeover Effects of Delaware Law and our Sixth Amended and
Restated Certificate of Incorporation and Bylaws" for a more complete
description of our capital stock, our certificate of incorporation and the
effects of the Delaware General Corporation Law that could hinder a third
party's attempts to acquire control of us.
23
<PAGE>
ENFORCEABILITY OF CIVIL LIABILITIES
We are a company organized under the laws of Delaware, but substantially all
of our assets are located in the PRC. We have appointed CT Corporation System,
111 Eighth Avenue, New York, New York 10011, as our agent to receive service of
process with respect to any action brought against us in the United States
District Court for the Southern District of New York under the securities laws
of the United States or of any State of the United States, or any action
brought against us in the Supreme Court of the State of New York in the County
of New York under the securities laws of the State of New York. However, it may
be difficult for investors to enforce outside the United States judgments
against us obtained in the United States in any such actions, including actions
predicated upon the civil liability provisions of the federal securities laws
of the United States or of the securities laws of any State of the United
States. In addition, certain of our directors and officers and certain of the
experts named herein are resident outside the United States (principally in the
PRC) and all or a substantial portion of the assets of such persons are or may
be located outside the United States. As a result, it may not be possible for
investors to effect service of process within the United States upon such
persons, or to enforce against them or us judgments obtained in United States
courts, including judgments predicated upon the civil liability provisions of
the federal securities laws of the United States or of the securities laws of
any State of the United States. We have been advised by our PRC counsel,
TransAsia Lawyers, that in their opinion, there is doubt as to the
enforceability in the PRC, in original actions or in actions for enforcement of
judgments of United States courts, of civil liabilities predicated solely upon
the federal securities laws of the United States or the securities laws of any
State of the United States.
------------
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements that are based on our
current expectations, assumptions, estimates and projections about us and our
industry. All statements other than statements of historical fact in this
prospectus are forward-looking statements. These forward-looking statements are
subject to various risks and uncertainties. Generally, these forward-looking
statements can be identified by the use of forward-looking terminology such as
"may", "will", "expect", "anticipate", "estimate", "plan" or other similar
words. These statements discuss future expectations, identify strategies,
contain our projections of future results of operations or financial condition
or state other "forward-looking" information. Known and unknown risks,
uncertainties and other factors could cause the actual results to differ
materially from those contained in any forward-looking statement.
Although we believe that our expectations expressed in these forward-looking
statements are reasonable, we cannot assure you that our expectations will turn
out to be correct. Our actual results could be materially different from and
worse than our expectations. We have no obligation to update publicly or revise
any forward-looking statements. Important risks and factors that could cause
our actual results to be materially different from our expectations are
generally set forth in the "Risk Factors", "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business"
sections and elsewhere in this prospectus.
24
<PAGE>
USE OF PROCEEDS
We estimate that we will receive net proceeds from this offering of
approximately $54 million, or approximately $62 million if the U.S.
underwriters' and international managers' over-allotment option is exercised in
full, after deducting the estimated underwriting discount and offering expenses
payable by us.
We intend to use approximately $17.0 million of the net proceeds to fund
capital expenditures, with additions to our networking and computer
infrastructure accounting for approximately $15.5 million. In addition, we
intend to use approximately $36.0 million for sales and marketing activities.
The remainder of the net proceeds will be used for general corporate purposes,
including working capital and expansion of our work force. We may also use a
portion of the net proceeds for possible acquisitions of or investments in
businesses, products and technologies that are complementary to our business,
although we do not currently have any agreements or understandings to make any
acquisitions or investments.
The foregoing represents our present intentions with respect to the
allocation of the net proceeds of this offering based upon our present plans
and business conditions. The occurrence of unforeseen events or changed
business conditions could result in the application of the proceeds of this
offering in a manner other than as described in this prospectus.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock. We
currently intend to retain future earnings, if any, to finance our business and
to fund growth and, therefore, do not expect to pay any cash dividends for the
foreseeable future. Any future determination to pay dividends will be made at
the discretion of our board of directors and will be based upon our earnings,
cash flow, financial condition and capital requirements and any other
conditions our board of directors deems relevant. In addition, the payment of
dividends may be limited by financing agreements that we may enter into in the
future.
25
<PAGE>
CAPITALIZATION
The following table sets forth our cash and cash equivalents, short-term
debt and capitalization as of March 31, 2000:
(1) on an actual basis;
(2) on a pro forma basis to reflect:
. the conversion of 2,925,000 shares of Series A preferred stock into
2,925,000 shares of common stock;
. the conversion of 4,521,166 shares of Series B preferred stock into
7,535,276 shares of common stock;
. the conversion of 879,567 shares of Series B-1 preferred stock into
879,567 shares of common stock;
. the conversion of 3,846,718 shares of Series C preferred stock into
3,846,718 shares of common stock;
. the conversion of 2,021,989 shares of Series D preferred stock into
2,021,989 shares of common stock;
(3) on a pro forma as adjusted basis to reflect the mandatory conversion of
all the preferred stock and the sale of 4,600,000 shares of common
stock offered in this offering at the initial public offering price of
$13.00 per share, after the deduction of underwriting discounts and
estimated expenses payable by us in this offering.
In connection with this offering, under the terms of our preferred stock,
all of our outstanding shares of preferred stock will mandatorily convert into
shares of common stock if and when the aggregate proceeds from this offering
are not less than $20,000,000 and with a price to the public of at least
$14.837 per share. The holders of preferred stock have agreed to reduce this
minimum price to $13.00 per share.
26
<PAGE>
You should read this table together with "Selected Consolidated Financial
Data", "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and our consolidated financial statements, including the notes
thereto, appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
As of March 31, 2000
----------------------------
Pro forma
as
Actual Pro forma adjusted
------- --------- ---------
(in thousands)
<S> <C> <C> <C>
Cash and cash equivalents.......................... $33,106 $33,106 $87,120
======= ======= =======
Short-term debt.................................... $ 2,899 $ 2,899 $ 2,899
======= ======= =======
Long-term debt..................................... $ -- $ -- $ --
------- ------- -------
Mandatorily redeemable preferred stock:
Series B and B-1 mandatorily redeemable
convertible preferred stock, par value $0.001:
5,400,733 shares authorized, 5,400,733 shares
issued and outstanding, actual (no shares
authorized or outstanding, pro forma and pro
forma as adjusted)(1)........................... $ 2,947 $ -- $ --
Series C mandatorily redeemable convertible
preferred stock, par value $0.001: 4,807,101
shares authorized, 3,846,718 shares issued and
outstanding, actual (no shares authorized or
outstanding, pro forma and pro forma as
adjusted)(2).................................... 7,721 -- --
Series D mandatorily redeemable convertible
preferred stock, par value $0.001: 2,021,989
shares authorized, 2,021,989 shares outstanding,
actual (no shares authorized or outstanding, pro
forma and pro forma as adjusted)(3)............. 31,053 -- --
------- ------- -------
Total mandatorily redeemable preferred stock... $41,721 $ -- $ --
------- ------- -------
Shareholders' equity (deficit):
Series A convertible preferred stock, par value
$0.001: 2,925,000 shares authorized, 2,925,000
shares issued and outstanding, actual (no shares
authorized or outstanding, pro forma and pro
forma as adjusted).............................. $ 3 $ -- $ --
Common stock, par value $0.001: 75,400,000 shares
authorized, 9,415,666 shares issued and
outstanding, actual (75,400,000 shares
authorized and 26,624,216 shares issued and
outstanding, pro forma; 31,224,216 shares issued
and outstanding, pro forma as adjusted)(4)...... 9 26 31
Additional paid-in capital......................... 2,265 43,972 97,000
Deferred compensation and other.................... (1,700) (1,700) (1,700)
Accumulated deficit................................ (9,509) (9,509) (9,509)
------- ------- -------
Total shareholders' equity (deficit)............. (8,932) 32,789 85,822
------- ------- -------
Total capitalization............................ $35,688 $35,688 $88,721
======= ======= =======
</TABLE>
---------------------
(1) Recorded at its issuance costs plus amortization of the increase in the
value of the Series B and B-1 preferred stock since issuance. The recorded
value of the preferred stock is being adjusted upwards to its estimated
redemption amount through periodic charges to retained earnings. These
charges, which are reflected in our statement of operations as accretion on
mandatory convertible preferred stock, totaled $244 and $467 for the years
ended December 31, 1998 and 1999, respectively, and $114 and $116 for the
three months ended March 31, 1999 and 2000, respectively.
(2) Recorded at its issuance costs plus amortization of the increase in the
value of the Series C preferred stock since issuance. The recorded value of
the preferred stock is being adjusted upwards to its estimated redemption
amount through periodic charges to retained earnings. These charges, which
are reflected in our statement of operations as accretion on mandatory
convertible preferred stock, totaled $0 and $450 for the years ended
December 31, 1998 and 1999, respectively, and $0 and $345 for the three
months ended March 31, 1999 and 2000, respectively.
(3) Recorded at its issuance costs plus amortization of the increase in the
value of the Series D preferred stock since issuance. The recorded value of
the preferred stock is being adjusted upwards to its estimated redemption
amount through periodic charges to retained earnings. These charges, which
are reflected in our statement of operations as accretion on mandatory
convertible preferred stock, totaled $0 and $0 for the years ended December
31, 1998 and 1999, respectively, and $1,098 for the three months ended
March 31, 2000.
(4) Excludes 1,071,312 shares reserved for issuance pursuant to options we may
issue in the future pursuant to our stock option plans and stock options
and warrants outstanding as of March 31, 2000 to purchase an aggregate of
1,616,654 shares of our common stock at a weighted average exercise price
of $2.95 per share and options to purchase up to 598,000 additional shares
of our common stock which we intend to grant prior to the closing of this
offering at an exercise price equal to the initial public offering price.
27
<PAGE>
DILUTION
As of March 31, 2000, our pro forma net tangible book value was $32,070,000,
or $1.20 per share. Pro forma net tangible book value per share represents the
amount of our total consolidated tangible assets, minus the amount of our total
consolidated liabilities, divided by the total number of shares of our common
stock outstanding on that date, as adjusted to give pro forma effect as of that
date to the conversion of all our outstanding preferred stock into common
stock. See "Capitalization". Assuming we had sold the shares of common
stock offered in this offering at the initial public offering price of $13.00
per share, after giving effect to the sale of the shares offered in this
offering and after deducting underwriting discounts and commissions and other
estimated expenses of this offering, our pro forma net tangible book value at
March 31, 2000 would have increased to $85,103,000, or $2.73 per share. This
represents an immediate increase of $1.53 in net tangible book value per share
to existing shareholders and an immediate dilution of $10.27 in net tangible
book value per share to new investors purchasing the shares at the initial
public offering price. Dilution is determined by subtracting pro forma net
tangible book value per share after this offering from the amount of cash paid
by a new investor for one share. The following table illustrates such per share
dilution.
<TABLE>
<S> <C> <C>
Initial public offering price per share........................... $13.00
Pro forma net tangible book value per share at March 31, 2000... $1.20
Increase in pro forma net tangible book value per share
attributable to new investors.................................. $1.53
------
Pro forma net tangible book value per share after giving effect to
this offering.................................................... $2.73
Dilution in pro forma net tangible book value per share to new
investors........................................................ $10.27
======
</TABLE>
The following table summarizes the number of shares purchased from us as of
March 31, 2000, the total consideration paid to us and the average price per
share paid by existing investors and by new investors purchasing shares in this
offering at the initial public offering price of $13.00 per share and without
giving effect to underwriting discounts and commissions and other estimated
expenses of this offering:
<TABLE>
<CAPTION>
Shares Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing investors......... 26,624,216 85.3% $39,350,000 39.7% $1.48
New investors.............. 4,600,000 14.7 59,800,000 60.3 13.00
---------- ------ ----------- ------ -----
Total.................... 31,224,216 100.00% $99,150,000 100.00% $3.18
========== ====== =========== ====== =====
</TABLE>
The foregoing discussion and table assumes no exercise of any outstanding
stock options or warrants. As of March 31, 2000, there were stock options and
warrants outstanding to purchase an aggregate of 1,616,654 shares of our common
stock at a weighted average exercise price of $2.95 per share. If all these
options and warrants had been exercised on March 31, 2000, before giving effect
to this offering, our pro forma net tangible book value would have been
approximately $36,841,000, or $1.30 per share. After giving effect to this
offering, our pro forma net tangible book value on March 31, 2000 would have
been approximately $89,872,129, or $2.74 per share, the increase in net
tangible book value attributable to new investors would have been $1.44 per
share and the dilution in net tangible book value to new investors would have
been $10.26 per share. In addition, the dilution will be $10.07 per share if
the U.S. underwriters and international managers fully exercise their over-
allotment options.
28
<PAGE>
EXCHANGE RATE INFORMATION
The following table sets forth information concerning the noon buying rates
in New York City for cable transfers in Renminbi and U.S. Dollars, as certified
for customs purposes by the Federal Reserve Bank in New York, for the periods
indicated:
<TABLE>
<CAPTION>
Noon Buying Rate
-----------------------------------
Period Period End Average(1) High Low
------ ---------- ---------- ------ ------
(RMB per $1.00)
<S> <C> <C> <C> <C>
1994........................................ 8.6442 8.6306 8.8270 8.4545
1995........................................ 8.3374 8.3713 8.5000 8.2916
1996........................................ 8.3284 8.3394 8.5000 8.3002
1997........................................ 8.3100 8.3194 8.3290 8.2911
1998........................................ 8.2789 8.3009 8.3180 8.2774
1999........................................ 8.2795 8.2784 8.2800 8.2770
2000 (through July 3, 2000)................. 8.2786 8.2784 8.2799 8.2768
</TABLE>
---------------------
(1) Determined by averaging the rates on the last business day of each month
during the respective period.
29
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data is qualified by reference
to, and should be read in conjunction with, our financial statements and the
notes to those statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere in this
prospectus. The selected statement of operations data presented below for the
years ended December 31, 1997, 1998 and 1999, and the selected balance sheet
data as of December 31, 1998 and 1999, are derived from our financial
statements that have been audited by PricewaterhouseCoopers, independent public
accountants, and are included elsewhere in this prospectus. The statement of
operations data presented below for the period from August 2, 1996 (inception)
to December 31, 1996, and the selected balance sheet data as of December 31,
1996, are derived from our audited financial statements not included in this
prospectus. The selected statement of operations data for the three-months
periods ended March 31, 1999 and 2000, and the selected balance sheet data as
of March 31, 2000, are derived from our unaudited financial statements included
elsewhere in this prospectus. These unaudited financial statements have been
prepared on the same basis as our audited financial statements and, in our
opinion, include all material adjustments, consisting only of normal recurring
adjustments, necessary to state fairly this unaudited financial information.
Our consolidated financial statements are prepared and presented in
accordance with United States generally accepted accounting principles. Basic
and diluted pro forma net loss per share in 1999 is computed using the weighted
average number of common shares outstanding, including the pro forma effects of
the mandatory conversion of the Series A, B, B-1, C preferred stock into common
stock upon the consummation of this offering. Basic and diluted pro forma net
loss per share for the three months ended March 31, 1999 and 2000 is computed
using the weighted average number of shares of common stock outstanding,
including the pro forma effects of the mandatory conversion of the Series A, B,
B-1, C and D preferred stock into common stock upon the consummation of this
offering.
30
<PAGE>
<TABLE>
<CAPTION>
Period from
August 2, 1996 Three months ended
(inception) to Year ended December 31, March 31,
December 31, ---------------------------------- ----------------------
1996 1997 1998 1999 1999 2000
-------------- ---------- ---------- ---------- ---------- ----------
(in thousands, except for per share and share data)
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $ -- $ 78 $ 472 $ 1,617 $ 233 $ 842
Costs and expenses:
Cost of revenues....... -- 19 215 1,576 172 811
Product development.... -- 50 208 427 55 348
Sales and marketing.... -- 94 351 1,758 126 1,533
General and
administrative........ 18 75 308 1,270 163 516
Stock-based
compensation(1)....... 12 -- -- 46 -- 201
---------- ---------- ---------- ---------- ---------- ----------
Total costs and
expenses........... 30 238 1,082 5,077 516 3,409
---------- ---------- ---------- ---------- ---------- ----------
Operating loss......... (30) (160) (610) (3,460) (283) (2,567)
Interest income........ 1 -- 23 25 7 31
Interest expense --
related party......... -- -- (28) (14) -- --
---------- ---------- ---------- ---------- ---------- ----------
Net loss................ (29) (160) (615) (3,449) (276) (2,536)
Accretion on mandatorily
redeemable convertible
preferred stock........ -- -- (244) (917) (114) (1,559)
---------- ---------- ---------- ---------- ---------- ----------
Net loss attributable to
common stockholders.... $ (29) $ (160) $ (859) $ (4,366) $ (390) $ (4,095)
========== ========== ========== ========== ========== ==========
Basic and diluted net
loss per share
attributable to common
stockholders........... $ (0.003) $ (0.02) $ (0.09) $ (0.47) $ (0.04) $ (0.43)
Shares used in computing
basic and diluted net
loss per share......... 9,100,000 9,100,000 9,224,000 9,328,000 9,265,000 9,416,000
Basic and diluted pro
forma net loss per
share.................. $ (0.16) $ (0.10)
Shares used in computing
basic and diluted pro
forma net loss per
share.................. 21,615,000 25,950,000
Cost of revenues..... $ -- -- -- $ 13 $ -- $ 6
Product development.. -- -- -- 11 -- 4
Sales and marketing.. -- -- -- 14 -- 17
General and
administrative...... 12 -- -- 8 -- 174
---------- ---------- ---------- ---------- ---------- ----------
$ 12 $ -- $ -- $ 46 $ -- $ 201
========== ========== ========== ========== ========== ==========
</TABLE>
---------------------
(1) Stock-based compensation:
31
<PAGE>
The following table is a summary of our consolidated balance sheet as of
December 31, 1996, 1997, 1998 and 1999 and as of March 31, 2000:
. on an actual basis;
. on a pro forma basis to give effect to the mandatory conversion of all
outstanding Series A, B, B-1, C and D preferred stock into common stock
upon the closing of this offering; and
. on a pro forma as adjusted basis to reflect the mandatory conversion of
all the preferred stock and the sale of 4,600,000 shares of common stock
offered at the initial public offering price of $13.00 per share, after
deducting estimated underwriting discounts and commissions and offering
expenses.
<TABLE>
<CAPTION>
As of December 31, As of March 31, 2000
------------------------- ------------------------------
Pro forma
1996 1997 1998 1999 Actual Pro forma as adjusted
---- ---- ------ ------- ------- --------- -----------
(in thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash
equivalents............ $87 $111 $1,232 $ 3,924 $33,106 $33,106 $87,120
Working capital......... 194 22 1,303 2,577 28,801 28,801 82,815
Total assets............ 217 179 1,778 7,076 38,111 38,111 91,144
Total liabilities....... 18 115 204 1,911 5,322 5,322 5,322
Mandatorily redeemable
convertible preferred
stock.................. -- -- 2,362 10,207 41,721 -- --
Total shareholders'
equity (deficit)....... 199 64 (788) (5,042) (8,932) 32,789 85,822
</TABLE>
32
<PAGE>
CORPORATE RESTRUCTURING
Overview
Under current PRC regulations, foreign companies such as Sohu.com Inc. may
not own or operate telecommunications businesses in China, which may include
the operation of Internet content provision businesses. Our wholly owned PRC
subsidiary, Beijing ITC, does not have a license to provide internet content or
information services. As a result, we recently restructured our operations in
China. As part of this restructuring, we and Beijing ITC entered into a series
of agreements with Beijing Sohu and Beijing Sohu's two shareholders. Beijing
Sohu is a PRC company that is 80% owned by Dr. Charles Zhang, our founder,
President and Chief Executive Officer, and 20% owned by Ms. Jinmei He, an
executive officer of Beijing ITC, both of whom are PRC nationals.
Under our restructuring and agreements with Beijing Sohu and its two
shareholders:
. Beijing ITC is responsible for all technical matters relating to our
www.sohu.com platform, conducts our online advertising, e-commerce
applications, directory and search engine and other businesses as
described in this prospectus and continues to receive the revenues from
these activities.
. Our content-related operations, including the development, collection,
classification, supervision and dissemination of content for our Web
site, were transferred to Beijing Sohu, which has received approval from
the MII to develop Internet content and information services.
. Beijing ITC will transfer its ten content related servers, related
equipment and up to 25 content editors and supervisors to Beijing Sohu.
. Beijing Sohu provides and develops content for use by Beijing ITC on our
Web site for a monthly fee subject to periodic adjustment as agreed by
the parties.
. Beijing ITC provides relevant consulting and technical services to
Beijing Sohu and grants to Beijing Sohu, and will assist Beijing Sohu in
obtaining from our company, the necessary domain name, trade name,
trademark and copyright licenses to support Beijing Sohu's operations.
. Beijing ITC or a third party designated by Beijing ITC will have the
right, at any time, subject to PRC law (including any restrictions on
foreign investment), to purchase the entire ownership interest in
Beijing Sohu of the two Beijing Sohu shareholders.
. We plan to extend a loan for $176,000 to Dr. Charles Zhang and a loan
for $43,000 to Ms. Jinmei He, solely for the purpose of helping them
fund their additional equity investments in Beijing Sohu as a result of
our restructuring. Dr. Zhang and Ms. He have pledged all of their shares
in Beijing Sohu to us as security for the loans.
For more information on these agreements, see "Related Party Transactions".
In the opinion of our PRC counsel, the ownership structures of Sohu.com
Inc., Beijing ITC and Beijing Sohu, both currently and after giving effect to
this offering, and the businesses and operations of Sohu, Beijing ITC and
Beijing Sohu as described in this prospectus, comply with all existing laws,
rules and regulations of the PRC, and no consent, approval or license other
than those already obtained is required under any of the existing laws, rules
and regulations of the PRC for such ownership structures, businesses and
operations or this offering. See "Risk Factors -- PRC Internet laws and
regulations are unclear and will likely change in the near future. If we are
found to be in violation of current or future PRC laws and regulations, we
could be subject to severe penalties" and "PRC Regulatory Matters".
33
<PAGE>
The following chart illustrates our corporate structure after the corporate
restructuring.
[RESTRUCTURING CHART]
(1) Beijing ITC is responsible for the consulting and technical matters
relating to the www.sohu.com platform, conducts online advertising, e-
commerce applications, directory and search engine and other businesses
as described in this prospectus and receives the revenue from these
activities.
(2) Beijing Sohu is responsible for our content-related operations,
including the development, collection, classification, supervision and
dissemination of content for the Web site, and has received approval
from the MII to develop Internet information services.
Pro Forma Effect of Corporate Restructuring
As a result of the corporate restructuring described above, our financial
statements have been affected as follows:
. Reduce the balance of cash and record a corresponding loan receivable in
the amount of $219,000 for funds lent to the shareholders of Beijing
Sohu; and
. Reduce the balance of fixed assets by $89,000 and record a corresponding
receivable with respect to the net book value of the computer equipment
transferred to Beijing Sohu.
In addition, subsequent to the corporate restructuring, certain content-related
operations previously conducted by Beijing ITC will be conducted by Beijing
Sohu. For the three months ended March 31, 2000, the cost of conducting these
operations was approximately $97,000. If Beijing Sohu had conducted these
operations during the three months ended March 31, 2000, the estimated cost
would have been approximately $106,000. The incremental cost represents
additional tax and overhead costs associated with conducting these operations
in a separate PRC legal entity. As Beijing ITC uses the content developed by
Beijing Sohu, and as we expect to fund Beijing Sohu's ongoing operations
through a monthly fee payable under the cooperation agreement, Beijing ITC will
record an expense approximately equal to the entire amount of Beijing Sohu's
costs on a monthly basis plus business tax charges.
34
<PAGE>
The following tables, which are unaudited, show the pro forma effect of our
restructuring as if it had occurred on January 1, 1999 for statement of
operations purposes and as of March 31, 2000 for balance sheet purposes.
<TABLE>
<CAPTION>
Year Ended December 31, 1999 Three Months Ended March 31, 2000
------------------------------------ ------------------------------------
Pro forma Pro forma
Actual adjustments Pro forma Actual adjustments Pro forma
---------- ----------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
(in thousands, except for per share and share data)
Statement of Operation
Data:
Revenues................ $ 1,617 $-- $ 1,617 $ 842 $-- $ 842
Costs and expenses...... (5,077) (30)(/1/) (5,107) (3,409) (9)(/1/) (3,418)
Operating loss.......... (3,460) (30) (3,490) (2,567) (9) (2,576)
Net loss................ (3,449) (30) (3,479) (2,536) (9) (2,545)
Net loss attributable to
common stockholders.... (4,366) (30) (4,396) (4,095) (9) (4,041)
Basic and diluted net
loss per share
attributable to common
stockholders........... $ (0.47) $ (0.47) $ (0.43) $ (0.43)
Shares used in computing
basic and diluted net
loss per share......... 9,328,000 9,328,000 9,416,000 9,416,000
</TABLE>
---------------------
(1) Reflects pro forma increases in costs and expenses for the year ended
December 31, 1999 and the three month period ended March 31, 2000. The
adjustments include the net effect of: (i) a decrease in our expenses
representing the expenses of the content management and development
operations formerly incurred by Beijing ITC that were transferred to
Beijing Sohu and (ii) an increase in our expenses representing the monthly
fee that Beijing ITC pays to Beijing Sohu under the cooperation agreement.
The monthly fee is higher than Beijing Sohu's expenses because the fee is
designed to reimburse Beijing Sohu for the expenses plus incremental 5%
business taxes.
<TABLE>
<CAPTION>
As of March 31, 2000
-------------------------------
Pro forma Pro
Actual adjustments forma
------- ----------- -------
<S> <C> <C> <C>
(in thousands)
Balance Sheet Data:
Cash and cash equivalents.................... $33,106 $(219)(/1/) $32,887
Working capital.............................. 28,801 (219)(/2/) 28,582
Fixed assets................................. 2,227 (41)(/3/) 2,186
Total assets................................. 38,111 -- 38,111
Total liabilities............................ 5,322 -- 5,322
Mandatorily redeemable convertible preferred
stock....................................... 41,721 -- 41,721
Total shareholders' equity (deficit)......... (8,932) -- (8,932)
</TABLE>
---------------------
(1) Reflects a pro forma decrease in cash and cash equivalents of $219 as of
March 31, 2000 due to the extension of loans to Charles Zhang and Jinme He,
the shareholders of Beijing Sohu, to fund their additional investment in
Beijing Sohu. The ten year loans will be reflected on our balance sheet as
long term receivables, which are reflected in pro forma total assets.
Accordingly, this adjustment has no net effect on pro forma total assets.
(2) Reflects a pro forma decrease in working capital of $219 as of March 31,
2000 due to the loans described above of $219. The receivable of $41 from
the sale of the fixed assets to Beijing Sohu is recorded in long-term
assets and thus does not affect working capital.
(3) Reflects a pro forma decrease in fixed assets of $41 as of March 31, 2000,
representing the book value of the servers of Beijing ITC that will be
transferred to Beijing Sohu under the restructuring. This amount excludes
certain servers acquired by Beijing ITC after March 31, 2000 at a cost of
approximately $48 that will also be transferred to Beijing Sohu under the
restructuring.
35
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated
financial statements and notes to those statements and other financial
information appearing elsewhere in this prospectus.
Overview
Sohu is a leading Internet portal in China in terms of brand recognition,
page views and registered users. We were incorporated in August 1996 as
Internet Technologies China Incorporated, and for the period from our inception
through December 1996, we focused our activities on the development of our Web
site while incurring minimal operating expenses. We launched our original Web
site, www.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 Web site
under www.sohu.com.cn, and during 1998, we also:
. launched our online directory and search engine;
. began offering content channels, including news and sports;
. improved and upgraded our services;
. expanded our production staff; and
. increased our marketing activities in order to build the Sohu brand.
In 1999, we re-named our company Sohu.com Inc., and continued the
development of our Web site, as well as our business, sales and marketing
activities. In particular, we:
. experienced substantial growth in registered users and page views;
. upgraded our search engine capabilities and launched our e-mail
services;
. significantly increased our production, marketing and sales staff;
. expanded our branded content channels, featuring news, sports, business
and finance and other topics of interest to Internet users in China; and
. began providing e-commerce services on a trial basis.
Substantially all of our operations are conducted through Sohu ITC
Information Technology (Beijing) Co., Ltd., or Beijing ITC, our wholly owned
PRC subsidiary, which was incorporated in 1997. Under current PRC regulations,
foreign companies such as Sohu.com Inc. may not own or operate
telecommunications businesses in China, which may include the operation of
Internet content provision businesses. As a result, we recently restructured
our operations in the PRC. As part of this restructuring, our content-related
operations were transferred to Beijing Sohu Online Network Information
Services, Ltd., or Beijing Sohu, a PRC company that is 80% owned by Charles
Zhang, our founder, President and Chief Executive Officer, and 20% owned by
Jinmei He, an executive officer of Beijing ITC. Beijing Sohu is not a
subsidiary of our company. PRC regulations currently restrict us from holding
an equity interest in Beijing Sohu. As a result, the assets, liabilities and
results of operations of Beijing Sohu will not be consolidated with those of
our company. However, as we will continue to provide financial support and
assistance to Beijing Sohu, to the extent that losses are incurred by Beijing
Sohu in the future we will record those losses in our consolidated financial
statements. For a description of the pro forma effects of the restructuring on
our consolidated financial statements for the year ended December 31, 1999 and
the three months ended March 31, 2000, see "Corporate Restructuring -- Pro
Forma Effect of Corporate Restructuring".
36
<PAGE>
Revenues
We have derived substantially all of our revenues from the sale of
advertisements on our portal. Advertising revenues are derived principally
from:
. advertising arrangements under which we receive fixed fees for banners
placed on our Web sites for specified periods of time and with a
guaranteed number of impressions;
. sponsorship arrangements which allow advertisers to sponsor an area on
our Web site in exchange for a fixed payment; such arrangements may also
guarantee a number of impressions over a specified period of time; and
. design, coordination and production of advertising campaigns to be
placed on our portal.
Rates for banner advertising depend on:
. term of the contract;
. whether the impressions are for general audiences or targeted audiences;
. where the banner advertisements are placed within our portal; and
. the number of guaranteed impressions or other performance obligations.
Sponsorship arrangements generally have higher advertising rates than banner
advertising, because sponsorship arrangements typically provide advertisers
with the right to specify the content to be included, and may also provide the
exclusive right to advertise in a specific, designated location on our Web site
for a specified period of time. Sponsorship arrangements also may have longer
terms and other performance obligations. These performance obligations relate
to the design, integration and co-ordination of content and links in the
content channels on our Web site. Sponsorship contracts do not generally
include an allocation of the contract value among specific services provided,
and we have not made any such allocation for the purpose of revenue
recognition. Revenue from short-term (i.e., less than 90 days) sponsorship
contracts is recognized once the related services have been performed and the
channel and related links have been placed on our Web site. Revenue from long-
term (i.e., more than 90 days) sponsorship contracts is recognized ratably over
the term of the sponsorship agreement.
Advertising revenues are recognized ratably in the period in which the
advertisement is displayed, provided that no significant obligations remain at
the end of the period and collection of the resulting receivable is probable.
To the extent minimum guaranteed impression levels or other performance
obligations are not met, we defer recognition of the corresponding revenues
until guaranteed levels are achieved or the remaining performance obligations
are met.
Under some of our content arrangements, we have agreed to pay royalties to
content providers based on a percentage of the advertising revenues derived
from advertisements placed on our channels. Under some of the other content
arrangements, we pay fixed fees for content provided over a specified period of
time, generally ranging from three to 24 months. Where content agreements
provide for royalties, those royalty rates generally range from 15% to 50% of
the related revenues. In 1999, 6.6% of our revenues were subject to such
royalty agreements with content providers, with royalties in the amount of
$24,000 being paid to content providers. In the first quarter of 2000,
approximately 4% of our revenues were subject to such royalty arrangements,
with $2,000 in royalties being paid to content providers. We have recorded the
entire amount of revenues subject to fixed fee and royalty arrangements in our
consolidated revenues and the fees and royalties due to our content providers
in our cost of revenues.
To date, we have not recorded any revenues from barter transactions.
37
<PAGE>
In 1999, the duration of our advertising contracts ranged from 2 days to
365 days, with an average duration of 45 days, compared to an average duration
of 107 days in 1998. In the first quarter of 2000, the duration ranged from 2
days to 268 days, with an average of 56 days. In addition, in 1999, we charged
an average price of $18 per 1,000 guaranteed impressions, compared to an
average price of $13 in 1998. The average price in the first quarter of 2000
was $20 per 1,000 guaranteed impressions. We believe that our online
advertising rates are currently set at general market levels.
To date, we have not recorded any e-commerce revenues, but have engaged in
pilot trials of e-commerce activities.
Costs and Expenses
Our cost of revenues is made up of Internet access and bandwidth leasing
charges, royalty payments, content fees, Web site maintenance costs,
amortization of purchased technology, depreciation of computer equipment and
other production costs. We intend to continue increasing our number of content
suppliers. Some content providers have recently increased the fees they charge
for their content. This trend could increase our expenses and could adversely
affect our ability to obtain quality content at an economically acceptable
cost.
Product development expenses include compensation and related expenses for
personnel engaged in the enhancement of our Web site and online directory,
amortization of software licenses and other third party technology expenses
and compensation and related costs of employees in the business development
department. Costs incurred in the enhancement of our Web site and the
classification and organization of listings within our portal and enhancements
to existing products are charged to product development expense as incurred.
Material software development costs incurred during the application
development stage, including the costs related to the development of our Web
site, are capitalized as other assets and are amortized over three years.
Sales and marketing expenses primarily consist of advertising and promotion
on television, online and in print; promotional materials and sponsorship of
special events; and compensation, benefits and sales commissions to our direct
sales force. Our sales and marketing costs are expected to increase in the
future as we enhance our selling and marketing efforts and as we shift toward
a commission-based compensation system for our direct sales force. In
particular, the largest component of our sales and marketing expenses is
marketing costs for new user acquisition, which is closely tied to our user
growth.
General and administrative expenses primarily consist of compensation and
benefits for general management, finance and administrative personnel costs,
professional fees, depreciation of office equipment and other office expenses.
We intend to expand our Guangzhou and Shanghai offices to conduct sales and
marketing, and to assist Beijing Sohu in developing content partner
relationships. This may result in our hiring of additional staff and
purchasing of additional office equipment and computer and networking
equipment, all of which will increase our general and administrative expenses.
In 1999, we recorded deferred stock-based compensation of approximately
$67,000. In general, deferred stock-based compensation is recognized based on
the difference, if any, between the estimated fair value of our common stock
and the amount an employee must pay to acquire the stock, as determined on the
date the option is granted. The difference is initially recorded as a
reduction of shareholders' equity and then amortized and charged to expense on
an accelerated basis over the vesting period of the applicable options, which
is typically four years or less. Of the total stock-based compensation amount,
$46,000 was amortized and charged to expense in 1999.
In January 2000, we granted options for the purchase of 330,200 shares of
common stock to certain of our employees and a director at an exercise price
of $5.77. In connection with these option grants, we recorded deferred stock
compensation of approximately $1.9 million which is being amortized and
charged to expense on an accelerated basis over the vesting period of the
applicable options. The options granted generally vest over periods ranging
from one to four years beginning with the first quarter subsequent to the date
of grant of the options. Compensation expense associated with this grant and
recognized during the three months ended March 31, 2000 totaled $201,000.
Based on options issued and outstanding as of May 31, 2000, we currently
expect to amortize and charge to expense the following amounts of stock-based
compensation:
. 2000 - $990,000;
38
<PAGE>
. 2001 - $530,000;
. 2002 - $260,000;
. 2003 - $114,000; and
. 2004 - $ 6,000.
At March 31, 2000, we had incurred approximately $981,000 of transaction
expenses relating to this offering, which are being deferred and included as
other assets. Upon the consummation of this offering, these costs will be
offset against the proceeds of this offering in additional paid-in-capital.
Accretion of Mandatorily Redeemable Convertible Preferred Stock
After March 5, 2003, holders of our Series B and B-1 preferred stock may
request that our company redeem all of their shares at a price of $0.796 per
share plus any declared but unpaid dividends. After September 9, 2004, holders
of our Series C preferred stock may request that our company redeem all of
their shares at a price of $3.617 per share plus any declared but unpaid
dividends. After January 25, 2005, holders of our Series D preferred stock may
request that our company redeem all of their shares at a price of $29.674 per
share plus any declared but unpaid dividends. Accordingly, the Series B, B-1, C
and D preferred stock are being accreted to its estimated redemption value
through periodic charges to retained earnings. For 1999, charges with respect
to the Series B and B-1 preferred stock totaled $467,000, while charges with
respect to the Series C preferred stock totaled $450,000. For the three months
ended March 31, 2000, charges with respect to the Series B and B-1 preferred
stock totaled $116,000 and charges with respect to the Series C preferred stock
totaled $345,000, while charges with respect to the Series D preferred stock
totaled $1,098,000. These charges are also reflected in our statement of
operations as accretion on mandatorily redeemable convertible preferred stock.
Since all of the outstanding shares of preferred stock will be mandatorily
converted into shares of common stock upon the consummation of this offering,
we do not expect to incur additional accretion of mandatorily redeemable
convertible preferred stock after the consummation of this offering.
Limited Operating History
We have incurred significant net losses and negative cash flows from
operations since our inception. At March 31, 2000, we had an accumulated
deficit of $9.5 million. These losses have been funded primarily through the
issuance of preferred stock. We have not achieved profitability, and expect to
continue to incur net losses in 2000 and subsequent fiscal periods. We intend
to invest heavily in marketing and brand development, content enhancements and
technology and infrastructure development, which would result in substantial
net losses and negative cash flows for the foreseeable future. Moreover, the
amount of these losses is expected to increase from current levels. Even if we
do achieve profitability, we may be unable to sustain or increase profitability
in the future.
We have a limited operating history for you to use as a basis for evaluating
our business. You must consider the risks and difficulties frequently
encountered by early stage companies like us in new and rapidly evolving
markets, including the Internet advertising market in the PRC.
Dependence on a Limited Number of Advertisers
In the first quarter of 2000, two of our advertisers, Nokia Corporation and
Alibaba.com, each accounted for over 8% of our revenues, and our five largest
advertisers accounted for more than 34% of our revenues and 40% of our accounts
receivable. In 1999, two of our advertisers, Intel Corporation, which is one of
our shareholders, and Nokia Corporation, each accounted for more than 10% of
our revenues, and our five largest advertisers accounted for approximately 34%
of our revenues and 43% of our accounts receivable. In 1998, two advertisers
each accounted for greater than 10% of our revenues, and our five largest
advertisers accounted for 71% of our revenues and 93% of our accounts
receivable. In 1997, two advertisers each accounted for greater than 10% of our
revenues, and our five largest advertisers accounted for 65% of our revenues
and 91% of our accounts receivable.
39
<PAGE>
During January 2000, we entered into multi-year advertising agreements with
an affiliate of Pacific Century Cyberworks Limited, an affiliate of Legend
Holdings Limited and Hikari Tsushin, Inc. We expect to derive a significant
portion of our revenues over the next three years from these agreements. The
loss of any of these agreements or any of our significant advertisers, or a
decrease in the volume of advertising by any of the advertisers, would have a
material adverse effect on our business, financial condition and results of
operations. See "Risk Factors -- The loss of one of our top advertisers would
reduce our advertising revenues and materially and adversely affect our
business".
Results of Operations
Comparison of the Three-Month Periods ended March 31, 2000 and March 31, 1999
Revenues
Our revenues increased to $842,000 for the three months ended March 31, 2000
compared to $233,000 for the same period in 1999. This increase was primarily
due to a significant increase in advertising revenue, which was in turn a
result of a significant increase in our marketing and sales promotional
activities during this period. Approximately 79% of our revenues in the three
months ended March 31, 2000 was attributable to new customer sales, and
approximately 21% was attributable to sales to customers existing in the three
months ended March 31, 1999. We did not record any e-commerce revenues during
these periods.
Cost and Expenses
Cost of Revenues. Our cost of revenues increased to $811,000 for the three
months ended March 31, 2000 compared to $172,000 for the same period in 1999.
This increase was principally the result of an increase of $410,000 in
bandwidth leasing charges due to our leasing of additional bandwidth from the
Beijing Telecom Administration and an increase of $139,000 in personnel costs
due to a significant expansion of the services provided on our Web site.
Bandwidth leasing charges and personnel costs constituted approximately 52% and
30%, respectively, of our cost of revenues during this period.
Product Development Expenses. Our product development expenses increased to
$348,000 for the three months ended March 31, 2000 compared to $55,000 for the
same period in 1999. This increase was mainly a result of an increase of
$130,000 in compensation and related expenses for personnel engaged in the
enhancement of our Web site and the establishment of our business development
department in the latter part of 1999. Personnel costs constituted
approximately 49% of our product development expenses during this period.
Sales and Marketing Expenses. Our sales and marketing expenses increased to
$1,533,000 for the three months ended March 31, 2000 compared to $126,000 for
the same period in 1999. This increase was primarily due to an increase in
costs of $652,000 in our cost of advertising activities and an increase of
$488,000 for special promotional events, such as our two-year anniversary
concert in February 2000. Advertising expenses constituted approximately 42% of
our sales and marketing expenses during this period.
General and Administrative Expenses. Our general and administrative expenses
increased to $516,000 for the three months ended March 31, 2000 compared to
$163,000 for the same period in 1999. This increase was principally a result of
an increase of $148,000 in personnel costs due to the hiring of additional
administrative personnel and an increase of $53,000 in professional fees.
Personnel costs and professional fees constituted approximately 36% and 18%,
respectively, of our general and administrative expenses during this period.
Stock-Based Compensation Expenses. Our stock-based compensation expenses
were $201,000 for the three months ended March 31, 2000. This amount represents
the amortization during this period of our deferred stock-based compensation
relating to stock options granted in 1999 and 2000. We did not incur stock-
based compensation expenses during the same period in 1999.
Operating Loss
As a result of the foregoing, we had an operating loss of $2,567,000 for the
three months ended March 31, 2000 compared to an operating loss of $283,000 for
the same period in 1999.
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Interest Income
Interest income increased to $31,000 for the three months ended March 31,
2000 compared to $7,000 for the same period in 1999. This increase was
primarily due to increased cash balances held at bank accounts or invested in
short-term instruments or certificates of deposit.
Net Loss, Accretion on Mandatorily Redeemable Convertible Preferred Stock,
Income Tax and Net Loss Attributable to Common Stockholders
As a result of the foregoing, our net loss increased to $2,536,000 for the
three months ended March 31, 2000 compared to $276,000 for the same period in
1999. Accretion on mandatorily redeemable convertible preferred stock was
$1,559,000 for the three months ended March 31, 2000 compared to $114,000 for
the same period in 1999. As we have incurred losses since inception, no
provision for income taxes has been made. Net loss attributable to common
stockholders was $4,095,000 for the three months ended March 31, 2000 compared
to $390,000 for the same period in 1999.
Comparison of the Years 1999 and 1998
Revenues
Our revenues increased to $1,617,000 in 1999 compared to $472,000 in 1998.
This was primarily due to an increase in the number of advertising contracts
and in the average dollar amount of the contracts. We did not record any e-
commerce revenues during these periods. Approximately 60% of our revenues in
1999 was attributable to new customer sales and approximately 40% was
attributable to sales to customers existing in the prior year. Approximately
69% of our revenues in 1998 was attributable to new customer sales and
approximately 31% were attributable to sales to existing customers.
Costs and Expenses
Cost of Revenues. Our cost of revenues increased to $1,576,000 in 1999
compared to $215,000 in 1998. This was principally a result of a significant
increase of $481,000 due to the hiring of additional personnel and related
personnel costs, as well as an increase of $515,000 in Internet access and
bandwidth leasing charges due to our leasing of additional bandwidth from the
Beijing Telecom Administration. This increase was also due to an increase of
$100,000 in hardware and software amortization costs and an increase of $55,000
in royalty and fixed fee payments to content providers. Most of these costs are
fixed costs. Personnel costs, Internet bandwidth and leasing charges, hardware
and software amortization costs and payments to content providers constituted
approximately 38%, 33%, 7% and 7%, respectively, of our cost of revenues in
1999.
Product Development Expenses. Our product development expenses increased to
$427,000 in 1999 compared to $208,000 in 1998. This increase was largely a
result of an increase of $124,000 due to the increase in the number of
personnel and related personnel costs, as well as the costs incurred during the
preliminary project stage of new product development projects, such as the
development of our branded content channels and the upgrading of our Chinese
key word search software and e-mail service. In addition, we established a
business development department in 1999. Personnel costs constituted
approximately 61% of our product development expenses in 1999.
Sales and Marketing Expenses. Our sales and marketing expenses increased to
$1,758,000 in 1999 compared to $351,000 in 1998. This increase was primarily
due to an increase of $1,043,000 related to the launch of our new advertising
campaign, including print, radio and billboard advertising, as well as an
increase of $199,000 in personnel costs associated with the expansion of our
sales and marketing staff to 30 persons in 1999 from 15 persons in 1998. Prior
to 1999, we did not incur any advertising costs. Advertising expenses
constituted approximately 59% of our sales and marketing expenses in 1999.
General and Administrative Expenses. Our general and administrative expenses
increased to $1,270,000 in 1999 compared to $308,000 in 1998. This increase was
mainly caused by an increase of $176,000 related to the hiring of additional
administrative personnel, increased professional service fees of $425,000 and
costs associated with the opening of our Guangzhou office. In addition, we
recognized $60,000 in expenses associated with
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services provided by affiliates of one of our shareholders in 1999. Personnel
costs and professional service fees constituted approximately 20% and 41% of
our general and administrative expenses in 1999.
Stock-Based Compensation Expenses. Our stock-based compensation expenses
were $46,000 in 1999. This amount represents the amortization during this
period of our deferred stock-based compensation relating to stock options
granted in 1999. We did not incur stock-based compensation expenses in 1998.
Operating Loss
As a result of the foregoing, we had an operating loss of $3,460,000 in
1999 compared to $610,000 in 1998.
Interest Income
Interest income increased to $25,000 in 1999 compared to $23,000 in 1998.
This increase was primarily due to increased cash balances held at bank
accounts or invested in short-term instruments or certificates of deposit.
Net Loss, Accretion on Mandatorily Redeemable Convertible Preferred Stock,
Income Tax and Net Loss Attributable to Common Stockholders
As a result of the foregoing, our net loss increased to $3,449,000 in 1999
compared to $615,000 in 1998. Accretion on mandatorily redeemable convertible
preferred stock was $917,000 in 1999 compared to $244,000 in 1998. As we have
incurred losses since inception, no provision for income taxes has been made.
Net loss attributable to common stockholders was $4,366,000 in 1999 compared
to $859,000 in 1998.
Comparison of the Years 1998 and 1997
Revenues
Our revenues increased to $472,000 in 1998 compared to $78,000 in 1997.
This increase was primarily due to an increase in the number of advertising
contracts and in the average size of the contracts, including a sponsorship
arrangement with Intel for a fixed fee of $150,000. Approximately 69% of our
revenues in 1998 were attributable to new customer sales and approximately 31%
were attributable to sales to customers existing in the prior year.
Substantially all of our revenues in 1997 were attributable to new customer
sales.
Costs and Expenses
Cost of Revenues. Our cost of revenues increased to $215,000 in 1998
compared to $19,000 in 1997. This increase was primarily due to the launching
of our online directory and search engine and improvements to our
infrastructure, which resulted in significantly higher expenditures related to
Internet access and bandwidth leasing, personnel and other production costs.
Personnel costs increased by $99,000 and constituted approximately 52% of our
cost of revenues in 1998.
Product Development Expenses. Our product development expenses increased to
$208,000 in 1998 compared to $50,000 in 1997. This increase was largely due to
an increase of $109,000 in personnel costs related to the increase of our
product development team from six persons in 1997 to 23 persons in 1998.
During 1998, we also launched our online directory and search engine and
continued to make enhancements to our Web site. Personnel costs constituted
approximately 66% of our product development expenses in 1998.
Sales and Marketing Expenses. Our sales and marketing expenses increased to
$351,000 in 1998 compared to $94,000 in 1997. This increase was primarily due
to an increase of $137,000 resulting from higher sales and marketing personnel
costs and related expenses. These costs and expenses constituted approximately
80% of our sales and marketing expenses in 1998.
General and Administrative Expenses. Our general and administrative
expenses increased to $308,000 in 1998 compared to $75,000 in 1997. This
increase was mainly a result of an increase in personnel costs of $54,000 due
to the hiring of additional personnel, increased professional service fees of
$77,000 and costs associated with the opening of our Shanghai office.
Personnel costs and professional service fees constituted approximately 26%
and 31% of our general and administrative expenses in 1998.
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Stock-Based Compensation Expenses. We did not have any stock-based
compensation expenses in 1998 and 1997.
Operating Loss
As a result of the foregoing, we had an operating loss of $610,000 in 1998
compared to $160,000 in 1997.
Interest Income
We had interest income of $23,000 in 1998, mainly as a result of cash
balances held in interest bearing accounts or invested in short-term
instruments or certificates of deposit. We did not have any interest income in
1997, as all of our cash balances were held in non-interest bearing accounts.
Net Loss, Accretion on Mandatorily Redeemable Convertible Preferred Stock,
Income Tax and Net Loss Attributable to Common Stockholders.
As a result of the foregoing, our net loss increased to $615,000 in 1998
compared to $160,000 in 1997. Accretion on mandatorily redeemable convertible
preferred stock was $244,000 in 1998. No mandatorily redeemable convertible
preferred stock was issued in 1997. As we have incurred losses since
inception, no provision for income taxes has been made. Net loss attributable
to common stockholders was $859,000 in 1998 compared to $160,000 in 1997.
Quarterly Results of Operations
The following table sets forth, for the periods presented, our unaudited
quarterly results of operations for the eight fiscal quarters ended March 31,
2000. The data have been derived from our unaudited consolidated financial
statements, and in our management's opinion, they have been prepared on
substantially the same basis as the annual financial statements and include
all adjustments, consisting only of normal recurring adjustments, necessary
for a fair statement of the financial results for the periods presented. This
information should be read in conjunction with the annual financial statements
included elsewhere in this prospectus. The operating results in any quarter
are not necessarily indicative of the results that may be expected for any
future period.
<TABLE>
<CAPTION>
Three months ended
----------------------------------------------------------------------------
June 30, September December March 31, June 30, September December March 31,
1998 30, 1998 31, 1998 1999 1999 30, 1999 31, 1999 2000
-------- --------- -------- --------- -------- --------- -------- ---------
(in thousands)
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ 75 $ 62 $ 309 $ 233 $ 434 $ 401 $ 549 $ 842
Costs and expenses:
Cost of revenues(1).... 25 41 129 172 272 494 638 811
Product
development(1)........ 39 58 82 55 84 116 172 348
Sales and
marketing(1).......... 45 85 185 126 163 465 1,004 1,533
General and
administrative(1)..... 48 96 125 163 250 377 480 516
Stock-based
compensation.......... -- -- -- -- 36 6 4 201
----- ----- ----- ----- ----- ------- ------- -------
Total costs and
expenses............ 157 280 521 516 805 1,458 2,298 3,409
----- ----- ----- ----- ----- ------- ------- -------
Operating loss.......... (82) (218) (212) (283) (371) (1,057) (1,749) (2,567)
Interest income......... 2 6 15 7 5 6 7 31
Interest expense --
related party.......... (3) -- -- -- -- (14) -- --
----- ----- ----- ----- ----- ------- ------- -------
Net loss................ (83) (212) (197) (276) (366) (1,065) (1,742) (2,536)
Accretion on mandatorily
redeemable preferred
stock.................. (32) (87) (114) (114) (114) (118) (571) (1,559)
----- ----- ----- ----- ----- ------- ------- -------
Net loss attributable to
common stockholders.... $(115) $(299) $(311) $(390) $(480) $(1,183) $(2,313) $(4,095)
===== ===== ===== ===== ===== ======= ======= =======
</TABLE>
--------------------
(1) Excluding stock-based compensation. See our consolidated financial
statements.
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Liquidity and Capital Resources
To date, we have primarily financed our operations through the sale of our
preferred stock, a one-time extension of an interim loan from one of our
shareholders, which was converted into shares of our Series C preferred stock
as part of our Series C preferred stock financing in October of 1999, and a
short-term bank loan extended in March 2000. As of March 31, 2000, we had
approximately $33,106,000 in cash and cash equivalents.
Net cash used in operating activities was $2,351,000 for the three months
ended March 31, 2000 compared to $341,000 for the same period in 1999. Net cash
used in operating activities was $1,720,000 in 1999 compared to $678,000 in
1998. To date, we have experienced significant negative cash flows from
operating activities. Costs associated with increases in personnel and
increased sales and marketing initiatives contributed to our negative cash flow
position.
Net cash used in investing activities was $1,325,000 for the three months
ended March 31, 2000 compared to $66,000 for the same period in 1999. Net cash
used in investing activities was $2,521,000 in 1999 compared to $227,000 in
1998. Net cash used in investing activities during these periods primarily
resulted from the purchase of fixed assets and computer software from third
party vendors.
Net cash provided by financing activities was $32,858,000 for the three
months ended March 31, 2000 compared to $0 for the same period in 1999. Net
cash provided by financing activities was $6,933,000 in 1999 compared to
$2,026,000 in 1998. Net cash provided by financing activities for the three
months ended March 31, 2000 primarily consisted of the issuance of our Series D
preferred stock for $30.0 million and a short-term bank loan for $2,899,000
which has been subsequently repaid. Net cash provided by financing activities
during 1999 primarily consisted of the interim loan of $1.5 million from one of
our shareholders and the issuance of our Series C preferred stock for
$5.4 million.
Net cash used in operating activities was $678,000 in 1998 compared to
$101,000 in 1997. Significant uses of cash in operations that contributed to
our negative cash flow position in 1998 include costs associated with our
marketing initiatives, technology development and increased staffing in our
content aggregation and business operations.
Net cash used in investing activities was $227,000 in 1998 compared to
$30,000 in 1997. Net cash used in investing activities during these periods
related to the purchase of fixed assets.
Net cash provided by financing activities was $2,026,000 in 1998 compared to
$155,000 in 1997. The 1997 amounts represented loans and investments from our
founders. In 1998, net cash provided by financing activities primarily
consisted of proceeds from the sale of Series B preferred stock.
Our principal commitments consist of obligations outstanding under lease
contracts for our office space in Beijing. We made capital expenditures of
approximately $0.9 million in 1999, and expect to make capital expenditures
totaling approximately $4.0 million for 2000 and $13.0 million for 2001. The
capital expenditures in 1999 principally consisted of purchases of, or
investments in, our network infrastructure. We expect our capital expenditures
in 2000 and 2001 to primarily consist of purchases of additional servers,
computer software and workstations. In addition, we expect that our capital
expenditures will increase significantly in the future as we make technological
improvements to our network infrastructure and enter into strategic joint
ventures or acquisitions. We also intend to upgrade our financial and
accounting systems and infrastructure. In addition to capital expenditures, we
have substantial future cash needs for our planned substantial future increases
in expenses, including sales, marketing, promotional and work force expenses
and bandwidth leasing charges.
Our net accounts receivable balance increased significantly from $401,000 at
December 31, 1999 to $776,000 at March 31, 2000. The number of days sales
outstanding in accounts receivable also increased from an average of 53 days
during 1999 to 63 days during the first quarter of 2000. These increases were
primarily due to the fact that our resources devoted to accounts receivable
collection did not keep pace with our revenue
44
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growth. During March and April 2000, we have: (1) increased staff dedicated to
billing and collections; (2) tied our sales staff's commissions to accounts
receivable collections; and (3) in some cases, required prepayments for our
advertising contracts.
We believe that our current cash and cash equivalents, cash flow from
operations and the proceeds from this offering will be sufficient to meet our
anticipated cash needs, including for working capital and capital expenditures,
for at least the next twelve months. We may, however, require additional cash
resources due to changed business conditions or other future developments,
including any investments or acquisitions we may decide to pursue. If these
sources are insufficient to satisfy our cash requirements, we may seek to sell
additional equity or debt securities or to obtain a credit facility. The sale
of additional equity or convertible debt securities could result in additional
dilution to our shareholders. The incurrence of indebtedness would result in
increased debt service obligations and could result in operating and financial
covenants that would restrict our operations. We cannot assure you that
financing will be available in amounts or on terms acceptable to us, if at all.
Holding Company Structure
We are a holding company with no operations other than our ownership of
Beijing ITC, our wholly-owned subsidiary in the PRC that, together with Beijing
Sohu, owns and conducts our entire Internet business. As a result, we rely on
dividends and other distributions paid by Beijing ITC, including the funds
necessary to service any debt we may incur. If Beijing ITC incurs debt on its
own behalf in the future, the instruments governing the debt may restrict
Beijing ITC's ability to pay dividends or make other distributions to us. In
addition, PRC legal restrictions permit payment of dividends to us by Beijing
ITC only out of U.S. Beijing ITC's net income, if any, determined in accordance
with PRC accounting standards and regulations. Under PRC law Beijing ITC is
also required to set aside a portion of its net income, if any, each year to
fund certain reserve funds. These reserves are not distributable as cash
dividends. See note 5 to our consolidated financial statements included in this
prospectus.
Taxation
Sohu is subject to income taxes in the United States while our PRC operating
subsidiary, Beijing ITC, is subject to income tax in the PRC.
Beijing ITC is subject to the Income Tax Law of the People's Republic of
China concerning Foreign Investment Enterprises and Foreign Enterprises and
various local tax laws. Under these tax laws, Beijing ITC is subject to income
tax at a statutory rate of 33% (30% state income taxes plus 3% local income
taxes) on PRC taxable income. Although Beijing ITC's income is generally not
taxable in the United States, dividends distributed from Beijing ITC to our
company are subject to income tax in the United States. Under the applicable
PRC tax laws, these dividends are exempt from withholding tax in China. Subject
to certain limitations, the income taxes paid by Beijing ITC on its earnings
are creditable against Sohu's tax liabilities in the United States.
Sohu and Beijing ITC have not paid any income taxes because we have incurred
losses since inception. As of December 31, 1999, we had a net operating loss
for U.S. federal income tax purposes of $689,000 and a net operating loss for
PRC income tax purposes of $2,915,000 available to offset future U.S. federal
and PRC income tax liabilities, respectively. The net operating loss for U.S.
federal income tax purposes will expire from 2012 to 2020, while the net
operating loss for PRC income tax purposes will expire from 2002 to 2004. We
have provided a full valuation allowance against deferred tax assets relating
to these net operating losses due to the uncertainty surrounding their
realization.
China contribution plan and profit appropriation
Beijing ITC participates in a government-mandated, multi-employer defined
contribution plan, through which employees receive retirement, medical and
other welfare benefits. PRC labor regulations stipulate that
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<PAGE>
Beijing ITC must pay a monthly contribution to the local labor bureau. The
monthly contribution rate is based on the monthly basic compensation amount of
qualified employees. Beijing ITC has no further commitments beyond its monthly
contribution, and the relevant local labor bureau is responsible for meeting
all retirement benefit obligations.
Under applicable PRC laws, Beijing ITC is required to make appropriations
from after-tax profit to non-distributable reserve funds which are determined
by its board of directors. These reserve funds must include a general reserve,
an enterprise expansion fund and a staff bonus and welfare fund. Ten percent of
after-tax profit (as determined under PRC GAAP) must be put in the general
reserve fund per annum, while the other fund appropriations are at Sohu's
discretion. Since Beijing ITC is in a loss position, no appropriations have
been made.
Foreign Currency Exchange Losses
While our reporting currency is the U.S. dollar, to date virtually all of
our revenues and costs are denominated in Renminbi and a significant portion of
our assets and liabilities are denominated in Renminbi. As a result, we are
exposed to foreign exchange risk as our revenues and results of operations may
be impacted by fluctuations in the exchange rate between U.S. Dollars and
Renminbi. If the Renminbi depreciates against the U.S. Dollar, the value of our
Renminbi revenues and assets as expressed in our U.S. Dollar financial
statements will decline. We do not hold any derivative or other financial
instruments that expose us to substantial market risk. See "Risk Factors -- We
may suffer currency exchange losses if the Renminbi depreciates relative to the
U.S. Dollar". See note 3 to our consolidated financial statements included in
this prospectus.
The Renminbi is currently freely convertible under the "current account",
which includes dividends, trade and service-related foreign exchange
transactions, but not under the "capital account", which includes foreign
direct investment. To date, we have not entered into any hedging transactions
in an effort to reduce our exposure to foreign currency exchange risk. While we
may decide to enter into hedging transactions in the future, the effectiveness
of these hedges may be limited and we may not be able to successfully hedge our
exposure at all. Accordingly, we may incur economic losses in the future due to
foreign exchange rate fluctuations which may have a negative impact on our
financial condition and results of operations.
Recent Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued SFAS No.133,
"Accounting for Derivative Instruments and Hedging Activities". SFAS No.133,
which is effective, as amended, for all quarters in fiscal years beginning
after June 15, 2000, establishes accounting and reporting standards for
derivative financial instruments and hedging activities related to those
instruments, as well as other hedging activities. As we do not currently engage
in derivative or hedging activities, we do not expect the adoption of this
standard to have a significant impact on our consolidated financial statements.
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BUSINESS
Overview
We are a leading Internet portal in China in terms of brand recognition,
page views and registered users. As of June 24, 2000, we averaged in excess of
16.3 million page views per day during June 2000. Our mission is to make Sohu
an indispensable part of the daily life of every person in China.
Our portal consists of sophisticated Chinese language Web navigational and
search capabilities, 12 main content channels, Web-based communications and
community services and a platform for e-commerce services. As of May 31, 2000
our online directory contained over 270,000 Chinese language Web listings, each
reviewed and classified by our editorial staff. In addition, we have
contractural content relationships with over 85 Chinese language media and
information providers. Each of our interest-specific main channels contains
multi-level sub-channels that cover a comprehensive range of topics, including
news, business, entertainment, sports and career. We also promote user affinity
to Sohu by providing free Chinese language e-mail, online bulletin boards, chat
rooms and instant messaging. All of our products and services are designed to
meet the specific interests and needs of Internet users in China.
We are a pioneer of the Internet industry in China, having introduced the
first Chinese language online directory and search engine. We have exclusively
targeted the Internet market in China since our inception. Our Web site is
tailored to the particular thinking and viewing habits of Internet users in
China. According to a survey conducted in December 1999 by Hui Cong Research,
one of the largest information technology market research firms in the PRC,
Sohu was the most favored Chinese language Web site among PRC Internet users.
In addition, according to studies commissioned by our company and conducted by
The Gallup Organization in February and April 2000 in three of the largest
cities in the PRC (Beijing, Shanghai and Guangzhou), Sohu had the highest
overall level of unaided Web site awareness among Internet users.
As a leading Internet portal in China, we are well positioned to capitalize
on the emergence of the Web as a new advertising medium and commerce platform
in China. We believe that by providing a well tuned and highly relevant
navigational context and comprehensive range of China-specific content, we
provide advertisers and merchants with targeted access to an audience with
highly desirable demographic profiles. To expand our user and revenue base, we
began offering free Web-based e-mail in July 1999 and, as of June 24, 2000, we
had over 3.1 million registered e-mail users. We offer a universal registration
system, whereby a user that has registered for our e-mail service is
automatically registered for our chat, bulletin board, instant messaging and
other services. We have attracted several strategic investors, including Dow
Jones & Company, Inc., Intel Corporation, an affiliate of Pacific Century
Cyberworks Limited, an affiliate of Legend Holdings Limited and Hikari Tsushin,
Inc.
Industry Background
The Internet has developed into a significant global mass medium that allows
millions of people worldwide to find information, interact with others and
conduct business electronically. International Data Corporation, or IDC,
estimates that the number of Internet users worldwide will grow from
approximately 196.1 million at the end of 1999 to approximately 502.4 million
by the end of 2003. The rapidly growing number of users and the ability of
corporations to effectively target them has led to online advertising and
e-commerce opportunities. According to Forrester Research, the dollar value of
Internet advertising worldwide is expected to increase from approximately $3.3
billion in 1999 to approximately $24.1 billion in 2003. In addition, IDC is
also projecting an increase in e-commerce transactions on the Internet from
$111.4 billion in 1999 to approximately $1,317 billion in 2003.
The Growth of the Internet in China
Internet use in China has grown rapidly in recent years and is expected to
significantly outpace growth in worldwide Internet use over the next several
years. According to IDC, between January 1, 1999 and
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<PAGE>
December 31, 1999, the number of PRC Internet users increased from
approximately 2.4 million to approximately 3.8 million. In addition, IDC
projects the number of Internet users in China will grow to approximately 25.2
million in 2003.
Increased competition among telecommunications providers and increased
infrastructure spending have accelerated network infrastructure improvements.
Together with significant decreases in charges for telephone installation and
usage and Internet access, these factors have contributed, and are expected to
continue to contribute, to the growth of Internet use in China. Furthermore,
personal computer penetration in urban centers in China has increased rapidly,
and we expect this penetration rate to continue to increase as prices of
personal computers decline. In addition, the potential for Internet access
through alternative devices, such as television set-top boxes and wireless
telephones, as well as the development of broadband Internet access services,
may further accelerate the growth of the number of Internet users in China.
According to the PRC National Bureau of Statistics, as of December 31, 1998,
there were approximately 330 million households, of which 90% owned
televisions, and, according to the Ministry of Information Industry,
approximately 40 million cellular telephone users in China.
As Internet use becomes more pervasive in China, and as the PRC online
population continues to develop and expand, the opportunities for online
advertising and commerce will also expand. Although China's per capita GDP is
relatively low, there is a large and growing segment of the population that is
well educated and relatively affluent and has demonstrated a willingness to
embrace new technologies. For example, according to statistics published by the
PRC National Bureau of Statistics and estimates prepared by the MII, the number
of cellular subscribers in China grew from approximately 1.6 million
subscribers in 1994 to approximately 40 million subscribers in 1999.
Zenith Media estimates that advertising expenditures for television,
newspapers, magazines, TV, radio and other traditional media in China totaled
over $4.1 billion in 1999. In addition, Forrester Research estimates that the
aggregate online advertising market in China in 1999 was only $8.0 million. As
the number of Internet users increases, we believe that online advertising will
capture an increasing percentage of the overall PRC advertising market. Zenith
Media has estimated that in 2002 China's overall advertising market will total
$6.1 billion, while Forrester Research has estimated that China's online
advertising market will total $100.0 million in 2002 and $440.0 million in
2004. Similarly, the volume of e-commerce transactions in China is expected to
increase significantly as the online population expands. According to IDC,
total e-commerce revenue in China is expected to grow from approximately $43.0
million in 1999 to approximately $11.7 billion in 2004.
The projected amounts set forth above have been derived from or copied from
market research reports. You should note that there can be no assurance any of
these projected amounts will be achieved.
Unique Challenges and Demands of China's Internet Market
We believe that China's Internet market faces the following unique
challenges and demands:
. Demand for Chinese directories and local content tailored for Internet
users in China. PRC Internet users demand content and services that are
distinct from those offered in the overseas Chinese language Internet
markets, such as Hong Kong, Taiwan and the North American Chinese
communities. China uses a simplified version of the Chinese characters
while the overseas Chinese-speaking population typically uses the
traditional characters. The distinct cultural and historical background
of China's Internet users also translates into viewing and thinking
habits that are distinct from those in other markets. This requires not
only that online directories and content contain different information,
but that such information be uniquely structured to best reflect such
viewing and thinking habits in order to provide users with the most
user-friendly online experience.
. Chinese language is not key word search-friendly. Key word searches in
Chinese are more complicated than searches in English and require
specially designed software. In particular, sentences
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in Chinese are made up of phrases, equivalent to words in English, that
consist of one to several characters. Unlike in English where words in a
sentence are separated by spaces, Chinese phrases with varying numbers
of characters are not separated out in a sentence. Therefore, Chinese
text must be indexed to separate out the phrases before they can be
subjected to key word/phrase searches. In addition, a Chinese phrase
generally has more synonyms or closely associated phrases than the
equivalent English word, which makes it crucial to develop a
comprehensive database of synonyms and closely associated phrases for an
effective Chinese key word search function. The fact that each character
in Chinese requires twice the number of bytes needed for a letter in
English may also create additional software complications.
. Limited Bandwidth Resources. The telecommunications infrastructure in
China remains underdeveloped. In particular, bandwidth remains
relatively expensive and scarce, posing significant challenges to Web
sites that encounter heavy and fluctuating traffic. In addition, the
services provided by network backbone operators and server hosting
facilities are still relatively poor. Moreover, most users in China
currently access the Web through low-speed dial-up modems. As a result,
Internet companies offering content and services in China must design
their operations within the confines of these technological constraints
and execute their business strategies accordingly.
. Underdeveloped product distribution networks and payment systems hinder
the growth of e-commerce. The most important factor affecting the
development of e-commerce in China is the availability of efficient
product distribution channels that provide timely and satisfactory
fulfillment of purchase orders. As China currently does not have a
reliable nationwide product distribution network, the fulfillment of
goods purchased over the Internet will continue to be a factor
constraining the growth of e-commerce. Furthermore, an additional
barrier to the development of e-commerce is the lack of reliable payment
systems. In particular, the use of credit cards or another viable means
of electronic payment in sales transactions in China is not as well
developed as some other countries, such as the United States.
. The business and regulatory environment in China is often uncertain and
difficult to understand and navigate. The business and regulatory
environment in China remains poorly understood by most businesses
outside China. China has only recently transformed itself from a
predominantly socialist economy to a market-oriented economy, and many
industries are still monopolized by state-owned companies. Business
relationships are often defined by past practices and mutual
understandings as opposed to precise contractual provisions. As a
result, foreign companies, including overseas Chinese companies, often
find China's business environment frustrating. In addition, the
regulatory environment for the Internet in China and for businesses in
general remains uncertain in many respects. Without extensive knowledge
about China, businesses often fail to effectively interact with
regulators and such failure may result in fatal delays in their strategy
execution. The distinctiveness of the PRC Internet market from the other
overseas Chinese markets also limits the advantages a regional Internet
business may gain by leveraging across the mainland China and overseas
Chinese markets, especially since the mainland China market is expected
to be far larger than other overseas Chinese markets within several
years.
The Sohu.com Solution
We have developed our portal to address the unique challenges and needs of
China's Internet market. We believe that our success to date is attributable to
the following factors, and we believe that these factors will continue to be
our competitive strengths:
Exclusive Focus on Mainland China
We focus exclusively on the Internet market in China. Our products and
services are tailored to the specific interests, needs and viewing habits of
our PRC Internet users. We have based our operations in China since our
inception, and substantially all of our employees are based in the PRC. Our
local presence allows us
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to better understand the needs of advertisers and business partners that
operate in China, and to build and maintain strong relationships with them. For
example, we have established contractual content relationships with over 85
Chinese language media and information providers. Moreover, as a result of our
local presence, we are able to maintain a regular dialogue with the relevant
PRC regulatory authorities, and consequently we believe we are better attuned
to operating an Internet business within the existing PRC business and
regulatory environment.
First Mover Advantage and Brand Leadership
We are a pioneer of the Internet industry in China, having introduced the
first Chinese language online directory and search engine. According to a
survey conducted in December 1999 by Hui Cong Research, one of the largest
information technology market research firms in the PRC, Sohu was the most
favored Chinese language Web site among PRC Internet users. In addition,
according to studies commissioned by our company and conducted by The Gallup
Organization in February and April 2000 in three of the largest cities in the
PRC (Beijing, Shanghai and Guangzhou), Sohu.com had the highest overall level
of unaided Web site awareness among Internet users. A significant part of our
branding strategy revolves around the creation of public awareness of Sohu when
we introduce new concepts and standards to PRC Internet users. In so doing, we
believe we have become synonymous with the evolution and development of the PRC
Internet industry. Our brand recognition has enabled us to attract a growing
user audience and leading companies as advertisers and e-commerce partners.
Proprietary Web Navigational and Search Capabilities
Our Sohu online directory, the centerpiece of our portal, was carefully
designed and has been continuously refined to reflect the unique cultural
characteristics and thinking and viewing habits of PRC Internet users. As of
May 31, 2000, our online directory contained over 270,000 Chinese language Web
listings, each reviewed and classified by our editorial staff. We currently
receive approximately 1,000 requests every day from other Web sites for
inclusion in our directory. Most Web site listings in our directory are
classified in multiple subcategories, and each site sits at the end point of,
on average, three different paths in our directory. As a result, our directory
is highly complex, proprietary and China-specific, and we believe it would be
very difficult for our competitors to duplicate our directory. In addition, our
customized Web search software is designed to meet the unique challenges posed
by the Chinese language and its pictographic characters. In particular, our
large database of Chinese synonyms and closely associated phrases enables users
to execute key word searches effectively both for Web site listings and within
our content channels.
Highly Attractive Platform for Advertising and Commerce
We believe that Sohu is a highly attractive platform for advertisers and
merchants because we have a leading Internet brand in China and provide access
to a user group with a highly desirable demographic profile. We have developed
a client service group dedicated to enhancing our relationship with advertisers
and maximizing the effectiveness of their advertising campaigns. We also
provide advertisers with detailed and timely data regarding the number of
advertisements displayed and the number of users who clicked through for
additional information. Moreover, we intend to take advantage of our high
visitor traffic by developing a user-friendly e-commerce platform that will
allow merchants with the necessary fulfillment capabilities to easily transact
business on our Web site. We also plan to facilitate transactional activity by
handling order tracking as well as product database management. In addition, we
are working with a number of commercial banks in China under which our payment
systems will utilize debit and credit card systems developed and supported by
these banks.
Technical Expertise in Dealing with Bandwidth Limitations
Bandwidth limitations resulting from the underdeveloped telecommunications
infrastructure and server hosting environment in China may adversely affect the
ability of a Web site to accommodate and process heavy
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Web traffic reliably and quickly. As a result of our experience in China, we
believe we have substantial technical expertise and are an industry leader in
designing our operations within the confines of these technological
constraints. We constantly seek to conserve our bandwidth resources by
adjusting and fine-tuning our network and traffic routing configurations to
minimize passing traffic between our servers. In addition, all of our sites are
designed to maximize download speed, and our content aggregation is tailored
for a limited bandwidth environment.
Our Strategy
Our objective is to strengthen our position as a leading Internet portal in
China. In order to accomplish this objective, we plan to:
Maintain and Extend Our Brand Recognition
We intend to continue building our brand and strengthening our brand
leadership in China through:
. focusing our marketing efforts on increasing user registration;
. promoting services and features that target the youth market;
. building new marketing and distribution relationships;
. leveraging the media attention and publicity afforded to Sohu in our
capacity as a pioneer of the PRC Internet industry; and
. sponsoring television shows, newspaper columns, events and concerts.
Increase the Number of Visitors to Our Portal and the Duration of Each Visit
In addition to our marketing efforts, we intend to increase the number of
visitors to our portal, as well as the duration of each visit to our portal
(commonly referred to as the "stickiness" of our Web site), through continuing
efforts to improve our content, online directory and search engine, including
the following measures:
. leverage our brand leadership in China to build new content, advertising
and e-commerce relationships and add new product offerings;
. continue to add new utility features and communication tools to extend
the function/solution aspects of our content channels with the goal of
making our portal an indispensable source of solutions and information
for our users; and
. enhance our community offerings and increase interactivity among users;
. enable our users to personalize and customize the comprehensive range of
products, services and utility features we offer;
. continue to integrate our channels and sub-channels to better reflect
the thinking and viewing habits of Chinese online users and create
maximum ease of use and simplicity;
. continue our focus on increasing the download speed of our sites and
maintaining the high quality and uniform appearance of our sites.
Increase Online Advertising Revenues and Develop an E-Commerce Business
We plan to increase our online advertising revenue streams by increasing the
number of advertisers and, as the user base grows, increasing our net
advertising rates. We also intend to increase the number of Web site
sponsorship arrangements with leading advertisers in China, which are of longer
term and higher value than typical banner advertising sales arrangements. We
plan to achieve this mainly by expanding our sales force
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targeting large corporations and Internet companies, as well as continuing to
improve the quality of our client services group. Furthermore, we plan to
increase user registration and enhance our advertising measurement capabilities
in order to gain a better understanding of our user demographics and improve
our ability to target advertisement delivery.
We also plan to leverage our brand recognition and heavy traffic volume to
generate revenues from e-commerce activities. In particular, we intend to
become an aggregator of online merchants by providing online space on our
portal to third party merchants. Companies that have sold products on a trial
basis on our Web site include Motorola (pagers) and Compaq (personal
computers). In addition to providing merchants with access to our users, we
plan to provide order tracking, product database management and payment
facilities. Presently, we have no intention to handle direct-to-customer
product fulfillment. We intend to charge online merchants fees and, in some
cases, commissions for e-commerce transactions conducted through our portal.
Currently, three merchants are online on our portal.
Acquire Complementary Assets, Technologies and Businesses
We intend to actively identify and acquire assets, technologies and
businesses that are complementary to our existing portal business. We expect to
target our acquisition efforts to businesses that can help us:
. expand our user and revenue base;
. widen geographic coverage within China;
. enhance our content and service offerings;
. advance our technology; and
. strengthen our technical talent pool.
The Sohu.com Portal
The following is a brief description of the products and services we offer
under the main categories of home page and navigational context, aggregated
content, communication tools and e-commerce services. We intend to continue to
add new products and services to our portal, to better integrate our products
and services and to expand the function/solution aspects of our content
channels. In 1999, a majority of our revenues were derived from online
advertising on our home page and our Business and Finance, Technology and
Learning channels.
Home Page and Navigational Context Aggregated Content
Online Directory Main Channels:
Search Engine News
Business and Finance
Communication Tools Dow Jones
Free E-Mail Sports
Chat Rooms Information Technology
Instant Messaging Women
Message Boards Entertainment
Online Polling Music
Learning
E-Commerce Services Career
Shopping Real Estate
Auction Games
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Home Page and Navigational Context
Our portal is organized around the Sohu.com home page and the central
feature of our home page is our online directory. A screen shot of our home
page is included on the inside front cover of this prospectus.
Online Directory. Our online directory was designed and has been
continuously refined to reflect the unique cultural characteristics and
thinking and viewing habits of PRC Internet users. We are the first site in
China to introduce manual Web classification, and Chinese Web site
classification remains one of our key strengths. On average we add
approximately 400 new listings (less deletions of inactive Web links) to our
directory per day. As of May 31, 2000, our directory contained over 270,000
Chinese language Web listings under the following 18 principal categories:
<TABLE>
<S> <C> <C>
Arts Literature Science/Technology
Business/Finance Living/Service Social Sciences
Computer/Internet Medicine/Health Society/Culture
Country/Region News/Media Sports/Exercise
Education Politics/Law Travel/Transportation
Entertainment/Leisure Reference Personal Homepage
</TABLE>
Our Web sites are further organized under these principal categories within
approximately 550 hierarchical subcategories and, as appropriate, individual
Web items are referenced under multiple subcategories. Each site sits at the
end point of, on average, three different paths in our directory. In addition,
each site has been reviewed and classified by our editorial staff, and our
basic Web site listings are in most cases supplemented by a brief descriptive
commentary. As a result, our directory is highly complex, proprietary and
China-specific, and we believe it offers comprehensiveness and relevance that
would be very difficult for our competitors to duplicate.
Search Engine. Users can browse our directory listings through a Chinese
keyword search request that scans the contents of the entire directory or
within any category or subcategory. Our search software enables us to build and
continuously fine-tune a large database of Chinese synonyms and closely
associated phrases, which is essential for the accurate and efficient execution
of Chinese key word searches. We believe our large database is also difficult
for our competitors to duplicate.
In addition, we offer a function called "Global Web Search". The Global Web
Search uses our proprietary association database to browse the World Wide Web
and collect and organize Chinese language Web content. We also offer English
language search functions.
Aggregated Content
We aggregate content on a variety of topics, organized around the above-
mentioned 12 main channels. Each main channel contains numerous sub-channels
and features news, commentaries and various utilities and solutions relating to
a specific topic. As of May 31, 2000, we had over 85 content suppliers, which
enable us to provide a wide range of content offerings. Our content suppliers
are leading Chinese language media and information providers in a variety of
fields with coverage over all major cities in China. The arrangements we have
with our content suppliers are typically short-term and not exclusive and often
provide for revenue sharing as compensation to our content suppliers.
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, our "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 large spacing
used in our directories and the reporting style. The first row of the
navigation bar remains the same in each channel, listing the 12 main channels
as set forth below, but the links in the second row of the navigation bar are
selected to reflect users' interests in that specific channel.
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Main Content Channels:
News Delivers a comprehensive selection of local, national
and international news from newspapers, magazines and
other information providers throughout China. Full
text search is available on each page.
Business and Features business and financial news provided by
Finance leading financial information services in China, as
well as content translated and updated by the Dow
Jones team in Beijing. This channel also features a
co-branded Dow Jones Business Center that is popular
among Chinese professionals. Users can retrieve real-
time stock quotes, exchange rates and annual reports,
research reports and other information on selected
companies on this channel.
Dow Jones Delivers business, financial and other information
provided by Dow Jones & Company, Inc. This channel
primarily focuses on international business and
financials news.
Sports Provides the latest in national and international
sports headlines, results, commentaries and analyses.
Users can also compete in contests over national
soccer tournament rankings and participate on our
sports bulletin board.
Information Features information technology news, product reviews
Technology and software downloads. This channel also provides
Web navigation handbooks for Internet novices, as
well as Webmonkey China (translated daily from
HotWired), which offers Web design tutorials for
sophisticated Web users.
Women Covers a broad range of lifestyle-related topics that
are of particular interest to Chinese women. This
channel includes content from fashion publications,
such as the Chinese editions of Cosmopolitan and
Trends magazines, as well as publications covering
beauty, society, travel and other areas.
Entertainment Contains extensive coverage of the entertainment
arenas that are of interest to Chinese users,
including dining, movies, television programs, plays
and operas and best-selling and classic books.
Music Covers music stars, events, record releases and other
news and reports relating to the music industry, as
well as music rankings in China, Taiwan, Hong Kong
and the United States. This channel also offers music
downloads, interviews and contests.
Learning Provides educational resources and information. This
channel is unique among Chinese language portals, and
introduces the Internet and Sohu.com to many
children. Intel financially sponsored the
establishment of this channel, and we developed this
channel with top providers of electronic publishing
education programs in China.
Career Provides job listings and resume databases, as well
as career advice and career-related news and reports.
Real Estate Offers a directory of apartment and other residential
housing listings, and publishes advice on general
real estate matters.
Games
Features news and reviews related to games and a
game-related bulletin board. It also offers free,
downloadable and frequently updated games.
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Communication and Community Tools
We offer a variety of communication and community tools for our Chinese
online users which are important in promoting user affinity to our portal:
Free E-Mail We began offering free Web-based e-mail services in
July 1999, and as of June 24, 2000, we had over 3.1
million registered e-mail users. We recently upgraded
our e-mail technology.
Chat Room Our Java-based chat services enable participants to
interact in real-time group discussions or create
their own private one-on-one chat rooms. We currently
have chat rooms covering 12 broad interest areas such
as sports, romance, finance and current events. Twice
a week, we host live celebrity chats that offer our
users the chance to discuss a variety of topics with
well-known personalities. For example, in the past,
we have hosted major events on these forums that drew
tens of thousands of participants, such as the July
1999 question and answer session on the PRC national
college entrance examinations.
Instant Messaging Our instant messaging service enables our users to
detect whether their friends and other users with
similar interests are online, as well as send
messages in Chinese directly to them. Our users can
subscribe for specific interest groups and
communicate with people who share similar interests.
Message Boards Users can post and exchange information on message
boards covering 16 main topics ranging from education
and immigration to fashion and sports. On average,
50,000 messages are posted online each day.
Online Polling From time to time our channels place short, focused
pollings covering a variety of topics that are of
interest to our users and advertisers.
E-Commerce Services
We have introduced e-commerce activities on our portal and have conducted
limited e-commerce transactions on a trial basis. We have established an e-
commerce platform, and are in the early stages of actively marketing our e-
commerce services to potential customers. We plan to leverage our brand and
position as a leading PRC Internet portal and utilize our heavy visitor traffic
to develop our e-commerce business. Under our e-commerce business model,
merchants and manufacturers will provide, handle and distribute merchandise,
while banks and technology companies will manage the operational aspects of e-
commerce transactions, such as payment collection and settlement. We will also
work closely with our technology suppliers to further develop and refine our e-
commerce software platform.
Shopping We currently have three merchants on our portal, one
of which is the largest television shopping network
in Beijing. This television shopping network offers
its products on our e-commerce platform, and handles
all matters relating to product fulfillment. All
transactions are settled either through debit cards
or by cash on delivery.
Auction We have built a business-to-consumer online auction
platform, and we conducted online auctions on our Web
site in September 1999 and December 1999. We intend
to further develop our online auction platform and
may enter into strategic alliances with other online
auction houses.
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Online Advertising Sales
Advertising Programs
Our typical advertising contract involves an advertiser or advertising
agency paying us a fixed fee for displaying an advertisement for a specified
period of time with a guaranteed number of impressions. As our advertising
revenues are recognized ratably over the term of the contract (subject to
meeting the guaranteed impression levels), any increase in our page views over
the life of an advertising contract would not increase our revenues. Our
advertising contracts typically have terms ranging from three to 24 months.
Advertising on our portal currently consists of banner-style advertisements and
buttons from which viewers can hyperlink directly to the advertiser's own Web
site. In addition, we also offer advertisers text links and sponsorships of
subchannels, message boards and chat rooms. Our standard charge in terms of
cost per thousand impressions, commonly referred to as CPMs, for banner
advertisements varies depending on the terms of the contract and the
advertisement's location within our portal.
Discounts from standard rates are typically provided for higher volume,
longer-term advertising contracts, and may be provided for promotional
purposes. We have also, from time to time, performed Chinese language Web site
design services for our advertising customers (although design services are not
a material part of our revenues). In addition, we offer promotional advertising
programs, such as contests and sampling, in order to build brand awareness,
generate leads and drive traffic to an advertiser's site. In the near future,
we plan to increasingly develop Web site sponsorship arrangements with leading
advertisers in China. We expect these arrangements to be of longer term and
higher value than typical banner advertising arrangements.
Advertising Customers
During 1999, 117 companies advertised on our portal, up from 90 advertisers
during 1998 and 40 advertisers during 1997. During 1999, our principal
advertising customers included:
. Intel;
. Legend;
. Motorola;
. Nokia; and
. NBCi/Snap.
We have derived substantially all of our revenues to date from the sale of
online advertising. In 1999, two of our advertisers, Intel and Nokia, each
accounted for over 10% of total revenues. During the same period, our five
largest advertisers accounted for approximately 34% of total revenues. In the
first quarter of 2000, two of our advertisers, Nokia Corporation and
Alibaba.com, each accounted for over 8% of our revenues, and our five largest
advertisers accounted for more than 34% of our revenues and 40% of our accounts
receivable.
In May 2000, the State Administration of Industry and Commerce, or SAIC,
selected a number of Internet companies in China to participate in a one-year
online advertising trial program. The SAIC is expected to formulate online
advertising regulations based on the information gathered during the trial
program. We were selected as one of the Internet companies that will
participate in the trial program. We obtained a one-year advertising business
permit from the SAIC on May 18, 2000.
In January 2000, we also entered into long-term advertising contracts with
our Series D preferred stockholders. Under the contracts, the Series D
preferred stockholders have committed to purchase certain services from the
Company, including banner advertising, sponsorship of Web site channels,
directory services and use of the Company's e-commerce platform, over the terms
of the contracts, which range from 2 1/2 to 3 years. The total value of the
contracts is $9 million and is generally payable by the Series D preferred
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stockholders in periodic installments over the life of the agreements,
commencing December 1, 2000. The detailed description of specific services to
be provided under these agreements will be decided over the term of the
contracts, with the individual fees for services consistent with rates charged
to the Company's most preferred customers. These contracts are generally
terminable by either party where the other party has breached the contract and
where the breach is not satisfactorily cured within a specified period of time.
In addition, one of the advertising contracts is terminable at the discretion
of the customer during the second and third year of the contract if our web
site is not ranked within the top five Web sites in China based on the level of
average monthly impressions.
Strategic Relationships
Intel Corporation. Intel Corporation, one of our shareholders, provided
funding of $150,000 toward the creation of our Learning channel. Intel has
also selected us as a primary Internet link in its Pentium III promotion
program in China. As part of the promotion, portions of our Learning and
Shopping channels were Pentium III enabled.
Dow Jones & Company, Inc. Dow Jones & Company, one of our shareholders, is
an important, non-exclusive content provider to our Business and Finance
channel. The Dow Jones team in Beijing translates and updates the latest
business and finance information 40 times a day. Dow Jones also operates
the Dow Jones Business Center within our Business and Finance channel,
which provides categorized and comprehensive business information, and has
been especially popular among Chinese professionals. In addition, Dow Jones
provides us with real-time information on international financial markets.
Furthermore, Dow Jones has the right to sell a portion of our banner
advertising inventories on our Business and Finance channel inside and
outside China. Dow Jones also has the non-exclusive right to sell
advertising for the directories, the keyword search and other channels to
customers who require advertising space beyond the Business and Finance
channel. Dow Jones shares in a percentage of the revenues derived from our
Business and Finance channel. This arrangement has a one-year term which
commenced in December 1999.
Pacific Century Cyberworks Limited. We have entered into a non-exclusive
advertising contract at market rates with an affiliate of Pacific Century
Cyberworks Limited. This agreement has a two and a half-year term
commencing July 2000. An affiliate of Pacific Century Cyberworks is one of
our shareholders. Pacific Century Cyberworks is a Hong Kong Stock Exchange
listed company that is primarily involved in Internet technology-related
businesses. Pacific Century Cyberworks recently entered into an agreement
to acquire all of the outstanding shares of common stock of Cable &
Wireless HKT, the leading fixed line and wireless telecommunication
provider in Hong Kong.
Legend Holdings Limited. We have entered into a non-exclusive advertising
contract at market rates with an affiliate of Legend Holdings Limited. This
agreement has a three-year term commencing in January 2000. Legend Holdings
is one of the largest manufacturers of personal computers and other
computer hardware in the PRC. Legend is listed on the Hong Kong Stock
Exchange. An affiliate of Legend Holdings is one of our shareholders.
Hikari Tsushin, Inc. Hikari Tsushin, one of our shareholders, is one of the
leading retail distributors of cellular telephones and paging devices in
Japan. We have entered into a non-exclusive advertising contract at market
rates with Hikari Tsushin. This agreement has a three-year term commencing
in January 2000.
Nokia Corporation. We have entered into a non-exclusive agreement with an
affiliate of Nokia Corporation, under which we are Nokia's preferred
partner in China for the development of wireless access protocol, or WAP,
mobile Internet services, as well as Nokia's short message service, or SMS.
We are currently Nokia's only content partner for WAP and SMS services in
China, and are responsible for aggregating content and services, such as
stock quotes, news, e-mail and advertising, and tailoring it for
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mobile telephone users. The identification, development and aggregation of
these services for distribution over WAP-enabled devices will be funded by
us. Nokia is not obligated under the agreement to make any payments to us.
We commenced providing content for this WAP service on April 27, 2000.
Service and advertisement revenues derived from WAP-based and SMS-based
services will be shared between our company and Nokia based on a ratio to
be agreed upon at the end of the initial trial phase. This agreement has a
one-year term commencing March 2000.
Sales and Marketing
Sales Organization
We mainly rely on direct sales by our internal sales force for the placement
of our online advertisement inventory, and plan to expand sales through
agencies outside of China and in regions of China not covered by our direct
sales force. Our sales organization is dedicated to maintaining close
relationships with top advertisers and large multinational corporations
operating in China. As of March 31, 2000, our direct sales organization
consisted of 28 sales staff located in Beijing, Shanghai and Guangzhou. These
offices cover sales in the northern, eastern and southern regions of China,
respectively. We intend to expand and develop our sales organization in our key
markets in China. The compensation package for our sales staff typically
consists of a base salary plus sales commissions.
Marketing and Brand Awareness
The focus of our marketing strategy is to generate brand awareness for
Sohu.com. Since our inception through March 31, 2000, we spent approximately
$3.7 million in sales and marketing expenses, an amount we believe to be much
smaller than that spent by some of our competitors. However, primarily as a
result of the media attention afforded to Sohu in our capacity as a pioneer of
the PRC Internet industry, we have been able to generate substantial public
awareness of Sohu. As of March 31, 2000, our marketing department consisted of
22 persons located in Beijing, Shanghai and Guangzhou.
Competition
There are many companies that distribute online content and services
targeting Chinese users. We compete with distributors of content and services
over the Internet, including Web directories, search engines, content sites,
Internet service providers and sites maintained by government and educational
institutions. These sites compete with us for visitor traffic, advertising
dollars, e-commerce transactions and potential partners. The Internet market in
China is new and rapidly evolving. Competition is intense and is expected to
increase significantly in the future because there are no substantial barriers
to entry in our market.
We have many competitors in the PRC Internet portal market, including
China.com, Netease, Sina.com and Yahoo!China. In addition, a number of existing
or new PRC Internet portals, including those controlled or sponsored by PRC
government entities, may have competitive advantages over us in terms of:
. global brand recognition;
. financial and technical resources; and
. better access to original content.
However, we believe we have competitive advantages over our competitors
because of:
. our brand name, which is one of the most recognized among PRC Internet
companies;
. our exclusive focus on China;
. our ability to offer products and services that are tailored to the
specific interests, needs and viewing habits of PRC Internet users; and
. the experience and quality of our management team.
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We compete with other portals in China for advertising and e-commerce
revenues primarily on the following basis:
. brand recognition;
. volume of traffic and users;
. quality of web site and content;
. strategic relationships;
. quality of online advertising and e-commerce services;
. effectiveness of sales and marketing efforts; 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. In particular our online directory
also faces competition from software and other Internet products and services
incorporating search and retrieval capabilities. In addition, operators of
leading Web sites or Internet service providers, including large corporations
such as Microsoft/MSN, Yahoo!, Lycos and America Online, currently offer, and
could expand, their online products and services targeting China. 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, like newspapers, magazines, radio and television
for advertisers and advertising revenue. Please refer to "Risk Factors" for a
more detailed discussion of the risks we face from our competitors.
Intellectual Property and Proprietary Rights
We regard our copyrights, service marks, trademarks, trade secrets and other
intellectual property as critical to our success. We rely on trademark and
copyright law, trade secret protection, non-competition and confidentiality
and/or license agreements with our employees, customers, partners and others to
protect our intellectual property rights. Despite our precautions, it may be
possible for third parties to obtain and use our intellectual property without
authorization. Furthermore, the validity, enforceability and scope of
protection of intellectual property rights in Internet-related industries is
uncertain and still evolving. The laws of the PRC and certain other countries
do not protect intellectual property to the same extent as do the laws of the
United States.
We have registered the domain name "www.Sohu.com" with Network Solutions and
the domain name "www.Sohu.com.cn" with China Internet Network Information
Center, a domain name registration service in China, and have full legal rights
over these domain names. We have also filed trademark applications for the mark
"Sohu.com" with the China Trademark Office. China's trademark law, however,
adopts a system whereby the first applicant to receive a registration
certificate for a mark will preempt all other applicants. Prior use of an
unregistered mark is generally irrelevant except for "well-known" marks. As a
result, until actual registration certificates are issued by the China
Trademark Office, we do not have any legal rights over the mark "Sohu.com".
We have filed a service mark application for the "Sohu.com" service mark
with the U.S. Patent and Trademark Office. We are in the process of publishing
the "Sohu.com" service mark and expect to complete the registration process in
the near future. We have also filed service mark applications in Hong Kong and
Taiwan, and are in the process of applying for registration in Malaysia and
Singapore. Policing unauthorized use of our marks, however, is difficult and
expensive. In addition, it is possible that our competitors will adopt product
or service names similar to ours, thereby impeding our ability to distinguish
our brand and possibly leading to customer confusion.
Many parties are actively developing chat, homepage, search and related Web
technologies. We expect these parties to continue to take steps to protect
these technologies, including seeking patent protection. There may be patents
issued or pending that are held by others and that cover significant parts of
our technology,
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business methods or services. For example, we are aware that a number of
patents have been issued in the areas of e-commerce, Web-based information
indexing and retrieval and online direct marketing. Disputes over rights to
these technologies are likely to arise in the future. We cannot be certain that
our products do not or will not infringe valid patents, copyrights or other
intellectual property rights held by third parties. We may be subject to legal
proceedings and claims from time to time relating to the intellectual property
of others in the ordinary course of our business.
We also intend to continue licensing technology from third parties,
including technology relating to the following:
<TABLE>
<CAPTION>
Licensor Function Duration
-------- -------- --------
<S> <C> <C>
Netgravity Ad serving software One-time technology purchase with perpetual license; annual
maintenance fee.
Lodesoft Instant messaging software One-time technology purchase with perpetual license; additional
payments after reaching 50 million registered users.
OMRON Search engine software One-time technology purchase with perpetual license.
Microsoft Commercial Internet system One-time technology purchase with perpetual license for 5,000
active users; additional payments for additional active users.
</TABLE>
The market is evolving and we may need to license additional technologies to
remain competitive. We may not be able to license these technologies on
commercially reasonable terms or at all. In addition, we may fail to
successfully integrate any licensed technology into our services. Our inability
to obtain any of these licenses could delay product and service development
until alternative technologies can be identified, licensed and integrated.
Technology Infrastructure
We maintain all of our servers at the premises of the Beijing Telecom
Administration, or BTA, pursuant to one-year server hosting agreements and we
do not maintain any backup servers outside Beijing. The BTA is the
administrator of the central hub of the ChinaNet backbone, and is currently the
only provider of interconnection services to the ChinaNet backbone in Beijing.
Our servers are hosted by the BTA in the same building where ChinaNet is
administered. We have leased two 100 Mbps circuits that connect directly to the
ChinaNet backbone, and we expect to require additional circuits as our Web site
traffic continues to grow. Internet access rates in China, when compared to
rates in the United States and other more developed countries, remain
relatively expensive.
We have developed a close working relationship with the BTA. Our operations
depend on the ability of the BTA to protect their systems against damage from
fire, power loss, telecommunications, failure, break-ins, or other events. The
BTA provides us with support services 24 hours per day, 7 days per week. The
BTA also provides connectivity for our servers through multiple high-speed
connections. All facilities are protected by multiple power supplies.
For reliability, availability, and serviceability, we have created an
environment in which each server can function separately. Key components of our
server architecture are served by multiple redundant machines. We also employ
in-house and third-party monitoring software. Reporting and tracking systems
generate daily traffic, demographic, and advertising reports.
Our portal must accommodate a high volume of traffic and deliver frequently
updated information. Components or features of our portal have in the past
suffered outages or experienced slower response time because of equipment or
software down time. These events did not have a material adverse effect on our
business, but we cannot assure you that such events will not have a material
adverse effect in the future.
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Employees
As of May 31, 2000, we had 236 full-time employees, of whom 28 worked in
sales, 96 in product and content, 22 in marketing, 53 in technology and
business development, and 37 in finance and administration. From time to time,
we employ independent contractors to support our research and development,
marketing, sales and editorial departments. None of our personnel are
represented under collective bargaining agreements. We consider our relations
with our employees to be good.
All of our management and key executives, and substantially all of our other
employees, have entered into confidentiality, non-competition and non-
solicitation agreements with us. In addition, all of our management and key
executives, and substantially all of our department managers and group leaders,
have entered into employment agreements with Beijing ITC, our PRC operating
subsidiary, which contain substantially similar confidentiality and non-
competition undertakings. However, the degree of protection afforded to an
employer pursuant to confidentiality and non-competition undertakings governed
by PRC law may be more limited when compared to the degree of protection
afforded under the laws of other jurisdictions. A significant number of our
employees hold incentive stock options in Sohu, which provide financial
opportunities to them that vest on average over a period of two to four years.
Facilities
Our principal executive offices are located in approximately 26,295 square
feet of office space in Beijing, China under leases that expires on December
31, 2001 and December 31, 2002. We also lease sales and marketing office space
in Shanghai and Guangzhou.
Legal Proceedings
There are no material legal proceedings pending or, to our knowledge,
threatened against us or Beijing ITC. From time to time we become subject to
legal proceedings and claims in the ordinary course of our business. Such legal
proceedings or claims, even if not meritorious, could result in the expenditure
of significant financial and managerial resources.
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REGULATION OF THE PRC INTERNET INDUSTRY
The following description of PRC laws and regulations is based upon the
opinion of TransAsia Lawyers, our PRC counsel. For a description of certain
legal risks relating to our ownership structure and businesses, see "Risk
Factors".
Overview
Certain areas related to the Internet, such as telecommunications,
international connections for computer information networks, information
security and censorship, as well as foreign investment in those areas, are
covered in detail by a number of existing laws and regulations. The PRC
Internet industry is regulated by various governmental authorities, such as the
Ministry of Information Industry, or MII (formerly the Ministry of Post and
Telecommunications, or MPT), the State Administration of Industry and Commerce,
or SAIC, and the Ministry of Public Security.
The PRC has recently announced its policies, and is in the process of
enacting regulations, regarding the legality of foreign investment in the PRC
Internet industry, the existence and enforcement of content restrictions on the
Internet e-commerce activities and online news dissemination, as well as
domestic approval procedures for Internet companies in the PRC wishing to offer
securities in China or abroad. In November 1999, China and the United States
reached an agreement concerning China's entry into the World Trade
Organization, or WTO. The provisions of this agreement will likely be reflected
in new PRC legislation, and will likely affect the interpretation of existing
regulations relating to the PRC Internet sector. However, we cannot predict the
timing or the effect of future developments in the regulatory framework for the
PRC Internet sector.
Under current PRC regulations, foreign companies such as Sohu.com Inc.
cannot own or operate value-added telecommunications businesses in the PRC. It
is not clear whether the operation of Internet content provision services is
considered value-added telecommunications services. The China-U.S. WTO
agreement has since confirmed that the value-added telecommunications sector
may include online information or content provision services. As a result, we
recently restructured our operations. As part of this restructuring, Beijing
ITC entered into a series of agreements with Beijing Sohu and Beijing Sohu's
two shareholders. Beijing Sohu is a PRC company that is 80% owned by Dr.
Charles Zhang, our founder, President and Chief Executive Officer, and 20%
owned by Ms. Jinmei He, an executive officer of Beijing ITC. Under the
restructuring, Beijing Sohu will be structured as an Internet information
service provider and has obtained approval from the MII to develop Internet
content and information services.
In the opinion of our PRC counsel, the ownership structures of Sohu, Beijing
ITC and Beijing Sohu, both currently and after giving effect to this offering,
and the businesses and operations of Sohu, Beijing ITC and Beijing Sohu as
described in this prospectus, comply with all existing laws, rules and
regulations of the PRC. In addition, no consent, approval or license other than
those already obtained is required under any of the existing laws, rules and
regulations of the PRC for such ownership structures, businesses and operations
or this offering. The restructuring of our business in the PRC was conducted
pursuant to the advice of MII officials.
Foreign Investment in the Telecommunications Sector
In the opinion of TransAsia Lawyers, there are currently no laws, rules or
regulations prohibiting foreign investment in the PRC Internet sector, but
there are regulations promulgated by the MII relating to foreign investment in
the telecommunications sector in China, including:
. Provisional Administrative Measures Regarding the Examination and
Approval of Deregulated Telecommunications Operations (1993);
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. Provisional Regulations for the Administration of the Deregulated
Telecommunications Operations Market (1995); and
. Definitions of Various Deregulated Telecommunications Operations (1995).
These regulations prohibit a foreign person or entity, including any foreign
investment enterprise established in the PRC, such as Beijing ITC, from
investing in, or operating or participating in the operation of, any business
that provides "value-added telecommunications services". These services are
defined under PRC legislation to include, among other services, "computer
information services" and "electronic mail box services". These regulations
were promulgated and the definitions were adopted, however, prior to the
emergence of the Internet in China and prior to the signing of the WTO accord
between China and the United States. In the opinion of TransAsia Lawyers, our
business activities in China following our restructuring do not fall within the
definition of "computer information services" or "electronic mail box
services", each as defined under the Definitions of Various Deregulated
Telecommunications Operations (1995), because:
. the term "computer information services" is intended to refer to China's
public telecom database network, where fees are levied on database
users; and
. the term "electronic mail box" refers to a service launched by China
Telecom at the beginning of 1992 on the ChinaPAC platform, which is a
completely different data transmission network than the Internet.
International Connections for Computer Information Networks
The State Council and the MII have promulgated regulations governing
international connections for PRC computer networks, including:
. Provisional Regulations of the People's Republic of China for the
Administration of International Connections to Computer Information
Networks (1997) and their Implementing Measures (1998);
. Measures for the Administration of International Connections to China's
Public Computer Interconnected Networks (1996); and
. Reply Concerning the Verification and Issuance of Operating Permits for
Business Relating to International Connections for Computer Information
Networks and for Public Multimedia Telecommunications Business (1998).
Under these regulations, any entity seeking access to international
connections for computer information networks in China, such as Beijing ITC and
Beijing Sohu, must comply with the following requirements:
. be a PRC legal person;
. have the appropriate equipment, facilities and technical and
administrative personnel;
. have implemented and registered a system of information security and
censorship; and
. effect all international connections with an authorized Internet service
provider in China.
In the opinion of TransAsia Lawyers, both Beijing ITC and Beijing Sohu are
in proper compliance with all of these requirements.
Information Security and Censorship
The principal PRC regulations concerning information security and censorship
are:
. The Law of the People's Republic of China on the Preservation of State
Secrets (1988) and its implementing rules (1990);
. The Law of the People's Republic of China on State Security (1993) and
its implementing rules (1994);
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. Rules of the People's Republic of China for Protecting the Security of
Computer Information Systems (1994);
. Notice Concerning Work Relating to the Filing of Computer Information
Systems with International Connections (1996);
. Administrative Measures for Protecting the Security of Computer
Information Network with International Connections (1997); and
. Regulations for the Protection of State Secrets for Computer Information
Systems on the Internet (2000).
The aforementioned regulations specifically prohibit the use of Internet
infrastructure which results in a breach of public security or the provision of
socially destabilizing content or transmits state secrets.
. ""A breach of public security" includes breach of national security or
disclosure of state secrets; infringement on state, social or collective
interests or the legal rights and interests of citizens; or illegal or
criminal activities.
. ""Socially destabilizing content" includes any action that incites
defiance or violation of Chinese laws and regulations; incites
subversion of state power and the overturning of the socialist system;
fabricates or distorts the truth, spreads rumors or disrupts social
order; or spreads feudal superstition, involves obscenities,
pornography, gambling, violence, murder, horrific acts or instigates
criminal acts.
. ""State secrets" are defined as "matters that affect the security and
interest of the state". The term covers such broad areas as national
defense, diplomatic affairs, policy decisions on state affairs, national
economic and social development, political parties and "other state
secrets that the State Secrets Bureau has determined should be
safeguarded".
According to these regulations, it is mandatory for Internet companies in
China to complete security filing procedures with the local public security
bureau and for them to update regularly with the local public security bureau
regarding information security and censorship systems for their Web sites. In
the opinion of TransAsia Lawyers, Beijing Sohu has, as required by PRC law and
as agreed under the restructuring agreements, established an internal security
committee and adopted security maintenance measures, employed a full-time
bulletin board system supervisor and exchanged information with the local
public security bureau with regard to sensitive or censored information and Web
sites on a regular basis, and therefore is in full compliance with the above
regulations.
In addition, the State Secrets Bureau has recently issued regulations
authorizing the blocking of access to any site it deems to be leaking state
secrets or failing to meet the relevant regulations regarding the protection of
state secrets in the distribution of online information. Specifically, Internet
companies in China with bulletin board systems, chat rooms or similar services,
such as our company, must apply for the approval of the State Secrets Bureau.
As implementing rules for the regulations have not been issued, however,
details concerning how Web sites should comply with the regulations remain to
be clarified.
Encryption Software
In October 1999, the State Encryption Administration Commission promulgated
the Regulations for the Administration of Commercial Encryption, which was
followed in November 1999 by the Notice of the General Office of the State
Encryption Administration Commission. Both of these regulations address the use
in China of software with encryption functions. According to these regulations,
encryption products purchased for use must be reported. Violation of the
encryption regulations may result in the issuance of a warning, levying of a
penalty, confiscation of the encryption products and even criminal liabilities.
Since there are currently no publicly issued official interpretations of, or
detailed implementing rules for, these regulations, it is unclear how PRC
Internet companies should comply with these regulations.
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Web-Based Services
In the opinion of TransAsia Lawyers, there are no existing PRC laws, rules
or regulations that address the development and provision of Web-based
services, such as online directories, search engines, free e-mail boxes, e-
commerce and online advertising, except for two product-specific regulations
governing the online sale of audio-visual products and books that forbid
foreign-invested companies from conducting such businesses in China. In
addition, there are no existing PRC laws, rules or regulations that regulate
bulletin board systems, chat rooms and instant messenger functions. However,
the information that is exchanged among users using such functions is itself
subject to the various legislation mentioned above governing information
security and censorship, with which we are in compliance. The Beijing
Administration of Industry and Commerce recently issued a regulation requiring
all companies engaging in online business activities to complete filing and
registration procedures. Beijing ITC has done so and is therefore in compliance
with the regulation.
In the opinion of TransAsia Lawyers, online advertising is neither regulated
nor prohibited by any existing PRC laws, rules or regulations, including the
Advertising Law of the People's Republic of China (1994). The SAIC, the
government authority responsible for the area, is currently considering
adopting new regulations governing online advertising. We cannot predict the
timing and effects of such new regulations. On May 18, 2000, the SAIC issued to
Beijing ITC a one-year advertising business permit, which enables us to conduct
online advertising business.
There are no existing PRC laws, rules or regulations that specifically
define or regulate Internet content providers. According to the Measures for
the Administration of China Public Multimedia Telecommunications, "information
sources providers" are required to report to the MII for verification and to
execute an interconnections agreement and an understanding letter for
information security with China Telecom or other "node service providers". In
the opinion of TransAsia Lawyers, after the restructuring, Beijing ITC is not
an "information source provider" as defined under the above regulation and
merely operates a technical platform on which content provided by information
source providers is displayed.
Accordingly, in the opinion of TransAsia Lawyers, the current and proposed
web-based services provided by us, including our online directories, search
engine, email, e-commerce and online advertising services, comply with the
existing PRC laws, rules and regulations.
Business License and Approval for Foreign Investment
Beijing ITC is structured as a technology-oriented company engaged in the
development of Internet technologies and related software, as well as online
advertising businesses and e-commerce activities. Under current PRC law, the
legal establishment of such a technology company must be approved by the
relevant local Commission for Foreign Economic Relations and Trade, and may
commence operations only upon the issuance of a business license by the SAIC.
In the opinion of TransAsia Lawyers, Beijing ITC has satisfied all of the
aforementioned requirements.
Beijing Sohu is structured as an Internet information services company
engaged in online information services and content development. Despite the
absence of relevant legislation, the establishment of Beijing Sohu with these
business activities was approved by the MII. In the opinion of TransAsia
Lawyers, Beijing Sohu has satisfied all relevant regulations and MII
requirements.
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MANAGEMENT
Directors and Executive Officers of Sohu.com
The following table sets forth information regarding the directors and
executive officers of Sohu.com:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Directors and Executive Officers
Charles Zhang......................... 36 Chairman of the Board of Directors,
President
and Chief Executive Officer
Edward Roberts........................ 64 Director
James McGregor........................ 46 Director
George Chang.......................... 47 Director
Mary Ma............................... 48 Director
Thomas Gurnee......................... 49 Chief Financial Officer and
Senior Vice President, Finance
Alan Li............................... 51 Chief Operating Officer
Victor Koo............................ 34 Senior Vice President,
Corporate Business Development
Edwin Chan............................ 55 Senior Vice President, Marketing and Sales
Gary Zhao............................. 37 Vice President, Finance
Xin Ye................................ 36 Vice President, Technology
</TABLE>
Dr. Charles Zhang is the founder of Sohu and has been Chairman of the Board,
President and Chief Executive Officer since August 1996. Prior to founding
Sohu, Dr. Zhang worked for Internet Securities Inc. (ISI) and helped establish
its China operations. Prior to joining ISI, he worked as Massachusetts
Institute of Technology's liaison officer with China. Dr. Zhang has a Ph.D
degree in experimental physics from Massachusetts Institute of Technology and a
Bachelor of Science degree from Qinghua University in Beijing. Dr. Zhang is a
native of the People's Republic of China.
Dr. Edward Roberts has been a director of Sohu since September 1996. He is
the David Sarnoff Professor of Management of Technology at Massachusetts
Institute of Technology's Alfred P. Sloan School of Management. He has chaired
the Sloan School Management of Technology program since 1967. Dr. Roberts has
been a co-founder and director of numerous emerging technology companies and
venture capital funds, including Zero Stage and First Stage Capital Equity
Funds, Medical Information Technology, Advanced Magnetics, NETSilicon,
Pegasystems and Selfcare. He has authored over 140 articles and eleven books,
the most recent being Entrepreneurs in High Technology (Oxford University
Press, 1991), winner of the Association of American Publishers' award as
Outstanding Book of 1991 in Business and Management. Dr. Roberts received four
degrees from M.I.T., including a Ph.D degree in 1962.
James McGregor has been a director of Sohu since August 1998. He is Vice
President, China, of Dow Jones & Company, Inc. and the chief business
representative for Dow Jones in China. From July 1990 to the end of 1993, Mr.
McGregor was The Wall Street Journal's bureau chief in China. Mr. McGregor
served as chairman of the American Chamber of Commerce in Beijing in 1996 and
as president of the Foreign Correspondents Club in Beijing in 1991. Mr.
McGregor received a journalism degree from University of Minnesota.
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George Chang has been a director of Sohu since January 2000. He is a
director of various companies within the Morningside group, a private global
investment house, including Morningside Asia Advisory Limited. Morningside Asia
Advisory Limited is an affiliate of Maxtech Enterprises Limited, one of our
shareholders. Prior to joining Morningside in 1991, Mr. Chang held senior
financial positions with various trading companies in Hong Kong, and was chief
financial officer of a major multinational trading and sourcing operation. Mr.
Chang has worked with Arthur Andersen in Hong Kong and in Toronto, Canada. He
holds both Bachelor of Business Administration and Master of Business
Administration degrees from the University of Wisconsin, and is a member of the
American Institute of Certified Public Accountants, the Canadian Institute of
Chartered Accountants and the Hong Kong Society of Accountants.
Mary Ma has been a director of Sohu since March 2000. She is the Executive
Director and Senior Vice President of Legend Holdings Limited, a public company
with shares listed on the Hong Kong Stock Exchange and an affiliate of one of
our shareholders. She is responsible for the management of the overall
operations, strategic planning and business development of Legend Holdings. She
has over 22 years' experience in the strategic developments of international
alliances. Ms. Ma graduated from Capital Normal University in 1976 with a
Bachelor of Arts degree, and also studied English literature through a
scholarship program at King's College in Britain.
Thomas Gurnee has been the Chief Financial Officer and Senior Vice
President, Finance, of Sohu since January 2000. Prior to joining Sohu, Mr.
Gurnee held a number of senior positions with Chartered Semiconductor
Manufacturing Ltd, one of the world's leading independent semiconductor
foundries, including Vice President for Business Development, President (North
America), Chief Operating Officer (Singapore) and Chief Financial Officer
(Singapore). Prior to joining Chartered Semiconductor Manufacturing, Mr. Gurnee
spent thirteen years at Schlumberger Ltd, an oil field services and measurement
systems company, as finance director of various divisions in France, Singapore
and the United States. Mr. Gurnee obtained a Bachelor of Arts degree from
Stanford University and a Master of Business Administration degree from
University of Santa Clara.
Alan Li has been the Chief Operating Officer of Sohu since March 2000. Prior
to joining Sohu, Mr. Li held a number of senior positions with Oracle China,
including Executive Director responsible for strategic and new venture
development and Managing Director. Prior to joining Oracle China, Mr. Li spent
fourteen years with Digital Equipment Corporation, and was the General Manager
of Huadi Computer Co. Ltd., a joint venture between Digital and China Aerospace
Corporation. Prior to joining Digital, he spent eight years with IBM in Hong
Kong. Mr. Li holds a Bachelor of Science degree from Hong Kong University and a
Masters of Business Administration degree from The Chinese University of Hong
Kong, and has completed all course work for the Doctorate of Business
Administration degree from Nova University.
Victor Koo has been Senior Vice President, Corporate Business Development of
Sohu since January 2000. He also served as Senior Vice President, Operations
and Chief Financial Officer of Sohu between March and December of 1999. Prior
to joining Sohu, Mr. Koo held numerous senior positions in Richina Group, a
China based venture capital firm, since 1994, including as Vice President and
Director of Business Development. Prior to his employment with Richina Group,
Mr. Koo was with Bain & Company in San Francisco and Procter & Gamble
International in Hong Kong. Mr. Koo received a Masters of Business
Administration degree from Stanford University where he won a fellowship from
the Center for East Asian Studies. He was a Regent's Scholar at the University
of California at Berkeley, where he received a Bachelor of Science degree.
Edwin Chan has been Senior Vice President, Marketing and Sales of Sohu since
September 1999. Prior to joining Sohu, Mr. Chan founded his own advertising
agency and, after its merger with another agency, served as a partner of the
combined agency. Prior to that, Mr. Chan served for nearly ten years as
managing director at multinational advertising agencies J. Walter Thompson and
BBDO. Mr. Chan received a Bachelor of Arts degree from Hong Kong University.
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Gary Zhao has been Vice President, Finance, of Sohu since January 2000.
Prior to joining Sohu, he held senior positions with Motorola Corporation, GE
Capital Corporation, A.T. Kearney, Lehman Brothers and General Motors. Mr. Zhao
holds a Bachelor of Science degree from Tsinghua University, a Master of
Science degree from University of Minnesota and a Master of Business
Administration degree from the University of Pennsylvania's Wharton School of
Business.
Xin Ye has been Vice President, Technology, of Sohu since May 2000. Prior to
joining Sohu, he held senior positions with a number of Silicon Valley
technology firms, including Marimba, Innovix Technologies, Inc., Renaissance
Software, Tibco and Watkins-Johnson Co. Mr. Ye holds a Bachelor of Science
degree in Computer Engineering from Tsinghua University and a Master of Science
degree in Computer Science from Marquette University.
Audit and Compensation Committees
We have established an audit committee and a compensation committee. The
audit committee reviews our internal accounting procedures and considers and
reports to the board of directors with respect to other auditing and accounting
matters, including the selection of our independent auditors, the scope of
annual audits, fees to be paid to our independent auditors and the performance
of our independent auditors. The audit committee currently consists of James
McGregor, George Chang and Mary Ma.
The compensation committee reviews and recommends to the board of directors
the salaries, benefits and stock option grants of all employees, consultants,
directors and other individuals compensated by us. The compensation committee
also administers our stock option and other employee benefits plans. The
compensation committee currently consists of Edward Roberts.
Classified Board of Directors
Our board of directors is divided into two classes of directors serving
staggered two-year terms. Upon the expiration of the term of a class of
directors, the directors in that class will be elected for two-year terms at
the annual meeting of shareholders in the year in which their term expires.
With respect to each class, a director's term will be subject to the election
and qualification of their successors, or their earlier death, resignation or
removal. These provisions, when coupled with the provision of our fifth amended
and restated certificate of incorporation authorizing the board of directors to
fill vacant directorships or increase the size of the board of directors, may
deter a shareholder from removing incumbent directors and simultaneously
gaining control of the board of directors by filling vacancies created by such
removal with its own nominees.
Our board of directors has resolved that Mr. George Chang and Ms. Mary Ma
will serve as Class I Directors whose terms expire at the 2001 annual meeting
of shareholders, and Dr. Charles Zhang, Dr. Edward Roberts and Mr. James
McGregor will serve as Class II Directors whose terms expire at the 2002 annual
meeting of shareholders.
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Directors, Executive Officers and Key Employees of Beijing ITC
The following table sets forth information regarding the directors,
executive officers and key employees of Beijing ITC:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Executive Officers
Charles Zhang......................... 36 Chairman of the Board of Directors,
President and Chief Executive Officer
Thomas Gurnee......................... 49 Chief Financial Officer and
Senior Vice President, Finance
Alan Li............................... 51 Chief Operating Officer
Victor Koo............................ 34 Senior Vice President, Corporate Business
Development
Edwin Chan............................ 55 Senior Vice President, Marketing and Sales
Gary Zhao............................. 37 Vice President, Finance
Xin Ye................................ 36 Vice President, Technology
Key Employees
Min Yang.............................. 32 Financial Controller
Jinmei He............................. 28 Marketing Director
Peter Song............................ 33 Technology Director
Michael Ma............................ 33 Regional Sales Director
Elaine Feng........................... 28 Business Development Director
Jianjun Wang.......................... 30 Manager of Classification Group
Maggie Wu............................. 26 Content Development Director
Tony Cheung........................... 29 Regional Sales Manager
</TABLE>
Min Yang joined Beijing ITC in 1998 and has been the Financial Controller
since May 1999. He was previously finance and administration manager at Zeneca
SinoPharm in Beijing. Prior to that, he worked at De Nora Electrochemical
Industrial Corporation. Mr. Yang received a Bachelor of Arts degree from
Northeast University of Finance and Economics.
Jinmei He joined Beijing ITC in September 1997 and has been the Marketing
Director since November 1999. She was previously with Internet Securities
Inc.'s Beijing representative office. She received a Bachelor of Arts degree
from Southwest Jiatong University.
Peter Song has been Beijing ITC's Technology Director since April 1998. He
was previously with SINOPEC, a PRC state-owned oil company, and has held
several programming and technical positions. Mr. Song received a Bachelor of
Science degree from Tianjin University.
Michael Ma joined Beijing ITC in January 2000 and is the Regional Sales
Director. Prior to joining Beijing ITC, he held a number of marketing positions
with Gillette (China) Ltd. Mr. Ma received a Bachelor of Business
Administration degree from Zhongshan University School of Management and a
Certificate in Business Administration from the University of California at
Berkeley.
Elaine Feng joined Beijing ITC in May 1998 as the Sales Manager and has been
the Business Development Director since November 1999. She was previously a
business development manager at Star TV. Prior to that, Ms. Feng worked for
Richina Media.
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Jianjun Wang has been the Manager of Beijing ITC Classification Group since
August 1999. He is also a part-time lecturer at Beijing Teachers' University.
Dr. Wang received his doctorate degree from Beijing Teachers' University.
Maggie Wu joined Beijing ITC in 1997 and held positions in marketing and
sales prior to becoming Content Development Director in 2000. She received a
Bachelor of Arts degree from International Trade Shanghai Financial and
Economic University.
Tony Cheung joined Beijing ITC in September 1999 and is the Regional
Advertising Sales Manager. He was previously advertising manager and senior
manager, China region at CAAC Inflight Magazine. He received a Bachelor of
Business Administration degree from the University of Oregon and a Master of
Business Administration Degree from Sheffield Hallam University.
Executive Officers
Our board of directors appoints our executive officers. Our executive
officers serve at the discretion of our board of directors.
Director Compensation
Directors do not currently receive any cash compensation for serving on the
board of directors of Sohu or Beijing ITC, although they are reimbursed for
reasonable travel expenses incurred in connection with attending board of
directors and committee meetings.
In January 2000, Edward Roberts received options to purchase 10,400 shares
of common stock pursuant to our stock incentive plan. These options have an
exercise price of $5.77 and vest on a quarterly basis, with options to purchase
2,600 shares vesting at the end of each quarter of the year beginning with the
vesting commencement date.
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Executive Compensation
The following table sets forth the compensation earned for all services
rendered to us in all capacities during 1999 by our executive officers.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Long-Term
Compensation(1) Compensation Awards
-------------------------------------
Fiscal Securities
Name and Principal Position Year Salary Bonus Underlying Options(#)
--------------------------- ------ -------- ----------------------------
<S> <C> <C> <C> <C>
Charles Zhang.................... 1999 $ 50,000 $ -- 130,000
Chairman of the Board,
President and Chief Executive
Officer
Thomas Gurnee(2)................. 1999 $ -- $ -- 182,000
Chief Financial Officer and
Senior Vice President, Finance
Alan Li(3)....................... 1999 $ -- $ -- --
Chief Operating Officer
Victor Koo(4).................... 1999 $ 75,000 $ -- 208,907
Senior Vice President,
Corporate Business Development
Edwin Chan(5).................... 1999 $ 58,334 $ -- 78,000
Senior Vice President,
Marketing and Sales
Gary Zhao(6)..................... 1999 $ -- $ -- --
Vice President, Finance
Xin Ye(7)........................ 1999 $ -- $ -- --
Vice President, Technology
</TABLE>
---------------------
(1) The column for "Other Annual Compensation" has been omitted because there
is no compensation required to be reported in that column. The aggregate
amount of perquisites and other personal benefits provided to each officer
listed above is less than 10% of the total annual salary and bonus of that
officer.
(2) Mr. Gurnee joined Sohu in January 2000. His employment agreement provides
for an annual salary in 2000 of $170,000.
(3) Mr. Li joined Sohu in March 2000. His employment agreement provides for an
annual salary in 2000 of $170,000, and he was granted options to purchase
182,000 shares of common stock in March 2000.
(4) Mr. Koo joined Sohu in April 1999. His employment agreement provides for an
annual salary in 2000 of $120,000.
(5) Mr. Chan joined Sohu in September 1999. His employment agreement provides
for an annual salary in 2000 of $200,000.
(6) Mr. Zhao joined Sohu in January 2000. His employment agreement provides for
an annual salary in 2000 of $120,000, and he was granted options to
purchase 78,000 shares of common stock in January 2000.
(7) Mr. Ye joined Sohu in May 2000. His employment agreement provides for an
annual salary in 2000 of $120,000.
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Option Grants In Fiscal Year 1999
The following table sets forth information regarding stock options granted
to our executive officers listed on the Summary Compensation Table for 1999. We
have never granted any stock appreciation rights.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates of Stock
Price Appreciation for
Individual Grants Option Term(1)
------------------------------------------------------------ -----------------------
Number of
Securities Percent of Total
Underlying Options Granted
Options to Employees in Exercise Price
Name Granted Fiscal Year 1999 per Share Expiration Date 5% 10%
---- ---------- ---------------- -------------- --------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Charles Zhang........... 130,000(2) 14% $1.81 Sept. 21, 2009 $ 2,517,732 $ 4,418,325
Thomas Gurnee........... 182,000(3) 19% $3.85 Dec. 5, 2009 $ 3,153,965 $ 5,436,795
Alan Li(4).............. -- -- -- -- -- --
Victor Koo.............. 208,907(5) 22% $1.81 Nov. 1, 2009 $ 4,045,937 $ 6,666,262
Edwin Chan.............. 78,000(6) 8% $3.85 Dec. 5, 2009 $ 1,351,699 $ 2,330,055
Gary Zhao(7)............ -- -- -- -- -- --
Xin Ye(8)............... -- -- -- -- -- --
</TABLE>
---------------------
(1) The potential realizable value is based on the term of the option at the
time of its grant, which is ten years for the stock options granted to the
executive officers in the table. The assumed 5% and 10% annual rates of
appreciation over the term of the options are set forth in accordance with
rules and regulations adopted by the Securities and Exchange Commission and
do not represent our estimates of stock price appreciation. The potential
realizable value is calculated using the initial public offering price of
our common stock of $13.00 per share as the base value on which
appreciation has been calculated.
(2) Options granted vest ratably on a quarterly basis over one year commencing
from September 21, 1999.
(3) Options granted vest over a three year period commencing January 1, 2000,
with one-third of the options vesting at the end of the first year and the
remaining options vesting ratably on a quarterly basis over the remaining
term of the options.
(4) Mr. Li joined our company in March 2000 and he was granted options to
purchase 182,000 shares of common stock.
(5) Options granted vest ratably over three years on a quarterly basis
commencing from May 1, 1999.
(6) Options granted vest over a four year period commencing September 15, 1999,
with one-quarter of the options resting at the end of the first year and
the remaining options vesting ratably on a quarterly basis over the
remaining term of the options.
(7) Mr. Zhao joined our company in January 2000 and he was granted options to
purchase 78,000 shares of common stock.
(8) Mr. Ye joined our company in May 2000.
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Aggregate Option Exercises in Fiscal Year 1999 And Fiscal Year-End Option
Values
The following table sets forth information concerning the exercise of stock
options during the fiscal year ended December 31, 1999 by our officers listed
on the Summary Compensation Table and the fiscal year-end value of unexercised
in-the-money options held by such officers.
<TABLE>
<CAPTION>
Number of Securities Underlying Value Of Unexercised
Unexercised Options at In-the-money Options at
December 31, 1999 December 31, 1999(1)
----------------------------------- -------------------------
Shares Acquired
Name on Exercise Value Realized(2) Exercisable Unexercisable Exercisable Unexercisable
---- --------------- ----------------- --------------- ---------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Charles Zhang........... -- -- 32,500 97,500 $363,725 $1,091,175
Thomas Gurnee........... -- -- -- 182,000 -- $1,666,000
Alan Li(3).............. -- -- -- -- -- --
Victor Koo.............. -- -- 34,818 174,089 $389,665 $1,948,326
Edwin Chan.............. -- -- -- 78,000 -- $ 714,000
Gary Zhao(4)............ -- -- -- -- -- --
Xin Ye(5)............... -- -- -- -- -- --
</TABLE>
---------------------
(1) There was no public market for the common stock on December 31, 1999. The
value of unexercised in-the-money options at December 31, 1999 has been
calculated based on the initial public offering price of our common stock
of $13.00 per share, less the applicable exercise price per share
multiplied by the number of underlying shares.
(2) None of our executive officers exercised any stock options during 1999.
(3) Mr. Li joined our company in March 2000.
(4) Mr. Zhao joined our company in January 2000.
(5) Mr. Ye joined our company in May 2000.
In January 2000, our board of directors granted options for the purchase of
330,200 shares of common stock to certain of our employees and a director at an
exercise price of $5.77 per share. The options granted generally vest over
periods ranging from one to four years beginning with the first quarter
subsequent to the date of grant of the options.
Employment Arrangements
Each of Charles Zhang, Thomas Gurnee, Alan Li, Victor Koo, Edwin Chan, Gary
Zhao and Xin Ye has entered into a confidentiality, non-competition and non-
solicitation agreement with us. Such agreements prohibit each of them from
competing with us or soliciting our employees, customers, suppliers or partners
in competition with us during his employment with us and for a period of one
year after the termination of his employment for any reason. Under such
agreement, each executive officer has also agreed to use any confidential
information belonging to us or held by us in confidence solely for our benefit
and not to disclose such confidential information during and after his
employment with us.
In addition, all of our executive officers have entered into employment
agreements with Beijing ITC, our PRC operating subsidiary, which contain
substantially similar confidentiality and non-competition undertakings.
However, the degree of protection afforded to an employer pursuant to
confidentiality and non-competition undertakings governed by PRC law may be
more limited in certain respects when compared to the degree of protection
afforded under the laws of other jurisdictions.
Stock Incentive Plan
We have adopted a stock incentive plan as of January 25, 2000 to assist us
in attracting and retaining highly competent people to serve as employees,
directors and advisors who will contribute to our success and the success of
the members of our network. We also seek to motivate those people to achieve
long-term
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<PAGE>
objectives which will benefit our shareholders. The following groups of people
are eligible to receive options under the stock incentive plan:
. employees;
. directors;
. advisors and consultants.
Our stock incentive plan also provides these groups of people with
opportunities to make direct purchases of our common stock.
Our board of directors administers the stock incentive plan and has wide
discretion to award options. Subject to the provisions of the stock incentive
plan, our board of directors determines who will be granted options, the type
and timing of options to be granted, vesting schedules and other terms and
conditions of options, including the exercise price. A significant number of
our employees are granted options. The number of options awarded to a person
is based on the person's potential ability to contribute to our company's
success. the person's position with our company and sometimes length of
service.
Our board of directors may award "incentive" options or "non-qualified"
options. We have granted both incentive and non-qualified options under the
stock option plan. If the holder of an incentive option exercises the option
and holds the shares of common stock he receives for the holding periods
required by the Internal Revenue Code, the exercise of the incentive does not
result in taxable income to the holder. We are therefore not entitled to a
corresponding tax deduction. The incentive options we granted under the stock
incentive plan are designed to meet the requirements of the Internal Revenue
Code, including a requirement that the exercise price is at least 100% of the
fair market value of our common stock on the date we grant the option and that
the option has a term no longer than ten years. However, no person who owns,
directly or indirectly, more than 10% of the total combined voting power of
all classes of our shares may receive incentive options unless the exercise
price is at least 110% of the fair market value of our common stock on the
grant date and the term is no longer than five years. Options granted under
the stock incentive plan are not transferable by the optionee, other than by
will or by the laws of descent and distribution.
By contrast, if the holder of a non-qualified option exercises the option,
the holder will be required to recognize taxable income on the date of
exercise. The taxable income is equal to the difference between the fair
market value of the shares acquired by exercising the option and the exercise
price of the option. We are then entitled to a corresponding tax deduction.
At May 31, 2000, options to purchase 1,358,882 shares of common stock were
outstanding under the stock incentive plan and 1,071,312 shares remained
available for future option grants. The weighted average exercise price for
these outstanding options is $3.14 per share. Most of these outstanding
options become exercisable on a schedule at least as rapid as the following:
. with respect to 25% of the shares subject to the option, on the first
anniversary of the date of grant; and
. with respect to the remaining 75% of the shares subject to the option in
twelve equal quarterly installment beginning one calendar quarter after
the date of such anniversary.
These options terminate upon the earliest to occur of the following: 90
days after termination of an optionee's employment, 180 days after an
optionee's employment is terminated for any other reason, including
retirement, disability or death, and ten years after the grant date.
Notwithstanding the foregoing, upon a change of control (for example, a merger
or similar transaction or the removal of a majority of the members of our
current board of directors) of our company, all unvested portions of options
then outstanding will vest in full on that date.
We intend to grant options for the purchase of up to 598,000 shares of
common stock to certain of our directors and employees prior to the closing of
this offering at an exercise price equal to the initial public offering price.
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<PAGE>
Our board of directors may amend, alter, suspend, or terminate the stock
incentive plan at any time, provided, however, that the board must first seek
the approval of shareholders, if required by law or regulation, and that of
each affected optionee if such amendment, alteration, suspension or termination
would adversely affect his or her rights under any option granted prior to that
date.
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<PAGE>
PRINCIPAL SHAREHOLDERS
The following table, sets forth information with respect to the beneficial
ownership, within the meaning of Section 13(d)(3) of the Securities Exchange
Act 1934, as amended, of our common stock, as of June 26, 2000 and as adjusted
to reflect the sale of the shares of common stock offered in this offering for:
. each person who we know owns beneficially more than 5% of our common
stock;
. each of our directors;
. each of our executive officers; and
. all of our executive officers and directors as a group.
The following information gives effect to the conversion of all outstanding
shares of our preferred stock into common stock upon the consummation of this
offering (assuming no exercise of the over-allotment option).
<TABLE>
<CAPTION>
Shares of Shares of
Common Stock Common Stock
Beneficially Owned Beneficially Owned
Before this Offering After this Offering Number of Number of
--------------------- --------------------- exercisable excluded
Name of Beneficial Owner Number Percentage Number Percentage options/warrants(1) options/warrants(2)
------------------------ ---------- ---------- ---------- ---------- ------------------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Charles Zhang(3)(16).... 8,988,000 33.1% 8,988,000 28.3% 65,000 65,000
Maxtech Enterprises
Limited(4)(16)......... 6,572,894 24.2 6,572,894 20.7 212,675 --
Intel
Corporation(5)(16)..... 3,350,750 12.3 3,350,750 10.5 -- --
Edward Roberts(6)(16)... 1,384,097 5.1 1,384,097 4.4 5,200 5,200
James McGregor(7)....... -- -- -- -- -- --
George Chang(9)......... -- -- -- -- -- --
Mary Ma(8).............. -- -- -- -- -- --
Thomas Gurnee(10)....... -- -- -- -- -- 182,000
Alan Li (11)............ * * * * 11,375 170,625
Victor Koo(12).......... * * * * 87,040 121,867
Edwin Chan(13).......... -- -- -- -- -- 78,000
Gary Zhao(14)........... -- -- -- -- -- 78,000
Xin Ye(15).............. -- -- -- --
All directors and
executive officers as a
group
(11 persons)........... 10,437,362 38.4% 10,437,362 32.9% 168,615 700,692
</TABLE>
---------------------
* Indicates less than one percent of the common stock
(1) Shows shares of our common stock issuable upon exercise of options that are
currently exercisable or are exercisable within 60 days of the date of this
prospectus. These shares are included in the total number of shares
beneficially owned.
(2) Shows shares of our common stock issuable upon exercise of options that
will not be exercisable within 60 days of the date of this prospectus.
These shares are not included in the total number of shares beneficially
owned.
(3) Dr. Zhang's address is c/o Sohu.com Inc., 7 Jianguomen Nei Avenue, Suite
1519, Tower 2, Bright Chiina Chang An Building, Beijing 100005, People's
Republic of China.
(4) A British Virgin Islands corporation that is wholly-owned by Morningside
Technologies Inc., a Cayman Islands corporation, which is in turn wholly-
owned by Morningside CyberVentures Holdings Limited, a British Virgin
Islands corporation, which is in turn wholly-owned by The NTX-II Trust, an
Isle of Man Trust. The trustee of the trust is Verrall Limited, an Isle of
Man corporation. Verrall Limited controls indirectly, through The NTX-II
Trust, a 100% ownership interest in Maxtech Enterprises Limited, and has
sole power to vote and dispose of the shares of Sohu held by Maxtech
Enterprises Limited. The address of
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<PAGE>
Maxtech Enterprises Limited is Suite 835A, Europort, Gilbraltar. The
address of Verrall Limited is c/o Dickinson, Cruickshank & Co., 33/37,
Athol Street, Douglas IM1 1LB, Isle of Man.
(5) Intel Corporation's address is 2200 Mission College Boulevard, Santa
Clara, CA 95052, U.S.A.
(6) Dr. Roberts' address is c/o M.I.T. Sloan School of Management, 50 Memorial
Drive, E52-535, Cambridge, MA 02142-1347, U.S.A.
(7) Mr. McGregor's address is c/o Dow Jones China, Unit 1101, Tower A, Beijing
Ke Lun Building, 12A Guanghua Lu, Chaoyang District, Beijing 100020,
People's Republic of China.
(8) Ms. Ma's address is c/o Legend Holdings Limited, 20/F, Devon House, Taikoo
Place, 979 King's Road, Quarry Bay, Hong Kong.
(9) Mr. Chang's address is c/o Morningside Asia Advisory Limited, Room 2311,
Hang Lung Centre, 2-20 Paterson Street, Causeway Bay, Hong Kong.
(10) Mr. Gurnee's address is c/o Sohu.com Inc., 7 Jianguomen Nei Avenue, Suite
1519, Tower 2, Bright China Chang An Building, Beijing 100005, People's
Republic of China.
(11) Mr. Li's address is c/o Sohu.com Inc., 7 Jianguomen Nei Avenue, Suite
1519, Tower 2, Bright China Chang An Building, Beijing 100005, People's
Republic of China.
(12) Mr. Koo's address is c/o Sohu.com Inc., 7 Jianguomen Nei Avenue, Suite
1519, Tower 2, Bright China Chang An Building, Beijing 100005, People's
Republic of China.
(13) Mr. Chan's address is c/o Sohu.com Inc., 7 Jianguomen Nei Avenue, Suite
1519, Tower 2, Bright China Chang An Building, Beijing 100005, People's
Republic of China.
(14) Mr. Zhao's address is c/o Sohu.com Inc., 7 Jianguomen Nei Avenue, Suite
1519, Tower 2, Bright China Chang An Building, Beijing 100005, People's
Republic of China.
(15) Mr. Ye's address is c/o Sohu.com Inc., 7 Jianguomen Nei Avenue, Suite
1519, Tower 2, Bright China Chang An Building, Beijing 100005, People's
Republic of China.
(16) These shareholders and certain other shareholders are parties to a voting
agreement. Under the agreement (i) Dow Jones and Intel may each nominate
one director to our board of directors; (ii) Harrison Enterprises and
Maxtech Enterprises may jointly nominate one director to our board of
directors; (iii) all parties to the agreement will vote the voting
securities owned by them in favor of the nominees specified above; and
(iv) none of parties will vote to remove any director nominated in
accordance with the stockholders' voting agreement, other than for cause,
without the consent of the party or parties entitled to nominate the
director. For each of Dow Jones and Intel, its nomination rights will
terminate when it no longer holds at least 50% of the preferred stock it
had purchased or at least 50% of the common stock into which any such
preferred stock has been converted. For Harrison Enterprises and Maxtech
Enterprises, their joint nomination rights will terminate when, between
them, they no longer hold at least 50% of the preferred stock they had
purchased or at least 50% of the common stock into which any such
preferred stock has been converted. The nomination rights for all parties
will terminate in their entirety when none of (x) Harrison Enterprises
and Maxtech Enterprises collectively, (y) Dow Jones or (z) Intel holds at
least 50% of the preferred stock originally purchased or at least 50% of
the common stock into which any such preferred stock has been converted.
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<PAGE>
RELATED PARTY TRANSACTIONS
We have entered into an agreement whereby we provide Internet advertising
and promotional services to a subsidiary of Intel Corporation, one of our
shareholders. The total amount of revenue recorded under this agreement was $0,
$175,000 and $178,000 for the years ended December 31, 1997, 1998 and 1999,
respectively. During 1999, affiliates of Maxtech Enterprises Limited, one of
our shareholders, provided certain professional and managerial services to us.
The estimated fair value of these services was approximately $60,000 for the
year ended December 31, 1999. In connection with these services, Maxtech
received a warrant from us in October 1999 giving it the right to purchase
212,675 shares of our common stock at a price of $2.351 per share. This warrant
is exercisable during the two year period from the date of its issuance.
Sohu, Dr. Charles Zhang and holders of our Series A, B, B-1 and C preferred
stock are parties to the second amended and restated stockholders' voting
agreement. This agreement provides that, among other things:
. Dow Jones and Intel may each nominate one director to our board of
directors;
. Harrison Enterprises and Maxtech Enterprises may jointly nominate one
director to our board of directors;
. all of the parties will vote the voting securities owned by them in
favor of the nominees specified above; and
. none of the parties will vote to remove any director nominated in
accordance with the stockholders' voting agreement, other than for
cause, without the consent of the party entitled to nominate the
director.
The parties to the stockholders' voting agreement, with the exception of Dr.
Charles Zhang, together with Hikari Tsushin, Inc., Internet Creations Limited,
a subsidiary of Pacific Century Cyberworks Limited, and Legend New-Tech
Investment Limited, a subsidiary of Legend Holdings Limited, have entered into
the third amended and restated investor rights agreement. This agreement
provide that, among other things:
. parties holding more than 20% of our outstanding common stock (excluding
shares of common stock acquired by our founding shareholders pursuant to
the exercise of stock options or warrants or the conversion of preferred
stock) have the right to require the filing of a registration statement
with the Securities and Exchange Commission during any period, and no
more than two over any period, to register for sale shares of our common
stock owned by them;
. parties proposing to sell common stock at an aggregate price to the
public of $500,000 or more have the right to require the filing of a
Form S-3 registration statement with the Securities and Exchange
Commission during any period to register for sale the shares of common
stock owned by them; and
. all parties have rights to participate in registration statements filed
by Sohu for the sale of our common stock in an underwritten offering for
its own account or for the account of other shareholders;
. however, we are not obligated to file a registration statement with the
SEC if, within the six month period preceding the date of the request
for registration, we have already effected a registration statement in
accordance with the terms of the agreement.
The existence and exercise of these registration rights may make it more
difficult for us to arrange future financing and may have an adverse effect on
the market price of our common stock. See "Description of Capital Stock --
Registration Rights".
During 1999, Kummell Investments Limited, an affiliate of Maxtech
Enterprises, extended a one-time $1,500,000 loan to us. This loan was
subsequently converted into 829,434 shares of our Series C preferred stock as
part of our Series C preferred stock financing.
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<PAGE>
On July 12, 2000, Dr. Charles Zhang, our founder, President and Chief
Executive Officer, agreed with Pacific Century Cyberworks Limited, an affiliate
of one of the holders of our Series D preferred stock, to procure Sohu.com Inc.
to purchase within a period of three years not less than $6.0 million of
services, including but not limited to, broadband, web distribution,
advertising, consultancy services and such other services, from Pacific Century
Cyberworks Limited and its affiliated group companies at their then current
fees and charges.
During June 2000, we and our wholly owned PRC subsidiary, Beijing ITC,
entered into a series of agreements with Beijing Sohu and Beijing Sohu's two
shareholders. Beijing Sohu is a PRC company that is 80% owned by Dr. Charles
Zhang, our founder, President and Chief Executive Officer, and 20% owned by Ms.
Jinmei He, an executive officer of Beijing ITC.
Cooperation Agreement
Under this agreement, Beijing Sohu agreed to provide to Beijing ITC, for a
monthly service fee of RMB Internet information services including the
following:
. providing, collecting, classifying, editing, supervising and
disseminating content for use by Beijing ITC on the www.sohu.com Web
site;
. collecting and supervising the original content that Beijing ITC may use
to develop the digitalized content to be released in online and wireless
access protocol, or WAP, versions;
. upon consultation with Beijing ITC, developing and entering into new
content supplier relationships;
. providing online space for use by Beijing ITC in conducting its online
advertising and commerce activities on the www.sohu.com Web site;
. providing Beijing ITC with other internet information services
reasonably requested by Beijing ITC.
The monthly service fee is subject to periodic adjustment as agreed by the
parties. The parties intend that the fee will be an amount necessary to
reimburse Beijing Sohu for all its costs and expenses incurred in conducting
its content operations under the cooperation agreement.
Moreover, in order to allow Beijing Sohu to provide the services described
above, Beijing ITC has granted to Beijing Sohu and will assist Beijing Sohu in
obtaining from our company, the following licenses by agreements to be
separately signed for a fixed monthly fee:
. domain name licenses for the non-exclusive use of the www.sohu.com and
www.sohu.com.cn domain names;
. trade name and trademark license for the non-exclusive use of the
English and Chinese language versions of the "Sohu" name and trademark;
and
. copyright license for the non-exclusive use of our overall Web site
design and the digitalized content developed and owned by Beijing ITC to
be released in online and WAP versions.
All of the licenses granted above are granted only for Beijing Sohu's
services to be provided to Beijing ITC pursuant to this agreement in China.
Beijing Sohu is responsible for obtaining and maintaining the necessary
operating permits, including an information services permit, an online news
dissemination permit, if required, and computer network security registrations
and complying with PRC law regarding the distribution of content on our Web
site.
In order to support Beijing Sohu's operations and services, Beijing ITC has
agreed that it will provide exclusive technical services to Beijing Sohu in the
following areas:
. portal Web site technology;
. Web site server application software;
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<PAGE>
. solutions for system operations; and
. training for technical personnel and provision for technical consulting.
In addition, Beijing Sohu agreed to rely exclusively on Beijing ITC's
technical support and services and will enter into a separate agreement for the
specifics of these services.
The cooperation agreement has a term of 20 years, and may be terminated by
either party upon (i) a breach of the agreement that is not remedied within ten
days after notice of the breach has been provided by the non-breaching party to
the breaching party, or (ii) a force majeure event that continues for 30 days
or more and makes it impossible for one or both parties to continue performing
under the agreement.
Beijing Sohu also has agreed that without Beijing ITC's written consent,
Beijing Sohu may not transfer, mortgage or sub-license to any third party or
use for the benefit of any third party any of its rights under this agreement
and may not use the rights granted under this agreement in any way detrimental
to the commercial reputation of Beijing ITC.
Each party's obligations under this agreement can be excused from
performance upon a force majeure event, which is defined to include
unforeseeable and unavoidable events, including hacker attacks.
This agreement is governed by PRC law and disputes arising under this
agreement will be subject to arbitration proceedings in China.
Assets and Business Restructuring Agreement
Under this agreement, Beijing ITC agreed to, among other things, do the
following:
. transfer all ten of its content-related servers and related equipment to
Beijing Sohu for an amount equal to the net book value of the servers
and the equipment as audited by our accountants, which we estimate to be
approximately RMB740,000 and is payable six months after the transfer
date;
. assign up to 25 of its content editors and supervisors to Beijing Sohu.
In return, Beijing Sohu agreed to, among other things, the following:
. use the content-related servers and related equipment solely for the
purpose of providing information services to our www.sohu.com Web site
in China; and
. be responsible for the compensation, welfare and employment of the
content editors and supervisors assigned to Beijing Sohu.
The assets and business restructuring agreement has a term of 20 years, and
may be terminated by either party upon (1) a breach of the agreement that is
not remedied within ten days after notice of the breach has been provided by
the non-breaching party to the breaching party or (2) a force majeure event
that continues for 30 days or more and makes it impossible for one or both
parties to continue performing under the agreement.
Each party's obligations under this agreement can be excused from
performance upon a force majeure event, which is defined to include
unforeseeable and unavoidable events, including hacker attacks.
This agreement is governed by PRC law and disputes arising under with this
agreement will be subject to arbitration proceedings in China.
Option Agreement
Beijing ITC entered into an exclusive twenty year option agreement with the
shareholders of Beijing Sohu, Dr. Charles Zhang and Ms. Jinmei He. Under this
agreement, Beijing ITC or a third party designated by Beijing ITC will have the
right, at any time, subject to the laws of the PRC, including any applicable
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restrictions on foreign investment, to purchase from Dr. Zhang and Ms. He at an
aggregate price of RMB2,000,000, their entire ownership interest in Beijing
Sohu. The option may be exercised in whole or in part on one or more occasions.
This agreement expires upon the earlier of twenty years after its execution and
the date on which the entire ownership interest of Beijing Sohu is acquired by
Beijing ITC.
This agreement is governed by PRC law and disputes arising under this
agreement will be subject to arbitration proceedings in China.
Loan Agreements
We entered into a loan agreement for $176,000 with Dr. Charles Zhang and a
loan agreement for $43,000 with Ms. Jinmei He. The sole purpose of these loans
is to help them fund their additional equity investments in Beijing Sohu as a
result of our corporate restructuring. The loans will not bear any interest,
will have a term of ten years and will be repayable in full at maturity. In the
event Beijing ITC or its designee purchases shares of Beijing Sohu pursuant to
the option agreement described above, the net proceeds to Dr. Zhang and Ms. He
from the sale of shares will be applied towards partial repayment of the loans.
Dr. Zhang and Ms. He have pledged all of their shares in Beijing Sohu to us as
security for the loans.
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SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no public market for our stock. We
cannot predict the effect, if any, that sales of shares or the availability of
shares for sale will have on the market price prevailing from time to time.
Future sales of substantial amounts of our stock in the public market, or the
perception that such sales may occur, could adversely affect the prevailing
market price of our stock.
Upon completion of this offering, we expect to have 31,224,216 shares of
common stock outstanding or 31,914,216 shares if the U.S. underwriters and
international managers fully exercise their over-allotment option to purchase
additional shares. Of these shares, all of the shares sold in this offering
will be freely tradeable without restriction under the Securities Act, except
for any such shares which may be acquired by one of our affiliates. Rule 144
defines an affiliate of a company as a person that, directly or indirectly,
through one or more intermediaries, controls or is controlled by, or is under
common control with, our company. All shares of common stock outstanding prior
to this offering are "restricted securities", as such term is defined under
Rule 144, because they were issued in private transactions not involving a
public offering. These shares may not be sold in the absence of registration
other than in accordance with Rule 144 or Rule 701 under the Securities Act or
another exemption form registration. This prospectus may not be used in
connection with any resale of shares of common stock acquired in this offering
by our affiliates.
We have agreed that we will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, or file with the Securities and
Exchange Commission a registration statement under the Securities Act relating
to, any shares of our common stock or securities convertible into or
exchangeable or exercisable for any shares of our common stock, or publicly
disclose the intention to make any such offer, sale, pledge, disposition or
filing, without the prior written consent of Credit Suisse First Boston
Corporation for a period of 180 days after the date of this prospectus, except
issuances pursuant to the exercise of employee stock options outstanding on the
date hereof.
Our executive officers and directors and most of our preferred shareholders,
together holding approximately 98% of our shares outstanding without giving
effect to this offering, have agreed that they will not offer, sell, contract
to sell, pledge or otherwise dispose of, directly or indirectly, any shares of
our common stock or securities convertible into or exchangeable or exercisable
for any shares of our common stock, enter into a transaction which would have
the same effect, or enter into any swap, hedge or other arrangement that
transfers, in whole or in part, any of the economic consequences of ownership
of our common stock, whether any such aforementioned transaction is to be
settled by delivery of our common stock or such other securities, in cash or
otherwise, or publicly disclose the intention to make any such offer, sale,
pledge or disposition, or to enter into any such transaction, swap, hedge or
other arrangement, without, in each case, the prior written consent of Credit
Suisse First Boston Corporation for a period of 180 days after the date of this
prospectus.
Rule 144
In general, under Rule 144 if a period of at least one year has elapsed
since the later of the date the restricted shares were acquired from Sohu and
the date they were acquired from an affiliate, then the holder of such
restricted shares, including an affiliate, is entitled to sell a number of
shares within any three-month period that does not exceed the greater of:
. one percent of the then outstanding shares; and
. the average weekly reported volume of trading of such shares on Nasdaq
during the four calendar weeks preceding the date on which notice of the
sale is filed with the Securities and Exchange Commission.
The holder may only sell such shares through unsolicited brokers'
transactions. Sales under Rule 144 are also subject to certain requirements
pertaining to:
. the manner of such sales;
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. notices of such sales; and
. the availability of current public information concerning Sohu.
Rule 144(k)
Under Rule 144 (k), a holder of restricted shares may sell shares
immediately without regard to the volume limitations and other restrictions
described above if:
. a period of at least two years has passed between the later of (1) the
date restricted securities were acquired from Sohu and (2) the date they
were acquired from an affiliate, as applicable;
. the holder is not an affiliate at the time of the sale; and
. the holder has not been an affiliate for at least three months prior to
the sale.
Rule 144 does not require the same person to have held the securities for
the applicable periods. The foregoing summary of Rule 144 is not intended to be
a complete description.
Rule 701
In general, under Rule 701 of the Securities Act as currently in effect,
each of our directors, officers, employees, consultants or advisors who
purchased shares of common stock from us in connection with a compensatory
share plan or other written agreement may be eligible to resell such shares 90
days after the closing of this offering in reliance on Rule 144, but without
compliance with certain restrictions, including the holding period, contained
in Rule 144. Beginning 90 days after the date of this prospectus,
approximately, 1,260,000 shares acquired upon exercise of options issued under
our stock option plan will be outstanding and eligible for sale in reliance
upon Rule 701. Additional shares may be available if options are exercised in
the 180-day period following the date of this prospectus.
Registration Rights
After completion of this offering, the holders of approximately 17,200,000
shares of common stock, or their transferees, will be entitled to exercise
rights to cause us to register those shares for resale under the Securities
Act. These holders have these registration rights under the provisions of a
registration rights agreement that was entered into in connection with the
private placement of our Series B, Series B-1, Series C and Series D preferred
stock. These rights cover the shares of common stock into which the preferred
stock will be converted upon completion of this offering, as well as any shares
obtained by these shareholders from time to time after this offering.
Registration of these shares of our common stock would permit the sale of these
shares without regard to the restrictions of Rule 144. For a further
description of these registration rights, see the "Certain Relationships"
section of this prospectus.
Stock Incentive Plan
Immediately after this offering, we intend to file a registration statement
under the Securities Act covering 2,340,000 shares of common stock reserved for
issuance under our stock incentive plan. This registration statement is
expected to be filed as soon as practicable after the closing of this offering.
Through May 31, 2000, options to purchase a total of 1,358,882 shares had
been issued and are outstanding. All of these shares will be eligible for sale
in the public market from time to time, subject to vesting provisions, Rule 144
volume and other limitations applicable to our affiliates and, in the case of
some of the options, the expiration of lockup agreements.
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DESCRIPTION OF CAPITAL STOCK
General
Our sixth amended and restated certificate of incorporation and our amended
and restated bylaws, which will become effective upon the closing of this
offering, authorize the issuance of up to 75,400,000 shares of common stock,
par value $0.001 per share, and 1,000,000 shares of preferred stock, par value
$0.001 per share, the rights and preferences of which may be established from
time to time by our board of directors. The following summarizes the terms and
provisions of our capital stock upon the closing of this offering. The summary
is not complete, and you should read the forms of our sixth amended and
restated certificate of incorporation and bylaws, which will be filed as
exhibits to the registration statement of which this prospectus is a part. As
of May 31, 2000, 9,415,666 shares of common stock were issued and outstanding,
14,194,440 shares of convertible preferred stock (Series A, B, B-1, C and D)
convertible into 17,208,550 shares of common stock were issued and outstanding
and options and warrants to purchase 1,616,654 shares of common stock were
issued and outstanding.
Common Stock
Under our sixth amended and restated certificate of incorporation, holders
of our common stock are entitled to one vote for each share held of record on
all matters submitted to a vote of the shareholders, including the election of
directors. They do not have cumulative voting rights, so that holders of a
plurality of the shares of common stock present at a meeting at which a quorum
is present will be able to elect all of our directors eligible for election in
a given year. The holders of a majority of the voting power of the issued and
outstanding common stock will constitute a quorum. Subject to preferences that
may be applicable to any then outstanding preferred stock, holders of our
common stock are entitled to receive ratably dividends, if any, as may be
declared by the board of directors out of legally available funds. In case of
our liquidation, dissolution or winding up, the holders of common stock will be
entitled to share ratably in the net assets legally available for distribution
to shareholders after payment of all of our liabilities and liquidation
preference of any preferred stock then outstanding. Holders of common stock
have no preemptive or conversion rights or other subscription rights. There are
no redemption or sinking fund provisions applicable to the common stock. The
rights, preferences and privileges of holders of common stock are subject to
the rights of the holders of shares of any series of preferred stock that we
may designate and issue in the future. After the closing of this offering,
there will be no shares of preferred stock outstanding.
Preferred Stock
Our board of directors will be authorized to issue preferred stock in one or
more series and to establish the number of shares to be included in each series
and to fix the designations, powers, preferences and rights of the shares of
each series and any qualifications, limitations or restrictions of each series.
Because the board of directors will have the power to establish the preferences
and rights of the shares of any series of preferred stock, it may afford the
holders of any series of preferred stock preferences, powers and rights,
including voting rights, senior to the rights of the holders of common stock.
The issuance of preferred stock may have the effect of delaying, deferring or
preventing a change in control of our company.
Registration Rights
A number of our shareholders are parties to the third amended and restated
investor rights agreement. Under the terms of the agreement, parties holding at
least 20% of the then outstanding shares of the common stock subject to the
agreement have the right to require the filing, on no more than two occasions
and not more than once in any six-month period, of a registration statement
with the SEC to register for sale shares of common stock owned by them.
Furthermore, if we become eligible to file registration statements on Form S-3,
parties to the agreement proposing to sell common stock at an aggregate price
to the public of US$500,000 or more have the right to require us to file a
registration statement on Form S-3 under the Securities Act to register for
sale shares of
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common stock owned by them. We will not be required to effect any Form S-3
registration more than once in any six-month period. Shareholders who are
parties to the agreement will be entitled to require us to register the common
stock owned by them when we register common stock for our own account or the
account of other shareholders. This type of registration right is commonly
known as a "piggyback" registration right.
The foregoing registration rights are subject to certain conditions and
limitations, including:
. the right of the underwriters in any underwritten offering to limit the
number of shares of common stock held by shareholders with registration
rights to be included in any demand, Form S-3 or piggyback registration;
and
. our right to delay for up to 90 days the filing or effectiveness of a
registration statement pursuant to a demand for registration if the
board of directors determines that the registration would not be in our
best interest at that time.
We are generally required to bear all of the expenses of all registrations,
except underwriting discounts and commissions. Registration of any of the
shares of common stock held by shareholders with registration rights would
result in those shares becoming freely tradable without restriction under the
Securities Act immediately after effectiveness of the registration. We have
agreed to indemnify the holders of registration rights in connection with
demand, Form S-3 and piggyback registration under the terms of the third
amended and restated investor rights agreement.
Anti-Takeover Effects of Delaware Law and Our Sixth Amended and Restated
Certificate of Incorporation and Bylaws
Section 203 of the Delaware General Corporation Law
We must comply with the provisions of Section 203 of the Delaware General
Corporation Law. In general, Section 203 prohibits a publicly held Delaware
corporation from engaging in a "business combination" with an "interested
shareholder" for a period of three years after the date of the transaction in
which the person became an interested shareholder, unless the business
combination is approved in a prescribed manner.
A "business combination" includes a merger, asset sale or other transaction
resulting in a financial benefit to the interested shareholder. An "interested
shareholder" is a person who, together with affiliates and associates, owns,
or, in some cases, within three years prior, did own, 15% or more of the
corporation's voting stock. Under Section 203, a business combination between
our company and an interested shareholder is prohibited unless it satisfies one
of the following three conditions:
. our board of directors must have previously approved either the business
combination or the transaction that resulted in the shareholder becoming
an interested shareholder;
. upon consummation of the transaction that resulted in the shareholder
becoming an interested shareholder, the interested shareholder owned at
least 85% of our voting stock outstanding at the time the transaction
commenced, excluding, for purposes of determining the number of shares
outstanding, shares owned by (1) persons who are directors and also
officers and (2) employee stock plans, in some instances; or
. the business combination is approved by our board of directors and
authorized at an annual or special meeting of the shareholders by the
affirmative vote of the holders of at least 66 2/3% of the outstanding
voting stock that is not owned by the interested shareholder.
Provisions of our sixth amended and restated certificate of incorporation
and amended and restated bylaws, which are summarized in the following
paragraphs, may be deemed to have an anti-takeover effect and may delay, defer
or prevent a tender offer or takeover attempt that a shareholder might consider
to be in its best
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interest, including those attempts that might result in a premium over the
market price for the shares of common stock held by our shareholders.
Classified Board of Directors
Our sixth amended and restated certificate of incorporation provides that
the number of directors shall be determined in accordance with the bylaws. Upon
the completion of this offering, our board of directors will be divided into
two classes of directors serving staggered two-year terms. As a result,
approximately one-half of the board of directors will be elected each year.
With respect to each class, a director's term will be subject to the election
and qualification of their successors, or their earlier death, resignation or
removal. In addition, our board of directors may be removed only for cause.
These provisions, when coupled with the provision of our sixth amended and
restated certificate of incorporation authorizing the board of directors to
fill vacant directorships or increase the size of the board of directors, may
deter a shareholder from removing incumbent directors and simultaneously
gaining control of the board of directors by filling the vacancies created by
such removal with its own nominees.
Stockholder Action; Special Meetings of Shareholders
Our sixth amended and restated certificate of incorporation eliminates the
ability of shareholders to act by written consent. It further provides that
special meetings of our shareholders may be called only by the chairman of the
board, president or a majority of the board of directors. These provisions may
render it more difficult for shareholders to take action opposed by the board
of directors.
Advance Notice Requirements for shareholder Proposals and Director Nominations
Our amended and restated bylaws provide that stockholders seeking to bring
business before an annual meeting of shareholders, or to nominate candidates
for election as directors at an annual meeting of shareholders, must provide
timely notice in writing. To be timely, a shareholder's notice must be
delivered to or mailed and received at our principal executive offices not less
than 60 days nor more than 90 days prior to the anniversary date of the
immediately preceding annual meeting of shareholders; provided, that in the
event that the annual meeting is called for a date that is not within 30 days
before or after such anniversary date, notice by the shareholder in order to be
timely must be received not later than the close of business on the tenth day
following the date on which notice of the date of the annual meeting was mailed
to shareholders or made public, whichever first occurs. In the case of a
special meeting of shareholders called for the purpose of electing directors,
notice by the shareholder in order to be timely must be received not later than
the close of business on the tenth day following the day on which notice of the
date of the special meeting was mailed or public disclosure of the date of the
special meting was made, whichever first occurs. Our amended and restated
bylaws also specify certain requirements as to the form and content of a
shareholder's notice. These provisions may preclude shareholders from bringing
matters before an annual meeting of shareholders or from making nominations for
directors at an annual meeting of shareholders.
Supermajority approvals
Our amended and restated by laws provide that the provisions of our
certificate of incorporation referred to above will not be able to be altered
without approval by our stockholders holding not less than 80% of the voting
power of the outstanding shares.
Authorized But Unissued Shares
The authorized but unissued shares of preferred stock are available for
future issuance without shareholder approval. The existence of authorized but
unissued shares of preferred stock could render more difficult or discourage an
attempt to obtain control of us by means of a proxy contest, tender offer,
merger or otherwise.
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Indemnification, and Limitation of Liability for Directors and Officers
Our sixth amended and restated certificate of incorporation provides that we
will indemnify our directors and officers to the fullest extent permitted by
the laws of the State of Delaware. Our charter also provides that a director of
our company shall not be personally liable to us or our stockholders for
monetary damages for breach of fiduciary duty as a director, except to the
extent such exemption from liability or limitation thereof is not permitted
under the Delaware General Corporation Law as the same exists or may hereafter
be amended.
The indemnification rights conferred by our certificate of incorporation are
not exclusive of any other right to which a person seeking indemnification may
otherwise be entitled. We will also provide liability insurance for our
directors and officers for certain losses arising from claims or charges made
against them, while acting in their capacities as directors or officers.
Transfer Agent and Registrar
Our transfer agent is The Bank of New York.
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TAXATION
Certain United States Tax Consequences to Non-U.S. Holders of Common Stock
This section summarizes certain United States federal income and estate tax
consequences of the ownership and disposition of common stock by a non-U.S.
holder. You are a non-U.S. holder if you are, for United States federal income
tax purposes:
. a nonresident alien individual,
. a foreign corporation,
. a foreign partnership, or
. an estate or trust that in either case is not subject to United States
federal income tax on a net income basis on income or gain from common
stock.
This section does not consider the specific facts and circumstances that may
be relevant to a particular non-U.S. holder and does not address the treatment
of a non-U.S. holder under the laws of any state, local or foreign taxing
jurisdiction. This section is based on the tax laws of the United States,
including the Internal Revenue Code of 1986, as amended, existing and proposed
regulations, and administrative and judicial interpretations, all as currently
in effect. These laws are subject to change, possibly on a retroactive basis.
You should consult a tax advisor regarding the United States federal tax
consequences of acquiring, holding and disposing of common stock in your
particular circumstances, as well as any tax consequences that may arise
under the laws of any state, local or foreign taxing jurisdiction.
Dividends
Generally, a percentage of any dividend paid by a United States corporation
that received at least 80% of its gross income from one or more active foreign
businesses for the three tax years before the tax year in which the dividend is
paid (or, if the corporation has no gross income for such three-year period, in
the tax year in which the dividend is paid) is not subject to withholding of
United States federal income tax. The applicable percentage is determined by
dividing the corporation's foreign gross income for the testing period by the
corporation's total gross income for that period. Any remaining portion of the
dividend would be subject to withholding tax as described below. We believe
that we are likely to satisfy the 80% foreign business requirement, but this
conclusion is a factual determination made annually and no assurances can be
made that we will do so.
Except for that portion of any dividend not subject to withholding as
described above and except as described below, if you are a non-U.S. holder of
common stock, dividends paid to you are subject to withholding of United States
federal income tax at a 30% rate or at a lower rate if you are eligible for the
benefits of an income tax treaty that provides for a lower rate. Under
currently effective United States Treasury regulations, for purposes of
determining if dividends are subject to the 30% withholding tax, dividends paid
to an address in a foreign country are presumed to be paid to a resident of
that country, unless the person making the payment has knowledge to the
contrary. Under current interpretations of United States Treasury regulations,
this presumption also applies for purposes of determining whether a lower
withholding rate applies under an income tax treaty.
Under United States Treasury regulations that will generally apply to
dividends paid after December 31, 2000, you must satisfy certain certification
requirements in order to claim the benefit of a lower treaty rate.
Additionally, if you are a partner in a foreign partnership that holds the
common stock, you, in addition to the foreign partnership, must satisfy the
certification requirements and the partnership must provide certain information
as well. The Internal Revenue Service will apply a look-through rule in the
case of tiered partnerships.
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If you are eligible for a reduced rate of United States withholding tax
under a tax treaty, you may obtain a refund of any amounts withheld in excess
of that rate by filing a refund claim with the United States Internal Revenue
Service.
If the dividends are "effectively connected" with your conduct of a trade or
business within the United States, and, if required by a tax treaty, the
dividends are attributable to a permanent establishment, or in the case of an
individual a "fixed base", that you maintain in the United States, then the
dividends generally are not subject to withholding tax, provided you file the
appropriate Internal Revenue Service form with the payor. Instead, "effectively
connected" dividends are taxed at rates applicable to United States citizens,
resident aliens and domestic United States corporations.
If you are a corporate non-U.S. holder, "effectively connected" dividends
that you receive may, under certain circumstances, be subject to an additional
"branch profits tax" at a 30% rate or at a lower rate if you are eligible for
the benefits of an income tax treaty that provides for a lower rate.
Gain on Disposition of Common Stock
If you are a non-U.S. holder, you generally will not be subject to United
States federal income tax on gain that you recognize on a disposition of common
stock unless:
. the gain is "effectively connected" with your conduct of a trade or
business in the United States, and the gain is attributable to a
permanent establishment, or in the case of an individual a "fixed base",
that you maintain in the United States, if that is required by an
applicable income tax treaty as a condition for subjecting you to United
States taxation on a net income basis,
. you are an individual, you hold the common stock as a capital asset, you
are present in the United States for 183 or more days in the taxable
year of the sale and certain other conditions are satisfied, or
. we are or have been a "United States real property holding corporation"
for federal income tax purposes and you held, directly or indirectly, at
any time during the five-year period ending on the date of disposition,
more than 5% of the common stock and you are not eligible for any treaty
exemption.
If you are a corporate non-U.S. holder, "effectively connected" gains that
you recognize may also, under certain circumstances, be subject to an
additional "branch profits tax" at a 30% rate or at a lower rate if you are
eligible for the benefits of an income tax treaty that provides for a lower
rate.
We have not been, are not and do not anticipate becoming a United States
real property holding corporation for United States federal income tax
purposes.
Federal Estate Taxes
Common stock held by an individual who is a non-U.S. holder at the time of
death will be included in the holder's gross estate for United States federal
estate tax purposes, unless an applicable estate tax treaty provides otherwise.
Information Reporting and Backup Withholding
Under currently applicable law, if you are a non-U.S. holder, dividends paid
to you at an address outside the United States will not be subject to United
States information reporting requirements or backup withholding tax. Beginning
with respect to payments made after December 31, 2000, a non-U.S. holder will
be entitled to such exemption only if the non-U.S. holder provides a Form W-8
(or satisfies certain documentary evidence requirements for establishing that
it is a non-U.S. holder) or otherwise establishes an exemption.
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If you sell your common stock outside of the United States through a non-
U.S. office of a non-U.S. broker, and the sales proceeds are paid to you
outside the United States, then United States backup withholding and
information reporting requirements generally will not apply to that payment.
However, United States information reporting, but not backup withholding, will
apply to a payment of sales proceeds, even if that payment is made outside the
United States, if you sell your common stock through a non-U.S. office of a
broker that:
. is a United States person,
. derives 50% or more of its gross income for certain periods from the
conduct of a trade or business in the United States,
. is a "controlled foreign corporation" as to the United States, or with
respect to payments made after December 31, 2000, is a foreign
partnership, if at any time during its tax year:
-- one or more of its partners are U.S. persons, as defined in United
States Treasury regulations, who in the aggregate hold more than 50%
of the income or capital interests in the partnership, or
-- at any time during its tax year, the foreign partnership is engaged
in a United States trade or business,
unless the broker has documentary evidence in its files that you are a non-U.S.
person or you otherwise establish an exemption.
If you receive payments of the proceeds of a sale of common stock to or
through a United States office of a broker, the payment is subject to both
United States backup withholding and information reporting unless you certify,
under penalties of perjury, that you are a non-U.S. person or you otherwise
establish an exemption.
You generally may obtain a refund of any amounts withheld under the backup
withholding rules that exceed your income tax liability by filing a refund
claim with the United States Internal Revenue Service.
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UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated , 2000, we have agreed to sell to the underwriters named
below, for whom Credit Suisse First Boston Corporation is acting as
representative for the U.S. underwriters and Credit Suisse First Boston (Hong
Kong) Limited is acting as representative for the international managers, the
following respective number of shares of common stock:
<TABLE>
<CAPTION>
Number
U.S. Underwriters of Shares
----------------- ---------
<S> <C>
Credit Suisse First Boston Corporation................................ 1,564,000
BOCI Asia Limited..................................................... 368,000
Donaldson, Lufkin & Jenrette Securities Corporation................... 368,000
---------
Subtotal............................................................ 2,300,000
---------
</TABLE>
<TABLE>
<CAPTION>
Number
International Managers of Shares
---------------------- ---------
<S> <C>
Credit Suisse First Boston (Hong Kong) Limited........................ 1,564,000
BOCI Asia Limited..................................................... 368,000
Donaldson, Lufkin & Jenrette Asia Limited............................. 368,000
---------
Subtotal............................................................ 2,300,000
---------
Total............................................................. 4,600,000
=========
</TABLE>
The U.S. offering and the international offering are each conditioned upon
the closing of the other.
The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of common stock in the offering if any are purchased,
other than those shares covered by the over-allotment option described below.
The underwriting agreement also provides that if an underwriter defaults, the
purchase commitments by the non-defaulting underwriters may be increased or
this offering of common stock may be terminated.
We have granted the underwriters a 30-day option to purchase on a pro rata
basis up to 690,000 additional shares of common stock from us at the initial
public offering price, less the underwriting discounts and commissions. The
option may be exercised only to cover any over-allotments of common stock.
The underwriters propose to offer the shares of common stock initially at
the public offering price on the cover page of this prospectus and to selling
group members at that price less a concession of $0.54 per share. The
underwriters and selling group members may allow a discount of $0.10 per share
on sales to other broker/dealers. After the initial public offering, the public
offering price and concession and discount to broker/dealers may be changed by
the representatives.
The following table summarizes the compensation and estimated expenses we
will pay.
<TABLE>
<CAPTION>
Per Share Total
----------------------------- -----------------------------
Without With Without With
Over-allotment Over-allotment Over-allotment Over-allotment
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting discounts
and commissions
paid by us............. $0.91 $0.91 $4,186,000 $4,813,900
Expenses payable by us.. $0.60 $0.52 $2,765,811 $2,765,811
</TABLE>
We will reimburse certain expenses of the underwriters incurred in
connection with this offering.
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The underwriters have informed us that they do not expect discretionary
sales to exceed 5% of our common stock being offered.
Pursuant to an agreement between the U.S. underwriters and international
managers, each U.S. underwriter has agreed that, as a part of its distribution
of the common stock and subject to permitted exceptions, it has not offered or
sold, and will not offer or sell, directly or indirectly, any shares of common
stock or distribute any prospectus relating to the common stock to any person
outside the United States or Canada or to any other dealer who does not so
agree. Each international manager has agreed that, as part of its distribution
of the common stock and subject to permitted exceptions, it has not offered or
sold, and will not offer or sell, directly or indirectly, any shares of common
stock or distribute any prospectus relating to the common stock in the United
States or Canada or to any other dealer who does not so agree. The foregoing
limitations do not apply to stabilization transactions or to transactions
between the U.S. underwriters and international managers. As used herein,
"United States" means the United States of America (including the States and
the District of Columbia), its territories, possessions and other areas subject
to its jurisdiction; "Canada" means Canada, its provinces, territories,
possessions and other areas subject to its jurisdiction; and an offer or sale
shall be in the United States or Canada if its is made to (i) any individual
resident in the United States or Canada or (ii) any corporation, partnership,
pension, profit-sharing or other trust or entity (including any such entity
acting as an investment adviser with discretionary authority) whose office most
directly involved with the purchase is located in the United States or Canada.
Each of the international managers severally represents and agrees that:
In the United Kingdom:
. it has not offered or sold, and prior to the date six months after the
date of issue of the common stock will not offer or sell, any shares of
common stock to persons in the United Kingdom except to persons whose
ordinary activities involve them in acquiring, holding, managing or
disposing of investments (as principal or agent) for the purposes of
their businesses or otherwise in circumstances which have not resulted
and will not result in an offer to the public in the United Kingdom
within the meaning of the Public Offers of Securities Regulation 1995;
. it has complied and will comply with all applicable provisions of the
Financial Services Act 1986 with respect to anything done by it in
relation to the common stock in, from or otherwise involving the United
Kingdom;
. it has only issued or passed on and will only issue or passed on and
will only issue or pass on in the United Kingdom any document received
by it in connection with the issue of the common stock to a person who
is of a kind described in Article 11(3) of the Financial Services Act
1986 (Investment Advertisements) (Exemptions) Order 1996 or is a person
to whom such document may otherwise lawfully be issued or passed on;
In Japan:
. it has not offered or sold and will not offer or sell, directly or
indirectly, in Japan or to or for the account of any resident of Japan
any shares of common stock, except (1) under an exemption from the
registration requirements of the Securities and Exchange Law of Japan
and (2) in compliance with any other applicable requirements of Japanese
law;
. it will send to any dealer who purchases from it any shares of common
stock a notice stating in substance that, by purchasing such shares, the
dealer represents and agrees that it has not offered or sold, and will
not offer or sell, any shares of common stock, directly or indirectly,
in Japan or to or for the account of any resident thereof except
pursuant to any exemption from the registration requirements of the
Securities and Exchange Law of Japan, and that the dealer will send to
any other dealer to whom it sells any shares of common stock a notice
containing substantially the same statement as is contained in this
sentence;
92
<PAGE>
In Hong Kong:
. it has not offered or sold and will not offer or sell any shares of
common stock in Hong Kong by means of any document, other than to
persons whose ordinary business it is to buy or sell shares or
debentures, whether as principal or agent, except in circumstances which
do not constitute an offer to the public within the meaning of the
Companies Ordinance (Chapter 32) of Hong Kong;
. it has not issued and will not issue any initiation or advertisement
relating to the common stock in Hong Kong, except if permitted to do so
by the securities law of Hong Kong, other than with respect to shares of
common stock intended to be disposed of to persons outside Hong Kong or
to be disposed of in Hong Kong only to persons whose business involves
the acquisition, disposal or holding of shares whether as principal or
agent; and
In Singapore:
. it has not and will not offer or sell any shares of common stock or
distribute any document or other material relating to the common stock,
either directly or indirectly, to the public or any member of the public
in Singapore other than (1) to an institutional investor or other person
specified in Section 106C of the Companies Act, Chapter 50 of Singapore,
(2) to a sophisticated investor, and in accordance with the conditions,
specified in Section 106D of the Companies Act, Chapter 50 of Singapore
or (3) otherwise pursuant to, and in accordance with the conditions of,
any other provision of the Companies Act, Chapter 50 of Singapore.
A copy of this prospectus has been lodged with the Registrar of Companies
and Businesses in Singapore as an information memorandum for the purposes of
Section 106D of the Companies Act Chapter 50 of Singapore. The Registrar of
Companies and Businesses in Singapore takes no responsibility as to the
contents of this document.
We have agreed that we will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, or file with the Securities and
Exchange Commission a registration statement under the Securities Act relating
to, any shares of our common stock or securities convertible into or
exchangeable or exercisable for any shares of our common stock, or publicly
disclose the intention to make any such offer, sale, pledge, disposition or
filing, without the prior written consent of Credit Suisse First Boston
Corporation for a period of 180 days after the date of this prospectus, except
issuances pursuant to the exercise of employee stock options outstanding on the
date hereof.
Our executive officers and directors and most of our preferred shareholders
have agreed that they will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, any shares of our common stock or
securities convertible into or exchangeable or exercisable for any shares of
our common stock, enter into a transaction which would have the same effect, or
enter into any swap, hedge or other arrangement that transfers, in whole or in
part, any of the economic consequences of ownership of our common stock,
whether any such aforementioned transaction is to be settled by delivery of our
common stock or such other securities, in cash or otherwise, or publicly
disclose the intention to make any such offer, sale, pledge or disposition, or
to enter into any such transaction, swap, hedge or other arrangement, without,
in each case, the prior written consent of Credit Suisse First Boston
Corporation for a period of 180 days after the date of this prospectus.
The underwriters have reserved for sale, at the initial public offering
price, up to 230,000 shares of the common stock to be sold in this offering, to
strategic partners, consultants and friends and family of our officers. The
number of shares available for sale to the general public in this offering will
be reduced to the extent these persons purchase the reserved shares. Any
reserved shares not so purchased will be offered by the underwriters to the
general public on the same terms as the other shares.
The underwriters have agreed to reimburse certain of our expenses incurred
in connection with this offering.
93
<PAGE>
BOCI Asia Limited is not a U.S. registered broker-dealer and, therefore,
does not intend to effect any sales of shares in the United States.
We have agreed to indemnify the underwriters against liabilities under the
Securities Act, or to contribute to payments that the underwriters may be
required to make in that respect.
Our common stock has been approved for quotation on The Nasdaq Stock
Market's National Market under the symbol "SOHU".
Prior to this offering, there has been no public market for our common
stock. The initial public offering price will be determined by negotiation
between us and the representatives and does not reflect the market price for
our common stock following this offering. Among the principal factors
considered in determining the initial public offering price will be:
. the information in this prospectus and otherwise available to the
representatives;
. market conditions for initial public offerings;
. the history of and prospects for the industry in which we will compete;
. our past and present operations;
. our past and present earnings and current financial position;
. the ability of our management;
. our prospects for future revenues and earnings;
. the present state of our development;
. the recent market prices of, and the demand for, publicly traded common
stock of generally comparable companies; and
. the general condition of the securities markets at the time of this
offering.
We can offer no assurance that the initial public offering price will
correspond to the price at which the common stock will trade in the public
market subsequent to this offering or that an active trading market for the
common stock will develop and continue after this offering.
The representatives on behalf of the underwriters may engage in over-
allotment, stabilizing transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Securities Exchange Act
of 1934, as amended.
. Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.
. Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
. Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions.
. Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by such
syndicate member is purchased in a stabilizing transaction or a
syndicate covering transaction to cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty
bids may cause the price of the common stock to be higher than it would
otherwise be in the absence of such transactions. These transactions may be
effected on The Nasdaq Stock Market's National Market or otherwise and, if
commenced, may be discontinued at anytime.
A prospectus in electronic format will be made available on the Web sites
maintained by one or more of the underwriters participating in this offering.
The representatives may agree to allocate a number of shares to underwriters
for sale to their online brokerage account holders. Internet distributions will
be allocated by the underwriters that will make Internet distributions on the
same basis as other allocations.
94
<PAGE>
NOTICE TO CANADIAN RESIDENTS
Resale Restrictions
The distribution of the securities in Canada is being made only on a private
placement basis exempt from the requirement that we prepare and file a
prospectus with the securities regulatory authorities in each province where
trades of securities are effected. Accordingly, any resale of the securities in
Canada must be made in accordance with applicable securities laws which will
vary depending on the relevant jurisdiction, and which may require resales to
be made in accordance with available statutory exemptions or pursuant to a
discretionary exemption granted by the applicable Canadian securities
regulatory authority. Purchasers are advised to seek legal advice prior to any
resale of the securities.
Representations of Purchasers
Each purchaser of securities in Canada who receives a purchase confirmation
will be deemed to represent to us and the dealer from whom such purchase
confirmation is received that (1) such purchaser is entitled under applicable
provincial securities laws to purchase such securities without the benefit of a
prospectus qualified under such securities laws, (2) where required by law,
that such purchaser is purchasing as principal and not as agent, and (3) such
purchaser has reviewed the text above under "Resale Restrictions".
Rights of Action (Ontario Purchasers)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.
Enforcement of Legal Rights
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be
possible for Canadian purchasers to effect service of process within Canada
upon the issuer or such persons. All or a substantial portion of the assets of
the issuer and such persons may be located outside of Canada and, as a result,
it may not be possible to satisfy a judgment against the issuer or such persons
in Canada or to enforce a judgment obtained in Canadian courts against such
issuer or persons outside of Canada.
Notice to British Columbia Residents
A purchaser of securities to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
securities acquired by such purchaser pursuant to this offering. Such report
must be in the form attached to British Columbia Securities Commission Blanket
Order BOR #95/17, a copy of which may be obtained from us. Only one such report
must be filed in respect of securities acquired on the same date and under the
same prospectus exemption.
Taxation and Eligibility for Investment
Canadian purchasers of securities should consult their own legal and tax
advisors with respect to the tax consequences of an investment in the
securities in their particular circumstances and with respect to the
eligibility of the securities for investment by the purchaser under relevant
Canadian legislation.
95
<PAGE>
VALIDITY OF COMMON STOCK
The validity of the common stock will be passed upon for Sohu.com Inc. by
Sullivan & Cromwell, Hong Kong and New York, New York. Certain legal matters
under U.S. federal and New York law will be passed upon for the underwriters by
Cravath, Swaine & Moore, Hong Kong and New York, New York. Certain legal
matters as to PRC law will be passed upon for Sohu.com Inc. by TransAsia
Lawyers, Beijing and for the underwriters by Commerce & Finance Law Offices,
Beijing.
EXPERTS
The consolidated financial statements as of December 31, 1998 and 1999 and
for each of the three years in the period ended December 31, 1999 included in
this prospectus have been so included in reliance on the report of
PricewaterhouseCoopers, independent accountants, given on the authority of said
firm as experts in auditing and accounting. We have included in this prospectus
descriptions concerning PRC laws and regulations and our regulatory compliance
in reliance upon the opinion of TransAsia Lawyers and their authority as
experts in PRC legal matters.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a Registration
Statement on Form S-1 under the Securities Act with respect to the shares of
our common stock offered in this offering. This prospectus does not contain all
of the information in the Registration Statement and the exhibits. We have
omitted certain portions pursuant to the rules and regulations of the
Securities and Exchange Commission.
As a result of this offering, we will become subject to the periodic
reporting and other informational requirements of the Securities Exchange Act
of 1934, as amended. In accordance with these requirements, we will file
reports and other information with the Securities and Exchange Commission.
For further information with respect to us and the shares being offered in
this offering, please refer to the Registration Statement, including the
exhibits filed therewith. You can inspect and copy the Registration Statement
and the exhibits as well as other reports and information at the public
reference facilities maintained by the Securities and Exchange Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549; and
at the regional offices of the Securities and Exchange Commission at Seven
World Trade Center, 13th Floor, New York, New York 10048; and at Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You can
obtain copies of these materials from the Public Reference Section of the
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C.
20549 at prescribed rates. Further information on the operation of the Public
Reference Room in Washington, D.C. can be obtained by calling the Securities
and Exchange Commission at 1-800-SEC-0330.
The Securities and Exchange Commission also maintains a Web site that
contains reports, proxy statements and other information about issuers, such as
Sohu.com Inc., who file electronically with the Securities and Exchange
Commission. The address of that site is http://www.sec.gov.
You should rely only on the information contained in this prospectus. We
have not authorized anyone to give any information or make any representation
about us or this offering that is different from, or in addition to, that
contained in this prospectus or in any of the materials that we have
incorporated into this document. Therefore, if anyone does give you information
of this sort, you should not rely on it. If you are in a jurisdiction where
offers to sell, or solicitations of offers to buy, the securities offered by
this document are unlawful, or if you are a person to whom it is unlawful to
direct these types of activities, then the offer presented in this document
does not extend to you. The information contained in this document speaks only
as of the date of this document unless the information specifically indicates
that another date applies.
96
<PAGE>
SOHU.COM INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants........................................ F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999 and March
31, 2000 (unaudited); and Pro forma March 31, 2000 (unaudited).......... F-3
Consolidated Statements of Operations for each of the three years ended
December 31, 1997, 1998 and 1999 and for each of the three month periods
ended March 31, 1999 (unaudited) and 2000 (unaudited)................... F-4
Consolidated Statements of Cash Flows for each of the three years ended
December 31, 1997, 1998 and 1999 and for each of the three month periods
ended March 31, 1999 (unaudited) and 2000 (unaudited)................... F-5
Consolidated Statements of Stockholders' Equity (Deficit) for each of the
three years ended December 31, 1997, 1998 and 1999 and for the three
month period ended March 31, 2000 (unaudited)........................... F-6
Notes to Consolidated Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Sohu.com Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of cash flows and of shareholders'
equity (deficit) expressed in U.S. dollars present fairly, in all material
respects, the financial position of Sohu.com Inc. (the "Company") and its
subsidiary at December 31, 1998 and 1999, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1999, in conformity with accounting principles generally accepted in the
United States. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers
Beijing, People's Republic of China
February 2, 2000, except for Note 17 which is as of June 22, 2000
F-2
<PAGE>
SOHU.COM INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands of US dollars, except share data)
<TABLE>
<CAPTION>
Pro Forma
December 31, December 31, March 31, March 31,
1998 1999 2000 2000
------------ ------------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..... $1,232 $3,924 $33,106 $33,106
Accounts receivable, net...... 68 401 776 776
Accounts receivable-related
parties...................... 158 37 -- --
Prepaid and other current
assets....................... 49 126 241 241
------ ------ ------- -------
Total current assets........ 1,507 4,488 34,123 34,123
Fixed assets, net............... 236 999 2,227 2,227
Other assets, net............... 35 1,589 1,761 1,761
------ ------ ------- -------
$1,778 $7,076 $38,111 $38,111
====== ====== ======= =======
LIABILITIES AND SHAREHOLDERS
EQUITY (DEFICIT)
Current liabilities:
Short-term loan............... $ -- $ -- $ 2,899 $ 2,899
Accounts payable.............. 72 500 1,039 1,039
Accrued liabilities........... 132 1,411 1,384 1,384
------ ------ ------- -------
Total current liabilities... 204 1,911 5,322 5,322
Commitments and contingencies
(Note 11)
Series B Mandatorily Redeemable
Convertible Preferred Stock:
$0.001 par value per share
(5,400,733 shares authorized;
5,394,454, 5,400,733 and
5,400,733 shares issued and
outstanding at December 31,
1998 and 1999 and March 31,
2000 (unaudited), no shares
issued and outstanding on a Pro
Forma basis at March 31, 2000
(unaudited))................... 2,362 2,831 2,947 --
Series C Mandatorily Redeemable
Convertible Preferred Stock:
$0.001 par value per share
(4,807,101 shares authorized;
3,846,718 issued and
outstanding at December 31,
1999 and March 31, 2000
(unaudited), no shares issued
and outstanding on a Pro Forma
basis at March 31, 2000
(unaudited))................... 7,376 7,721 --
Series D Mandatorily Redeemable
Convertible Preferred Stock:
$0.001 par value per share
(2,021,989 shares authorized,
issued and outstanding at March
31, 2000 (unaudited), no shares
issued and outstanding on a Pro
Forma basis at March 31, 2000
(unaudited)) .................. -- -- 31,053
------ ------ ------- -------
Total Mandatorily Redeemable
Convertible Preferred
Stock...................... 2,362 10,207 41,721 --
Shareholders' equity (deficit):
Series A Preferred Stock:
$0.001 par value per share
(2,925,000 shares authorized,
issued and outstanding at
December 31, 1998 and 1999
and March 31, 2000
(unaudited), no shares issued
and outstanding on a Pro
Forma basis at March 31, 2000
(unaudited))................. 3 3 3 --
Common Stock: $0.001 par value
per share (75,400,000 shares
authorized; 9,265,347,
9,415,666 and 9,415,666
shares issued and outstanding
at December 31, 1998 and 1999
and March 31, 2000
(unaudited); and 26,624,216
shares issued and outstanding
on a Pro Forma basis at
March 31, 2000 (unaudited)... 9 9 9 26
Additional paid-in capital...... 248 382 2,265 43,972
Deferred compensation and
other.......................... -- (22) (1,700) (1,700)
Accumulated deficit............. (1,048) (5,414) (9,509) (9,509)
------ ------ ------- -------
Total shareholders' equity
(deficit).................. (788) (5,042) (8,932) 32,789
------ ------ ------- -------
$1,778 $7,076 $38,111 $38,111
====== ====== ======= =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
SOHU.COM INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands of US dollars, except share data)
<TABLE>
<CAPTION>
Year ended Three months Ended
-------------------------------------- -------------------
December 31, December 31, December 31, March 31, March 31,
1997 1998 1999 1999 2000
------------ ------------ ------------ --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Revenues (including
related party amounts
of $0, $175, $178, $20
(unaudited) and $36
(unaudited))........... $ 78 $ 472 $ 1,617 $ 233 $ 842
Costs and expenses:
Cost of revenues....... 19 215 1,576 172 811
Product development.... 50 208 427 55 348
Sales and marketing.... 94 351 1,758 126 1,533
General and
administrative
(including related
party amounts of $60
in 1999).............. 75 308 1,270 163 516
Stock-based
compensation*......... -- -- 46 -- 201
------ ------ ------- ------ -------
Total costs and
expenses............ 238 1,082 5,077 516 3,409
------ ------ ------- ------ -------
Operating loss......... (160) (610) (3,460) (283) (2,567)
Interest income........ -- 23 25 7 31
Interest expense-
related party......... -- (28) (14) -- --
------ ------ ------- ------ -------
Net loss................ (160) (615) (3,449) (276) (2,536)
Accretion on Series B, C
and D mandatorily
redeemable convertible
preferred stock........ -- (244) (917) (114) (1,559)
------ ------ ------- ------ -------
Net loss attributable to
common stockholders.... $ (160) $ (859) $(4,366) $ (390) $(4,095)
====== ====== ======= ====== =======
Basic and diluted net
loss per share
attributable to common
stockholders........... $(0.02) $(0.09) $ (0.47) $(0.04) $ (0.43)
====== ====== ======= ====== =======
Shares used in computing
basic and diluted net
loss per share......... 9,100 9,224 9,328 9,265 9,416
====== ====== ======= ====== =======
Basic and diluted pro
forma net loss per
share (unaudited)...... $ (0.16) $ (0.10)
======= =======
Shares used in computing
basic and diluted pro
forma net loss per
share (unaudited)...... 21,615 25,950
======= =======
Cost of revenues..... $ -- $ -- $ 13 $ -- $ 6
Product development.. -- -- 11 -- 4
Sales and marketing.. -- -- 14 -- 17
General and
administrative...... -- -- 8 -- 174
------ ------ ------- ------ -------
$ -- $ -- $ 46 $ -- $ 201
====== ====== ======= ====== =======
</TABLE>
*Stock-based compensation:
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
SOHU.COM INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands of US dollars, except share data)
<TABLE>
<CAPTION>
Year ended Three months ended,
--------------------------------------- -------------------
December 31, December 31, December 31, March 31, March 31,
1997 1998 1999 1999 2000
------------ ------------- ------------ --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss.............. $(160) $ (615) $(3,449) $(276) $(2,536)
Adjustments to
reconcile net loss to
net cash used in
operating activities:
Loss on disposal of
fixed assets........ -- -- 6 -- --
Depreciation and
amortization........ 3 23 277 23 163
Services rendered by
shareholder......... -- -- 60 -- --
Stock-based
compensation
expense............. -- -- 46 -- 201
Amortization of
discount on
convertible
promissory notes.... -- 25 -- -- --
Changes in assets and
liabilities:
Accounts receivable... (13) (55) (333) (245) (374)
Accounts receivable--
related parties...... -- (158) 121 8 36
Prepaids and other
current assets....... 56 (35) (77) (30) (116)
Other assets.......... (9) (26) (78) (76) (237)
Accounts payable...... 23 49 428 (46) 539
Accrued liabilities... (1) 114 1,279 301 (27)
----- ------ ------- ----- -------
Net cash used in
operating
activities......... (101) (678) (1,720) (341) (2,351)
Cash flows from
investing activities:
Acquisition of fixed
assets............... (30) (227) (942) (66) (1,325)
Acquisition of other
assets............... -- -- (1,580) -- --
Disposal of fixed
assets............... -- -- 1 -- --
----- ------ ------- ----- -------
Net cash used in
investing
activities......... (30) (227) (2,521) (66) (1,325)
Cash flows from
financing activities:
Issuance/(repayment)
of Convertible
Promissory Notes--
related party........ 100 (100) 1,500 -- --
Issuance of Series A
Preferred Stock...... 55 -- -- -- --
Issuance of Series B
Mandatorily
Redeemable
Convertible Preferred
Stock................ -- 2,118 -- -- --
Issuance of Series C
Mandatorily
Redeemable
Convertible Preferred
Stock ............... -- -- 5,426 -- --
Issuance of Series D
Mandatorily
Redeemable
Convertible Preferred
Stock................ -- -- -- -- 29,959
Issuance of Common
Stock................ -- 8 7 -- --
Short-term loan....... -- -- -- -- 2,899
----- ------ ------- ----- -------
Net cash provided by
financing
activities........... 155 2,026 6,933 -- 32,858
Net
increase/(decrease)
in cash and cash
equivalents........ 24 1,121 2,692 (407) 29,182
Cash and cash
equivalents at
beginning of period... 87 111 1,232 1,233 3,924
----- ------ ------- ----- -------
Cash and cash
equivalents at end of
period................ $ 111 $1,232 $ 3,924 $ 826 $33,106
===== ====== ======= ===== =======
Non-cash financing
activity:
Conversion of
convertible
promissory note and
accrued interest into
Series C Mandatorily
Redeemable
Convertible Preferred
Stock................ $ -- $ -- $ 1,514 $ -- $ --
===== ====== ======= ===== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
SOHU.COM INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(Amounts in thousands of US dollars, except share data)
<TABLE>
<CAPTION>
Series A
Preferred Stock Common Stock Total
---------------- ---------------- Additional Deferred Shareholders'
Shares Shares Paid-in- Compensation Accumulated Equity
Issued Amount Issued Amount Capital and Other Deficit (Deficit)
--------- ------ --------- ------ ---------- ------------ ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1997................... 2,210,000 $ 2 9,100,000 $ 9 $ 161 $ -- $ (29) $ 143
Issuance of Series A
Preferred Stock....... 715,000 1 -- -- 54 -- -- 55
Issuance of warrants... -- -- -- -- 25 -- -- 25
Net loss............... -- -- -- -- -- -- (160) (160)
--------- --- --------- --- ------ ------- ------- -------
Balance, December 31,
1997................... 2,925,000 3 9,100,000 9 240 -- (189) 63
Issuance of common
stock................. -- -- 165,347 -- 8 -- -- 8
Accretion of Series B
Mandatorily Redeemable
Convertible Preferred
Stock................. -- -- -- -- -- -- (244) (244)
Net loss............... -- -- -- -- -- -- (615) (615)
--------- --- --------- --- ------ ------- ------- -------
Balance, December 31,
1998................... 2,925,000 3 9,265,347 9 248 -- (1,048) (788)
Issuance of common
stock................. -- -- 150,319 -- 7 -- -- 7
Accretion of Series B
and C Mandatorily
Redeemable Convertible
Preferred Stocks...... -- -- -- -- -- -- (917) (917)
Issuance of
compensatory stock
options............... -- -- -- -- 67 (67) -- --
Amortization of
deferred
compensation.......... -- -- -- -- -- 46 -- 46
Services rendered by
shareholder........... -- -- -- -- 60 -- -- 60
Foreign currency
translation
adjustment............ (1) -- (1)
Net loss............... -- -- -- -- -- -- (3,449) (3,449)
--------- --- --------- --- ------ ------- ------- -------
Balance, December 31,
1999................... 2,925,000 $ 3 9,415,666 $ 9 $ 382 $ (22) $(5,414) $(5,042)
Accretion of Series B,
C and D Mandatorily
Redeemable Convertible
Preferred Stock
(unaudited)........... -- -- -- -- -- -- (1,559) (1,559)
Issuance of
compensatory stock
options (unaudited)... -- -- -- -- 1,883 (1,883) -- --
Amortization of
deferred compensation
(unaudited)........... -- -- -- -- -- 201 -- 201
Foreign currency
translation adjustment
(unaudited)........... -- -- -- -- -- 4 -- 4
Net loss (unaudited)... -- -- -- -- -- -- (2,536) (2,536)
--------- --- --------- --- ------ ------- ------- -------
Balance, March 31, 2000
(unaudited)............ 2,925,000 $ 3 9,415,666 $ 9 $2,265 $(1,700) $(9,509) $(8,932)
========= === ========= === ====== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands of US dollars, except number of shares and per share
data)
1. Organisation and Nature of Operations
Sohu.com Inc. (the "Company") was incorporated in Delaware, USA in August
1996 under the name of Internet Technologies China, Inc. The Company changed
its name to Sohu.com Inc. in September 1999. The Company does not have any
substantive operations of its own and substantially all of its primary business
operations are conducted through its wholly-owned subsidiary, Sohu ITC
Information Technology (Beijing) Co., Ltd., which was incorporated in the
People's Republic of China during 1997. The Company offers internet-based
advertising and content through its internet portal site, Sohu.com. The Company
conducts its business within one industry segment and markets its products and
services to clients primarily in the People's Republic of China.
The consolidated financial statements are prepared in accordance with
generally accepted accounting principles in the United States of America.
2. Summary of Significant Accounting Policies
(a) Consolidation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary incorporated in the People's Republic of China.
All intercompany balances and transactions have been eliminated.
(b) Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
(c) Cash and cash equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less when purchased to be cash equivalents. Cash
equivalents are composed primarily of investments in money market accounts
stated at cost, which approximates fair value.
(d) Fixed assets and depreciation
Fixed assets, comprising computer hardware and office furniture and
equipment, are stated at cost less accumulated depreciation. Depreciation is
computed using the straight-line method over the estimated useful lives of the
assets, generally three to five years.
(e) Other assets, net
Other assets includes rental deposits, as well as computer software
purchased from unrelated third parties which is being amortized over its
estimated useful life of three years. Also included in other assets are direct
costs related to the development of the Company's website which have been
capitalized and are being amortized over their estimated useful life of three
years.
At December 31, 1999 and March 31, 2000, the Company had incurred
approximately $780 and $981 (unaudited), respectively, of transaction expenses
relating to the Company's proposed initial public offering
F-7
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
which are being deferred and included as other assets. Upon the successful
closing of the Company's proposed initial public offering, these costs will be
offset against the proceeds of the offering in Additional Paid-In-Capital.
(f) Impairment of long-lived assets
The Company reviews long-lived assets based upon expected gross cash flows
and will reserve for impairment whenever events or changes in circumstances
indicate the carrying amount of the assets may not be fully recoverable. Based
on its most recent analysis, the Company believes that there was no impairment
of its fixed assets and intangible assets as at March 31, 2000 (unaudited).
(g) Product development
Cost incurred in the enhancement of the Company's website and the
classification and organization of listings within internet properties and
enhancements to existing products are charged to product development expense as
incurred. Material software development costs incurred during the application
development stage, including the costs related to the development of the
Company's website, are capitalized as other assets once technological
feasibility has been established. Website development costs are amortized over
three years.
(h) Foreign currency translation
Foreign currency transactions are translated at the applicable rates of
exchange in effect at the transaction dates. Monetary assets and liabilities
denominated in foreign currencies at the balance sheet date are translated at
the applicable rates of exchange in effect at that date. Foreign currency
transaction gains and losses were not material for any period presented.
The Company's functional and reporting currency is the U.S. dollar. The
functional currency of the Company's subsidiary in China is the Renminbi
("RMB"). Sales and purchase and other expense transactions are generally
denominated in RMB. Accordingly, assets and liabilities of the China subsidiary
are translated at the current exchange rate in effect at the balance sheet
date, and revenues and expenses are translated at the average exchange rates in
effect during the reporting period. Gains and losses resulting from foreign
currency translation, if material, are recorded in a separate component of
shareholders' equity. Foreign currency translation adjustments of $0.1, $0.2
and $0.9 in 1997, 1998 and 1999, respectively, are included in Deferred
Compensation and Other in the consolidated statement of shareholders equity
(deficit) for the periods presented.
(i) Advertising expense
Advertising expenses are charged to the income statement when incurred.
Included in sales and marketing expenses are advertising costs of $597, $0
(unaudited) and $652 (unaudited) for the year ended December 31, 1999 and three
months ended March 31, 1999 and 2000, respectively. Prior to 1999, the Company
incurred no advertising costs.
(j) Revenue recognition
The Company's revenues are derived principally from the sale of banner
advertisements pursuant to short-term contracts. Revenues on banner advertising
contracts are recognized ratably over the period in which the advertisement is
displayed. Company obligations typically also include guarantees of a minimum
number of impressions or times that an advertisement appears in pages viewed by
users. To the extent that minimum
F-8
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
guaranteed impressions are not met within the contractual time period, the
Company defers recognition of the corresponding revenues until the remaining
guaranteed impression levels are achieved. The Company also earns revenue from
sponsorship contracts whereby the Company provides services relating to the
design, integration and co-ordination of content and links in channels on the
Company's Web site. Sponsorship contracts do not generally include an
allocation of the contract value among specific services provided, and no such
allocation has been made by the Company for the purpose of revenue recognition.
Revenue from short-term (i.e., less than 90 days) sponsorship contracts is
recognized once the related services have been performed and the channel and
related links have been placed on the Company's Web site. Revenue from long-
term (i.e., more than 90 days) sponsorship contracts is recognized ratably over
the term of the sponsorship agreement. Revenues and costs related to banner
development services are recognized upon completion of the contract due to the
short time period between when the contract is started and the service is
completed.
For all Company services, revenue is only recognized provided that no
significant Company obligations remain at the end of the period and the
collection of the resulting receivable is probable.
Revenue from on-line commercial transactions conducted between third party
vendors and customers will be recognized on a net commission basis following
both successful on-line verification of customer payment and the shipment of
products. Rental fees received from online merchants will be recognized over
the term of the rental agreement. Placement fees received for items to be sold
on the Company's online auction platform will be recognized as revenue at the
time the item is listed. Success fees received for items sold on the Company's
online auction platform will be recognized as revenue at the time that the
auction is successfully concluded, calculated as a percentage of the final
sales transaction value. To date, the Company has not recorded any revenues
pursuant to such transactions.
To date, the Company has not recorded any material revenues from barter
transactions. Revenue from barter transactions will be recognized during the
period in which the advertisements are displayed on the Company's website,
Barter transactions are recorded at the lower of the fair value of the goods or
services received or the fair value of the advertisement given.
(k) Cost of revenues
Royalties paid to content providers are expensed as incurred and included as
cost of revenues. Contracts with content providers generally range from 3 to 36
months in duration and may be terminated by either party upon notice. Certain
contracts provide for a guaranteed minimum fee to be paid to the content
provider over a specified period of time; such minimum fixed fees are charged
to expense over the period in which content is received. In addition to minimum
fixed fee arrangements, certain contracts require payments to content providers
based on a stated percentage, generally ranging from 15% to 50%, of the related
advertising revenues generated. Such payments are expensed as incurred and
included as cost of revenues. During 1997, 1998 and 1999 and the three months
ended March 31, 1999 and 2000, cost of revenues includes $0, $0, $94, $4 and
$19, respectively, for fixed fees under content provider agreements and $0, $4,
$24, $2 and $1, respectively, for variable royalties paid to content providers
based on revenues generated.
(l) Stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with APB No. 25, "Accounting for Stock Issued to Employees", ("APB
No. 25") and complies with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", ("SFAS No. 123"). In general,
compensation cost under APB No. 25 is recognized based on the difference, if
any, between the estimated fair value of the Company's common stock and the
amount an employee must pay to acquire the stock, as determined on the date the
option is granted. Total compensation cost as determined at the date of option
grant
F-9
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
is recorded in Shareholders' Equity as Additional Paid-in-Capital with an
offsetting entry to Deferred Compensation. Deferred Compensation is amortized
on an accelerated basis and charged to expense in accordance with FASB
Interpretation No. 28 (FIN 28) over the vesting period of the underlying
options, generally ranging from two to four years.
(m) Income taxes
Income taxes are accounted for using an asset and liability approach which
requires the recognition of income taxes payable or refundable for the current
year and deferred tax liabilities and assets for the future tax consequences of
events that have been recognized in the Company's financial statements or tax
returns. The measurement of deferred tax assets is reduced, if necessary, by
the amount of any tax benefits that, based on available evidence, are not
expected to be realised. As the Company has incurred losses since inception, no
provision for income taxes has been made.
(n) Net loss per share
The basic net loss per share is computed by dividing the net income or loss
available to common shareholders for the period by the weighted average number
of common shares outstanding during the period. Diluted net income or loss per
share is computed by dividing the net income or loss for the period by the
weighted average number of common and common equivalent shares outstanding
during the period. Common equivalent shares, composed of incremental common
shares issuable upon the exercise of stock options and warrants and the
conversion of preferred stock, are included in diluted net income or loss per
share to the extent such shares are dilutive. The diluted net loss per share is
the same as the basic net loss per share for all periods presented as all
common equivalent shares have the effect of reducing the net loss per share and
thus have not been included.
(o) Interim results (unaudited)
The accompanying balance sheet as of March 31, 2000, the statement of
operations and of cash flows for the three months ended March 31, 1999 and 2000
and the statement of stockholders' equity (deficit) for the three months ended
March 31, 2000 are unaudited. In the opinion of management, such unaudited
financial statements have been prepared on the same basis as the audited
financial statements and include all adjustments, consisting only of normal
recurring adjustments necessary for a fair statement of the results of the
interim period. The data disclosed in the notes to the financial statements as
of such dates and for such periods are unaudited.
(p) Pro forma net loss per share (unaudited)
Pro forma net loss per share for the year ended December 31, 1999 and the
three months ended March 31, 2000 are computed using the weighted average
number of common shares outstanding, including the pro forma effect, on an as-
if-converted basis, of the automatic conversion of Series B, C and D
Mandatorily Redeemable Convertible Preferred Stock and Series A Preferred Stock
into shares of common stock effective upon the closing of an initial public
offering by the Company if and when the aggregate proceeds from the Offering
are not less than $20,000 and with a price to the public of at least $14.837
per share. Pro forma diluted net loss per share is computed using the pro forma
weighted average number of shares of common stock and common stock equivalents
outstanding. Common stock equivalent shares, composed of shares of common stock
issuable upon the exercise of stock options and warrants, are not included in
pro forma diluted net loss per share as this would reduce the net loss per
share.
F-10
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
(q) Comprehensive income
Comprehensive income is defined as the change in equity of a company during
a period from transactions and other events and circumstances excluding
transactions resulting from investments from owners and distributions to
owners. For the Company, the difference between comprehensive loss and net loss
is attributable to foreign currency translation adjustments of $0.1, $0.2, and
$0.9 for 1997, 1998 and 1999, respectively. Accordingly, comprehensive loss did
not differ materially from net loss for the periods presented.
(r) Stock split
On October 15, 1999, the Company's Board of Directors approved a five-for-
one stock split of the issued and outstanding common stock, which was effected
on October 15, 1999. All shares and per share amounts have been retroactively
adjusted to reflect this stock split.
(s) Proposed initial public offering of common stock and pro forma balance
sheet (unaudited)
In conjunction with an initial public offering of the Company's common
stock, (the "Offering"), all of the outstanding shares of Series B, C and D
Mandatorily Redeemable Convertible Preferred Stock and Series A Preferred Stock
will automatically convert into shares of common stock if and when the
aggregate proceeds from the Offering are not less than $20,000 and with a price
to the public of at least $14.837 per share. As further discussed in note 18,
the minimum per share price at which the Series B, C and D Mandatorily
Redeemable Convertible Preferred Stock and Series A Preferred Stock would
automatically convert into shares of Common Stock was subsequently modified to
$13.00. The pro forma effect of this conversion of preferred stock has been
reflected in the accompanying unaudited Pro Forma Consolidated Balance Sheet at
March 31, 2000.
3. Risks and Uncertainties
Financial instruments that potentially subject the Company to significant
concentration of credit risk consist primarily of cash, cash equivalents, and
accounts receivable. As of March 31, 2000, substantially all of the Company's
cash and cash equivalents were held in two financial institutions; one
institution is a federally insured financial institution located in the United
States and the second institution is located in the People's Republic of China.
At various times, the Company maintains cash balances in excess of United
States federally insured limits or in institutions in the People's Republic of
China. Accounts receivable are typically unsecured, denominated in Chinese RMB,
and are derived from revenues earned from customers primarily located in the
People's Republic of China. The Company performs ongoing credit evaluations of
its customers and, if necessary, maintains reserves for potential credit
losses. Historically, such losses have been within management's expectations.
The Company's client base is limited. Revenues from its five largest
customers represented 65%, 71%, 34%, 13% (unaudited) and 34% (unaudited) of
total revenues for the three years ended December 31, 1997, 1998 and 1999 and
the three months ended March 31, 1999 and 2000, respectively. These same five
customers represent 93%, 43% and 40% (unaudited) of accounts receivable as of
December 31, 1998 and 1999 and March 31, 2000, respectively.
The Company's sales and purchase and expense transactions are generally
denominated in RMB and a significant portion of the Company's assets and
liabilities are denominated in RMB. The RMB is not freely convertible into
foreign currencies. In China, foreign exchange transactions are required by law
to be transacted only by authorized financial institutions at exchange rates
set by the Bank of China. Remittances in currencies other than RMB by the
Company's subsidiary in China must be processed through the Bank of China or
other PRC foreign exchange regulatory bodies and require certain supporting
documentation in order to effect the remittance.
The Company faces certain macro-economic and regulatory risks and
uncertainties relating to the Company's China operations (see note 11).
F-11
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
4. Balance Sheet Components
<TABLE>
<CAPTION>
December 31, December 31, March 31,
1998 1999 2000
------------ ------------ -----------
(unaudited)
<S> <C> <C> <C>
Accounts receivable, net
Accounts receivable................ $ 68 $ 427 $ 836
Less: Allowance for doubtful
accounts.......................... -- (26) (60)
---- ------ ------
$ 68 $ 401 $ 776
==== ====== ======
Fixed Assets
Computer equipment................. $215 $1,029 $2,125
Office furniture and equipment..... 48 170 399
---- ------ ------
263 1,199 2,524
Accumulated depreciation........... (27) (200) (297)
---- ------ ------
$236 $ 999 $2,227
==== ====== ======
Other Assets
Deferred offering costs............ $-- $ 780 $ 981
Purchased computer software........ -- 669 725
Website development costs.......... -- 131 131
Rental deposits and other.......... 35 113 61
---- ------ ------
35 1,693 1,898
Accumulated amortization........... -- (104) (137)
---- ------ ------
$ 35 $1,589 $1,761
==== ====== ======
Accrued liabilities
Compensation and benefits.......... $ 85 $ 581 $ 758
Professional services.............. 25 657 367
Others............................. 22 173 259
---- ------ ------
$132 $1,411 $1,384
==== ====== ======
</TABLE>
5. China contribution plan and profit appropriation
The Company's subsidiary in China participates in a government-mandated
multi-employer defined contribution plan pursuant to which certain retirement,
medical and other welfare benefits are provided to employees. Chinese labor
regulations require the Company's subsidiary to pay to the local labor bureau a
monthly contribution at a stated contribution rate based on the monthly basic
compensation of qualified employees. The relevant local labor bureau is
responsible for meeting all retirement benefit obligations; the Company has no
further commitments beyond its monthly contribution. During 1997, 1998 and
1999, the Company contributed a total of $14, $103, and $470, respectively, to
these funds.
Pursuant to the laws applicable to China's Foreign Investment Enterprises,
the Company's subsidiary in China must make appropriations from after-tax
profit to non-distributable reserve funds as determined by the Board of
Directors. These reserve funds include a (i) general reserve, (ii) enterprise
expansion fund and (iii) staff bonus and welfare fund. The general reserve fund
requires annual appropriations of 10% of after-tax profit (as determined under
PRC GAAP); the other fund appropriations are at the Company's discretion. Since
the Company's PRC subsidiary is in a loss position, no appropriations have been
made to the general reserve fund.
F-12
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
6. Borrowings
During 1999, the Company borrowed $1,500 through the issuance of a
convertible promissory note to a preferred shareholder. The note bore interest
at an annual rate of 4.79%; during 1999, the Company recognized interest
expense of $14. The entire principal amount of the note plus accrued interest
was converted automatically into Series C Preferred Stock upon the issuance of
Series C Preferred Stock in October, 1999 (see Note 8).
During 1997, the Company issued promissory notes to preferred shareholders
totalling $100. These notes were subject to an annual interest rate of 10%. On
March 21, 1998, the Company repaid the principal of $100 and related interest
of $3. Warrants to purchase 120,263 shares of common stock at an exercise price
of $0.077 per share were issued and vested in connection with the Company's
issuance of these promissory notes. The amount of the proceeds attributable to
the relative value of the warrants in the amount of $25 was recorded as a
discount related to the promissory notes and is reflected as an adjustment to
interest expense over the term of the notes. As of March 31, 2000 (unaudited),
warrants to purchase 75,166 shares of common stock had been exercised and
warrants to purchase 45,097 shares of common stock remained outstanding.
In March 2000, the Company entered into a $2,899 (unaudited) short-term loan
agreement with a PRC financial institution. The loan is denominated in Renminbi
and bears annual interest at 6.138%. This loan was fully repaid in April 2000.
7. Series B Mandatorily Redeemable Convertible Preferred Stock
At December 31, 1999, there were 5,400,733 shares of Series B and Series B-1
Mandatorily Redeemable Convertible Preferred Stock ("Series B Preferred Stock")
authorized, issued and outstanding. The following table sets forth the activity
related to the Series B Preferred Stock (amounts in thousands of US dollars,
except share data):
<TABLE>
<CAPTION>
Series B Series B-1 Total
---------------- -------------- ----------------
Shares Amount Shares Amount Shares Amount
--------- ------ ------- ------ --------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1998... -- $ -- -- $-- -- $ --
Issuance of preferred shares
for cash, net of issue
costs....................... 4,514,887 1,773 879,567 345 5,394,454 2,118
Accretion to estimated
redemption value............ -- 204 -- 40 -- 244
--------- ------ ------- ---- --------- ------
Balance at December 31,
1998........................ 4,514,887 1,977 879,567 385 5,394,454 2,362
Exercise of warrants......... 6,279 2 -- -- 6,279 2
Accretion to estimated
redemption value............ -- 391 -- 76 -- 467
--------- ------ ------- ---- --------- ------
Balance at December 31,
1999........................ 4,521,166 $2,370 879,567 $461 5,400,733 $2,831
========= ====== ======= ==== ========= ======
Accretion to estimated
redemption value
(unaudited)................. -- 97 -- 19 -- 116
--------- ------ ------- ---- --------- ------
Balance at March 31, 2000
(unaudited)................. 4,521,166 $2,467 879,567 $480 5,400,733 $2,947
========= ====== ======= ==== ========= ======
</TABLE>
Following amendment of the Company's Articles of Incorporation, the holders
of Series B Preferred Stock have various rights and preferences as follows:
Voting
Each holder of Series B Preferred Stock has voting rights equal to the
number of shares of common stock then issuable upon its conversion into common
stock. Each holder of Series B Preferred Stock will generally vote together
with the common stock shareholders.
F-13
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
Dividends
No dividends, whether in cash, in property or in shares of the common stock
of the Company shall be declared on outstanding common shares unless the Board
of Directors has declared a dividend for Series B Preferred Stock. Where
dividends on Series B Preferred Stock are declared, dividends will be allocated
to Series B Preferred shares based on the equivalent number of common shares
into which such Series B Preferred Stock could be converted. The Board through
December 31, 1999 has declared no dividends on Series B Preferred Stock.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, the holders of Series B Preferred Stock shall
be entitled to receive, prior and in preference to any distribution of any of
the assets of the Company to the holders of Series A Preferred Stock, an amount
equal to $0.3979 per share of Series B Preferred Stock, plus declared but
unpaid dividends. After the liquidation preference of the holders of the Series
B Preferred Stock has been satisfied, the holders of the Series A Preferred
Stock shall be entitled to receive an amount equal to $0.0769 per share, plus
declared but unpaid dividends. After setting apart or paying in full the
preferential amounts due to the holders of Series B Preferred Stock and Series
A Preferred Stock as noted above, the holders of the Series B Preferred Stock
shall be entitled to receive an amount equal to $0.1990 per share, plus
declared but unpaid dividends. Should the Company's legally available assets be
insufficient to satisfy the liquidation preferences, the entire amount of
assets will be distributed ratably to the holders of Series B Preferred Stock.
Conversion
Each share of Series B-1 Preferred Stock is convertible, at the option of
the holder commencing from the date of issuance, into common shares on a share
for share basis. Each share of Series B Preferred Stock was originally
convertible, at the option of the Holder commencing from the date of issuance,
to common shares on a share for share basis. Further adjustments to both of
these ratios will be made where there are accrued and unpaid dividends on
preferred stock or where common stock is issued at less than $0.0769 per share.
Certain events which occurred in 1998 resulted in a change to the conversion
ratio for Series B Preferred Stock such that each share of Series B Preferred
Stock became convertible using a basis of one share of Series B Preferred Stock
for 1.667 shares of common stock. This change in the conversion ratio did not
represent a beneficial conversion feature at the date of issuance of the Series
B Preferred Stock in 1998. The Series B Preferred Stock will be converted
automatically into Common Stock, at the then applicable conversion rate, upon
the closing of an underwritten public offering of shares of Common Stock of the
Company at a public offering price of at least $14.837 per share and gross
proceeds to the Company in excess of $20,000.
Redemption
After March 5, 2003, holders of Series B Preferred Stock may request that
the Company redeem all the outstanding shares at a price of $0.796 per share
plus any declared but unpaid dividends. Accordingly, the Series B Preferred
Stock is being accreted to its estimated redemption value through charges to
retained earnings; such charges totalled $244, $467, $114 (unaudited), and $116
(unaudited) for the years ended December 31, 1998 and 1999 and three months
ended March 31, 1999 and 2000, respectively.
Warrants
In connection with the issuance of the Company's Series B Convertible
Preferred Stock financing in 1998, the Company granted an option to purchase
6,279 shares of the Company's Series B Convertible Preferred Stock at an
exercise price of $0.398 per share. This option was exercised in 1999.
F-14
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
8. Series C Mandatorily Redeemable Convertible Preferred Stock
In October 1999, the Company entered into a Series C Preferred Stock
Purchase agreement, whereby the Company authorized 4,807,101 shares of the
Company's Series C Mandatory Redeemable Convertible Preferred Stock ("Series C
Preferred Stock") at an issue price of $1.808 per share. At December 31, 1999,
there were 3,846,718 shares issued and outstanding. Following amendment of the
Company's Articles of Incorporation, the holders of Series C Preferred Stock
have various rights and preferences as follows:
Voting
Each holder of Series C Preferred Stock has voting rights equal to the
number of shares of common stock then issuable upon its conversion into common
stock. Each holder of Series C Preferred Stock will generally vote together
with the common stock shareholders.
Dividends
No dividends, whether in cash, in property or in shares of the common stock
of the Company shall be declared on outstanding common shares unless the Board
of Directors has declared a dividend for Series C Preferred Stock. Where
dividends on Series C Preferred Stock are declared, dividends will be allocated
to Series C Preferred shares based on the equivalent number of common shares
into which such Series C Preferred Stock could be converted. The Board through
December 31, 1999 has declared no dividends on Series C Preferred Stock.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, the holders of Series C Preferred Stock shall
be entitled to receive, prior and in preference to any distribution of any of
the assets of the Company to the holders of the Common stock, an amount equal
to $1.808 per share, plus declared but unpaid dividends.
Conversion
Each share of Series C Preferred Stock is convertible, at the option of the
holder commencing from the date of issuance, into common shares on a share for
share basis. Adjustments to this ratio will be made where there are accrued and
unpaid dividends on preferred stock or common stock. The Series C Preferred
Stock will be converted automatically into Common Stock, at the then applicable
conversion rate, upon the closing of an underwritten public offering of shares
of Common Stock of the Company at a public offering price of at least $14.837
per share and gross proceeds to the Company in excess of $20,000.
Redemption
After September 9, 2004, holders of Series C Preferred Stock may request
that the Company redeem all the outstanding shares at a price of $3.617 per
share plus any declared but unpaid dividends. Accordingly, the Series C
Preferred Stock is being accreted to its estimated redemption value through
charges to from retained earnings; such charges totalled $450 and $345
(unaudited) for the year ended December 31, 1999 and three months ended March
31, 2000. The redemption rights of the Series C Preferred Stock are subordinate
to the Series B Preferred Stock.
F-15
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
9. Series D Mandatorily Redeemable Convertible Preferred Stock (unaudited)
In January and February 2000, the Company entered into a Series D Preferred
Stock Purchase agreement, whereby the Company authorized 2,021,989 shares of
the Company's Series D Mandatorily Redeemable Convertible Preferred Stock
("Series D Preferred Stock") at an issue price of $14.837 per share. At March
31, 2000, there were 2,021,989 shares issued and outstanding. Following
amendment of the Company's Articles of Incorporation, the holders of Series D
Preferred Stock have various rights and preferences as follows:
Voting
Each holder of Series D Preferred Stock has voting rights equal to the
number of shares of common stock then issuable upon its conversion into common
stock. Each holder of Series D Preferred Stock will generally vote together
with the common stock shareholders.
Dividends
No dividends, whether in cash, in property or in shares of the common stock
of the Company shall be declared on outstanding common shares unless the Board
of Directors has declared a dividend for Series D Preferred Stock. Where
dividends on Series D Preferred Stock are declared, dividends will be allocated
to Series C Preferred shares based on the equivalent number of common shares
into which such Series D Preferred Stock could be converted. The Board through
March 31, 2000 has declared no dividends on Series D Preferred Stock.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, the holders of Series D Preferred Stock shall
be entitled to receive, prior and in preference to any distribution of any of
the assets of the Company to the holders of the Common stock, an amount equal
to $14.837 per share, plus declared but unpaid dividends.
Conversion
Each share of Series D Preferred Stock is convertible, at the option of the
holder commencing from the date of issuance, into common shares on a share for
share basis. Adjustments to this ratio will be made where there are accrued and
unpaid dividends on preferred stock or common stock. The Series D Preferred
Stock will be converted automatically into Common Stock, at the then applicable
conversion rate, upon the closing of an underwritten public offering of shares
of Common Stock of the Company at a public offering price of at least $14.837
per share and gross proceeds to the Company in excess of $20,000.
Redemption
After January 25, 2005, holders of Series D Preferred Stock may request that
the Company redeem all the outstanding shares at a price of $29.674 per share
plus any declared but unpaid dividends. Accordingly, the Series D Preferred
Stock is being accreted to its estimated redemption value through charges to
retained earnings; such charges totalled $1,098 for the three months ended
March 31, 2000. The redemption rights of the Series D Preferred Stock are
subordinate to the Series C Preferred Stock.
F-16
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
Advertising contracts
In January 2000, the Company also entered into long-term advertising
contracts with each of its Series D preferred shareholders. Under the
contracts, the Series D preferred shareholders have committed to purchase
certain services from the Company, including banner advertising, sponsorship of
website channels, directory services and use of the Company's e-commerce
platform, over the terms of the contracts, which range from 2 1/2 to 3 years.
The contract value of $9,000 is generally payable by Series D preferred
shareholders in periodic installments to be made over the life of the
agreements, commencing December 1, 2000. The detailed description of specific
services to be provided under these agreements will be decided over the term of
the contracts, with the individual fees for specific services to be set at
rates consistent with those charged to the Company's most preferred customers.
During the three months ended March 31, 2000, no cash was received and no
revenues were recognized pursuant to these long-term advertising contracts.
The contracts are generally terminable by either the Company or the customer
where the counter party has breached the contract and where the breach is not
satisfactorily cured within a specified period of time. In addition, one of the
advertising contracts is terminable at the discretion of the customer during
the second and third year of the contract if the Company's Web site is not
ranked within the top five Web sites in China based on the level of average
monthly impressions.
10. Series A Preferred Stock
At December 31, 1999, there were 2,925,000 shares of Series A Preferred
Stock ("Preferred A") issued and outstanding at an issue price of $0.077 per
share. Following amendment of the Company's Articles of Incorporation, the
holders of Preferred A shares have various rights and preferences as follows:
Voting
Each holder of Series A Preferred Stock has voting rights equal to the
number of shares of common stock then issuable upon its conversion into common
stock. Each holder of Series A Preferred Stock will generally vote together
with the common stock shareholders.
Dividends
No dividends, whether in cash, in property or in shares of the capital stock
of the Company shall be declared for Preferred A unless the Board of Directors
has declared a dividend on outstanding common shares. Where dividends on
Preferred A are declared, dividends will be allocated to Preferred A based on
the equivalent number of common shares into which such preferred shares could
be converted. The Board through December 31, 1999 has declared no dividends on
Preferred A.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company,
either voluntary or involuntary, the holders of Series A Preferred Stock shall
be entitled to receive, prior and in preference to any distribution of any of
the assets or surplus funds of the Company to the holders of the Common Stock
or to the holders of the Series B, B-1 and C Preferred Stock after the
satisfaction of the liquidation preference indicated in Note 7 above, an amount
equal to $0.077 per share, plus declared but unpaid dividends.
F-17
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
Conversion
Each share of Series A Preferred Stock is convertible at the holder's option
into common shares on a share for share basis. Adjustments to this ratio will
be made where there are accrued and unpaid dividends on preferred stock or
where common stock has been issued at less than $0.077 per share. The Series A
Preferred Stock will be converted automatically into Common Stock, at the then
applicable conversion rate, upon the closing of an underwritten, public
offering of shares of Common Stock of the Company at a public offering price of
at least $14.837 per share and gross proceeds for the Company in excess of
$20,000.
11. Commitments and Contingencies
As of December 31, 1999 and March 31, 2000, the Company had future minimum
rental lease payments under non-cancellable operating leases as follows:
<TABLE>
<CAPTION>
December March 31,
31, 2000 2000
-------- -----------
<S> <C> <C>
(unaudited)
2000................... $ 597 $ 448
2001................... 506 506
------ -----------
$1,103 $ 954
====== ===========
</TABLE>
As of December 31, 1999, future payments of minimum fixed fees to content
providers totaled $36. The Company recognized $56, $157, $205, $36 (unaudited)
and $149 (unaudited) of rent expense for the years ended December 31, 1997,
1998 and 1999 and three months ended March 31, 1999 and 2000, respectively.
The Chinese market in which the Company operates poses certain macro-
economic and regulatory risks and uncertainties. These uncertainties extend to
the ability of the Company to operate an internet business and to conduct on-
line advertising in the People's Republic of China. Though the People's
Republic of China has, since 1978, implemented wide range market-oriented
economic reforms, continued reforms and progress towards a full market-oriented
economy are uncertain. In addition, the telecommunication, information, and
media industries remain highly regulated. Restrictions are currently in place
or are unclear regarding in what specific segments of these industries foreign
owned entities, like the Company, may operate. The Company's legal structure
and scope of operations in China could be subjected to restrictions which could
result in severe limits to the Company's ability to conduct business in the
People's Republic of China and this could have a material adverse effect on the
Company's financial position, results of operations and cash flows.
12. Related Party Transactions
The Company has entered into an agreement whereby the Company provides
internet advertising and promotional services to a preferred shareholder. The
total amount of revenue recorded under agreements with this preferred
shareholder was $0, $175, $178, $20 (unaudited) and $36 (unaudited) for the
three years ended December 31, 1997, 1998, 1999 and the three months ended
March 31, 1999 and 2000, respectively. As of December 31, 1998 and 1999 and
March 31, 2000, $158, $37, $0 (unaudited), respectively, were included in
Accounts receivable--related parties related to this arrangement.
F-18
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
In connection with a warrant issued by the Company on October 18, 1999 for
the purchase of 212,675 shares of common stock at an exercise price of $2.351
per share, one of the Company's preferred shareholders arranged for certain of
its affiliates to provide certain professional and managerial services to the
Company. The estimated fair value of such services of approximately $60 for the
year ended December 31, 1999 was determined by the Company by reference to
salaries paid to comparable employees and has been charged to expense and
credited to additional paid-in capital. As of December 31, 1999 and March 31,
2000 (unaudited) this warrant remains outstanding.
Pursuant to a one-year agreement that commenced in December 1999, the
Company has provided a link from its website to a related party's website. In
addition, the related party provides internet content on an updated daily basis
to the Company's website. The link allows for certain news and other
informational content to be made available to users of the Company's internet
portal site, with revenues generated from advertising placed in conjunction
with the service to be allocated between both parties on a contractually agreed
basis. For the year ended December 31, 1999 and the three months ended March
31, 2000, the Company has recognized expense of $16, $0 and $4 (unaudited),
respectively, as a result of this collaborative arrangement.
13. Income Taxes
The Company is subject to taxes in both the United States and the People's
Republic of China. The Company's subsidiary in China is governed by the Income
Tax Law of the People's Republic of China concerning Foreign Investment
Enterprises and Foreign Enterprises and various local income tax laws (the "PRC
Income Tax Law"). Pursuant to the PRC Income Tax Law, wholly-owned foreign
enterprises are subject to income tax at a statutory rate of 33% (30% State
income tax plus 3% local income tax) on PRC taxable income. The Company is in a
loss position in both the U.S. and China. No provision or benefit for income
taxes have been provided in any periods. The following is a reconciliation
between the U.S. federal statutory rate and the Company's effective tax rate:
<TABLE>
<CAPTION>
December 31,
------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
U.S. federal statutory rate: (34)% (34)% (34)%
Foreign tax difference from U.S. rate................. 1 1 1
Permanent book-tax differences........................ -- 10 8
Valuation allowance for deferred tax assets........... 33 23 25
--- --- ---
0 % 0 % 0 %
=== === ===
</TABLE>
Significant components of the Company"s deferred tax assets and liabilities
consist of the following:
<TABLE>
<CAPTION>
December 31,
--------------
1998 1999
------ -------
<S> <C> <C>
Deferred tax assets:
Net operating loss carry forwards.......................... $ 59 $ 1,196
Other book-tax basis differences........................... 12 25
----- -------
Total deferred tax assets.................................. 71 1,221
----- -------
Valuation allowance........................................ (71) (1,190)
----- -------
-- 31
----- -------
Deferred tax liabilities:
Capitalized expenses....................................... -- (31)
----- -------
$ -- $ --
===== =======
</TABLE>
F-19
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
The Company has provided a full valuation allowance against net deferred tax
assets due to the uncertainty surrounding their realization.
As of December 31, 1999, the Company had federal net operating loss ("NOL")
and Chinese NOL of approximately $689 and $2,915, respectively, available to
offset future federal and Chinese income tax liabilities, respectively. The
U.S. NOL will expire from 2012 to 2020 and the Chinese NOL will expire from
2002 to 2004.
14. Financial Instruments
The carrying amount of the Company's cash and cash equivalents approximates
their fair value due to the short maturity of those instruments. The carrying
value of receivables and payables approximated their market values based on
their short-term maturities. The fair value of related party receivables and
payables is not readily determinable due to the related party nature of the
accounts.
15. Stock Options
The Company has adopted a share option plan, which provides for the issuance
of up to 2,340,000 shares of common stock. The share option plan allows for the
grant of incentive share options qualified within the meaning of Section 422 of
the U.S. Internal Revenue Code of 1986 and non-qualified share options, which
do not so qualify.
The Company has reserved 2,340,000 shares of Common Stock for issuance under
the Company's Stock Option Plan and at December 31, 1999 and March 31, 2000,
1,401,512 and 1,071,312 (unaudited) options, respectively, were available for
grant under the plan.
F-20
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
The following table summarizes the Company's stock option activity:
<TABLE>
<CAPTION>
Three Months Ended
Year Ended December 31, March 31,
----------------------------------------------------------------- ---------------------
1997 1998 1999 2000
--------------------- --------------------- --------------------- ---------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Options Exercise Options Exercise Options Exercise Options Exercise
Outstanding Price ($) Outstanding Price ($) Outstanding Price ($) Outstanding Price ($)
----------- --------- ----------- --------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
(unaudited)
Outstanding at beginning
of Period.............. 330,694 $0.038 330,694 $0.038 210,144 $0.038 1,028,682 $2.30
Granted................ -- -- -- -- 952,377 2.48 330,200 5.77
Exercised.............. -- -- (120,250) 0.038 (120,250) 0.038 -- --
Cancelled.............. -- -- -- -- (13,889) 0.38 -- --
------- ------ -------- ------ --------- ------ --------- -----
Outstanding at period
end.................... 330,694 $0.038 210,444 $0.038 1,028,682 $2.30 1,358,882 $3.14
======= ====== ======== ====== ========= ====== ========= =====
</TABLE>
<TABLE>
<CAPTION>
Options Outstanding at Options Exercisable at
December 31, 1999 December 31, 1999
--------------------------------------------- ----------------------------
Weighted Average
Range of Remaining Weighted Average Weighted Average
Exercise Number Contractual Life Exercise Price Number Exercise Price
Prices Outstanding (years) ($) outstanding ($)
-------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$0.038 90,194 6.68 $0.038 90,194 $0.038
$0.385 161,611 9.45 $0.385 69,268 $0.385
$1.808 338,907 9.39 $1.808 34,819 $1.808
$3.846 437,970 9.95 $3.846 -- $3.846
<CAPTION>
Options Outstanding at Options Exercisable at
March 31, 2000 March 31, 2000
--------------------------------------------- ----------------------------
(unaudited) (unaudited)
Weighted Average
Range of Remaining Weighted Average Weighted Average
Exercise Number Contractual Life Exercise Price Number Exercise Price
Prices Outstanding (years) ($) outstanding ($)
-------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$0.038 90,194 6.44 $0.038 90,194 $0.038
$0.385 161,611 9.21 $0.385 70,662 $0.385
$1.808 338,907 9.14 $1.808 87,382 $1.808
$3.846 437,970 9.70 $3.846 -- $3.846
$5.769 330,200 9.82 $5.769 -- $5.769
</TABLE>
Stock-based compensation. In connection with certain stock option grants
during the year ended December 31, 1999 and the three months ended March 31,
1999 and 2000, the Company recognized deferred stock compensation totalling
$67, $0 (unaudited) and $1,883 (unaudited), respectively, which is being
amortized over the vesting periods of the related options, which generally
range from two to four years. Compensation expense recognized during the year
ended December 31, 1999 and the three months ended March 31, 1999 and 2000
totaled $46, $0 (unaudited) and $201 (unaudited), respectively.
F-21
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
Minimum value disclosures. The Company calculated the minimum value of stock
option grants on the date of grant using the Black-Scholes pricing method with
the following assumptions:
<TABLE>
<CAPTION>
Year Ended
December 31,
1999
------------
<S> <C>
Risk-free interest rate..................................... 4.96%-5.37%
Expected life (years)....................................... 1-4
Expected dividend yield..................................... --
Volatility.................................................. --
Weighted average grant date fair value of options granted
during the period.......................................... $0-$0.86
</TABLE>
Had compensation cost for the Company's stock-based compensation plan been
determined based on the fair value at the grant dates for the stock option
awards as prescribed by SFAS No. 123, the Company's net loss per share would
have resulted in the pro forma amounts disclosed below:
<TABLE>
<CAPTION>
Year Ended
December 31,
1999
------------
<S> <C>
Net loss attributable to common shareholders:
As reported................................................. $(4,366)
Pro forma................................................... $(4,411)
Net loss per share, basic and diluted:
As reported................................................. $ (0.47)
Pro forma................................................... $ (0.47)
</TABLE>
The effects of applying SFAS No. 123 methodology in this pro forma
disclosure may not be indicative of future amounts. Additional stock option
awards in future years are expected.
16. Net Loss Per Share
Net loss per share. The following table sets forth the computation of basic
and diluted net loss per share for the periods indicated:
<TABLE>
<CAPTION>
Three Months
Year Ended December Ended March
31, 31,
----------------------- ---------------
1997 1998 1999 1999 2000
------ ------ ------- ------ -------
<S> <C> <C> <C> <C> <C>
(unaudited)
Numerator:
Net loss........................... $ (160) $ (615) $(3,449) $ (276) $(2,536)
Accretion of Series B, C and D
Mandatorily Redeemable Preferred
Stock to redemption value......... -- (244) (917) (114) (1,559)
------ ------ ------- ------ -------
Net loss attributable to common
shareholders...................... $ (160) $ (859) $(4,366) $ (390) $(4,095)
====== ====== ======= ====== =======
Denominator:
Shares used in computing basic and
diluted net loss per share (in
thousands)........................ 9,100 9,224 9,328 9,265 9,416
====== ====== ======= ====== =======
Basic and diluted net loss per share
attributable to common
shareholders........................ $(0.02) $(0.09) $ (0.47) $(0.04) $ (0.43)
====== ====== ======= ====== =======
Antidilutive securities including
options, warrants, and preferred
shares not included in net loss per
share calculation (in thousands).... 3,221 7,812 12,820 11,526 17,493
====== ====== ======= ====== =======
</TABLE>
F-22
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
Pro forma net loss per share (unaudited) Pro forma basic and diluted net
loss per share is computed using the weighted average number of shares of
common stock outstanding, including the pro forma effects, on an as-if-
converted basis, of the automatic conversion of Series B, C and D Mandatorily
Redeemable Preferred Stocks and Series A Preferred Stock into shares of common
stock effective upon the closing of an initial public offering by the Company
if and when the aggregate proceeds from the Offering are not less than $20,000
and with a price to the public of at least $14.837 per share. Common stock
equivalent shares, composed of shares of common stock issuable upon the
exercise of stock options and warrants, are not included in pro forma diluted
net loss per share as this would reduce the net loss per share. The following
table sets forth the computation of pro forma basic and diluted net loss per
share for the year ended December 31, 1999 and three months ended March 31,
2000 (unaudited):
<TABLE>
<CAPTION>
Pro Forma
Pro Forma Three Month
Year ended Ended
December 31, March 31,
1999 2000
------------ -----------
<S> <C> <C>
Numerator:
Net loss............................................ $(3,449) $(2,536)
======= =======
Denominator:
Shares used in computing basic and diluted net loss
per share.......................................... 9,328 9,416
Adjustment to reflect assumed conversion of all
preferred stock to common stock from date of
issuance........................................... 12,287 16,534
------- -------
Shares used in computing pro forma basic and diluted
net loss per share................................. 21,615 25,950
------- -------
Basic and diluted pro forma net loss per share
(unaudited).......................................... $(0.16) $(0.10)
======= =======
Antidilutive securities including options and warrants
not included in pro forma net loss per share
calculation.......................................... 533 958
======= =======
</TABLE>
17. Stock Split
On June 22, 2000, the Company's Board of Directors declared and effected a
2.6-for-one stock split of the Company's issued and outstanding common stock.
All shares and per share amounts have been retroactively adjusted to reflect
this stock split.
18. Subsequent Events (Unaudited)
During June 2000, the Company entered into certain agreements with Beijing
Sohu Online Network Information Services, Ltd. ("Beijing Sohu"), a PRC company
that is owned by a major shareholder of the Company and an employee of the
Company. Pursuant to the agreements with Beijing Sohu and the shareholders of
Beijing Sohu, certain operations related to the Company's online content will
be transferred to Beijing Sohu in order to allow Beijing Sohu to develop and
provide content to the Company for a monthly service fee, which will be subject
to periodic adjustment as agreed between the parties.
As part of these agreements, the Company will sell certain computer
equipment to Beijing Sohu for an amount equal to the net book value of the
equipment, which is estimated to be approximately $89 and is payable six months
after the transfer date. The Company will also extend loans in the amount of
$219 to the shareholders of Beijing Sohu in order to finance their equity
investment in Beijing Sohu. The shareholders of Beijing Sohu have pledged their
shares in Beijing Sohu as collateral for the loan. The loans bear no interest
and are due in full at the end of ten years.
F-23
<PAGE>
SOHU.COM INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Amounts in thousands of US dollars, except number of shares and per share
data)
The Company's PRC subsidiary has also entered into an option agreement
giving it the right, at any time, subject to PRC law, to purchase the entire
ownership in Beijing Sohu of the two Beijing Sohu shareholders for RMB 2,000
($242 as at March 31, 2000).
The arrangement entered into with Beijing Sohu has been undertaken solely to
satisfy PRC regulations, which prohibit foreign companies from owning or
operating telecommunications businesses in China. PRC regulations currently
restrict the Company from holding an equity interest in Beijing Sohu;
therefore, the financial statements of Beijing Sohu will not be consolidated
with those of the Company. As the shareholders of Beijing Sohu are also
officers and shareholders of the Company, Beijing Sohu is a related party of
the Company and the Company will disclose transactions with Beijing Sohu in
accordance with SFAS 57. The Company will extend a loan to the shareholders of
Beijing Sohu to finance their equity investment in Beijing Sohu and the Company
expects that it will continue to be involved in and provide financial support
to Beijing Sohu. Accordingly, to the extent that losses are incurred by Beijing
Sohu, the Company will accrue for such losses by recording a valuation
allowance against the loan receivable from the shareholders of Beijing Sohu.
In March 2000, the Company entered into a one-year non-exclusive agreement
with an affiliate of Nokia Corporation whereby the Company agreed to identify,
develop and aggregate suitable content and services for use in mobile devices
enabled with the wireless application protocol, or WAP, and Nokia's short
message service, or SMS. The identification, development and aggregation of
such services for distribution over WAP-enabled devices will be funded by the
Company. Nokia is not obligated under the agreement to make any payments to the
Company. For the three month period ended March 31, 2000, the Company has
incurred related costs of approximately US$18, which have been charged to
product development expenses.
In April and May of 2000, the Company, a Nokia affiliate in China and the
mobile operators in eight Chinese provinces and municipalities signed a
memorandum of understanding for a 6 month trial of WAP services. Under the
terms of the memorandum of understanding, the Company will identify and develop
content for use in the WAP trial. The identification, development and
aggregation of such WAP content will be funded by the Company.
In June 2000, a majority of the holders of the Company's outstanding Series
B, C and D Mandatorily Redeemable Convertible Preferred Stock and Series A
Preferred Stock (cumulatively, the "Preferred Shares") consented to the
lowering of the minimum per share price at which the Preferred Shares will be
converted automatically into Common Stock upon the closing of an underwritten,
public offering of shares of the Company's Common Stock to a public offering
price of at least $13.00 per share.
F-24
<PAGE>
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<PAGE>
[This page intentionally left blank]
<PAGE>
[Inside back cover --
(1) Heading "Sohu -- The Search Fox, Opening up China to the Internet" followed
by four footprints of a fox. Beside each footprint is one of four elements
of the Sohu.com solution -- "Mainland China Focus", "Pure Portal Play",
"Leading Brand Presence" and "Proven Organic Growth".
(2) Background -- The tail of the "Search Fox".]
<PAGE>
[LOGO OF SOHU.COM]
