ALTABA INC. 10-K 2007
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number 0-28018
701 First Avenue
Sunnyvale, California 94089
(Address of principal executive offices, including zip code)
Registrants telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Common stock, $.001 par value
(Title of Class)
Indicate by check mark if the Registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No þ
As of June 30, 2006, the aggregate market value of voting stock held by non-affiliates of the Registrant, based upon the closing sales price for the Registrants common stock, as reported in the NASDAQ Stock Market, was $41,812,571,856. Shares of common stock held by each officer and director and by each person who owns 10 percent or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.
The number of shares of the Registrants common stock outstanding as of February 15, 2007 was 1,356,539,645.
The following documents (or parts thereof) are incorporated by reference into the following parts of this Form 10-K:
(1) Proxy Statement for the 2007 Annual Meeting of Stockholders Part III Items 10, 11, 12, 13 and 14.
The trademarks and/or registered trademarks of Yahoo! Inc. and its subsidiaries referred to herein include, but are not limited to, Yahoo!, del.icio.us, Flickr, FareChase, HotJobs, Inktomi, Kelkoo, Musicmatch, Overture and Jumpcut. All other names are trademarks and/or registered trademarks of their respective owners.
Yahoo! Inc., together with its consolidated subsidiaries (Yahoo!, the Company, our, we, or us), is a leading global Internet brand and one of the most trafficked Internet destinations worldwide. Our mission is to connect people to their passions, their communities, and the worlds knowledge. We seek to provide Internet services that are essential and relevant to our global audience of users and our advertisers.
To our global audience of users, we provide our owned and operated online properties and services (the Yahoo! Properties). To our advertisers, we provide a range of tools and marketing solutions designed to enable businesses to reach our users. We focus on expanding our audience of users and deepening their engagement on the Yahoo! Properties to enhance the value of our audience of users to advertisers and to increase the spending of these advertisers. We believe that we can expand our audience of users by offering compelling Internet services and effectively integrating search, community, personalization, and content to create a powerful user experience. These user relationships and the social community they create enable us to leverage our online advertising as well as our fee based services.
We also focus on extending our marketing platform and access to Internet users beyond the Yahoo! Properties through our distribution network of third party entities (which we refer to as affiliates) who have integrated our search and/or display advertising offerings into their websites.
Many of our services are free to our users. We generate revenue by providing marketing services to businesses across the majority of our properties and by establishing paying relationships with users of our premium offerings. We classify these revenues as either marketing services or fees. Our offerings to users and businesses currently fall into five categories Search; Marketplace; Information and Entertainment; Communications, Communities and Front Doors; and Connected Life. The majority of our offerings are available globally in more than 20 languages.
Yahoo! was developed and first made available in 1994 by our founders, David Filo and Jerry Yang, while they were graduate students at Stanford University. We were incorporated in 1995 and are a Delaware corporation. We are headquartered in Sunnyvale, California, and have offices in more than 20 markets globally.
In December 2006, we announced a reorganization of our structure and management to align our operations with our key customer groups. Under the new structure, we will have two customer-focused groups: the Audience Group and the Advertiser & Publisher Group. Each of these groups will be supported by the Technology Group. We believe having a more customer-focused organization, supported by robust technology, will speed the development of leading-edge offerings for our most valuable audience segments and the provision of marketing services to our advertisers. This reorganization is expected to be completed by the end of the first quarter of 2007.
The following are some of our key accomplishments during 2006 directed at furthering our objective of providing essential and relevant Internet services to users and advertisers:
Since our formation we have made a number of strategic acquisitions, including business combinations, asset acquisitions and investments. We expect to continue to acquire or make investments in companies, products, services and technologies in the future. See Note 3 Acquisitions of the Notes to the Consolidated Financial Statements, which appears in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to our acquisitions.
Our accomplishments are possible because of our dedicated, highly skilled and talented employees. We believe that Yahoo! attracts among the most highly qualified and accomplished scientists, engineers, design specialists, marketers and professionals. We seek to recruit and retain people who thrive on the opportunity Yahoo! provides to solve some of the most technically challenging problems benefiting hundreds of millions of users across a range of areas, including search, communications, media, mobility, community, data and advertising.
As part of our strategy to provide the most efficient and effective marketing services for businesses, we are committed to providing a comprehensive set of Internet marketing solutions for advertisers. There is ongoing growth in the advertising market and an increasing shift in advertisers use of online media as audiences shift toward the Internet from traditional media. We are committed to capitalizing on this shift and helping our advertisers create and execute Internet marketing solutions that both engage users to interact with our advertisers brands as well as provide valuable insights into their customer base. We utilize our continuing research of the marketplace and our understanding of our users and their interests to offer a suite of targeted marketing services for our advertisers to meet the full range of their needs from brand building to consumer awareness, direct marketing, lead generation and commerce services. Our offerings enable marketers to display their advertisements in different formats and in different locations on the Yahoo! Properties and off-network on our affiliates websites.
Advertisers can display graphical advertisements on the pages that are viewed by our users across the Yahoo! Properties and on our affiliates websites. Yahoo! offers a broad range of tools available for online display advertising, including rich media, video and targeting. We work with our advertisers to maximize the effectiveness of their campaigns by optimizing advertisement formats and placement on the network. We also use our targeting capabilities to help advertisers reach their desired audiences by placing contextually relevant advertisements on our pages. For these advertising services, we earn revenue as impressions are delivered. An impression is delivered when an advertisement appears in pages viewed by users.
Advertising is also provided through a series of search offerings that enable advertisers to display text based links to their websites on the Yahoo! Properties, as well as on our affiliates websites. These advertisements are displayed in response to different user actions when a keyword is used in a search query initiated by a user or when specific content is being viewed by a user on the Yahoo! Properties or on the websites of our affiliates. For example, if a user searches using the keyword television in the Yahoo! Search box or the search box on the website of one of our affiliates, two sets of results will appear based upon algorithmic and sponsored search technology. Links to websites for advertisers selling televisions will appear alongside the algorithmic search results. As another example, if the user is reading an article about interest rates, he or she may be presented with advertising links to websites for mortgage-related advertisers. For these advertising services, we earn revenue when click-throughs occur. A click-through occurs when a user clicks on an advertisers listing. We refer to such advertising services as search marketing.
In addition to offering marketing services to businesses we also provide the following services:
Yahoo! HotJobs is one of the leaders in the online recruiting industry, providing comprehensive solutions for employers, staffing firms and job seekers. Yahoo! HotJobs tools and advice put job seekers in control of their career search and make it easier and more cost-effective for recruiters and employers to find qualified candidates compared to traditional methods. Yahoo! HotJobs enables job seekers to create an online resume and to search and apply for jobs, and provides access to newsletters, online forums and salary research, free of charge. We generate revenue from employers and staffing firms that pay to access our database of job seekers and use our tools to post, track and manage job openings.
In late 2006, we formed a strategic partnership with a consortium of newspaper companies that will enable the newspapers to provide advertisers who list jobs in any of the consortiums newspapers the ability to also post their jobs on Yahoo! HotJobs and throughout the Yahoo! network. We believe this arrangement will create a powerful local and national jobs network, enabling recruitment advertisers to reach a larger, more diverse candidate pool of both active and passive job seekers. In addition, all of the newspapers online career sections will be powered by Yahoo! HotJobs and co-branded between Yahoo! and the local newspaper.
Yahoo! Small Business provides a comprehensive and integrated suite of fee-based online services including Yahoo! Domains, Yahoo! Web Hosting, Yahoo! Business Mail and our e-commerce platform called Yahoo! Merchant Solutions. By integrating one of the leading hosting solutions with business critical services and information, Yahoo! enables customers to easily get online, sell online, and market and promote online.
Yahoo! Local offers businesses a free service called Yahoo! Local Basic Listing allowing them to post detailed company information, such as their business hours, contact information, product/services offered and website
address for Yahoo! users to see. Yahoo! Local also launched a self-serve version of Featured Listings, a simplified local advertising product for businesses to ensure preferred placement in the Yahoo! Local Sponsored Results section. Businesses can also submit additional content such as photos, logo and/or marketing information for a monthly fee through the Yahoo! Local Enhanced Listing service. These Featured and Enhanced Listings products meet the advertisers demands to advertise their local business in a simplified model that is similar to the print edition of the Yellow Pages.
Our offerings to users on our Yahoo! Properties currently fall into five categories: Search; Marketplace; Information and Entertainment; Communications, Communities and Front Doors; and Connected Life.
Our Search offerings are often the starting point for users navigating the Internet and searching for information, whether from their computer or mobile device. In Search, our goal is to provide the worlds most valued and trusted search experience for users, advertisers and developers and to enrich peoples lives by enabling them to find, use, share and expand all human knowledge. In the newly emerging areas of social search and media, our goal is to create the worlds most valued communities, large and small, to enable people to connect and exchange knowledge, insights and experiences with each other. Social search and media enable users to leverage their network of friends and other trusted information sources to improve everyday web browsing and searching experiences.
Our Search product offerings include the following:
Yahoo! Search, our proprietary algorithmic search technology, provides users with a free comprehensive and highly relevant online search experience and free Internet search results sorted based on relevance to the users search query. Yahoo! Search discovers and processes billions of documents on the Internet to give users a comprehensive, up-to-date, and relevant search experience. Pages on the Internet are ranked according to their relevance to a particular query by analyzing document features, including text, title and description accuracy, source, associated links, and other unique document characteristics. For example, if the user enters the phrase hybrid car into the Yahoo! Search box, the Yahoo! search technology will search the Internet and return links to what it identifies as the most relevant websites regarding hybrid car on the Internet. A single search gives immediate results from a database that is updated frequently to capture newly created and changing pages, including late breaking news and timely events. The search might also return results from Yahoo! Answers, a social search platform that enables our users to post and answer questions in hundreds of categories. Yahoo! Answers is where millions of users come to get answers to those questions.
To further extend our reach in social search products, we now provide users with easy ways to remember, search, organize and share their favorite websites and web pages. Through the popular social bookmarking website del.icio.us, acquired by Yahoo! in 2005, users are able to access, manage and share their favorite pages on the Internet from any computer.
In 2006, we enhanced our social media offerings including Image Search, Video and Flickr. Continuing the hybrid car search example above, a user may select a search view link to focus the web results on images, news, video or other options relevant to the search topic. For example, selecting the Images link and entering the search term hybrid car will yield pictures of hybrid cars on the Internet.
Flickr, our popular photo sharing and community site enables users to upload photos and offer the option of keeping them private, sharing them with a group of invited friends and family, or making them publicly available. Users can search the photos based on title, descriptions and tags. Access to and basic registration on the site are free. Flickr
offers premium accounts, which include unlimited upload storage and permanent image archiving as well as other benefits, for a fee.
Yahoo! Video is an online video destination that hosts Yahoo!s video search product, which enables users to search through an index of millions of video results compiled by crawling the web and accepting feeds from multiple sites. Yahoo! Video also enables individual users and partners to upload video content directly to Yahoo! Video, where it can then be accessed by other users. The site is free and users can upload an unlimited amount of video content. In 2006, to further enhance our video offerings, Yahoo! acquired Jumpcut, providing an online service for creating, editing, and sharing videos.
Yahoo! Toolbar is a free web browser add-on that enables users to conveniently access our properties and services from anywhere on the Internet and provides free security services to enhance the user experience. In 2006, we released a beta version of the new Toolbar for Internet Explorer which allows users to more easily customize their toolbar and make customized buttons for one click access to any website.
Yahoo! Search on Mobile enables users to access web, image and local search on their wireless devices. In 2006, we launched paid mobile advertising, thus enabling monetization of mobile search results and bringing a new consumer channel to our advertiser base. We also launched several mobile-related partnerships which allow us to distribute search results and our advertising platform on mobile devices in many countries around the world.
Our Local offerings include three individual properties whose primary services are available free to users: Yahoo! Local, Yahoo! Yellow Pages, and Yahoo! Maps.
Yahoo! Local is a stand-alone offering, using content and technology from other properties such as Yahoo! Yellow Pages and Yahoo! Maps to help users find local listings, recommendations, events and user reviews. In 2006, we introduced new features that enable users to contribute additional types of user content to Yahoo! Local including photos and tags. A My Local dashboard was launched for users to view all of their contributions, organize their local findings into collections or lists, and share them with the community.
Yahoo! Yellow Pages enables users to quickly connect to local and national merchants in the United States.
Yahoo! Maps provides interactive maps with zooming, real time traffic conditions and incident reports, together with integrated driving directions. In 2006, we continued to enhance Yahoo! Maps with an improved user interface, providing users an interactive look and feel with new features such as multi-point driving directions, local content integration, larger main map and dynamic pan, zoom and re-center technology, aerial satellite imagery and international maps coverage.
Marketplace offerings are often the starting point for users seeking to purchase products and services on the Internet and seeking to access free services on the Internet. Our specific Marketplace product offerings include the following:
Yahoo! Shopping provides comprehensive search functionality and comparison-shopping tools for users to find, research, compare and buy products online. This property also provides a full suite of merchant ratings and product review tools and in many countries includes the services of Kelkoo, S.A. (Kelkoo). We generate revenue from
merchants when users click-through to their websites or through a revenue share of the final selling value when users purchase products. We launched the Yahoo! Shopping Bargains Center in late 2006 as part of our redesign of Yahoo! Shopping. The Bargains Center provides users with coupons, rebates, free shipping offers, and sale items to help them find the best deals for the products they seek. These deals are updated daily, so users are able to return to the Bargains Center everyday to find new offers. We generate revenue when users click-through to the offers.
Kelkoo is our International shopping platform, which became part of Yahoo! through an acquisition in 2004. It provides product search functionality and an online comparison shopping service with operations in 10 European countries and now also powers the Yahoo! Shopping services in Australia and Taiwan.
Yahoo! Auctions is incorporated into the Yahoo! Shopping platform and is a marketplace for buyers and sellers to trade goods in an auction-style setting. Yahoo! Auctions connects buyers and sellers and is available free of charge.
Yahoo! Real Estate provides information and services for users who are looking to buy, sell, or rent a home. Users are able to search across multiple property types such as existing homes, new homes, apartment rentals, foreclosures, and classifieds while also searching based on geography, price and key amenities. Yahoo! Real Estate offers decision-support tools such as interactive maps, home valuation tools, a variety of calculators including mortgage and rent vs. own calculators, and content about local neighborhoods, schools, home loans, insurance, moving services, and finding a real estate agent. In 2006, we updated the look and feel of the Yahoo! Real Estate property and enhanced many of these features. Yahoo! Real Estate generates revenue from partners who pay to list their properties on our site.
Yahoo! Travel is a comprehensive online travel research and booking site for users to find, compare and conveniently purchase travel products such as airline tickets, hotel rooms, car rentals, vacation packages and cruises. Yahoo! Travel also includes Yahoo! Trip Planner, a social media product that allows users to document their personal travel experiences and share those experiences with others. We generate revenue from our travel partners through a revenue share of the booking value when users make travel arrangements on Yahoo! Travel. Separately, Yahoo! offers a travel search engine called Yahoo! FareChase. FareChase is an extension of our search offerings that allows users to search for travel information from multiple travel service providers websites simultaneously and obtain results from all providers on one page for purposes of comparison shopping.
Yahoo! Autos enables users to research, price and compare cars online. Information and services available free of charge to our users include vehicle pricing, specification and option information, used car listings, expert reviews, user reviews and ratings, car comparisons, financing calculators, and new car quotes from dealers. We earn fees on a per lead basis for transactions completed between our users and automotive manufacturers and dealers. In 2006, we launched the Yahoo! Autos Green Center that provides expert and user generated content across all types of alternative fuel vehicles including hybrid, biodiesel, ethanol and natural gas vehicles and includes video, tools, articles and proprietary green ratings for every car.
Yahoo! Personals is a leading online dating service. It allows users, free of charge, to post a profile and search for others with whom to communicate within the Yahoo! Personals community. Users can also send short one-time messages to others to communicate their interest without charge. With a paid subscription, Yahoo! Personals users can e-mail and use Yahoo! Messenger to communicate with others in the Yahoo! Personals community. The standard Yahoo! Personals subscription service serves a large population of daters with a user experience that is tailored to meet the communication needs of todays online daters. Yahoo! Personals Premier offers deeper profiling and advanced searching tools.
Our Information and Entertainment offerings deliver content that is available without charge to our users, and also provide some of our content on a fee or subscription basis. Our Information and Entertainment offerings include the following:
Yahoo! News aggregates news stories from news providers such as the Associated Press, Reuters, AFP, The Washington Post, ABC News, CBS News, National Public Radio, and U.S. News and World Report. Through Yahoo! News, users receive free up-to-the-minute news coverage with video, text, photos and audio from multiple sources and points of view. In 2006, we made many enhancements to our offerings, including the award winning Kevin Sites in the Hot Zone, featuring original coverage on armed conflict in the world, and formed a partnership with CBS Corporation to provide streaming video coverage of the popular news magazine show, 60 Minutes. Local news coverage was expanded in 2006 through agreements with new partners, including CBS Corporation for local video content, as well as the December 2006 launch of You Witness News, community news video content provided by users.
Yahoo! Finance provides a comprehensive set of financial resources that range from investment and company information to personal financial management tools. Free tools are provided to help users manage their personal finances as well as gather data, news and information for making informed investment decisions. Company conference call transcripts, analyst research reports and real-time streaming quotes are available through Yahoo! Finance for a fee. In 2006, Yahoo! Finance launched a free news video initiative that aggregates business news clips and delivers business-focused video news. Yahoo! Finance also added other new offerings during 2006, such as streaming quotes, interactive stock charts and enhanced stock message boards to its site.
Yahoo! Food launched in late 2006 as a one-stop online food destination. The site contains free recipes, chef and restaurant information, food video segments and select blogs dedicated to food topics. Content is provided by recognized authorities and personalities in the food space and by users through recipe submissions, postings and reviews.
Yahoo! Tech launched in 2006 and offers users a variety of free information on consumer electronics including product comparisons, consumer reviews and Hook Me Up, a streaming video product that evaluates consumer electronics. Yahoo! Tech was developed with the simple philosophy of making technology easy for all Yahoo! users, especially those without a deep understanding of technology and gadgets.
Yahoo! Health is a comprehensive healthcare destination. Yahoo! Health provides free information on healthy living, medical conditions clinical trials, diet tools and drugs. The site contains online community tools, complete with groups focused on popular health topics, as well as blogs provided by recognized experts.
Yahoo! Sports provides a fast, live and interactive online experience for sports fans including original fantasy games, up-to-the-minute news, real-time statistics and scoring, broadcast programming, integrated shopping, and an online sports community. Yahoo! Sports has content and marketing relationships with professional sports organizations and media outlets including the National Basketball Association, Players Inc., Major League Baseball Players Association, Sports Illustrated Interactive, Stats, Inc. and the Associated Press. Yahoo! Sports also offers fee-based fantasy games, real-time statistical trackers and live sports audio broadcasts. In 2006, Yahoo! Sports entered into a key partnership with the National Football League (NFL) to launch a subscription service to broadcast live NFL games to international users. In addition, the property broadened its free video content to fantasy users by launching a weekly Fantasy Football Live show.
Yahoo! Music offers a wide selection of free services, including streaming audio, one of the Internets largest collection of music videos, Internet radio, exclusive artist features and music news. Yahoo! Music also offers fee-
based music services including premium Internet radio and music subscription services. Nissan Live Sets is the latest offering of exclusive artist features, incorporating original artist performances with social networking elements, allowing users to submit photos, blog and interact with the artists. Yahoo! Music also promotes user generated content through programs such as Get Your Freak On, where fans can submit their own videos of their favorite artists and Yahoo! Music edits together the best clips. With a library of more than two million songs, the Yahoo! Music Unlimited (YMU) service is available to users for a low monthly or annual subscription fee. With YMU users can build personalized music libraries, transfer tracks to portable devices, purchase permanent downloads, access commercial-free Internet radio stations, develop personalized music recommendations based on ratings and musical tastes, as well as share and discover music with friends through Yahoo! Messenger.
Yahoo! Movies and Yahoo! TV offer free entertainment services which include compelling and exclusive video content such as trailers, clips and never-before-seen extras, entertainment news, photo galleries, and reviews. Yahoo! Movies features paid-for film promotions for major movie studios, including Disney, Sony, Warner Bros., Universal and Fox. Yahoo! Movies also provides coverage of the Oscars and other Red Carpet events. Yahoo! TV partners with key television networks, producers and content creators to provide users a deeper, more engaging experience with their favorite programs including a best of breed, comprehensive guide to Fall TV which features exclusive full-length episodes and clips of the seasons hottest shows. Additionally Yahoo! TV partners with Mark Burnett Productions to produce and host The Apprentice website on Yahoo! TV. Releases for 2006 included THE 9, a daily collection of some of the most popular content on the Internet, packaged in a format that makes it easy for viewers to get a quick download of whats hot on the Web every weekday morning. In addition, in the fourth quarter of 2006, we launched the Talent Show, an eight week competition to discover original talent on the Internet and to bring original, high quality user generated video content to our users.
Yahoo! Games offers free classic board, card, arcade and word games along with downloadable games, game strategy guides, shopping guides, gaming news, tournaments, leagues and reviews on computer and console videogames. Our integration of games with Yahoo! Messenger allows users to see what games their friends are playing and join the game through Yahoo! Messenger. Yahoo! Games also offers a variety of fee-based premium game downloads.
Yahoo! Kids, formerly known as Yahooligans, is a free entertainment and educational Internet guide designed for children ages six to twelve. Yahoo! Kids offerings include games, reference materials and movie information. Additionally, in 2006, Yahoo! Kids expanded its content to include a study zone section with resources for classroom and after class exploration.
Our Communications, Communities and Front Doors offerings provide a wide range of communication services to users and small businesses including those that extend a wide range of Yahoo! services beyond the browser and across a variety of devices and through our access alliances. We offer some services free of charge to our users and also provide some of our services on a fee or subscription basis. Our offerings include the following:
Yahoo! Mail is a free global service available in over 20 languages that provides users with a full-featured e-mail experience including industry-leading spam and virus protection, significant free storage and attachment size capacity, advanced search capabilities, and robust address book functionality. In addition to our basic e-mail service, for a subscription fee we offer Yahoo! Mail Plus, a premium mail service providing a number of premium features, including personalized spam filter, additional storage capacity, graphical ad blocker, and personalized stationery. In 2006, we extended the reach of the beta version of Yahoo! Mail which provides a faster experience with enhanced functionality, such as drag and drop e-mail organization and message previews in addition to other enhanced features to a wider audience of Yahoo! users around the world.
The Yahoo! Messenger with Voice instant messaging (IM) service provides a free, interactive and personalized way for people to connect and share experiences with their friends, family and colleagues in real time. Yahoo! Messengers communications suite integrates leading Yahoo! services including Games, Music, Photos, and Search. Yahoo! Messenger allows users to stay connected to each other through text IM, e-mail, video or mobile messaging. In 2006, we launched the next generation version of IM, which connects users of Yahoo! Messenger and MSN Messenger to create the largest IM community in the world. In addition, the new version of Yahoo! Messenger offers enhanced voice calling capabilities, allowing calls to and from traditional and mobile phones. Additionally, in 2006, we introduced custom plug-ins, which are free mini applications that users can add to their IM to make it more personalized and interactive.
Yahoo! Communities helps users build and manage identity and relationships, and includes properties such as Groups, 360º, Message Boards and Photos. Yahoo! 360º is an innovative free service providing users with an integrated experience, seamlessly bringing together popular communications, content and community services such as Yahoo! Messenger, Yahoo! Photos, Yahoo! Music and Yahoo! Groups with sharing tools for recommending favorite movies, restaurants, music and more. Yahoo! Communities provides users with the opportunity to discover, connect and interact with other users who share similar interests and ideas.
Yahoo! Photos makes it easy for people to upload, store and share their photos for free. In 2006, we launched the limited beta of the next generation version of Yahoo! Photos which offers desktop-like functionality including drag-and-drop organization, tagging, comments and advanced search capabilities. Users can also order high-quality prints and photo gifts as a premium service and pick-up their prints in one hour from their local Target store.
Yahoo! Front Page (www.yahoo.com) serves as a free navigation hub and entry point into the Yahoo! Properties. Among many available features on the page are the ability to perform an Internet search, read the latest news, link to Yahoo! websites in the Yahoo! Properties, and view promotions from Yahoo!s advertisers.
My Yahoo! is our free, personalized Web information service that allows registered members to create a personal profile and organizes and delivers information of personal interest to the user via a user-customized interface. The My Yahoo! platform allows us to deliver targeted advertising and transaction-based services on behalf of our advertisers and partners.
Yahoo!s Connected Life group includes the Companys mobile, co-branded broadband, digital home and PC desktop services. The Connected Life group offers services designed to give consumers easy access to integrated Yahoo! content and communities across a variety of Internet-enabled devices including mobile devices, televisions and the PC desktop.
Yahoo! Mobile Yahoo! Mobile focuses on extending consumers Internet communities and personalized content to their mobile phones. Throughout 2006, Yahoo! extended the Companys offerings in mobile services through a range of new partnerships and product launches. In 2006, Yahoo! launched a number of new ways for consumers to access their Yahoo! services, including Yahoo! Search, Yahoo! Mobile Web, and Yahoo! Go for Mobile. Through relationships with leading mobile operators and device manufacturers, Yahoo! is able to bring a wide range of services into consumers hands. Consumers in many countries throughout the world can access Yahoo!s mobile services such as Yahoo! Go for Mobile, Yahoo! Mobile Web, Yahoo! Search, Yahoo! Mail and Yahoo! Messenger.
Yahoo! has also developed advertising opportunities on mobile devices. Yahoo! has launched pilot programs for mobile sponsored search in Japan, the United Kingdom, and the United States. In November 2006, Yahoo! launched a beta version of its display advertising platform for the Yahoo! Mobile Web service in the United States and later that month announced that Yahoo! will become Vodafones exclusive display advertising partner in the UK.
Yahoo! Broadband Yahoo! has partnered with a number of broadband Internet access providers to provide a suite of Internet services for customers of these partner Internet access service offerings. We have strategic partnerships with AT&T Inc. and Verizon Communications, Inc. in the United States, an ongoing Internet access partnership with BT Telecommunications PLC in the United Kingdom and Rogers Cable Inc. (Rogers) in Canada and have recently entered into a partnership with Telecom New Zealand.
Yahoo! Digital Home The Yahoo! Digital Home initiative focuses on delivering Yahoo! content and personalized information through user interfaces designed for viewing on the television or other devices. With products like Yahoo! Go for TV, Yahoo! Digital Home is building a platform that will deliver many forms of Web content (music, videos, and photos) to the television. Yahoo! is also working with partners to develop applications for emerging digital home technology such as AT&Ts IPTV based Uverse product offering and AT&T Homezone which combines satellite TV programming, communications features and high speed Internet in one integrated receiver. Other Yahoo! Digital Home applications such as the integration of Yahoo! Fantasy Sports deliver contextual Internet content to enhance the television viewing experience.
Yahoo! PC Desktop Yahoo! PC Desktop services makes it easy for users to keep up-to-date on and to interact with their Yahoo! services and other Internet based information on PC desktop without using an Internet browser application. Yahoo! Widgets is a platform that allows consumers to take advantage of more than 4,000 lightweight applications that may reside on a users PC desktop to perform a wide variety of tasks and provide access to an array of information.
We manage and measure our business geographically. Our principal geographies are the United States and International. We seek to increase our global audience of users by developing Internet offerings focused on specific geographic regions both domestically and internationally. Additional information required by this item is incorporated herein by reference to Note 15 Segments of the Notes to the Consolidated Financial Statements, which appears in Part II, Item 8 of this Annual Report on Form 10-K.
We provide services in more than 20 languages in more than 20 countries, regions and territories, including localized versions of Yahoo! in Argentina, Australia, Brazil, Canada, China, France, Germany, Greece, Hong Kong, India, Italy, Japan, Korea, Malaysia, Mexico, Northern Europe and Scandinavia (Denmark, Norway, Sweden), Russia, Singapore, Spain, Taiwan, the United Kingdom and Ireland, and the United States. We also provide some of our most popular and point-of-entry services through Yahoo! Asia (our portal to Southeast Asia including Indonesia, Malaysia, Philippines, Thailand and Vietnam), Yahoo! Chinese (United States Chinese language site), Yahoo! Telemundo (United States Hispanic site), Yahoo! Canada en français (French Canadian site) and Yahoo! en Català (part of Yahoo! Spains Catalan language offerings). Outside of Yahoos English-speaking markets, we have built independent, localized-language directories, websites and other content, developed by native speakers of each language. We own a majority or 100 percent of these international operations (except in Australia, New Zealand, China and Japan), and have established offices worldwide to facilitate the local development of these businesses. We have pursued a consistent strategy of content aggregation with leading third parties and currently plan to continue to introduce certain selected services for our international markets.
We maintain three primary channels for selling our marketing services: direct, online, and telemarketing. Our direct advertising sales team focuses on selling our marketing services and solutions to leading advertising agencies and marketers in the United States. Our online channel is fulfilled by a self-service program that enables advertisers to place targeted text based links to their websites on the Yahoo! Properties as well as on our affiliates websites. Our telemarketing channel focuses on sales of marketing services to small- and medium- sized businesses. We have combined our graphical and search marketing sales teams under the common leadership to better respond to advertisers who are increasingly using both forms of advertising on Yahoo! Properties to achieve their desired marketing goals. No individual customer represented more than 10 percent of our revenues in 2004, 2005 or 2006.
We employ sales professionals in locations across the United States, including Atlanta, Boston, Chicago, Dallas, Detroit, Hillsboro, the Los Angeles area, Miami, New York, San Francisco, and Sunnyvale. Our sales organization
consults regularly with agencies and advertisers on design and placement of online advertising, and provides customers with measurements and analyses of advertising effectiveness as well as effective consumer insights that can be turned into marketing campaigns. In addition to our geographic sales structure, we have industry focused sales teams for automotive, consumer packaged goods, entertainment, finance, retail, pharmaceuticals, sports, technology, telecommunications and travel. In international markets, we have either our own internal sales professionals or we have established sales agency relationships in more than 20 countries.
We believe that world-class marketing can be a competitive advantage. The Yahoo! brand is one of the most widely recognized in the world. Maintaining and growing that brand enables us to attract, retain, and more deeply engage users and advertisers. We believe a great brand begins with a great product. Yahoo! marketing engages in each step of product development, deployment and management to understand our offerings and how best to market them to our audience of potential and existing users. Our marketing communications efforts help accelerate product momentum, awareness, adoption, and engagement. We use online, television, print, radio and outdoor advertising, and we leverage our global online network and our distribution partnerships to market our products and services to the right people at the right time. With continued investment in global brand and product marketing, we believe we can continue to attract and engage users and advertisers.
We operate in the Internet products, services and content market, which is highly competitive and characterized by rapid change, converging technologies, and increasing competition from companies offering communication, information and entertainment services integrated into other products and media properties. We primarily compete with companies to attract users to our website and advertisers to our marketing services. We expect the market to become increasingly competitive if online marketing continues to grow and gain acceptance on a global basis.
Globally, our most significant competition is from Google Inc. (Google), Microsoft Corporation (Microsoft) and Time Warners America Online business (AOL or America Online).
The principal competitive factors relating to attracting and retaining users include the quality and relevance of our search results, and the usefulness, accessibility, integration and personalization of the online services that we offer as well as the overall user experience on our website. In the case of attracting advertisers, the principal competitive factors are the reach, effectiveness and efficiency of our marketing services as well as the creativity of the marketing solutions that we offer.
We also compete for customers, users and advertisers with many other providers of online services, including web businesses where expertise in a particular market segment may provide a competitive advantage and with social media and networking competitors.
Internationally, we compete with local portals that are predominantly supported by local telecommunication providers, or local providers of specific locally designed and marketed Internet services, some of which may have a potential competitive advantage due to an existing direct billing relationship with their users.
We believe that we are effectively competing in the Internet services market as we continue to refine our search technology, build onto our existing online properties and services, and further improve our users experience.
Additional information regarding competition is included in Part I, Item 1A Risk Factors of this Annual Report on Form 10-K.
Yahoo! continually enhances, expands and launches products and features to meet evolving user, advertiser and publisher needs for technological innovation and a deeper, more integrated experience.
As a complement to our core engineering and production teams, we also have scientists working in our Yahoo! Research Labs dedicated to developing novel algorithms and technology that empower users, businesses, and advertisers worldwide to maximize the social and economic potential of the Internet. Yahoo! performs research to
address fundamental problems facing users such as: making their search for information on the Internet easier and more relevant; bringing them tools to help solve their problems; finding new and better ways for them to connect and communicate with family and community; and guiding family and friends towards high-quality products, songs, movies, and other resources. We also use technology to match relevant business services with customers most likely to be interested in such services. Yahoo! Research Berkeley is a research facility that operates in a unique partnership between Yahoo! Research Labs and the University of California at Berkeley (UCB). We believe this is a mutually beneficial intellectual property arrangement, and an opportunity for students and staff at UCB to gain access to resource and scale typically not afforded in the academic environment. The mission of Yahoo! Research Berkeley is to explore and invent social media and mobile media technology and applications that will enable people to create, describe, share, find and remix media on the web.
Most of our software products and features are developed internally; however, we purchase technology and license intellectual property rights when the opportunity is strategically aligned, operationally compatible and economically advantageous. We believe that Yahoo! is not materially dependent upon licenses and other agreements with third parties relating to product development.
Yahoo! launched its new search marketing system, known as Project Panama, in the fourth quarter of 2006. We have been transitioning our advertisers on to the new system in the United States and will begin transitioning our advertisers in international markets in the second quarter of 2007. This system provides advertisers with additional tools for budgeting, testing and optimizing their marketing campaigns. This new system also provides a new ranking model launched in early February 2007 that ranks ads by relevance in addition to keyword bid price. We believe the new search marketing system will provide a more relevant search experience to users, more valuable customer leads to advertisers, and additional opportunities to our distribution partners.
Also during 2006, we introduced the Hack Yahoo! Program, which is designed to encourage and empower employee and third-party innovation. This global program consists of a speaker series, an intranet site and blog, workshops, and quarterly Hack Days that are an ongoing opportunity to foster and celebrate the creativity of our employees and third parties. Consistent with this spirit of innovation and openness, we sponsored the Yahoo! Developer Network which makes Yahoo!s infrastructure, platform and audience accessible to third-parties via Application Programming Interfaces (or APIs.) This has established a mutually beneficial ecosystem, in which thousands of developers have used and built upon technology from Yahoo! services, including Yahoo! Search,Yahoo! Photos and Yahoo! Maps, to further increase the relevance of Yahoo! products and services for individual users and the greater community.
Our engineering and production teams are primarily located in our Sunnyvale, California headquarters and in Carlsbad, California; Burbank, California; Dallas, Texas; and Bangalore, India. Our research teams are located in our Sunnyvale, California headquarters and in Berkeley, California; Burbank, California; New York, New York; Barcelona, Spain; and Santiago, Chile. We have internally developed, acquired or licensed the products and services we offer. Product development expenses for 2004, 2005 and 2006 totaled approximately $381 million, $570 million, and $833 million, respectively, which included stock-based compensation expense of $12 million, $22 million and $145 million, respectively.
We create, own and maintain a wide array of intellectual property assets that we believe are among our most valuable assets. Our intellectual property assets include patents and patent applications related to our innovations, products and services; trademarks related to our brands, products and services; copyrights in software and creative content; trade secrets; and other intellectual property rights and licenses of various kinds. We seek to protect our intellectual property assets through patent, copyright, trade secret, trademark and other laws of the United States and other countries, and through contractual provisions. We enter into confidentiality and invention assignment agreements with our employees and contractors, and non-disclosure agreements with third parties with whom we conduct business in order to limit access to, and disclosure of, our proprietary information. We consider the Yahoo! trademark and our many related trademarks to be among our most valuable assets and we have registered these trademarks in the United States and other countries throughout the world and aggressively seek to protect them. We have licensed in the past, and expect that we may license in the future, certain of our proprietary rights, such as
trademark, patent, copyright and trade secret rights to third parties. Additional information regarding certain risks related to our intellectual property is included in Part I, Item 1A Risk Factors of this Annual Report on Form 10-K.
As of December 31, 2006, we had approximately 11,400 full-time employees. Our future success is substantially dependent on the performance of our senior management and key technical personnel, as well as our continuing ability to attract and retain highly qualified technical and managerial personnel. Additional information regarding certain risks related to our employees is included in Part I, Item 1A Risk Factors of this Annual Report on Form 10-K.
Our website is located at http://www.yahoo.com. Our investor relations website is located at
http://yhoo.client.shareholder.com/. We make available free of charge on our investor relations website under SEC Filings our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (SEC). Further, a copy of this annual report on Form 10-K is located at the SECs Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding our filings at http://www.sec.gov.
We face significant competition from large-scale Internet content, product and service aggregators, principally Google, Microsoft and AOL.
We face significant competition from companies, principally Google, Microsoft and AOL, that have aggregated a variety of Internet products, services and content in a manner similar to Yahoo!. Googles Internet search service directly competes with us for affiliate and advertiser arrangements, both of which are key to our business and operating results. Additionally, Google offers many other services that directly compete with our services, including a consumer e-mail service, desktop search, local search, instant messaging, photos, maps, shopping services and advertising solutions. Microsoft has introduced its own Internet search service with paid search and may release features that may make Internet searching capabilities a more integrated part of its Windows operating system. AOL has access to content from Time Warners movie, television, music, book, periodical, news, sports and other media holdings; access to a network of cable and other broadband users and delivery technologies; and considerable resources for future growth and expansion. Some of the existing competitors and possible additional entrants may have greater operational, strategic, financial, personnel or other resources than we do, as well as greater brand recognition either overall or for certain products and services. We expect these competitors increasingly to use their financial and engineering resources to compete with us, individually, and potentially in combination with each other. In certain of these cases, most notably AOL, our competition has a direct billing relationship with a greater number of their users through Internet access and other services than we have with our users through our premium services. This relationship may permit such competitors to be more effective than us in targeting services and advertisements to the specific preferences of their users thereby giving them a competitive advantage. If our competitors are more successful than we are in developing compelling products or attracting and retaining users or advertisers, then our revenues and growth rates could decline.
We also face competition from other Internet service companies, including Internet access providers, device manufacturers offering online services and destination websites.
Our users must access our services through Internet access providers, including wireless providers and providers of cable and broadband Internet access. To the extent that an access provider or device manufacturer offers online services competitive with those of Yahoo!, the user may elect to use the services or properties of that access provider or manufacturer. In addition, the access provider or manufacturer may make it difficult to access our services by not
listing them in the access providers or manufacturers own directory or by providing Yahoo! with less prominent listings than the access provider, manufacturer, or a competitors offerings. Such access providers and manufacturers may prove better able to target services and advertisements to the preferences of their users. If such access providers and device manufacturers are more successful than we are in developing compelling products or attracting and retaining customers, users or advertisers, then our revenues could decline. Further, to the extent that Internet access providers, mobile service providers or network providers increase the costs of service to users or restrict Yahoo!s ability to deliver products, services and content to end users or increase our costs of doing so, our revenues could decline.
We also compete for customers, users and advertisers with many other providers of online services, including destination websites and social media and networking sites. Some of these competitors may have more expertise in a particular segment of the market, and within such segment, have longer operating histories, larger advertiser or user bases, and more brand recognition or technological features than we offer.
In the future, competitors may acquire additional competitive offerings, and if we are unable to complete strategic acquisitions or investments, our business could become less competitive. Further, competitors may consolidate with each other to become more competitive, and new competitors may enter the market. If our competitors are more successful than we are in developing compelling products or attracting and retaining users, advertisers or customers, then our revenues and growth rates could decline.
We face significant competition from traditional media companies which could adversely affect our future operating results.
We also compete with traditional media companies for advertising. Most advertisers currently spend only a small portion of their advertising budgets on Internet advertising. If we fail to persuade existing advertisers to retain and increase their spending with us and if we fail to persuade new advertisers to spend a portion of their budget on advertising with us, our revenues could decline and our future operating results could be adversely affected.
If we are unable to provide search technologies and other services which generate significant traffic to our websites, or we are unable to enter into or continue distribution relationships that drive significant traffic to our websites, our business could be harmed, causing our revenues to decline.
We have deployed our own Internet search technology to provide search results on our network. We have more limited experience in operating our own search service than do some of our competitors. Internet search is characterized by rapidly changing technology, significant competition, evolving industry standards and frequent product and service enhancements. We must continually invest in improving our users experience, including search relevance, speed and services responsive to their needs and preferences, to continue to attract, retain and expand our user base. If we are unable to provide search technologies and other services which generate significant traffic to our websites, or if we are unable to enter into distribution relationships that continue to drive significant traffic to our websites, our business could be harmed, causing our revenues to decline.
The majority of our revenues are derived from marketing services, and the reduction in spending by or loss of current or potential advertisers would cause our revenues and operating results to decline.
For the year ended December 31, 2006, 88 percent of our total revenues came from marketing services. Our ability to continue to retain and grow marketing services revenue depends upon:
In many cases, our agreements with advertisers have terms of one year or less, or, in the case of search marketing, may be terminated at any time by the advertiser. Search marketing agreements often have payments dependent upon usage or click-through levels. Accordingly, it is difficult to forecast marketing services revenues accurately. However, our expense levels are based in part on expectations of future revenues, including occasional guaranteed minimum payments to our affiliates in connection with search and/or display advertising, and are fixed over the short-term with respect to certain categories. Any reduction in spending by or loss of existing or potential future advertisers would cause our revenues to decline. Further, we may be unable to adjust spending quickly enough to compensate for any unexpected revenue shortfall.
In certain markets, we depend on a limited number of sources to direct a significant percentage of users and businesses to our service to conduct searches, and a loss of any of these sources could harm our operating results.
A significant percentage of users and businesses that conduct searches and access our search marketing listings comes from a limited number of sources in certain markets. In addition to the Yahoo! Properties, sources for users are members of our affiliate network, including portals, browsers and other affiliates. Our agreements with affiliates vary in duration, and depending on the agreement, provide varying levels of discretion to the affiliate in the implementation of search marketing, including the degree to which affiliates can modify the presentation of the search marketing listings on their websites or integrate search marketing with their own services. The agreements may be terminable upon the occurrence of certain events, including failure to meet certain service levels, material breaches of agreement terms, changes in control or in some instances, at will. We may not be successful in renewing our affiliate agreements on as favorable terms or at all. The loss of affiliates providing significant users or businesses or an adverse change in implementation of search marketing by any of these affiliates could harm our ability to generate revenue, our operating results and cash flows from operations.
We may not be able to generate substantial revenues from our alliances with Internet access providers.
Through alliances with Internet access providers, we offer access services that combine customized content and services from Yahoo! (including browser and other communications services) and Internet access from third party access providers. We may not be able to retain the alliances with our existing Internet access providers or to obtain new alliances with Internet access providers on terms that are reasonable. In addition, these Internet access services compete with many large companies such as AOL, Microsoft, Comcast Corporation and other established Internet access providers. In certain of these cases, our competition has substantially greater market presence (including an existing user base) and greater financial, technical, marketing or other resources. As a result of these and other competitive factors, the Internet access providers with which we have formed alliances may not be able to attract, grow or retain their customer bases, which would negatively impact our ability to sell customized content and services through this channel and, in turn, reduce our anticipated revenues from our alliances.
We typically receive co-branded revenue through revenue sharing arrangements or a portion of transactions revenue. In some cases, our revenue arrangements require that minimum levels of user impressions be provided by us. These arrangements expose us to potentially significant financial risks in the event our usage levels decrease, including the following:
Accordingly, any leveling off or decrease of our user base (or usage by our existing base) or the failure to generate anticipated levels of shared transactions revenue could result in a significant decrease in our revenues.
Decreases or delays in advertising spending by our advertisers due to general economic conditions could harm our ability to generate advertising revenue.
Expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Since we derive most of our revenues from advertising, any decreases in or delays in advertising spending due to general economic conditions could reduce our revenues or negatively impact our ability to grow our revenues.
There can be no assurance that the purchasing pattern of advertisers on the Yahoo! Properties will not fluctuate, that advertisers will not make smaller and shorter-term purchases, or that market prices for online advertising will not decrease due to competitive or other factors. In addition, there can be no assurance that the volume of searches conducted, the amounts bid by advertisers for search marketing listings or the number of advertisers that bid in our search marketing marketplace will not vary widely from period to period. As revenues from new sources increase, it may become more difficult to predict our financial results based on historical performance. You should not rely on the results for any period as an indication of future performance.
We estimate tax liabilities, the final determination of which is subject to review by domestic and international taxation authorities.
We are subject to income taxes and other taxes in both the United States and the foreign jurisdictions in which we currently operate or have historically operated. We are also subject to review and audit by both domestic and foreign taxation authorities. The determination of our worldwide provision for income taxes and current and deferred tax assets and liabilities requires judgment and estimation. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the ultimate tax outcome may materially differ from the tax amounts recorded in our consolidated financial statements and may materially affect our income tax provision, net income or cash flows in the period or periods for which such determination is made.
We rely on the value of our brands, and a failure to maintain or enhance the Yahoo! brands in a cost-effective manner could harm our operating results.
We believe that maintaining and enhancing our brands, including those that contain the Yahoo! name as well as those that do not, is an important aspect of our efforts to attract and expand our user and advertiser base. We also believe that the importance of brand recognition will increase due to the relatively low barriers to entry in the Internet market. We have spent considerable money and resources to date on the establishment and maintenance of our brands, and we anticipate spending increasing amounts of money on, and devoting greater resources to, advertising, marketing and other brand-building efforts to preserve and enhance consumer awareness of our brands. We may not be able to successfully maintain or enhance consumer awareness of our brands and, even if we are successful in our branding efforts, these efforts may not be cost-effective. If we are unable to maintain or enhance customer awareness of our brands in a cost-effective manner, our business, operating results and financial condition could be harmed.
If we are unable to license or acquire compelling content at reasonable costs or if we do not develop or commission compelling content of our own, the number of users of our services may not grow as anticipated, or may decline, or users level of engagement with our services may decline, all or any of which could harm our operating results.
Our future success depends in part upon our ability to aggregate compelling content and deliver that content through our online properties. We license much of the content on our online properties, such as news items, stock quotes, weather reports, maps and audio and video content from third parties. We have been providing increasing amounts of audio and video content to our users, and we believe that users will increasingly demand high-quality audio and video content, such as music, film, speeches, news footage, concerts and other special events. Such content may require us to make substantial payments to third parties from whom we license or acquire such content. For example, our music and entertainment properties rely on major sports organizations, radio and television stations, record labels, music publishers, cable networks, businesses, colleges and universities, film producers and distributors, and other organizations for a large portion of the content available on our properties. Our ability to maintain and build relationships with third-party content providers will be critical to our success. In addition, as new methods for accessing the Internet become available, including through alternative devices, we may need to enter into amended content agreements with existing third-party content providers to cover the new devices. Also, to the extent that Yahoo! develops content of its own, Yahoo!s current and potential third-party content providers may view our services as competitive with their own, and this may adversely affect their willingness to contract with us. We may be unable to enter into new, or preserve existing, relationships with the third parties whose content we seek to obtain. In addition, as competition for compelling content increases both domestically and internationally, our content providers may increase the prices at which they offer their content to us, and potential content providers may not offer their content to us or offer it on terms agreeable to us. An increase in the prices charged to us by third-party content providers could harm our operating results and financial condition. Further, many of our content licenses with third parties are non-exclusive. Accordingly, other webcasters and other media such as radio or television may be able to offer similar or identical content. This increases the importance of our ability to deliver compelling editorial content and personalization of this content for users in order to differentiate Yahoo! from other businesses. If we are unable to license or acquire compelling content at reasonable prices, if other companies broadcast content that is similar to or the same as that provided by Yahoo!, or if we do not develop compelling editorial content or personalization services, the number of users of our services may not grow as anticipated, or may decline, which could harm our operating results.
Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our brand image and harm our business and our operating results.
We create, own and maintain a wide array of intellectual property assets, including copyrights, patents, trademarks, trade dress, trade secrets and rights to certain domain names, which we believe are among our most valuable assets. We seek to protect our intellectual property assets through patent, copyright, trade secret, trademark and other laws of the United States and other countries of the world, and through contractual provisions. The efforts we have taken to protect our intellectual property and proprietary rights may not be sufficient or effective at stopping unauthorized use of those rights. In addition, effective trademark, patent, copyright and trade secret protection may not be available or cost-effective in every country in which our products and media properties are distributed or made available through the Internet. There may be instances where we are not able to fully protect or utilize our intellectual property assets in a manner to maximize competitive advantages. Further, while we attempt to ensure that the quality of our brand is maintained by our licensees, our licensees may take actions that could impair the value of our brand, our proprietary rights or the reputation of our products and media properties. We are aware that third parties have, from time to time, copied significant content available on Yahoo! for use in competitive Internet services. Protection of the distinctive elements of Yahoo! may not be available under copyright law or trademark law. If we are unable to protect our proprietary rights from unauthorized use, the value of our brand image may be reduced. Any impairment of our brand could negatively impact our business. In addition, protecting our intellectual property and other proprietary rights is expensive and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and consequently harm our operating results.
We are, and may in the future be, subject to intellectual property infringement claims, which are costly to defend, could result in significant damage awards, and could limit our ability to provide certain content or use certain technologies in the future.
Internet, technology, media companies and patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing or purchasing search, indexing, electronic commerce and other Internet-related technologies, as well as a variety of online business models and methods. We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection. As a result, disputes regarding the ownership of technologies and rights associated with online business are likely to continue to arise in the future. From time to time, parties assert patent infringement claims against us. Currently, we are engaged in several lawsuits regarding patent issues and have been notified of a number of other potential disputes.
In addition to patent claims, third parties have asserted, and are likely in the future to assert, claims against us alleging infringement of copyrights, trademark rights, trade secret rights or other proprietary rights, or alleging unfair competition or violations of privacy rights or failure to maintain confidentiality of user data. Currently, our subsidiary LAUNCH Media, Inc. (LAUNCH) is engaged in a lawsuit regarding copyright issues that commenced prior to our acquisition of LAUNCH. In addition, third parties have made, and may continue to make, trademark infringement and related claims against us over the display of search results triggered by search terms that include trademark terms.
As we expand our business and develop new technologies, products and services, we may become increasingly subject to intellectual property infringement claims. In the event that there is a determination that we have infringed third-party proprietary rights such as patents, copyrights, trademark rights, trade secret rights or other third party rights such as publicity and privacy rights, we could incur substantial monetary liability, be required to enter into costly royalty or licensing agreements or be prevented from using the rights, which could require us to change our business practices in the future and limit our ability to compete effectively. We may also incur substantial expenses in defending against third-party infringement claims regardless of the merit of such claims. In addition, many of our agreements with our customers or affiliates require us to indemnify them for certain third-party intellectual property infringement claims, which could increase our costs in defending such claims and our damages. The occurrence of any of these results could harm our brand and negatively impact our operating results.
We are subject to United States and foreign government regulation of Internet, mobile, and Voice over Internet Protocol services which could subject us to claims and remedies including monetary liabilities and limitations on our business practices.
We are subject to regulations and laws directly applicable to providers of Internet, mobile, and Voice over Internet Protocol services both domestically and internationally. The application of existing domestic and international laws and regulations to Yahoo! relating to issues such as user privacy and data protection, defamation, pricing, advertising, taxation, gambling, sweepstakes, promotions, billing, real estate, consumer protection, content regulation, quality of services, telecommunications, mobile and intellectual property ownership and infringement in many instances is unclear or unsettled. In addition, we will also be subject to any new laws and regulations directly applicable to our domestic and international activities. Further, the application of existing laws to Yahoo! or our subsidiaries regulating or requiring licenses for certain businesses of our advertisers including, for example, distribution of pharmaceuticals, alcohol, adult content, tobacco or firearms, as well as insurance and securities brokerage and legal services, can be unclear. Internationally, we may also be subject to domestic laws regulating our activities in foreign countries and to foreign laws and regulations that are inconsistent from country to country. We may incur substantial liabilities for expenses necessary to comply with these laws and regulations or penalties for any failure to comply. Compliance with these laws and regulations may also cause us to change or limit our business practices in a manner adverse to our business.
A number of U.S. federal laws, including those referenced below, impact our business. The Digital Millennium Copyright Act (DMCA) is intended, in part, to limit the liability of eligible online service providers for listing or linking to third-party websites that include materials that infringe copyrights or other rights of others. Portions of the Communications Decency Act (CDA) are intended to provide statutory protections to online service providers
who distribute third party content. Yahoo! relies on the protections provided by both the DMCA and CDA in conducting its business. Any changes in these laws or judicial interpretations narrowing their protections will subject us to greater risk of liability and may increase our costs of compliance with these regulations or limit our ability to operate certain lines of business. The Childrens Online Protection Act and the Childrens Online Privacy Protection Act are intended to restrict the distribution of certain materials deemed harmful to children and impose additional restrictions on the ability of online services to collect user information from minors. In addition, the Protection of Children From Sexual Predators Act of 1998 requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances. The costs of compliance with these regulations may increase in the future as a result of changes in the regulations or the interpretation of them. Further, any failures on our part to comply with these regulations may subject us to significant liabilities.
Changes in regulations or user concerns regarding privacy and protection of user data could adversely affect our business.
Federal, state, foreign and international laws and regulations may govern the collection, use, retention, sharing and security of data that we receive from our users and partners. In addition, we have and post on our website our own privacy policies and practices concerning the collection, use and disclosure of user data. Any failure, or perceived failure, by us to comply with our posted privacy policies or with any data-related consent orders, Federal Trade Commission requirements or other federal, state or international privacy-related laws and regulations could result in proceedings or actions against us by governmental entities or others, which could potentially have an adverse effect on our business.
Further, failure or perceived failure to comply with our policies or applicable requirements related to the collection, use, sharing or security of personal information or other privacy-related matters could result in a loss of user confidence in us, damage to the Yahoo! brands, and ultimately in a loss of users, partners or advertisers, which could adversely affect our business.
A large number of legislative proposals pending before the United States Congress, various state legislative bodies and foreign governments concern data privacy and retention issues related to our business. It is not possible to predict whether or when such legislation may be adopted. Certain proposals, if adopted, could impose requirements that may result in a decrease in our user registrations and revenues. In addition, the interpretation and application of user data protection laws are in a state of flux. These laws may be interpreted and applied inconsistently from country to country and inconsistently with our current data protection policies and practices. Complying with these varying international requirements could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business.
Acquisitions and strategic investments could result in adverse impacts on our operations and in unanticipated liabilities.
We have acquired, and have made strategic investments in, a number of companies (including through joint ventures) in the past and expect to make additional acquisitions and strategic investments in the future. Such transactions may result in dilutive issuances of equity securities, use of our cash resources, incurrence of debt and amortization of expenses related to intangible assets. Our acquisitions and strategic investments to date were accompanied by a number of risks, including:
We are likely to experience similar risks in connection with our future acquisitions and strategic investments. Our failure to be successful in addressing these risks or other problems encountered in connection with our past or future acquisitions and strategic investments could cause us to fail to realize the anticipated benefits of such acquisitions or investments, incur unanticipated liabilities and harm our business generally.
We are continuing to grow, diversify and evolve our business both in the United States and internationally. As a result of the diversification of our business, personnel growth, acquisitions and international expansion in the recent years, more than one-half of our employees are now based outside of our Sunnyvale, California headquarters. If we are unable to effectively manage a large and geographically dispersed group of employees or to anticipate our future growth and personnel needs, our business may be adversely affected.
As we grow and diversify our business, we must also expand and adapt our operational infrastructure. Our business relies on our data systems, billing systems for our fee-based services, and other operational and financial reporting and control systems. All of these systems have become increasingly complex in the recent past due to the growing diversification and complexity of our business, to acquisitions of new businesses with different systems and to increased regulation over controls and procedures. To effectively manage our technical support infrastructure, we will need to continue to upgrade and improve our data systems, billing systems, and other operational and financial systems, procedures and controls. In particular, as our fee-based services for which we bill users grow, any failure of our billing systems to accommodate the increasing number of transactions and accurately bill users could adversely affect our business and ability to collect revenue. These upgrades and improvements will require a dedication of resources and in some cases are likely to be complex. If we are unable to adapt our systems in a timely manner to accommodate our growth, our business may be adversely affected.
To better and more efficiently manage our business, we recently announced, and are currently implementing, a reorganization of our structure and management to align our operations with our key customer groups audiences and advertisers. Implementing the reorganization requires significant time and resource commitments from our senior management. In the event that we are unable to effectively implement the reorganization, we are unable to recruit or retain key employees as a result of the reorganization or the reorganization does not yield the anticipated benefits, our business may be adversely affected.
We have dedicated considerable resources to provide a variety of premium services, which may not prove to be successful in generating significant revenue for us.
We offer fee-based enhancements to many of our free services, including e-mail, personals, finance, games, music and sports. The development cycles for these technologies are long and generally require significant investment by us. We have and will continue to invest in new products and services. Some of these new products and services may not be profitable or may not meet anticipated user adoption rates. We have previously discontinued certain non-profitable premium services and may discontinue others. We must however continue to provide new services that are compelling to our users while continuing to develop an effective method for generating revenues for such
services. General economic conditions as well as the rapidly evolving competitive landscape may affect users willingness to pay for such services. If we cannot generate revenues from these services that are greater than the cost of providing such services, our operating results could be harmed.
We expect our operating expenses to continue to increase as we attempt to expand the Yahoo! brand, fund product development, develop media properties and acquire other businesses or technologies, which could harm our operating results.
We currently expect that our operating expenses will continue to increase as we expand our operations in areas of expected growth, continue to develop and extend the Yahoo! brand, fund greater levels of product development, develop and commercialize additional media properties and premium services, and acquire and integrate complementary businesses and technologies. If our expenses increase at a greater pace than our revenues, our operating results could be harmed.
If we are unable to retain our existing senior management and key personnel and hire new highly skilled personnel, we may not be able to execute our business plan.
We are substantially dependent on the continued services of our senior management, including our two founders, our chief executive officer, chief financial officer, chief technical officer, and our executive and senior vice presidents. These individuals have acquired specialized knowledge and skills with respect to Yahoo! and its operations. The loss of any of these individuals could harm our business. Our business is also dependent on our ability to retain, hire and motivate talented, highly skilled personnel. The competition for such executives and for other highly skilled personnel can be intense, particularly in the San Francisco Bay Area, where our corporate headquarters, and the headquarters of several of our vertical and horizontal competitors, are located. If we do not succeed in recruiting, retaining and motivating our key employees and in attracting new key personnel, we may be unable to meet our business plan and as a result, our stock price may decline.
More individuals are utilizing non-PC devices to access the Internet, and versions of our service developed or optimized for these devices may not gain widespread adoption by users, manufacturers or distributors of such devices.
The number of individuals who access the Internet through devices other than a personal computer, such as personal digital assistants, mobile telephones, televisions and set-top box devices, has increased dramatically, and the trend is likely to continue. Our services were originally designed for rich, graphical environments such as those available on desktop and laptop computers. The lower resolution, functionality and memory associated with alternative devices currently available may make the use of our services through such devices difficult, and the versions of our service developed for these devices may not be compelling to users, manufacturers or distributors of alternative devices. As we have limited experience to date in operating versions of our service developed or optimized for users of alternative devices, and as new devices and new platforms are continually being released, it is difficult to predict the problems we may encounter in doing so, and we may need to devote significant resources to the creation, support and maintenance of such versions. If we are unable to attract and retain a substantial number of alternative device manufacturers, distributors and users to our online services, we may fail to capture a sufficient share of an increasingly important portion of the market for online services and may fail to attract both advertisers and premium service subscribers.
We plan to expand operations in international markets in which we may have limited experience or rely on business partners.
We plan to expand Yahoo! branded online properties and search offerings in international markets. We have currently developed, through joint ventures, strategic investments, subsidiaries and branch offices, localized offerings in over 20 countries outside of the United States. As we expand into new international markets, we will have only limited experience in marketing and operating our products and services in such markets. In other instances, including our strategic investment in Alibaba, we may rely on the efforts and abilities of foreign business partners in such markets. Certain international markets may be slower than domestic markets in adopting the
Internet as an advertising and commerce medium and so our operations in international markets may not develop at a rate that supports our level of investment.
In international markets we compete with local Internet service providers that may have competitive advantages.
In a number of international markets, especially those in Asia, Europe and Latin America, we face substantial competition from local Internet service providers and other portals that offer search, communications and other commercial services. Many of these companies have a dominant market share in their territories and are owned by local telecommunications providers which give them a competitive advantage. Local providers of competing online services may also have a substantial advantage over us in attracting users in their country due to more established branding in that country, greater knowledge with respect to the tastes and preferences of users residing in that country and/or their focus on a single market. Further, the local providers may have greater regulatory and operational flexibility than Yahoo! due to the fact that we are subject to both United States and foreign regulatory requirements. We must continue to improve our local offerings, become more knowledgeable about our local users and their preferences, deepen our relationships with our local users as well as increase our branding and other marketing activities in order to remain competitive and strengthen our international market position.
Our international operations are subject to increased risks which could harm our business, operating results and financial condition.
In addition to uncertainty about our ability to continue to generate revenues from our foreign operations and expand our international market position, there are certain risks inherent in doing business internationally, including:
One or more of these factors could harm our future international operations and consequently, could harm our brand, business, operating results and financial condition.
We host a wide variety of services that enable individuals and businesses to exchange information, generate content, advertise products and services, conduct business and engage in various online activities on an international basis. The law relating to the liability of providers of these online services for activities of their users is currently unsettled both within the United States and internationally. Claims have been threatened and have been brought against us for defamation, negligence, copyright or trademark infringement, unlawful activity, tort, including personal injury, fraud, or other theories based on the nature and content of information that we provide links to or that may be posted online or generated by our users or with respect to auctioned materials. In addition, Yahoo! was the subject of a claim brought by certain entities in a French court regarding, among other things, the availability of certain content within our services which was alleged to violate French law. We may be subject to similar actions in domestic or
other international jurisdictions in the future. Our defense of any such actions could be costly and involve significant time and attention of our management and other resources.
We also periodically enter into arrangements to offer third-party products, services or content under the Yahoo! brand or via distribution on the Yahoo! Properties, including stock quotes and trading information. We may be subject to claims concerning these products, services or content by virtue of our involvement in marketing, branding, broadcasting or providing access to them, even if we do not ourselves host, operate, provide, or provide access to these products, services or content. While our agreements with respect to these products, services and content, often provide that we will be indemnified against such liabilities, the ability to receive such indemnification depends on the financial resources of the other party to the agreement and any amounts received may not be adequate to cover our liabilities.
It is also possible that, if any information provided directly by us contains errors or is otherwise negligently provided to users, third parties could make claims against us. For example, we offer web-based e-mail services, which expose us to potential risks, such as liabilities or claims resulting from unsolicited e-mail, lost or misdirected messages, illegal or fraudulent use of e-mail, or interruptions or delays in e-mail service. Investigating and defending any of these types of claims is expensive, even to the extent that the claims are without merit or do not ultimately result in liability.
We may have difficulty scaling and adapting our existing technology architecture to accommodate increased traffic and technology advances or requirements of our users and advertisers.
As one of the most highly trafficked websites on the Internet, Yahoo! delivers a growing number of products, services and page views to an increasing number of users around the world. In addition, the products and services offered by Yahoo! have expanded and changed significantly and are expected to continue to expand and change rapidly in the future to accommodate new technologies and new means of content delivery, such as rich media audio and video. Our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our products and services to evolving industry standards and to improve the performance and reliability of our products and services. Rapid increases in the levels or types of use of our online properties and services could result in delays or interruptions in our service.
Widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require substantial expenditures to modify or adapt our services or infrastructure. The technology architectures utilized for our services are highly complex and may not provide satisfactory support in the future, as usage increases and products and services expand, change and become more complex. In the future, we may make changes to our architectures and systems, including moving to completely new architectures and systems. Such changes may be technologically challenging to develop and implement, may take time to test and deploy, may cause us to incur substantial costs or data loss, and may cause users, advertisers, and affiliates to experience delays or interruptions in our service. These changes, delays or interruptions in our service may cause users, advertisers and affiliates to become dissatisfied with our service and move to competing providers of online services. Further, to the extent that demands for our services increase, we will need to expand our infrastructure, including the capacity of our hardware servers and the sophistication of our software. This expansion is likely to be expensive and complex and require additional technical expertise. As we acquire users who rely upon us for a wide variety of services, it becomes more technologically complex and costly to retrieve, store and integrate data that will enable us to track each users preferences. Any difficulties experienced in adapting our architectures and infrastructure to accommodate increased traffic, to store user data and track user preferences, together with the associated costs and potential loss of traffic, could harm our operating results, cash flows from operations and financial condition.
Our business depends on the continued growth and maintenance of the Internet infrastructure.
The success and the availability of our Internet-based products and services depends in part upon the continued growth and maintenance of the Internet infrastructure itself, including its protocols, architecture, network backbone, data capacity and security. Spam, viruses, worms, spyware, denial of service attacks and other acts of malice may affect not only the Internets speed, reliability and availability but also its continued desirability as a vehicle for commerce, information and user engagement. If the Internet proves unable to meet the new threats and increased
demands placed upon it, our business plans, user and advertiser relationships, site traffic and revenues could be adversely affected.
New technologies could block our advertisements or our search marketing listings, which would harm our operating results.
Technologies have been developed and are likely to continue to be developed that can block the display of our advertisements or our search marketing listings. Most of our revenues are derived from fees paid to us by advertisers in connection with the display of advertisements or our search marketing listings on web pages. As a result, advertisement-blocking technology could reduce the number of advertisements and search results that we are able to deliver and, in turn, our advertising revenues and operating results.
We rely on third party providers for our principal Internet connections and technologies, databases and services critical to our properties and services, and any errors, failures or disruption in the services provided by these third parties could significantly harm our business and operating results.
We rely on private third-party providers for our principal Internet connections, co-location of a significant portion of our data servers and network access. Any disruption, from natural disasters, technology malfunctions, sabotage or other factors, in the Internet or network access or co-location services provided by these third-party providers or any failure of these third-party providers to handle current or higher volumes of use could significantly harm our business, operating results and financial condition. We have little control over these third-party providers, which increases our vulnerability to disruptions or problems with their services. Any financial difficulties experienced by our providers may have negative effects on our business, the nature and extent of which we cannot predict. We license technology and related databases from third parties for certain elements of our properties, including, among others, technology underlying the delivery of news, stock quotes and current financial information, chat services, street mapping and telephone listings, streaming capabilities and similar services. We have experienced and expect to continue to experience interruptions and delays in service and availability for such elements. We also rely on a third-party provider for key components of our e-mail service. Furthermore, we depend on hardware and software suppliers for prompt delivery, installation and service of servers and other equipment to deliver our services. Any errors, failures, interruptions or delays experienced in connection with these third-party technologies and information services could negatively impact our relationship with users and adversely affect our brand, our business and operating results.
We rely on distribution agreements and relationships with various third parties, and any failure to obtain or maintain such distribution relationships on reasonable terms could impair our ability to fully execute our business plan.
In addition to our relationships with Internet access providers, to increase traffic for our offerings and make them more available and attractive to advertisers and users, we have certain distribution agreements and informal relationships with operators of online networks and leading websites, software companies, electronics companies, and computer manufacturers. Depending on the distributor and the agreement, these distribution arrangements may not be exclusive and may only have a short term. Some of our distributors, particularly distributors who are also competitors or potential competitors, may not renew their distribution agreements with us. In addition, as new methods for accessing the Internet become available, including through alternative devices, we may need to enter into amended distributions agreements with existing distributors to cover the new devices and agreements with additional distributors. In the future, existing and potential distributors may not offer distribution of our properties and services to us on reasonable terms, or at all. If we fail to obtain distribution or to obtain distribution on terms that are reasonable, we may not be able to fully execute our business plan.
We rely on third party providers of rich media products to provide the technologies required to deliver rich media content to our users, and any change in the licensing terms, costs, availability or user acceptance of these products could adversely affect our business.
We rely on leading providers of streaming media products to license the software necessary to deliver rich media content to our users. There can be no assurance that these providers will continue to license these products to us on
reasonable terms, or at all. Our users are currently able to electronically download copies of the software to play rich media free of charge, but providers of rich media products may begin charging users for copies of their player software or otherwise change their business model in a manner that slows the widespread acceptance of these products. In order for our rich media services to be successful, there must be a large base of users of these rich media products. We have limited or no control over the availability or acceptance of rich media software, and to the extent that any of these circumstances occur, our business may be adversely affected.
If we fail to prevent click fraud or if we choose to manage undesirable clicks in a way that advertisers find unsatisfactory, we could lose the confidence of our advertisers as well as face potential litigation, which could adversely impact our business and profitability.
We are exposed to the risk of click fraud or other clicks that advertisers may perceive as undesirable. If fraudulent activity occurs and we are unable to detect and prevent it, or if we choose to manage undesirable clicks in a way that advertisers find unsatisfactory, the affected advertisers may experience or perceive a reduced return on their investment in our advertising programs which could lead the advertisers to become dissatisfied with our advertising programs. This could damage our brand and lead to a loss of advertisers and revenue. Advertiser dissatisfaction has led to litigation alleging click fraud and could potentially lead to further litigation. We may also issue refunds or credits as a result of such activity. Any increase in costs due to any such litigation, refunds or credits could negatively impact our profitability.
Interruptions, delays or failures in the provision of our services could damage our brand and harm our operating results.
Our operations are susceptible to outages and interruptions due to fire, floods, power loss, telecommunications failures, cyber attacks, terrorist attacks and similar events. In addition, a significant portion of our network infrastructure is located in Northern California, an area subject to earthquakes. Despite our implementation of network security measures, our servers are vulnerable to computer viruses, worms, physical and electronic break-ins, sabotage and similar disruptions from unauthorized tampering with our computer systems. For example, we are vulnerable to coordinated attempts to overload our systems with data, resulting in denial or reduction of service to some or all of our users for a period of time. We have experienced a coordinated denial of service attack in the past, and may experience such attempts in the future. We do not have multiple site capacity for all of our services and some of our systems are not fully redundant in the event of any such occurrence. In an effort to reduce the likelihood of a geographical or other disaster impacting our business, we have distributed and intend to continue distributing our servers among additional data centers located around the world. Failure to execute these changes properly or in a timely manner could result in delays or interruptions to our service, which could result in a loss of users and damage to our brand, and harm our operating results. We may not carry sufficient business interruption insurance to compensate us for losses that may occur as a result of any events, which cause interruptions in our service.
We may be required to record a significant charge to earnings if our goodwill, amortizable intangible assets or investments in equity interests become impaired.
We are required under generally accepted accounting principles to review our amortizable intangible assets and investments in equity interests for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, and slower growth rates in our industry. Factors that may be considered a change in circumstances indicating that the carrying value of an investment in equity interest may not be recoverable include a decline in the stock price of an equity investee that is a public company or a decline in the operating performance of an equity investee. We may be required to record a significant charge to earnings in our consolidated financial statements during the period in which any impairment of our goodwill, amortizable intangible assets or investments in equity interests is determined. This would adversely impact our results of operations.
Our stock price has been volatile historically and may continue to be volatile regardless of our operating performance.
The trading price of our common stock has been and may continue to be subject to wide fluctuations. During the year ended December 31, 2006, the closing sale prices of our common stock on the Nasdaq ranged from $22.99 to $43.42 per share and the closing sale price on February 15, 2007 was $31.25 per share. Our stock price may fluctuate in response to a number of events and factors, such as quarterly variations in operating results; announcements and implementations of technological innovations or new services, upgrades and media properties by us or our competitors; changes in financial estimates and recommendations by securities analysts; the operating and stock price performance of other companies that investors may deem comparable to us; the operating performance of companies in which we have an equity investment, including Yahoo! Japan and Alibaba; and news reports relating to trends in our markets or general economic conditions.
In addition, the stock market in general, and the market prices for Internet-related companies in particular, have experienced volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, all of whom have been granted stock options or other stock-based awards.
We have adopted a stockholder rights plan and initially declared a dividend distribution of one right for each outstanding share of common stock to stockholders of record as of March 20, 2001. As a result of our two-for-one stock split effective May 11, 2004, each share of common stock is now associated with one-half of one right. Each right entitles the holder to purchase one unit consisting of one one-thousandth of a share of our Series A Junior Participating Preferred Stock for $250 per unit. Under certain circumstances, if a person or group acquires 15 percent or more of our outstanding common stock, holders of the rights (other than the person or group triggering their exercise) will be able to purchase, in exchange for the $250 exercise price, shares of our common stock or of any company into which we are merged having a value of $500. The rights expire on March 1, 2011, unless extended by our Board of Directors. Because the rights may substantially dilute the stock ownership of a person or group attempting to take us over without the approval of our Board of Directors, our rights plan could make it more difficult for a third party to acquire us (or a significant percentage of our outstanding capital stock) without first negotiating with our Board of Directors regarding that acquisition.
In addition, our Board of Directors has the authority to issue up to 10 million shares of Preferred Stock (of which 2 million shares have been designated as Series A Junior Participating Preferred Stock) and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders.
The rights of the holders of our common stock may be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock may have the effect of delaying, deterring or preventing a change of control of Yahoo! without further action by the stockholders and may adversely affect the voting and other rights of the holders of our common stock. Further, certain provisions of our charter documents, including provisions eliminating the ability of stockholders to take action by written consent and limiting the ability of stockholders to raise matters at a meeting of stockholders without giving advance notice, may have the effect of delaying or preventing changes in control or management of Yahoo!, which could have an adverse effect on the market price of our stock. In addition, our charter documents do not permit cumulative voting, which may make it more difficult for a third party to gain control of our Board of Directors. Further, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit us from engaging in a business combination with an interested stockholder for a period of three years after the date of the transaction in which the person became an interested stockholder, even if such combination is favored by a majority of stockholders, unless the business combination is approved in a prescribed manner. The application of Section 203 also could have the effect of delaying or preventing a change of control or management.
Our headquarters is located in Sunnyvale, California and consists of owned and leased space aggregating approximately 1.7 million square feet. In 2006, we purchased additional land in Santa Clara, California. Office space is also leased in Amsterdam, Bangalore, Buenos Aires, Calgary, Copenhagen, Dublin, Dusseldorf, Echirolles, Hamburg, Hong Kong, London, Oslo, Madrid, Melbourne, Mexico City, Milan, Montreal, Mumbai, Munich, New Delhi, Osaka, Paris, São Paulo, Seoul, Singapore, Stockholm, Sydney, Taipei, Tokyo, Toronto and Trondheim. We also lease offices in various locations in the United States, including Atlanta, Berkeley, Boston, Chicago, Columbus, Dallas, Detroit, Hillsboro, the Los Angeles Area, Miami, New York, Orlando, Reston, the San Diego Area, the San Francisco Bay Area, the Seattle Area, and Washington, D.C. Our data centers are operated in locations in the United States, Europe and Asia.
We believe that our existing facilities are adequate to meet current requirements, and that suitable additional or substitute space will be available as needed to accommodate any further physical expansion of operations and for any additional sales offices.
From time to time, third parties assert patent infringement claims against Yahoo!. Currently, we are engaged in several lawsuits regarding patent issues and have been notified of a number of other potential patent disputes. In addition, from time to time we are subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights, trade secrets and other intellectual property rights, claims related to employment matters, and a variety of other claims, including claims alleging defamation or invasion of privacy, arising in connection with our e-mail, message boards, auction sites, shopping services and other communications and community features.
On May 24, 2001, Arista Records, Inc., Bad Boy Records, BMG Music d/b/a The RCA Records Label, Capitol Records, Inc., Virgin Records America, Inc., Sony Music Entertainment, Inc., UMG Recordings, Inc., Interscope Records, Motown Record Company, L.P., and Zomba Recording Corporation filed a lawsuit alleging copyright infringement against LAUNCH Media, Inc. (LAUNCH) in the United States District Court for the Southern District of New York. The plaintiffs allege, among other things, that the consumer-influenced portion of LAUNCHs LAUNCHcast service is interactive within the meaning of Section 114 of the Copyright Act and therefore does not qualify for the compulsory license provided for by the Copyright Act. The Complaint seeks declaratory and injunctive relief and damages for the alleged infringement. After the lawsuit was commenced, Yahoo! entered into an agreement to acquire LAUNCH, which closed in August 2001, and since that time LAUNCH has been a wholly owned subsidiary of Yahoo!. Because LAUNCH settled the LAUNCH litigation as to all other plaintiffs, BMG Music d/b/a/The RCA Records Label is the sole remaining plaintiff in this proceeding. On November 4, 2005, the Court issued an order denying the plaintiffs summary judgment motions as to interactivity and willful infringement. A trial date has been set for April 16, 2007. We do not believe it is feasible to predict or determine the outcome or resolution of the LAUNCH litigation at this time. The range of possible resolutions of such LAUNCH litigation could include judgments against LAUNCH or settlements that could require substantial payments by LAUNCH.
On July 12, 2001, the first of several purported securities class action lawsuits was filed in the United States District Court, Southern District of New York against certain underwriters involved in Overture Services Inc.s (Overture) initial public offering, Overture, and certain of Overtures current and former officers and directors. The Court consolidated the cases against Overture. Plaintiffs allege, among other things, violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 involving undisclosed compensation to the underwriters, and improper practices by the underwriters, and seek unspecified damages. Similar complaints were filed in the same court against numerous public companies that conducted initial public offerings of their common stock since the mid-1990s. All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin. On April 19, 2002, plaintiffs filed an amended complaint, alleging Rule 10b-5 claims of fraud. On July 15, 2002, the
issuers filed an omnibus motion to dismiss for failure to comply with applicable pleading standards. On October 8, 2002, the Court entered an Order of Dismissal as to all of the individual defendants in the Overture IPO litigation, without prejudice. On February 19, 2003, the Court denied the motion to dismiss the Rule 10b-5 claims against certain defendants, including Overture. Overture accepted a proposal for the settlement and release of claims against the issuer defendants, including Overture. The settlement was presented to the Court in June 2004. On February 15, 2005, the Court issued an order granting conditional preliminary approval of the settlement proposal. On August 31, 2005, the Court issued an order confirming preliminary approval of the settlement. On April 24, 2006, the Court held a fairness hearing in connection with the motion for final approval of the settlement. The Court has yet to issue a ruling on the motion for final approval. The settlement remains subject to a number of conditions, including final approval of the Court. On December 5, 2006, the Court of Appeals for the Second Circuit reversed the Courts October 2004 order certifying a class in six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceeding. Overture is not one of the test cases and it is unclear what impact this will have on the class in Overtures case. If the settlement does not occur, and litigation against Overture continues, we intend to defend the case vigorously.
We do not believe, based on current knowledge, that any of the foregoing legal proceedings or claims are likely to have a material adverse effect on our financial position, results of operations or cash flows. However, we may incur substantial expenses in defending against third party claims. In the event of a determination adverse to Yahoo! or its subsidiaries, we may incur substantial monetary liability, and be required to change our business practices. Either of these could have a material adverse effect on our financial position, results of operations or cash flows.
No matters were submitted to a vote of security holders during the fourth quarter of 2006.
Yahoo! Inc. common stock is quoted on the Nasdaq Global Select Market under the symbol YHOO. The following table sets forth the range of high and low per share sales prices as reported for each period indicated and reflects all stock splits effected:
We had 11,152 stockholders of record as of February 15, 2007.
We have not declared or paid any cash dividends on our common stock. We presently do not have plans to pay any cash dividends in the near future.
In October 2006 we acquired the outstanding stock of Kenet Works AB. On December 11, 2006, we issued an aggregate of 119,931 shares of our common stock to several shareholders of Kenet Works AB in satisfaction of a
portion of the purchase price. The December 11, 2006 issuance of our shares was made in reliance upon an exemption from the registration requirements of the Securities Act of 1933, as amended, provided by Regulation D or the safe harbors provided by Regulation S. The shareholders who received shares of our common stock made representations to us as to their accredited investor status or non-U.S. person status and as to their investment intent and financial sophistication. The shares are subject to certain restrictions on transfer, including a restriction on transfer absent compliance with Regulation D, the safe harbors provided by Regulation S or other available exemption from or registration under the Securities Act of 1933, as amended.
Stock repurchase activity during the three months ended December 31, 2006 was as follows:
This performance graph shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the Exchange Act) or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any filing of Yahoo! under the Securities Act of 1933, as amended or the Exchange Act.
The following graph compares, for the five year period ended December 31, 2006, the cumulative total stockholder return for the Companys common stock, the Nasdaq Stock Market (U.S. companies) Index (the Nasdaq Market Index), the Goldman Sachs Internet Trading Index (the GIN) and the Standard & Poors 500 Stock Index (the S&P 500 Index). Measurement points are the last trading day of each of the Companys fiscal years ended December 31, 2001, December 31, 2002, December 31, 2003, December 31, 2004, December 31, 2005 and December 31, 2006. The graph assumes that $100 was invested on December 31, 2001 in the common stock of the Company, the Nasdaq Market Index, the GIN and the S&P 500 Stock Index and assumes reinvestment of any dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
In addition to current and historical information, this Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future operations, prospects, potential products, services, developments and business strategies. These statements can, in some cases, be identified by the use of terms such as may, will, should, could, would, intend, expect, plan, anticipate, believe, estimate, predict, project, potential, or continue or the negative of such terms or other comparable terminology. This Report includes, among others, forward-looking statements regarding our:
These statements involve certain known and unknown risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those listed in Part 1 Item 1A Risk Factors of this Annual Report on Form 10-K. We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this Report to reflect actual results or future events or circumstances.
We are a leading global Internet brand and one of the most trafficked Internet destinations worldwide. Our mission is to connect people to their passions, their communities and the worlds knowledge. We seek to provide Internet services that are essential and relevant to our global audience of users and advertisers. To our global audience of users, we provide our owned and operated online properties and services (the Yahoo! Properties). To our advertisers, we provide a range of tools and marketing solutions designed to enable them to reach our community of users through the Yahoo! Properties and our distribution network of third-party entities (referred to as affiliates) who have integrated our search and/or display advertising offerings into their websites.
We offer a broad range of innovative and high quality Internet products and services that are designed to provide our users with the power to connect, communicate, create, access, and share information online. We seek to provide efficient and effective marketing services for advertisers to reach our global audience of users. Our focus is on engaging more deeply with users and increasing the user base on the Yahoo! Properties, thereby enhancing value for our advertisers. We believe that we can increase our existing and potential user base and our users engagement on the Yahoo! Properties not only by offering compelling Internet services, but also by effectively integrating search, community, personalization and content to create a more powerful user experience.
Many of our services are free to users. We generate revenues by providing marketing services to advertisers across a majority of our properties and by charging our users for premium services. We classify these revenues as either marketing services or fees. Our offerings to users currently fall into five categories Search; Marketplace; Information and Entertainment; Communications, Communities and Front Doors; and Connected Life. See Part I Business Offerings to Users for additional information. The majority of our offerings are available globally in more than 20 languages. We manage and measure our business geographically. Our principal geographies are the United States and International.
Marketing Services Revenue. The majority of our marketing services revenue is from sales of online display advertising and is generated from several offerings including: the display of rich media advertisements, display of text based links to an advertisers website, listing based services, and commerce based transactions.
We recognize revenue from the display of graphical advertisements (display advertising) on the Yahoo! Properties and on the websites of our affiliates as impressions are delivered. An impression is delivered when an advertisement appears in pages viewed by users. We also recognize revenue from the display of text based links to the websites of our advertisers (search advertising) which are placed on the Yahoo! Properties and also on the websites of our affiliates who have integrated our search offerings into their websites. We recognize revenue from these arrangements as click-throughs occur. A click-through occurs when a user clicks on an advertisers listing.
Marketing services revenue also includes listings revenue and transaction revenue. Listings revenue is generated from a variety of consumer and business listings-based services, including access to the Yahoo! HotJobs database and classifieds such as Yahoo! Autos, Yahoo! Real Estate and other services. We recognize listings revenue when the services are performed. Transaction revenue is generated from facilitating commercial transactions through the Yahoo! Properties, principally from Yahoo! Travel and Yahoo! Shopping. We recognize transaction revenue when there is evidence that qualifying transactions have occurred, for example, when travel arrangements are booked through Yahoo! Travel.
Fees Revenue. Fees revenue consists of revenues generated from a variety of consumer and business fee-based services, including Internet broadband services, premium mail, music and personals offerings, as well as services for small businesses. We recognize fees revenue when the services are performed.
Our revenue growth for the year ended December 31, 2006, compared to the prior year, can be attributed to an increasing number and activity level of users across our offerings on the Yahoo! Properties and through our distribution network of affiliates. Marketing services revenues and fees revenues experienced 22% and 20% year over year growth, respectively.
Cash generated from our operations is a measure of the cash productivity of our business model and is an area of focus for us. Our operating activities in 2006 generated adequate cash to meet our operating needs. Cash used in investing activities in 2006 included capital expenditures of $689 million (including $112 million for a purchase of land in Santa Clara, California), as well as cash consideration for acquisitions, including the strategic investments in Right Media Inc., an online advertising exchange, and Gmarket Inc., a retail e-commerce provider in South Korea. Cash used in financing activities in 2006 reflected our net cash used for direct and structured stock repurchases of $2.0 billion, offset by cash proceeds from the issuance of common stock of $318 million as a result of the exercise of employee stock options.
We believe the search queries, page views, click-throughs and related marketing services revenues and fees revenues correlate to the number and activity level of users across our offerings on the Yahoo! Properties. In the fourth quarter of 2006, we launched a new search marketing system, referred to as Project Panama, and we have been transitioning our advertisers on to the new system gradually in the United States and will begin transitioning our advertisers in international markets in the second quarter of 2007. We believe the new search marketing system, including the new ranking model which was launched in the United States in the first quarter of 2007, will enable us to provide a more relevant search experience to users, more valuable customer leads to advertisers, and additional opportunities to our distribution partners. By providing a platform for our users that brings together our search technology, content, and community while allowing for personalization and integration across devices, we seek to become more essential to, increase our share of, and deepen the engagement of, our users with our products and services. We believe this deeper engagement of new and existing users and our new search marketing system, coupled with the growth of the Internet as an advertising medium will increase our revenues in 2007.
In the following Managements Discussion and Analysis, we discuss the following areas of our financial results:
Results of Operations
The following table sets forth selected information on our results of operations as a percentage of revenues for the periods indicated:
Revenues. Revenues by groups of similar services were as follows (dollars in thousands):
Marketing Services Revenue. Marketing services revenue for the year ended December 31, 2006 increased by approximately $1,033 million, or 22 percent, as compared to the prior year. Our marketing services revenue in 2006 was impacted by declining revenues from our relationship with Microsoft Corporation (Microsoft), which completed the transition of its United States search business in-house during 2006. Marketing services revenue for the year ended December 31, 2005 increased by approximately $1,467 million, or 47 percent, as compared to 2004. The year over year growth in marketing services revenue in 2006, despite the impact of Microsofts transition, and in 2005 can be attributed to a combination of factors that have driven increased marketing service revenue across the Yahoo! Properties both domestically and internationally. These included an increase in our user base and activity levels on the Yahoo! Properties, which resulted in a higher volume of search queries, page views and click-throughs.
On the Yahoo! Properties, our number of unique users worldwide as of December 31, 2006 was approximately 16 percent higher than the number of unique users as of December 31, 2005, which was 6 percent higher than December 31, 2004. Unique users refers to our internal estimates of the number of people who visited the Yahoo! Properties in a given month.
During the year ended December 31, 2006, we refined our method for computing changes in the volume of page views and searches and average revenue per page view and search to include only page views (which include searches) on the Yahoo! Properties and searches performed on our affiliate network sites, and to exclude the impact of content match links. Since the introduction of the content match offering in 2005, the growth in the number of content match links on our affiliate network sites has been significant but the related revenues have not been proportionate, resulting in a disproportionate impact on our volume and revenue yield measures as computed under our prior methodology.
Using this refined method, which we believe more accurately reflects trends in our volume and revenue yield measures, the combined number of page views and searches increased by approximately 21 percent in the year ended December 31, 2006, compared to the prior year. The combined number of page views and searches increased by approximately 28 percent in the year ended December 31, 2005, compared to the same period in 2004 using our refined method. The increases in the volume of page views and searches can be attributed to an increased number of users, an increased number of affiliates, and an expanded offering of properties which increased our inventory of page views. The combined average revenue per page view and search increased by approximately one percent in the year ended December 31, 2006, compared to the same period in 2005. Our combined revenue per page view and search in 2006 benefited as we expanded our offerings on the Yahoo! Properties, introduced new inventory with different yields and better monetized our inventory. The combined average revenue per page view and search increased by approximately 14 percent in the year ended December 31, 2005, compared to the same period in 2004. This increase resulted primarily from sales mix changes from period to period as we expanded our offerings on the Yahoo! Properties and introduced new inventory with differing yields.
We believe our growing number of users, advertisers and inventory, both on and off our network, over the past couple of years has been driving the increases in our marketing services revenues. We believe our expanding offerings, including our enhanced algorithmic search technology, contribute to our growing number of users. As our user base increases, we generate a higher number of page views, which we view as inventory, and process a higher number of search queries which potentially result in a higher number of impressions and paid clicks. We also believe that our growing audience of users makes the Yahoo! Properties more attractive to advertisers and increases their spending on marketing services. Further, we believe the growth in users on the Yahoo! Properties and on the Internet overall reflects the increasing acceptance, importance and dependence of users on the Internet. As a result of the increasing online audience, we believe advertisers are shifting a greater percentage of their spending from traditional media to the Internet to reach this growing audience.
Fees Revenue. For the year ended December 31, 2006, fees revenue increased approximately $135 million, or 20 percent, as compared to the prior year. The year over year growth is associated with an increase in the number of paying users for our fee-based services, which numbered 16.3 million as of December 31, 2006, compared to 12.6 million as of December 31, 2005, an increase of 29 percent. The impact of this increase in our number of paying users was offset by a reduction in the average monthly revenues per paying user. For the year ended December 31, 2005, fees revenue increased approximately $216 million, or 48 percent, as compared to 2004 of which $46 million related to acquisitions. Approximately $147 million was associated with an increase in the number of paying users for our fee-based services, which were 12.6 million as of December 31, 2005 compared to 8.4 million as of December 31, 2004, an increase of 50 percent.
Our increased base of paying users was due to user growth across most of our offerings, with the largest growth generated from new Internet broadband subscribers. Our fee-based services include Internet broadband services, sports, music, games, personals, and premium mail offerings, as well as our services for small businesses. Average monthly revenue per paying user decreased to approximately $3.50 for the year ended December 31, 2006, compared to approximately $4.00 for the same periods in 2005 and 2004. The decline in average monthly revenue per paying user reflects the continued growth of paying users in our services with lower fees.
We currently expect marketing services revenue to increase in absolute dollars for 2007 compared to 2006 as we seek to increase users and traffic on our Yahoo! Properties by providing a more relevant search experience to users, providing more relevant and valuable customer leads to advertisers from our new search marketing system, by continuously improving our technologies to expand our offerings, and by further benefiting from expected growth
in the online advertising market. We also currently expect fees revenue to increase in absolute dollars for 2007 compared to 2006 as we expect to increase our number of paying users in 2007.
Costs and Expenses: Operating costs and expenses were as follows (dollars in thousands):
Stock-based compensation expense was allocated as follows (in thousands):
See Note 1 The Company and Summary of Significant Accounting Policies and Note 12 Employee Benefits in the consolidated financial statements, as well as our Critical Accounting Policies, Judgments and Estimates, for additional information about stock-based compensation.
Cost of Revenues. Cost of revenues consists of traffic acquisition costs and other expenses associated with the production and usage of the Yahoo! Properties, including amortization of acquired intellectual property rights and developed technology.
Traffic Acquisition Costs (TAC). TAC consists of payments made to affiliates who have integrated our search and/or display advertising offerings into their websites and payments made to companies that direct consumer and business traffic to the Yahoo! Properties. We enter into agreements of varying duration that involve TAC. There are generally three economic structures of the affiliate agreements: fixed payments based on a guaranteed minimum amount of traffic delivered, which often carry reciprocal performance guarantees from the affiliate; variable payments based on a percentage of our revenue or based on a certain metric, such as number of searches or paid clicks; or a combination of the two. We expense TAC under two different methods. Agreements with fixed payments are expensed ratably over the term the fixed payment covers, and agreements based on a percentage of revenue, number of paid introductions, number of searches, or other metrics are expensed based on the volume of the underlying activity or revenue multiplied by the agreed-upon price or rate.
Other Cost of Revenues. Other cost of revenues consists of fees paid to third parties for content, Internet connection charges, data center costs, server equipment depreciation, technology license fees, amortization of acquired intellectual property rights and developed technology, and compensation related expenses.
Cost of revenues were as follows (dollars in thousands):
Cost of revenues for the year ended December 31, 2006 increased approximately $580 million, or 28 percent, compared to the prior year. The increase included $304 million of additional TAC, as well as increases of $75 million in server equipment depreciation and maintenance costs, $55 million in content costs, and $49 million in amortization of developed technology and intellectual property rights acquired. Internet connection charges and data center costs also increased by $36 million in 2006, compared to 2005.
The year over year increase in TAC of 19 percent in 2006 was primarily driven by our 22 percent growth in marketing services revenue, higher average TAC rates and a product mix change toward revenue streams that have associated TAC. The year over year increase in TAC in 2006 was also impacted by reduced TAC related to our relationship with Microsoft, which completed the transition of its United States Search business in-house during the year. The increase in depreciation expense and data center costs primarily resulted from our increased investment in information technology assets. The increase in content costs was primarily from our expanded offerings some of which required content for new and enhanced services on Yahoo! Properties including video, music, sports, and games. The increase in the amortization of developed technology and intellectual property rights acquired resulted from our continued investments in, and acquisitions of, businesses and technology. Increased Internet connection charges and data center costs supported our growing audience of users, traffic, and new offerings on Yahoo! Properties.
Cost of revenues for the year ended December 31, 2005 increased approximately $754 million, or 56 percent, as compared to 2004. The increase included $587 million of additional TAC, as well as increases of $64 million in content costs, $39 million in depreciation expense, $27 million in Internet connection charges and data center costs, and $20 million in amortization of developed technology and intellectual property rights acquired.
Cost of revenues in 2006, 2005, and 2004 were 42 percent, 40 percent, and 38 percent of revenues, respectively. The year over year increases reflected the additional TAC described above as well as additional expenses associated with our continued acquisition of new technology and server equipment to support our expanded offerings and increased traffic on the Yahoo! Properties.
We currently believe that cost of revenues will continue to increase in absolute dollars in 2007 compared to 2006. TAC is expected to increase as our marketing services revenue increases and as TAC rates increase in the competitive search market. Additionally, we expect to continue to increase our global audience of users and offerings, which drive network usage and in turn higher Internet connection charges and data center costs. Further, we expect higher costs related to the introduction of additional content for new and enhanced services.
Sales and Marketing. Sales and marketing expenses consist primarily of advertising and other marketing related expenses, compensation related expenses (including stock-based compensation expense), sales commissions and travel costs.
Sales and marketing expenses for the year ended December 31, 2006, increased approximately $288 million, or 28 percent, as compared to the prior year. The year over year increase was largely due to increases in compensation expenses. Compensation expense increased approximately $252 million, including an additional $146 million of stock-based compensation expense, compared to the prior year. The increase in stock-based compensation expense was due to our adoption of SFAS 123R. In addition to stock-based compensation expense, the growth in compensation expense was also attributable to an increase in our sales and marketing headcount as we expanded our presence in certain territories to support our growing advertiser base. Year over year spending on marketing
increased by $25 million for the year ended December 31, 2006, reflecting our continued investment in our product branding and development of our distribution channels.
Sales and marketing expenses for the year ended December 31, 2005, increased approximately $246 million, or 31 percent, as compared to the prior year. Approximately $141 million of the increase was related to compensation expense as we increased our sales and marketing headcount to expand our presence in certain territories. Additionally, year over year spending on marketing and distribution increased by $56 million, as we continued to invest in product branding and further develop our distribution channels.
Sales and marketing expenses as a percentage of revenue in 2006 was 20 percent (including 2 percent related to stock-based compensation expense), compared to 20 percent and 22 percent in 2005 and 2004, respectively.
We currently believe that sales and marketing expenses will increase in absolute dollars in 2007 compared to 2006, as we continue to grow and expand our reach to advertisers and users.
Product Development. Product development expenses consist primarily of compensation related expenses (including stock-based compensation expense) incurred for the development of, enhancements to and maintenance of the Yahoo! Properties, classification and organization of listings within Yahoo! Properties, research and development, and Yahoo!s technology platforms and infrastructure. Depreciation expense and other operating costs are also included in product development.
Product development expenses for the year ended December 31, 2006 increased $264 million, or 46 percent, as compared to the prior year. Product development compensation expense increased by approximately $248 million compared to the prior year, of which $122 million was additional stock-based compensation expense due to our adoption of SFAS 123R. In addition to stock-based compensation expense, the increased compensation expenses also reflect our continued hiring of engineering talent to further develop and enhance new and existing offerings and services on the Yahoo! Properties.
Product development expenses for the year ended December 31, 2005 increased approximately $189 million, or 50 percent, as compared to the year ended December 31, 2004. Approximately $131 million related to increased compensation expense as we continued to hire engineers to further develop and create new offerings and services on the Yahoo! Properties. Additionally, approximately $22 million of the increase related to higher depreciation expense arising from our additional investments in property and equipment to support further product development, and $23 million related to the increase in supplies and equipment related expenses required to support our growing headcount.
Product development expenses as a percentage of revenue in 2006 was 13 percent (including 2 percent related to stock-based compensation expense), compared to 11 percent in both 2005 and 2004.
We currently believe that product development expenses will increase in absolute dollars in 2007 compared to 2006, as we believe that continued investments in product development are required to remain competitive.
General and Administrative. General and administrative expenses consist primarily of compensation related expenses (including stock-based compensation expense) and fees for professional services.
General and administrative expense for the year ended December 31, 2006 increased $188 million, or 55 percent, as compared to the prior year. The increase was primarily due to an additional $97 million of stock-based compensation expense as a result of the adoption of SFAS 123R. Additionally, fees for professional services increased $32 million and facilities expense increased $25 million for the year ended December 31, 2006, compared to the prior year.
General and administrative expenses for the year ended December 31, 2005 increased approximately $68 million, or 25 percent, as compared to the year ended December 31, 2004. The increase was primarily due to a $48 million increase in professional services and compensation related expenses, which related to the expansion of our team to support growing compliance and infrastructure needs.
General and administrative expense as a percentage of revenue was 8 percent (including 2 percent related to stock-based compensation expense) in 2006, compared to 6 percent in 2005 and 7 percent in 2004.
We currently believe that general and administrative expenses in absolute dollars will increase in 2007 compared to 2006, as we continue to invest in our infrastructure to support our continued business expansion.
Amortization of Intangibles. We have purchased, and expect to continue purchasing, assets or businesses, which may include the purchase of intangible assets. Amortization of acquired intellectual property rights and developed technology is included in the cost of revenues and not in amortization of intangibles. Amortization of intangibles was approximately $125 million, or 2 percent of revenues for the year ended December 31, 2006, compared to $109 million or 2 percent of revenues for 2005 and $102 million or 3 percent of revenues for 2004. The year over year increases in amortization of intangibles reflected our continued acquisition activity resulting in increased amortizable intangible assets, which were partially offset by declining amortization expenses due to intangible assets that became fully amortized during the year. As of December 31, 2006, we had net intangible assets of $406 million on our consolidated balance sheets.
Other Income, Net. Other income, net was as follows (in thousands):
Other income, net decreased in the year ended December 31, 2006, compared to 2005 primarily due to investment gains of $987 million from sales of non-strategic marketable equity securities recorded in 2005 offset by an impairment loss of $28 million on an available-for-sale investment in 2005, with no transactions of comparable size in 2006. Additionally, our recorded non-cash gain arising from the reduction in our ownership in Alibaba from approximately 46 percent to 44 percent, which was treated as an incremental sale of additional equity interests in Yahoo! China, was $15 million in 2006, compared to a non-cash gain of $338 million recorded from the divesture of Yahoo! China in connection with the Alibaba transaction in the prior year.
In the year ended December 31, 2006 there was an increase in interest and investment income over the prior period as higher average interest rates more than offset the lower average invested balances. The average interest rate was approximately 3.9 percent in 2006, compared to 2.9 percent in 2005 and 2.1 percent in 2004. Other income, net may fluctuate in future periods due to realized gains and losses on investments, impairments of investments, changes in our average investment balances, and changes in interest and foreign exchange rates.
Income Taxes. The provision for income taxes for the year ended December 31, 2006 differs from the amount computed by applying the federal statutory income tax rate due to state taxes and foreign income taxed at different rates and non-deductible stock-based compensation expense. The provisions for income taxes for the years ended December 31, 2005 and 2004 differ from the amounts computed by applying the federal statutory income tax rate due to state taxes and foreign losses for which no tax benefit was provided. Additionally, in 2005, the provision for income taxes reflects a tax benefit related to a subsidiary restructuring transaction. In 2004, the provision for income taxes reflects utilization of previously unbenefited capital losses.
The following table summarizes the differences between our provision for income taxes and the amount computed by applying the federal statutory income tax rate to income before income taxes (dollars in thousands):
Our effective tax rate for the year ended December 31, 2006 was 42 percent, compared to 30 percent in the prior year. The higher effective tax rate in 2006 was mainly attributable to the impact of a global reorganization intended to streamline our operational structure and the non-deductible portion of stock-based compensation expense resulting from the adoption of SFAS 123R. These impacts were offset by a reduction in deferred tax liabilities totaling $17 million that we recorded to correct amounts accrued in years prior to 2004. Our effective tax rate for the year ended December 31, 2005 was 30 percent compared to 37 percent in 2004. The decreased rate was mainly attributable to the tax benefit related to a subsidiary restructuring transaction. In 2005, as part of our ongoing efforts to streamline our operational structure, we completed a taxable liquidation of a subsidiary we acquired several years ago. This transaction gave rise to a capital loss for tax purposes, which offset a substantial portion of the gains from sales of equity investments during the year. The resulting tax benefit recorded in 2005 was approximately $248 million.
Based on current estimates, we expect our effective tax rate will increase in 2007 compared to 2006.
Earnings in Equity Interests. Earnings in equity interests was approximately $112 million for the year ended December 31, 2006, which consisted of our share of the net income or loss of our equity investments in Yahoo! Japan and Alibaba. During the first quarter of 2006, we started recording, one quarter in arrears, our share of the results of Alibaba and the related amortization expense of the acquired intangible assets. Earnings in equity interests for the years ended December 31, 2005 and 2004 were $128 million and $95 million, respectively, as a result of our investment in Yahoo! Japan. See Note 4 Investments in Equity Interests in the consolidated financial statements for additional information.
Minority Interests in Operations of Consolidated Subsidiaries. Minority interests in operations of consolidated subsidiaries represents the minority holders percentage share of income or losses from the subsidiaries in which we hold a majority, but less than 100 percent, ownership interest and consolidate the subsidiaries results in our financial statements. Minority interests in operations of consolidated subsidiaries was approximately $1 million in 2006, compared to $8 million in 2005 and $2 million in 2004. Minority interests recorded in 2006 were related to our strategic partnership with Seven Network Limited (Yahoo! 7). Minority interests recorded in 2005 and 2004 were related to our joint ventures in France, Germany and the United Kingdom (collectively Yahoo! Europe) and Yahoo! Korea. In 2005, we purchased the remaining outstanding shares of Yahoo! Europe and Yahoo! Korea from our partner in these ventures, and accordingly, these entities became our wholly owned subsidiaries. See Note 3 Acquisitions in the consolidated financial statements for additional information.
We manage our business geographically. Our primary areas of measurement and decision-making are the United States and International. Management relies on an internal management reporting process that provides revenue
and segment operating income before depreciation, amortization and stock-based compensation expense for making financial decisions and allocating resources. Segment operating income before depreciation, amortization and stock-based compensation expense, includes income from operations before depreciation, amortization and stock-based compensation expense. Management believes that segment operating income before depreciation, amortization and stock-based compensation expense is an appropriate measure for evaluating the operational performance of our segments. However, this measure should be considered in addition to, not as a substitute for, or superior to, income from operations or other measures of financial performance prepared in accordance with generally accepted accounting principles in the United States (GAAP).
Summarized information by segment was as follows (dollars in thousands):
Revenue is attributed to individual countries according to the international online property that generated the revenue. No single foreign country accounted for more than 10 percent of revenues in 2006, 2005, or 2004.
United States. United States revenues for the year ended December 31, 2006 increased approximately $698 million, or 19 percent, as compared to the prior year. United States revenues for the year ended December 31, 2005 increased approximately $1,014 million, or 38 percent, as compared to 2004. The year over year increases in 2006 and 2005 were a result of growth in advertising across the Yahoo! Properties, as well as growth from our fee-based services. Approximately 82 percent of the 2006 increase, or $570 million, came from marketing services revenue. Approximately 82 percent of the 2005 increase, or $827 million, came from marketing services revenue. The advertising growth can be attributed to our expanding audience of users and increased inventory of our page views which has attracted more advertisers and led to increases in our marketing services revenue. The growth in our fee-based services is due to the increase in our paying users for both existing and new offerings.
International. International revenues for the year ended December 31, 2006 increased approximately $470 million, or 30 percent, as compared to the prior year. International revenues for the year ended December 31, 2005 increased approximately $669 million, or 73 percent, as compared to 2004. More than 95 percent of the international revenue increases in 2006 and 2005 came from marketing services revenue. The year over year growth in international marketing services revenue can be attributed to our increased penetration into existing markets, coupled with continued growth of the global online advertising marketplace and our affiliate network.
International revenues accounted for approximately 32 percent of total revenues during 2006 as compared to 30 percent during 2005 and 26 percent during 2004. The strong performance of our international operations has increased our exposure to foreign currency fluctuations. Revenues and related expenses generated from our international subsidiaries are generally denominated in the currencies of the local countries. Primary currencies include Euros, British Pounds, Japanese Yen, Korean Won, and Australian Dollars. The statements of income of our international operations are translated into United States dollars at the average exchange rates in each applicable period. To the extent the United States dollar strengthens against foreign currencies, the translation of these foreign currency denominated transactions results in reduced revenues, operating expenses and net income for our International segment. Similarly, our revenues, operating expenses and net income will increase for our International segment if the United States dollar weakens against foreign currencies. The application of our 2005 average foreign currency exchange rates to our international revenues and segment operating income before depreciation, amortization and stock-based compensation expense in 2006 would have had an immaterial impact on our reported results. Using the average foreign currency exchange rates in the year ended December 31, 2004, our international revenues for 2005 would have been lower than we reported by approximately $42 million and our international segment operating income before depreciation, amortization and stock-based compensation expense would have been lower than we reported by $8 million.
Significant acquisitions and strategic investments completed in the last three years include the following:
See Note 3 Acquisitions and Note 4 Investments in Equity Interests in the consolidated financial statements for additional information relating to these and other acquisitions.
We expect to continue to evaluate possible acquisitions of, or strategic investments in, businesses, products, and technologies that are complementary to our business, which may require the use of cash.
As of and for each of the three years ended December 31, 2006 (dollars in thousands):
Our operating activities for each year in the three years ended December 31, 2006 have generated adequate cash to meet our operating needs. As of December 31, 2006, we had cash, cash equivalents and marketable debt securities totaling $3.5 billion, compared to $4.0 billion as of December 31, 2005. During the year ended December 31, 2006, we invested $2.0 billion in direct and structured stock repurchases, $689 million in net capital expenditures, including $112 million for purchase of land in Santa Clara, California, and a net $142 million in acquisitions. The cash used for these investments was offset by $1.4 billion cash generated from operating activities, $318 million from the issuance of common stock as a result of the exercise of employee stock options, and $597 million of excess tax benefits from stock-based awards (which was reported as a reduction of cash flows from operating activities and an increase to cash flows from financing activities).
As of December 31, 2006, approximately $0.7 billion of earnings held by our foreign subsidiaries and a corporate joint venture are designated as indefinitely invested outside the United States. If these funds were required for our operations in the United States, we would be required to accrue and pay additional taxes to repatriate these funds. Currently, we do not anticipate a need to repatriate these funds to our United States operations.
We invest excess cash predominantly in marketable debt securities that are liquid, of high-quality investment grade, and the majority of which have effective maturities of less than two years. We also invest excess cash to support our growing infrastructure needs and expand our operations, as consideration for acquisitions and strategic investments, to repurchase shares of our stock and in other transactions. As of December 31, 2006, certain of our marketable debt securities had a fair value below cost due to the changes in market rates of interest and yields on these securities. We evaluate these investments periodically for possible other-than-temporary impairment and review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and our ability and intent to hold the investment for a period of time which may be sufficient for an anticipated recovery in market value. We have the intent and ability to hold these securities for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the initial cost of the investment and expect to realize the full value of all of these investments upon maturity or sale.
We expect to continue to generate positive cash flow from operations in 2007. Management believes existing cash, cash equivalents and investments in marketable debt securities, together with any cash generated from operations will be sufficient to meet normal operating requirements including capital expenditures for the next 12 months. However, we may sell additional equity or debt securities or obtain credit facilities to further enhance our liquidity position, and the sale of additional equity securities could result in dilution to our stockholders.
Cash provided by operating activities is driven by our net income, adjusted for non-cash items, and non-operating gains and losses from sales of investments. Non-cash adjustments include depreciation, amortization of intangible assets, stock-based compensation expense, tax benefits from stock-based awards, deferred income taxes, and
earnings in equity interests. Cash provided by operating activities was greater than net income in 2006 mainly due to the net impact of non-cash adjustments to income. In each of the three years ended December 31, 2006, 2005, and 2004, cash flows from operations were reduced by the increase in our accounts receivable balance, mainly reflecting increases in revenues. The days of sales outstanding metric increased over the three years ended December 31, 2006. Additionally, in the years ended December 31, 2006, 2005, and 2004, there were significant increases in accrued expenses and other liabilities that positively impacted cash flow from operations. These increases were mainly due to higher accrual balances for TAC payments to affiliates arising from increased revenue.
Cash used in investing activities is primarily attributable to capital expenditures, purchases and sales of marketable debt and equity securities, as well as acquisitions including our strategic investments. Our capital expenditures totaled $689 million, $409 million, and $246 million in 2006, 2005, and 2004, respectively. Our capital expenditures have been primarily used for purchases and internal development of information technology assets and real estate to support our expanding offerings, our increased number of users and our international growth. Our capital expenditures in 2006 included $112 million for purchase of land in Santa Clara, California. We invested a net of $142 million in acquisitions, including strategic investments, in 2006, compared to $1,698 million and $762 million in 2005 and 2004, respectively. Acquisitions and investments in 2006 included cash outlays for our investments in Yahoo! 7, Gmarket Inc. and Right Media Inc. Our acquisitions in 2005 included net cash consideration of approximately $1.0 billion for our investment in Alibaba, $0.5 billion for the purchase of the outstanding interests in our joint ventures in Europe and Korea and $54 million for the Verdisoft acquisition. The acquisitions of 3721, Kelkoo, and Musicmatch were the main cash outlays for acquisitions in 2004. Our cash proceeds from the net sales and maturities of marketable debt securities were $623 million in 2006, compared to cash proceeds of $318 million in 2005 and net purchases of $807 million in 2004. Additionally, we generated cash in the amounts of $1,006 million and $503 million in 2005 and 2004, respectively, from the sale of non-strategic marketable equity securities for which there was no comparable activity in 2006.
Cash provided by (used in) financing activities is driven by our financing activities relating to employee option exercises and stock repurchases. Our cash proceeds from employee option exercises were $318 million in 2006, compared to $747 million and $651 million in 2005 and 2004, respectively. The decrease in 2006 compared to 2005 was primarily a result of a reduced number of employees exercising options in 2006. The increase in 2005 was a result of the increase in our employee numbers and an increase in the weighted average exercise prices of our options when compared to 2004.
During 2006, we used $1.8 billon in the direct purchase of 61.5 million shares of our common stock at an average price of $28.98 per share. During 2005, we used $388 million in the direct repurchase of 11.7 million shares of our common stock at an average price of $33.20 per share. There were no comparable transactions in 2004.
In 2006, we entered into structured stock repurchase transactions, which settle in cash or stock depending on the market price of our common stock on the date of maturity, resulting in a total cash outlay of $0.5 billion. This $0.5 billion cash outlay was offset by cash receipts of $272 million from the settlement of a structured stock repurchase transactions entered into in 2005, for a net cash usage of $228 million for these transactions in 2006. In 2005, we entered into structured stock repurchase transactions resulting in a total cash outlay of $1.4 billion. This $1.4 billion cash outlay was offset by cash receipts of $0.8 billion from the settlement of structured stock repurchase transactions in 2005, for a net cash usage of $0.6 billion for these transactions in 2005. During 2004, we entered into structured stock repurchase transactions resulting in a total cash outlay of $150 million, which were offset by cash receipts of $80 million from the settlement of structured stock repurchase transactions, for a net cash usage of $70 million for these transactions in 2004.
Additionally, in 2006, excess tax benefits from stock-based awards of $597 million was included as a source of cash flows from financing activities.
Upon adoption of SFAS 123R on January 1, 2006, we have included as part of our cash flows from financing activities, the benefit of tax deductions related to stock-based awards in excess of the gross tax benefits expected at the grant date of the related stock-based awards. This amount is shown as a reduction to cash flows from operating activities and an increase to cash flows from financing activities. Net cash flows remain unchanged from what would have been reported prior to the adoption of SFAS 123R.
In April 2003, we issued $750 million of zero coupon senior convertible notes (the Notes) which are due in April 2008. These Notes are convertible into Yahoo! common stock at a conversion price of $20.50 per share, subject to adjustment upon the occurrence of certain events. Each $1,000 principal amount of the Notes will be convertible prior to April 2008 if the market price of our common stock reaches a specified threshold for a defined period of time or specified corporate transactions occur. Upon conversion, we have the right to deliver cash in lieu of common stock. As of December 31, 2006, the market price condition for convertibility of the Notes was satisfied with respect to the fiscal quarter beginning January 1, 2007 and ending March 31, 2007. We may be required to repurchase all of the Notes following a fundamental change of the Company, such as a change of control, prior to maturity at face value. We may not redeem the Notes prior to their maturity. See Note 9 Long-Term Debt in the consolidated financial statements for additional information.
In March 2005, following the completion of the $0.5 billion stock repurchase program that was authorized in 2001 and extended in 2003, our Board of Directors authorized the repurchase of up to $3.0 billion of our outstanding shares of common stock over the next five years, dependent on market conditions, share price and other factors. Under this program, during the year ended December 31, 2006, we repurchased 93.1 million shares of common stock at an average price of $29.84 per share, including 31.6 million shares received upon the maturity of structured stock repurchase transactions, and substantially completed this program in October 2006. Total cash consideration for the stock repurchases in 2006 was $2.8 billion which consisted of $1.8 billion direct stock repurchases, $0.5 billion as a result of settlements of structured stock repurchase transactions originally entered into in 2005, and $0.5 billion as a result of settlements of structured stock repurchase transactions originally entered into in 2006. See Note 11 Stockholders Equity in the consolidated financial statements for additional information.
In October 2006, our Board of Directors authorized a new stock repurchase program for us to repurchase up to $3.0 billion of our outstanding shares of common stock from time to time over the next five years, depending on market conditions, share price, and other factors. We believe that additional repurchases made under appropriate market conditions are a prudent use of cash currently available to us in order to enhance long-term stockholder value. Repurchases may take place in the open market or in privately negotiated transactions, including derivative transactions, and may be made under a Rule 10b5-1 plan.
Subsequent to December 31, 2006 we repurchased approximately 14 million shares of our common stock under the current stock repurchase program at an average price of $29.97 per share, for a total amount of $408 million.
Capital expenditures have generally comprised purchases of computer hardware, software, server equipment, furniture and fixtures, and real estate. Capital expenditures, net were $689 million in 2006, including $112 million for a land purchase in Santa Clara, California, compared to $409 million in 2005. Our capital expenditures in 2007 are expected to be consistent with 2006 levels as we continue to invest in the expansion of the Yahoo! Properties and our offerings. This level of expenditure, together with the increase in operating lease commitments, is consistent with our increased headcount and operational expansion, and we anticipate that this will continue in the future as business conditions merit.
The following table presents certain payments due under contractual obligations with minimum firm commitments as of December 31, 2006 (in millions):
In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements, services to be provided by us, or from intellectual property infringement claims made by third parties. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. We have also agreed to indemnify certain former officers, directors and employees of acquired companies in connection with the acquisition of such companies. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers. It is not possible to determine the maximum potential loss under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements may not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements and we have not accrued any liabilities related to such indemnification obligations in our consolidated financial statements.
In 2006, we reversed an earn-out accrual related to a prior acquisition, which resulted in a $10 million reduction to operating expenses in the consolidated statements of income.
As of December 31, 2006, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
In February 2007, we committed to invest up to $200 million through July 2008 to acquire rights to intellectual property. License payments associated with the acquired rights will be amortized over the useful life of the related intellectual property.
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur, could materially impact the consolidated financial statements. We believe that the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the consolidated financial statements.
Revenue Recognition. Our revenues are generated from marketing services and fees. Marketing services revenue is generated from several offerings including: the display of textual, rich media advertisements, display of text based links to the advertisers websites, listing based services, and commerce based transactions. Fees revenue includes revenue from a variety of consumer and business fee-based services. While the majority of our revenue transactions contain standard business terms and conditions, there are certain transactions that contain non-standard business terms and conditions. In addition, we may enter into certain sales transactions that involve multiple element arrangements (arrangements with more than one deliverable). We also enter into arrangements to purchase goods and/or services from certain customers. As a result, significant contract interpretation is sometimes required to determine the appropriate accounting for these transactions including: (1) whether an arrangement exists; (2) how the arrangement consideration should be allocated among potential multiple elements; (3) when to recognize revenue on the deliverables; (4) whether all elements of the arrangement have been delivered; (5) whether the arrangements should be reported gross as a principal versus net as an agent; and (6) whether we receive a separately identifiable benefit from purchase arrangements with our customers for which we can reasonably estimate fair value. In addition, our revenue recognition policy requires an assessment as to whether collection is reasonably assured, which inherently requires us to evaluate the creditworthiness of our customers. Changes in judgments on these assumptions and estimates could materially impact the timing or amount of revenue recognition.
Deferred Income Tax Asset Valuation Allowance. We record a valuation allowance to reduce our deferred income tax assets to the amount that is more likely than not to be realized. In evaluating our ability to recover our deferred income tax assets we consider all available positive and negative evidence, including our operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes. The valuation allowance decreased by $1.4 billion during the year ended December 31, 2006. The decrease included a $236 million release to additional paid-in capital and a $95 million release to goodwill. The remaining decrease in the valuation allowance of $1.1 billion relates to deferred income tax assets pertaining to net operating loss and tax credit carryforwards resulting from the exercise of employee stock options in prior years and represents tax benefits in excess of stock-based compensation expense as determined under APB 25. See Note 10 Income Taxes in the consolidated financial statements for additional information.
Goodwill and Other Intangible Assets. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, and determining appropriate discount rates, growth rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit which could trigger impairment. See Note 5 Goodwill in the consolidated
financial statements for additional information. Based on our 2006 impairment test, there would have to be a significant unfavorable change to our assumptions used in such calculations for an impairment to exist.
We amortize other intangible assets over their estimated useful lives. We record an impairment charge on these assets when we determine that their carrying value may not be recoverable. The carrying value is not recoverable if it exceeds the undiscounted future cash flows resulting from the use of the asset and its eventual disposition. When there is existence of one or more indicators of impairment, we measure any impairment of intangible assets based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our business model. Our estimates of future cash flows attributable to our other intangible assets require significant judgment based on our historical and anticipated results and are subject to many factors. Different assumptions and judgments could materially affect the calculation of the fair value of our other intangible assets which could trigger impairment.
Investments in Equity Interests. We account for investments in entities in which we can exercise significant influence but do not own a majority equity interest or otherwise control using the equity method. In accounting for these investments we record our proportionate share of these entities net income or loss, one quarter in arrears.
We review all of our investments in equity interests for impairment whenever events or changes in business circumstances indicate that the carrying amount of the investment may not be fully recoverable. The impairment review requires significant judgment to identify events or circumstances that would likely have a significant adverse effect on the fair value of the investment. Investments identified as having an indication of impairment are subject to further analysis to determine if the impairment is other-than-temporary and this analysis requires estimating the fair value of the investment. The determination of the fair value of the investment involves considering factors such as the following: the stock prices of public companies in which we have an equity investment, current economic and market conditions, the operating performance of the companies including current earnings trends and undiscounted cash flows, quoted stock prices of comparable public companies, and other company specific information including recent financing rounds. The fair value determination, particularly for investments in privately-held companies, requires significant judgment to determine appropriate estimates and assumptions. Changes in these estimates and assumptions could affect the calculation of the fair value of the investments and the determination of whether any identified impairment is other-than-temporary.
Stock-Based Compensation Expense. Effective January 1, 2006 we adopted SFAS 123R using the modified prospective method and therefore have not restated prior periods results. Under the fair value recognition provisions of SFAS 123R, we recognize stock-based compensation net of an estimated forfeiture rate and therefore only recognize compensation cost for those shares expected to vest over the service period of the award. Prior to SFAS 123R adoption, we accounted for share-based payments under APB 25 and accordingly, generally recognized stock-based compensation expense related to restricted stock awards and stock options with intrinsic value that we exchanged in connection with acquisitions and accounted for forfeitures as they occurred.
Calculating stock-based compensation expense requires the input of highly subjective assumptions, including the expected term of the stock-based awards, stock price volatility, and the pre-vesting option forfeiture rate. We estimate the expected life of options granted based on historical exercise patterns, which we believe are representative of future behavior. We estimate the volatility of our common stock on the date of grant based on the implied volatility of publicly traded options on our common stock, with a term of one year or greater. We believe that implied volatility calculated based on actively traded options on our common stock is a better indicator of expected volatility and future stock price trends than historical volatility. Therefore, expected volatility for the year ended December 31, 2006 was based on a market-based implied volatility. The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. We estimate the forfeiture rate based on historical experience of our stock-based awards that are granted, exercised and cancelled. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. See Note 12 Employee Benefits in the consolidated financial statements for additional information.
Recent Accounting Pronouncements. In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting for uncertainty in income tax positions. This Interpretation requires that we recognize in our financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for us on January 1, 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48 and its impact on our financial position, cash flows, and results of operations.
In September 2006, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 provides interpretive guidance on the SECs views on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. We adopted SAB 108 during the fourth quarter of 2006. The adoption did not have a material impact on our financial position, cash flows or results of operations.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which clarifies the definition of fair value, establishes guidelines for measuring fair value, and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 will be effective for us on January 1, 2008. We are currently evaluating the impact of adopting SFAS 157 but do not believe that the adoption of SFAS 157 will have any material impact on our financial position, cash flows, or results of operations.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159) which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS 159 will be effective for us on January 1, 2008. We are currently evaluating the impact of adopting SFAS 159 on our financial position, cash flows, and results of operations.
We are exposed to the impact of interest rate changes, foreign currency fluctuations, and changes in the market values of our investments.
Interest Rate Risk. Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We invest excess cash in marketable debt instruments of the United States Government and its agencies, and in high-quality corporate issuers and, by policy, limit the amount of credit exposure to any one issuer. We protect and preserve invested funds by limiting default, market and reinvestment risk.
Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates. As of December 31, 2006 and 2005, we had investments in short-term marketable debt securities of approximately $1.0 billion and $1.1 billion, respectively. Such investments had a weighted-average yield of approximately 4.3 percent and 3.5 percent, respectively. As of December 31, 2006 and 2005, we had investments in long-term marketable debt securities of approximately $0.9 billion and $1.4 billion, respectively. Such investments had a weighted average yield of approximately 4.6 percent and 3.8 percent, respectively. A hypothetical 100 basis point increase in interest rates would result in an approximate $16 million and $26 million decrease (approximately 1 percent), respectively, in the fair value of our available-for-sale debt securities as of December 31, 2006 and 2005.
The fair market value of the zero coupon senior convertible notes (the Notes) issued by Yahoo! and due in April 2008 is subject to interest rate risk and market risk due to the convertible feature of the Notes. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. The fair market value of the Notes will also increase as the market price of the Yahoo! stock increases and decrease as the
market price falls. The interest and market value changes affect the fair market value of the Notes but do not impact our financial position, cash flows or results of operations. As of December 31, 2006 and 2005, the fair value of the Notes was approximately $1.0 billion and $1.4 billion, respectively, based on quoted market prices.
Foreign Currency Risk. International revenues accounted for approximately 32 percent of total revenues in 2006, compared to 30 percent of total revenues in 2005. International revenues in 2006 increased $470 million, or 30 percent, compared to the prior year. The growth in our international operations has increased our exposure to foreign currency fluctuations. Revenues and related expenses generated from our international subsidiaries are generally denominated in the functional currencies of the local countries. Primary currencies include Euros, British Pounds, Japanese Yen, Korean Won and Australian Dollars. The statements of income of our international operations are translated into United States dollars at the average exchange rates in each applicable period. To the extent the United States dollar strengthens against foreign currencies, the translation of these foreign currency denominated transactions results in reduced revenues, operating expenses and net income for our International segment. Similarly, our revenues, operating expenses and net income will increase for our International segment, if the United States dollar weakens against foreign currencies. The application of our 2005 average foreign currency exchange rates to our international revenues and segment operating income before depreciation, amortization and stock-based compensation expense in 2006 would have had an immaterial impact on our reported results. Using the average foreign currency exchange rates from 2004, our international revenues for 2005 would have been lower than we reported by approximately $42 million and our international segment operating income before depreciation, amortization and stock-based compensation expense would have been lower than we reported by $8 million.
We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries and our investments in equity interests into United States dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries financial statements into United States dollars will lead to a translation gain or loss which is recorded as a component of accumulated other comprehensive income which is part of stockholders equity. In addition, we have certain assets and liabilities that are denominated in currencies other than the relevant entitys functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a transaction gain or loss. In the year ended December 31, 2006, we recorded net foreign currency transaction gains, realized and unrealized, of approximately $5 million, net losses of $8 million and net gains of $6 million in 2005 and 2004, respectively, which were recorded in other income, net on the consolidated statements of income.
Investment Risk. The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and current and long-term investments in a variety of securities, including both government and corporate obligations and money market funds. As of December 31, 2006 and 2005, net unrealized losses on these investments were not material.
We are exposed to market risk as it relates to changes in the market value of our investments. We invest in equity instruments of public companies for business and strategic purposes and have classified these securities as available-for-sale. These available-for-sale equity investments are subject to significant fluctuations in fair value due to the volatility of the stock market and the industries in which these companies participate. We have realized gains and losses from the sale of investments, as well as impairment charges on some of our investments. In 2006, we recorded an impairment loss of $4 million on an available-for-sale equity investment, compared to $28 million recorded in 2005. Our investments in available-for-sale equity securities were not material as of December 31, 2006 and 2005. Our objective in managing exposure to stock market fluctuations is to minimize the impact of stock market declines to earnings and cash flows. Using a hypothetical reduction of 10 percent in the stock price of these equity securities, the fair value of our equity investments would decrease by approximately $11 million and $3 million as of December 31, 2006 and 2005, respectively.
To the Board of Directors and Stockholders of Yahoo! Inc.:
We have completed integrated audits of Yahoo! Inc.s Consolidated Financial Statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Yahoo! Inc. and its subsidiaries as of December 31, 2005 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements 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 our opinion.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, the Company changed its method of accounting for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment.
Internal control over financial reporting
Also, in our opinion, managements assessment, included in Managements Report on Internal Control over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control Integrated Framework issued by the COSO. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on managements assessment and on the effectiveness of the Companys internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance
with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
San Jose, California
February 23, 2007
Consolidated Statements of Income
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Balance Sheets