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ALTABA INC. 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-10.24
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32
  6. Ex-32

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended September 30, 2006

 

 

OR

 

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the transition period from     to     

 

Commission File Number 0-28018

 


 

YAHOO! INC.

(Exact name of Registrant as specified in its charter)

Delaware

 

77-0398689

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

701 First Avenue

Sunnyvale, California 94089

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code: (408) 349-3300

 


 

Indicate by check mark whether the Registrant (1) has filed all reports required 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 x  No 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 x                  Accelerated filer o                            Non-Accelerated filero

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class

 

Outstanding at October 31, 2006

Common stock, $0.001 par value

 

1,360,218,273

 

 




 

YAHOO! INC.

Table of Contents

 

 

 

Page

PART I.

 

FINANCIAL INFORMATION

 

3

 

 

 

 

 

Item 1.

 

Condensed Consolidated Financial Statements (unaudited)

 

3

 

 

Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2005 and 2006

 

3

 

 

Condensed Consolidated Balance Sheets as of December 31, 2005 and September 30, 2006

 

4

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2006

 

5

 

 

Notes to Condensed Consolidated Financial Statements

 

7

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

25

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

39

Item 4.

 

Controls and Procedures

 

40

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

41

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

41

Item 1A.

 

Risk Factors

 

42

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

55

Item 3.

 

Defaults Upon Senior Securities

 

55

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

55

Item 5.

 

Other Information

 

55

Item 6.

 

Exhibits

 

56

 

 

Signatures

 

57

 

2




 

PART I—FINANCIAL INFORMATION

Item 1.  Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Statements of Income
(unaudited, in thousands except per share amounts)

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

September 30,

 

September 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

1,329,929

 

$

1,580,322

 

$

3,756,668

 

$

4,723,231

 

Cost of revenues (*)

 

534,381

 

681,120

 

1,501,463

 

1,984,830

 

Gross profit

 

795,548

 

899,202

 

2,255,205

 

2,738,401

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing (*)

 

267,992

 

331,025

 

747,916

 

988,030

 

Product development (*)

 

148,433

 

202,079

 

400,329

 

628,399

 

General and administrative (*)

 

82,162

 

130,984

 

247,549

 

391,198

 

Amortization of intangibles

 

26,904

 

32,774

 

80,634

 

97,635

 

Total operating expenses

 

525,491

 

696,862

 

1,476,428

 

2,105,262

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

270,057

 

202,340

 

778,777

 

633,139

 

Other income, net

 

65,995

 

50,268

 

1,095,725

 

121,794

 

Income before income taxes, earnings in equity interests and minority interests

 

336,052

 

252,608

 

1,874,502

 

754,933

 

Provision for income taxes

 

(113,797

)

(124,372

)

(750,087

)

(350,002

)

Earnings in equity interests

 

32,164

 

30,190

 

94,647

 

78,261

 

Minority interests in operations of consolidated subsidiaries

 

(646

)

103

 

(6,040

)

(474

)

Net income

 

$

253,773

 

$

158,529

 

$

1,213,022

 

$

482,718

 

 

 

 

 

 

 

 

 

 

 

Net income per share—basic

 

$

0.18

 

$

0.12

 

$

0.87

 

$

0.34

 

 

 

 

 

 

 

 

 

 

 

Net income per share—diluted

 

$

0.17

 

$

0.11

 

$

0.82

 

$

0.33

 

 

 

 

 

 

 

 

 

 

 

Shares used in per share calculation—basic

 

1,405,012

 

1,375,884

 

1,395,188

 

1,399,800

 

 

 

 

 

 

 

 

 

 

 

Shares used in per share calculation—diluted

 

1,486,876

 

1,442,429

 

1,482,739

 

1,471,832

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation expense by function (*):

 

 

 

 

 

 

 

 

 

Cost of revenues

 

$

 

$

1,689

 

$

 

$

4,956

 

Sales and marketing

 

2,278

 

42,470

 

5,277

 

119,826

 

Product development

 

6,817

 

38,260

 

13,820

 

112,147

 

General and administrative

 

4,429

 

39,072

 

14,841

 

92,926

 

 

 

 

 

 

 

 

 

 

 

Total stock-based compensation expense

 

$

13,524

 

$

121,491

 

$

33,938

 

$

329,855

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

(*)  Cost of revenues and operating expenses for the three and nine months ended September 30, 2006 include stock-based compensation expense in accordance with Statement of Financial Accounting Standards No. 123R, which the Company adopted on January 1, 2006.  See Note 10—“Stock-Based Compensation” for additional information.

3




 

YAHOO! INC.

Condensed Consolidated Balance Sheets
(unaudited, in thousands except par values)

 

 

December 31,

 

September 30,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

1,429,693

 

$

1,185,259

 

Marketable debt securities

 

1,131,141

 

923,792

 

Accounts receivable, net

 

721,723

 

784,460

 

Prepaid expenses and other current assets

 

166,976

 

166,111

 

Total current assets

 

3,449,533

 

3,059,622

 

Long-term marketable debt securities

 

1,439,014

 

1,120,930

 

Property and equipment, net

 

697,522

 

1,048,574

 

Goodwill

 

2,895,557

 

2,976,576

 

Intangible assets, net

 

534,615

 

407,368

 

Other assets

 

57,192

 

140,437

 

Investments in equity interests

 

1,758,401

 

1,863,560

 

Total assets

 

$

10,831,834

 

$

10,617,067

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

70,291

 

$

142,479

 

Accrued expenses and other current liabilities

 

827,589

 

987,280

 

Deferred revenue

 

306,172

 

329,385

 

Total current liabilities

 

1,204,052

 

1,459,144

 

Long-term deferred revenue

 

67,792

 

67,168

 

Long-term debt

 

749,995

 

749,960

 

Other long-term liabilities

 

243,580

 

265,738

 

Minority interests in consolidated subsidiaries

 

 

7,818

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common Stock, $0.001 par value; 5,000,000 shares authorized; 1,430,162 and 1,362,479 issued and outstanding, respectively

 

1,470

 

1,487

 

Additional paid-in capital

 

6,417,858

 

7,588,272

 

Deferred stock-based compensation

 

(235,394

)

 

Treasury stock

 

(547,723

)

(3,074,863

)

Retained earnings

 

2,966,169

 

3,448,887

 

Accumulated other comprehensive income (loss)

 

(35,965

)

103,456

 

Total stockholders’ equity

 

8,566,415

 

8,067,239

 

Total liabilities and stockholders’ equity

 

$

10,831,834

 

$

10,617,067

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

4




 

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows
(unaudited, in thousands)

 

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

1,213,022

 

$

482,718

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

163,245

 

217,730

 

Amortization of intangible assets

 

122,664

 

184,804

 

Stock-based compensation expense

 

33,938

 

329,855

 

Tax benefits from stock-based compensation

 

723,748

 

275,093

 

Excess tax benefits from stock-based compensation

 

 

(354,966

)

Earnings in equity interests

 

(94,647

)

(78,261

)

Dividends received

 

10,670

 

12,908

 

Minority interests in operations of consolidated subsidiaries

 

6,040

 

474

 

Gains from sales of investments, assets, and other, net

 

(976,738

)

(15,811

)

Changes in assets and liabilities, net of effects of acquisitions:

 

 

 

 

 

Accounts receivable, net

 

(128,921

)

(46,780

)

Prepaid expenses and other

 

7,736

 

(28,252

)

Accounts payable

 

(5,354

)

66,985

 

Accrued expenses and other liabilities

 

111,396

 

138,787

 

Deferred revenue

 

43,242

 

18,935

 

Net cash provided by operating activities

 

1,230,041

 

1,204,219

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Acquisition of property and equipment, net

 

(257,294

)

(557,586

)

Purchases of marketable debt securities

 

(6,632,419

)

(889,023

)

Proceeds from sales and maturities of marketable debt securities

 

6,789,521

 

1,431,206

 

Acquisitions, net of cash acquired

 

(127,463

)

(61,300

)

Proceeds from sales of marketable equity securities

 

1,006,142

 

 

Other investing activities, net

 

(39,030

)

18,476

 

Net cash provided by (used in) investing activities

 

739,457

 

(58,227

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of common stock, net

 

377,751

 

231,451

 

Repurchases of common stock

 

(373,352

)

(1,782,140

)

Structured stock repurchases, net

 

(752,717

)

(227,705

)

Excess tax benefits from stock-based compensation

 

 

354,966

 

Other financing activities, net

 

1,749

 

 

Net cash provided by (used in) financing activities

 

(746,569

)

(1,423,428

)

Effect of exchange rate changes on cash and cash equivalents

 

(19,649

)

33,002

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

1,203,280

 

(244,434

)

Cash and cash equivalents at beginning of period

 

823,723

 

1,429,693

 

Cash and cash equivalents at end of period

 

$

2,027,003

 

$

1,185,259

 

 

5




 

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows (Continued)
(unaudited, in thousands)

Supplemental cash flow disclosures:

Acquisition-related activities:

 

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2005

 

2006

 

 

 

 

 

 

 

Cash paid for acquisitions

 

$

128,592

 

$

68,977

 

Cash acquired in acquisitions

 

(1,129

)

(7,677

)

 

 

$

127,463

 

$

61,300

 

 

 

 

 

 

 

Common stock, restricted stock and stock options issued in connection with acquisitions

 

$

44,381

 

$

 

 

See Note 3—“Acquisitions” for additional information.

The accompanying notes are an integral part of these condensed consolidated financial statements.

6




 

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 1 THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company.  Yahoo! Inc. (together with its consolidated subsidiaries, “Yahoo!” or the “Company”) is a leading global Internet brand and one of the most trafficked Internet destinations worldwide.  Yahoo! seeks to provide Internet services that are essential and relevant to users and businesses.  To users, Yahoo! provides its owned and operated online properties and services (the “Yahoo Properties”).  To businesses, Yahoo! provides a range of tools and marketing solutions designed to enable businesses to reach its community of users through the Yahoo! Properties and to also reach the users of its network of third party partners (referred to as “affiliates”) who have integrated the Company’s search and/or graphical advertising offerings into their websites.

Basis of Presentation.  The condensed consolidated financial statements include the accounts of Yahoo! and its majority-owned or otherwise controlled subsidiaries.  All significant intercompany accounts and transactions have been eliminated.  Investments in entities in which the Company can exercise significant influence, but does not own a majority equity interest or otherwise control, are accounted for using the equity method and are included as Investments in equity interests on the condensed consolidated balance sheets.  The Company has included the results of operations of acquired companies from the closing date of the acquisition.

Certain prior period amounts have been reclassified to conform to the current period presentation.  The Company has changed the classification of amortization expense related to developed technology and intellectual property rights acquired through acquisitions in the condensed consolidated statements of income.  Amortization expenses of $14 million and $42 million for the three and nine months ended September 30, 2005, respectively, were previously included as part of operating expenses and have been reclassified to cost of revenues.  Amortization expenses included in cost of revenues for the three and nine months ended September 30, 2006 were $38 million and $87 million, respectively.

The accompanying unaudited condensed consolidated interim financial statements reflect all adjustments, consisting of only normal recurring items, which in the opinion of management, are necessary for a fair statement of the results of operations for the periods shown.  The results of operations for such periods are not necessarily indicative of the results expected for the full year or for any future period.

The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities.  On an on-going basis, the Company evaluates its estimates, including those related to uncollectible receivables, the useful lives of long-lived assets including property and equipment, investment fair values, goodwill and other intangible assets, investments in equity interests, income taxes, and contingencies.  In addition, the Company uses assumptions when employing the Black-Scholes option valuation model to calculate the fair value of stock-based awards granted.  The Company bases its estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, when these carrying values are not readily available from other sources.  Actual results may differ from these estimates.

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations.  The condensed consolidated balance sheet as of December 31, 2005 was derived from the Company’s audited financial statements for the year ended December 31, 2005, but does not include all disclosures required by GAAP.  However, the Company believes the disclosures are adequate to make the information presented not misleading.

Recent Accounting Pronouncements

Effective January 1, 2006 the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment” (“SFAS 123R”), and the Company’s condensed consolidated financial statements as of and for the three and nine months ended September 30, 2006 reflect the impact of SFAS 123R.  For the three and nine months ended September 30, 2006, the Company recorded stock-based compensation expense of $121 million and $330 million, respectively, which reduced gross profit by $2 million and $5 million, respectively.  As a result of adopting SFAS 123R the Company’s income from operations for the three and nine months ended September 30, 2006 was lower by $92 million and $255 million, respectively, and net income by $60 million and $174 million, respectively, than if the Company had continued

7




 

to account for stock-based compensation under Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”).  Basic and diluted net income per share for the three and nine months ended September 30, 2006 was $0.04 and $0.12 lower, respectively, than if the Company had continued to account for stock-based compensation under APB 25.  The Company also capitalized $4 million and $10 million of stock-based compensation expense in the three and nine months ended September 30, 2006, respectively, which is now part of property and equipment, net on the condensed consolidated balance sheets.  For the three and nine months ended September 30, 2005, the Company recognized $14 million and $34 million, respectively, of stock-based compensation expense under the intrinsic value method in accordance with APB 25.  In addition, prior to the adoption of SFAS 123R, the Company presented tax benefits from stock-based compensation as cash flows from operating activities.  Upon the adoption of SFAS 123R, the gross benefits of tax deductions related to stock-based compensation in excess of the grant date fair value of the related stock-based awards are now classified as cash flows from financing activities.  See Note 10—“Stock-Based Compensation” for additional information.

In July 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 the Company recognize in its 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 the Company on January 1, 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings.  The Company is currently evaluating the impact of adopting FIN 48 on its financial position, cash flows, and 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 the Company on January 1, 2008. The Company is currently evaluating the impact of adopting SFAS 157 on its 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 SEC’s views on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The provisions of SAB 108 will be effective for the Company for the fiscal year ended December 31, 2006. The Company is currently evaluating the impact of applying SAB 108 but does not believe that the application of SAB 108 will have a material effect on its financial position, cash flows, and results of operations.

Note 2 BASIC AND DILUTED NET INCOME PER SHARE

Basic net income per share is computed using the weighted average number of common shares outstanding during the period, excluding any unvested restricted stock that is subject to repurchase.  Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period.  Potential common shares consist of unvested restricted stock and restricted stock units, collectively referred to as “restricted stock awards” (using the treasury stock method), the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s zero coupon senior convertible notes (using the if-converted method).  For the three months ended September 30, 2005 and 2006, approximately 67 million and 117 million options to purchase common stock, respectively, were excluded from the calculation, as they were anti-dilutive.  For the nine months ended September 30, 2005 and 2006, approximately 62 million and 95 million options to purchase common stock, respectively, were excluded from the calculation, as they were anti-dilutive.  See Note 9—“Long-Term Debt” for additional information related to the Company’s zero coupon senior convertible notes.

The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):

8




 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

September 30,

 

September 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

253,773

 

$

158,529

 

$

1,213,022

 

$

482,718

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares

 

1,409,065

 

1,380,496

 

1,398,276

 

1,404,538

 

Weighted average unvested restricted stock subject to repurchase

 

(4,053

)

(4,612

)

(3,088

)

(4,738

)

Denominator for basic calculation

 

1,405,012

 

1,375,884

 

1,395,188

 

1,399,800

 

 

 

 

 

 

 

 

 

 

 

Weighted average effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options

 

44,643

 

27,649

 

50,189

 

33,606

 

Convertible notes

 

36,585

 

36,583

 

36,585

 

36,584

 

Restricted stock awards

 

636

 

2,313

 

777

 

1,842

 

Denominator for diluted calculation

 

1,486,876

 

1,442,429

 

1,482,739

 

1,471,832

 

Net income per share—basic

 

$

0.18

 

$

0.12

 

$

0.87

 

$

0.34

 

Net income per share—diluted

 

$

0.17

 

$

0.11

 

$

0.82

 

$

0.33

 

 

Note 3 ACQUISITIONS

Transactions completed in 2005

Verdisoft Corporation.   On February 11, 2005, the Company acquired Verdisoft Corporation (“Verdisoft”), a software development company.  The acquisition of Verdisoft enhanced the Company’s platform for delivering content and services to mobile devices as part of the Company’s strategy to provide users with seamless access to its network.  The transaction was treated as an asset acquisition for accounting purposes and therefore no goodwill was recorded.  The purchase price was $58 million and consisted of $54 million in cash consideration, $3 million related to stock options exchanged and $1 million of direct transaction costs.  In connection with the acquisition, the Company also issued approximately 1 million shares of restricted stock valued at $35 million that will be recognized as expense over three years as the Company’s right to repurchase these shares lapses on the third anniversary of the date of grant.  For accounting purposes,  $93 million was allocated to amortizable intangible assets, $37 million to liabilities, primarily deferred income tax liabilities, and $2 million to deferred stock-based compensation (of which the outstanding balance on January 1, 2006 was netted against additional paid-in capital upon the adoption of SFAS 123R).  The amortizable intangible assets have useful lives not exceeding four years and a weighted average useful life of approximately 3 years.

Yahoo! Europe and Yahoo! Korea.   In November 1996, the Company entered into joint ventures with SOFTBANK Corp. (together with its consolidated affiliates, “SOFTBANK”) whereby separate companies were formed in the United Kingdom, France and Germany (collectively, “Yahoo! Europe”), which established and managed local versions of Yahoo! in those countries.  In August 1997, the Company entered into a similar joint venture with SOFTBANK in Korea.  Prior to November 2005, the Company had a majority share of approximately 70 percent in each of the Yahoo! Europe entities and 67 percent in Yahoo! Korea and therefore the results of these entities were included in the Company’s consolidated financial statements, with minority interests separately presented on the consolidated statements of income and consolidated balance sheets.  On November 23, 2005, the Company purchased SOFTBANK’s remaining shares in the joint ventures giving the Company 100 percent ownership in these entities.

The total purchase price of $501 million consisted of $500 million in cash consideration and direct transaction costs of $1 million.

9




 

The allocation of the purchase price to the assets acquired and liabilities assumed based on their fair values was as follows (in thousands):

Net tangible assets acquired

 

$

52,484

 

Amortizable intangible assets:

 

 

 

Customer contracts and related relationships

 

30,561

 

Developed technology and intellectual property rights

 

6,570

 

Trade name, trademark and domain name

 

50,121

 

Goodwill

 

387,771

 

Total assets acquired

 

527,507

 

Deferred income taxes

 

(26,633

)

Total

 

$

500,874

 

 

The amortizable intangible assets have useful lives not exceeding five years and a weighted average life of approximately 4 years.  No amount has been allocated to in-process research and development and $388 million has been allocated to goodwill.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes.

Other Acquisitions—Business Combinations.   During the year ended December 31, 2005, the Company acquired four other companies which were accounted for as business combinations.  The total purchase price for these four acquisitions was $79 million and consisted of $73 million in cash consideration, $3 million related to stock options exchanged and $3 million of direct transaction costs.  The total cash consideration of $73 million less cash acquired of $3 million resulted in net cash outlay of $70 million.  Of the purchase price, $58 million was allocated to goodwill, $32 million to amortizable intangible assets and $11 million to net assumed liabilities.  Approximately $1 million was allocated to in-process research and development and expensed in the condensed consolidated statements of income.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes.

The purchase price allocations for certain of these acquisitions are preliminary and subject to revision as more detailed analyses are completed and additional information on the fair value of assets and liabilities becomes available.  Any change in the fair value of the net assets of the acquired companies will change the amount of the purchase price allocable to goodwill.

During 2005, the Company also made a strategic investment in Alibaba.com Corporation (“Alibaba”)—see Note 4—“Investments in Equity Interests”—and completed immaterial asset acquisitions that did not qualify as business combinations.

Transactions completed in 2006

Seven Networks Limited.   On January 29, 2006, the Company and Seven Network Limited (“Seven”), a leading Australian media company, completed a strategic partnership in which the Company contributed its Australian Internet business, Yahoo! Australia and New Zealand (“Yahoo! Australia”), and Seven contributed its online assets, television and magazine content, an option to purchase its 33 percent ownership interest in mobile solutions provider m.Net Corporation Ltd, and cash of AUD $10 million.  The Company believes this strategic partnership and the contribution of the respective businesses with their rich media and entertainment content will create a comprehensive and engaging online experience for local users and advertisers.  The Company obtained a 50 percent equity ownership interest in the newly formed entity, which operates as “Yahoo!7.”  Pursuant to a shareholders agreement and a power of attorney granted by Seven to vote certain of its shares, the Company has the right to vote 50.1 percent of the outstanding voting interests in Yahoo!7 and control over the day-to-day operations and therefore consolidates Yahoo!7, which includes the operations of Yahoo! Australia.  For accounting purposes, the Company is considered to have acquired the assets contributed by Seven in exchange for 50 percent of the ownership of Yahoo! Australia.  Accordingly, the Company accounted for this transaction in accordance with SFAS No. 141 “Business Combinations.”  The total estimated purchase price was $34 million including direct transaction costs of $2 million.

10




 

The preliminary allocation of the purchase price of the Company’s share of the assets acquired and liabilities assumed based on their fair values was as follows (in thousands):

Cash acquired

 

$

3,763

 

Other tangible assets acquired

 

2,400

 

Amortizable intangible assets:

 

 

 

Customer contracts, related relationships and developed technology and intellectual property rights

 

18,600

 

Goodwill

 

15,641

 

Total assets acquired

 

40,404

 

Deferred income taxes

 

(6,075

)

Total

 

$

34,329

 

 

The amortizable intangible assets have useful lives not exceeding seven years and a weighted average useful life of seven years. No amounts have been allocated to in-process research and development and approximately $16 million has been allocated to goodwill.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes.  The preliminary allocation of the purchase price is subject to revision as more detailed analyses are completed and additional information on the fair value of assets and liabilities becomes available.  Any change in the fair value of the net assets acquired will change the amount of the purchase price allocable to goodwill.

As a result of this transaction, the Company’s ownership in Yahoo! Australia, which is now part of Yahoo!7, decreased to 50 percent.  The Company effectively recognized a non-cash gain of approximately $30 million representing the difference between the fair value of Yahoo! Australia and its carrying value adjusted for the Company’s continued ownership in Yahoo!7.  This non-cash gain was accounted for as a capital transaction and recorded as additional paid-in capital because of certain future events that could affect actual realization of the gain. The Company also recorded a minority interest of $7 million related to its reduced ownership of Yahoo! Australia and Seven’s retained interest in their contributed net assets.

Investment in Gmarket Inc.   On June 12, 2006, the Company acquired an approximate 10 percent interest in Gmarket Inc., a leading retail e-commerce provider in South Korea, for $61 million, including direct transaction costs of approximately $1 million.

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Note 4 INVESTMENTS IN EQUITY INTERESTS

The following table summarizes the Company’s investments in equity interests (dollars in thousands):

 

 

December 31,

 

September 30,

 

Percent

 

 

 

2005

 

2006

 

Ownership

 

Alibaba

 

$

1,408,716

 

$

1,407,132

 

44%

 

Yahoo! Japan

 

349,685

 

456,428

 

34%

 

Total

 

$

1,758,401

 

$

1,863,560

 

 

 

 

Equity Investment in Alibaba.   On October 23, 2005, the Company acquired approximately 46 percent of the outstanding common stock of Alibaba, which represented an approximate 40 percent equity interest on a fully diluted basis, in exchange for $1.0 billion in cash, the contribution of the Company’s China based businesses, including 3721 Network Software Company Limited (“Yahoo! China”), and direct transaction costs of $8 million.  Pursuant to the terms of a shareholder agreement, the Company has an approximate 35 percent voting interest in Alibaba, with the remainder of its voting rights subject to a voting agreement with Alibaba management.  Other investors in Alibaba include SOFTBANK.

Through this transaction, the Company has combined its leading search capabilities with Alibaba’s leading online marketplace and online payment system and Alibaba’s strong local presence, expertise and vision in the China market.  These factors contributed to a purchase price in excess of the Company’s share of the fair value of Alibaba’s net tangible and intangible assets acquired resulting in goodwill.

The investment in Alibaba is being accounted for using the equity method, and the total investment, including net tangible assets, identifiable intangible assets and goodwill, is classified as part of investments in equity interests on the Company’s condensed consolidated balance sheets.  The Company records its share of the results of Alibaba and any related amortization expense, one quarter in arrears, within earnings in equity interests on the condensed consolidated statements of income.  The purchase price was based on acquiring a 40 percent equity interest in Alibaba on a fully diluted basis.  As of June 30, 2006, the Company’s ownership interest in Alibaba was 44 percent, an approximate 2 percent decrease from the prior period, primarily as a result of the conversion of Alibaba’s outstanding convertible debt.   The Company’s ownership interest in Alibaba may be further diluted to 40 percent upon exercise of Alibaba’s employee stock options.  The Company will recognize non-cash gains if and when such further dilution to its ownership interest in Alibaba occurs.  In allocating the excess of the carrying value of its investment in Alibaba over its proportionate share of the net assets of Alibaba, the Company allocated a portion of the excess to goodwill to account for the estimated reductions in the carrying value of the investment in Alibaba that may occur as the Company’s equity interest is diluted to 40 percent.  Therefore, the reduction in ownership interest of 2 percent from the prior period did not result in any impact on the condensed consolidated statements of income other than for the non-cash gain related to such reduction being treated as an incremental sale of Yahoo! China as discussed below.

As of September 30, 2006, the difference between the Company’s carrying value of its investment in Alibaba and its proportionate share of the net assets of Alibaba is summarized as follows (in thousands):

Carrying value of investment in Alibaba

 

$

1,407,132

 

Proportionate share of net assets of Alibaba

 

922,669

 

Excess of carrying value of investment over proportionate share of net assets

 

$

484,463

 

 

 

 

 

The excess carrying value has been primarily assigned to:

 

 

 

Goodwill

 

$

412,225

 

Amortizable intangible assets

 

74,668

 

Deferred income taxes

 

(2,430

)

Total

 

$

484,463

 

 

The amortizable intangible assets have useful lives not exceeding seven years and a weighted average useful life of approximately 5 years.  No amount has been allocated to in-process research and development.  Goodwill is not deductible for tax purposes.

Following the acquisition date, Yahoo! China has not been included in the Company’s consolidated results but is included within earnings in equity interests on the condensed consolidated statements of income to the extent of the Company’s continued ownership in Alibaba.  The results of operations of Yahoo! China were not material to the consolidated results of the Company for the three and nine months ended September 30, 2005.  In connection with the transaction, in the fourth quarter of 2005, the Company recorded a non-cash gain of $338 million in other income, net, based on the difference between the fair value of Yahoo! China and its carrying value adjusted for the Company’s continued ownership in the newly

12




 

combined entity.

As a result of the conversion of Alibaba’s outstanding convertible debt described above, the Company recorded a non-cash gain during the three months ended September 30, 2006 of approximately $14 million in other income, net to account for an approximate 2 percent reduction in the Company’s ownership interest in Alibaba from 46 percent to 44 percent, which was treated as an incremental sale of additional equity interests in Yahoo! China.  See Note 7—“Other Income, Net” for additional information.

The Company also has commercial arrangements with Alibaba to provide technical and development services.  For the three and nine months ended September 30, 2006, these transactions were not material.

Equity Investment in Yahoo! Japan.   During April 1996, the Company signed a joint venture agreement with SOFTBANK, which was amended in September 1997, whereby Yahoo! Japan Corporation (“Yahoo! Japan”) was formed.  Yahoo! Japan was formed to establish and manage a local version of Yahoo! in Japan.  During the nine months ended September 30, 2005 and 2006, the Company received cash dividends from Yahoo! Japan in the amounts of $11 million and $13 million, respectively, which were recorded as reductions in the Company’s investment in Yahoo! Japan.  The Company also has commercial arrangements with Yahoo! Japan, consisting of services, including algorithmic search services and sponsored search services and the related traffic acquisition costs and license fees.  The net cost of these arrangements was approximately $49 million and $64 million for the three months ended September 30, 2005 and 2006, respectively.  The net cost of these arrangements was approximately $121 million and $183 million for the nine months ended September 30, 2005 and 2006, respectively.

The investment in Yahoo! Japan is being accounted for using the equity method and the total investment is classified as a part of the Investments in equity interests balance on the condensed consolidated balance sheets.  The Company records its share of the results of Yahoo! Japan one quarter in arrears within earnings in equity interests on the condensed consolidated statements of income.  The fair value of the Company’s approximate 34 percent ownership interest in Yahoo! Japan, based on the quoted stock price, was approximately $8 billion as of September 30, 2006.

The following table presents Yahoo! Japan’s condensed financial information, as derived from the Yahoo! Japan financial statements for the three and nine months ended June 30, 2005, and 2006 and as of September 30, 2005 and June 30, 2006 (in thousands):

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

June 30,

 

June 30,

 

June 30,

 

June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Operating data

 

 

 

 

 

 

 

 

 

Revenues

 

$

361,536

 

$

430,685

 

$

997,416

 

$

1,230,820

 

Gross profit

 

$

329,099

 

$

412,886

 

$

912,701

 

$

1,162,555

 

Income from operations

 

$

171,180

 

$

209,721

 

$

485,239

 

$

591,642

 

Net income

 

$

95,880

 

$

115,412

 

$

282,116

 

$

334,392

 

 

 

 

September 30,

 

June 30,

 

 

 

2005

 

2006

 

Balance sheet data

 

 

 

 

 

Current assets

 

$

900,149

 

$

732,207

 

Long-term assets

 

$

469,077

 

$

1,553,026

 

Current liabilities

 

$

306,441

 

$

432,783

 

Long-term liabilities

 

$

19,663

 

$

532,015

 

 

The differences between United States and Japanese generally accepted accounting principles did not materially impact the amounts reflected in the Company’s financial statements.

Note 5 GOODWILL

The changes in the carrying amount of goodwill for the nine months ended September 30, 2006 are as follows (in thousands):

 

 

United States

 

International

 

Total

 

Balance as of January 1, 2006

 

$

1,720,752

 

$

1,174,805

 

$

2,895,557

 

Acquisitions and other*

 

1,219

 

13,977

 

15,196

 

Foreign currency translation adjustments

 

 

65,823

 

65,823

 

Balance as of September 30, 2006

 

$

1,721,971

 

$

1,254,605

 

$

2,976,576

 

 

*                    Other primarily includes certain purchase price adjustments that affect existing goodwill.

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Note 6 INTANGIBLE ASSETS, NET

The following table summarizes the Company’s intangible assets, net (in thousands):

 

 

December 31, 2005

 

September 30, 2006

 

 

 

Net

 

Gross carrying

Amount

 

Accumulated

amortization*

 

Net

 

 

 

 

 

 

 

 

 

 

 

Trademark, trade name and domain name

 

$

122,657

 

$

185,674

 

$

(81,343

)

$

104,331

 

Customer, affiliate, and advertiser related relationships

 

159,442

 

367,339

 

(255,697

)

111,642

 

Developed technology and intellectual property rights

 

252,516

 

396,356

 

(204,961

)

191,395

 

Total intangible assets, net

 

$

534,615

 

$

949,369

 

$

(542,001

)

$

407,368

 

 

*                    Foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities, totaled approximately $12 million as of September 30, 2006.

For the three months ended September 30, 2005 and 2006, the Company recognized amortization expense for intangible assets of $41 million and $71 million, respectively.  For the nine months ended September 30, 2005 and 2006 the Company recognized amortization expense for intangible assets of approximately $123 million and $185 million, respectively.  Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2006 and each of the succeeding five years is as follows: three months ending December 31, 2006: $51 million; 2007: $183 million; 2008: $126 million; 2009: $27 million; 2010: $14 million; 2011: $3 million; and thereafter: $3 million.

Note 7 OTHER INCOME, NET

Other income, net is comprised of (in thousands):

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

2005

 

September 30,

2006

 

September 30,

2005

 

September 30,

2006

 

 

 

 

 

 

 

 

 

 

 

Interest and investment income

 

$

37,676

 

$

35,340

 

$

88,548

 

$

108,741

 

Investment gains (losses), net

 

26,948

 

1,528

 

995,231

 

(2,649

)

Gain on divestiture of Yahoo! China *

 

 

14,316

 

 

15,158

 

Other

 

1,371

 

(916

)

11,946

 

544

 

 

 

 

 

 

 

 

 

 

 

Total other income, net

 

$

65,995

 

$

50,268

 

$

1,095,725

 

$

121,794

 

 

*                    Represents non-cash gains arising from reductions in the Company’s ownership in Alibaba, which are treated as incremental sales of additional equity interests in Yahoo! China, see Note 4 — “Investments in Equity Interests” for additional information.

Investment gains (losses), net include realized investment gains, realized investment losses, realized gains on derivatives, and impairment charges related to declines in values of publicly traded and privately held companies judged to be other than temporary.  Investment gains (losses), net include gains in the amounts of $27 million and $987 million in the three and nine months ended September 30, 2005, respectively, related to the sales of non-strategic marketable equity securities.

14




 

Note 8 COMPREHENSIVE INCOME

Comprehensive income, net of taxes, is comprised of (in thousands):

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

2005

 

September 30,

2006

 

September 30,

2005

 

September 30,

2006

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

253,773

 

$

158,529

 

$

1,213,022

 

$

482,718

 

 

 

 

 

 

 

 

 

 

 

Change in net unrealized gains /losses on available-for-sale securities, net of tax and reclassification adjustments

 

(31,584

)

5,692

 

(494,875

)

25,891

 

Foreign currency translation adjustment

 

(3,942

)

13,462

 

(52,933

)

113,530

 

Other comprehensive income (loss)

 

(35,526

)

19,154

 

(547,808

)

139,421

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

218,247

 

$

177,683

 

$

665,214

 

$

622,139

 

 

The following table summarizes the components of accumulated other comprehensive income (loss) (in thousands):

 

 

December 31,

2005

 

September 30,

2006

 

 

 

 

 

 

 

Unrealized gains (losses) on available-for-sale securities, net of tax

 

$

(16,218

)

$

9,673

 

Cumulative foreign currency translation adjustment

 

(19,747

)

93,783

 

 

 

 

 

 

 

Accumulated other comprehensive income (loss)

 

$

(35,965

)

$

103,456

 

 

Note 9 LONG-TERM DEBT

In April 2003, the Company issued $750 million of zero coupon senior convertible notes (the “Notes”) due April 2008, resulting in net proceeds to the Company of approximately $733 million after transaction fees of $17 million, which have been deferred and are included on the condensed consolidated balance sheets in other assets.  As of September 30, 2006, $5 million of the transaction fees remain to be amortized.  The Notes were issued at par and bear no interest.  The Notes are convertible into Yahoo! common stock at a conversion price of $20.50 per share, which would result in the issuance of an aggregate of approximately 37 million shares, subject to adjustment upon the occurrence of specified events.  Each $1,000 principal amount of the Notes will initially be convertible into 48.78 shares of Yahoo! common stock.

The Notes are convertible prior to the final maturity date (1) during any fiscal quarter if the closing sale price of the Company’s common stock for at least 20 trading days in the 30 trading-day period ending on the last trading day of the immediately preceding fiscal quarter exceeded 110 percent of the conversion price on that 30th trading day, (2) during the period beginning January 1, 2008 through the maturity date, if the closing sale price of the Company’s common stock on the previous trading day was 110 percent or more of the then current conversion price, and (3) upon specified corporate transactions.  Upon conversion, the Company has the right to deliver cash in lieu of common stock.  The Company 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.  The Company may not redeem the Notes prior to their maturity.

As of September 30, 2006, the market price condition for convertibility of the Notes was satisfied with respect to the fiscal quarter beginning on October 1, 2006 and ending on December 31, 2006.  During this period holders of the Notes will be able to convert their Notes into shares of Yahoo! common stock at the rate of 48.78 shares of Yahoo! common stock for each Note.  The Notes will also be convertible into shares of Yahoo! common stock in subsequent fiscal quarters, if any, with respect to which the market price condition for convertibility is met.

As of September 30, 2006 the fair value of the Notes was approximately $0.9 billion based on quoted market prices.  The shares issuable upon conversion of the Notes have been included in the computation of diluted net income per share since the Notes were issued.

15




 

Note 10 STOCK-BASED COMPENSATION

Stock-Based Compensation.  Prior to January 1, 2006, the Company accounted for employee stock-based compensation using the intrinsic value method supplemented by pro forma disclosures in accordance with APB 25 and SFAS No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123.”  Under the intrinsic value method, the recorded stock-based compensation expense was related to the amortization of the intrinsic value of Yahoo! stock options issued and assumed in connection with business combinations and other stock-based awards issued by the Company.  Options granted with exercise prices equal to the grant date fair value of the Company’s stock have no intrinsic value and therefore no expense was recorded for these options under APB 25.  For stock options whose exercise price was below the grant date fair value of the Company’s stock (principally options assumed in business combinations), the difference between the exercise price and the grant date fair value of the Company’s stock was expensed over the service period (generally the vesting period) using an accelerated amortization approach in accordance with FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.”  Other stock-based awards for which stock-based compensation expense was recorded were generally grants of restricted stock awards which were measured at fair value on the date of grant based on the number of shares granted and the quoted price of the Company’s common stock.  Such value was recognized as an expense over the corresponding service period.

Effective January 1, 2006 the Company adopted SFAS 123R using the modified prospective approach and accordingly prior periods have not been restated to reflect the impact of SFAS 123R.  Under SFAS 123R, stock-based awards granted prior to its adoption are expensed over the remaining portion of their vesting period.  These awards are expensed under the accelerated amortization approach using the same fair value measurements which were used in calculating pro forma stock-based compensation expense under SFAS 123.  For stock-based awards granted on or after January 1, 2006, the Company records stock-based compensation expense on a straight-line basis over the requisite service period, which is generally a four year vesting period.  SFAS 123R requires that the deferred stock-based compensation on the condensed consolidated balance sheet on the date of adoption be netted against additional paid-in capital.  As of December 31, 2005, there was a balance of $235 million of deferred stock-based compensation that was netted against additional paid-in capital on January 1, 2006.

For the three and nine months ended September 30, 2006, the Company recorded stock-based compensation expense of $121 million and $330 million, respectively, which reduced gross profit by $2 million and $5 million, respectively.  As a result of adopting SFAS 123R the Company’s income from operations for the three and nine months ended September 30, 2006 was lower by $92 million and $255 million, respectively, and net income by $60 million and $174 million, respectively, than if the Company had continued to account for stock-based compensation under APB 25.  Basic and diluted net income per share for the three and nine months ended September 30, 2006 was $0.04 and $0.12 lower, respectively, than if the Company had continued to account for stock-based compensation under APB 25.  For the three and nine months ended September 30, 2005, the Company recognized $14 million and $34 million, respectively, of stock-based compensation expense under the intrinsic value method.

SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.  Stock-based compensation expense was recorded net of estimated forfeitures for the three and nine months ended September 30, 2006 such that expense was recorded only for those stock-based awards that are expected to vest.  Previously under APB 25 to the extent awards were forfeited prior to vesting, the corresponding previously recognized expense was reversed in the period of forfeiture.  Upon the adoption of SFAS 123R, the Company recorded a cumulative adjustment to account for the expected forfeitures of stock-based awards granted prior to January 1, 2006 for which the Company previously recorded an expense.  This adjustment was not material and was recorded as a reduction to stock-based compensation expense in the three months ended March 31, 2006.

Upon the adoption of SFAS 123R, the Company included as part of cash flows from financing activities the gross benefit of tax deductions related to stock-based awards in excess of the grant date fair value of the related stock-based awards for the options exercised during the nine months ended September 30, 2006 and certain options exercised in prior periods.  This amount is shown as a reduction to cash flows from operating activities and an increase to cash flows from financing activities.  Total cash flows remain unchanged from what would have been reported prior to the adoption of SFAS 123R.

Stock Plans.   The Company’s 1995 Stock Plan and stock option plans assumed through acquisitions are collectively referred to as the “Plans.”  The 1995 Stock Plan provides for the issuance of stock-based awards to employees, including executive officers and consultants.  The 1995 Stock Plan permits the granting of incentive stock options, non-statutory stock options, restricted stock, restricted stock units, stock appreciation rights, indexed options, and dividend equivalents.

Options granted under the 1995 Stock Plan before May 19, 2005 generally expire 10 years after the grant date and options granted after May 19, 2005 generally expire seven years after the grant date.  Options generally become exercisable over a four year period based on continued employment and vest either monthly, quarterly, semi-annually, or annually.

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The 1995 Stock Plan permits the granting of restricted stock and restricted stock units (collectively referred to as “restricted stock awards”).  Restricted stock awards generally vest upon meeting certain performance-based objectives or the passage of time, or a combination of both, and continued employment through the vesting period.  Restricted stock award grants are generally measured at fair value on the date of grant based on the number of shares granted and the quoted price of the Company’s common stock.  Such value is recognized as an expense over the corresponding service period.  Each share of the Company’s common stock issued in settlement of restricted stock awards will be counted as 1.75 shares against the 1995 Stock Plan’s share limit.

The 1995 Stock Plan provides for the issuance of a maximum of approximately 654 million shares of which 64 million were still available for issuance as of September 30, 2006.

The 1996 Directors’ Option Plan (the “Directors’ Plan”) provides for the grant of nonqualified stock options and restricted stock units to non-employee directors of the Company.  The Directors’ Plan provides for the issuance of up to approximately 9 million shares of the Company’s common stock, of which approximately 5 million were still available for issuance as of September 30, 2006.  Each share of the Company’s common stock issued in settlement of restricted stock units granted under the Directors’ Plan will be counted as 1.75 shares against the Directors’ Plans’ share limit.

Options granted under the Directors’ Plan before May 25, 2006 generally become exercisable, based on continued service as a director, for initial grants to new directors, in equal monthly installments over four years, and for annual grants, with 25 percent of such options vesting on the one year anniversary of the date of grant and the remaining options vesting in equal monthly installments over the remaining 36-month period thereafter.  Such options generally expire 10 years after the grant date.  Options granted on or after May 25, 2006 become exercisable, based on continued service as a director, in equal quarterly installments over one year.  Such options generally expire seven years after the grant date.

Restricted stock units granted under the Directors’ Plan vest in equal quarterly installments over a one year period following the date of grant and are payable in an equal number of shares of the Company’s common stock on the earlier of the third anniversary of the grant date or the date the director ceases to be a member of the board.

Non-employee directors are now also permitted to elect an award of restricted stock units or a stock option under the Directors’ Plan in lieu of a cash payment of fees for serving as chairperson of a board committee.  Such stock options or restricted stock unit awards granted on conversion of chairperson fees are fully vested on the grant date.

Employee Stock Purchase Plan.   The Company’s 1996 Employee Stock Purchase Plan (the “Purchase Plan”) allows employees to purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their annual compensation subject to certain Internal Revenue Code limitations.  The price of common stock purchased under the Purchase Plan is equal to 85 percent of the lower of the fair market value of the common stock on the commencement date of each 24-month offering period or the specified purchase date.  The Purchase Plan provides for the issuance of a maximum of approximately 30 million shares of common stock of which 14 million shares were still available as at September 30, 2006.  For the three and nine months ended September 30, 2006, the stock-based compensation expense related to the activity under the Purchase Plan was $15 million and $42 million, respectively.  As of September 30, 2006 there was $38 million of unamortized stock-based compensation cost which will be recognized over a weighted average period of 1.1 years.

Executive Retention Compensation Agreement.  During the three months ended June 30, 2006, the Compensation Committee of the Company’s Board of Directors, approved a three year performance and retention compensation arrangement with the Company’s Chief Executive Officer (“CEO”).  For each of the years 2006 to 2008, the CEO will be eligible to receive a discretionary annual bonus payable in the form of a fully vested non-qualified stock option for up to 1 million shares with an exercise price equal to the closing trading price of the Company’s common stock on the date of the grant.  As of September 30, 2006 there was $4 million of unamortized stock-based compensation cost related to the 2006 portion of this award which is expected to be recognized over the remainder of 2006.

17




 

Stock option activity under the Company’s Plans and Directors’ Plan for the nine months ended September 30, 2006 is summarized as follows (in thousands, except per share amounts and as noted):

 

 

Shares

 

Weighted Average

Exercise Price per

Share

 

Weighted Average

Remaining

Contractual Life

(in years)

 

Aggregate

Intrinsic Value

 

Outstanding at December 31, 2005

 

182,694

 

$

28.11

 

 

 

 

 

Options granted

 

28,797

 

$

32.29

 

 

 

 

 

Options exercised (2)

 

(15,710

)

$

12.08

 

 

 

 

 

Options cancelled/forfeited/expired

 

(12,425

)

$

37.23

 

 

 

 

 

Outstanding at September 30, 2006

 

183,356

 

$

29.53

 

5.8

 

$

758,806

 

 

 

 

 

 

 

 

 

 

 

Vested and expected to vest at September 30, 2006 (1)

 

174,630

 

$

29.34

 

5.8

 

$

755,742

 

 

 

 

 

 

 

 

 

 

 

Exercisable at September 30, 2006

 

110,850

 

$

27.88

 

5.1

 

$

681,372

 

 

(1)             The expected to vest options are the result of applying the pre-vesting forfeiture rate assumptions to total outstanding options.

(2)             The Company’s current practice is to issue new shares to satisfy stock option exercises.

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the aggregate difference between the closing stock price of the Company’s common stock on September 30, 2006 and the exercise price for in-the-money options) that would have been received by the option holders if all in-the-money options had been exercised on September 30, 2006.  The total intrinsic value of options exercised in the three and nine months ended September 30, 2006 was $67 million and $326 million, respectively.  The weighted average grant date fair value of options granted in the three and nine months ended September 30, 2006 was $9.64 and $10.29, respectively.  The weighted average grant date fair value of options granted in the three and nine months ended September 30, 2005 was $11.17 and $11.88, respectively.

As of September 30, 2006, there was $452 million of unamortized stock-based compensation cost related to unvested stock options which is expected to be recognized over a weighted average period of 3.2 years.

Cash received from option exercises and purchases of shares under the Purchase Plan for the nine months ended September 30, 2006 was $231 million.

The total tax benefit attributable to options exercised in the nine months ended September 30, 2006 was $116 million.

The tax benefits from stock-based compensation for the nine months ended September 30, 2006 was $275 million, which is reported on the condensed consolidated statements of cash flows.  This represents the total amount of income tax benefit in the current period related to options exercised in current and prior periods, net of deferred tax benefits related to our current period stock-based compensation expense.

The gross excess tax benefits from stock-based compensation for the nine months ended September 30, 2006 of $355 million, as reported on the condensed consolidated statements of cash flows in financing activities represent the reduction in income taxes otherwise payable during the period, attributable to the actual gross tax benefits in excess of the expected tax benefits for options exercised in current and prior periods.  The gross excess tax benefits for the nine months ended September 30, 2006 were comprised of $93 million related to options exercised during the nine months ended September 30, 2006 and $262 million related to options exercised in prior periods.  The Company has accumulated excess tax deductions relating to stock options exercised prior to January 1, 2006 available to reduce income taxes otherwise payable.  To the extent such deductions are expected to reduce income taxes payable in the current year, they are reported as financing activities in the condensed consolidated statements of cash flows.

18




 

The fair value of option grants was estimated using the Black-Scholes option pricing model with the following weighted average assumptions:

 

 

Stock Options

 

Purchase Plan (5)

 

 

 

Three Months Ended

 

Three Months Ended

 

 

 

September 30,

2005

 

September 30,

2006

 

September 30,

2005

 

September 30,

2006

 

Expected dividend yield (1)

 

0.0

%

0.0

%

0.0

%

0.0

%

Risk-free interest rate (2)

 

4.0

%

4.9

%

1.3

%

5.0

%

Expected volatility (3)

 

37.0

%

34.0

%

39.4

%

31.7

%

Expected life (in years) (4)

 

3.8

 

3.8

 

0.5

 

1.2

 

 

 

 

 

Stock Options

 

Purchase Plan (5)

 

 

 

Nine Months Ended

 

Nine Months Ended

 

 

 

September 30,

2005

 

September 30,

2006

 

September 30,

2005

 

September 30,

2006

 

Expected dividend yield (1)

 

0.0

%

0.0

%

0.0

%

0.0

%

Risk-free interest rate (2)

 

3.8

%

4.9

%

1.3

%

5.0

%

Expected volatility (3)

 

39.3

%

34.1

%

39.4

%

31.7

%

Expected life (in years) (4)

 

3.8

 

3.8

 

0.5

 

1.2

 

 

(1)             The Company has no history or expectation of paying cash dividends on its common stock.

(2)             The risk-free interest rate is based on the U.S. Treasury yield for a term consistent with the expected life of the awards in effect at the time of grant.

(3)             The Company estimates the volatility of its common stock at the date of grant based on the implied volatility of publicly traded options on its common stock, with a term of one year or greater. Up to September 30, 2005, including the three and nine months ended September 30, 2005, the Company used an equally weighted average of trailing volatility and market based implied volatility for the computation.

(4)             The expected life of stock options granted under the Plans is based on historical exercise patterns, which the Company believes are representative of future behavior.  The expected life of options granted under the Purchase Plan represents the amount of time remaining in the 24-month offering period.

(5)             Assumptions for the Purchase Plan relate to the most recent enrollment period.  Enrollment is currently permitted in May and November of each year.

Restricted stock awards activity for the nine months ended September 30, 2006 is summarized as follows (in thousands, except per share amounts):

 

 

Shares

 

Weighted Average

Grant Date Fair

Value

 

Unvested at December 31, 2005

 

7,666

 

$

36.13

 

Granted

 

4,539

 

$

30.81

 

Vested

 

(170

)

$

30.15

 

Forfeited

 

(561

)

$

34.85

 

 

 

 

 

 

 

Unvested at September 30, 2006

 

11,474

 

$

34.17

 

 

As of September 30, 2006, there was $229 million of unamortized stock-based compensation cost related to unvested restricted stock awards which is expected to be recognized over a weighted average period of 2.2 years.  The total fair value of restricted stock awards vested during the three months ended September 30, 2006 and 2005 was $0.2 million and nil, respectively.  The total fair value of restricted stock awards vested during the nine months ended September 30, 2006 and 2005 was $6 million and $5 million, respectively.

If the fair value based method under SFAS 123, had been applied in measuring stock-based compensation expense for the three and nine months ended September 30, 2005, the pro forma effect on net income and net income per share would have been as follows, as previously disclosed (in thousands, except per share amounts):

19




 

 

 

Three Months

Ended

 

Nine Months

Ended

 

 

 

September 30,

2005

 

September 30,

2005

 

Net income:

 

 

 

 

 

As reported

 

$

253,773

 

$

1,213,022

 

Add: Stock-based compensation expense included in reported net income, net of tax

 

8,114

 

20,363

 

Less: Stock-based compensation expense determined under fair value based method for all awards, net of tax

 

(58,570

)

(172,764

)

Pro forma net income

 

$

203,317

 

$

1,060,621

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

As reported—basic

 

$

0.18

 

$

0.87

 

As reported—diluted

 

$

0.17

 

$

0.82

 

Pro forma—basic

 

$

0.14

 

$

0.76

 

Pro forma—diluted

 

$

0.14

 

$

0.71

 

 

Note 11 STOCK REPURCHASE PROGRAMS

In March 2001, the Company’s Board of Directors authorized the Company to repurchase up to $500 million of its outstanding shares of common stock over the following two years, depending on market conditions, share price and other factors.  In March 2003, the Company’s Board of Directors authorized a two year extension of this stock repurchase program until March 2005.  Under this program, from March 2001 through December 31, 2004, the Company repurchased 32.9 million shares of common stock at an average price of $4.86 per share for total consideration of $160 million.  During this period, of the shares repurchased, 32.1 million shares were purchased from SOFTBANK at an average price of $4.84 per share.  During the three months ended March 31, 2005, the Company repurchased an additional 4.9 million shares in the open market, at an average price of $33.60 per share, for total consideration of $165 million.  This stock repurchase program expired in March 2005.

In March 2005, the Company’s Board of Directors authorized a new stock repurchase program for the Company to repurchase up to $3.0 billion of its outstanding shares of common stock over the next five years, depending on market conditions, share price and other factors.  Under this program in the year ended December 31, 2005, the Company repurchased 6.8 million shares of common stock at an average price of $32.90 per share, for total consideration of $223 million.

In the three months ended September 30, 2006, the Company repurchased 48.7 million shares of common stock including 8.1 million shares received upon the maturity of structured stock repurchase transactions.  The Company repurchased the shares at an average price of $27.53 per share.  Total cash consideration for the repurchased stock was $1,342 million, including cash consideration of $1,092 million paid during the current quarter and $250 million invested in structured stock repurchase transactions entered into during the first quarter of 2006.

For the nine months ended September 30, 2006 the Company repurchased 84.6 million shares at an average price of $29.87 per share.  Total cash consideration for the repurchased stock was $2,527 mi