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ALTABA INC. 10-Q 2010
Form 10-Q
Table of Contents

 

 

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 June 30, 2010

Or

 

¨ 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 000-28018

 

 

Yahoo! Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   77-0398689

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

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 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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    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 July 30, 2010

Common Stock, $0.001 par value

 

1,348,278,127

 

 

 


Table of Contents

YAHOO! INC.

Table of Contents

 

PART I   FINANCIAL INFORMATION    3
Item 1.   Condensed Consolidated Financial Statements (unaudited)    3
  Condensed Consolidated Statements of Income for the three and six months ended June 30, 2009 and 2010    3
  Condensed Consolidated Balance Sheets as of December 31, 2009 and June 30, 2010    4
  Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2009 and 2010    5
  Notes to Condensed Consolidated Financial Statements    6
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    23
Item 3.   Quantitative and Qualitative Disclosures About Market Risk    33
Item 4.   Controls and Procedures    34
PART II   OTHER INFORMATION    35
Item 1.   Legal Proceedings    35
Item 1A.   Risk Factors    35
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds    46
Item 3.   Defaults Upon Senior Securities    46
Item 5.   Other Information    46
Item 6.   Exhibits    46
  Signatures    47

 

2


Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Statements of Income

 

     Three Months Ended     Six Months Ended  
     June 30,
2009
    June 30,
2010
    June 30,
2009
    June 30,
2010
 
     (Unaudited, in thousands except per share amounts)  

Revenue

   $ 1,572,897      $ 1,601,379      $ 3,152,939      $ 3,198,339   

Cost of revenue

     712,453        682,722        1,413,190        1,389,104   
                                

Gross profit

     860,444        918,657        1,739,749        1,809,235   
                                

Operating expenses:

        

Sales and marketing

     280,386        331,468        601,498        645,006   

Product development

     291,398        268,552        597,441        534,629   

General and administrative

     138,652        125,333        275,649        235,761   

Amortization of intangibles

     9,253        7,880        18,920        15,982   

Restructuring charges, net

     65,002        10,052        69,803        14,464   
                                

Total operating expenses

     784,691        743,285        1,563,311        1,445,842   
                                

Income from operations

     75,753        175,372        176,438        363,393   

Other income, net

     72,010        12,588        76,970        98,916   
                                

Income before income taxes and earnings in equity interests

     147,763        187,960        253,408        462,309   

Provision for income taxes

     (68,879     (68,524     (104,763     (117,968

Earnings in equity interests

     64,156        96,707        113,090        184,081   
                                

Net income

     143,040        216,143        261,735        528,422   

Less: Net income attributable to noncontrolling interests

     (1,653     (2,822     (2,790     (4,910
                                

Net income attributable to Yahoo! Inc.

   $ 141,387      $ 213,321      $ 258,945      $ 523,512   
                                

Net income attributable to Yahoo! Inc. common stockholders per share — basic

   $ 0.10      $ 0.15      $ 0.19      $ 0.38   
                                

Net income attributable to Yahoo! Inc. common stockholders per share — diluted

   $ 0.10      $ 0.15      $ 0.18      $ 0.37   
                                

Shares used in per share calculation — basic

     1,394,783        1,378,374        1,393,155        1,388,341   
                                

Shares used in per share calculation — diluted

     1,414,295        1,390,240        1,410,348        1,401,836   
                                

Stock-based compensation expense by function:

        

Cost of revenue

   $ 2,663      $ 580      $ 6,242      $ 1,591   

Sales and marketing

   $ 35,651      $ 21,540      $ 85,548      $ 35,218   

Product development

   $ 51,647      $ 26,132      $ 105,925      $ 58,505   

General and administrative

   $ 22,565      $ 9,345      $ 41,531      $ 23,066   

Restructuring expense reversals

   $ (7,600   $ —        $ (7,600   $ —     

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

 

3


Table of Contents

YAHOO! INC.

Condensed Consolidated Balance Sheets

 

     December 31,
2009
    June 30,
2010
 
     (Unaudited, in thousands
except par values)
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 1,275,430      $ 1,183,325   

Short-term marketable debt securities

     2,015,655        1,576,276   

Accounts receivable, net

     1,003,362        921,636   

Prepaid expenses and other current assets

     300,325        366,855   
                

Total current assets

     4,594,772        4,048,092   

Long-term marketable debt securities

     1,226,919        1,039,327   

Property and equipment, net

     1,426,862        1,517,891   

Goodwill

     3,640,373        3,640,659   

Intangible assets, net

     355,883        288,282   

Other long-term assets

     194,933        216,072   

Investments in equity interests

     3,496,288        3,601,511   
                

Total assets

   $ 14,936,030      $ 14,351,834   
                
LIABILITIES AND EQUITY     

Current liabilities:

    

Accounts payable

   $ 136,769      $ 132,478   

Accrued expenses and other current liabilities

     1,169,815        960,452   

Deferred revenue

     411,144        346,829   
                

Total current liabilities

     1,717,728        1,439,759   

Long-term deferred revenue

     122,550        82,113   

Capital lease and other long-term liabilities

     83,021        140,087   

Deferred and other long-term tax liabilities, net

     494,095        525,321   
                

Total liabilities

     2,417,394        2,187,280   

Commitments and contingencies (Note 11)

     —          —     

Yahoo! Inc. stockholders’ equity:

    

Common stock, $0.001 par value; 5,000,000 shares authorized; 1,413,718 shares issued and 1,406,075 shares outstanding as of December 31, 2009 and 1,425,919 shares issued and 1,361,583 shares outstanding as of June 30, 2010

     1,410        1,423   

Additional paid-in capital

     10,640,367        10,804,220   

Treasury stock at cost, 7,643 shares as of December 31, 2009 and 64,336 shares as of June 30, 2010

     (117,331     (998,748

Retained earnings

     1,599,638        2,123,150   

Accumulated other comprehensive income

     369,236        204,283   
                

Total Yahoo! Inc. stockholders’ equity

     12,493,320        12,134,328   

Noncontrolling interests

     25,316        30,226   
                

Total equity

     12,518,636        12,164,554   
                

Total liabilities and equity

   $ 14,936,030      $ 14,351,834   
                

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

 

4


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

 

     Six Months Ended  
     June 30,
2009
    June 30,
2010
 
     (Unaudited, in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

  

Net income

   $ 261,735      $ 528,422   

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

    

Depreciation

     273,502        255,192   

Amortization of intangible assets

     105,811        68,024   

Stock-based compensation expense, net

     231,646        118,380   

Non-cash restructuring charges

     6,467        72   

Tax benefits from stock-based awards

     16,536        21,922   

Excess tax benefits from stock-based awards

     (67,186     (64,014

Deferred income taxes

     24,741        28,903   

Earnings in equity interests

     (113,090     (184,081

Dividends received from equity investee

     26,145        60,918   

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

     (72,243     (52,581

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

    

Accounts receivable, net

     163,262        60,323   

Prepaid expenses and other

     4,618        (67,267

Accounts payable

     (69,621     1,440   

Accrued expenses and other liabilities

     (139,378     (208,589

Deferred revenue

     (48,802     (76,500
                

Net cash provided by operating activities

     604,143        490,564   
                

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Acquisition of property and equipment, net

     (165,155     (302,811

Purchases of marketable debt securities

     (2,173,606     (1,367,688

Proceeds from sales of marketable debt securities

     56,159        507,364   

Proceeds from maturities of marketable debt securities

     1,439,837        1,460,172   

Proceeds from sales of marketable equity securities

     119,987        —     

Acquisitions, net of cash acquired

     —          (112,361

Purchases of intangible assets

     (21,751     (12,617

Proceeds from the sale of a divested business

     —          100,000   

Other investing activities, net

     (86     (18,846
                

Net cash (used in) provided by investing activities

     (744,615     253,213   
                

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from issuance of common stock, net

     71,052        83,604   

Repayments of capital lease obligations

     —          (804

Repurchases of common stock

     —          (881,317

Excess tax benefits from stock-based awards

     67,186        64,014   

Tax withholdings related to net share settlements of restricted stock awards and restricted stock units

     (26,618     (40,739
                

Net cash provided by (used in) financing activities

     111,620        (775,242
                

Effect of exchange rate changes on cash and cash equivalents

     20,642        (60,640

Net change in cash and cash equivalents

     (8,210     (92,105

Cash and cash equivalents at beginning of period

     2,292,296        1,275,430   
                

Cash and cash equivalents at end of period

   $ 2,284,086      $ 1,183,325   
                

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

 

5


Table of Contents

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”), attracts hundreds of millions of users every month through its innovative technology and engaging content and services, making it one of the most trafficked Internet destinations and a world class online media company. Yahoo!’s vision is to be the center of people’s online lives by delivering personally relevant, meaningful Internet experiences. Together with the Company’s owned and operated online properties and services (“Yahoo! Properties” or “Owned and Operated sites”), Yahoo! also provides its advertising offerings and access to Internet users beyond Yahoo! through its distribution network of third-party entities (“Affiliates”), who have integrated the Company’s advertising offerings into their Websites, referred to as Affiliate sites, or their other offerings. The Company generates revenue by providing marketing services to advertisers across a majority of Yahoo! Properties and Affiliate sites. Additionally, although many of the services the Company provides to users are free, Yahoo! does charge fees for a range of premium services.

Basis of Presentation. The condensed consolidated financial statements include the accounts of Yahoo! Inc. 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 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 periods.

The preparation of consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States (“U.S.”) requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses and the related disclosure of contingent assets and liabilities. On a regular 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, stock-based compensation, goodwill and other intangible assets, income taxes, contingencies, and restructuring charges. 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, 2009. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted except for the Company’s change in revenue recognition policy pursuant to such rules and regulations. The condensed consolidated balance sheet as of December 31, 2009 was derived from the Company’s audited financial statements for the year ended December 31, 2009, but does not include all disclosures required by U.S. GAAP. However, the Company believes the disclosures are adequate to make the information presented not misleading.

Revenue Recognition. In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standard for multiple deliverable revenue arrangements, which provided updated guidance on whether multiple deliverables exist, how deliverables in an arrangement should be separated, and how consideration should be allocated. This standard eliminates the use of the residual method and will require arrangement consideration to be allocated based on the relative selling price for each deliverable. The selling price for each arrangement deliverable can be established based on vendor specific objective evidence (“VSOE”) and third-party evidence (“TPE”) if VSOE is not available. The new standard provides additional flexibility to utilize an estimate of selling price (“ESP”) if neither VSOE nor TPE is available.

The Company elected to early adopt this accounting standard on January 1, 2010 on a prospective basis for applicable transactions originating or materially modified after December 31, 2009. The adoption of this standard did not have a significant impact on the Company’s revenue recognition for multiple deliverable arrangements. Upon adoption, the selling prices for certain custom advertising solutions may use the best estimate of selling price as provided under the new standard. The adoption of this standard did not have a material impact on the Company’s consolidated financial position, cash flows, or results of operations for the three and six months ended June 30, 2010.

The Company’s revenue is derived principally from services, which comprise marketing services for advertisers and publishers and offerings to users. The Company classifies this revenue as marketing services and fees.

 

6


Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

In all cases, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectability of the related fee is reasonably assured. The Company’s arrangements generally do not include a provision for cancellation, termination, or refunds that would significantly impact revenue recognition.

Marketing services revenue is generated from several offerings including the display of graphical advertisements (“display advertising”), the display of text-based links to an advertiser’s Website (“search advertising”), listing-based services, and commerce-based transactions.

The Company recognizes revenue from display advertising on Yahoo! Properties as “impressions” are delivered. An “impression” is delivered when an advertisement appears in pages viewed by users. Arrangements for these services generally have terms of up to one year and in some cases the terms may be up to three years.

The Company is beginning to offer customized display advertising solutions to advertisers. These customized display advertising solutions will combine the Company’s standard display advertising with customized content, customer insights, and campaign analysis. Due to the unique nature of these products, the Company may not be able to establish selling prices based on historical stand-alone sales or third party evidence, therefore the Company may use its best estimate to establish selling prices. The Company establishes best estimates within a range of selling prices considering multiple factors including, but not limited to, factors such as class of advertiser, size of transaction, seasonality, margin objectives, observed pricing trends, available online inventory, industry pricing strategies, and market conditions. The Company believes the use of the best estimates of selling price will allow revenue recognition in a manner consistent with the underlying economics of the transaction.

The Company also recognizes revenue from search advertising on Yahoo! Properties. Search advertising revenue is recognized as “click-throughs” occur. A “click-through” occurs when a user clicks on an advertiser’s search result listing.

Marketing services revenue also includes listings 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 classified advertising such as Yahoo! Autos, Yahoo! Real Estate, and other services. The Company recognizes listings revenue when the services are performed. Transaction revenue is generated from facilitating commercial transactions through Yahoo! Properties, principally from Small Business, Yahoo! Travel and Yahoo! Shopping. The Company recognizes transaction revenue when there is evidence that qualifying transactions have occurred (for example, when travel arrangements are booked through Yahoo! Travel).

In addition to delivering search and display advertising on Yahoo! Properties, the Company also generates revenue from search and/or display advertising offerings on Affiliate sites. The Company pays Affiliates for the revenue generated from the display of these advertisements on the Affiliates’ Websites. These payments are called traffic acquisition costs (“TAC”). The revenue derived from these arrangements that involve traffic supplied by Affiliates is reported gross of the payment to Affiliates. This revenue is reported gross due to the fact that the Company is the primary obligor to the advertisers who are the customers of the advertising service.

Fees revenue consists of revenue generated from a variety of consumer and business fee-based services, including Internet broadband services, royalties received from joint venture partners, premium mail, music and personals offerings as well as services for small businesses. The Company recognizes fees revenue when the services are performed.

The Company accounts for cash consideration given to customers, for which it does not receive a separately identifiable benefit or cannot reasonably estimate fair value, as a reduction of revenue rather than as an expense. Cash consideration received in an arrangement with a provider may require consideration of classification of amounts received as revenue or a reimbursement of costs incurred. Additionally, the Company reports revenue for which it is the primary obligor in the arrangement and for which it provided a product or service at the gross amount.

Current deferred revenue is comprised of contractual billings in excess of recognized revenue and payments received in advance of revenue recognition. Long-term deferred revenue includes amounts received from customers for which services will not be delivered within the next 12 months.

Note 2 BASIC AND DILUTED NET INCOME ATTRIBUTABLE TO YAHOO! INC. COMMON STOCKHOLDERS PER SHARE

Basic and diluted net income attributable to Yahoo! common stockholders per share is computed using the weighted average number of common shares outstanding during the period, excluding net income attributable to participating securities (restricted stock awards granted under the Company’s 1995 Stock Plan and restricted stock units granted under the 1996 Directors’ Stock Plan (the “Directors’ Plan”)). 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 are calculated using the treasury stock method and consist of unvested restricted stock and shares underlying unvested restricted stock units, the incremental common shares issuable upon the exercise of stock options, and shares to be purchased under the employee stock purchase plan. The Company calculates potential tax windfalls and shortfalls by including the impact of pro forma deferred tax assets.

The Company takes into account the effect on consolidated net income per share of dilutive securities of entities in which the Company holds equity interests that are accounted for using the equity method.

 

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Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Potentially dilutive securities representing approximately 86 million shares of common stock for the three and six months ended June 30, 2010, respectively, and 133 million and 138 million shares of common stock for the three and six months ended June 30, 2009, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive.

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2009
    June 30,
2010
    June 30,
2009
    June 30,
2010
 

Basic:

        

Numerator:

        

Net income attributable to Yahoo!

   $ 141,387      $ 213,321      $ 258,945      $ 523,512   

Less: Net income allocated to participating securities

     (171     (55     (324     (103
                                

Net income attributable to Yahoo! common stockholders — basic

   $ 141,216      $ 213,266      $ 258,621      $ 523,409   
                                

Denominator:

        

Weighted average common shares

     1,394,783        1,378,374        1,393,155        1,388,341   
                                

Net income attributable to Yahoo! common stockholders per share — basic

   $ 0.10      $ 0.15      $ 0.19      $ 0.38   
                                

Diluted:

        

Numerator:

        

Net income attributable to Yahoo!

   $ 141,387      $ 213,321      $ 258,945      $ 523,512   

Less: Net income allocated to participating securities

     (24     (19     (55     (41

Less: Effect of dilutive securities issued by equity investees

     (219     (670     (445     (1,348
                                

Net income attributable to Yahoo! common stockholders — diluted

   $ 141,144      $ 212,632      $ 258,445      $ 522,123   
                                

Denominator:

        

Denominator for basic calculation

     1,394,783        1,378,374        1,393,155        1,388,341   

Weighted average effect of Yahoo! dilutive securities:

        

Restricted stock and restricted stock units

     11,741        6,157        11,255        6,819   

Stock options and employee stock purchase plan

     7,771        5,709        5,938        6,676   
                                

Denominator for diluted calculation

     1,414,295        1,390,240        1,410,348        1,401,836   
                                

Net income attributable to Yahoo! common stockholders per share — diluted

   $ 0.10      $ 0.15      $ 0.18      $ 0.37   
                                

Note 3 ACQUISITIONS

During the six months ended June 30, 2010, the Company acquired three companies, which were accounted for as business combinations. The total purchase price for these acquisitions was $114 million. The total cash consideration of $114 million less cash acquired of $2 million resulted in a net cash outlay of $112 million. Of the purchase price, $75 million was preliminarily allocated to goodwill, $32 million to amortizable intangible assets, $17 million to tangible assets, $2 million to cash acquired, and $12 million to net assumed liabilities. 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. In connection with the acquisitions, the Company issued stock-based awards valued at $9 million, which is being recognized as stock-based compensation expense as the awards vest over a period of up to four years.

The Company’s business combinations completed during the six months ended June 30, 2010 did not have a material impact on the Company’s consolidated financial statements, and therefore pro forma disclosures have not been presented.

 

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Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Note 4 INVESTMENTS IN EQUITY INTERESTS

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

 

     December 31,
2009
   June 30,
2010
   Percent
Ownership of
Common Stock
 

Alibaba Group

   $ 2,167,007    $ 2,205,669    43

Yahoo Japan

     1,329,281      1,395,842    35
                

Total

   $ 3,496,288    $ 3,601,511   
                

Equity Investment in Alibaba Group. The investment in Alibaba Group Holding Limited (“Alibaba Group”) is 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 Group, and its consolidated subsidiaries, and any related amortization expense, one quarter in arrears, within earnings in equity interests in the condensed consolidated statements of income.

As of June 30, 2010, the difference between the Company’s carrying value of its investment in Alibaba Group and its proportionate share of Alibaba Group’s stockholders’ equity is summarized as follows (in thousands):

 

Carrying value of investment in Alibaba Group

   $ 2,205,669

Proportionate share of Alibaba Group stockholders’ equity

     1,568,767
      

Excess of carrying value of investment over proportionate share of Alibaba Group’s stockholders’ equity(*)

   $ 636,902
      

 

(*)

The excess carrying value has been primarily assigned to goodwill.

The following tables present Alibaba Group’s U.S. GAAP condensed financial information, as derived from the Alibaba Group consolidated financial statements (in thousands):

 

     Three Months Ended    Six Months Ended  
     March 31,
2009
    March 31,
2010
   March 31,
2009
    March 31,
2010
 

Operating data:

         

Revenue

   $ 156,628      $ 281,955    $ 309,276      $ 555,767   

Gross profit

   $ 115,122      $ 207,189    $ 218,615      $ 420,074   

Income (loss) from operations(*)

   $ 1,934      $ 35,548    $ (43,676   $ (133,574

Net income (loss)

   $ 4,545      $ 45,013    $ (46,459   $ (100,212

Net (loss) income attributable to Alibaba Group

   $ (5,423   $ 32,060    $ (64,511   $ (124,636
                September 30,
2009
    March 31,
2010
 

Balance sheet data:

         

Current assets

        $ 3,191,097      $ 3,848,578   

Long-term assets

        $ 2,308,099      $ 2,252,401   

Current liabilities

        $ 1,559,975      $ 2,179,753   

Long-term liabilities

        $ 25,815      $ 48,913   

Noncontrolling interests

        $ 185,055      $ 225,207   

 

(*)

The loss from operations of $134 million for the six months ended March 31, 2010 is primarily due to Alibaba Group’s impairment loss of $192 million on goodwill related to the business that Yahoo! contributed to Alibaba Group. This impairment does not impact Yahoo!’s earnings in equity interests as Yahoo!’s investment balance related to this contributed business was carried over at cost and therefore Yahoo! has no basis in the impaired goodwill.

The Company also has commercial arrangements with Alibaba Group to provide technical, development, and advertising services. For the three and six months ended June 30, 2009 and 2010, these transactions were not material.

Equity Investment in Yahoo Japan. The investment in Yahoo Japan Corporation (“Yahoo Japan”) is 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 Yahoo Japan, and its consolidated subsidiaries, and any related amortization expense, one quarter in arrears, within earnings in equity interests in the condensed consolidated statements of income.

 

9


Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Differences between U.S. GAAP and accounting principles generally accepted in Japan (“Japanese GAAP”), the standards by which Yahoo Japan’s financial statements are prepared, did not materially impact the amounts reflected in the Company’s condensed consolidated financial statements. The Company does, however, make adjustments to the earnings in equity interests line in the condensed consolidated statements of income for any differences between U.S. GAAP and Japanese GAAP.

The fair value of the Company’s ownership interest in the common stock of Yahoo Japan, based on the quoted stock price, was approximately $8 billion as of June 30, 2010.

During the three months ended June 30, 2009 and 2010, the Company received cash dividends from Yahoo Japan in the amounts of $26 million and $61 million, net of taxes, respectively, which were recorded as reductions to the Company’s investment in Yahoo Japan.

The following tables present summarized financial information derived from Yahoo Japan’s consolidated financial statements, which are prepared on the basis of Japanese GAAP. The Company has made adjustments to the Yahoo Japan financial information to address differences between Japanese GAAP and U.S. GAAP that materially impact the summarized financial information below. Due to these adjustments, the Yahoo Japan summarized financial information presented below is not materially different than such information presented on the basis of U.S. GAAP.

 

     Three Months Ended    Six Months Ended
     March 31,
2009
   March 31,
2010
   March 31,
2009
   March 31,
2010
     (in thousands)

Operating data:

  

Revenue

   $ 803,611    $ 896,822    $ 1,582,258    $ 1,790,717

Gross profit

   $ 681,792    $ 720,102    $ 1,339,770    $ 1,454,038

Income from operations

   $ 380,281    $ 426,552    $ 724,586    $ 832,212

Net income

   $ 200,770    $ 258,877    $ 401,286    $ 492,805

Net income attributable to Yahoo Japan

   $ 199,840    $ 257,379    $ 398,549    $ 489,625
               September 30,
2009
   March 31,
2010
               (in thousands)

Balance sheet data:

        

Current assets

         $ 1,599,624    $ 2,193,611

Long-term assets

         $ 2,395,863    $ 2,318,512

Current liabilities

         $ 997,722    $ 1,138,856

Long-term liabilities

         $ 3,556    $ 4,520

Noncontrolling interests

         $ 26,662    $ 24,456

 

Through its commercial arrangement with Yahoo Japan, the Company provides advertising and search marketing services to Yahoo Japan for a service fee. Under this arrangement, the Company records marketing services revenue from Yahoo Japan for the provision of search marketing services based on a percentage of advertising revenue earned by Yahoo Japan for the delivery of sponsored search results. In addition, the Company recognizes revenue from license fees received from Yahoo Japan. These arrangements resulted in revenue of approximately $73 million and $76 million for the three months ended June 30, 2009 and 2010, respectively, and revenue of approximately $148 million and $150 million, respectively, for the six months ended June 30, 2009 and 2010. As of both December 31, 2009 and June 30, 2010, the Company had a net receivable balance from Yahoo Japan of approximately $41 million.

Note 5 GOODWILL

The Company’s goodwill balance was $3.6 billion as of December 31, 2009, of which $2.6 billion was recorded in the Americas segment, $0.6 billion in the EMEA segment, and $0.4 billion in the Asia Pacific segment. The change in the carrying amount of goodwill for the six months ended June 30, 2010 was primarily due to the addition of $75 million related to acquisitions in the Americas segment, foreign currency translation losses of $55 million, and a reduction of $19 million related to the allocation of goodwill for the February 2010 sale of Zimbra, Inc., an acquisition made by the Company in October 2007. As of June 30, 2010, the Company’s goodwill balance was $3.6 billion, of which $2.7 billion was recorded in the Americas segment, $0.5 billion in the EMEA segment, and $0.4 billion in the Asia Pacific segment.

 

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Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Note 6 INTANGIBLE ASSETS, NET

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

 

     December 31, 2009    June 30, 2010
     Net    Gross Carrying
Amount
   Accumulated
Amortization(*)
    Net

Customer and advertiser related relationships

   $ 83,232    $ 134,984    $ (66,470   $ 68,514

Developed technology and patents

     239,285      400,352      (209,062     191,290

Trade names, trademarks, and domain names

     33,366      76,628      (48,150     28,478
                            

Total intangible assets, net

   $ 355,883    $ 611,964    $ (323,682   $ 288,282
                            

 

(*)

Foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities, totaled approximately $13 million as of June 30, 2010.

For the three months ended June 30, 2009 and 2010, the Company recognized amortization expense for intangible assets of $59 million and $32 million, respectively, including $50 million in cost of revenue for the three months ended June 30, 2009 and $25 million in cost of revenue for the three months ended June 30, 2010. For the six months ended June 30, 2009 and 2010, the Company recognized amortization expense for intangible assets of $106 million and $68 million, respectively, including $87 million in cost of revenue for the six months ended June 30, 2009 and $52 million in cost of revenue for the six months ended June 30, 2010. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2010 and each of the succeeding years is as follows: six months ending December 31, 2010: $57 million; 2011: $95 million; 2012: $68 million; 2013: $31 million; 2014: $16 million; 2015: $4 million; and cumulatively thereafter: $2 million.

Note 7 OTHER INCOME, NET

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

 

     Three Months Ended    Six Months Ended
     June 30,
2009
   June 30,
2010
   June 30,
2009
    June 30,
2010

Interest and investment income

   $ 4,640    $ 5,837    $ 11,488      $ 12,180

Gain on sale of marketable equity securities

     66,684      —        66,684        —  

Gain on sale of Zimbra, Inc

     —        —        —          66,130

Other

     686      6,751      (1,202     20,606
                            

Total other income, net

   $ 72,010    $ 12,588    $ 76,970      $ 98,916
                            

Interest and investment income consists of income earned from cash in bank accounts and investments made in marketable debt securities and money market funds.

Gain on sale of marketable equity securities includes gains from sales of investments in publicly traded companies. In May 2009, the Company sold all of its Gmarket shares for net proceeds of $120 million. The Company recorded a pre-tax gain of $67 million.

In February 2010, the Company sold Zimbra, Inc., an acquisition the Company made in October 2007, for net proceeds of $100 million. The Company recorded a pre-tax gain of $66 million.

Other consists of foreign exchange gains and losses due to re-measurement of monetary assets and liabilities denominated in non-functional currencies, gains/losses from sales of marketable debt securities and/or investments in privately held companies, and other non-operating items.

Note 8 COMPREHENSIVE INCOME

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2009
    June 30,
2010
    June 30,
2009
    June 30,
2010
 

Net income

   $ 143,040      $ 216,143      $ 261,735      $ 528,422   

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

     (7,073     4,702        (7,401     5,748   

Foreign currency translation adjustments

     15,653        (111,471     97,769        (170,701
                                

Other comprehensive income

     8,580        (106,769     90,368        (164,953
                                

Comprehensive income

     151,620        109,374        352,103        363,469   

Comprehensive income attributable to noncontrolling interests

     (1,653     (2,822     (2,790     (4,910
                                

Comprehensive income attributable to Yahoo! Inc.

   $ 149,967      $ 106,552      $ 349,313      $ 358,559   
                                

 

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YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

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

 

     December 31,
2009
   June 30,
2010

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

   $ 4,921    $ 10,669

Foreign currency translation, net of tax

     364,315      193,614
             

Accumulated other comprehensive income

   $ 369,236    $ 204,283
             

Note 9 INVESTMENTS

The following tables summarize the investments in available-for-sale securities (in thousands):

 

     December 31, 2009
   Gross
Amortized
Costs
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair Value

Government and agency securities

   $ 1,781,674    $ 868    $ (1,825 )   $ 1,780,717

Municipal bonds

     465,823      739      (3 )     466,559

Corporate debt securities, commercial paper, and bank certificates of deposit

     995,291      1,305      (1,298 )     995,298

Corporate equity securities

     2,597      —        —          2,597
                            

Total investments in available-for-sale securities

   $ 3,245,385    $ 2,912    $ (3,126 )   $ 3,245,171
                            

 

     June 30, 2010
   Gross
Amortized
Costs
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair Value

Government and agency securities

   $ 1,515,717    $ 2,293    $ (188   $ 1,517,822

Municipal bonds

     215,092      153      (10     215,235

Corporate debt securities, commercial paper, and bank certificates of deposit

     882,980      1,422      (1,856     882,546

Corporate equity securities

     2,597      —        (1,507     1,090
                            

Total investments in available-for-sale securities

   $ 2,616,386    $ 3,868    $ (3,561   $ 2,616,693
                            
               December 31,
2009
    June 30,
2010

Reported as:

          

Short-term marketable debt securities

         $ 2,015,655      $ 1,576,276

Long-term marketable debt securities

           1,226,919        1,039,327

Other assets

           2,597        1,090
                    

Total

         $ 3,245,171      $ 2,616,693
                    

Available-for-sale securities included in cash and cash equivalents on the condensed consolidated balance sheets are not included in the table above as the gross unrealized gains and losses were immaterial for both 2009 and the six months ended June 30, 2010 as the carrying value approximates fair value because of the short maturity of those instruments.

The contractual maturities of available-for-sale marketable debt securities were as follows (in thousands):

 

     December 31,
2009
   June 30,
2010

Due within one year

   $ 2,015,655    $ 1,576,276

Due after one year through five years

     1,226,919      1,039,327
             

Total available-for-sale marketable debt securities

   $ 3,242,574    $ 2,615,603
             

 

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Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

The following tables show all investments in an unrealized loss position for which an other-than-temporary impairment has not been recognized and the related gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):

 

     December 31, 2009  
   Less than 12 Months     12 Months or Greater    Total  
   Fair
Value
   Unrealized
Loss
    Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 

Government and agency securities

   $ 886,657    $ (1,825   $ —      $ —      $ 886,657    $ (1,825

Municipal bonds

     8,760      (3     —        —        8,760      (3

Corporate debt securities and commercial paper

     352,031      (1,298     —        —        352,031      (1,298
                                            

Total investments in available-for-sale securities

   $ 1,247,448    $ (3,126   $ —      $ —      $ 1,247,448    $ (3,126
                                            

 

     June 30, 2010  
   Less than 12 Months     12 Months or Greater    Total  
   Fair
Value
   Unrealized
Loss
    Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 

Government and agency securities

   $ 241,284    $ (188   $ —      $ —      $ 241,284    $ (188

Municipal bonds

     20,358      (10     —        —        20,358      (10

Corporate debt securities and commercial paper

     306,814      (1,856     —        —        306,814      (1,856

Corporate equity securities

     1,090      (1,507     —        —        1,090      (1,507
                                            

Total investments in available-for-sale securities

   $ 569,546    $ (3,561   $ —      $ —      $ 569,546    $ (3,561
                                            

The Company’s investment portfolio consists of liquid high-quality fixed income government, agency, municipal, and corporate debt securities, money market funds, and time deposits with financial institutions. 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. Fixed income securities may have their fair market value adversely impacted due to a deterioration of the credit quality of the issuer. The longer the term of the securities, the more susceptible they are to changes in market rates. Investments are reviewed periodically to identify possible other-than-temporary impairment. The Company has no current requirement or intent to sell these securities. The Company expects to recover up to (or beyond) the initial cost of investment for securities held.

The FASB’s authoritative guidance on fair value measurements establishes a framework for measuring fair value and requires disclosures about fair value measurements by establishing a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

Basis of Fair Value Measurement

 

Level 1    Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2    Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3    Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

 

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Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

The following table sets forth the financial assets, measured at fair value, by level within the fair value hierarchy as of December 31, 2009 (in thousands):

 

     Fair Value Measurements at Reporting Date Using

Assets

   Level 1    Level 2    Total

Money market funds(1)

   $ 364,602    $ —      $ 364,602

Available-for-sale securities:

        

Government and agency securities(1)

     —        1,938,608      1,938,608

Municipal bonds(1)

     —        470,031      470,031

Commercial paper and bank certificates of deposit(1)

     —        445,786      445,786

Corporate debt securities(1)

     —        641,104      641,104
                    

Available-for-sale securities at fair value

   $ 364,602    $ 3,495,529    $ 3,860,131

Corporate equity securities(2)

     2,597      —        2,597
                    

Total assets at fair value

   $ 367,199    $ 3,495,529    $ 3,862,728
                    

 

(1)

The money market funds, Government and agency securities, municipal bonds, commercial paper and bank certificates of deposit, and corporate debt securities are classified as part of either cash and cash equivalents or investments in marketable debt securities in the condensed consolidated balance sheets.

(2)

The corporate equity securities are classified as part of other long-term assets in the condensed consolidated balance sheets.

The amount of cash and cash equivalents as of December 31, 2009 includes $658 million in cash deposited with commercial banks, of which $205 million are time deposits.

The following table sets forth the financial assets, measured at fair value, by level within the fair value hierarchy as of June 30, 2010 (in thousands):

 

     Fair Value Measurements at Reporting Date Using

Assets

   Level 1    Level 2    Total

Money market funds(1)

   $ 293,090    $ —      $ 293,090

Available-for-sale securities:

        

Government and agency securities(1)

     —        1,550,914      1,550,914

Municipal bonds(1)

     —        215,235      215,235

Commercial paper and bank certificates of deposit(1)

     —        267,718      267,718

Corporate debt securities(1)

     —        692,268      692,268
                    

Available-for-sale securities at fair value

   $ 293,090    $ 2,726,135    $ 3,019,225

Corporate equity securities(2)

     1,090      —        1,090
                    

Total assets at fair value

   $ 294,180    $ 2,726,135    $ 3,020,315
                    

 

(1)

The money market funds, Government and agency securities, municipal bonds, commercial paper and bank certificates of deposit, and corporate debt securities are classified as part of either cash and cash equivalents or investments in marketable debt securities in the condensed consolidated balance sheets.

(2)

The corporate equity securities are classified as part of other long-term assets in the condensed consolidated balance sheets.

The amount of cash and cash equivalents as of June 30, 2010 includes $780 million in cash deposited with commercial banks, of which $298 million are time deposits.

The fair values of the Company’s Level 1 financial assets are based on quoted market prices of the identical underlying security. The fair values of the Company’s Level 2 financial assets are obtained from readily-available pricing sources for the identical underlying security that may not be actively traded. The Company utilizes a pricing service to assist in obtaining fair value pricing for the majority of this investment portfolio. The Company conducts reviews on a quarterly basis to verify pricing, assess liquidity, and determine if significant inputs have changed that would impact the fair value hierarchy disclosure. During the six months ended June 30, 2010, the Company did not make significant transfers between Level 1 and Level 2 assets. As of December 31, 2009 and June 30, 2010, the Company did not have any significant Level 3 financial assets.

Note 10 STOCKHOLDERS’ EQUITY AND EMPLOYEE BENEFITS

Employee Stock Purchase Plan. As of June 30, 2010, there was $5 million of unamortized stock-based compensation cost related to the Company’s employee stock purchase plan which is expected to be recognized over a weighted average period of 0.4 years.

 

14


Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Stock Options. The Company’s 1995 Stock Plan, the Directors’ Plan, and other stock-based award plans assumed through acquisitions are collectively referred to as the “Plans.” Stock option activity under the Company’s Plans for the six months ended June 30, 2010 is summarized as follows (in thousands, except per share amounts):

 

     Shares     Weighted Average
Exercise Price per
Share

Outstanding at December 31, 2009

   119,593      $ 25.74

Options granted

   6,914      $ 15.28

Options exercised(*)

   (2,724   $ 10.45

Options expired

   (11,013   $ 45.29

Options cancelled/forfeited

   (5,289   $ 18.65
        

Outstanding at June 30, 2010

   107,481      $ 23.80
        

 

(*)

The Company issued new shares to satisfy stock option exercises.

As of June 30, 2010, there was $155 million of unrecognized stock-based compensation cost related to unvested stock options which is expected to be recognized over a weighted average period of 2.1 years.

The Company determines the grant-date fair value of stock options, including the options granted under the Company’s employee stock purchase plan, using a Black-Scholes model, unless the options are subject to market conditions, in which case the Company uses a Monte Carlo simulation model. The Monte Carlo simulation model utilizes multiple input variables to estimate the probability that market conditions will be achieved. The following weighted average assumptions were used in determining the fair value of option grants using the Black-Scholes option pricing model:

 

     Stock Options     Purchase Plan  
     Three Months Ended     Three Months Ended  
     June 30,
2009
    June 30,
2010
    June 30,
2009
    June 30,
2010
 

Expected dividend yield

   0.0   0.0   0.0   0.0

Risk-free interest rate

   2.0   2.2   3.3   2.3

Expected volatility

   48.4   36.7   52.5   68.1

Expected life (in years)

   4.00      4.50      1.50      0.36   

 

     Stock Options     Purchase Plan  
     Six Months Ended     Six Months Ended  
     June 30,
2009
    June 30,
2010
    June 30,
2009
    June 30,
2010
 

Expected dividend yield

   0.0   0.0   0.0   0.0

Risk-free interest rate

   1.8   2.2   2.9   2.3

Expected volatility

   52.8   34.0   62.1   68.9

Expected life (in years)

   4.00      4.50      1.32      0.44   

Restricted stock awards and restricted stock units activity for the six months ended June 30, 2010 is summarized as follows (in thousands, except per share amounts):

 

     Shares     Weighted
Average Grant
Date Fair

Value

Awarded and unvested at December 31, 2009(*)

   26,189      $ 21.14

Granted(*)

   14,481      $ 15.59

Vested

   (6,765   $ 22.21

Forfeited

   (3,095   $ 17.67
        

Awarded and unvested at June 30, 2010(*)

   30,810      $ 18.64
        

 

(*)

Includes the maximum number of shares issuable under the Company’s performance-based executive incentive restricted stock unit awards.

As of June 30, 2010, there was $268 million of unrecognized stock-based compensation cost related to unvested restricted stock awards and restricted stock units which is expected to be recognized over a weighted average period of 2.5 years.

During the six months ended June 30, 2010, 6.8 million shares subject to previously granted restricted stock awards and restricted stock units vested. A majority of these vested restricted stock awards and restricted stock units were net share settled. The Company withheld 2.5 million shares based upon the Company’s closing stock price on the vesting date to settle the employees’ minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities.

 

15


Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Total payments for the employees’ tax obligations to the relevant taxing authorities were $41 million for the six months ended June 30, 2010 and are reflected as a financing activity within the condensed consolidated statements of cash flows. The payments were used for tax withholdings related to the net share settlements of restricted stock units and tax withholding-related reacquisition of shares of restricted stock. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.

During the six months ended June 30, 2009, 5.8 million shares subject to previously granted restricted stock awards and restricted stock units vested. A majority of these vested restricted stock awards and restricted stock units were net share settled. The Company withheld 2 million shares based upon the Company’s closing stock price on the vesting date to settle the employees’ minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities.

Total payments for the employees’ tax obligations to the relevant taxing authorities were $27 million for the six months ended June 30, 2009 and are reflected as a financing activity within the condensed consolidated statements of cash flows. Upon the vesting of shares of certain restricted stock awards, 0.2 million shares were reacquired by the Company to satisfy the related tax withholding obligations and $2 million was recorded as treasury stock. Payments of $25 million related to the net share settlement of 2 million restricted stock units had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.

Performance-Based Executive Incentive Restricted Stock Units. In February 2009, the Compensation Committee approved long-term performance-based incentive equity awards to Ms. Bartz and other senior officers, including two types of restricted stock units that vest based on the Company’s achievement of certain performance goals. For both types of restricted stock units, the number of shares which ultimately vest will range from 0 percent to 200 percent of the target amount stated in each executive’s award agreement based on the performance of the Company relative to the applicable performance target. The first type of restricted stock unit generally will vest on the third anniversary of the grant date based on the Company’s attainment of certain annual financial performance targets as well as the executive’s continued employment through that vesting date. The annual financial performance targets are established at the beginning of each fiscal year and, accordingly, the tranche of the award subject to each annual target is treated as a separate annual grant for accounting purposes. The fair value of each of the 2009 tranche and the 2010 tranche of the February 2009 annual financial performance restricted stock unit grant was $3 million. Based on the Company’s relative attainment of the 2009 performance target, 75 percent of the target amount of the 2009 tranche shares will vest, provided each executive remains employed through the third anniversary of the grant date. For accounting purposes, the 2009 and 2010 tranches are being recognized as stock-based compensation expense over a three- and two-year service period, respectively. The second type of restricted stock unit generally will vest following the third anniversary of the grant date based on the Company’s attainment of certain levels of total stockholder return relative to the returns for the NASDAQ 100 Index companies as well as the executive’s continued employment through that vesting date. The fair value of these restricted stock units is $13 million and is being recognized as stock-based compensation expense over a three-year service period.

Separately in February 2010, the Compensation Committee approved additional long-term performance-based incentive equity awards to Ms. Bartz and other senior officers, including two types of restricted stock units that vest based on the Company’s achievement of certain performance goals. For both types of restricted stock units, the number of shares which ultimately vest will range from 0 percent to 200 percent of the target amount stated in each executive’s award agreement based on the performance of the Company relative to the applicable performance target. The first type of restricted stock unit generally will vest on the third anniversary of the grant date based on the Company’s attainment of certain annual financial performance targets as well as the executive’s continued employment through that vesting date. The annual financial performance targets are established at the beginning of each fiscal year and, accordingly, the portion of the award subject to each annual target is treated as a separate annual grant for accounting purposes. The amount of stock-based compensation recorded for the first type of restricted stock unit will vary depending on the Company’s attainment of annual financial performance targets and the completion of the service period. The fair value of the 2010 tranche of the February 2010 annual financial performance restricted stock unit grant is $4 million and is being recognized as stock-based compensation expense over a three-year service period. The second type of restricted stock unit generally will vest following the third anniversary of the grant date based on the Company’s attainment of certain levels of total stockholder return relative to the returns for the NASDAQ 100 Index companies as well as the executive’s continued employment through that vesting date. The fair value of these restricted stock units is $15 million and is being recognized as stock-based compensation expense over a three-year service period.

Stock Repurchases. During the six months ended June 30, 2010, the Company repurchased approximately 56.7 million shares of its common stock under the stock repurchase program announced in October 2006 at an average price of $15.55 per share for a total of $881 million. On June 24, 2010, the Company’s Board of Directors approved a new stock repurchase program. Under the new program, which expires in June 2013, the Company is authorized to repurchase up to $3 billion of its outstanding shares of common stock from time to time. The 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. No purchases were made under the new program during the six months ended June 30, 2010. See Note 16 - “Subsequent Events” for share repurchase activity subsequent to June 30, 2010.

 

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YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Note 11 COMMITMENTS AND CONTINGENCIES

Lease Commitments. The Company leases office space and data centers under operating lease and capital lease agreements with original lease periods of up to 13 years, expiring between 2010 and 2019.

During the second quarter of 2010, the Company acquired certain office space for a total of $72 million ($7 million in cash and the assumption of $65 million in debt). In the first quarter of 2010, the property was reclassified from an operating lease to a capital lease as a result of a commitment to purchase the property. Accordingly, in the second quarter the Company reduced the capital lease obligation for the $7 million cash outlay and reclassified the remaining $65 million as assumed debt in its condensed consolidated balance sheets.

A summary of gross and net lease commitments as of June 30, 2010 is as follows (in millions):

 

     Gross Operating
Lease
Commitments
   Sublease
Income
    Net Operating
Lease
Commitments
 

Six months ending December 31, 2010

   $ 80    $ (3   $ 77   

Years ending December 31,

       

2011

     153      (7     146   

2012

     125      (5     120   

2013

     106      (4     102   

2014

     85      (4     81   

2015

     69      (2     67   

Due after 5 years

     70      —          70   
                       

Total gross and net lease commitments

   $ 688    $ (25   $ 663   
                       
                Capital Lease
Commitment
 

Six months ending December 31, 2010

        $ 4   

Years ending December 31,

       

2011

          7   

2012

          7   

2013

          8   

2014

          8   

2015

          8   

Due after 5 years

          30   
             

Gross lease commitment

        $ 72   
             

Less: interest

          (31
             

Net lease commitment

        $ 41   
             

Affiliate Commitments. In connection with contracts to provide advertising services to Affiliates, the Company is obligated to make payments, which represent TAC, to its Affiliates. As of June 30, 2010, these commitments totaled $166 million, of which $67 million will be payable in the remainder of 2010, $90 million will be payable in 2011, $6 million will be payable in 2012, and $3 million will be payable in 2013.

Intellectual Property Rights. The Company is committed to make certain payments under various intellectual property arrangements of up to $39 million through 2023.

Other Commitments. In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, joint ventures and business partners, purchasers of assets or subsidiaries and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of agreements or representations and warranties made by the Company, services to be provided by the Company, intellectual property infringement claims made by third parties or, with respect to the sale of assets or a subsidiary, matters related to the Company’s conduct of the business and tax matters prior to the sale. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The Company has also agreed to indemnify certain former officers, directors, and employees of acquired companies in connection with the acquisition of such companies. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers, and former directors and officers of acquired companies, in certain circumstances. It is not possible to determine the aggregate 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 might not be subject to maximum loss clauses. Historically, the Company has not incurred material costs as a result of obligations under these agreements and it has not accrued any liabilities related to such indemnification obligations in its condensed consolidated financial statements.

 

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YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Contingencies. From time to time, third parties assert patent infringement claims against Yahoo!. Currently, the Company is engaged in lawsuits regarding patent issues and has been notified of other potential patent disputes. In addition, from time to time, the Company is 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, invasion of privacy, or similar claims arising in connection with the Company’s e-mail, message boards, photo and video sites, auction sites, shopping services, and other communications and community features.

On July 12, 2001, the first of several purported securities class action lawsuits was filed in the U.S. District Court for the Southern District of New York against certain underwriters involved in Overture Services Inc.’s (“Overture”) IPO, Overture, and certain of Overture’s 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 (the “Exchange Act”) 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 IPOs of their common stock since the mid-1990s. All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin. On April 1, 2009, the parties filed a motion with the Court for preliminary approval of a stipulated global settlement. On October 5, 2009, the Court granted class certification and granted final approval of the settlement and plan of allocation. Notices of appeal have been filed with the U.S. Court of Appeals for the Second Circuit.

On June 14, 2007, a stockholder derivative action was filed in the U.S. District Court for the Central District of California by Jill Watkins against members of the Board and selected officers. The complaint filed by the plaintiff alleged breaches of fiduciary duties and corporate waste, similar to the allegations in the former Brodsky/Hacker class action litigation relating to stock price declines during the period April 2004 to July 2006, and alleged violation of Section 10(b) of the Exchange Act. On July 16, 2009, the plaintiff Watkins voluntarily dismissed the action against all defendants without prejudice. On July 17, 2009, plaintiff Miguel Leyte-Vidal, who had previously substituted in as plaintiff prior to the dismissal of the federal Watkins action, re-filed a shareholder derivative action in Santa Clara County Superior Court against members of the Board and selected officers. The Santa Clara County Superior Court derivative action purports to assert causes of action on behalf of the Company for violation of specified provisions of the California Corporations Code, for breaches of fiduciary duty regarding financial accounting and insider selling and for unjust enrichment. The Court sustained Yahoo!’s demurrer, which challenged the sufficiency of the claim. Plaintiff filed an amended complaint on June 21, 2010. The Yahoo! defendants refiled demurrers to the amended complaint on July 23, 2010.

Plaintiff Congregation Beth Aaron voluntarily dismissed an action filed in Santa Clara County Superior Court and on December 3, 2008 re-filed in the U.S. District Court for the Northern District of California alleging claims for breach of fiduciary duty and corporate waste in connection with Yahoo!’s consideration of proposals by Microsoft Corporation to purchase all or a part of Yahoo! in 2008, adoption of severance plans, and the June 12, 2008 agreement between Google Inc. and Yahoo!. Plaintiff filed an amended complaint on February 20, 2009. The complaint also alleges claims under Section 14(a) of the Exchange Act for alleged false statements or omissions in Yahoo!’s June 9, 2008 proxy statement regarding the severance plans and for control person liability under Section 20(a) of the Exchange Act, and also alleges that the defendants’ decision to settle similar Microsoft-related Delaware lawsuits constituted an independent breach of fiduciary duty. The complaint seeks unspecified compensatory damages, injunctive relief, and an award of plaintiffs’ attorneys’ fees and costs. On June 15, 2009, the Court granted defendants’ motion to dismiss all of Congregation Beth Aaron’s claims without leave to amend, which the Congregation has since appealed to the U.S. Court of Appeals for the Ninth Circuit.

While the outcome of the unsettled matters is currently not determinable, the Company does not believe, based on current knowledge, that any of the foregoing legal proceedings or claims is likely to have a material adverse effect on its financial position, results of operations, or cash flows. In the event of a determination adverse to Yahoo!, its subsidiaries, directors, or officers, in these matters, however, the Company may incur substantial monetary liability, and be required to change its business practices. Either of these could have a material adverse effect on the Company’s financial position, results of operations, or cash flows. The Company may also incur substantial expenses in defending against these claims.

Note 12 SEGMENTS

The Company manages its business geographically. Through the first quarter of 2010, the primary areas of measurement and decision-making were the U.S. and International. Beginning in the second quarter of 2010, the business management structure of the Company was redefined along three geographies: Americas, EMEA (Europe, Middle East, and Africa), and Asia Pacific. Prior period presentations have been updated to conform to the segments currently being used by management to evaluate the operational performance of the Company.

In the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, the segment profitability measure reported by the Company was segment operating income before depreciation, amortization, and stock-based compensation expense. Management no longer uses this measure to evaluate the operational performance of the Company’s segments. Beginning in the first quarter of 2010, management relies on an internal reporting process that provides revenue and direct costs by segment and consolidated income from operations for making decisions related to the evaluation of the financial performance of, and allocating resources to, the Company’s segments. Prior period presentations have been updated to conform to the current profitability measures being used by management to evaluate the financial performance of the Company’s segments.

 

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YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

The following tables present summarized information by segment (in thousands):

 

     Three Months Ended    Six Months Ended
     June 30,
2009
   June 30,
2010
   June 30,
2009
   June 30,
2010

Revenue by segment:

           

Americas

   $ 1,186,086    $ 1,133,216    $ 2,401,694    $ 2,288,228

EMEA

     150,244      140,513      296,971      282,338

Asia Pacific

     236,567      327,650      454,274      627,773
                           

Total revenue

     1,572,897      1,601,379      3,152,939      3,198,339

Direct costs by segment(1):

           

Americas

     441,318      427,405      891,350      854,056

EMEA

     87,808      80,429      169,174      164,621

Asia Pacific

     122,927      176,765      233,754      342,596

Global operating costs(2)

     469,823      515,789      993,861      1,017,613

Restructuring charges, net

     65,002      10,052      69,803      14,464

Depreciation and amortization

     197,740      157,970      379,313      323,216

Stock-based compensation expense

     112,526      57,597      239,246      118,380
                           

Income from operations

   $ 75,753    $ 175,372    $ 176,438    $ 363,393
                           

 

(1)       Direct costs for each segment include TAC, other cost of revenue, and other operating expenses that are directly attributable to the segment such as employee compensation expense (excluding stock-based compensation expense), local sales and marketing expenses, and facilities expenses.

(2)       Global operating costs include product development, service engineering and operations, marketing, customer advocacy, general and administrative, and other corporate expenses that are managed on a global basis and that are not directly attributable to any segment.

     Three Months Ended      Six Months Ended
    

 

June 30,

2009

    

 

June 30,

2010

    

 

June 30,

2009

    

 

June 30,

2010

Capital expenditures, net:

           

Americas

   $ 83,037    $ 147,551    $ 140,875    $ 239,350

EMEA

     3,870      23,560      11,399      35,131

Asia Pacific

     7,767      19,159      12,881      28,330
                           

Total capital expenditures, net

   $ 94,674    $ 190,270    $ 165,155    $ 302,811
                           

 

     December 31,
2009
   June 30,
2010

Property and equipment, net:

     

Americas

   $ 1,314,712    $ 1,389,294

EMEA

     40,311      56,075

Asia Pacific

     71,839      72,522
             

Total property and equipment, net

   $ 1,426,862    $ 1,517,891
             

The following table presents revenue for groups of similar services (in thousands):

 

     Three Months Ended    Six Months Ended
     June 30,
2009
   June 30,
2010
   June 30,
2009
   June 30,
2010

Marketing services:

           

Owned and Operated sites

   $ 858,160    $ 881,051    $ 1,730,063    $ 1,755,871

Affiliate sites

     519,690      557,421      1,030,968      1,105,119
                           

Marketing services

     1,377,850      1,438,472      2,761,031      2,860,990

Fees

     195,047      162,907      391,908      337,349
                           

Total revenue

   $ 1,572,897    $ 1,601,379    $ 3,152,939    $ 3,198,339
                           

 

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YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Note 13 INCOME TAXES

The effective tax rates for the three and six months ended June 30, 2010 were 36 percent and 26 percent, respectively, compared to 47 percent and 41 percent for the same periods in 2009. The effective tax rates for the three and six months ended June 30, 2010 differ from the statutory federal income tax rate of 35 percent due to the reduction of the Company’s reserves for tax uncertainties and the usage of loss carryforwards to offset the tax on the gain from sale of Zimbra, Inc. In addition to those recognized benefits, the effective tax rate differs from the statutory rate as a result of several factors, including state taxes, the effect of non-U.S. operations, and non-deductible stock-based compensation expense. The effective tax rates for the three and six months ended June 30, 2010 differed from the rates for the same periods in 2009 as a result of the same factors.

During the quarter ended June 30, 2010, the U.S. Internal Revenue Service (“IRS”) completed its field examination of the Company’s 2005 and 2006 tax returns and issued notices of proposed adjustment. The Company reached an agreement with the IRS in connection with several of the adjustments and adjusted its reserves accordingly. There are other proposed adjustments, including an intercompany transfer pricing matter which could have a significant impact on the Company’s tax liability in future years if not resolved favorably, that the Company has not agreed to and is contesting through the administrative process. The Company believes its existing reserves are adequate.

The Company’s gross amount of unrecognized tax benefits as of June 30, 2010 is $624 million, of which $464 million is recorded on the condensed consolidated balance sheets. In the six months ended June 30, 2010 the Company reached an agreement with the IRS in connection with several adjustments to prior years’ tax returns and this agreement resulted in a reduction to the Company’s gross unrecognized tax benefits of $312 million. Of this $312 million reduction in unrecognized tax benefits, $81 million resulted in an effective tax rate benefit during the six months ended June 30, 2010, $88 million was recorded as a deferred tax asset representing capital loss carryforwards and the remainder represents potential benefits that have been disallowed but which were not previously recorded as benefits nor used to reduce income taxes payable in prior periods. A full valuation allowance was immediately applied in connection with the recorded capital loss carryforwards as a result of the uncertainties related to their future use. The reduction to the gross unrecognized tax benefits has been partially offset by increases from current year tax positions. In total, the gross unrecognized tax benefits as of June 30, 2010 decreased by $270 million from the recorded balance as of December 31, 2009.

The Company is in various stages of the examination and appeals process in connection with all of its tax audits worldwide and it is difficult to determine when these examinations will be settled. In addition, the Company is working to complete a pre-filing agreement with the IRS for its 2009 U.S. Federal income tax return. As a result of all of the above, it is reasonably possible that over the next twelve-month period the Company may experience an increase or decrease in its unrecognized tax benefits. It is not possible to determine either the magnitude or range of any increase or decrease at this time.

Note 14 RESTRUCTURING CHARGES, NET

Restructuring charges, net was comprised of the following (in thousands):

 

     Three Months Ended    Six Months Ended
     June 30,
2009
    June 30,
2010
   June 30,
2009
    June 30,
2010

Employee severance pay and related costs

   $ 30,389      $ 692    $ 32,198      $ 950

Non-cancelable lease, contract termination, and other charges

     42,213        9,360      45,205        13,514
                             

Sub-total before reversal of stock-based compensation expense

     72,602        10,052      77,403        14,464

Reversal of stock-based compensation expense for forfeitures

     (7,600     —        (7,600     —  
                             

Restructuring charges, net

   $ 65,002      $ 10,052    $ 69,803      $ 14,464
                             

Although the Company does not allocate restructuring charges to its segments, the amounts of the restructuring charges relating to each segment are presented below.

Q4’08 Restructuring Plan. During the fourth quarter of 2008, the Company implemented certain cost reduction initiatives, including a workforce reduction and consolidation of certain real estate facilities. During the three and six months ended June 30, 2009, the Company incurred total pre-tax cash charges of approximately $42 million and $47 million, respectively, in severance, facility, and other restructuring costs related to the Q4’08 restructuring plan. Net charges under the Q4’08 restructuring plan relating to the Americas segment were $40 million and $46 million for the three and six months ended June 30, 2009, respectively. Net charges under the Q4’08 restructuring plan relating to the EMEA segment were $2 million and $1 million (which is net of a $1 million credit in the first quarter of 2009) for the three and six months ended June 30, 2009, respectively. During the three and six months ended June 30, 2010, the Company incurred total pre-tax cash charges of approximately $10 million and $14 million, respectively, in facility and other restructuring costs related to the Q4’08 restructuring plan. Net charges under the Q4’08 restructuring plan relating to the Americas segment were $9 million and $14 million for the three and six months ended June 30, 2010, respectively. Net charges under the Q4’08 restructuring plan relating to the EMEA segment were $1 million and $0 million (which is net of a $1 million credit in the first quarter of 2010) for the three and six months ended June 30, 2010, respectively.

 

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YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

Q2’09 Restructuring Plan. During the second quarter of 2009, the Company implemented new cost reduction initiatives to further reduce the Company’s worldwide workforce by approximately 5 percent. During the three and six months ended June 30, 2009, the Company incurred total pre-tax cash charges of approximately $31 million in severance and other related costs related to the Q2’09 restructuring plan. The pre-tax cash charges were offset by an $8 million reduction related to non-cash stock-based compensation expense reversals for unvested stock awards that were forfeited. Of the $23 million restructuring charges, net recorded in the three and six months ended June 30, 2009, $16 million related to the Americas segment, $6 million related to the EMEA segment, and $1 million related to the Asia Pacific segment. During the three and six months ended June 30, 2010, the Company did not incur any charges related to the Q2’09 restructuring plan.

Q4’09 Restructuring Charges. During the fourth quarter of 2009, the Company decided to close one of its EMEA facilities and began implementation of a workforce realignment at the facility to focus resources on its strategic initiatives. The Company plans to exit the facility in the third quarter of 2010. In connection with the strategic realignment efforts, an executive of one of the Company’s acquired businesses departed. During the three and six months ended June 30, 2010, the Company incurred total pre-tax cash charges of less than $1 million in severance and other related costs related to the Q4’09 restructuring charges, consisting of charges related to the EMEA segment.

Restructuring Accruals. As of December 31, 2009 and June 30, 2010, the aggregate outstanding restructuring liability related to the cost reduction initiatives was $79 million and $66 million, respectively. Of the $66 million restructuring liability as of June 30, 2010, $11 million relates to employee severance pay expenses which the Company expects to substantially pay out by the end of the second quarter of 2011, and $55 million relates to non-cancelable lease costs which the Company expects to pay over the terms of the related obligations, which extend to the second quarter of 2017.

The activity in the Company’s restructuring accruals for the six months ended June 30, 2010 is summarized as follows (in thousands):

 

     Q4’08
Restructuring
Plan
    Q2’09
Restructuring
Plan
    Q4’09
Restructuring
Charges
    Total  

Balance as of January 1, 2010

   $ 59,965      $ 4,302      $ 14,765      $ 79,032   

Employee severance pay and related costs

     361        225        767        1,353   

Non-cancelable lease, contract termination, and other charges

     15,636        —          —          15,636   

Other non-cash charges

     72        —          —          72   

Reversal of previous charges

     (2,194     (403     —          (2,597
                                

Restructuring charges, net for the six months ended June 30, 2010

   $ 13,875      $ (178   $ 767      $ 14,464   

Cash paid

     (18,707     (2,299     (4,166     (25,172

Non-cash adjustments

     226        (628     (1,949     (2,351
                                

Balance as of June 30, 2010

   $ 55,359      $ 1,197      $ 9,417      $ 65,973   
                                

Restructuring accruals by segment consisted of the following (in thousands):

 

     December 31,
2009
   June 30,
2010

Americas

   $ 52,860    $ 50,303

EMEA

     25,869      15,605

Asia Pacific

     303      65
             

Total restructuring accruals

   $ 79,032    $ 65,973
             

Note 15 SEARCH AGREEMENT WITH MICROSOFT CORPORATION

On December 4, 2009, the Company entered into a Search and Advertising Services and Sales Agreement (“Search Agreement”) with Microsoft Corporation (“Microsoft”) under which Microsoft will be the Company’s exclusive platform technology provider for algorithmic and paid search services and non-exclusive provider for contextual advertising. The Company also entered into a License Agreement with Microsoft. Under the License Agreement, Microsoft acquired an exclusive 10-year license to the Company’s core search technology and will have the ability to integrate this technology into its existing Web search platforms. The Company received regulatory clearance from both the U.S. Department of Justice and the European Commission on February 18, 2010 and commenced implementation of the Search Agreement on February 23, 2010. Under the Search Agreement, the Company will be the exclusive worldwide relationship sales force for both companies’ premium search advertisers, which include advertisers meeting certain spending or other criteria, advertising agencies that specialize in or offer search engine marketing services and their clients, and resellers and their clients seeking assistance with their paid search accounts. The term of the Search Agreement is 10 years from February 23, 2010, subject to earlier termination as provided in the Search Agreement.

 

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Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements—Continued

(unaudited)

 

During the first five years of the term of the Search Agreement, the Company will be entitled to receive 88 percent of the net revenue generated from Microsoft’s services on Yahoo! Properties (the “Revenue Share Rate”) and it will also be entitled to receive its share (at the Revenue Share Rate) of the net revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of net revenue is deducted. For new Affiliates during the term of the Search Agreement, and for all Affiliates after the first five years of such term, the Company will receive its share (at the Revenue Share Rate) of the net revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of net revenue and certain Microsoft costs are deducted. On the fifth anniversary of the date of implementation of the Search Agreement, Microsoft will have the option to terminate the Company’s sales exclusivity for premium search advertisers. If Microsoft exercises its option, the Revenue Share Rate will increase to 93 percent for the remainder of the term of the Search Agreement, unless the Company exercises its option to retain the Company’s sales exclusivity, in which case the Revenue Share Rate would be reduced to 83 percent for the remainder of the term. If Microsoft does not exercise such option, the Revenue Share Rate will be 90 percent for the remainder of the term of the Search Agreement.

Microsoft has agreed to reimburse the Company for certain transition costs up to an aggregate total of $150 million during the first three years of the Search Agreement. From February 23, 2010 until the applicable services are fully transitioned to Microsoft, Microsoft will also reimburse the Company for the costs of running its algorithmic and paid search services subject to specified exclusions and limitations. These search operating cost reimbursements and certain employee retention costs are separate from and in addition to the $150 million of transition cost reimbursement payments.

The global transition of the Company’s algorithmic and paid search platforms to Microsoft and migration of its paid search advertisers and publishers is expected to take up to 24 months from the date the Company commenced implementation and will be done on a market by market basis. The Company began reflecting reimbursements from Microsoft for transition costs and the cost of running its algorithmic and paid search services during the quarter ended March 31, 2010. Based on the Company’s current levels of revenue and operating expenses, it expects the Search Agreement, when fully implemented, to have a positive impact on its operating income and to result in capital expenditures savings.

The Company’s results for the three and six months ended June 30, 2010 reflect $86 million and $121 million, respectively, in search operating cost reimbursements from Microsoft under the Search Agreement. Search operating cost reimbursements are expected to continue in each quarter of 2010 at an estimated rate of $75 to $85 million per quarter. Search operating cost reimbursements will continue until the Company has fully transitioned to Microsoft’s search platform. As the Company transitions each market, search operating cost reimbursements will decline and the underlying expenses will be removed from our cost structure.

The Company’s results for the three and six months ended June 30, 2010 also reflect transition cost reimbursements from Microsoft under the Search Agreement, which were equal to the transition costs of $18 million and $42 million, respectively, incurred by Yahoo! related to the Search Agreement in 2010. In addition, in the six months ended June 30, 2010, $43 million was recorded for reimbursement of transition costs incurred in 2009, $15 million for employee retention costs incurred in 2010, and $5 million for employee retention costs incurred in 2009. The 2009 transition cost reimbursements were recorded in 2010 after regulatory clearance in the U.S. and Europe was received, implementation of the Search Agreement commenced, and Microsoft became obligated to make such payments. In the future, quarterly transition cost reimbursements are expected to continue to be roughly equal to quarterly transition costs.

Reimbursement receivables are recorded as the reimbursable costs are incurred and are applied against the operating expense categories in which the costs were incurred. As of June 30, 2010, a total of $226 million of reimbursable expenses had been incurred by the Company related to the Search Agreement. Of that amount, $151 million had been received from Microsoft and $75 million was classified as part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets as of June 30, 2010.

Note 16 SUBSEQUENT EVENTS

Stock Repurchase Transactions. Subsequent to June 30, 2010, the Company repurchased approximately 23.2 million shares of its common stock at an average price of $14.02 per share, for a total of $326 million. Of such repurchases, $92 million was under the October 2006 program and $234 million was under the June 2010 program.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

In addition to current and historical information, this Quarterly Report on Form 10-Q (“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:

 

   

expectations about revenue for marketing services and fees;

 

   

expectations about growth in users;

 

   

expectations about cost of revenue and operating expenses;

 

   

expectations about the amount of unrecognized tax benefits and the adequacy of our existing tax reserves;

 

   

anticipated capital expenditures;

 

   

expectations about the implementation and the financial and operational impacts of our search agreement with Microsoft;

 

   

impact of recent acquisitions on our business and evaluation of, and expectations for, possible acquisitions of, or investments in, businesses, products, and technologies; and

 

   

expectations about positive cash flow generation and existing cash, cash equivalents, and investments being sufficient to meet normal operating requirements.

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 II, Item 1A. “Risk Factors” of this Report. 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.

Overview

Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo!,” the “Company,” “we,” “us,” or “our”), attracts hundreds of millions of users every month through its innovative technology and engaging content and services, making it one of the most trafficked Internet destinations and a world class online media company. Yahoo!’s vision is to be the center of people’s online lives by delivering personally relevant, meaningful Internet experiences. To users, we provide online properties and services (“Yahoo! Properties” or our “Owned and Operated sites”). To advertisers, we provide a range of marketing services designed to reach and connect with users of our Owned and Operated sites, as well as with Internet users beyond Yahoo! Properties, through a distribution network of third-party entities (our “Affiliates”) that have integrated our advertising offerings into their Websites, referred to as Affiliate sites, or their other offerings. We believe that our marketing services enable advertisers to deliver highly relevant marketing messages to their target audiences.

We generate revenue by providing marketing services to advertisers across a majority of Yahoo! Properties and Affiliate sites. Our marketing services offerings include the display of graphical advertisements (“display advertising”), the display of text-based links to an advertiser’s Website (“search advertising”), listing-based services, and commerce-based transactions. Additionally, although many of the services we provide to users are free, we charge fees for a range of premium services.

Our offerings to users on Yahoo! Properties currently fall into four categories: Integrated Consumer Experiences, Applications (Communications and Communities), Search, and Media Products and Solutions. The majority of our offerings are available in more than 25 languages. We manage and measure our business geographically, principally the Americas, EMEA (Europe, Middle East, and Africa) and Asia Pacific.

As used below, “Page Views” is defined as our internal estimate of the total number of Web pages viewed by users on Owned and Operated sites. “Search” is defined as an online search query that may yield Internet search results ranked and sorted based on relevance to the user’s search query. “Sponsored search results” are a subset of the overall search results and provide links to paying advertisers’ Web pages. A “click-through” occurs when a user clicks on an advertiser’s link.

 

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Second Quarter Results

 

     Three Months Ended
June 30,
   Dollar
Change
   Six Months Ended
June 30,
    Dollar
Change
 

Operating Results

   2009    2010       2009     2010    
     (In thousands)  

Revenue

   $ 1,572,897    $ 1,601,379    $ 28,482    $ 3,152,939      $ 3,198,339      $ 45,400   

Income from operations

   $ 75,753    $ 175,372    $ 99,619    $ 176,438      $ 363,393      $ 186,955   
                    Six Months Ended
June 30,
    Dollar
Change
 

Cash Flow Results

   2009     2010    
     (In thousands)  

Net cash provided by operating activities

   $ 604,143      $ 490,564      $ (113,579

Net cash (used in) provided by investing activities

   $ (744,615   $ 253,213      $ 997,828   

Net cash provided by (used in) financing activities

   $ 111,620      $ (775,242   $ (886,862

Our revenue increased 2 percent and 1 percent for the three and six months ended June 30, 2010, respectively, compared to the same periods in 2009. This can be attributed to an increase in our marketing services revenue, offset by a decrease in our fees revenue. The increase in income from operations of $100 million and $187 million for the three and six months ended June 30, 2010, respectively, reflects a slight increase in revenue and a decrease in operating expenses of $41 million and $117 million for the three and six months ended June 30, 2010, respectively, compared to the same periods in 2009. The decrease in operating expenses is primarily attributable to decreases in stock-based compensation, restructuring charges, and depreciation and amortization expense.

Cash generated by operating activities is a measure of the cash productivity of our business model. Our operating activities in the six months ended June 30, 2010 generated adequate cash to meet our operating needs. Cash provided by investing activities in the six months ended June 30, 2010 included net proceeds from sales and maturities of marketable debt securities of $600 million and proceeds from the sale of a divested business of $100 million, offset by net capital expenditures of $303 million, and $112 million, net used for acquisitions. Cash used in financing activities included $881 million used in the direct repurchase of common stock and $41 million used for tax withholding payments related to the net share settlements of restricted stock units and tax withholding-related reacquisition of shares of restricted stock, offset by $84 million in proceeds from employee option exercises and employee stock purchases.

Search Agreement with Microsoft Corporation

Our results for the three and six months ended June 30, 2010 reflect $86 million and $121 million, respectively, in search operating cost reimbursements from Microsoft under our Search and Advertising Services and Sales Agreement (“Search Agreement”). Search operating cost reimbursements are expected to continue in each quarter of 2010 at an estimated rate of $75 to $85 million per quarter. Search operating cost reimbursements will continue until we have fully transitioned to Microsoft’s search platform. The global transition of the algorithmic and paid search platforms to Microsoft and migration of paid search advertisers and publishers is expected to take up to 24 months from February 23, 2010, the date we began implementing the Search Agreement, and will be done on a market by market basis. As we transition each market, search operating cost reimbursements will decline and the underlying expenses will be removed from our cost structure.

Our results for the three and six months ended June 30, 2010 also reflect transition cost reimbursements from Microsoft under the Search Agreement, which were equal to the transition costs of $18 million and $42 million, respectively, incurred by Yahoo! related to the Search Agreement in 2010. In addition, in the six months ended June 30, 2010, we recorded $43 million for reimbursement of transition costs incurred in 2009, $15 million for employee retention costs incurred in 2010, and $5 million for employee retention costs incurred in 2009. The 2009 transition cost reimbursements were recorded in 2010 after regulatory clearance in the U.S. and Europe was received, implementation of the Search Agreement commenced, and Microsoft became obligated to make such payments. In the future, quarterly transition cost reimbursements are expected to continue to be roughly equal to quarterly transition costs.

We record receivables for the reimbursements as costs are incurred and apply them against the operating expense categories in which the costs were incurred. As of June 30, 2010, we had incurred a total of $226 million of reimbursable expenses related to the Search Agreement. Of that amount, $151 million had been received from Microsoft, and $75 million was classified as part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets as of June 30, 2010.

We expect migration of our paid search advertisers and publishers to Microsoft’s platforms to start in late 2010 or early 2011 after sufficient testing and training has been conducted to enable our advertisers and publishers to transition with quality and without adverse impact to advertisers’ holiday season. We expect search revenue sharing to begin at that time. Based on our current levels of revenue and operating expenses, we expect the Search Agreement, when fully implemented, to have a positive impact on our operating income and to result in capital expenditures savings.

 

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See Note 15 – “Search Agreement with Microsoft Corporation” in the Notes to the condensed consolidated financial statements for additional information.

Results of Operations

Revenue. Revenue by groups of similar services was as follows (dollars in thousands):

 

     Three Months Ended June 30,     Percent
Change
    Six Months Ended June 30,     Percent
Change
 
     2009    (*)     2010    (*)       2009    (*)     2010    (*)    

Marketing services:

                        

Owned and Operated sites

   $ 858,160    55   $ 881,051    55   3   $ 1,730,063    55   $ 1,755,871    55   1

Affiliate sites

     519,690    33     557,421    35   7     1,030,968    33     1,105,119    34   7
                                                        

Marketing services

     1,377,850    88     1,438,472    90   4     2,761,031    88     2,860,990    89   4

Fees

     195,047    12     162,907    10   (16 )%      391,908    12     337,349    11   (14 )% 
                                                        

Total revenue

   $ 1,572,897    100   $ 1,601,379    100   2   $ 3,152,939    100   $ 3,198,339    100   1
                                                        

 

(*)

Percent of total revenue.

We generate marketing services revenue principally from display advertising on Owned and Operated sites and from search advertising. We also receive revenue for click-throughs on content match links (advertising in the form of contextually relevant advertiser links) on Owned and Operated and Affiliate sites and display advertising on Affiliate sites. The net revenue and related volume metrics from these additional sources are not currently material and are excluded from the discussion and calculation of average revenue per Page View on Owned and Operated sites and average revenue per search on Affiliate sites that follows.

We currently expect revenue to increase for the three months ending September 30, 2010 compared to the three months ended September 30, 2009 provided advertising spending increases.

Marketing Services Revenue from Owned and Operated Sites. Marketing services revenue from Owned and Operated sites for the three and six months ended June 30, 2010 increased by 3 percent and 1 percent, respectively, as compared to the same periods in 2009. The primary components of our marketing services revenue from Owned and Operated sites are search and display advertising. For both the three and six months ended June 30, 2010, revenue from display advertising on Owned and Operated sites increased 19 percent, compared to the same periods in 2009. For the three and six months ended June 30, 2010, revenue from search advertising on Owned and Operated sites decreased 8 percent and 11 percent, respectively, compared to the same periods in 2009. Increased advertising spending in display and a shift towards higher-yielding display inventory have resulted in increased display revenue. Search advertising revenue decreased primarily due to the impact of discontinuing our paid inclusion search product as part of our advertising quality initiatives and declines in revenue per search. While overall search queries on Yahoo! Properties increased, the higher international volume growth had lower revenue per search. This created a shift in the mix of monetizable searches which yielded lower overall Owned and Operated revenue per search.

We periodically review and refine our methodology for monitoring, gathering, and counting Page Views to more accurately reflect the total number of Web pages viewed by users on Yahoo! Properties. Based on this process, from time to time we update our methodology to exclude from the count of Page Views interactions with our servers that we determine or believe are not the result of user visits to our Owned and Operated sites. For the three and six months ended June 30, 2010, Page Views decreased 4 percent and 2 percent, respectively, and revenue per Page View increased 7 percent and 4 percent, respectively, compared to the same period in 2009.

Marketing Services Revenue from Affiliate Sites. Marketing services revenue from Affiliate sites for both the three and six months ended June 30, 2010 increased 7 percent, compared to the same periods in 2009. The number of searches on Affiliate sites increased by approximately 1 percent and 2 percent, respectively, for the three and six months ended June 30, 2010, as compared to the same periods in 2009. The increase in revenue can be attributed primarily to the impact of foreign exchange rate fluctuations in the Asia Pacific segment, increased traffic on Affiliate sites, and a new Affiliate in the Asia Pacific segment added in the fourth quarter of 2009. The average revenue per search on our Affiliate sites increased by 9 percent and 6 percent for the three and six months ended June 30, 2010, respectively, as compared to the same periods in 2009.

Fees Revenue. Our fees revenue includes premium fee-based services such as services for small businesses, Internet broadband services, premium e-mail, sports, photos, games, personals, and music. Other fee-based revenue includes royalties, licenses, and mobile services. Fees revenue for the three and six months ended June 30, 2010 decreased by 16 percent and 14 percent, respectively, compared to the same periods in 2009. The decrease in fees revenue is primarily attributed to changes in certain of our broadband access partnerships, from being fee-paying user based to other fee structures such as advertising revenue sharing or fixed fee. In addition, revenue from other premium services has declined year-over-year as we continue to outsource various offerings.

Costs and Expenses. Operating costs and expenses consist of cost of revenue, sales and marketing, product development, general and administrative, amortization of intangible assets, and restructuring charges, net. Cost of revenue consists of traffic acquisition costs (“TAC”), Internet connection charges, and other expenses associated with the production and usage of Yahoo! Properties, including amortization of acquired intellectual property rights and developed technology.

 

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Table of Contents

Operating costs and expenses were as follows (dollars in thousands):

 

     Three Months Ended June 30,     Percent
Change
    Dollar
Change
 
     2009    (*)     2010    (*)      

Cost of revenue

   $ 712,453    45   $ 682,722    43   (4 )%    $ (29,731

Sales and marketing

   $ 280,386    18   $ 331,468    21   18   $ 51,082   

Product development

   $ 291,398    19   $ 268,552    17   (8 )%    $ (22,846

General and administrative

   $ 138,652    9   $ 125,333    8   (10 )%    $ (13,319

Amortization of intangibles

   $ 9,253    1   $ 7,880    0   (15 )%    $ (1,373

Restructuring charges, net

   $ 65,002    4   $ 10,052    1   (85 )%    $ (54,950
     Six Months Ended June 30,     Percent
Change
    Dollar
Change
 
     2009    (*)     2010    (*)      

Cost of revenue

   $ 1,413,190    45   $ 1,389,104    43   (2 )%    $ (24,086

Sales and marketing

   $ 601,498    19   $ 645,006    20   7   $ 43,508   

Product development

   $ 597,441    19   $ 534,629    17   (11 )%    $ (62,812

General and administrative

   $ 275,649    9   $ 235,761    7   (14 )%    $ (39,888

Amortization of intangibles

   $ 18,920    1   $ 15,982    0   (16 )%    $ (2,938

Restructuring charges, net

   $ 69,803    2   $ 14,464    0   (79 )%    $ (55,339

 

(*)

Percent of total revenue.

Stock-based compensation expense was allocated as follows (in thousands):

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2009     2010    2009     2010

Cost of revenue

   $ 2,663      $ 580    $ 6,242      $ 1,591

Sales and marketing

     35,651        21,540      85,548        35,218

Product development

     51,647        26,132      105,925        58,505

General and administrative

     22,565        9,345      41,531        23,066

Restructuring expense reversals, net

     (7,600     —        (7,600     —  
                             

Total stock-based compensation expense

   $ 104,926      $ 57,597    $ 231,646      $ 118,380
                             

For additional information about stock-based compensation, see Note 10 — “Stockholders’ Equity and Employee Benefits” in the Notes to the condensed consolidated financial statements elsewhere in this Report as well as “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2009 under the caption Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Traffic Acquisition Costs. TAC consists of payments made to Affiliates and payments made to companies that direct consumer and business traffic to 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.

Compensation, Information Technology, Depreciation and Amortization, and Facilities Expenses. Compensation expense consists primarily of salary, bonuses, commissions, and stock-based compensation expense. Information and technology expense includes telecom usage charges and data center operating costs. Depreciation and amortization expense consists primarily of depreciation of server equipment and information technology assets and amortization of developed or acquired technology and intellectual property rights. Facilities expense consists primarily of building maintenance costs, rent expense, and utilities.

The changes in operating costs and expenses for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 are comprised of the following (in thousands):

 

     Compensation     Information
Technology
    Depreciation and
Amortization
    Facilities     TAC    Other     Total  

Cost of revenue

   $ (8,844   $ (21,487   $ (35,906   $ 2,099      $ 36,699    $ (2,292   $ (29,731

Sales and marketing

     15,619        (590     (548     (2,085     —        38,686        51,082   

Product development

     (24,937     5,043        (645     (4,033     —        1,726        (22,846

General and administrative

     (13,329     (295     (1,296     (349     —        1,950        (13,319

Amortization of intangibles

     —          —          (1,373     —