UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý

 

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

 

 

 

For the quarterly period ended September 30, 2003

 

 

 

OR

 

 

 

o

 

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

 

 

 

For the transition period from               to              

 

 

 

Commission File Number 0-28018

 

YAHOO! INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

77-0398689

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

701 First Avenue
Sunnyvale, California 94089

(Address of principal executive offices)

 

 

 

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

 

Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days: Yes ý  No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ý  No o

 

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

 

Class

 

Outstanding at October 31, 2003

Common stock, $0.001 par value

 

657,333,967

 

 



 

YAHOO! INC.

 

Table of Contents

 

 

 

 

Page

 

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements (unaudited)

 

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2003

 

3

 

Condensed Consolidated Balance Sheets at December 31, 2002 and September 30, 2003

 

4

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2003

 

5

 

Condensed Consolidated Statements of Stockholders’ Equity for the three and nine months ended September 30, 2002 and 2003

 

6

 

Notes to Condensed Consolidated Financial Statements

 

7

Item 2.

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

 

19

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

44

Item 4.

Controls and Procedures

 

45

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

46

Item 2.

Changes in Securities and Use of Proceeds

 

47

Item 3.

Defaults Upon Senior Securities

 

47

Item 4.

Submission of Matters to a Vote of Security Holders

 

47

Item 5.

Other Information

 

47

Item 6.

Exhibits and Reports on Form 8-K

 

47

 

Signatures

 

 

 

2



 

PART I — FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

 

YAHOO! INC.

Condensed Consolidated Statements of Operations

(unaudited, in thousands except per share amounts)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Net revenues

 

$

248,823

 

$

356,821

 

$

667,280

 

$

961,175

 

Cost of revenues

 

41,033

 

47,287

 

120,562

 

137,261

 

Gross profit

 

207,790

 

309,534

 

546,718

 

823,914

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

109,086

 

128,846

 

315,247

 

364,752

 

Product development

 

37,352

 

48,026

 

105,296

 

130,397

 

General and administrative

 

25,961

 

39,653

 

78,067

 

102,498

 

Amortization of intangibles

 

5,914

 

9,511

 

15,288

 

25,020

 

Total operating expenses

 

178,313

 

226,036

 

513,898

 

622,667

 

Income from operations

 

29,477

 

83,498

 

32,820

 

201,247

 

 

 

 

 

 

 

 

 

 

 

Other income, net

 

19,535

 

23,935

 

71,432

 

66,529

 

Minority interests in operations of consolidated subsidiaries

 

(916

)

(2,063

)

(565

)

(5,097

)

Income before income taxes and cumulative effect of accounting change

 

48,096

 

105,370

 

103,687

 

262,679

 

Provision for income taxes

 

19,239

 

40,041

 

42,961

 

99,819

 

Income before cumulative effect of accounting change

 

28,857

 

65,329

 

60,726

 

162,860

 

Cumulative effect of accounting change

 

 

 

(64,120

)

 

Net income (loss)

 

$

28,857

 

$

65,329

 

$

(3,394

)

$

162,860

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share—basic:

 

 

 

 

 

 

 

 

 

Income before cumulative effect of accounting change

 

$

0.05

 

$

0.11

 

$

0.10

 

$

0.27

 

Cumulative effect of accounting change

 

 

 

(0.11

)

 

Net income (loss) per share—basic

 

$

0.05

 

$

0.11

 

$

(0.01

)

$

0.27

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share—diluted:

 

 

 

 

 

 

 

 

 

Income before cumulative effect of accounting change

 

$

0.05

 

$

0.10

 

$

0.10

 

$

0.26

 

Cumulative effect of accounting change

 

 

 

(0.11

)

 

Net income (loss) per share—diluted

 

$

0.05

 

$

0.10

 

$

(0.01

)

$

0.26

 

 

 

 

 

 

 

 

 

 

 

Shares used in per share calculation—basic

 

596,743

 

610,697

 

594,120

 

603,786

 

 

 

 

 

 

 

 

 

 

 

Shares used in per share calculation—diluted

 

607,134

 

637,444

 

610,899

 

627,270

 

 

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

 

3



 

YAHOO! INC.

Condensed Consolidated Balance Sheets

(unaudited, in thousands)

 

 

 

December 31,
2002

 

September 30,
2003

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

310,972

 

$

681,518

 

Short-term investments in marketable securities

 

463,204

 

564,283

 

Accounts receivable, net

 

113,612

 

151,024

 

Prepaid expenses and other current assets

 

82,216

 

105,221

 

Total current assets

 

970,004

 

1,502,046

 

 

 

 

 

 

 

Long-term investments in marketable securities

 

763,408

 

1,243,708

 

Property and equipment, net

 

371,272

 

386,443

 

Goodwill

 

415,225

 

635,488

 

Intangible assets, net

 

96,252

 

121,023

 

Other assets

 

174,020

 

216,997

 

Total assets

 

$

2,790,181

 

$

4,105,705

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

18,738

 

$

19,771

 

Accrued expenses and other current liabilities

 

257,575

 

321,299

 

Deferred revenue

 

135,501

 

150,518

 

Total current liabilities

 

411,814

 

491,588

 

 

 

 

 

 

 

Long-term debt

 

 

750,000

 

Other liabilities

 

84,540

 

102,374

 

Minority interests in consolidated subsidiaries

 

31,557

 

36,654

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

611

 

629

 

Additional paid-in capital

 

2,430,222

 

2,729,020

 

Treasury stock

 

(159,988

)

(159,988

)

Retained earnings (accumulated deficit)

 

(7,493

)

155,367

 

Accumulated other comprehensive income (loss)

 

(1,082

)

61

 

Total stockholders’ equity

 

2,262,270

 

2,725,089

 

Total liabilities and stockholders’ equity

 

$

2,790,181

 

$

4,105,705

 

 

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

 

4



 

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)

 

 

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income (loss)

 

$

(3,394

)

$

162,860

 

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

80,182

 

96,589

 

Tax benefits from stock options

 

38,443

 

85,843

 

Cumulative effect of accounting change

 

64,120

 

 

Earnings in equity interests

 

(15,327

)

(32,225

)

Minority interests in operations of consolidated subsidiaries

 

565

 

5,097

 

Non-cash (gains) losses and impairments from investments

 

(2,930

)

6,081

 

Other non-cash charges

 

9,228

 

5,201

 

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

 

 

 

 

 

Accounts receivable, net

 

(20,759

)

(31,815

)

Prepaid expenses and other assets

 

24,972

 

(756

)

Accounts payable

 

(1,080

)

280

 

Accrued expenses and other liabilities

 

(4,595

)

18,147

 

Current deferred revenue

 

23,665

 

10,982

 

Long-term deferred revenue

 

30,000

 

 

Net cash provided by operating activities

 

223,090

 

326,284

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Acquisition of property and equipment

 

(34,881

)

(79,718

)

Purchases of marketable securities

 

(797,231

)

(1,632,298

)

Proceeds from sales and maturities of marketable securities

 

808,740

 

1,041,429

 

Acquisitions, net of cash acquired

 

(189,168

)

(228,318

)

Purchases of other investments

 

(7,649

)

 

Proceeds from the sales of other investments

 

687

 

2,763

 

Net cash used in investing activities

 

(219,502

)

(896,142

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of debt, net

 

 

733,125

 

Proceeds from issuance of common stock, net

 

38,615

 

203,027

 

Repurchase of common stock

 

(100,000

)

 

Net cash provided by (used in) financing activities

 

(61,385

)

936,152

 

Effect of exchange rate changes on cash and cash equivalents

 

4,484

 

4,252

 

Net change in cash and cash equivalents

 

(53,313

)

370,546

 

Cash and cash equivalents at beginning of period

 

372,632

 

310,972

 

Cash and cash equivalents at end of period

 

$

319,319

 

$

681,518

 

 

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

 

5



 

YAHOO! INC.

Condensed Consolidated Statements of Stockholders’ Equity

(unaudited, in thousands)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

606

 

$

624

 

$

581

 

$

611

 

Common stock issued

 

 

5

 

25

 

18

 

Balance, end of period

 

606

 

629

 

606

 

629

 

 

 

 

 

 

 

 

 

 

 

Additional paid-in capital

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

2,343,926

 

2,621,560

 

2,067,410

 

2,430,222

 

Common stock issued

 

2,916

 

74,414

 

264,118

 

206,345

 

Compensation expense on option grants

 

952

 

486

 

7,693

 

1,951

 

Tax benefit on stock options

 

19,990

 

32,560

 

32,491

 

81,929

 

Other

 

 

 

(3,928

)

8,573

 

Balance, end of period

 

2,367,784

 

2,729,020

 

2,367,784

 

2,729,020

 

 

 

 

 

 

 

 

 

 

 

Treasury stock

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

(59,988

)

(159,988

)

(59,988

)

(159,988

)

Repurchase of common stock

 

(100,000

)

 

(100,000

)

 

Balance, end of period

 

(159,988

)

(159,988

)

(159,988

)

(159,988

)

 

 

 

 

 

 

 

 

 

 

Retained earnings (accumulated deficit)

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

(82,559

)

90,038

 

(50,308

)

(7,493

)

Net income (loss)

 

28,857

 

65,329

 

(3,394

)

162,860

 

Balance, end of period

 

(53,702

)

155,367

 

(53,702

)

155,367

 

 

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

(3,122

)

4,599

 

9,322

 

(1,082

)

Net unrealized gains (losses) on securities

 

3,456

 

(5,452

)

(8,924

)

(5,829

)

Foreign currency translation adjustments

 

621

 

914

 

557

 

6,972

 

Balance, end of period

 

955

 

61

 

955

 

61

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

$

2,155,655

 

$

2,725,089

 

$

2,155,655

 

$

2,725,089

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

28,857

 

$

65,329

 

$

(3,394

)

$

162,860

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Net unrealized gains (losses) on securities

 

3,456

 

(5,452

)

(8,924

)

(5,829

)

Foreign currency translation adjustment

 

621

 

914

 

557

 

6,972

 

Comprehensive income (loss)

 

$

32,934

 

$

60,791

 

$

(11,761

)

$

164,003

 

 

 

 

Number of Shares

 

Common stock

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

600,503

 

607,350

 

575,520

 

594,860

 

Common stock issued

 

566

 

5,306

 

25,549

 

17,796

 

Repurchase of common stock

 

(11,074

)

 

(11,074

)

 

Balance, end of period

 

589,995

 

612,656

 

589,995

 

612,656

 

 

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

 

6



 

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 1—The Company and Basis of Presentation

 

Yahoo! Inc. (“Yahoo!” or the “Company”) is a leading provider of comprehensive online products and services to consumers and businesses worldwide. The Company, a Delaware corporation, commenced operations in 1995.

 

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

 

These 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, 2002.  Certain prior period balances have been reclassified to conform to current period presentation.

 

Note 2—Summary of Significant Accounting Policies

 

Revenue Recognition.  The Company’s revenues are derived principally from services, which include marketing services, fees, and listings.

 

Marketing services revenues are primarily generated from the sale of banner, sponsorship, and text-link advertisements, including sponsored search advertisements, and transaction revenues.  Banner advertising agreements typically range from one week to three years.  The Company recognizes marketing services revenues related to banner advertisements as “impressions” are delivered on pages on the Yahoo! network by the Company.  “Impressions” are defined as the number of times that an advertisement appears in pages viewed by users of the Yahoo! network.  Sponsorship advertising agreements have longer terms than banner advertising agreements, typically ranging from three months to three years, and can involve multiple element arrangements that may include placement on specific properties, exclusivity and content integration.  Sponsorship advertisement revenues are recognized as “impressions” are delivered or ratably over the contract period, where applicable, and when collection of the resulting receivable is reasonably assured. Text-link advertisements, including sponsored searches, are generally recognized as the net amount earned in the period in which the “click-throughs” occur.  “Click-throughs” are defined as the number of times a user clicks on an advertisement or search result.  Transactions revenues include service fees for facilitating transactions through the Yahoo! network, principally from the Company’s commerce properties. Transactions revenues are recognized when there is evidence that the qualifying transactions have occurred. The Company recognizes revenue on these arrangements in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition in Financial Statements,” and Emerging Issues Task Force (“EITF”) Issue 00-21, "Revenue Arrangements with Multiple Deliverables." 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 collectibility of the resulting receivable is reasonably assured.

 

Periodically, the Company engages in barter transactions for marketing services. Barter revenue is recognized over the periods in which the Company completes its obligations under the arrangement.  Barter revenues represented approximately 2% of total revenues each for the three and nine months ended September 30, 2002, compared to less than 1% of total revenues each for the three and nine months ended September 30, 2003.  During the three and nine months ended September 30, 2002, the Company delivered approximately 0.5 billion and 3.3 billion impressions, respectively, under barter arrangements where fair value was not determinable under EITF 99-17 “Accounting for Advertising Barter Transactions” and, accordingly, revenue was not recognized, compared to approximately 1.2 billion and 2.7 billion impressions for the three and nine months ended September 30, 2003, respectively.

 

7



 

Fees revenues consist of revenues generated from a variety of consumer and business fee-based services, including SBC Yahoo! DSL and SBC Yahoo! Dial, Yahoo! Personals, Small Business Services, Yahoo! Mail and Yahoo! Enterprise Solutions. With the exception of Yahoo! Portal Solutions, which is part of Yahoo! Enterprise Solutions, revenues are recognized in the month in which the services are performed, provided that no significant Company obligations remain and collection of the resulting receivable is reasonably assured. Revenues from Yahoo! Portal Solutions consist of software license and platform service revenues, which are principally platform and maintenance services.  Yahoo! Portal Solutions revenue is recognized in accordance with Statement of Position No. 97-2, “Software Revenue Recognition” and Statement of Position 98-9, “Modification of SOP No. 97-2 with Respect to Certain Transactions.” License revenues are recognized when persuasive evidence of an arrangement exists, delivery of the license has occurred, the fee is fixed or determinable, and collection is probable.  License revenues from Portal Solutions were not material to the Company as they represented less than 1% of total net revenue for all periods presented.  Platform services are sold as a subscription and are recognized ratably over the subscription period.  Platform services are priced based on the specific content or service purchased by the customer.  These services are optional and renewable annually at fixed renewal rates.  Maintenance is generally sold under annual contracts with fixed renewal rates.  Maintenance revenue is recognized ratably over the contract period.  Yahoo! Portal Solutions revenues have represented less than 10% of total net revenues in all periods presented.

 

Listings revenues consist of revenues generated from a variety of consumer and business listings-based services, including access to the HotJobs database and classifieds such as Yahoo! Autos, Yahoo! Real Estate and other Search and Directory services.   Revenues are recognized in the month in which the services are performed, provided that no significant Company obligations remain and collection of the resulting receivable is reasonably assured.

 

Deferred revenue primarily consists of contractual billings in excess of recognized revenue and payments received in advance of revenue recognition.

 

Use of Estimates.  The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. On an on-going basis, the Company evaluates its estimates, including those related to uncollectible receivables, investment values, goodwill and intangible assets, income taxes, restructuring costs and contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Basic and Diluted Net Income (Loss) per Share.  Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted average number of common and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of shares issuable upon the exercise of stock options and warrants (using the treasury stock method).  For the three month period ended September 30, 2002, potential common shares of 10.4 million were included in the computation and were related to shares issuable upon the exercise of stock options.  For the nine month period ended September 30, 2002, potential common shares related to shares issuable upon the exercise of stock options of 16.8 million were not included in the computation because they were anti-dilutive.  For the three and nine month period ended September 30, 2003, potential common shares of 26.7 million and 23.5 million, respectively, were included in the computation and were related to shares issuable upon the exercise of stock options.  For the three month period ended September 30, 2003, the 18.3 million common shares issuable under the terms of the zero coupon senior convertible notes that the Company issued in April 2003 have not been included in potential common shares as the conversion of the notes is subject to certain contingencies that have not yet been met.

 

8



 

Stock-Based Compensation.  The Company measures compensation expense for its stock-based employee compensation plans using the intrinsic value method. If the fair value based method had been applied in measuring stock compensation expense, the pro forma effect on net income (loss) and net income (loss) per share would have been as follows (in thousands, except per share amounts):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Net income (loss):

 

 

 

 

 

 

 

 

 

As reported

 

$

28,857

 

$

65,329

 

$

(3,394

)

$

162,860

 

Stock compensation expense, net of tax

 

(118,337

)

(81,470

)

(372,927

)

(224,567

)

Pro forma

 

$

(89,480

)

$

(16,141

)

$

(376,321

)

$

(61,707

)

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

As reported - basic

 

$

0.05

 

$

0.11

 

$

(0.01

)

$

0.27

 

Pro forma - basic

 

$

(0.15

)

$

(0.03

)

$

(0.63

)

$

(0.10

)

 

 

 

 

 

 

 

 

 

 

As reported - diluted

 

$

0.05

 

$

0.10

 

$

(0.01

)

$

0.26

 

Pro forma - diluted

 

$

(0.15

)

$

(0.03

)

$

(0.63

)

$

(0.10

)

 

Pro forma diluted net loss per share for the three months ended September 30, 2002 is computed excluding potential common shares of 10.4 million, as the effect is anti-dilutive.   Diluted net loss per share and pro forma diluted net loss per share for the nine months ended September 30, 2002 are computed excluding potential common shares of 16.8 million, as the effect is anti-dilutive.  Pro forma diluted net loss per share for the three and nine months ended September 30, 2003 is computed excluding potential common shares of 26.7 million and 23.5 million, respectively, as the effect is anti-dilutive.

 

The Company recorded compensation expense in the amount of $1.0 million, and $0.5 million in the three months ended September 30, 2002 and 2003, respectively.  The Company recorded compensation expense in the amount of $7.7 million, and $2.0 million in the nine months ended September 30, 2002 and 2003, respectively.   As of September 30, 2003, approximately $1.4 million remains to be amortized over the remaining vesting periods of the options.

 

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company’s options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of its options.

 

Note 3—Recent Accounting Pronouncements

 

In November 2002, the EITF reached a consensus on Issue 00-21, addressing how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The final consensus is applicable to agreements entered into in fiscal periods beginning after June 15, 2003. The provisions of this consensus did not have a significant effect on the Company’s results of operations or financial position.

 

9



 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46 (“FIN 46”) “Consolidation of Variable Interest Entities.” Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity, as defined, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns.  The Company is currently evaluating the effect of adopting FIN 46 on its results of operations and financial position.

 

In April 2003, the FASB issued SFAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, which amends SFAS 133 for certain decisions made by the FASB Derivatives Implementation Group.  In particular, SFAS 149: (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” and (4) amends certain other existing pronouncements.  This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS 149 are to be applied prospectively.  The adoption of SFAS 149 did not have a material impact on the Company’s financial position, cash flows or results of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS 150”).  SFAS 150 changes the accounting for certain financial instruments that under previous guidance issuers could account for as equity.  It requires that those instruments be classified as liabilities in balance sheets.  The guidance in SFAS 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective on July 1, 2003.  The adoption of SFAS 150 did not have a material impact on the Company’s financial position, cash flows or results of operations.

 

Note 4—Goodwill

 

The changes in the carrying amount of goodwill for the nine months ended September 30, 2003 are as follows (in thousands):

 

 

 

United States

 

International

 

Total

 

 

 

 

 

 

 

 

 

Balance at December 31, 2002

 

$

327,082

 

$

88,143

 

$

415,225

 

Acquisitions and other (1)

 

216,366

 

3,897

 

220,263

 

Balance at September 30, 2003

 

$

543,448

 

$

92,040

 

$

635,488

 

 


(1)                                  Other primarily includes certain purchase price adjustments that affect existing goodwill. See also Note 9—Acquisition.

 

The Company performed a transitional impairment test of its goodwill and intangible assets as of January 1, 2002. Due to, among other things, the overall softening of the global economy and the related decline in international advertising, the Company recorded a transitional goodwill impairment loss of $64.1 million, which was recorded during the first quarter of 2002 as a cumulative effect of an accounting change in the Company’s Condensed Consolidated Statements of Operations. The fair value of the reporting unit giving rise to the transitional impairment loss was estimated using the expected present value of future cash flows and market valuation approach.

 

10



 

Note 5—Intangible Assets, Net

(in thousands)

 

 

 

December 31, 2002

 

September 30, 2003

 

 

 

Net

 

Gross carrying
amount

 

Accumulated
amortization

 

Net

 

 

 

 

 

 

 

 

 

 

 

Trademarks

 

$

48,894

 

$

57,100

 

$

(14,629

)

$

42,471

 

Customer-related intangible assets

 

38,605

 

76,230

 

(26,764

)

49,466

 

Developed technology

 

7,161

 

34,600

 

(5,514

)

29,086

 

Content and other

 

1,592

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

96,252

 

$

167,930

 

$

(46,907

)

$

121,023

 

 

The intangible assets are all amortizable and have original estimated useful lives as follows: Trademarks—four to seven years; Customer-related intangible assets—one to seven years; Developed technology—three to five years; Content and other—two to three years. Based on the amount of intangibles subject to amortization as of September 30, 2003, excluding effects of the intangible assets acquired in the October 2003 acquisition of Overture Services, Inc. ("Overture") as described in Note 12—Subsequent Event, the estimated amortization expense for each of the succeeding five years is as follows: Three months ending December 31, 2003: $9.0 million; Years ending December 31, 2004: $28.6 million; 2005: $23.6 million; 2006: $22.8 million; and 2007: $21.0 million.

 

Note 6—Restructuring Costs

 

During 2001, the Company announced restructuring programs to balance its investment in growth areas with the desire to modify its near-term business plan to reflect an economic and capital market slowdown. These restructuring programs included a charge for worldwide workforce reductions of approximately $15.1 million and consolidation of excess facilities and other charges of approximately $42.3 million, which were classified as operating expenses in 2001.  If facilities rental rates continue to decrease in these markets or if it takes longer than expected to sublease these facilities, the maximum amount the actual loss could exceed the original estimate is approximately $5.0 million.

 

A summary of the restructuring accrual during the nine months ended September 30, 2003 is as follows (in thousands):

 

 

 

Restructuring
Accrual at
December 31, 2002

 


Cash

 

Restructuring Accrual at
September 30, 2003

 

 

 

 

Payments

 

 

 

 

 

 

 

 

 

 

Consolidation of excess facilities and other charges

 

$

11,745

 

$

(3,311

)

$

8,434

 

 

The restructuring accrual is included on the balance sheet in accrued expenses and other liabilities. The accrual related to the workforce reduction was paid by December 31, 2002. Amounts related to the net lease expense due to the consolidation of facilities will be paid over the respective lease terms through December 2012.

 

11



 

Note 7—Long-Term Debt

 

In April 2003, the Company issued $750 million of zero coupon senior convertible notes (the “Notes”) due April 2008, which resulted in net proceeds to the Company of approximately $733 million after transaction fees of approximately $17 million, which have been deferred and are included on the balance sheet in other assets.  The Notes were issued at par and bear no interest.  The Notes are convertible into Yahoo! common stock at a conversion price of $41.00 per share, which would result in an aggregate of 18.3 million shares, subject to adjustment upon the occurrence of specified events.  Each $1,000 principal amount of the Notes will initially be convertible into 24.3902 shares of Yahoo! common stock prior to April 1, 2008 if the sale price of our common stock issuable upon conversion of the Notes reaches a specified threshold for a defined period of time or specified corporate transactions have occurred.  The specified thresholds for conversion prior to the maturity date are (1) the closing sale price of the Company’s common stock for at least 20 trading days in the 30 trading-day period ending on the last trading day of the immediately preceding fiscal quarter exceeds 110% of the conversion price on that 30th trading day, and (2) during the period beginning January 1, 2008 through the maturity date, the closing sale price of the Company’s common stock on the previous trading day was 110% or more of the then current conversion price.  Upon conversion, Yahoo! has the right to deliver cash in lieu of common stock.   The Company may be required to repurchase all of the notes following a fundamental change of the Company, such as a change of control, prior to maturity.  Yahoo! may not redeem the Notes prior to their maturity.

 

Note 8—Stockholders’ Equity

 

Stock Repurchase Program.  In March 2001, the Company announced that its Board of Directors had authorized the Company to repurchase up to $500 million of its outstanding shares of common stock from time to time over the next two years, depending on market conditions, share price and other factors.   In March 2003, the Company’s Board of Directors authorized a two-year extension of the stock repurchase program, which extension authorizes the Company to repurchase up to approximately $340 million (representing the balance of the $500 million originally authorized in March 2001) of its outstanding shares of common stock from time to time over the next two years, depending on market conditions, share price and other factors.  The Company may utilize equity instrument contracts to facilitate the repurchase of common stock.  From March 2001 through September 30, 2003, the Company had repurchased 16,458,620 shares of common stock at an average of $9.72 per share for a total amount of approximately $160 million. Of the shares repurchased, 16,033,620 shares were purchased from SOFTBANK at an average of $9.67 per share.  No shares were repurchased during the nine months ended September 30, 2003.  Treasury stock is accounted for under the cost method.

 

Note 9—Acquisition

 

On March 19, 2003, the Company completed the acquisition of Inktomi Corporation, (“Inktomi”), a provider of original equipment manufacturer Web search and paid inclusion services.  The acquisition combined Yahoo!’s global audience and Inktomi’s search technology to allow the Company to create a more relevant, comprehensive and higher quality search offering on the Web.  These factors contributed to a purchase price in excess of the fair value of the Inktomi net tangible and intangible assets acquired, and as a result, the Company has recorded goodwill in connection with this transaction.

 

The total estimated purchase price of approximately $289.6 million consisted of $272.9 million in cash consideration, approximately $13.4 million of stock options exchanged, and direct transaction costs of approximately $3.3 million.  The value of the stock options was determined using the Black-Scholes option valuation model.

 

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

 

Cash acquired

 

$

44,610

 

Other tangible assets acquired

 

27,408

 

Amortizable intangible assets

 

49,400

 

Goodwill

 

216,188

 

Liabilities assumed

 

(49,287

)

Deferred stock-based compensation

 

1,287

 

Total

 

$

289,606

 

 

12



 

Amortizable intangible assets consist of customer-related intangible assets and developed technology with useful lives not exceeding five years.  A preliminary estimate of $216.2 million has been allocated to goodwill.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired, and is not deductible for tax purposes.  Goodwill will not be amortized and will be tested for impairment, at least annually.  The preliminary purchase price allocation for Inktomi is subject to revision as more detailed analysis is completed and additional information on the fair value of assets and liabilities becomes available.  Any change in the fair value of the net assets of Inktomi will change the amount of the purchase price allocable to goodwill.  Liabilities assumed included approximately $12.7 million of restructuring costs associated with the acquisition, of which approximately $5.6 million remains as of September 30, 2003.

 

The results of operations of Inktomi have been included in the Company’s condensed consolidated statements of operations since the completion of the acquisition on March 19, 2003.  The following unaudited pro forma information presents a summary of the results of operations of the Company assuming the acquisitions of Inktomi and HotJobs (acquired in February 2002) occurred on January 1, 2002 (in thousands, except per share amounts):

 

 

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

Net revenues

 

$

734,915

 

$

976,106

 

Income (loss) before cumulative effect of accounting change

 

$

(171,898

)

$

161,836

 

Net income (loss)

 

$

(236,018

)

$

161,836

 

 

 

 

 

 

 

Net income (loss) per share — basic:

 

 

 

 

 

Income (loss) per share before cumulative effect of accounting change

 

$

(0.29

)

$

0.27

 

Net income (loss) per share

 

$

(0.39

)

$

0.27

 

Net income (loss) per share— diluted:

 

 

 

 

 

Income (loss) per share before cumulative effect of accounting change

 

$

(0.29

)

$

0.26

 

Net income (loss) per share

 

$

(0.39

)

$

0.26

 

 

Note 10—Segment Information

 

The Company manages its business geographically. The Company’s primary areas of measurement and decision-making are the United States and International. The Company’s management relies on an internal management reporting process that provides revenue and segment information for making financial decisions and allocating resources. Segment operating income before depreciation and amortization includes income (loss) from operations before amortization of intangibles and depreciation.  Segment operating income before depreciation and amortization (previously referred to as “Segment EBITDA”) for prior years has been reclassified to include stock compensation expense, consistent with the current year presentation.  Management believes that segment operating income before depreciation and amortization is an appropriate measure of evaluating the operating performance of the Company’s segments. However, segment operating income before depreciation and amortization should be considered only in addition to, not as a substitute for or superior to, operating income, cash flows or other measures of financial performance prepared in accordance with generally accepted accounting principles.

 

Revenue is attributed to individual countries according to the international online property that generated the revenue. No single foreign country accounted for more than 10% of net revenues during the three and nine months ended September 30, 2002 and 2003.

 

Summarized information by segment is as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Net revenues by segment:

 

 

 

 

 

 

 

 

 

United States

 

$

210,135

 

$

299,759

 

$

564,212

 

$

809,650

 

International

 

38,688

 

57,062

 

103,068

 

151,525

 

Total net revenues

 

$

248,823

 

$

356,821

 

$

667,280

 

$

961,175

 

 

13



 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Segment operating income (loss) before depreciation and amortization:

 

 

 

 

 

 

 

 

 

United States

 

$

57,621

 

$

106,122

 

$

123,004

 

$

273,625

 

International

 

1,607

 

10,389

 

(10,002

)

24,211

 

Total segment operating income before depreciation and amortization

 

$

59,228

 

$

116,511

 

$

113,002

 

$

297,836

 

 

 

 

 

 

 

 

 

 

 

Operating income before depreciation and amortization reconciliation:

 

 

 

 

 

 

 

 

 

Income from operations

 

$

29,477

 

$

83,498

 

$

32,820

 

$

201,247

 

Depreciation and amortization

 

29,751

 

33,013

 

80,182

 

96,589

 

Operating income before depreciation and amortization

 

$

59,228

 

$

116,511

 

$

113,002

 

$

297,836

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss) before depreciation and amortization by segment reconciliations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

 

 

Income from operations

 

$

30,751

 

$

77,684

 

$

51,354

 

$

189,156

 

Depreciation and amortization

 

26,870

 

28,438

 

71,650

 

84,469

 

Segment operating income before depreciation and amortization – United States

 

$

57,621

 

$

106,122

 

$

123,004

 

$

273,625

 

 

 

 

 

 

 

 

 

 

 

International

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

$

(1,274

)

$

5,814

 

$

(18,534

)

$

12,091

 

Depreciation and amortization

 

2,881

 

4,575

 

8,532

 

12,120

 

Segment operating income (loss) before depreciation and amortization – International

 

$

1,607

 

$

10,389

 

$

(10,002

)

$

24,211

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures, net:

 

 

 

 

 

 

 

 

 

United States

 

$

10,868

 

$

33,174

 

$

30,660

 

$

65,544

 

International

 

2,425

 

5,271

 

4,221

 

14,174

 

Total consolidated capital expenditures, net

 

$

13,293

 

$

38,445

 

$

34,881

 

$

79,718

 

 

 

 

 

December 31,
2002

 

September 30,
2003

 

Long-lived assets:

 

 

 

 

 

United States

 

$

919,667

 

$

1,224,672

 

International

 

137,102

 

135,279

 

Total consolidated long-lived assets

 

$

1,056,769

 

$

1,359,951

 

 

The amounts above include property and equipment information, which is based on the physical location of the assets.

 

14



 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Marketing services

 

$

165,761

 

$

245,072

 

$

455,146

 

$

654,235

 

Fees

 

57,331

 

79,358

 

145,940

 

213,013

 

Listings

 

25,731

 

32,391

 

66,194

 

93,927

 

Total net revenues

 

$

248,823

 

$

356,821

 

$

667,280

 

$

961,175

 

 

Revenues from the Company’s agreement with Overture are included in marketing services, and amounted to approximately 15% and 20% of total net revenues for the three months ended September 30, 2002 and 2003, respectively, and approximately 13% and 20% of total net revenues for the nine months ended September 30, 2002 and 2003, respectively.  See Note 12 – Subsequent Event.

 

Note 11—Commitments and Contingencies

 

Operating Leases.  The Company has entered into various non-cancelable operating lease agreements for its offices throughout the U.S. and for its international subsidiaries with original lease periods up to 13 years and expiring between 2003 and 2012.

 

In addition, the Company has entered into various sublease arrangements associated with its excess facilities under the 2001 Restructuring programs. Such subleases have terms extending through 2006 and amounts estimated to be received have been included in determining the restructuring accrual.

 

Net lease commitments as of September 30, 2003 can be summarized as follows (in millions):

 

 

 

Gross lease
commitments

 

Sublease
income

 

Net lease
commitments

 

 

 

 

 

 

 

 

 

Three months ending December 31, 2003

 

$

8.2

 

$

(2.2

)

$

6.0

 

Years ending December 31,

 

 

 

 

 

 

 

2004

 

28.8

 

(6.2

)

22.6

 

2005

 

24.3

 

(4.0

)

20.3

 

2006

 

22.3

 

(3.2

)

19.1

 

2007

 

18.4

 

 

18.4

 

2008

 

14.5

 

 

14.5

 

Thereafter

 

96.7

 

 

96.7

 

 

Investment in Privately-Held Company.  During 2002, the Company acquired an equity interest of approximately 16% in Sonera zed OY (“Zed”), a Finnish company and previously wholly-owned subsidiary of a publicly-held telecommunications company. Under the terms of the investment agreement, the Company has call options to acquire the remaining interests not owned by the Company and a put option to sell back its shares.  In addition, Zed has a put option enabling Zed to require the Company to acquire  the remaining interests not owned by the Company if the Company exercises its option to buy a majority of Zed’s outstanding shares.  The amount of the purchase price for the remaining equity interests in Zed not held by the Company under these options is not determinable at this time but will be based on an operating performance based valuation of Zed.   The Company is not obligated to purchase additional equity in Zed unless it chooses to exercise the option described above.  As part of the transaction, the Company has agreed to provide up to 4.0 million Euro in additional funding to Zed.  Other than this amount, the Company is not obligated to guarantee any obligations of Zed or to provide any funding to Zed.  The Company’s investment in Zed was immaterial to its condensed consolidated balance sheet as of September 30, 2003.

 

15



 

Other Commitments.  In the ordinary course of business the Company enters into various arrangements with vendors and other business partners, principally for marketing, technology, bandwidth and content arrangements. There are no material commitments for these arrangements extending beyond September 30, 2004.

 

In connection with Company’s commercial agreements, Yahoo! provides indemnifications of varying scope and terms to customers, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements and out of intellectual property infringement claims made by third parties.  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 maintains directors and officers insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers in certain circumstancesThe indemnification provided by the Company to its officers and directors does not have a stipulated maximum, therefore the Company is not able to develop a reasonable estimate of the maximum liabilities.  To date, the Company has not incurred material costs as a result of such obligations and has not accrued any liabilities related to such indemnification obligations in its financial statements.

 

Contingencies.  From time to time, third parties assert patent infringement claims against the Company in the form of letters, lawsuits, and other forms of communication.  Currently, the Company or its subsidiaries are engaged in several lawsuits regarding patent issues and have been notified of a number of other potential patent disputes.

 

In addition, from time to time the Company and its subsidiaries are subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights, and a variety of claims arising in connection with its commercial search, email, message boards, auction sites, shopping services, and other communications and community features, such as claims alleging defamation or invasion of privacy.

 

The Company does not believe, based on current knowledge, that any of the foregoing legal proceedings or claims are likely to have a material adverse effect on its financial position, results of operations or cash flows.  However, the Company may incur substantial expenses in defending against third party claims.  In the event of a determination adverse to the Company or its subsidiaries, 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.

 

On May 24, 2001, Arista Records, Inc., Bad Boy Records, BMG Music d/b/a The RCA Records Label, Capitol Records, Inc., Virgin Records America, Inc., Sony Music Entertainment Inc., UMG Recordings, Inc., Interscope Records, Motown Record Company, L.P., and Zomba Recording Corporation filed a lawsuit alleging copyright infringement against LAUNCH Media, Inc. (“LAUNCH”) in the United States District Court for the Southern District of New York.  After the lawsuit was commenced, the Company entered into an agreement to acquire LAUNCH.  In June 2001, LAUNCH settled the LAUNCH litigation as to UMG Recordings, Inc.  The Company’s acquisition of LAUNCH closed in August 2001, and since that time LAUNCH has been a wholly owned subsidiary of the Company.  The plaintiffs allege, among other things, that the consumer-influenced portion of LAUNCH’s LAUNCHcast service is “interactive” within the meaning of Section 114 of the Copyright Act and therefore does not qualify for the compulsory license provided for by the Copyright Act.  The Complaint seeks declaratory and injunctive relief and damages for the alleged infringement.  The Company and LAUNCH do not believe that LAUNCH has infringed any rights of plaintiffs and intend to vigorously contest the lawsuit.  The lawsuit is still in the preliminary, discovery phase and the Company does not believe it is feasible to predict or determine the outcome or resolution of the LAUNCH litigation.  The range of possible resolutions of the LAUNCH litigation could include judgments against the Company or settlements that could require substantial payments by the Company, which could have a material adverse impact on the Company’s financial position, results of operations or cash flows.   An estimate of the potential loss, if any, or range of loss that could arise from the LAUNCH litigation cannot be made at this time.  In January 2003, LAUNCH settled the LAUNCH litigation as to Sony Music Entertainment, Inc.  In October 2003, LAUNCH settled the litigation as to Capitol Records, Inc. and Virgin Records America, Inc.  Accordingly, BMG Music d/b/a The RCA Records Label is the sole remaining plaintiff in this proceeding as of October 2003.

 

16



 

Note 12—Subsequent Event

 

On October 7, 2003, Yahoo! completed the acquisition of Overture, a provider of commercial search services on the Internet.  Yahoo! believes that the combined assets will further position it as a leader in the Internet advertising sector. Together, the two companies will be able to provide a diversified suite of integrated marketing solutions, including branding, paid placement, graphical ads, text links, multimedia, and contextual advertising.  These factors contributed to a purchase price in excess of the fair market value of the net tangible and intangible assets acquired from Overture, and as a result, the Company has recorded goodwill in connection with this transaction.  See Note 10—Segment Information for information related to revenues generated from the Company’s agreement with Overture.

 

Under the terms of the acquisition agreement, each outstanding share of Overture was exchanged for 0.6108 shares of Yahoo! common stock and $4.75 in cash, which amounts to approximately $309 million in aggregate cash, and together with stock options exchanged and direct transaction costs resulted in an aggregate purchase price of approximately $1.7 billion.  The value of the common stock was determined based on the average market price of the common stock over the 5-day period surrounding the date the acquisition was announced in July 2003.  The value of the stock options was determined using the Black-Scholes option valuation model.

 

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

 

Cash acquired

 

$

152,212

 

Other tangible assets acquired

 

227,832

 

Amortizable intangible assets

 

 

 

Existing technology and patents

 

134,300

 

Affiliate contracts and related relationships

 

125,300

 

Advertiser contracts and related relationships

 

77,000

 

Trade name, trademark, and domain name

 

17,300

 

Goodwill

 

1,144,906

 

Total assets acquired

 

1,878,850

 

 

 

 

 

Liabilities assumed

 

(224,815

)

Deferred stock-based compensation

 

79,102

 

Total

 

$

1,733,137

 

 

A preliminary estimate of $354 million has been allocated to amortizable intangible assets consisting of existing technology, patents, affiliate and advertiser contracts and related relationships, trade names, trademarks and domain names with useful lives not exceeding five years.

 

Other tangible assets acquired of $228 million includes long-term prepaid traffic acquisition costs paid by Overture to Yahoo! of approximately $30 million.  Liabilities assumed of approximately $225 million includes a current liability for traffic acquisition costs owed by Overture to Yahoo! of approximately $34 million.

 

A preliminary estimate of $1.1 billion has been allocated to goodwill.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and amortizable intangible assets acquired, and is not deductible for tax purposes.  Goodwill will not be amortized and will be tested for impairment, at least annually.  The preliminary purchase price allocation for Overture is subject to revision as more detailed analysis is completed and additional information on the fair value of Overture’s assets and liabilities becomes available.  Any change in the fair value of the net assets of Overture will change the amount of the purchase price allocable to goodwill.

 

Overture’s commitments related to leases and affiliate contracts as of October 7, 2003 for each of the succeeding five years is as follows: Period ending December 31, 2003: $19.7 million; Years ending December 31, 2004: $60.6 million; 2005: $19.5 million; 2006: $6.4 million; and 2007: $2.0 million.

 

Overture's revenue and net income, as reported in their most recent quarterly filing on Form 10-Q for the six months ended June 30, 2003, were $490 million and $19 million, respectively. Overture's results of operations will be included in the Company's consolidated statements of operations beginning October 7, 2003, the date of acquisition.

 

17



 

In October 2000, 800-JR-Cigar, Inc. filed a complaint in the United States District Court for the District of New Jersey against Overture, a wholly-owned subsidiary of the Company acquired in October 2003.  In October 2002, Robert Novak, doing business as PetsWarehouse and PetsWarehouse.com, filed a complaint in the United States District Court for the Eastern District of New York against Overture.  In August 2003, Accor filed a complaint in the Nanterre District Court in France against Overture and Overture S.A.R.L, Overture’s wholly-owned subsidiary in France.  The plaintiffs in each of these cases claim, among other things, that they have trademark rights in certain search terms and that Overture violates these rights by allowing its advertisers to bid on these search terms.  Overture has also been named as a defendant in several other trade name infringement actions filed in Los Angeles, California in which plaintiffs made similar claims.  The Company and Overture believe that Overture has meritorious defenses to liability and damages in each of these lawsuits and are contesting them vigorously.

 

On July 12, 2001, the first of several purported securities class action lawsuits was filed in the United States District Court, Southern District of New York against certain underwriters involved in Overture’s initial public offering, Overture, and certain of Overture’s current and former officers and directors. The Court consolidated the cases against Overture into case number 01 Civ. 6339. Plaintiffs allege, among other things, violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 involving undisclosed compensation to the underwriters, and improper practices by the underwriters, and seek unspecified damages. Similar complaints were filed in the same court against numerous public companies that conducted initial public offerings of their common stock since the mid-1990s. All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin.  On April 19, 2002, plaintiffs filed an amended complaint, alleging Rule 10b-5 claims of fraud. On July 15, 2002, the issuers filed a motion to dismiss for failure to comply with applicable pleading standards. On October 8, 2002, the Court entered an Order of Dismissal as to all of the individual defendants in the Overture IPO litigation, without prejudice. On February 19, 2003, the Court denied the motion to dismiss the Rule 10b-5 claims against certain defendants, including Overture. Settlement discussions relating to this case on behalf of the named defendants have occurred over the last several months, resulting in a final settlement memorandum of understanding with the plaintiffs in the case and Overture’s insurance carriers. A proposal has been made for the settlement and release of claims against the issuer defendants, including Overture. The settlement is subject to a number of conditions, including approval of the proposed settling parties and the court. If the settlement does not occur, and litigation against Overture continues, the Company and Overture believe that Overture has meritorious defenses to liability and damages, and intend to defend the case vigorously.

 

 

18



 

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

 

This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including, without limitation, statements regarding the Company’s expectations, beliefs, intentions or future strategies that are signified by the words “expects,” “anticipates,” “intends,” “believes,” or similar language. These forward-looking statements, including those with respect to our operating results for 2003, are based upon current expectations and beliefs of the Company’s management and are subject to risks and uncertainties that could cause results to differ materially from those indicated in the forward-looking statements. Some, but not all, of the factors, which could cause actual results to differ materially include those set forth in the risks discussed below under the subheading “Risk Factors” and elsewhere in this report. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements, or to explain why actual results differ. Readers should carefully review the risk factors described in this section below and in any reports subsequently filed with the Securities and Exchange Commission (“SEC”).

 

Overview

 

Yahoo! Inc. (“Yahoo!”) is a global Internet company that offers a comprehensive branded network of properties and services to consumers and businesses worldwide.  As the first online navigational guide to the Web, www.yahoo.com is a leading guide in terms of traffic, advertising, household and business user reach.  Yahoo!’s global brand reaches the largest audience worldwide.  Our global Web network includes 25 world properties.  Headquartered in Sunnyvale, California, we have offices in the United States, Europe, Asia, Latin America, Australia and Canada.

 

We manage our business geographically. We rely on an internal management reporting process that provides revenue and certain operating cost information for making financial decisions and allocating resources. Our principal areas of measurement and decision-making are the United States and International.

 

On October 7, 2003, Yahoo! completed the acquisition of Overture Services Inc. (“Overture”), a provider of commercial search services on the Internet.  Revenues from the Company’s agreement with Overture are included in marketing services, and amounted to approximately 20% and 15% of total net revenues for the three months ended September 30, 2003 and 2002, respectively, and approximately 20% and 13% of total net revenues for the nine months ended September 30, 2003 and 2002, respectively. Overture's revenue and net income, as reported in their most recent quarterly filing on Form 10-Q for the six months ended June 30, 2003, were $490 million and $19 million, respectively. Overture's results of operations will be included in the Company's consolidated statements of operations beginning October 7, 2003, the date of acquisition. See Note 12 – Subsequent Event.

 

Results of Operations

 

Net Revenues

 

Net revenues by groups of similar service were as follows (dollars in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

(1)

 

September 30,
2003

 

(1)

 

September 30,
2002

 

(1)

 

September 30,
2003

 

(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Marketing services

 

$

165,761

 

67

%

$

245,072

 

69

%

$

455,146

 

68

%

$

654,235

 

68

%

Fees

 

57,331

 

23

%

79,358

 

22

%

145,940

 

22

%

213,013

 

22

%

Listings

 

25,731

 

10

%

32,391

 

9

%

66,194

 

10

%

93,927

 

10

%

Total net revenues

 

$

248,823

 

100

%

$

356,821

 

100

%

$

667,280

 

100

%

$

961,175

 

100

%

 


(1)           Percent of net revenues

 

19



 

Marketing Services Revenues.  Marketing services revenues are primarily generated from the sale of banner, sponsorship, and text-link advertisements, including sponsored search services primarily provided through our agreement with Overture, a recently acquired wholly-owned subsidiary of the Company, and transactions revenues.  Marketing services revenues for the third quarter of 2003 increased by approximately $79 million, or 48%, as compared to the same period in 2002.  This increase resulted primarily from our global sponsored search services, which increased approximately $43 million for the three months ended September 30, 2003, as well as increases in overall growth in the balance of Yahoo!’s global marketing services revenues of approximately $36 million.   Marketing services revenues for the nine months ended September 30, 2003 increased by $199 million, or 44%, as compared to the same period in 2002.   This increase resulted primarily from our global sponsored search services, which increased approximately $125 million for the nine months ended September 30, 2003, as well as increases in overall growth in the balance of Yahoo!’s global marketing services revenues of approximately $74 million.

 

The total number of impressions and click-throughs delivered under advertising arrangements, excluding barter arrangements, in the three months ended September 30, 2003 increased by approximately 13% on a combined basis as compared to the three months ended September 30, 2002, while the average price yield per impression and click-through delivered, also on a combined basis, increased approximately 21% for the same period.  The increase in volume primarily resulted from the addition of smaller-sized advertising units to certain of the Companys properties, which increased the number of ads per page and inventory available for sale, as well as an overall increase in total page views.  The increase in average price per unit primarily resulted from an overall increase in the price achieved for our network inventory.  The total number of impressions and click-throughs delivered under advertising arrangements, excluding barter arrangements, in the nine months ended September 30, 2003 increased by approximately 46% on a combined basis as compared to the nine months ended September 30, 2002, while the average price yield per impression and click-through delivered, also on a combined basis, declined approximately 1% for the same period.  The increase in volume and decrease in average price per unit primarily resulted from the addition of smaller-sized, lower-priced advertising units to certain of the Companys properties, which increased available inventory for sale and also resulted in a lower average price per unit.  The Companys focus remains on obtaining overall advertising dollars rather than maximizing price per unit or impression.  During the three months ended September 30, 2003 and 2002, revenues from our agreement with Overture accounted for approximately 20% and 15% of total net revenues, respectively.  During the nine months ended September 30, 2003 and 2002, revenues from our agreement with Overture accounted for approximately 20% and 13% of total net revenues, respectively.

 

Fees Revenues.  Fees revenues consist of revenues generated from a variety of consumer and business fee-based services we provide. These services primarily include SBC Yahoo! DSL and SBC Yahoo! Dial, Yahoo! Personals, Small Business Services, Yahoo! Mail and Yahoo! Enterprise Solutions.   Fees revenues for the third quarter of 2003 increased $22 million, or 38% as compared to the same period in 2002.  Fees revenues for the nine months ended September 30, 2003 increased $67 million, or 46% as compared to the same period in 2002.  The increases were driven by the growth in the number of our paying relationships for Yahoo!’s premium services, which were approximately 4.2 million as of September 30, 2003, compared to approximately 1.6 million in the same period in 2002.

 

Listings Revenues.  Listings revenues consist of revenues generated from a variety of consumer and business listings-based services we provide.  These services primarily include access to the HotJobs database and classifieds such as Yahoo! Autos, Yahoo! Real Estate and other Search and Directory services.  Listings revenues for the third quarter of 2003 increased approximately $7 million, or 26% compared to the same period in 2002 primarily due to an increase in our search and marketplace services revenues.  Listings revenues for the nine months ended September 30, 2003 increased approximately $28 million, or 42% compared to the same period in 2002.  This increase was primarily driven by the incremental contribution in revenue of approximately $25 million from our search and marketplace services revenues.

 

20



 

Costs and Expenses:

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

(1)

 

September 30,
2003

 

(1)

 

September 30,
2002

 

(1)

 

September 30,
2003

 

(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

$

41,033

 

16

%

$

47,287

 

13

%

$

120,562

 

18

%

$

137,261

 

14

%

Sales and marketing

 

109,086

 

44

%

128,846

 

36

%

315,247

 

47

%

364,752

 

38

%

Product development

 

37,352

 

15

%

48,026

 

13

%

105,296

 

16

%

130,397

 

14

%

General and administrative

 

25,961

 

10

%

39,653

 

11

%

78,067

 

12

%

102,498

 

11

%

 


(1)           Percent of net revenues

 

Cost of Revenues.  Cost of revenues consists of the expenses associated with the production and usage of the Yahoo! network. These costs primarily consist of fees paid to third parties for content included on our online media properties, Internet connection charges, equipment depreciation, technology license fees and compensation related expenses.

 

Cost of revenues in the third quarter of 2003 increased by approximately $6 million, or 15%, as compared to the same period of 2002.  Cost of revenues for the nine months ended September 30, 2003 increased by approximately $17 million, or 14%, as compared to the same period of 2002.  The increases for both the three and nine month periods were due to increased costs associated with greater network usage, premium services and content.

 

Sales and Marketing.  Sales and marketing expenses consist primarily of advertising and other marketing related expenses, compensation related expenses, sales commissions and travel costs.

 

Sales and marketing expenses in the third quarter of 2003 increased approximately $20 million, or 18%, as compared to the same period in 2002, primarily as a result of increases in total compensation expense and professional services.  Sales and marketing expenses for the nine months ended September 30, 2003 increased approximately $50 million, or 16%, as compared to the same period in 2002, as a result of increases in compensation and professional services expenses of approximately $26 million, and marketing spending of approximately $22 million.

 

Product Development.  Product development expenses consist primarily of compensation related expenses incurred for enhancements to and maintenance of the Yahoo! network, classification and organization of listings within Yahoo! properties, research and development expenses, and other operating costs.

 

Product development expenses in the third quarter of 2003 increased approximately $11 million, or 29%, as compared to the same period of 2002.   Product development expenses for the nine months ended September 30, 2003 increased approximately $25 million, or 24%, as compared to the same period of 2002.   The increases for both the three and nine month periods are the result of increases in our total compensation expense related to engineers that develop and enhance properties and services throughout the Yahoo! network.

 

General and Administrative.  General and administrative expenses consist primarily of compensation related expenses and fees for professional services.

 

General and administrative expenses in the third quarter of 2003 increased approximately $14 million, or 53%, as compared to the same period of 2002.  General and administrative expenses for the nine months ended September 30, 2003 increased approximately $24 million, or 31%, as compared to the same period of 2002.  The increases for both the three and nine month periods are primarily attributable to increased professional services expenses of approximately $8 million and $17 million, respectively.

 

Overall, we currently expect total combined primary operating costs and expenses for 2003, including the impact of Overture, to increase in absolute dollars as compared to 2002.

 

21



 

Amortization of Intangibles.  From time to time we have purchased, and expect to continue purchasing, assets or businesses, which may result in the creation of amortizable intangible assets.

 

Amortization of intangibles expense was approximately $10 million for the third quarter of 2003, or 3% of net revenues, compared to approximately $6 million, or 2% of net revenues for the third quarter of 2002.  Amortization of intangibles expense was approximately $25 million for the nine months ended September 30, 2003, or 3% of net revenues, compared to approximately $15 million, or 2% of net revenues for the nine months ended September 30, 2002.  The increase in amortization of intangibles is primarily the result of the additional amortizable intangibles acquired in conjunction with the Inktomi acquisition during the first quarter of 2003.

 

Effective January 1, 2002, we adopted the provisions of SFAS 142, “Goodwill and Other Intangible Assets,” and as a result, we performed a transitional impairment test of our goodwill and intangibles as of January 1, 2002. Due to, among other things, the overall softening of the global economy and the related decline in international advertising, we recorded a transitional goodwill impairment loss of approximately $64 million, which was recorded as a cumulative effect of an accounting change in our Condensed Consolidated Statements of Operations. The fair value of the reporting unit giving rise to the transitional impairment loss was estimated using the expected present value of future cash flows.

 

We currently expect amortization of intangibles to increase further, in absolute dollars, as compared to 2002 as a result of the Overture acquisition.

 

Restructuring Costs.  During 2001, we announced restructuring programs to balance our investment in growth areas with the desire to modify our near-term business plan to reflect an economic and capital market slowdown. These restructuring programs included worldwide workforce reductions of approximately $15 million and consolidation of excess facilities and other charges of approximately $42 million, which were classified as operating expenses in 2001.

 

A summary of the restructuring accrual during the nine months ended September 30, 2003 is as follows (in thousands):

 

 

 

Restructuring
Accrual at
December 31, 2002

 


Cash

 

Restructuring Accrual at
September 30, 2003

 

 

 

 

Payments

 

 

 

 

 

 

 

 

 

 

Consolidation of excess facilities and other charges

 

$

11,745

 

$

(3,311

)

$

8,434

 

 

The restructuring accrual is included on the balance sheet in accrued expenses and other liabilities. The accrual related to the workforce reduction was paid by December 31, 2002. Amounts related to the net lease expense due to the consolidation of facilities will be paid over the respective lease terms through December 2012.

 

Other Income, Net.  Other income, net was as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Interest and investment income

 

$

15,382

 

$

12,038

 

$

50,180

 

$

34,989

 

Investment gains (losses), net

 

(672

)

(6

)

2,341

 

(1,636

)

Contract termination proceeds, net

 

(843

)

 

1,661

 

750

 

Earnings in equity interests

 

5,527

 

12,495

 

15,327

 

32,225

 

Other

 

141

 

(592

)

1,923

 

201

 

Total other income,  net

 

$

19,535

 

$

23,935

 

$

71,432

 

$

66,529

 

 

22



 

Other income, net was approximately $24 million and $20 million, respectively, for the three months ended September 30, 2003 and 2002. Other income, net was approximately $67 million and $71 million, respectively, for the nine months ended September 30, 2003 and 2002.   The $3 million and $15 million decreases in interest and investment income for the three and nine months ended September 30, 2003, respectively, were primarily related to our investments in debt securities and an overall decline in interest rates.  These decreases were offset by increases of $7 million and $17 million, respectively, as a result of earnings in our equity interests primarily related to our investment in Yahoo! Japan.   Investment gains (losses), net for the nine months ended September 30, 2003 included a net gain of approximately $6 million on the sale of investments, offset by impairment of approximately $8 million on privately held equity investments. Investment gains (losses), net for the three months ended September 30, 2003 did not include any material comparative amounts.  Investment gains (losses), net for the nine months ended September 30, 2002 included a gain of approximately $8 million on the sale of investments, partially offset by an impairment of approximately $6 million on privately held equity investments.  Investment gains (losses), net for the three months ended September 30, 2002 did not include any material comparative amounts.

 

Other income, net in future periods may fluctuate as a result of changes in our average investment balances held, changes in market rates or the sale of investments, and investment impairments.

 

Minority Interests in Operations of Consolidated Subsidiaries.  Minority interests in operations of consolidated subsidiaries represents the minority investors’ percentage share of income or losses from subsidiaries in which we hold a majority ownership interest, but less than 100%, and consolidate the subsidiaries’ results in our financial statements.

 

Minority interests in income from operations of consolidated subsidiaries was an expense of approximately $2 million and $1 million for the three months ended September 30, 2003 and 2002, respectively.  Minority interests in income from operations of consolidated subsidiaries was an expense of approximately $5 million and $1 million for the nine months ended September 30, 2003 and 2002, respectively.  The change was due to net income in Europe, compared to net losses in Europe in the same period of the prior year, as well as increased net income in Korea.

 

Income Taxes.  The provision for income taxes for the three and nine months ended September 30, 2003 differs from the amount computed by applying the statutory federal rate principally due to nontaxable equity earnings from certain investments and foreign losses for which no tax benefit is provided.  For the three and nine months ended September 30, 2002, the provision for income taxes differed from the amount computed by applying the statutory federal rate principally due to state taxes, foreign losses for which no tax benefit is provided, and nontaxable equity earnings from certain investments.

 

Business Segment Results

 

We manage our business geographically. Our primary areas of measurement and decision-making are the United States and International.  Management relies on an internal management reporting process that provides revenue and segment operating income before depreciation and amortization for making financial decisions and allocating resources. Segment operating income before depreciation and amortization includes income (loss) from operations before amortization of intangibles and depreciation.  Segment operating income before depreciation and amortization (previously referred to as “Segment EBITDA”) for prior years has been reclassified to include stock compensation expense, consistent with the current year presentation.  Management believes that segment operating income before depreciation and amortization is an appropriate measure of evaluating the operating performance of the Company’s segments. However, segment operating income before depreciation and amortization should be considered only in addition to, not as a substitute for or superior to, operating income, cash flows or other measures of financial performance prepared in accordance with generally accepted accounting principles.

 

Revenue is attributed to individual countries according to the international online property that generated the revenue. No single foreign country accounted for more than 10% of net revenues during the three and nine months ended September 30, 2003 and 2002.

 

23



 

Summarized information by segment is as follows (in thousands):

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2002

 

(1)

 

2003

 

(1)

 

2002

 

(1)

 

2003

 

(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenues by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

210,135

 

84

%

$

299,759

 

84

%

$

564,212

 

85

%

$

809,650

 

84

%

International

 

38,688

 

16

%

57,062

 

16

%

103,068

 

15

%

151,525

 

16

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total net revenues

 

$

248,823

 

100

%

$

356,821

 

100

%

$

667,280

 

100

%

$

961,175

 

100

%

 

Segment operating income (loss) before depreciation and amortization:

 

 

 

 

 

(2)

 

 

 

(2)

 

 

 

(2)

 

 

 

(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

57,621

 

27

%

$

106,122

 

35

%

$

123,004

 

22

%

$

273,625

 

34

%

International

 

1,607

 

4

%

10,389

 

18

%

(10,002

)

(10

)%

24,211

 

16

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total segment operating income before depreciation and amortization

 

$

59,228

 

24

%

$

116,511

 

33

%

$

113,002

 

17

%

$

297,836

 

31

%

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

 

 

 

 

Operating income before depreciation and amortization reconciliation:

 

 

 

 

 

 

 

 

 

Income from operations

 

$

29,477

 

$

83,498

 

$

32,820

 

$

201,247

 

Depreciation and amortization

 

29,751

 

33,013

 

80,182

 

96,589

 

Operating income before depreciation and amortization

 

$

59,228

 

$

116,511

 

$

113,002

 

$

297,836

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss) before depreciation and amortization by segment reconciliations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

 

 

 

 

 

 

 

 

Income from operations

 

$

30,751

 

$

77,684

 

$

51,354

 

$

189,156

 

Depreciation and amortization

 

26,870

 

28,438

 

71,650

 

84,469

 

Segment operating income before depreciation and amortization – United States

 

$

57,621

 

$

106,122

 

$

123,004

 

$

273,625

 

 

 

 

 

 

 

 

 

 

 

International

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

$

(1,274

)

$

5,814

 

$

(18,534

)

$

12,091

 

Depreciation and amortization

 

2,881

 

4,575

 

8,532

 

12,120

 

Segment operating income (loss) before depreciation and amortization – International

 

$

1,607

 

$

10,389

 

$

(10,002

)

$

24,211

 

 


(1)          Percent of total net revenues.

(2)          Segment operating income before depreciation and amortization margin.

 

24



 

United States.  United States revenues in the third quarter of 2003 increased approximately $90 million, or 43% compared to the same period in 2002. United States revenues for the nine months ended September 30, 2003 increased approximately $245 million, or 44% compared to the same period in 2002.   The increase in revenues resulted from our search and marketplace properties, which includes sponsored search services, our network services offerings, which includes communications services and Yahoo! Personals, and our consumer services offerings, which includes SBC Yahoo! DSL and SBC Yahoo! Dial.  United States segment operating income before depreciation and amortization in the third quarter of 2003 increased approximately $49 million, or 84% compared to the same period of 2002. United States segment operating income before depreciation and amortization for the nine months ended September 30, 2003 increased approximately $151 million, or 122% compared to the same period of 2002.  The increase is primarily due to the increase in United States revenues, as well as continued efforts to control discretionary spending during the period.

 

International.  International revenues in the third quarter of 2003 increased approximately $18 million, or 47% compared to the same period in 2002.  International revenues for the nine months ended September 30, 2003 increased approximately $48 million, or 47% compared to the same period in 2002.  The increase was primarily due to overall strength in the European and Asian economies, which resulted in an increase in search and marketplace revenues, including sponsored search revenues.   International segment operating income before depreciation and amortization in the third quarter of 2003 increased approximately $9 million compared to the same period in 2002 and for the nine months ended September 30, 2003 increased approximately $34 million compared to the same period in 2002.  These increases were primarily a result of the increase in International revenues and continued efforts to control discretionary spending.

 

Acquisitions

 

On March 19, 2003, we completed the acquisition of Inktomi Corporation, (“Inktomi”), a provider of original equipment manufacturer Web search and paid inclusion services.  The acquisition combined Yahoo!’s global audience and Inktomi’s search technology to allow us to create a more relevant, comprehensive and higher quality search offering on the Web.  These factors contributed to a purchase price in excess of the fair value of the Inktomi net tangible and intangible assets acquired, and as a result, we have recorded goodwill in connection with this transaction.

 

The total estimated purchase price of approximately $289.6 million consisted of $272.9 million in cash consideration, approximately $13.4 million of stock options exchanged, and direct transaction costs of approximately $3.3 million.  The value of the stock options was determined using the Black-Scholes option valuation model.

 

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

 

Cash acquired

 

$

44,610

 

Other tangible assets acquired

 

27,408

 

Amortizable intangible assets

 

49,400

 

Goodwill

 

216,188

 

Liabilities assumed

 

(49,287

)

Deferred stock-based compensation

 

1,287

 

Total

 

$

289,606

 

 

Amortizable intangible assets consist of customer-related intangible assets and developed technology with useful lives not exceeding five years.  A preliminary estimate of $216.2 million has been allocated to goodwill.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired, and is not deductible for tax purposes.  Goodwill will not be amortized and will be tested for impairment, at least annually.  The preliminary purchase price allocation for Inktomi is subject to revision as more detailed analysis is completed and additional information on the fair value of assets and liabilities becomes available.  Any change in the fair value of the net assets of Inktomi will change the amount of the purchase price allocable to goodwill.  Liabilities assumed include approximately $12.7 million of restructuring costs associated with the acquisition, of which approximately $5.6 million remains as of September 30, 2003.

 

On October 7, 2003, Yahoo! completed the acquisition of Overture, a provider of commercial search services on the Internet. See Note 12 – Subsequent Event.

 

25



 

Related Party Transactions

 

SOFTBANK Corp., including its consolidated affiliates (“SOFTBANK”), was approximately a 4% stockholder of the Company at September 30, 2003. We have joint ventures with SOFTBANK in France, Germany, Japan, Korea and the United Kingdom. A Managing Partner of a SOFTBANK affiliate is also a member of our Board of Directors.  Revenues from SOFTBANK accounted for less than 1% of net revenues for the three and nine months ended September 30, 2003.   Revenues from SOFTBANK accounted for approximately 3% and 2% of net revenues for the three and nine months ended September 30, 2002, respectively.  We believe contracted prices are comparable to those given to unrelated customers.

 

In addition, the Company has license agreements with Yahoo! Japan and Yahoo! Korea from which, in each case, we have received in excess of $60,000 in royalty payments during the nine months ended September 30, 2003.  Pursuant to these license agreements the Company licenses specified uses of the Yahoo! brand and business model to each of Yahoo! Japan and Yahoo! Korea on an exclusive basis in Japan and Korea, respectively, in exchange for licensing fees.  Pursuant to the terms of such license agreements, Yahoo! Japan and Yahoo! Korea pay to the Company 3% and 8%, respectively, of their revenues.  Pursuant to the Yahoo! Korea license agreement, the amount payable by Yahoo! Korea to the Company for each quarter cannot be less than $12,500.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to uncollectible receivables, investment values, intangible assets, income taxes, restructuring costs and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: revenue recognition; valuation allowances, specifically the allowance for doubtful accounts and deferred tax assets valuation allowance; accounting for investments in private and publicly-traded securities; and goodwill impairment.

 

Revenue recognition.  Our revenues are primarily generated from the sale of banner, sponsorship, and text-link advertisements, including sponsored search advertisements, transactions revenues, and revenues generated from a variety of consumer and business fee and listings-based services. In accordance with generally accepted accounting principles in the United States, the recognition of these revenues is partly based on our assessment of the probability of collection of the resulting accounts receivable balance. As a result, the timing or amount of revenue recognition may have been different if different assessments of the probability of collection of accounts receivable had been made at the time the transactions were recorded in revenue.

 

Valuation Allowances.  We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 

We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the valuation allowance would likely increase stockholders’ equity as substantially all of our net operating losses result from employee stock option deductions.

 

Accounting for investments in private and publicly-traded securities.  We hold equity interests in companies, some of which are publicly traded and have highly volatile share prices. We record an investment impairment charge when we believe an investment has experienced a decline in value that is judged to be other than temporary. We monitor our investments for impairment by considering current factors including economic environment, market conditions and the operational performance and other specific factors relating to the business underlying the investment. Future adverse changes in these factors could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment’s current carrying value, thereby possibly requiring an impairment charge in the future. We recorded approximately $2 million and $8 million of impairments on the carrying value of privately held equity securities during the three and nine months ended September 30, 2003, respectively.   There were no impairment charges recorded in the three months ended September 30, 2002.  We recorded approximately $6 million of impairments on the carrying value of privately held equity securities during the nine months ended September 30, 2002, respectively.

 

26



 

Goodwill Impairment. Our long-lived assets include goodwill and other intangible assets. Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”) requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit.

 

Effective January 1, 2002, we adopted SFAS 142 and performed a transitional test of our goodwill and intangible assets.  Due to, among other things, the overall softening of the global economy and the related decline in international advertising, the Company recorded a goodwill impairment loss of approximately $64 million, which was recorded during the first quarter of 2002 as a cumulative effect of an accounting change in the Company’s consolidated financial statements.  The fair value of the reporting unit giving rise to the transitional impairment loss was estimated using the expected present value of future cash flows.  As of September 30, 2003, goodwill was approximately $635 million.  Any further impairment losses recorded in the future could have a material adverse impact on our financial condition and results of operations.

 

Recent Accounting Pronouncements

 

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue 00-21, addressing how to account for arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. Revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: (1) the delivered item has value to the customer on a standalone basis; (2) there is objective and reliable evidence of the fair value of undelivered items; and (3) delivery of any undelivered item is probable. Arrangement consideration should be allocated among the separate units of accounting based on their relative fair values, with the amount allocated to the delivered item being limited to the amount that is not contingent on the delivery of additional items or meeting other specified performance conditions. The final consensus is applicable to agreements entered into in fiscal periods beginning after June 15, 2003.  The provisions of this consensus did not have a significant effect on our results of operations or financial position.

 

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46 (“FIN 46”) “Consolidation of Variable Interest Entities.” Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity, as defined, to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns. Management is currently evaluating the effect of adopting FIN 46 on its results of operations and financial position.

 

In April 2003, the FASB issued SFAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”, which amends SFAS 133 for certain decisions made by the FASB Derivatives Implementation Group.  In particular, SFAS 149: (1) clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, (2) clarifies when a derivative contains a financing component, (3) amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” and (4) amends certain other existing pronouncements.  This Statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, most provisions of SFAS 149 are to be applied prospectively.  The adoption of SFAS 149 did not have a material impact on our financial position, cash flows or results of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity” (“SFAS 150”).  SFAS 150 changes the accounting for certain financial instruments that under previous guidance issuers could account for as equity.  It requires that those instruments be classified as liabilities in balance sheets.  The guidance in SFAS 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective on July 1, 2003.  The adoption of SFAS 150 did not have a material impact on our financial position, cash flows or results of operations.

 

27



 

Liquidity and Capital Resources

 

Summarized cash flow information is as follows (in thousands):

 

 

 

Nine Months Ended

 

 

 

September 30,
2002

 

September 30,
2003

 

 

 

 

 

 

 

Cash provided by operating activities

 

$

223,090

 

$

326,284

 

Cash used in investing activities

 

(219,502

)

(896,142

)

Cash provided by (used in) financing activities

 

(61,385

)

936,152

 

 

We invest excess cash predominantly in debt instruments that are highly liquid, of high-quality investment grade, and predominantly have maturities of less than two years, with the intent to make such funds readily available for operating purposes. We had cash, cash equivalents and investments in marketable debt securities totaling approximately $2.5 billion at September 30, 2003.

 

Cash provided by operating activities primarily consists of net income (loss) adjusted for certain non-cash items including depreciation, amortization, tax benefits from stock options, cumulative effect of accounting change, earnings in equity interests, noncash gains, losses and impairments from investments, other non-cash items, and the effect of changes in working capital and other activities.  Cash provided by operating activities for the nine months ended September 30, 2003 of approximately $326 million consisted primarily of net income of approximately $163 million adjusted for non-cash items of approximately $166 million and approximately $3 million used by working capital. Cash provided by operating activities for the nine months ended September 30, 2002 of approximately $223 million consisted primarily of net loss of approximately $3 million adjusted for non-cash items of approximately $110 million, cumulative effect of accounting change of approximately $64 million and approximately $52 million provided by working capital and other activities.

 

Cash used in investing activities in the nine months ended September 30, 2003 of approximately $896 million was primarily attributable to purchases of investments in marketable securities and other investments (net of proceeds from sales and maturities) of approximately $588 million, cash paid (net of cash acquired) for acquisitions of approximately $228 million, and capital expenditures totaling approximately $80 million.  Capital expenditures have generally comprised purchases of computer hardware, software, server equipment and furniture and fixtures, and including the impact of Overture, are currently expected to increase in 2003 compared to 2002.  Cash used in investing activities in the nine months ended September 30, 2002 of approximately $220 million was primarily attributable to cash paid (net of cash acquired) for acquisitions of approximately $189 million, capital expenditures of approximately $35 million, and proceeds from sales and maturities of investments in marketable securities and other investments (net of purchases) of approximately $4 million.

 

Cash provided by financing activities in the nine months ended September 30, 2003 of approximately $936 million was primarily attributable from proceeds from issuance of debt of approximately $733 million and proceeds from issuance of common stock of approximately $203 million as a result of the exercise of employee stock options.  Cash used in financing activities in the nine months ended September 30, 2002 of approximately $61 million, was primarily due to repurchase of common stock of approximately $100 million, partially offset by proceeds from the issuance of common stock of approximately $39 million as a result of the exercise of employee stock options.

 

In April 2003, we issued $750 million of zero coupon senior convertible notes (the “Notes”) due April 2008, which resulted in net proceeds of approximately $733 million after transaction fees of approximately $17 million, which have been deferred and are included on the balance sheet in other assets.  The Notes were issued at par and bear no interest.  The Notes are convertible into Yahoo! common stock at a conversion price of $41.00 per share, which would result in an aggregate of 18.3 million shares, subject to adjustment upon the occurrence of specified events.  Each $1,000 principal amount of the Notes will initially be convertible into 24.3902 shares of Yahoo! common stock prior to April 1, 2008 if the sale price of our common stock issuable upon conversion of the Notes reaches a specified threshold for a defined period of time or specified corporate transactions have occurred.  The specified thresholds for conversion prior to the maturity date are (1) the closing sale price of the Company’s common stock for at least 20 trading days in the 30 trading-day period ending on the last trading day of the immediately preceding fiscal quarter exceeds 110% of the conversion price on that 30th trading day, and (2) during the period beginning January 1, 2008 through the maturity date, the closing sale price of the Company’s common stock on the previous trading day was 110% or more of the then current conversion price.  Upon conversion, Yahoo! has the right to deliver cash in lieu of common stock.  The Company may be required to repurchase all of the notes following a fundamental change of the Company, such as a change of control, prior to maturity.  Yahoo! may not redeem the Notes prior to their maturity.  We intend to use these funds, together with existing cash and investments, for general corporate purposes including potential future acquisitions.

 

28



 

On October 7, 2003, Yahoo! completed the acquisition of Overture, a provider of commercial search services on the Internet.   Under the terms of the acquisition, each outstanding share of Overture was exchanged for 0.6108 shares of Yahoo! common stock and $4.75 in cash, which amounts to approximately $309 million in aggregate cash, and together with stock options exchanged and direct transaction costs resulted in an aggregate purchase price of approximately $1.7 billion.    See Note 12 – Subsequent Event for further discussion of the Overture acquisition.

 

Overture’s commitments related to leases and affiliate contracts as of October 7, 2003 for each of the succeeding five years is as follows: Period ending December 31, 2003: $19.7 million; Years ending December 31, 2004: $60.6 million; 2005: $19.5 million; 2006: $6.4 million; and 2007: $2.0 million.

 

Operating Leases

 

Operating Leases.  We have entered into various non-cancelable operating lease agreements for our offices throughout the U.S. and for our international subsidiaries with original lease periods ranging up to 13 years and expiring between 2003 and 2012.

 

In addition, we have entered into various sublease arrangements associated with our excess facilities under the 2001 Restructuring programs. Such subleases have terms extending through 2006 and amounts estimated to be received have been included in determining the restructuring accrual.

 

Net lease commitments as of September 30, 2003 can be summarized as follows (in millions):

 

 

 

Gross lease
commitments

 

Sublease
income

 

Net lease
commitments

 

 

 

 

 

 

 

 

 

Three months ending December 31, 2003

 

$

8.2

 

$

(2.2

)

$

6.0

 

Years ending December 31,

 

 

 

 

 

 

 

2004

 

28.8

 

(6.2

)

22.6

 

2005

 

24.3

 

(4.0

)

20.3

 

2006

 

22.3

 

(3.2

)

19.1

 

2007

 

18.4

 

 

18.4

 

2008

 

14.5

 

 

14.5

 

Thereafter

 

96.7

 

 

96.7

 

 

Investment in Privately-Held Company.

 

During 2002, Yahoo! acquired an equity interest of approximately 16% in Sonera zed OY (“Zed”), a Finnish company and previously wholly-owned subsidiary of a publicly-held telecommunications company. Under the terms of the investment agreement, Yahoo! has call options to acquire the remaining interests not owned by Yahoo! and a put option to sell back its shares.  In addition, Zed has a put option enabling Zed to require Yahoo! to acquire the remaining interests not owned by Yahoo! if Yahoo! exercises its option to buy a majority of Zed’s outstanding shares.  The amount of the purchase price for the remaining equity interests in Zed not held by Yahoo! under these options is not determinable at this time but will be based on an operating performance based valuation of Zed.   Yahoo! is not obligated to purchase additional equity in Zed unless it chooses to exercise the option described above.  As part of the transaction, Yahoo! has agreed to provide up to 4.0 million Euro in additional funding to Zed.  Other than this amount, Yahoo! is not obligated to guarantee any obligations of Zed or to provide any funding to Zed.  Yahoo!’s investment in Zed was immaterial to its condensed consolidated balance sheet as of September 30, 2003.

 

Other Commitments

 

In the ordinary course of business, Yahoo! enters into various arrangements with vendors and other business partners, principally for marketing, technology, bandwidth and content arrangements. There are no material commitments for these arrangements extending beyond September 30, 2004.

 

29



 

In connection with Company’s commercial agreements, Yahoo! provides indemnifications of varying scope and terms to customers, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of such agreements and out of intellectual property infringement claims made by third parties.  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 maintains directors and officers insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers in certain circumstancesThe indemnification provided by the Company to its officers and directors does not have a stipulated maximum, therefore the Company is not able to develop a reasonable estimate of the maximum liabilities.  To date, the Company has not incurred material costs as a result of such obligations and has not accrued any liabilities related to such indemnification obligations in its financial statements.

 

In March 2001, our Board of Directors authorized the repurchase of up to $500 million of Yahoo!’s outstanding shares of common stock from time to time over the next two years, depending on market conditions, share price and other factors.  In March 2003, our Board of Directors authorized a two-year extension of the stock repurchase program, which extension authorizes us to repurchase up to approximately $340 million (representing the balance of the $500 million originally authorized in March 2001) of our outstanding shares of common stock from time to time over the next two years, depending on market conditions, share price and other factors.  We may utilize equity instrument contracts to facilitate the repurchase of common stock.  From March 2001 through September 30, 2003, we had repurchased 16,458,620 shares of common stock at an average of $9.72 per share for a total amount of approximately $160 million. Of the shares repurchased, 16,033,620 shares were purchased from SOFTBANK at an average of $9.67 per share.  No shares were repurchased during the nine months ended September 30, 2003.  Repurchased shares are held in treasury stock.  Treasury stock is accounted for under the cost method.

 

We continue to increase capital expenditures and operating lease commitments, which is consistent with our increased staffing and operational expansion, and including the impact of Overture, we anticipate that this will continue in the future as business conditions merit.  Additionally, we will continue to evaluate possible acquisitions of, or investments in businesses, products, and technologies that are complementary to our business, which may require the use of cash. Management believes existing cash and investments will be sufficient to meet operating requirements for at least the next twelve months; however, we may sell additional equity or debt securities or obtain credit facilities to further enhance our liquidity position. The sale of additional securities could result in further dilution to our stockholders.

 

RISK FACTORS

 

If our competitors are more successful in attracting and retaining customers and users, then our revenues could decline.

 

We compete with many other providers of online navigation, Web search, commercial search, information, entertainment, business, recruitment, community, electronic commerce, and Internet access services. As we expand the scope of our Internet offerings, we will compete directly with a greater number of Internet sites, media companies, and companies providing business services across a wide range of different online services, including:

 

                  companies offering communications, Web search, commercial search, information, community and entertainment services and Internet access either on a stand alone basis or integrated into other products and media properties;

 

                  vertical markets where competitors may have advantages in expertise, brand recognition, available financial and other resources, and other factors;

 

                  online employment recruiting companies; and

 

                  online merchant hosting services.

 

In order to compete effectively, we may need to expend significant internal engineering resources or acquire other technologies and companies to provide or enhance our capabilities.  If we are unable to maintain or expand our customer and user base in the future, our revenues may decline.

 

30



 

Companies such as Time Warner and Microsoft may have a competitive advantage because they have greater access to content, maintain billing relationships with more customers and have access to established distribution networks.

 

We face significant competition from Time Warner’s America Online business (“AOL” or “America Online”) and Microsoft (“Microsoft” or “MSN”). The combination of America Online and Time Warner provides America Online with content from Time Warner’s movie and television, music, books and periodicals, news, sports and other media holdings; access to a network of cable and other broadband delivery technologies; and considerable resources for future growth and expansion. The America Online/Time Warner combination also provides America Online with access to a broad potential customer base consisting of Time Warner’s current customers and subscribers of its various media properties. To a less significant extent, we also face competition from other companies that have combined a variety of services under one brand in a manner similar to Yahoo!. In certain of these cases, most notably AOL and MSN, our competition has a direct billing relationship with a greater number of their users through access and other services than we have with our users through certain of our premium services. This relationship permits our competitors to have several potential advantages including the potential to be more effective than us in targeting services and advertisements to the specific taste of their users.

 

Our recent acquisitions of Inktomi and Overture expose our business to greater competition in the area of algorithmic Web search and paid inclusion services.

 

In March 2003 we completed our acquisition of Inktomi Corporation (“Inktomi”), a provider of OEM algorithmic Web search and paid inclusion services.  In addition, we completed our acquisition of Overture Services, Inc. (“Overture”) in October 2003, increasing our algorithmic Web search and paid inclusion business through Overture’s recently acquired Alta Vista and Fast Search & Transfer Web search businesses.  As a result of these acquisitions, we compete directly with other providers of Web search and related search services, including, among others, AskJeeves, Google, and LookSmart, Ltd.  Some of these competitors may have longer operating histories focusing on providing Web search services on an OEM basis, larger customer or user bases and greater brand recognition for their Web search businesses.  In addition to the general acquisition risks highlighted in these risk factors, we are subject to the risk that other companies with greater operational, strategic, financial, personnel or other resources may choose to enter the Web search or paid inclusion spaces by acquisition or internal development, and may create greater competition for advertisers, customers and users.

 

If Overture fails to maintain and grow its advertiser, user, business and affiliate constituencies, our revenues could significantly decline and our business could be adversely affected.

 

Overture’s paid placement search service is comprised of advertiser-generated listings, which are screened for relevance and accessed by users and businesses through the Yahoo! properties and through Overture’s affiliates, a network of other Web properties that have integrated Overture’s search service into their sites or that direct user traffic to Overture’s sites.  The search listings are ranked according to the advertiser’s bid; the higher the bid, the higher the ranking. Advertisers pay Overture the bid price for clicks on the advertiser’s search listing (also known as a paid introduction, click-through or a paid click).  Overture’s growth in commercial search services depends, in part on the maintenance of a critical mass of advertisers, users, affiliates and traffic generated by the Yahoo! properties and Overture’s network of other Web properties.  Such a critical mass encourages increased participation in Overture’s paid placement search marketplace.  To the extent Overture experiences a decline in the growth or number of any one or all constituents, the value of Overture’s paid placement service could be harmed, and our revenues or business could be adversely affected.

 

Our recent acquisition of Overture exposes our business to greater competition with providers of pay-per-click advertising search services.

 

As a result of our acquisition of Overture, we compete directly with other providers of pay-per-click advertising services and paid search that are similar to Overture’s, including Espotting Media, Inc. (which is under agreement to be acquired by FindWhat), FindWhat, Google, LookSmart, Primedia, and Terra Lycos.  In addition, we believe it is likely that there will be additional entrants to the pay-per-click search market.  Some of these entrants may have greater operational, strategic, financial, personnel or other resources than we do.  These competitors compete against Overture for affiliate arrangements and could cause Overture to enter into affiliate arrangements with less favorable terms or lose current affiliates or not acquire new affiliates, which could reduce the number of click-throughs, increase the amount of revenue shared with affiliates, and reduce total revenues and thereby harm our business, operating results and financial condition.

 

31



 

Acquisitions could result in operating difficulties.

 

As part of our business strategy, we acquired Overture in October 2003 and Inktomi Corporation in March 2003 and have completed several other acquisitions.  We expect to enter into additional business combinations and acquisitions in the future.  Acquisitions may result in dilutive issuances of equity securities, use of our cash resources, incurrence of debt and amortization of expenses related to intangible assets.  The acquisitions of Overture and Inktomi were accompanied by a number of risks, including:

 

                  the difficulty of assimilating the operations and personnel of Overture, which are principally located in Southern California, with and into Yahoo!’s operations, which are headquartered in Northern California;

 

                  the potential disruption of our ongoing business and distraction of management;

 

                  the difficulty of incorporating acquired technology or content and rights into our products and unanticipated expenses related to such integration;

 

                  the failure to further successfully develop acquired technology resulting in the impairment of amounts currently capitalized as intangible assets;

 

                  the impairment of relationships with customers of Overture and Inktomi, or our own customers as a result of any integration of operations;

 

                  the impairment of relationships with employees of Overture and Inktomi or our own business as a result of any integration of new management personnel; and

 

                  the potential unknown liabilities associated with Overture and Inktomi.

 

We may experience similar risks in connection with our future acquisitions.  We may not be successful in addressing these risks or any other problems encountered in connection with the acquisitions of Overture and Inktomi or that we could encounter in future acquisitions, which would harm our business or cause us to fail to realize the anticipated benefits of our acquisitions.

 

Our international segment competes with local Internet service providers that may have a competitive advantage.

 

On an international level, we compete directly with local providers; they may have several advantages, including greater knowledge about the particular country or local market and access to significant financial or strategic resources in such local markets. We must continue to obtain more knowledge about our users and their preferences, deepen our relationships with our users as well as increase our branding and other marketing activities in order to remain competitive and strengthen our international market position.

 

Our intellectual property rights are valuable and any inability to protect them could dilute our brand image.

 

We regard our copyrights, patents, trademarks, trade dress, trade secrets, and similar intellectual property, including our rights to certain domain names, as important to Yahoo!’s success.  Effective trademark, patent, copyright, and trade secret protection may not be available in every country in which our products and media properties are distributed or made available through the Internet.  Further, the efforts we have taken to protect our proprietary rights may not be sufficient or effective. If we are unable to protect our trademarks from unauthorized use, our brand image may be harmed. While we attempt to ensure that the quality of our brand is maintained by our licensees, our licensees may take actions that could impair the value of our proprietary rights or the reputation of our products and media properties. We are aware that third parties have, from time to time, copied significant content available on Yahoo! for use in competitive Internet services. Protection of the distinctive elements of Yahoo! may not be available under copyright law. Any impairment of our brand image could cause our stock price to drop. In addition, protecting our intellectual property and other proprietary rights can be expensive. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and consequently harm our operating results. In turn, this could harm the results of our business and lower our stock price.

 

32



&