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, 2004

 

 

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 27, 2004

Common stock, $0.001 par value

 

1,374,819,307

 

 



 

YAHOO! INC.

 

Table of Contents

 

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, 2003 and 2004

 

 

 

Condensed Consolidated Balance Sheets at December 31, 2003 and September 30, 2004

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2004

 

 

 

Condensed Consolidated Statements of Stockholders’ Equity for the three and nine months ended September 30, 2003 and 2004

 

 

 

Notes to Condensed Consolidated Financial Statements

 

Item 2.

 

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

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

Item 4.

 

Controls and Procedures

 

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

Item 2.

 

Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

Item 3.

 

Defaults Upon Senior Securities

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

Item 5.

 

Other Information

 

Item 6.

 

Exhibits

 

 

 

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,
2003

 

September 30,
2004

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

356,821

 

$

906,715

 

$

961,175

 

$

2,496,800

 

Cost of revenues

 

47,287

 

332,333

 

137,261

 

911,421

 

Gross profit

 

309,534

 

574,382

 

823,914

 

1,585,379

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

128,748

 

192,950

 

364,333

 

551,120

 

Product development

 

47,683

 

97,033

 

129,180

 

261,162

 

General and administrative

 

39,609

 

69,215

 

102,183

 

189,930

 

Stock compensation expense (1)

 

485

 

6,111

 

1,951

 

25,823

 

Amortization of intangibles

 

9,511

 

36,968

 

25,020

 

103,588

 

Total operating expenses

 

226,036

 

402,277

 

622,667

 

1,131,623

 

Income from operations

 

83,498

 

172,105

 

201,247

 

453,756

 

 

 

 

 

 

 

 

 

 

 

Other income, net

 

11,440

 

123,281

 

34,304

 

150,838

 

Earnings in equity interests

 

12,495

 

25,696

 

32,225

 

69,672

 

Minority interests in operations of consolidated subsidiaries

 

(2,063

)

(660

)

(5,097

)

(2,894

)

Income before income taxes

 

105,370

 

320,422

 

262,679

 

671,372

 

Provision for income taxes

 

40,041

 

67,117

 

99,819

 

204,343

 

Net income

 

$

65,329

 

$

253,305

 

$

162,860

 

$

467,029

 

 

 

 

 

 

 

 

 

 

 

Net income per share—basic:

 

$

0.05

 

$

0.19

 

$

0.13

 

$

0.35

 

 

 

 

 

 

 

 

 

 

 

Net income per share—diluted:

 

$

0.05

 

$

0.17

 

$

0.13

 

$

0.32

 

 

 

 

 

 

 

 

 

 

 

Shares used in per share calculation-basic

 

1,221,394

 

1,361,136

 

1,207,571

 

1,345,583

 

 

 

 

 

 

 

 

 

 

 

Shares used in per share calculation-diluted

 

1,274,888

 

1,458,610

 

1,254,540

 

1,444,955

 

 

(1)  Stock compensation expense by function:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

$

98

 

$

1,731

 

$

419

 

$

7,712

 

Product development

 

343

 

2,371

 

1,217

 

9,642

 

General and administrative

 

44

 

2,009

 

315

 

8,469

 

Total stock compensation expense

 

$

485

 

$

6,111

 

$

1,951

 

$

25,823

 

 

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

 

3



 

YAHOO! INC.

Condensed Consolidated Balance Sheets

(in thousands except par value)

 

 

 

December 31,
2003

 

September 30,
2004

 

 

 

 

 

(unaudited)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

713,539

 

$

963,528

 

Short-term investments in marketable debt securities

 

595,978

 

1,200,592

 

Short-term investments in marketable equity securities

 

 

762,280

 

Accounts receivable, net

 

282,415

 

384,738

 

Prepaid expenses and other current assets

 

129,777

 

158,611

 

Total current assets

 

1,721,709

 

3,469,749

 

 

 

 

 

 

 

Long-term investments in marketable debt securities

 

1,256,698

 

907,448

 

Property and equipment, net

 

449,512

 

484,703

 

Goodwill

 

1,805,561

 

2,324,916

 

Intangible assets, net

 

445,640

 

480,685

 

Other assets

 

252,534

 

279,034

 

Total assets

 

$

5,931,654

 

$

7,946,535

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

31,890

 

$

41,283

 

Accrued expenses and other current liabilities

 

483,628

 

586,252

 

Deferred revenue

 

192,278

 

224,261

 

Total current liabilities

 

707,796

 

851,796

 

 

 

 

 

 

 

Long-term deferred revenue

 

 

66,909

 

Long-term debt

 

750,000

 

750,000

 

Other liabilities

 

72,890

 

116,581

 

Minority interests in consolidated subsidiaries

 

37,478

 

44,472

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.001 par value; 5,000,000 shares authorized; 1,321,408 and 1,365,228 issued and outstanding, respectively

 

1,356

 

1,398

 

Additional paid-in capital

 

4,288,138

 

5,132,149

 

Treasury stock

 

(159,988

)

(159,988

)

Retained earnings

 

230,386

 

697,415

 

Accumulated other comprehensive income (loss)

 

3,598

 

445,803

 

Total stockholders’ equity

 

4,363,490

 

6,116,777

 

Total liabilities and stockholders’ equity

 

$

5,931,654

 

$

7,946,535

 

 

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,
2003

 

September 30,
2004

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

162,860

 

$

467,029

 

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

 

 

 

 

 

Depreciation and amortization

 

96,589

 

225,108

 

Tax benefits from stock options

 

85,843

 

177,266

 

Earnings in equity interests

 

(32,225

)

(69,672

)

Minority interests in operations of consolidated subsidiaries

 

5,097

 

2,894

 

Stock compensation expense

 

1,951

 

25,823

 

(Gains)/losses on sale of investments, assets and other, net

 

9,331

 

(91,067

)

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

 

 

 

 

 

Accounts receivable, net

 

(31,815

)

(83,288

)

Prepaid expenses and other assets

 

(756

)

(6,434

)

Accounts payable

 

280

 

(899

)

Accrued expenses and other liabilities

 

18,147

 

83,561

 

Deferred revenue

 

10,982

 

22,780

 

Net cash provided by operating activities

 

326,284

 

753,101

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Acquisition of property and equipment, net

 

(79,718

)

(160,132

)

Purchases of marketable debt securities

 

(1,632,298

)

(1,178,741

)

Proceeds from sales and maturities of marketable debt securities

 

1,041,429

 

902,072

 

Acquisitions, net of cash acquired

 

(228,318

)

(607,692

)

Proceeds from sales of marketable equity securities and other

 

2,763

 

206,933

 

Net cash used in investing activities

 

(896,142

)

(837,560

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of debt, net

 

733,125

 

 

Proceeds from issuance of common stock, net

 

203,027

 

423,591

 

Structured stock repurchase, net

 

 

(95,907

)

Net cash provided by financing activities

 

936,152

 

327,684

 

Effect of exchange rate changes on cash and cash equivalents

 

4,252

 

6,764

 

Net change in cash and cash equivalents

 

370,546

 

249,989

 

Cash and cash equivalents at beginning of period

 

310,972

 

713,539

 

Cash and cash equivalents at end of period

 

$

681,518

 

$

963,528

 

 

5



 

Supplemental schedule of investing activities:

 

Acquisition-related activities (in thousands):

 

 

 

Nine Months Ended

 

 

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

Cash paid for acquisitions

 

$

272,928

 

$

655,181

 

Cash acquired in acquisitions

 

(44,610

)

(47,489

)

 

 

$

228,318

 

$

607,692

 

 

 

 

 

 

 

Value of common stock options issued in connection with acquisitions

 

$

13,367

 

$

3,384

 

 

See Note 6—“Acquisitions” for further information.

 

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

 

6



 

YAHOO! INC.

Condensed Consolidated Statements of Stockholders’ Equity

(unaudited, in thousands)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2003

 

September 30,
2004

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

$

1,248

 

$

1,387

 

$

1,222

 

$

1,356

 

Common stock issued

 

10

 

11

 

36

 

42

 

Balance, end of period

 

1,258

 

1,398

 

1,258

 

1,398

 

 

 

 

 

 

 

 

 

 

 

Additional paid-in capital

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

2,620,936

 

4,695,991

 

2,429,611

 

4,288,138

 

Common stock issued

 

74,409

 

109,792

 

219,694

 

431,178

 

Stock compensation expense

 

485

 

6,111

 

1,951

 

25,823

 

Tax benefit from stock options, net

 

32,561

 

369,321

 

81,929

 

482,624

 

Structured stock repurchase, net

 

 

(45,907

)

 

(95,907

)

Deferred stock-based compensation

 

 

(3,159

)

(1,287

)

939

 

Other

 

 

 

(3,507

)

(646

)

Balance, end of period

 

2,728,391

 

5,132,149

 

2,728,391

 

5,132,149

 

 

 

 

 

 

 

 

 

 

 

Treasury stock

 

 

 

 

 

 

 

 

 

Balance, beginning and end of period

 

(159,988

)

(159,988

)

(159,988

)

(159,988

)

 

 

 

 

 

 

 

 

 

 

Retained earnings (accumulated deficit)

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

90,038

 

444,110

 

(7,493

)

230,386

 

Net income

 

65,329

 

253,305

 

162,860

 

467,029

 

Balance, end of period

 

155,367

 

697,415

 

155,367

 

697,415

 

 

 

 

 

 

 

 

 

 

 

Accumulated other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

4,599

 

(20,373

)

(1,082

)

3,598

 

Net unrealized gains (losses) on securities, net of tax

 

(5,452

)

456,283

 

(5,829

)

444,571

 

Foreign currency translation adjustments

 

914

 

9,893

 

6,972

 

(2,366

)

Balance, end of period

 

61

 

445,803

 

61

 

445,803

 

 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

$

2,725,089

 

$

6,116,777

 

$

2,725,089

 

$

6,116,777

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

Net income

 

$

65,329

 

$

253,305

 

$

162,860

 

$

467,029

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

Net unrealized gains (losses) on securities, net of tax

 

(5,452

)

456,283

 

(5,829

)

444,571

 

Foreign currency translation adjustment

 

914

 

9,893

 

6,972

 

(2,366

)

Comprehensive income

 

$

60,791

 

$

719,481

 

$

164,003

 

$

909,234

 

 

 

 

Number of Shares

 

Common stock

 

 

 

 

 

 

 

 

 

Balance, beginning of period

 

1,214,700

 

1,354,237

 

1,189,720

 

1,321,408

 

Common stock issued

 

10,612

 

10,991

 

35,592

 

43,820

 

Balance, end of period

 

1,225,312

 

1,365,228

 

1,225,312

 

1,365,228

 

 

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

 

7



 

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 recurring items, which in the opinion of management, are necessary for a fair statement of the results of operations for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full year or for any future period.

 

The results of operations of companies acquired during the period have been included in the Company’s consolidated statements of operations since the completion of the acquisitions. See Note 6 – “Acquisitions.”

 

On April 7, 2004, the Yahoo! Board of Directors approved a two-for-one split of the Company’s shares of common stock effected in the form of a stock dividend. As a result of the stock split, Yahoo! stockholders received one additional share of Yahoo! common stock for each share of common stock held of record on April 26, 2004. The additional shares of Yahoo! common stock were distributed on May 11, 2004. All share and per share amounts in these condensed consolidated financial statements and related notes have been retroactively adjusted to reflect the stock split for all periods presented.

 

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, 2003. Certain prior period balances have been reclassified to conform to the current year 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.

 

The Company recognizes revenue on arrangements in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104 “Revenue Recognition,” and Emerging Issues Task Force 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.

 

Marketing services revenue is primarily generated from rich media advertisements (banner and other media advertisements), sponsorship and text-link advertisements (including pay-for-performance search advertisements), paid inclusion, algorithmic search services and transactions. Banner advertising agreements typically range from one week to three years. The Company recognizes marketing services revenue related to banner advertisements as “impressions” are delivered 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 often involve multiple element arrangements (arrangements with more than one deliverable) that may include placement on specific properties, exclusivity and content integration. Sponsorship advertisement revenue is recognized as “impressions” are delivered or ratably over the contract period, where applicable. Text-link and hypertext link advertisements, including pay-for-performance search advertisements or results, are recognized 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. Per-query search fees are recognized based on the query volume in the period, and revenue from customers who pay a fixed fee to be included in the Web search index are recognized over the term of the agreement. Transactions revenue includes service fees for facilitating transactions through the Yahoo! network, principally from the Company’s commerce properties. Transactions revenue is recognized when there is evidence that the qualifying transactions have occurred.

 

8



 

Fees revenue consists of revenues generated from a variety of consumer and business fee-based services, including SBC Yahoo! DSL and SBC Yahoo! Dial, BT Yahoo! Broadband and BT Yahoo! Internet, Yahoo! Personals, Small Business Services and Yahoo! Mail. Revenue is 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.

 

Listings revenue consists 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 services. Revenue is 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 comprises contractual billings in excess of recognized revenue and payments received in advance of revenue recognition.

 

Traffic Acquisition Costs. The Company enters into agreements of varying duration with third party affiliates that integrate the Company’s pay-for-performance search service into their Web sites. There are generally three economic structures of the affiliate agreements: guaranteed fixed payments which often carry reciprocal performance guarantees from the affiliate, variable payments based on a percentage of the Company’s revenue or based on a certain metric, such as number of searches or paid clicks, or a combination of the two.

 

The Company expenses, as cost of revenues, traffic acquisition costs under two methods; agreements with fixed payments are expensed pro-rata over the term the fixed payment covers, and agreements based on a percentage of revenue, number of paid introductions, number of searches, or other metric are expensed based on the volume of the underlying activity or revenue multiplied by the agreed-upon price or rate.

 

Use of Estimates. The preparation of condensed 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. Actual results may differ from these estimates under different assumptions or conditions.

 

Basic and Diluted Net Income per Share. Basic net income per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income 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 the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s zero coupon senior convertible notes (the “Notes”), (using the if-converted method). For the three and nine month periods ended September 30, 2003, potential common shares of 53 million and 47 million, respectively, were included in the computation of diluted net income per share and were related to shares issuable upon the exercise of stock options. For the three and nine month periods ended September 30, 2003, 73 million and 86 million options to purchase common stock, respectively, were excluded from the calculation, as the effect was anti-dilutive. For the three month period ended September 30, 2004, total potential common shares of 97 million, consisting of 60 million shares issuable upon the exercise of stock options and 37 million shares issuable upon the conversion of the Notes, were included in the computation of diluted net income per share. For the nine month period ended September 30, 2004, total potential common shares of 99 million, consisting of 62 million shares issuable upon the exercise of stock options and 37 million shares issuable upon the conversion of the Notes, were included in the computation of diluted net income per share. For the three and nine month periods ended September 30, 2004, 45 million and 62 million options to purchase common stock, respectively, were excluded from the calculation, as the effect was anti-dilutive. See Note 8—“Long-Term Debt” for additional information related to the Notes.

 

Stock-Based Compensation. The Company measures compensation expense for its stock-based employee compensation plans using the intrinsic value method. The Company recorded compensation expense of less than $1 million and approximately $6 million in the three months ended September 30, 2003 and 2004, respectively. The Company recorded compensation expense of approximately $2 million and $26 million in the nine months ended September 30, 2003 and 2004, respectively.

 

As of September 30, 2004, approximately $22 million of deferred stock-based compensation expense remains to be amortized over the remaining vesting periods of the options and restricted stock, and is included in additional paid-in capital on the consolidated balance sheets.

 

9



 

If the Black-Scholes fair value based method had been applied in measuring stock compensation expense, the pro forma effect on net income and net income per share would have been as follows (in thousands, except per share amounts):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 2003

 

September 30, 2004

 

September 30, 2003

 

September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

Net income:

 

 

 

 

 

 

 

 

 

As reported

 

$

65,329

 

$

253,305

 

$

162,860

 

$

467,029

 

Add: Stock compensation expense included in reported net income, net of related tax effects

 

291

 

3,667

 

1,171

 

15,494

 

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

 

(81,761

)

(60,350

)

(225,738

)

(192,864

)

Pro forma net income (loss)

 

$

(16,141

)

$

196,622

 

$

(61,707

)

$

289,659

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per share:

 

 

 

 

 

 

 

 

 

As reported - basic

 

$

0.05

 

$

0.19

 

$

0.13

 

$

0.35

 

As reported - diluted

 

$

0.05

 

$

0.17

 

$

0.13

 

$

0.32

 

 

 

 

 

 

 

 

 

 

 

Pro forma - basic

 

$

(0.01

)

$

0.14

 

$

(0.05

)

$

0.22

 

Pro forma - diluted

 

$

(0.01

)

$

0.13

 

$

(0.05

)

$

0.20

 

 

Pro forma diluted net loss per share for the three and nine months ended September 30, 2003 is computed excluding potential common shares of 53 million and 47 million, respectively, as their effect is anti-dilutive.

 

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 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.  Certain provisions of FIN 46 became effective during the quarter ended March 31, 2004, the adoption of which did not have a material impact on the financial position, cash flows or results of operations of the Company.

 

In March 2004, the FASB issued a proposed Statement, “Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95,” that addresses the accounting for share-based payment transactions in which a Company receives employee services in exchange for either equity instruments of the Company or liabilities that are based on the fair value of the Company’s equity instruments or that may be settled by the issuance of such equity instruments. The proposed statement would eliminate the ability to account for share-based compensation transactions using the intrinsic method that the Company currently uses and generally would require that such transactions be accounted for using a fair-value-based method and recognized as expense in the consolidated statement of operations. The effective date of the proposed standard is for periods beginning after June 15, 2005.  It is expected that the final standard will be issued before December 31, 2004 and should it be finalized in its current form, it will have a significant impact on the consolidated statement of operations as the Company will be required to expense the fair value of stock option grants and stock purchases under employee stock purchase plan.

 

In April 2004, the Emerging Issues Task Force (“EITF”) issued Statement No. 03-06 “Participating Securities and the Two-Class Method Under FASB Statement No. 128, Earnings Per Share” (“EITF 03-06”).  EITF 03-06 addresses a number of questions regarding the computation of earnings per share by companies that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the company when, and if, it declares dividends on its common stock.  The issue also provides

 

10



 

further guidance in applying the two-class method of calculating earnings per share, clarifying what constitutes a participating security and how to apply the two-class method of computing earnings per share once it is determined that a security is participating, including how to allocate undistributed earnings to such a security.  EITF 03-06 became effective during the quarter ended June 30, 2004, the adoption of which did not have an impact on the calculation of earnings per share of the Company.

 

In July 2004, the EITF issued a draft abstract for EITF Issue No. 04-08, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share” (“EITF 04-08”). EITF 04-08 reflects the Task Force’s tentative conclusion that contingently convertible debt should be included in diluted earnings per share computations regardless of whether the market price trigger has been met. If adopted, the consensus reached by the Task Force in this Issue will be effective for reporting periods ending after December 15, 2004. Prior period earnings per share amounts presented for comparative purposes would be required to be restated to conform to this consensus and the Company would be required to include the shares issuable upon the conversion of the Notes in the diluted earnings per share computation for all periods during which the Notes are outstanding.  Since the first quarter of 2004, the Company has included the shares issuable upon conversion of the Notes in its computation of diluted earnings per share.

 

In September 2004, the EITF delayed the effective date for the recognition and measurement guidance previously discussed under EITF Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-01”) as included in paragraphs 10-20 of the proposed statement. The proposed statement will clarify the meaning of other-than-temporary impairment and its application to investments in debt and equity securities, in particular investments within the scope of FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and investments accounted for under the cost method. The Company is currently evaluating the effect of this proposed statement on its financial position and results of operations.

 

Note 4—Goodwill

 

The changes in the carrying amount of goodwill for the nine months ended September 30, 2004 are as follows (in thousands):

 

 

 

United States

 

International

 

Total

 

 

 

 

 

 

 

 

 

Balance at December 31, 2003

 

$

1,710,998

 

$

94,563

 

$

1,805,561

 

Acquisitions and other (1)

 

29,796

 

489,559

 

519,355

 

Reclassification (2)

 

(242,490

)

242,490

 

 

Balance at September 30, 2004

 

$

1,498,304

 

$

826,612

 

$

2,324,916

 

 

(1)                                  Other primarily includes certain purchase price adjustments that affect existing goodwill, and foreign currency translation adjustments of $(8.5) million for the nine months ended September 30, 2004. See also Note 6—“Acquisitions.”

(2)                                  Reclassification reflects the allocation of goodwill related to the Overture acquisition to our financial reporting segments.

 

Note 5—Intangible Assets, Net

 

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

 

 

 

December 31, 2003

 

September 30, 2004

 

 

 

Net

 

Gross carrying
amount

 

Accumulated
amortization (1)

 

Net

 

 

 

 

 

 

 

 

 

 

 

Trademark, trade name and domain name

 

$

56,830

 

$

136,700

 

$

(31,936

)

$

104,764

 

Customer, affiliate, and advertiser related relationships

 

233,390

 

323,985

 

(101,325

)

222,660

 

Developed technology and patents

 

155,420

 

196,378

 

(43,117

)

153,261

 

Total intangible assets, net

 

$

445,640

 

$

657,063

 

$

(176,378

)

$

480,685

 

 

(1)                                  Accumulated amortization includes foreign currency translation adjustments of approximately $2 million for the nine months ended September 30, 2004.

 

The intangible assets are all amortizable and have original estimated useful lives as follows: Trademark, trade name and domain name—four to seven years; Customer, affiliate, and advertiser related relationships—three to seven years; Developed technology and patents—two to five years. The Company recognized amortization expense on intangible assets of approximately $10 million and $37 million for the three months ended September 30, 2003 and 2004, respectively. The Company recognized amortization expense on intangible assets of approximately $25 million and $104 million for the nine months ended September 30, 2003 and 2004, respectively. Based on the

 

11



 

current amount of intangibles subject to amortization, the estimated amortization expense for each of the succeeding five years is as follows: Three months ending December 31, 2004: $37 million; years ending December 31, 2005: $143 million; 2006: $134 million; 2007: $100 million; and 2008 and thereafter: $67 million.

 

Note 6—Acquisitions

 

Acquisitions completed in 2003

 

Inktomi and Overture.  In March and October 2003, the Company acquired Inktomi Corporation (“Inktomi”) and Overture Services, Inc. (“Overture”), for aggregate purchase prices of approximately $290 million (including a net cash outlay of $228 million) and $1.7 billion (including a net cash outlay of $148 million), respectively. Based on preliminary estimates, goodwill of approximately $217 million and $1.2 billion, and other intangible assets of approximately $49 million and $354 million, respectively, were recorded as a result of the Inktomi and Overture acquisitions.  The purchase price allocation for Inktomi has been finalized without any significant changes, while the purchase price for Overture 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 Overture will change the amount of the purchase price allocated to goodwill.

 

The following unaudited pro forma information presents a summary of the results of operations of the Company assuming the acquisitions of Inktomi and Overture occurred on January 1, 2003 (in thousands, except per share amounts):

 

 

 

Nine Months Ended

 

 

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

Revenues

 

$

1,572,991

 

$

2,496,800

 

Net income

 

$

136,760

 

$

467,029

 

 

 

 

 

 

 

Net income per share — basic:

 

$

0.11

 

$

0.35

 

Net income per share — diluted:

 

$

0.10

 

$

0.32

 

 

Acquisitions completed in 2004

 

3721. On January 2, 2004, the Company completed the acquisition of all of the outstanding capital shares of 3721 Network Software Company Limited, (“3721”), a Hong Kong-based software development company. The acquisition combined the Company’s global audience and 3721’s keyword search technology to enable the Company to continue improving its global search services. These factors contributed to a purchase price in excess of the fair value of 3721’s 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 $54 million consisted of approximately $51 million in cash consideration, approximately $2 million related to stock options exchanged, and direct transaction costs of approximately $1 million. The total cash consideration of $51 million less cash acquired of approximately $7 million resulted in a net cash outlay of approximately $44 million. The value of the stock options was determined using the Black-Scholes option valuation model. Under the terms of the acquisition, the Company has also contingently agreed to pay an additional amount up to a maximum of $70 million in cash, part of which will be an increase to the purchase price and the remainder will be operating expense, over the two-year period ending December 31, 2005, if certain performance criteria are met.

 

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

 

$

6,917

 

Other tangible assets acquired

 

4,498

 

Amortizable intangible assets

 

 

 

Trade name, trademark and domain name

 

1,000

 

Customer, affiliate, and advertiser related relationships

 

7,600

 

Developed technology and patents

 

3,800

 

Goodwill

 

39,397

 

Total assets acquired

 

63,212

 

Liabilities assumed

 

(11,186

)

Deferred stock-based compensation

 

1,757

 

Total

 

$

53,783

 

 

12



 

Amortizable intangible assets consist of trade names, trademarks and domain names, customer, affiliate and advertiser related intangible assets and developed technology and patents, with useful lives not exceeding five years. Based on a preliminary estimate, no amount has been allocated to in-process research and development, and $39 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 3721 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 3721 will change the amount of the purchase price allocable to goodwill.

 

Kelkoo. On April 5, 2004, the Company completed the acquisition of a majority interest in Kelkoo S.A. (“Kelkoo”), a leading European online comparison shopping service. In July 2004, the Company completed the acquisition of additional interests in Kelkoo, increasing the Company’s total ownership interest in Kelkoo to 100 percent. The acquisition expands the Company’s global commerce presence and together with the Company’s current services is expected to increase the Company’s competitive position in Europe. These factors contributed to a purchase price in excess of the fair value of Kelkoo’s 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 $577 million consisted of approximately $568 million in cash consideration, $6 million in incurred liabilities and direct transaction costs of approximately $3 million. The total cash consideration of $568 million less cash acquired of approximately $39 million resulted in a net cash outlay of approximately $529 million.

 

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

 

$

38,817

 

Other tangible assets acquired

 

24,277

 

Amortizable intangible assets

 

 

 

Trade name, trademark and domain name

 

61,300

 

Customer, affiliate, and advertiser related relationships

 

36,100

 

Developed technology and patents

 

9,100

 

Goodwill

 

459,149

 

Total assets acquired

 

628,743

 

 

 

 

 

Liabilities assumed

 

(51,956

)

Total

 

$

576,787

 

 

Amortizable intangible assets consist of trade names, trademarks and domain names, customer, affiliate and advertiser related intangible assets and developed technology and patents, with useful lives not exceeding five years. Based on a preliminary estimate, no amount has been allocated to in-process research and development, and $459 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 Kelkoo 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 Kelkoo will change the amount of the purchase price allocable to goodwill.

 

Other Acquisitions. During the quarter ended September 30, 2004 the Company acquired two other companies which were accounted for as business combinations.  The total estimated purchase price for these two acquisitions was approximately $38 million and consisted of approximately $36 million in cash consideration and approximately $2 million related to stock options exchanged and direct transaction costs. The total cash consideration of $36 million less cash acquired of approximately $2 million resulted in a net cash outlay of approximately $34 million. Of the purchase price, approximately $31 million was allocated to goodwill, $11 million to amortizable intangible assets, and $4 million to net assumed liabilities. The purchase price allocations for these acquisitions are preliminary and subject to revision as more detailed analyses are completed and additional information on the fair value of assets and liabilities becomes available.

 

13



 

Any change in the fair value of the net assets of the acquired companies will change the amount of the purchase price allocable to goodwill.

 

The results of operations of each of the acquisitions completed during the year have been included in the Company’s condensed consolidated statements of operations since the date that the respective acquisition was completed. Proforma results of operations have not been presented for the acquisitions completed during the year as the results of the acquired companies either individually or in aggregate were not material to the Company.

 

Note 7 —Related Party Transactions

 

SOFTBANK Corp., including its consolidated affiliates (“SOFTBANK”) was approximately a four percent stockholder of the Company at September 30, 2004. The Company has joint ventures with SOFTBANK in France, Germany, Japan, South Korea and the United Kingdom to establish and manage versions of the Yahoo! Internet Guide for those countries. A Managing Partner of a SOFTBANK affiliate is also a member of the Company’s Board of Directors. In March 2004, SOFTBANK and the Company entered into an agreement that provided that, so long as SOFTBANK directly or indirectly owns or controls any shares of the Company’s common stock, SOFTBANK shall, at the Company’s direction, either vote or cause to be voted such shares of common stock in accordance with any written voting recommendation of the Company’s Board of Directors or grant a proxy to the Company entitling the Company to vote or cause to be voted such shares in proportion to the votes cast by the other stockholders of the Company. Revenues from SOFTBANK accounted for less than one percent of total revenues for the three and nine months ended September 30, 2003 and 2004. The Company believes that contracted prices in the relevant transactions are comparable to those with other similarly situated customers.

 

The Company and other third parties are limited partners in Softbank Capital Partners LP (“Softbank Capital”), a venture capital fund for which a SOFTBANK affiliate is the General Partner. The Company initially committed in July 1999 to a total investment of $30 million in the fund, and subsequently committed to invest an additional $6 million. To date, the total investment by the Company in Softbank Capital is approximately $34 million. Pursuant to the Partnership Agreement, the Company invested on the same terms and on the same basis as all other limited partners.

 

The Company has a 34 percent share in Yahoo! Japan, its joint venture with SOFTBANK in Japan. The Company records its share of the results of Yahoo! Japan one quarter in arrears within earnings in equity interests. The earnings in equity interests related to Yahoo! Japan amounted to approximately $26 million and $70 million for the three and nine months ended September 30, 2004, respectively, compared to $13 million and $33 million for the three and nine months ended September 30, 2003, respectively. The Company also has commercial arrangements with Yahoo! Japan, consisting of services, including search services and pay-for-performance search services and the related traffic acquisition costs, and license fees for which the net cost was approximately $22 million and $42 million in the three and nine months ended September 30, 2004, respectively, compared to net revenues of approximately $4 million and $11 million for the three and nine months ended September 30, 2003, respectively.

 

Note 8—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 consolidated balance sheets in other assets. As of September 30, 2004, approximately $12 million of the transaction fees remain to be amortized. The Notes were issued at par and bear no interest. The Notes are convertible into Yahoo! common stock at a conversion price of $20.50 per share, which would result in the issuance of an aggregate of approximately 37 million shares, subject to adjustment upon the occurrence of specified events. Each $1,000 principal amount of the Notes will initially be convertible into 48.78 shares of Yahoo! common stock. The Notes will be convertible prior to the final maturity date (1) during any fiscal quarter if the closing sale price of the Company’s common stock for at least 20 trading days in the 30 trading-day period ending on the last trading day of the immediately preceding fiscal quarter exceeded 110 percent of the conversion price on that 30th trading day, (2) during the period beginning January 1, 2008 through the maturity date, if the closing sale price of the Company’s common stock on the previous trading day was 110 percent or more of the then current conversion price, and (3) upon specified corporate transactions. Upon conversion, the Company has the right to deliver cash in lieu of common stock. The Company may be required to repurchase all of the Notes following a fundamental change of the Company, such as a change of control, prior to maturity at face value. The Company may not redeem the Notes prior to their maturity.

 

For the three and nine month periods ended September 30, 2004, the 37 million shares issuable upon the conversion of the Notes were included in the computation of diluted earnings per share. As of September 30, 2004, the market price condition for convertibility of the Notes was satisfied with respect to the fiscal quarter beginning October 1, 2004 and ending on December 31, 2004.  During this period holders of the Notes will be able to convert their Notes into shares of Yahoo! common stock at the rate of 48.78 shares of Yahoo! common stock for each Note.  The Notes will also be convertible into shares of Yahoo! common

 

14



 

stock in subsequent fiscal quarters, if any, with respect to which the market price condition for convertibility is met. As of September 30, 2004, the fair value of the Notes was approximately $1.3 billion based on quoted market prices.

 

Note 9— Other Income, Net

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2003

 

September 30,
2004

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

 

 

 

 

Interest and investment income

 

$

12,038

 

$

14,962

 

$

34,989

 

$

40,978

 

Investment gains (losses), net (1)

 

(6

)

110,268

 

(1,636

)

107,780

 

Other

 

(592

)

(1,949

)

951

 

2,080

 

Total other income, net

 

$

11,440

 

$

123,281

 

$

34,304

 

$

150,838

 

 

(1) See Note 13—“Litigation Settlement” for information relating to the investment gains in the three months ended September 30, 2004.

 

Note 10—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, 2004, the Company had repurchased 32,917,240 shares of common stock at an average of $4.86 per share for a total amount of approximately $160 million. Of the shares repurchased, 32,067,240 shares were purchased from SOFTBANK at an average of $4.84 per share. No shares were repurchased during the nine months ended September 30, 2004. Treasury stock is accounted for under the cost method.

 

Structured Stock Repurchase. During the nine months ended September 30, 2004, the Company entered into two structured stock repurchase transactions which settle in cash or stock depending on the market price of our common stock on the date of maturity. In February 2004, the Company entered into a six month structured stock repurchase transaction in the amount of $50 million which matured in August 2004 resulting in a cash settlement of $54 million.  In August 2004, the Company entered into a $100 million transaction which will mature in four separate tranches through March 31, 2005.  On each of the maturity dates, if the market price of Yahoo! common stock is at or above the pre-determined price agreed in connection with such transaction, which ranges from $25.29 to $26.74 for these four tranches, the Company will have its investment returned with a premium.  If the market price of the Company’s common stock is below the pre-determined price, the Company will receive shares of its common stock, up to an aggregate of 4.2 million shares. These transactions are recorded in stockholders’ equity on the consolidated balance sheets as of September 30, 2004. The shares underlying these transactions were considered outstanding at September 30, 2004 and have been included in the computation of both basic and diluted earnings per share for the three and nine months ended September 30, 2004.

 

Note 11Segment Information

 

The Company manages its business geographically. The 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 from operations before depreciation, amortization of intangible assets and amortization of stock compensation expense. Management believes that segment operating income before depreciation and amortization is an appropriate measure of evaluating the operational performance of the Company’s segments. However, this measure should be considered in addition to, not as a substitute for, or superior to, income from operations or other measures of financial performance prepared in accordance with generally accepted accounting principles.

 

15



 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2003

 

September 30,
2004

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

 

 

 

 

Revenues by segment:

 

 

 

 

 

 

 

 

 

United States

 

$

299,759

 

$

654,985

 

$

809,650

 

$

1,878,417

 

International

 

57,062

 

251,730

 

151,525

 

618,383

 

Total revenues

 

$

356,821

 

$

906,715

 

$

961,175

 

$

2,496,800

 

 

 

 

 

 

 

 

 

 

 

Segment operating income before depreciation and amortization:

 

 

 

 

 

 

 

 

 

United States

 

$

106,607

 

$

223,260

 

$

275,576

 

$

612,879

 

International

 

10,389

 

36,444

 

24,211

 

91,808

 

Total segment operating income before depreciation and amortization

 

116,996

 

259,704

 

299,787

 

704,687

 

Depreciation and amortization

 

(33,013

)

(81,488

)

(96,589

)

(225,108

)

Stock compensation expense

 

(485

)

(6,111

)

(1,951

)

(25,823

)

Income from operations

 

$

83,498

 

$

172,105

 

$

201,247

 

$

453,756

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures, net:

 

 

 

 

 

 

 

 

 

United States

 

$

33,174

 

$

47,757

 

$

65,544

 

$

126,039

 

International

 

5,271

 

17,987

 

14,174

 

34,093

 

Total consolidated capital expenditures, net

 

$

38,445

 

$

65,744

 

$

79,718

 

$

160,132

 

 

 

 

December 31,
2003

 

September 30,
2004

 

Property and equipment, net:

 

 

 

 

 

United States

 

$

414,632

 

$

431,018

 

International

 

34,880

 

53,685

 

Total consolidated property and equipment, net

 

$

449,512

 

$

484,703

 

 

Revenue is attributed to individual countries according to the international online property that generated the revenue. No single foreign country accounted for more than 10 percent of revenues during the three and nine months ended September 30, 2003 and 2004.

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2003

 

September 30,
2004

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

 

 

 

 

Marketing services

 

$

245,072

 

$

765,112

 

$

654,235

 

$

2,091,214

 

Fees

 

79,358

 

104,201

 

213,013

 

296,522

 

Listings

 

32,391

 

37,402

 

93,927

 

109,064

 

Total revenues

 

$

356,821

 

$

906,715

 

$

961,175

 

$

2,496,800

 

 

For the three and nine month periods ended September 30, 2003, revenues from the Company’s agreement with Overture (prior to being acquired by the Company) were included in marketing services and amounted to approximately 20 percent of total revenues in both periods.

 

16



 

Note 12—Commitments and Contingencies

 

Operating Leases. The Company has entered into various non-cancelable operating lease agreements for its offices throughout the United States, and for its international subsidiaries with original lease periods up to 23 years and expiring between 2004 and 2027. In addition, the Company has entered into various sublease arrangements associated with its excess facilities. Such subleases have terms extending through 2006.

 

Net lease commitments as of September 30, 2004 can be summarized as follows (in millions):

 

 

 

Gross lease
commitments

 

Sublease
income

 

Net lease
commitments

 

 

 

 

 

 

 

 

 

Three months ending December 31, 2004

 

$

11

 

$

(1

)

$

10

 

Years ending December 31,

 

 

 

 

 

 

 

2005

 

38

 

(5

)

33

 

2006

 

27

 

(3

)

24

 

2007

 

22

 

 

22

 

2008

 

17

 

 

17

 

2009

 

14

 

 

14

 

Thereafter

 

138

 

 

138

 

Total lease commitments

 

$

267

 

$

(9

)

$

258

 

 

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, 2005 that are not included in the contractual obligations table below.

 

In connection with the Company’s commercial agreements, the Company provides indemnifications of varying scope and terms to customers, lessors, 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 has also agreed to indemnify certain former officers, directors and employees of acquired companies in connection with the acquisition of such companies. The Company maintains directors and officers insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers, and former directors, officers and employees of acquired companies, in certain circumstances.

 

It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, the Company has not incurred material costs as a result of obligations under these agreements and the Company has not accrued any liabilities related to such indemnification obligations in its financial statements.

 

Contractual Obligations. Contractual obligations at September 30, 2004 are as follows (in millions):

 

 

 

Payments due by period

 

 

 

Total

 

Due in
2004

 

Due in
2005-2006

 

Due in
2007-2008

 

Due in
2009 or
after

 

Long-term debt (1)

 

$

750

 

$

 

$

 

$

750

 

$

 

Operating lease obligations, net of sublease income

 

258

 

10

 

57

 

39

 

152

 

Affiliate commitments (2)

 

388

 

38

 

346

 

4

 

 

Noncancelable purchase obligations

 

67

 

15

 

51

 

1

 

 

Total contractual obligations

 

$

1,463

 

$

63

 

$

454

 

$

794

 

$

152

 

 

(1)          The long-term debt matures in April 2008, unless converted into Yahoo! common stock at a conversion price of $20.50 per share, subject to adjustment upon the occurrence of certain events. Upon conversion, the Company has the right to deliver cash in lieu of common stock. See Note 8 – “Long-Term Debt” for further information related to the long-term debt.

(2)          Represents fixed payments that the Company is obligated to make under contracts to provide search services to its third party affiliates, which represent traffic acquisition costs.

 

17



 

At September 30, 2003 and 2004, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if the Company had engaged in such relationships.

 

On April 21, 2003, Overture completed its purchase of the Web Search unit of Fast Search and Transfer ASA, a Norway based developer of search and real-time filtering technologies, for $70 million in cash, plus a contingent earn-out payment of up to $30 million over three years based on specified operating criteria. The contingent earn-out payment is not included in the contractual obligations table above.

 

On January 2, 2004, the Company completed the acquisition of 3721. In January 2004, approximately $51 million in cash consideration was paid. Under the terms of the acquisition, the Company also contingently agreed to pay an additional amount up to a maximum of $70 million in cash, part of which will be an increase to the purchase price and the remainder will be operating expense, over the two-year period ending December 31, 2005, if certain performance criteria are met.           The contingent payment is not included in the contractual obligations table above. See Note 6 – “Acquisitions” for additional information related to this acquisition.

 

The remaining $2 million commitment to invest in Softbank Capital is not included in the contractual obligations table above. See Note 7 – “Related Party Transactions” for additional information.

 

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 is 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 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 Yahoo!, 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.

 

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 Yahoo! 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. In May 2004, Government Employees Insurance Company filed a complaint in the Eastern District of Virginia against Overture. 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. The complaints seek injunctive relief and damages. 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. Yahoo! and Overture believe that Overture has meritorious defenses to liability and damages in each of these lawsuits and are contesting them vigorously.

 

On May 24, 2001, Arista Records, Inc., Bad Boy Records, BMG Music d/b/a The RCA Records Label, Capitol Records, Inc., Virgin Records America, Inc., Sony Music Entertainment Inc., UMG Recordings, Inc., Interscope Records, Motown Record Company, L.P., and Zomba Recording Corporation filed a lawsuit alleging copyright infringement against LAUNCH Media, Inc. (“LAUNCH”) in the United States District Court for the Southern District of New York. The plaintiffs allege, among other things, that the consumer-influenced portion of 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. After the lawsuit was commenced, Yahoo! entered into an agreement to acquire LAUNCH. In June 2001, LAUNCH settled the LAUNCH litigation as to UMG Recordings, Inc.. Yahoo!’s acquisition of LAUNCH closed in August 2001, and since that time LAUNCH has been a wholly owned subsidiary of Yahoo!. Yahoo! and LAUNCH do not believe that LAUNCH has infringed any rights of plaintiffs and intend to vigorously contest the lawsuit. 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. On March 16, 2004, plaintiffs filed motions for partial summary judgment on the issues of willfulness and whether the consumer-

 

18



 

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. LAUNCH filed its opposition to the motions for partial summary judgment on April 30, 2004 and a hearing on the motions was held on June 18, 2004. The Court has not yet ruled on the motions for summary judgment. The Company does not believe it is feasible to predict or determine the outcome or resolution of the LAUNCH litigation at this time. The range of possible resolutions of the LAUNCH litigation could include judgments against LAUNCH or settlements that could require substantial payments by LAUNCH, 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.

 

On July 12, 2001, the first of several purported securities class action lawsuits was filed in the United States District Court for the 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. 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 year, 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 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.

 

On or about February 4, 2004, a shareholder derivative action was filed in the Court of Chancery of the State of Delaware in and for New Castle County, against the Company (as nominal defendant) and certain of its current and former officers and directors (the “Derivative Defendants”). Two similar shareholder derivative actions were filed in the California Superior Court for the County of San Mateo on February 13, 2004. The complaints generally allege breaches of fiduciary duties by the Derivative Defendants related to the alleged purchase of shares in initial public offerings or the alleged acquiescence in such conduct. The complaints seek unspecified monetary damages and other relief purportedly on behalf of Yahoo! from the Derivative Defendants. The Company understands the Derivative Defendants deny any impropriety and intend to defend the lawsuits vigorously. The Company does not believe that the ultimate costs to resolve these matters will have a material adverse effect on its financial condition, results of operations or cash flows. In addition, the Company believes there are procedural defects to permitting these complaints to proceed on Yahoo!’s behalf. In April 2004, Yahoo! filed a motion to dismiss the Delaware action for failure to plead demand futility. On August 2, 2004, the Delaware Court of Chancery granted the motion to dismiss.  On October 18, 2004, the plaintiffs appealed the granting of the motion to dismiss.

 

Note 13 – Litigation Settlement

 

In April 2002, the Company’s wholly owned subsidiary, Overture, filed a lawsuit against Google Inc. (“Google”) in the United States District Court for the Northern District of California. The lawsuit asserted that Google infringed Overture’s U.S. Patent No. 6,269,361 (“the 361 patent”). The 361 patent protects various features and innovations relating to bid-for-performance products and Overture’s pay-for-performance search technologies.

 

In addition, the Company had a second dispute with Google concerning the shares issuable to the Company pursuant to a warrant held by the Company to purchase Google shares that were received in connection with a June 2000 services agreement. Pursuant to a conversion provision in the warrant, in June 2003, Google issued 1.2 million shares to the Company. The Company believed it was entitled to a greater number of shares in accordance with the warrant agreement.

 

In August 2004, Google issued 2.7 million shares of Class A common stock in settlement of these two disputes. The Company agreed to dismiss the 361 patent lawsuit and has granted to Google a fully-paid license to the 361 patent as well as several related patent applications held by Overture. The Company allocated the 2.7 million shares between the two disputes, based on the relative fair values of the two disputes, including consideration of a valuation performed by a third party. A portion of the shares allocated to the patent dispute has been recorded as an adjustment to goodwill for the period that the patents were in effect prior to Overture’s acquisition by the Company. The portion of the shares received for the settlement of the patent dispute which has been allocated to future periods has been recorded in deferred revenue on the consolidated balance sheets and will be recognized as fees revenues over the remaining life of the patent, approximately 12 years. The shares allocated to the warrant dispute settlement did not have an income statement effect as the fair value of the warrant was recorded at the time the services were performed based on the fair value of the services rendered.

 

19



 

During the quarter ended September 30, 2004, the Company disposed of approximately 2.3 million shares of Google and recorded a gain of approximately $105 million, net of selling costs, which is included in other income, net on the consolidated statements of operations. The capital gain on this transaction, together with the increased fair value of marketable equity securities held by the Company, resulted in the recognition of a tax benefit related to previously reserved capital losses, which reduced the effective income tax rate for the quarter ended September 30, 2004 when compared to the quarter ended September 30, 2003.

 

The Company’s remaining holdings of approximately 5.9 million Google shares are now classified as available-for-sale securities and reported at fair value and included in short-term investments in marketable equity securities on the consolidated balance sheets. The unrealized gain, net of tax, of $450 million for the three months ended September 30, 2004 is recorded in other comprehensive income. The related tax effect has been credited to additional paid-in capital as it reduces the valuation allowance relating to net operating loss carryforwards and credit carryforwards resulting from the exercise of employee stock options.

 

Note 14—Subsequent Event

 

Musicmatch, Inc. On October 18, 2004, the Company completed the acquisition of Musicmatch, Inc. (“Musicmatch”), a leading provider of personalized music software and services for an aggregate cash purchase price of approximately $160 million. The allocation of the purchase price to the assets acquired and liabilities assumed is still being determined.

 

20



 

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 2004, 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.

 

Overview

 

Yahoo! Inc., including its consolidated subsidiaries (“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. 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.

 

In March and October 2003, we acquired Inktomi Corporation (“Inktomi”) and Overture Services, Inc. (“Overture”), for aggregate purchase prices including cash acquired of approximately $290 million and $1.7 billion, respectively.  In January and April 2004, we acquired 3721 Network Software Company Limited (“3721”) and Kelkoo S.A. (“Kelkoo”) for aggregate purchase prices including cash acquired of approximately $54 million and $577 million, respectively.

 

We generate service revenues from our marketing services, fees and listings offerings. Revenues for the three and nine months ended September 30, 2003 and 2004 were as follows (dollars in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

Revenues

 

September 30,
2003

 

September 30,
2004

 

Growth
($)

 

Growth
(%)

 

September 30,
2003

 

September 30,
2004

 

Growth
($)

 

Growth
(%)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Marketing services

 

$

245,072

 

$

765,112

 

$

520,040

 

212

%

$

654,235

 

$

2,091,214

 

$

1,436,979

 

220

%

Fees

 

79,358

 

104,201

 

24,843

 

31

%

213,013

 

296,522

 

83,509

 

39

%

Listings

 

32,391

 

37,402

 

5,011

 

15

%

93,927

 

109,064

 

15,137

 

16

%

Total revenues

 

$

356,821

 

$

906,715

 

$

549,894

 

154

%

$

961,175

 

$

2,496,800

 

$

1,535,625

 

160

%

 

21



 

As more fully explained below, total revenues increased for the three and nine month periods ended September 30, 2004 as compared to the same periods in 2003 primarily due to revenue increases of $430 million and $1.2 billion, respectively, from the acquisitions completed in the past year, and growth of 34 percent and 39 percent, respectively, in Yahoo!’s organic offerings.

 

Cash flows for nine months ended September 30, 2003 and 2004 were as follows (in thousands):

 

 

 

Nine Months Ended

 

Year -over- Year
Change
($)

 

 

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

326,284

 

$

753,101

 

$

426,817

 

Net cash used in investing activities

 

$

(896,142

)

$

(837,560

)

$

58,582

 

Net cash provided by financing activities

 

$

936,152

 

$

327,684

 

$

(608,468

)

 

The increase in net cash provided by operating activities for the nine months ended September 30, 2004 was primarily related to increased revenues described earlier. During the nine month period, we also generated $424 million in cash from the exercise of stock options by our employees and approximately $191 million from the sale of an equity investment. We used the cash we generated to continue to pursue our investment and acquisition strategies, and completed the acquisitions of Kelkoo, a leading European online comparison shopping service, for approximately $529 million, net of cash acquired, 3721, a Hong Kong-based software development company, for approximately $44 million, net of cash acquired and two smaller acquisitions in the quarter for total cash consideration of approximately $34 million, net of cash acquired. During the nine months ended September 30, 2004, we entered into two structured stock repurchase transactions which settle in cash or stock depending on the market price of our common stock on the date of maturity. In February 2004, we entered into a six month structured stock repurchase transaction in the amount of $50 million which matured in August 2004 resulting in a cash settlement of $54 million.  In August 2004, we entered into a $100 million transaction which will mature in four separate tranches through March 31, 2005.  On each of the maturity dates, if the market price of our common stock is at or above the pre-determined price agreed in connection with such transaction, which ranges from $25.29 to $26.74 for these four tranches, we will have our investment returned with a premium.  If the market price of our common stock is below the pre-determined price, we will receive shares of our common stock, up to an aggregate of 4.2 million shares. These transactions are recorded in stockholders’ equity on the consolidated balance sheets as of September 30, 2004. The shares underlying these transactions were considered outstanding at September 30, 2004 and have been included in the computation of both basic and diluted earnings per share for the three and nine months ended September 30, 2004.

 

Results of Operations

 

Revenues

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2003

 

(1)

 

September 30,
2004

 

(1)

 

September 30,
2003

 

(1)

 

September 30,
2004

 

(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Marketing services

 

$

245,072

 

69

%

$

765,112

 

84

%

$

654,235

 

68

%

$

2,091,214

 

84

%

Fees

 

79,358

 

22

%

104,201

 

12

%

213,013

 

22

%

296,522

 

12

%

Listings

 

32,391

 

9

%

37,402

 

4

%

93,927

 

10

%

109,064

 

4

%

Total revenues

 

$

356,821

 

100

%

$

906,715

 

100

%

$

961,175

 

100

%

$

2,496,800

 

100

%

 

(1)           Percent of revenues

 

Marketing Services Revenues. Marketing services revenue is primarily generated from rich media advertisements, sponsorship and text-link advertisements (including pay-for-performance search advertisements), paid inclusion, algorithmic search services and transactions. Marketing services revenue for the third quarter of 2004 increased by approximately $520 million, or 212 percent, as compared to the same period in 2003. This increase resulted from a 38 percent increase in organic marketing services revenues and incremental revenue of approximately $427 million associated with acquisitions completed in the past year. Marketing services revenue for the nine months ended September 30, 2004 increased by approximately $1.4 billion, or 220 percent, as compared to the same period in 2003. This increase resulted from a 44 percent increase in organic marketing services revenues, including approximately $10 million related to a gain from unredeemed third party loyalty program points that expired during the first quarter of 2004, and incremental revenue of approximately $1.1 billion associated with acquisitions completed during the past year.

 

22



 

The number of network page views delivered in the three and nine months ended September 30, 2004 increased by approximately 33 percent and 31 percent, respectively, as compared to the same periods in 2003. These increases resulted from a 29 percent increase in page views from organic operations, and the remainder from increases in page views associated with acquisitions completed in the past year.

 

Marketing services revenue yield per network page view increased approximately 135 percent and 143 percent for the three and nine month periods, respectively. The significant increases are primarily due to the acquisitions completed in the past year, including the impact of Overture, which provides advertising on affiliate Web sites, and whose Web traffic is not counted in our network page view figures. Excluding the effects of the acquisitions completed in the past year, revenue yield per network page view increased 7 percent and 11 percent in the three and nine months ended September 30, 2004, respectively, compared to the same periods in 2003.

 

Fees Revenues. Fees revenue is generated from a variety of consumer and business fee-based services. Fees revenue for the third quarter of 2004 increased approximately $25 million, or 31 percent as compared to the same period in 2003. Fees revenue for the nine months ended September 30, 2004 increased approximately $84 million, or 39 percent, as compared to the same period in 2003. The increases were driven by the growth in the number of our paying relationships for Yahoo!’s fee-based services, which comprised approximately 7.6 million users as of September 30, 2004, compared to approximately 4.2 million users as of September 30, 2003. Average revenue per paying user per month was unchanged at approximately $4 per user per month for the three month periods ended September 30, 2004 and September 30, 2003.

 

Listings Revenues. Listings revenue consists of revenues generated from a variety of consumer and business listings-based services. Listings revenue for the third quarter of 2004 increased approximately $5 million, or 15 percent compared to the same period in 2003. Listings revenue for the nine months ended September 30, 2004 increased approximately $15 million, or 16 percent, compared to the same period in 2003. The increases resulted from Hot Jobs’ revenue growth along with increases in many of our other classified categories including those from a company that we acquired in the past year.

 

For the fourth quarter of 2004, we expect total combined revenues for marketing services, fees, and listings to continue to increase in absolute dollars, compared to the same period in 2003.

 

Costs and Expenses:

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2003

 

(1)

 

September 30,
2004

 

(1)

 

September 30,
2003

 

(1)

 

September 30,
2004

 

(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

$

47,287

 

13

%

$

332,333

 

37

%

$

137,261

 

14

%

$

911,421

 

37

%

Sales and marketing

 

128,748

 

36

%

192,950

 

21

%

364,333

 

38

%

551,120

 

22

%

Product development

 

47,683

 

13

%

97,033

 

11

%

129,180

 

13

%

261,162

 

10

%

General and administrative

 

39,609

 

11

%

69,215

 

8

%

102,183

 

11

%

189,930

 

8

%

Stock compensation expense

 

485

 

%

6,111

 

1

%

1,951

 

%

25,823

 

1

%

Amortization of intangibles

 

9,511

 

3

%

36,968

 

4

%

25,020

 

3

%

103,588

 

4

%

 

(1)           Percent of total revenues

 

Cost of Revenues. Cost of revenues consists of traffic acquisition costs and other expenses associated with the production and usage of the Yahoo! network. Traffic acquisition costs consist of payments made to our third party affiliates that have integrated our pay-for-performance search services into their Web sites. Other cost of revenues 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 2004 increased by approximately $285 million as compared to the same period of 2003. The increase reflects approximately $270 million of incremental cost of revenues related to acquisitions completed during the past year, of which the majority related to traffic acquisition costs arising from the Overture acquisition. Cost of revenues in the nine months ended September 30, 2004 increased by approximately $774 million as compared to the same period of 2003. The increase reflects approximately $737 million of incremental cost of revenues related to acquisitions completed during the past year, of which the majority related to traffic acquisition costs.

 

23



 

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 2004 increased approximately $64 million, or 50 percent, as compared to the same period in 2003, primarily as a result of incremental costs of approximately $47 million associated with acquisitions completed during the past year. Sales and marketing expenses for the nine months ended September 30, 2004 increased approximately $187 million, or 51 percent, as compared to the same period in 2003, primarily as a result of incremental costs of approximately $102 million associated with acquisitions completed during the past year. The remainder of the increases for both the three and nine month periods were primarily due to increases in total compensation expenses related to increased headcount as well as marketing spending.

 

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 2004 increased approximately $49 million, or 103 percent, as compared to the same period of 2003. Product development expenses for the nine months ended September 30, 2004 increased approximately $132 million, or 102 percent, as compared to the same period of 2003. Approximately $33 million and $87 million of the increases in the three and nine months ended September 30, 2004, respectively, were due to incremental costs associated with the acquisitions completed during the past year. The remainder of the change was the result of increases in our total compensation expense related to an increase in the number of 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 2004 increased approximately $30 million, or 75 percent, as compared to the same period of 2003. General and administrative expenses for the nine months ended September 30, 2004 increased approximately $88 million, or 86 percent, as compared to the same period of 2003. Approximately $20 million and $60 million of the increases in the three and nine months ended September 30, 2004, respectively, were due to incremental costs associated with the acquisitions completed during the past year. The remainder of the increases was the result of increases in our total compensation related to increased headcount, and professional services expenses.

 

Stock Compensation. Stock compensation expense relates to the amortization of the intrinsic value of Yahoo! stock options issued in connection with acquisitions we have completed and other equity-based awards. This expense is primarily being recorded using an accelerated amortization method.

 

Stock compensation expense for the third quarter of 2004 was approximately $6 million, an increase of approximately $6 million as compared to the same period of 2003. Stock compensation expense for the nine months ended September 30, 2004 was approximately $26 million, an increase of approximately $24 million as compared to the same period of 2003. Stock compensation expense increased in connection with the acquisitions completed during the past year.  Stock compensation expense is allocated as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2003

 

September 30,
2004

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

$

98

 

$

1,731

 

$

419

 

$

7,712

 

Product development

 

343

 

2,371

 

1,217

 

9,642

 

General and administrative

 

44

 

2,009

 

315

 

8,469

 

Total stock compensation expense

 

$

485

 

$

6,111

 

$

1,951

 

$

25,823

 

 

Amortization of Intangibles. In the past, 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 $37 million for the third quarter of 2004, or 4 percent of total revenues, compared to approximately $10 million, or 3 percent of revenues, for the third quarter of 2003. Amortization of intangibles expense was approximately $104 million, or 4 percent of total revenues, for the nine months ended September 30, 2004, compared to approximately $25 million, or 3 percent of revenues, for the same period of 2003. The increase in amortization of intangibles is primarily the result of the additional amortizable intangibles acquired in conjunction with the acquisitions completed during the past year.

 

24



 

Overall, for the fourth quarter of 2004, we expect total operating costs and expenses to continue to increase in absolute dollars as compared to the same period in 2003, as the Company continues to grow. In addition, we expect to incur incremental costs related to acquisitions completed in 2003 and 2004.

 

Other Income, Net.

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,
2003

 

September 30,
2004

 

September 30,
2003

 

September 30,
2004

 

 

 

 

 

 

 

 

 

 

 

Interest and investment income

 

$

12,038

 

$

14,962

 

$

34,989

 

$

40,978

 

Investment gains (losses), net

 

(6

)

110,268

 

(1,636

)

107,780

 

Other

 

(592

)

(1,949

)

951

 

2,080

 

Total other income, net

 

$

11,440

 

$

123,281

 

$

34,304

 

$

150,838

 

 

The increase in other income, net for the three and nine months ended September 30, 2004 as compared to the same periods of 2003, is primarily due to the sale of an investment and the related gain of approximately $105 million.

 

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

 

Earnings in Equity Interests. Earnings in equity interests primarily represent our share of the results of Yahoo! Japan one quarter in arrears. For the three months ended September 30, 2004 and 2003 our earnings in equity interests were approximately $26 million and $12 million, respectively and approximately $70 million and $32 million for the nine months ended September 30, 2004 and 2003, respectively. These increases in the three and nine months ended September 30, 2004, compared to the same periods of 2003 are a result of the increased net income achieved by Yahoo! Japan.

 

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

 

Minority interests in income from operations of consolidated subsidiaries was approximately $1 million and $2 million for the three months ended September 30, 2004 and 2003, and approximately $3 million and $5 million for the nine months ended September 30, 2004 and 2003 respectively. In both comparison periods, the change was primarily due to reduced net income in our subsidiaries as a result of increased marketing spending.

 

Income Taxes.  The provision for income taxes for the three and nine months ended September 30, 2004 differs from the amount computed by applying the statutory federal rate principally due to utilization of capital loss carryovers, state taxes, foreign losses for which no tax benefit is provided, and nontaxable equity earnings from certain investments. For the three and nine months ended September 30, 2003, the provision for income taxes differed from the amount computed by applying the statutory federal rate principally due to foreign losses for which no tax benefit is provided and nontaxable equity earnings from certain investments. The effective tax rate for the three months ended September 30, 2004 was 21 percent, compared to 38 percent for the three months ended September 30, 2003. The effective tax rate for the nine months ended September 30, 2004 was 30 percent, compared to 38 percent for the nine months ended September 30, 2003. The principal reason for the reduced rates for both the three and nine months ended September 30, 2004 is the recognition of the tax benefit of previously reserved capital losses realized in the quarter due to the recognition of a capital gain on the sale of an investment and increased fair market values of certain marketable equity securities.

 

25



 

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 from operations before depreciation, amortization of intangibles and amortization of stock compensation expense. 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, this measure should be considered in addition to, not as a substitute for or superior to, income from operations or other measures of financial performance prepared in accordance with generally accepted accounting principles.

 

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

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2003

 

(1)

 

2004

 

(1)

 

2003

 

(1)

 

2004

 

(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues by segment:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

United States

 

$

299,759

 

84

%

$

654,985

 

72

%

$

809,650

 

84

%

$

1,878,417

 

75

%

International

 

57,062

 

16

%

251,730

 

28

%

151,525

 

16

%

618,383

 

25

%

Total revenues

 

$

356,821

 

100

%

$

906,715

 

100

%

$

961,175

 

100

%

$

2,496,800

 

100

%

 

(1)           Percent of total revenues.

 

Segment operating income before depreciation and amortization:

 

United States

 

$

106,607

 

 

 

$

223,260

 

 

 

$

275,576

 

 

 

$

612,879

 

 

 

International

 

10,389

 

 

 

36,444

 

 

 

24,211

 

 

 

91,808

 

 

 

Total segment operating income before depreciation and amortization

 

116,996

 

 

 

259,704

 

 

 

299,787

 

 

 

704,687

 

 

 

Depreciation and amortization

 

(33,013

)

 

 

(81,488

)

 

 

(96,589

)

 

 

(225,108

)

 

 

Stock compensation expense

 

(485

)

 

 

(6,111

)

 

 

(1,951

)

 

 

(25,823

)

 

 

Income from operations

 

$

83,498

 

 

 

$

172,105

 

 

 

$

201,247

 

 

 

$

453,756

 

 

 

 

Revenue is attributed to individual countries according to the international online property that generated the revenue. No single foreign country accounted for more than 10 percent of revenues during the three months and nine months ended September 30, 2004 and 2003.

 

United States. United States revenues in the third quarter of 2004 increased approximately $355 million, or 118 percent compared to the same period in 2003. United States revenues for the nine months ended September 30, 2004 increased approximately $1.1 billion or 132 percent compared to the same period in 2003. Approximately $258 million and $759 million of the increases, respectively, for the three months and nine months ended September 30, 2004 were due to incremental revenue associated with acquisitions completed during the past year. The remainder of the increase was due to a strong increase in organic revenues. United States segment operating income before depreciation and amortization in the third quarter of 2004 increased approximately $117 million, or 109 percent, compared to the same period of 2003. United States segment operating income before depreciation and amortization for the nine months ended September 30, 2004 increased approximately $337 million, or 122 percent, compared to the same period of 2003. The increases for both the three and nine month periods ended September 30, 2004 were primarily due to the increases in United States revenues, as well as continued efforts to control discretionary spending during the periods.

 

26



International.  International revenues in the third quarter of 2004 increased approximately $195 million, or 341 percent, compared to the same period in 2003.  International revenues for the nine months ended September 30, 2004 increased approximately $467 million, or 308 percent, compared to the same period in 2003.  Approximately $172 million and $397 million of the increases, respectively, for the three and nine months ended September 30, 2004 were due to incremental revenue associated with acquisitions completed during the past year.  The remainder of the increase was primarily due to overall strength in the European and Asian markets, which resulted in an increase in organic revenues.   International segment operating income before depreciation and amortization for the three and nine months ended September 30, 2004 increased approximately $26 million and $68 million, respectively, compared to the same periods in 2003.  These increases were primarily a result of the increase in International revenues and continued efforts to control discretionary spending during the periods.

 

Acquisitions completed in 2004

 

3721.  On January 2, 2004, we completed the acquisition of all of the outstanding capital shares of 3721, a Hong Kong-based software development company.  The acquisition combined Yahoo!’s global audience and 3721’s keyword search technology to enable Yahoo! to continue improving its global search services.  These factors contributed to a purchase price in excess of the fair value of 3721’s 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 $54 million consisted of approximately $51 million in cash consideration, approximately $2 million related to stock options exchanged, and direct transaction costs of approximately $1 million.  The total cash consideration of $51 million less cash acquired of approximately $7 million resulted in a net cash outlay of approximately $44 million. The value of the stock options was determined using the Black-Scholes option valuation model.  Under the terms of the acquisition, we have also contingently agreed to pay an additional amount up to a maximum of $70 million in cash, part of which will be an increase to the purchase price and the remainder will be operating expense, over the two-year period ending December 31, 2005, if certain performance criteria are met.

 

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

 

$

6,917

 

Other tangible assets acquired

 

4,498

 

Amortizable intangible assets

 

 

 

Trade name, trademark and domain name

 

1,000

 

Customer, affiliate, and advertiser related relationships

 

7,600

 

Developed technology and patents

 

3,800

 

Goodwill

 

39,397

 

Total assets acquired

 

63,212

 

 

 

 

 

Liabilities assumed

 

(11,186

)

Deferred stock-based compensation

 

1,757

 

Total

 

$

53,783

 

 

Amortizable intangible assets consist of trade names, trademarks and domain names, customer, affiliate and advertiser related intangible assets and developed technology and patents, with useful lives not exceeding five years.  Based on a preliminary estimate, no amount has been allocated to in-process research and development, and $39 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 3721 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 3721 will change the amount of the purchase price allocable to goodwill.

 

Kelkoo.  On April 5, 2004, we completed the acquisition of a majority interest in Kelkoo, a leading European online comparison shopping service.  In July 2004, we completed the acquisition of additional interests in Kelkoo, increasing our total ownership interest in Kelkoo to 100 percent.  The acquisition expands our global commerce presence and together with our current services is expected to increase our competitive position in Europe.  These factors contributed to a purchase price in excess of the fair value of Kelkoo’s net tangible and intangible assets acquired, and as a result, we have recorded goodwill in connection with this transaction.

 

27



 

The total estimated purchase price of approximately $577 million consisted of approximately $568 million in cash consideration, $6 million in incurred liabilities and direct transaction costs of approximately $3 million. The total cash consideration of $568 million less cash acquired of approximately $39 million resulted in a net cash outlay of approximately $529 million.

 

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

 

$

38,817

 

Other tangible assets acquired