UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

x

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

 

 

For the quarterly period ended June 30, 2006

 

 

OR

 

 

o

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

 

 

For the transition period from     to     

 

Commission File Number 0-28018

 


 

YAHOO! INC.

(Exact name of Registrant as specified in its charter)

 

Delaware

 

77-0398689

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

701 First Avenue
Sunnyvale, California 94089

(Address of principal executive offices)

 

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

 


 

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

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer x                  Accelerated filer o                            Non-Accelerated filero

 

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

Yes o  No x

 

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

 

Class

 

Outstanding at August 1, 2006

Common stock, $0.001 par value

 

1,381,175,598

 

 



 

YAHOO! INC.

 

Table of Contents

 

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements (unaudited)

 

3

 

Condensed Consolidated Statements of Income for the three and six months ended June 30, 2005 and 2006

 

3

 

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

 

4

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2006

 

5

 

Notes to Condensed Consolidated Financial Statements

 

7

Item 2.

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

 

23

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

36

Item 4.

Controls and Procedures

 

37

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

38

Item 1A.

Risk Factors

 

39

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

51

Item 3.

Defaults Upon Senior Securities

 

51

Item 4.

Submission of Matters to a Vote of Security Holders

 

51

Item 5.

Other Information

 

52

Item 6.

Exhibits

 

53

 

Signatures

 

54

 

2



 

PART I—FINANCIAL INFORMATION

 

Item 1.  Condensed Consolidated Financial Statements (unaudited)

 

YAHOO! INC.

 

Condensed Consolidated Statements of Income

(unaudited, in thousands except per share amounts)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

June 30,
2005

 

June 30,
2006

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

1,252,997

 

$

1,575,854

 

$

2,426,739

 

$

3,142,909

 

Cost of revenues (*)

 

500,158

 

645,767

 

967,082

 

1,303,710

 

Gross profit

 

752,839

 

930,087

 

1,459,657

 

1,839,199

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing (*)

 

247,915

 

325,845

 

479,924

 

657,005

 

Product development (*)

 

129,285

 

208,743

 

251,896

 

426,320

 

General and administrative (*)

 

87,128

 

131,909

 

165,387

 

260,214

 

Amortization of intangibles

 

27,154

 

34,003

 

53,730

 

64,861

 

Total operating expenses

 

491,482

 

700,500

 

950,937

 

1,408,400

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

261,357

 

229,587

 

508,720

 

430,799

 

Other income, net

 

979,736

 

36,090

 

1,029,730

 

71,526

 

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

 

1,241,093

 

265,677

 

1,538,450

 

502,325

 

Provision for income taxes

 

(515,855

)

(122,698

)

(636,290

)

(225,630

)

Earnings in equity interests

 

33,105

 

21,634

 

62,483

 

48,071

 

Minority interests in operations of consolidated subsidiaries

 

(3,654

)

(283

)

(5,394

)

(577

)

Net income

 

$

754,689

 

$

164,330

 

$

959,249

 

$

324,189

 

 

 

 

 

 

 

 

 

 

 

Net income per share—basic

 

$

0.54

 

$

0.12

 

$

0.69

 

$

0.23

 

 

 

 

 

 

 

 

 

 

 

Net income per share—diluted

 

$

0.51

 

$

0.11

 

$

0.65

 

$

0.22

 

 

 

 

 

 

 

 

 

 

 

Shares used in per share calculation—basic

 

1,395,596

 

1,405,598

 

1,390,277

 

1,411,758

 

 

 

 

 

 

 

 

 

 

 

Shares used in per share calculation—diluted

 

1,484,200

 

1,476,642

 

1,481,114

 

1,484,809

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation expense by function (*):

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

$

 

$

1,582

 

$

 

$

3,267

 

Sales and marketing

 

1,509

 

38,489

 

2,999

 

77,356

 

Product development

 

3,741

 

36,170

 

7,003

 

73,887

 

General and administrative

 

5,698

 

23,482

 

10,412

 

53,854

 

 

 

 

 

 

 

 

 

 

 

Total stock-based compensation expense

 

$

10,948

 

$

99,723

 

$

20,414

 

$

208,364

 

 

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

 

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

 

3



 

YAHOO! INC.

 

Condensed Consolidated Balance Sheets

(unaudited, in thousands, except par values)

 

 

 

December 31,
2005

 

June 30,
2006

 

 

 

 

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

1,429,693

 

$

1,591,223

 

Marketable debt securities

 

1,131,141

 

1,097,332

 

Accounts receivable, net

 

721,723

 

792,451

 

Prepaid expenses and other current assets

 

166,976

 

173,699

 

Total current assets

 

3,449,533

 

3,654,705

 

Long-term marketable debt securities

 

1,439,014

 

1,276,117

 

Property and equipment, net

 

697,522

 

884,005

 

Goodwill

 

2,895,557

 

2,975,278

 

Intangible assets, net

 

534,615

 

454,040

 

Other assets

 

57,192

 

136,175

 

Investment in equity interests

 

1,758,401

 

1,810,242

 

Total assets

 

$

10,831,834

 

$

11,190,562

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

70,291

 

$

139,378

 

Accrued expenses and other current liabilities

 

827,589

 

935,008

 

Deferred revenue

 

306,172

 

348,505

 

Total current liabilities

 

1,204,052

 

1,422,891

 

Long-term deferred revenue

 

67,792

 

64,189

 

Long-term debt

 

749,995

 

749,971

 

Other long-term liabilities

 

243,580

 

247,928

 

Minority interests in consolidated subsidiaries

 

 

7,921

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common Stock, $0.001 par value; 5,000,000 shares authorized; 1,430,162 and 1,414,422 issued and outstanding, respectively

 

1,470

 

1,483

 

Additional paid-in capital

 

6,417,858

 

7,054,451

 

Deferred stock-based compensation

 

(235,394

)

 

Treasury stock

 

(547,723

)

(1,732,932

)

Retained earnings

 

2,966,169

 

3,290,358

 

Accumulated other comprehensive income (loss)

 

(35,965

)

84,302

 

Total stockholders’ equity

 

8,566,415

 

8,697,662

 

Total liabilities and stockholders’ equity

 

$

10,831,834

 

$

11,190,562

 

 

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)

 

 

 

Six Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

959,249

 

$

324,189

 

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

 

 

 

 

 

Depreciation

 

102,751

 

139,201

 

Amortization of intangible assets

 

81,617

 

113,426

 

Stock-based compensation expense

 

20,414

 

208,364

 

Tax benefits from stock-based compensation

 

602,568

 

164,281

 

Excess tax benefits from stock-based compensation

 

 

(215,944

)

Earnings in equity interests

 

(62,483

)

(48,071

)

Dividends received

 

10,670

 

12,908

 

Minority interests in operations of consolidated subsidiaries

 

5,394

 

577

 

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

 

(952,266

)

(2,070

)

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

 

 

 

 

 

Accounts receivable, net

 

(78,157

)

(53,355

)

Prepaid expenses and other

 

10,240

 

(15,963

)

Accounts payable

 

(14,193

)

63,753

 

Accrued expenses and other liabilities

 

79,816

 

88,596

 

Deferred revenue

 

24,290

 

34,673

 

Net cash provided by operating activities

 

789,910

 

814,565

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Acquisition of property and equipment, net

 

(161,800

)

(316,825

)

Purchases of marketable debt securities

 

(5,474,827

)

(648,333

)

Proceeds from sales and maturities of marketable debt securities

 

5,374,465

 

845,674

 

Acquisitions, net of cash acquired

 

(126,374

)

(55,329

)

Proceeds from sales of marketable equity securities

 

970,296

 

 

Other investing activities, net

 

(38,595

)

(644

)

Net cash provided by (used in) investing activities

 

543,165

 

(175,457

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of common stock, net

 

302,724

 

189,825

 

Repurchases of common stock

 

(164,895

)

(690,209

)

Structured stock repurchases, net

 

(359,931

)

(227,705

)

Excess tax benefits from stock-based compensation

 

 

215,944

 

Other financing activities, net

 

800

 

 

Net cash provided by (used in) financing activities

 

(221,302

)

(512,145

)

Effect of exchange rate changes on cash and cash equivalents

 

(15,073

)

34,567

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

1,096,700

 

161,530

 

Cash and cash equivalents at beginning of period

 

823,723

 

1,429,693

 

Cash and cash equivalents at end of period

 

$

1,920,423

 

$

1,591,223

 

 

5



 

YAHOO! INC.

 

Condensed Consolidated Statements of Cash Flows (Continued)

(unaudited, in thousands)

 

Supplemental cash flow disclosures:

 

Acquisition-related activities (in thousands):

 

 

 

Six Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

 

 

 

 

 

 

Cash paid for acquisitions

 

$

127,452

 

$

63,006

 

Cash acquired in acquisitions

 

(1,078

)

(7,677

)

 

 

$

126,374

 

$

55,329

 

 

 

 

 

 

 

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

 

$

44,381

 

$

 

 

See Note 3—“Acquisitions” for additional information.

 

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

 

6



 

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

Note 1 THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The Company.  Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo!” or the “Company”) is a leading global Internet brand and one of the most trafficked Internet destinations worldwide.  Yahoo! seeks to provide Internet services that are essential and relevant to users and businesses through the provision of online properties (collectively referred to as the “Yahoo! Properties”) to Internet users and a range of tools and marketing solutions for businesses to market to that community of users.

 

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

 

Certain prior period amounts have been reclassified to conform to the current period presentation.  The Company has changed the classification of amortization expense related to developed technology and patents acquired through acquisitions in the condensed consolidated statements of income.  Amortization expenses of $14 million and $28 million for the three and six months ended June 30, 2005, respectively, were previously included as part of operating expenses and have been reclassified to cost of revenues.  Amortization expenses included in cost of revenues for the three and six months ended June 30, 2006 were $23 million and $49 million, respectively.

 

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

 

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

 

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

 

Recent Accounting Pronouncements

 

Effective January 1, 2006 the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment” (“SFAS 123R”), and the Company’s condensed consolidated financial statements as of and for the three and six months ended June 30, 2006 reflect the impact of SFAS 123R.  For the three and six months ended June 30, 2006, the Company recorded stock-based compensation expense of $100 million and $208 million, respectively, which reduced gross profit by $2 million and $3 million, respectively.  As a result of adopting SFAS 123R the Company’s income from operations for the three and six months ended June 30, 2006 was lower by $76 million and $163 million, respectively, and net income by $55 million and $113 million, respectively, than if the Company had continued to account for stock-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”).  Basic and diluted net income per share for the three and six months ended June 30, 2006 was $0.04 and $0.08 lower, respectively, than if the Company had continued to account for stock-based compensation under APB 25.  The Company also capitalized $3 million and $5 million of stock-based compensation

 

7



 

expense in the three and six months ended June 30, 2006, respectively which is now part of property and equipment, net on the condensed consolidated balance sheets.  For the three and six months ended June 30, 2005, the Company recognized $11 million and $20 million, respectively, of stock-based compensation expense under the intrinsic value method in accordance with APB 25.  In addition, prior to the adoption of SFAS 123R, the Company presented tax benefits from stock-based compensation as cash flows from operating activities.  Upon the adoption of SFAS 123R, the gross benefits of tax deductions related to stock-based compensation in excess of the grant date fair value of the related stock-based awards are now classified as cash flows from financing activities.  See Note 10—“Stock-Based Compensation” for further information. 

 

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in income tax positions.  This Interpretation requires that the Company recognize in its financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for the Company on January 1, 2007, with the cumulative effect of the change in accounting principle, if any, recorded as an adjustment to opening retained earnings.  The Company is currently evaluating the impact of adopting FIN 48 on its financial position, cash flows, and results of operations.

 

Note 2 BASIC AND DILUTED NET INCOME PER SHARE

 

Basic net income per share is computed using the weighted average number of common shares outstanding during the period, excluding any unvested restricted stock that is subject to repurchase.  Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period.  Potential common shares consist of unvested restricted stock and restricted stock units, collectively referred to as “restricted stock awards” (using the treasury stock method), the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s zero coupon senior convertible notes (using the if-converted method).  For the three months ended June 30, 2005 and 2006, approximately 55 million and 92 million options to purchase common stock, respectively, were excluded from the calculation, as they were anti-dilutive.  For the six months ended June 30, 2005 and 2006, approximately 61 million and 88 million options to purchase common stock, respectively were excluded from the calculation, as they were anti-dilutive.  See Note 9—“Long-Term Debt” for additional information related to the Company’s zero coupon senior convertible notes.  The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

June 30,
2005

 

June 30,
2006

 

 

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

754,689

 

$

164,330

 

$

959,249

 

$

324,189

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares

 

1,398,690

 

1,410,285

 

1,392,870

 

1,416,536

 

Weighted average unvested restricted stock subject to repurchase

 

(3,094

)

(4,687

)

(2,593

)

(4,778

)

Denominator for basic calculation

 

1,395,596

 

1,405,598

 

1,390,277

 

1,411,758

 

 

 

 

 

 

 

 

 

 

 

Weighted average effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Employee stock options

 

51,566

 

32,678

 

53,282

 

34,851

 

Convertible notes

 

36,585

 

36,585

 

36,585

 

36,585

 

Restricted stock awards

 

453

 

1,781

 

970

 

1,615

 

Denominator for diluted calculation

 

1,484,200

 

1,476,642

 

1,481,114

 

1,484,809

 

Net income per share—basic

 

$

0.54

 

$

0.12

 

$

0.69

 

$

0.23

 

Net income per share—diluted

 

$

0.51

 

$

0.11

 

$

0.65

 

$

0.22

 

 

8



 

Note 3 ACQUISITIONS

 

Transactions completed in 2005                 

 

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

 

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

 

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

 

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

 

Net tangible assets acquired

 

$

52,484

 

Amortizable intangible assets:

 

 

 

Customer contracts and related relationships

 

30,561

 

Developed technology and patents

 

6,570

 

Trade name, trademark and domain name

 

50,121

 

Goodwill

 

387,771

 

Total assets acquired

 

527,507

 

Deferred income taxes

 

(26,633

)

Total

 

$

500,874

 

 

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

 

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

 

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

 

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

 

9



 

Transactions completed in 2006

 

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

 

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

 

Cash acquired

 

$

3,763

 

Other tangible assets acquired

 

2,400

 

Amortizable intangible assets:

 

 

 

Customer contracts, related relationships and developed technology and patents

 

18,600

 

Goodwill

 

15,641

 

Total assets acquired

 

40,404

 

Deferred income taxes

 

(6,075

)

Total

 

$

34,329

 

 

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

 

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

 

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

 

Note 4 INVESTMENTS IN EQUITY INTERESTS

 

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

 

 

 

December 31,
2005

 

June 30,
2006

 

Percent
Ownership

 

Alibaba

 

$

1,408,716

 

$

1,399,652

 

46%

 

Yahoo! Japan

 

349,685

 

410,590

 

34%

 

Total

 

$

1,758,401

 

$

1,810,242

 

 

 

 

10



 

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

 

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

 

The investment in Alibaba is being accounted for using the equity method and the total investment, including net tangible assets, identifiable intangible assets and goodwill, is classified as part of the Investment in equity interests balance on the Company’s condensed consolidated balance sheets.  The Company records its share of the results of Alibaba and any related amortization expense, one quarter in arrears, within Earnings in equity interests on the condensed consolidated statements of income.  The purchase price was based on acquiring a 40 percent equity interest in Alibaba on a fully diluted basis.  As of March 31, 2006, the Company’s equity interest in the outstanding common stock of Alibaba was approximately 46 percent.  In allocating the excess of the carrying value of its investment in Alibaba over its proportionate share of the net assets of Alibaba, the Company allocated a portion of the excess to goodwill to account for the estimated reductions in the carrying value of the investment in Alibaba that may occur as the Company’s equity interest is diluted. 

 

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

 

Carrying value of investment in Alibaba

 

$

1,399,652

 

Proportionate share of net assets of Alibaba

 

887,531

 

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

 

$

512,121

 

 

 

 

 

The excess carrying value has been primarily assigned to:

 

 

 

Goodwill

 

$

435,346

 

Amortizable intangible assets

 

79,473

 

Deferred income taxes

 

(2,698

)

Total

 

$

512,121

 

 

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

 

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

 

In April 2006, the Company’s ownership interest in Alibaba decreased to approximately 44 percent primarily as a result of the conversion of Alibaba’s outstanding convertible debt.  As the Company records its share of the results of Alibaba one quarter in arrears, the Company will recognize the effects of this dilution in its condensed consolidated financial statements in the quarter ending September 30, 2006.  The Company’s ownership interest in Alibaba may be further diluted to 40 percent upon exercise of Alibaba’s employee stock options.  The Company will recognize non-cash gains if and when further dilution to its ownership interest in Alibaba occurs.

 

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

 

Equity Investment in Yahoo! Japan.   During April 1996, the Company signed a joint venture agreement with SOFTBANK, which was amended in September 1997, whereby Yahoo! Japan Corporation (“Yahoo! Japan”) was formed.  Yahoo! Japan was formed to establish and manage a local version of Yahoo! in Japan.  During the three months ended June 30, 2005 and 2006, the Company received cash dividends from Yahoo! Japan in the amounts of $11 million and $13 million, respectively which were recorded as reductions in the Company’s investment in Yahoo! Japan.  The Company also has commercial arrangements with Yahoo! Japan, consisting of services, including algorithmic search services and sponsored search services and the related traffic acquisition costs and license fees.  The net cost of these arrangements was approximately $38 million and $59 million for the

 

11



 

three months ended June 30, 2005 and 2006, respectively.  The net cost of these arrangements was approximately $72 million and $119 million for the six months ended June 30, 2005 and 2006, respectively.

 

The investment in Yahoo! Japan is being accounted for using the equity method and the total investment is classified as a part of the Investment in equity interests balance on the condensed consolidated balance sheets.  The Company records its share of the results of Yahoo! Japan one quarter in arrears within Earnings in equity interests on the condensed consolidated statements of income.  The fair value of the Company’s approximate 34 percent ownership interest in Yahoo! Japan, based on the quoted stock price, was approximately $11 billion as of June 30, 2006.

 

The following table presents Yahoo! Japan’s condensed operating financial information, as derived from the Yahoo! Japan statements of operations, for the three and six months ended March 31, 2005, and 2006 (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

March 31,
2005

 

March 31,
2006

 

March 31,
2005

 

March 31,
2006

 

Operating data

 

 

 

 

 

 

 

 

 

Revenues

 

$

342,845

 

$

402,601

 

$

635,880

 

$

800,120

 

Gross profit

 

$

311,699

 

$

388,381

 

$

583,602

 

$

749,653

 

Income from operations

 

$

167,773

 

$

201,805

 

$

314,059

 

$

381,912

 

Net income

 

$

98,680

 

$

111,148

 

$

186,236

 

$

218,975

 

 

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

 

Note 5 GOODWILL

 

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

 

 

 

United States

 

International

 

Total

 

 

 

 

 

 

 

 

 

Balance as of January 1, 2006

 

$

1,720,752

 

$

1,174,805

 

$

2,895,557

 

Acquisitions and other*

 

1,219

 

13,977

 

15,196

 

Foreign currency translation adjustments

 

 

64,525

 

64,525

 

Balance as of June 30, 2006

 

$

1,721,971

 

$

1,253,307

 

$

2,975,278

 

 

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

 

Note 6 INTANGIBLE ASSETS, NET

 

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

 

 

 

December 31, 2005

 

June 30, 2006

 

 

 

Net

 

Gross carrying
Amount

 

Accumulated
amortization*

 

Net

 

 

 

 

 

 

 

 

 

 

 

Trademark, trade name and domain name

 

$

122,657

 

$

185,657

 

$

71,957

 

$

113,700

 

Customer, affiliate, and advertiser related relationships

 

159,442

 

367,339

 

232,403

 

134,936

 

Developed technology and patents

 

252,516

 

372,123

 

166,719

 

205,404

 

Total intangible assets, net

 

$

534,615

 

$

925,119

 

$

471,079

 

$

454,040

 

 

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

 

For the three months ended June 30, 2005 and 2006, the Company recognized amortization expense for intangible assets of $41 million and $57 million, respectively.  For the six months ended June 30, 2005 and 2006 the Company recognized amortization expense for intangible assets of approximately $82 million and $113 million, respectively.  Based on the current amount of

 

12



 

intangibles subject to amortization, the estimated amortization expense for each of the succeeding five years is as follows: six months ending December 31, 2006: $110 million; 2007: $187 million; 2008: $114 million; 2009: $21 million; 2010: $12 million and thereafter: $10 million.

 

Note 7 OTHER INCOME, NET

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

June 30,
2005

 

June 30,
2006

 

 

 

 

 

 

 

 

 

 

 

Interest and investment income

 

$

27,100

 

$

37,924

 

$

50,872

 

$

73,401

 

Investment gains (losses), net

 

949,149

 

(4,106

)

968,283

 

(3,335

)

Other

 

3,487

 

2,272

 

10,575

 

1,460

 

 

 

 

 

 

 

 

 

 

 

Total other income, net

 

$

979,736

 

$

36,090

 

$

1,029,730

 

$

71,526

 

 

Investment gains (losses), net include realized investment gains, realized investment losses, realized gains on derivatives, and impairment charges related to declines in values of publicly traded and privately held companies judged to be other than temporary.  Investment gains (losses) include gains in the amounts of $949 million and $968 million in the three and six months ended June 30, 2005, respectively, related to the sales of non-strategic marketable equity security investments. 

 

Note 8 COMPREHENSIVE INCOME

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

June 30,
2005

 

June 30,
2006

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

754,689

 

$

164,330

 

$

959,249

 

$

324,189

 

 

 

 

 

 

 

 

 

 

 

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

 

(418,596

)

7,330

 

(463,291

)

20,199

 

Foreign currency translation adjustment

 

(46,066

)

85,331

 

(48,991

)

100,068

 

Other comprehensive income (loss)

 

(464,662

)

92,661

 

(512,282

)

120,267

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

290,027

 

$

256,991

 

$

446,967

 

$

444,456

 

 

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

 

 

 

December 31,
2005

 

June 30,
2006

 

 

 

 

 

 

 

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

 

$

(16,218

)

$

3,981

 

Cumulative foreign currency translation adjustment

 

(19,747

)

80,321

 

 

 

 

 

 

 

Accumulated other comprehensive income (loss)

 

$

(35,965

)

$

84,302

 

 

Note 9 LONG-TERM DEBT

 

In April 2003, the Company issued $750 million of zero coupon senior convertible notes (the “Notes”) due April 2008, resulting in net proceeds to the Company of approximately $733 million after transaction fees of $17 million, which have been deferred and are included on the condensed consolidated balance sheets in other assets.  As of June 30, 2006, $6 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

 

13



 

approximately 37 million shares, subject to adjustment upon the occurrence of specified events.  Each $1,000 principal amount of the Notes will initially be convertible into 48.78 shares of Yahoo! common stock.

 

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

 

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

 

As of June 30, 2006 the fair value of the Notes was approximately $1.2 billion based on quoted market prices.  The shares issuable upon conversion of the Notes have been included in the computation of diluted net income per share since the Notes were issued.

 

Note 10 STOCK-BASED COMPENSATION

 

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

 

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

 

For the three and six months ended June 30, 2006, the Company recorded stock-based compensation expense of $100 million and $208 million, respectively, which reduced gross profit by $2 million and $3 million, respectively.  As a result of adopting SFAS 123R the Company’s income from operations for the three and six months ended June 30, 2006 was lower by $76 million and $163 million, respectively, and net income by $55 million and $113 million, respectively, than if the Company had continued to account for stock-based compensation under APB 25.  Basic and diluted net income per share for the three and six months ended June 30, 2006 was $0.04 and $0.08 lower, respectively than if the company had continued to account for stock-based compensation under APB 25.  For the three and six months ended June 30, 2005, the Company recognized $11 million and $20 million, respectively, of stock-based compensation expense under the intrinsic value method. 

 

SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual

 

14



 

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

 

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

 

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

 

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

 

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

 

The Plans provide for the issuance of a maximum of approximately 654 million shares of which 64 million were still available for issuance as of June 30, 2006. 

 

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

 

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

 

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

 

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

 

Employee Stock Purchase Plan.   The Company has an Employee Stock Purchase Plan (the “Purchase Plan”), which allows employees to purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of their annual compensation subject to certain Internal Revenue Code limitations.  The price of common stock purchased under the Purchase Plan is equal to 85 percent of the lower of the fair market value of the common stock on the commencement date of each 24-month offering period or the specified purchase date.  The Purchase Plan provides for the issuance of a maximum of approximately 30 million shares of common stock of which 14 million shares were still available as at June 30, 2006.  For the

 

15



 

three and six months ended June 30, 2006, the stock-based compensation expense related to the activity under the Purchase Plan was $12 million and $26 million respectively.  As of June 30, 2006 there was $53 million of unamortized stock-based compensation cost which will be recognized over a weighted average period of 1.2 years.

 

Executive Retention Compensation Agreement.  During the three months ended June 30, 2006, the Compensation Committee of the Company’s Board of Directors, approved a three year performance and retention compensation arrangement with the Company’s Chief Executive Officer (“CEO”).  For each of the years 2006 to 2008, the CEO will be eligible to receive a discretionary annual bonus payable in the form of a fully vested non-qualified stock option for up to 1 million shares with an exercise price equal to the closing trading price of the Company’s common stock on the date of the grant.  As of June 30, 2006 there was $11 million of unamortized stock-based compensation cost related to the 2006 portion of this award which is expected to be recognized over the remainder of 2006. 

 

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

 

 

 

Shares

 

Weighted Average
Exercise Price per
Share

 

Weighted Average
Remaining
Contractual Life
(in years)

 

Aggregate
Intrinsic Value

 

Outstanding at December 31, 2005

 

182,694

 

$

28.11

 

 

 

 

 

Options granted

 

26,245

 

$

32.57

 

 

 

 

 

Options exercised (2)

 

(12,004

)

$

12.56

 

 

 

 

 

Options cancelled/forfeited/expired

 

(8,390

)

$

37.19

 

 

 

 

 

Outstanding at June 30, 2006

 

188,545

 

$

29.32

 

6.0

 

$

1,439,283

 

 

 

 

 

 

 

 

 

 

 

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

 

178,594

 

$

29.11

 

6.0

 

$

1,421,664

 

 

 

 

 

 

 

 

 

 

 

Exercisable at June 30, 2006

 

109,147

 

$

27.84

 

5.3

 

$

1,161,344

 

 

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

 

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

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the aggregate difference between the closing stock price of the Company’s common stock on June 30, 2006 and the exercise price for in-the-money options) that would have been received by the option holders if all in-the-money options had been exercised on June 30, 2006.  The total intrinsic value of options exercised in the three and six months ended June 30, 2006 was $115 million and $259 million, respectively.  The weighted average grant date fair value of options granted in the three months ended June 30, 2005 and 2006 was $11.66 and $10.46, respectively.  The weighted average grant date fair value of options granted in the six months ended June 30, 2005 and 2006 was $12.36 and $10.35, respectively.

 

As of  June 30, 2006, there was $507 million of unamortized stock-based compensation cost related to unvested stock options which is expected to be recognized over a weighted average period of 3.3 years. 

 

Cash received from option exercises and purchases of shares under the Purchase Plan for the six months ended June 30, 2006 was $190 million. 

 

The total tax benefit attributable to options exercised in the six months ended June 30, 2006 was $90 million.

 

The tax benefits from stock-based compensation for the six months ended June 30, 2006 was $164 million, which is reported on the condensed consolidated statements of cash flows.  This represents the total amount of income tax benefit in the current period related to options exercised in current and prior periods, net of deferred tax benefits related to our current period stock-based compensation expense.  

 

The gross excess tax benefits from stock-based compensation for the six months ended June 30, 2006 of $216 million, as reported on the condensed consolidated statements of cash flows in financing activities represent the reduction in income taxes otherwise payable during the period, attributable to the actual gross tax benefits in excess of the expected tax benefits for options exercised in current and prior periods.  The gross excess tax benefits for the six months ended June 30, 2006 were comprised of $73 million related to options exercised during the six months ended June 30, 2006 and $143 million related to options exercised in prior

 

16



 

periods.  The Company has accumulated excess tax deductions relating to stock options exercised prior to January 1, 2006 available to reduce income taxes otherwise payable.  To the extent such deductions are expected to reduce income taxes payable in the current year, they are reported as financing activities in the condensed consolidated statements of cash flows.

 

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

 

 

 

Stock Options

 

Purchase Plan (5)

 

 

 

Three Months Ended

 

Three Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

June 30,
2005

 

June 30,
2006

 

Expected dividend yield (1)

 

0.0

%

0.0

%

0.0

%

0.0

%

Risk-free interest rate (2)

 

3.7

%

5.0

%

1.3

%

5.0

%

Expected volatility (3)

 

40.1

%

34.3

%

39.4

%

31.7

%

Expected life (in years) (4)

 

3.5

 

3.8

 

0.5

 

1.2

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock Options

 

Purchase Plan (5)

 

 

 

Six Months Ended

 

Six Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

June 30,
2005

 

June 30,
2006

 

Expected dividend yield (1)

 

0.0

%

0.0

%

0.0

%

0.0

%

Risk-free interest rate (2)

 

3.7

%

4.9

%

1.3

%

5.0

%

Expected volatility (3)

 

40.9

%

34.0

%

39.4

%

31.7

%

Expected life (in years) (4)

 

3.8

 

3.8

 

0.5

 

1.2

 

 

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

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

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

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

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

 

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

 

 

 

Shares

 

Weighted Average
Grant Date Fair
Value

 

Unvested at December 31, 2005

 

7,666

 

$

36.13

 

Granted

 

3,141

 

$

31.82

 

Vested

 

(165

)

$

30.10

 

Forfeited

 

(309

)

$

33.31

 

 

 

 

 

 

 

Unvested at June 30, 2006

 

10,333

 

$

35.00

 

 

As of June 30, 2006, there was $226 million of unamortized stock-based compensation cost related to unvested restricted stock awards which is expected to be recognized over a weighted average period of 2.3 years.  No restricted stock awards vested during the three months ended June 30, 2005 and 2006 respectively.  The total fair value of restricted stock awards vested during the six months ended June 30, 2006 and 2005 was $6 million and $5 million, respectively.

 

17



 

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

 

 

 

Three Months
Ended

 

Six Months
Ended

 

 

 

June 30,
2005

 

June 30,
2005

 

Net income:

 

 

 

 

 

As reported

 

$

754,689

 

$

959,249

 

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

 

6,568

 

12,248

 

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

 

(57,147

)

(114,193

)

Pro forma net income

 

$

704,110

 

$

857,304

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

As reported—basic

 

$

0.54

 

$

0.69

 

As reported—diluted

 

$

0.51

 

$

0.65

 

Pro-forma—basic

 

$

0.50

 

$

0.62

 

Pro-forma—diluted

 

$

0.47

 

$

0.58

 

 

Note 11 STOCK REPURCHASE PROGRAMS

 

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

 

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

 

In the three months ended June 30, 2006, the Company repurchased 13.8 million shares of common stock including 12.0 million shares received upon the maturity of structured stock repurchase transactions.  The Company repurchased the shares at an average price of $31.62 per share.  Total cash consideration for the repurchased stock was $436 million including cash consideration of $51 million paid during the current quarter, $250 million invested in a structured stock repurchase transaction entered into during the third quarter of 2005, and $135 million invested in a structured stock repurchase transaction entered into during the fourth quarter of 2005.

 

For the six months ended June 30, 2006 the Company repurchased 35.9 million shares at an average price of $33.04 per share.  Total cash consideration for the repurchased stock was $1,185 million, including cash consideration of $690 million paid during the six months ended June 30, 2006, $250 million invested in a structured stock repurchase transaction entered into during the third quarter of 2005, and investments in structured stock repurchase transactions totaling $245 million entered into in the fourth quarter of 2005.  The Company also received $272 million in cash upon settlement of a $250 million structured stock repurchase transaction entered into in 2005. 

 

These repurchased shares are recorded as part of treasury stock.  Treasury stock is accounted for under the cost method.

 

In the three months ended June 30, 2006, the Company entered into a $250 million structured stock repurchase transaction, which settles in cash or stock depending on the market price of Yahoo!’s common stock on the date of maturity.  This transaction will settle in the fourth quarter of 2006.  If the market price of Yahoo! common stock is above $32.53 the Company will have its investment returned with a premium.  If the market price is at or below $32.53, the Company will repurchase 8.5 million shares of its common stock. 

 

In aggregate as of June 30, 2006, there were outstanding structured stock repurchase transactions totaling $500 million which were entered into in the six months ended June 30, 2006 and will mature in the third and fourth quarters of 2006 and could result in the repurchase of up to 16.5 million shares. 

 

These outstanding transactions are recorded in stockholders’ equity on the condensed consolidated balance sheets.  See Note 14 - “Subsequent Events” for additional information.

 

18



 

Note 12 COMMITMENTS AND CONTINGENCIES

 

Operating Lease Commitments.   The Company leases office space and data centers under operating lease agreements with original lease periods of up to 23 years, expiring between 2006 and 2027.

 

A summary of net lease commitments as of June 30, 2006 follows (in millions):

 

 

 

Gross lease
commitments

 

Sublease
income

 

Net lease
Commitments

 

Six months ending December 31, 2006

 

$

40

 

$

(2

)

$

38

 

Years ending December 31,

 

 

 

 

 

 

 

2007

 

86

 

(1

)

85

 

2008

 

96

 

(2

)

94

 

2009

 

95

 

(1

)

94

 

2010

 

85

 

(1

)

84

 

2011

 

71

 

 

71

 

Due after 5 years

 

392

 

 

392

 

Total net lease commitments

 

$

865

 

$

(7

)

$

858

 

 

Affiliate Commitments.  In connection with contracts to provide sponsored search services to affiliates, the Company is obligated to make payments, which represent traffic acquisition costs, to its affiliates.  As of June 30, 2006, these commitments total $113 million of which $102 million will be payable in the remainder of 2006 and $11 million will be payable in 2007.

 

Other Commitments.  In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of agreements, services to be provided by the Company, or from 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 director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers, and former directors and officers of acquired companies, in certain circumstances.

 

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

 

As of June 30, 2006, 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.

 

As of June 30, 2006 the Company had commitments to purchase land located in Santa Clara, California. See Note 14 – “Subsequent Events” for additional information.

 

Contingencies.  From time to time, third parties assert patent infringement claims against the Company.  Currently, the Company is engaged in several lawsuits regarding patent issues and has 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, trade secrets and other intellectual property rights, claims related to employment matters, and a variety of claims, including claims alleging defamation or invasion of privacy, arising in connection with the Company’s e-mail, message boards, auction sites, shopping services and other communications and community features.

 

On May 24, 2001, Arista Records, Inc., Bad Boy Records, BMG Music d/b/a The RCA Records Label, Capitol Records, Inc., Virgin Records America, Inc., Sony Music Entertainment, Inc., UMG Recordings, Inc., Interscope Records, Motown Record Company, L.P., and Zomba Recording Corporation filed a lawsuit alleging copyright infringement against LAUNCH in the United States District Court for the Southern District of New York.  The plaintiffs allege, among other things, that the

 

19



 

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, the Company entered into an agreement to acquire LAUNCH.  In June 2001, LAUNCH settled the LAUNCH litigation as to UMG Recordings, Inc.  The Company’s acquisition of LAUNCH closed in August 2001, and since that time LAUNCH has been a wholly owned subsidiary of the Company.  The Company 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, the plaintiff filed motions for partial summary judgment on the issues of willful infringement and whether 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.  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.  On November 4, 2005, the Court issued an order denying the plaintiff’s summary judgment motions as to interactivity and willful infringement.  The Company does not believe it is feasible to predict or determine the outcome or resolution of the remaining LAUNCH litigation at this time.  The range of possible resolutions of such LAUNCH litigation could include judgments against LAUNCH or settlements that could require substantial payments by LAUNCH.

 

On July 12, 2001, the first of several purported securities class action lawsuits was filed in the United States District Court 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.  On August 31, 2005, the Court entered an order confirming its preliminary approval of a settlement proposal made by plaintiffs, which includes settlement of, and release of claims against, the issuer defendants, including Overture.  The parties are awaiting final approval of the settlement.  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 will continue to defend the case vigorously.

 

The Company does not believe, based on current knowledge, that any of the foregoing legal proceedings or claims are likely to have a material adverse effect on its financial position, results of operations or cash flows.  However, the Company may incur substantial expenses in defending against third party claims.  In the event of a determination adverse to the Company or its subsidiaries, the Company may incur substantial monetary liability and be required to change our business practices.  Either of these could have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

20



 

Note 13 SEGMENTS

 

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, amortization and stock-based compensation expense for making financial decisions and allocating resources.  Segment operating income before depreciation, amortization and stock-based compensation expense includes income from operations before depreciation, amortization and stock-based compensation expense.  Management believes that segment operating income before depreciation, amortization and stock-based compensation expense is an appropriate measure 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.

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2005

 

June 30, 2006

 

June 30, 2005

 

June 30, 2006

 

 

 

 

 

 

 

 

 

 

 

Revenues by segment:

 

 

 

 

 

 

 

 

 

United States

 

$

869,517

 

$

1,070,134

 

$

1,688,243

 

$

2,167,172

 

International

 

383,480

 

505,720

 

738,496

 

975,737

 

Total revenues

 

$

1,252,997

 

$

1,575,854

 

$

2,426,739

 

$

3,142,909

 

 

 

 

 

 

 

 

 

 

 

Segment operating income before depreciation, amortization and stock-based compensation expense:

 

 

 

 

 

 

 

 

 

United States

 

$

291,244

 

340,598

 

$

561,659

 

$

675,867

 

International

 

77,196

 

116,260

 

151,843

 

215,923

 

 

 

 

 

 

 

 

 

 

 

Total segment operating income before depreciation, amortization and stock-based compensation expense

 

368,440

 

456,858

 

713,502

 

891,790

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

(96,135

)

(127,548

)

(184,368

)

(252,627

)

Stock-based compensation expense

 

(10,948

)

(99,723

)

(20,414

)

(208,364

)

Income from operations

 

$

261,357

 

$

229,587

 

$

508,720

 

$

430,799

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures, net:

 

 

 

 

 

 

 

 

 

United States

 

$

77,516

 

$

152,653

 

$

136,531

 

$

278,423

 

International

 

16,135

 

22,425

 

25,269

 

38,402

 

Total capital expenditures, net

 

$

93,651

 

$

175,078

 

$

161,800

 

$

316,825

 

 

 

 

December 31,
2005

 

June 30,
2006

 

Property and equipment, net:

 

 

 

 

 

United States

 

$

613,426

 

$

781,503

 

International

 

84,096

 

102,502

 

Total property and equipment, net

 

$

697,522

 

$

884,005

 

 

Revenue is attributed to individual countries according to the international online property that generated the revenue.  No single foreign country accounted for more than 10 percent of revenues in the three and six months ended June 30, 2005 and 2006.

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,
2005

 

June 30,
2006

 

June 30,
2005

 

June 30,
2006

 

 

 

 

 

 

 

 

 

 

 

Marketing services

 

$

1,094,301

 

$

1,386,245

 

$

2,119,097

 

$

2,767,099

 

Fees

 

158,696

 

189,609

 

307,642

 

375,810

 

Total revenues

 

$

1,252,997

 

$

1,575,854

 

$

2,426,739

 

$

3,142,909

 

 

21



 

Note 14 SUBSEQUENT EVENTS

 

Stock Repurchase Transactions.  Subsequent to June 30, 2006, the Company has repurchased an aggregate of 36.7 million of its own common shares at an average price of $27.69 per share for a total amount of $1,015 million.  These repurchases were completed as follows:

 

                  Structured Stock Repurchases.  Subsequent to June 30, 2006, the Company repurchased 8.1 million of its own common shares at an average repurchase price of $31.00 per share as a result of the settlement of a $250 million structured stock repurchase transaction entered into in January 2006.

 

                  Open Market Stock Repurchase Transactions.  Subsequent to June 30, 2006, the Company repurchased 28.6 million shares of its own common shares at an average price of $26.75 per share for a total amount of $765 million, of which $725 million has been paid through August 4, 2006 and $40 million will be paid by August 8, 2006.

 

Property and Equipment, Net.  Subsequent to June 30, 2006, the Company completed the purchase of land in Santa Clara, California with a total value of approximately $116 million, including expenses.

 

22



 

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

 

Forward-Looking Statements

 

In addition to current and historical information, this Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements relate to our future operations, prospects, potential products, services, developments and business strategies.  These statements can, in some cases, be identified by the use of terms such as “may,” “will,” “should,” “could,” “would,” “intend,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” or “continue” or the negative of such terms or other comparable terminology.  This Report includes, among others, forward-looking statements regarding our:

 

       expectations about revenues for marketing services and fees;

 

       expectations about cost of revenues and operating expenses;

 

       expectations about growth in users;

 

       anticipated capital expenditures;

 

       evaluation of possible acquisitions of, or investments in, businesses, products and technologies; and

 

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

 

These statements involve certain known and unknown risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements.  Such risks and uncertainties include, among others, those listed in Part II Item 1A  “Risk Factors” of this Report.  We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this Report to reflect actual results or future events or circumstances.

 

Overview

 

We are a leading global Internet brand and one of the most trafficked Internet destinations worldwide.  We seek to provide Internet services that are essential and relevant to users and businesses.  To users, we provide our owned and operated online properties and services (the “Yahoo! Properties”).  To businesses, we provide a range of tools and marketing solutions designed to enable businesses to reach our community of users.

 

We offer a broad range and deep array of innovative products and services that are designed to provide our users with the power to connect, communicate, create, access, and share information online.  We seek to provide efficient and effective marketing services for businesses to reach our community of users.  Our focus is on engaging more deeply with users and increasing the user base on the Yahoo! Properties, thereby enhancing value for our advertisers.  We believe that we can increase our existing and potential user base and our users’ engagement on the Yahoo! Properties not only by offering compelling Internet services, but also by effectively integrating search, community, personalization and content to create a more powerful user experience.

 

We also focus on extending our marketing platform and access to Internet users beyond the Yahoo! Properties through our distribution network of third party entities (referred to as “affiliates”) who have integrated our search offerings into their websites.

 

Many of our services are free to users.  We generate revenues by providing marketing services to businesses across a majority of our properties and by charging our users for premium services.  We classify these revenues as either marketing services or fees.  Our offerings to users and businesses currently fall into four categories—Search; Marketplace; Information and Entertainment; and Communications and Connected Life.  The majority of our offerings are available globally in more than 15 languages.  We manage and measure our business geographically.  Our principal geographies are the United States and International.

 

23



 

Second Quarter Performance Highlights

 

Revenues

 

Our revenues for the second quarter of 2006 increased 26 percent year over year to $1.6 billion, with unique users up 9 percent year over year (or up 28 percent excluding Yahoo! China as of June 30, 2005), fee paying users up 42 percent year over year, and page views up 25 percent year over year (or up 33 percent excluding Yahoo! China as of June 30, 2005). We divested Yahoo! China in October 2005 in connection with our strategic investment in Alibaba and accordingly have recalculated our unique user and page view growth rates as if the unique users and page views of Yahoo! China had been excluded as of June 30, 2005 to allow for comparison between the two periods.

 

 

 

Income from Operations

 

Operating income for the second quarter of 2006 declined year over year primarily due to the adoption, on a modified prospective basis of SFAS 123R, “Share-Based Payment” on January 1, 2006 which resulted in stock-based compensation expense of $100 million in the second quarter of 2006, compared to $11 million in the second quarter of 2005.

 

 

 

Stock repurchases

 

We repurchased 13.8 million shares of our common stock in the second quarter of 2006 at an average price of $31.62 per share. We have now repurchased 35.9 million shares of our common stock in the first half year of 2006 at an average price of $33.04 per share.

 

 

 

 

 

Three Months Ended June 30,

 

2005-2006

 

Six Months Ended June 30,

 

2005-2006

 

Operating Highlights

 

2005

 

2006

 

Change

 

2005

 

2006

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

1,252,997

 

$

1,575,854

 

$

322,857

 

$

2,426,739

 

$

3,142,909

 

$

716,170

 

Income from operations

 

$

261,357

 

$

229,587

 

$

(31,770

)

$

508,720

 

$

430,799

 

$

(77,921

)

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

2005-2006

 

Cash Flow Highlights

 

 

 

 

 

 

 

2005

 

2006

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

789,910

 

$

814,565

 

$

24,655

 

Net cash provided by (used in) investing activities

 

$

543,165

 

$

(175,457

)

$

(718,622

)

Net cash provided by (used in) financing activities

 

$

(221,302

)

$

(512,145

)

$

(290,843

)

 

We believe the search queries, page views, click-throughs and the related marketing services and fees revenues that we generate are correlated to the number and activity level of users across our offerings on the Yahoo! Properties.  By providing a platform for our users that brings together our search technology, content, and community while allowing for personalization and integration across devices, we seek to become more essential to, increase our share of, and deepen the engagement of, our users with our products and services.  We continue to believe this deeper engagement of new and existing users, coupled with the growth of the Internet as an advertising medium will increase our revenues for the remainder of 2006 over 2005.

 

24



 

Results of Operations

 

The following table sets forth selected information on our results of operations as a percentage of revenues for the periods indicated:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

100

%

100

%

100

%

100

%

Cost of revenues

 

40

 

41

 

40

 

41

 

Gross profit

 

60

 

59

 

60

 

59

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

20

 

21

 

20

 

21

 

Product development

 

10

 

13

 

10

 

14

 

General and administrative

 

7

 

8

 

7

 

8

 

Amortization of intangibles

 

2

 

2

 

2

 

2

 

 

 

 

 

 

 

 

 

 

 

Total operating expenses

 

39

 

44

 

39

 

45

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

21

 

15

 

21

 

14

 

Other income, net

 

78

 

2

 

42

 

2

 

 

 

 

 

 

 

 

 

 

 

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

 

99

 

17

 

63

 

16

 

Provision for income taxes

 

(41

)

(8

)

(26

)

(7

)

Earnings in equity interests

 

2

 

1

 

3

 

1

 

Minority interests in operations of consolidated subsidiaries

 

0

 

0

 

0

 

0

 

Net income

 

60

%

10

%

40

%

10

%

 

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

 

 

 

Three months Ended June 30,

 

Percent

 

Six months Ended June 30,

 

Percent

 

 

 

2005

 

(1)

 

2006

 

(1)

 

Change

 

2005

 

(1)

 

2006

 

(1)

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Marketing services

 

$

1,094,301

 

87

%

$

1,386,245

 

88

%

27

%

$

2,119,097

 

87

%

$

2,767,099

 

88

%

31

%

Fees

 

158,696

 

13

%

189,609

 

12

%

19

%

307,642

 

13

%

375,810

 

12

%

22

%

Total revenues

 

$

1,252,997

 

100

%

$

1,575,854

 

100

%

26

%

$

2,426,739

 

100

%

$

3,142,909

 

100

%

30

%

 

(1)                                  Percent of total revenues.

 

Marketing Services Revenue.  Marketing Services revenue for the second quarter of 2006 increased by $292 million, or 27 percent, as compared to the same period in 2005.  Marketing Services revenue for the six months ended June 30, 2006 increased by $648 million, or 31 percent, as compared to the same period in 2005.  Our year over year growth in marketing services revenue was impacted by declining revenues from our relationship with Microsoft Corporation (“Microsoft”) who largely transitioned its U.S. business in-house during the three months ended June 30, 2006.  The year over year growth in our marketing services revenue can be attributed to a combination of factors that are driving increased advertising revenue across the entire Yahoo! Properties.  These include an increase in our user base and activity levels on the Yahoo! Properties, which resulted in a higher volume of search queries, page views and click-throughs.  We believe our increased user audience has attracted new advertisers to our portfolio of marketing solutions and contributed to the increase in our marketing services revenue over the prior year period.

 

On the Yahoo! Properties, our number of unique users worldwide as of June 30, 2006 was approximately 9 percent higher than the number of unique users as of June 30, 2005.  Unique users are the estimated number of people who visited the Yahoo! Properties in a given month.  If the unique users of Yahoo! China had been excluded as of June 30, 2005, our estimated unique users as of June 30, 2006 would have been 28 percent higher than as of June 30, 2005.

 

 

25



 

We have refined our method for computing changes in the volume of page views and searches and average revenue per page view and search this quarter to include only page views (which include searches) on the Yahoo! Properties and searches performed on our affiliate network sites, and to exclude the impact of content match links.  Since the introduction of the content match offering last year, the growth in the number of content match links on our affiliate network sites has been significant but the related revenues have not been proportionate, resulting in a disproportionate impact on our volume and revenue yield measures as computed under our prior methodology.

 

Using this refined method, which we believe more accurately reflects trends in our volume and revenue yield measures, the combined number of page views and searches increased by approximately 20 percent and 21 percent in the three and six months ended June 30, 2006, respectively, as compared to the same periods in 2005.  The increases in the volume of page views and searches can be attributed to an increased number of users, an increased number of affiliates, and an expanded offering of properties which increased our inventory of page views.  The combined average revenue per page view and search increased by approximately 4 percent and 7 percent in the three and six months ended June 30, 2006, respectively, compared to the same periods in 2005.  Our combined revenue per page view and search was benefited as we expanded our offerings on the Yahoo! Properties, introduced new inventory with different yields and better monetized our inventory.

 

Applying this refined method for the quarter ended March 31, 2006 compared to the quarter ended March 31, 2005, the combined number of page views and searches increased by approximately 21 percent in the three months ended March 31, 2006 and the combined average revenue per page view and search increased by approximately 9 percent, respectively, when compared to the prior year.

 

We believe our growing number of users, advertisers and inventory has been driving this growth in our marketing services revenues.  We believe our expanding offerings as well as our enhanced algorithmic search technology, which provides a new level of personalization to the search experience, contribute to our growing number of users.  As our user base increases, we generate a higher number of page views, which we view as inventory, and process a higher number of search queries which potentially result in a higher number of impressions and paid clicks.  We also believe that our growing user base makes the Yahoo! Properties more attractive to advertisers and increases their spending on marketing solutions.  Further, we believe the growth in users on the Yahoo! Properties and on the Internet overall reflects the increasing acceptance, importance and dependence of users on the Internet.  As a result of the increasing online audience, we believe advertisers are shifting a greater percentage of their spending from traditional media to the Internet to reach this growing audience.

 

Fees Revenue.  Fees revenue for the second quarter of 2006 increased $31 million, or 19 percent, as compared to the same period in 2005.  Fees revenue for the six months ended June 30, 2006 increased $68 million, or 22 percent, as compared to the same period in 2005.  The year over year growth is associated with an increase in the number of paying users for our fee-based services, which numbered 14.3 million as of June 30, 2006, compared to 10.1 million as of June 30, 2005, an increase of 42 percent.  Our increased base of paying users was due to growth in users across most of our offerings, with the largest growth generated from new Internet broadband users.  Our fee-based services include Internet broadband services, sports, music, personals, and premium mail offerings, as well as our services for small businesses.  Average monthly revenue per paying user has decreased to approximately $3.50 for the three and six months ended June 2006, compared to approximately $4.00 for the same periods of 2005.  The decline in average monthly revenue per paying user reflects the continued growth of paying users in our services with lower fees.

 

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

 

 

 

Three Months Ended June 30,

 

Percent

 

Six Months Ended June 30,

 

Percent

 

 

 

2005

 

(1)

 

2006 (2)

 

(1)

 

Change (2)

 

2005

 

(1)

 

2006 (2)

 

(1)

 

Change (2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues (3)

 

$

500,158

 

40

%

$

645,767

 

41

%

29

%

$

967,082

 

40

%

$

1,303,710

 

41

%

35

%

Sales and marketing

 

$

247,915

 

20

%

$

325,845

 

21

%

31

%

$

479,924

 

20

%

$

657,005

 

21

%

37

%

Product development

 

$

129,285

 

10

%

$

208,743

 

13

%

61

%

$

251,896

 

10

%

$

426,320

 

14

%

69

%

General and administrative

 

$

87,128

 

7

%

$

131,909

 

8

%

51

%

$

165,387

 

7

%

$

260,214

 

8

%

57

%

Amortization of intangibles

 

$

27,154

 

2

%

$

34,003

 

2

%

25

%

$

53,730

 

2

%

$

64,861

 

2

%

21

%

 

(1)                                  Percent of total revenues.

(2)                                  Effective January 1, 2006, we adopted SFAS 123R and recorded stock-based compensation expense under the fair value method.  Prior to January 1, 2006, we accounted for stock-based compensation under APB 25 and used the intrinsic value method.  In the three and six months ended June 30, 2006, we recorded $100 million and $208 million, respectively, of stock-based compensation expense compared to $11 million and $20 million for the three and six months ended 2005, respectively.  This stock-based compensation expense has been included in the same income statement category as the cash compensation paid to the recipient of the stock-based award.

(3)                                  For the three and six months ended June 30, 2005, we have reclassified amortization expense of $14 million and $28 million, respectively, relating to developed technology and patents acquired through acquisitions, in the condensed consolidated statements of income from operating expenses to cost of revenues to conform with the classification for the three and six months ended June 30, 2006.  For the three and six months ended June 30, 2006 cost of revenues includes amortization expense of $23 million and $49 million, respectively, relating to developed technology and patents acquired through acquisitions.

 

26



 

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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

$

 

$

1,582

 

$

 

$

3,267

 

Sales and marketing

 

1,509

 

38,489

 

2,999

 

77,356

 

Product development

 

3,741

 

36,170

 

7,003

 

73,887

 

General and administrative

 

5,698

 

23,482

 

10,412

 

53,854

 

Total stock-based compensation expense

 

$

10,948

 

$

99,723

 

$

20,414

 

$

208,364

 

 

See Note 10“Stock-Based Compensation” in the condensed consolidated financial statements as well as our Critical Accounting Policies, Judgments and Estimates for additional information about stock-based compensation.

 

Cost of Revenues.  Cost of revenues consists of traffic acquisition costs (“TAC”) and other expenses associated with the production and usage of the Yahoo! Properties.  TAC consists of payments made to affiliates who have integrated our search and advertising offerings into their websites and payments made to companies that direct consumer and business traffic to the Yahoo! Properties.  Other cost of revenues consists of fees paid to third parties for content included on our online media properties, Internet connection charges, data center costs, server equipment depreciation, technology license fees, amortization of developed technology and patents, and compensation related expenses (including stock-based compensation expense).

 

 

 

Three Months Ended June 30,

 

Percent

 

Six Months Ended June 30,

 

Percent

 

 

 

2005

 

(1)

 

2006

 

(1)

 

Change

 

2005

 

(1)

 

2006

 

(1)

 

Change