Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

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

For the quarterly period ended June 30, 2011

Or

 

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

For the transition period from             to            

Commission file number 000-28018

 

 

Yahoo! Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   77-0398689

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

701 First Avenue

Sunnyvale, California 94089

(Address of principal executive offices, including zip code)

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

 

 

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

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

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

 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ

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

 

Class

 

Outstanding at July 29, 2011

Common Stock, $0.001 par value

  1,262,612,131

 

 

 


Table of Contents

YAHOO! INC.

Table of Contents

 

PART I

  FINANCIAL INFORMATION      3   

Item 1.

  Condensed Consolidated Financial Statements (unaudited)      3   
  Condensed Consolidated Statements of Income for the three and six months ended June 30, 2010 and 2011      3   
  Condensed Consolidated Balance Sheets as of December 31, 2010 and June 30, 2011      4   
  Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2011      5   
  Notes to Condensed Consolidated Financial Statements      6   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      24   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      37   

Item 4.

  Controls and Procedures      37   

PART II

  OTHER INFORMATION      39   

Item 1.

  Legal Proceedings      39   

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 5.

  Other Information      51   

Item 6.

  Exhibits      51   
  Signatures      52   

 

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PART I — FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Statements of Income

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2011
    June 30,
2010
    June 30,
2011
 
     (Unaudited, in thousands except per share amounts)  

Revenue

   $ 1,601,379      $ 1,229,024      $ 3,198,339      $ 2,443,381   

Cost of revenue

     682,722        371,155        1,389,104        748,617   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     918,657        857,869        1,809,235        1,694,764   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Sales and marketing

     331,468        280,312        645,006        542,546   

Product development

     268,552        246,513        534,629        489,580   

General and administrative

     125,333        131,330        235,761        254,554   

Amortization of intangibles

     7,880        8,582        15,982        16,632   

Restructuring charges, net

     10,052        237        14,464        10,812   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     743,285        666,974        1,445,842        1,314,124   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     175,372        190,895        363,393        380,640   

Other income (expense), net

     12,588        (5,666     98,916        (639
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes and earnings in equity interests

     187,960        185,229        462,309        380,001   

Provision for income taxes

     (68,524     (55,629     (117,968     (107,749

Earnings in equity interests

     96,707        108,902        184,081        191,082   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     216,143        238,502        528,422        463,334   

Less: Net income attributable to noncontrolling interests

     (2,822     (1,530     (4,910     (3,370
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc.

   $ 213,321      $ 236,972      $ 523,512      $ 459,964   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.15      $ 0.18      $ 0.38      $ 0.35   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.15      $ 0.18      $ 0.37      $ 0.35   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — basic

     1,378,374        1,299,947        1,388,341        1,304,505   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — diluted

     1,390,240        1,308,359        1,401,836        1,314,272   
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation expense by function:

        

Cost of revenue

   $ 580      $ 875      $ 1,591      $ 1,523   

Sales and marketing

   $ 21,540      $ 19,373      $ 35,218      $ 26,070   

Product development

   $ 26,132      $ 25,531      $ 58,505      $ 43,203   

General and administrative

   $ 9,345      $ 13,269      $ 23,066      $ 23,368   

Restructuring expense reversals

   $ —        $ (526   $ —        $ (1,278

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

 

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YAHOO! INC.

Condensed Consolidated Balance Sheets

 

     December 31,
2010
     June 30,
2011
 
     (Unaudited, in thousands
except par values)
 

ASSETS

     

Current assets:

     

Cash and cash equivalents

   $ 1,526,427       $ 1,580,837   

Short-term marketable debt securities

     1,357,661         972,635   

Accounts receivable, net

     1,028,900         956,560   

Prepaid expenses and other current assets

     432,560         379,888   
  

 

 

    

 

 

 

Total current assets

     4,345,548         3,889,920   

Long-term marketable debt securities

     744,594         701,556   

Property and equipment, net

     1,653,422         1,740,747   

Goodwill

     3,681,645         3,780,442   

Intangible assets, net

     255,870         235,865   

Other long-term assets

     235,136         235,243   

Investments in equity interests

     4,011,889         4,223,708   
  

 

 

    

 

 

 

Total assets

   $ 14,928,104       $ 14,807,481   
  

 

 

    

 

 

 

LIABILITIES AND EQUITY

     

Current liabilities:

     

Accounts payable

   $ 162,424       $ 155,133   

Accrued expenses and other current liabilities

     1,208,792         847,135   

Deferred revenue

     254,656         239,715   
  

 

 

    

 

 

 

Total current liabilities

     1,625,872         1,241,983   

Long-term deferred revenue

     56,365         40,837   

Capital lease and other long-term liabilities

     142,799         136,117   

Deferred and other long-term tax liabilities, net

     506,658         589,802   
  

 

 

    

 

 

 

Total liabilities

     2,331,694         2,008,739   

Commitments and contingencies (Note 11)

     —           —     

Yahoo! Inc. stockholders’ equity:

     

Common stock, $0.001 par value; 5,000,000 shares authorized; 1,308,836 shares issued and 1,308,836 shares outstanding as of December 31, 2010 and 1,320,425 shares issued and 1,281,804 shares outstanding as of June 30, 2011

     1,306         1,317   

Additional paid-in capital

     10,109,913         10,288,160   

Treasury stock at cost, zero shares as of December 31, 2010 and 38,621 shares as of June 30, 2011

     —           (609,187

Retained earnings

     1,942,656         2,402,620   

Accumulated other comprehensive income

     504,254         675,875   
  

 

 

    

 

 

 

Total Yahoo! Inc. stockholders’ equity

     12,558,129         12,758,785   

Noncontrolling interests

     38,281         39,957   
  

 

 

    

 

 

 

Total equity

     12,596,410         12,798,742   
  

 

 

    

 

 

 

Total liabilities and equity

   $ 14,928,104       $ 14,807,481   
  

 

 

    

 

 

 

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

 

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YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

 

     Six Months Ended  
     June 30,
2010
    June 30,
2011
 
     (Unaudited, in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 528,422      $ 463,334   

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

    

Depreciation

     255,192        275,901   

Amortization of intangible assets

     68,024        58,993   

Stock-based compensation expense, net

     118,380        92,886   

Non-cash restructuring charges

     72        —     

Tax benefits from stock-based awards

     21,922        12,483   

Excess tax benefits from stock-based awards

     (64,014     (30,225

Deferred income taxes

     28,903        45,832   

Earnings in equity interests

     (184,081     (191,082

Dividends received from equity investee

     60,918        75,391   

(Gain) loss from sales of investments, assets, and other, net

     (52,581     22,791   

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

    

Accounts receivable, net

     60,323        86,692   

Prepaid expenses and other

     (67,267     53,081   

Accounts payable

     1,440        (10,821

Accrued expenses and other liabilities

     (208,589     (383,149

Deferred revenue

     (76,500     (33,118
  

 

 

   

 

 

 

Net cash provided by operating activities

     490,564        538,989   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Acquisition of property and equipment, net

     (302,811     (339,066

Purchases of marketable debt securities

     (1,367,688     (1,124,597

Proceeds from sales of marketable debt securities

     507,364        882,228   

Proceeds from maturities of marketable debt securities

     1,460,172        657,916   

Acquisitions, net of cash acquired

     (112,361     (77,461

Purchases of intangible assets

     (12,617     (10,959

Proceeds from the sale of a divested business

     100,000        —     

Other investing activities, net

     (18,846     149   
  

 

 

   

 

 

 

Net cash provided (used in) by investing activities

     253,213        (11,790
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from issuance of common stock, net

     83,604        98,547   

Repurchases of common stock

     (881,317     (609,019

Excess tax benefits from stock-based awards

     64,014        30,225   

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

     (40,739     (33,669

Other financing activities, net

     (804     (1,463
  

 

 

   

 

 

 

Net cash used in financing activities

     (775,242     (515,379
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (60,640     42,590   

Net change in cash and cash equivalents

     (92,105     54,410   

Cash and cash equivalents at beginning of period

     1,275,430        1,526,427   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 1,183,325      $ 1,580,837   
  

 

 

   

 

 

 

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

 

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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 premier digital media company that delivers personalized digital content and experiences, across devices and around the globe, to vast audiences. Yahoo! provides engaging and innovative canvases for advertisers to connect with their target audiences using its unique blend of Science + Art + Scale. Through its proprietary technology and insights, Yahoo! delivers unique content and experiences for its audience and creates powerful opportunities for its advertisers to connect with their target audiences, in context and at scale. To users, Yahoo! provides online properties and services (“Yahoo! Properties”). To advertisers, Yahoo! provides a range of marketing services designed to reach and connect with users of its Yahoo! Properties, as well as with Internet users beyond Yahoo! Properties, through a distribution network of third-party entities (“Affiliates”) that have integrated Yahoo!’s advertising offerings into their Websites or other offerings (those Websites and offerings, “Affiliate sites”).

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

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

The preparation of consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States (“U.S.”) requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses and the related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to revenue, the useful lives of long-lived assets including property and equipment and intangible assets, investment fair values, stock-based compensation, goodwill, income taxes, contingencies, and restructuring charges. The Company bases its estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, when these carrying values are not readily available from other sources. Actual results may differ from these estimates.

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. The condensed consolidated balance sheet as of December 31, 2010 was derived from the Company’s audited financial statements for the year ended December 31, 2010, but does not include all disclosures required by U.S. GAAP. However, the Company believes the disclosures are adequate to make the information presented not misleading.

Recent Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board amended its guidance on the presentation of comprehensive income. Under the amended guidance, an entity has the option to present comprehensive income in either one continuous statement or two consecutive financial statements. A single statement must present the components of net income and total net income, the components of other comprehensive income and total other comprehensive income, and a total for comprehensive income. In a two-statement approach, an entity must present the components of net income and total net income in the first statement. That statement must be immediately followed by a financial statement that presents the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The option under the current guidance that permits the presentation of components of other comprehensive income as part of the statement of changes in stockholders’ equity has been eliminated. The amendment becomes effective on January 1, 2012 and is applied retrospectively. Early adoption is permitted. This guidance will not have an impact on the Company’s financial position, results of operations, or cash flows as it is disclosure-only in nature.

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

Basic and diluted net income attributable to Yahoo! common stockholders per share is computed using the weighted average number of common shares outstanding during the period, excluding net income attributable to participating securities (restricted stock awards granted under the Company’s 1995 Stock Plan and restricted stock units granted under the 1996 Directors’ Stock Plan (the “Directors’ Plan”)). Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares are calculated using the treasury stock method and

 

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Table of Contents

consist of unvested restricted stock and shares underlying unvested restricted stock units, the incremental common shares issuable upon the exercise of stock options, and shares to be purchased under the 1996 Employee Stock Purchase Plan (the “Employee Stock Purchase Plan”). The Company calculates potential tax windfalls and shortfalls by including the impact of pro forma deferred tax assets.

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

Potentially dilutive securities representing approximately 59 million shares of common stock for both the three and six months ended June 30, 2011 and 86 million shares of common stock for both the three and six months ended June 30, 2010 were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive.

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2011
    June 30,
2010
    June 30,
2011
 

Basic:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 213,321      $ 236,972      $ 523,512      $ 459,964   

Less: Net income allocated to participating securities

     (55     (3     (103     (8
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 213,266      $ 236,969      $ 523,409      $ 459,956   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average common shares

     1,378,374        1,299,947        1,388,341        1,304,505   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.15      $ 0.18      $ 0.38      $ 0.35   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 213,321      $ 236,972      $ 523,512      $ 459,964   

Less: Net income allocated to participating securities

     (19     (3     (41     (8

Less: Effect of dilutive securities issued by equity investees

     (670     (654     (1,348     (1,302
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 212,632      $ 236,315      $ 522,123      $ 458,654   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic calculation

     1,378,374        1,299,947        1,388,341        1,304,505   

Weighted average effect of Yahoo! Inc. dilutive securities:

        

Restricted stock and restricted stock units

     6,157        5,391        6,819        6,485   

Stock options and employee stock purchase plan

     5,709        3,021        6,676        3,282   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted calculation

     1,390,240        1,308,359        1,401,836        1,314,272   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.15      $ 0.18      $ 0.37      $ 0.35   
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 3 ACQUISITIONS

During the six months ended June 30, 2011, the Company acquired three companies, which were accounted for as business combinations. The total purchase price for these acquisitions was $72 million. The total cash consideration of $72 million less cash acquired of $3 million resulted in a net cash outlay of $69 million. Of the purchase price, $52 million was preliminarily allocated to goodwill, $26 million to amortizable intangible assets, $3 million to cash acquired, and $9 million to net assumed liabilities. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes.

The Company’s business combinations completed during the six months ended June 30, 2011 did not have a material impact on the Company’s condensed consolidated financial statements, and therefore pro forma disclosures have not been presented.

 

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Note 4 INVESTMENTS IN EQUITY INTERESTS

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

 

     December 31,
2010
     June 30,
2011
     Percent
Ownership of
Common Stock as of
June 30, 2011
 

Alibaba Group

   $ 2,280,602       $ 2,360,748         43

Yahoo Japan

     1,731,287         1,862,960         35
  

 

 

    

 

 

    

Total

   $ 4,011,889       $ 4,223,708      
  

 

 

    

 

 

    

Equity Investment in Alibaba Group. The investment in Alibaba Group Holding Limited (“Alibaba Group”) is accounted for using the equity method, and the total investment, including net tangible assets, identifiable intangible assets and goodwill, is classified as part of investments in equity interests on the Company’s condensed consolidated balance sheets. The Company records its share of the results of Alibaba Group, and any related amortization expense, one quarter in arrears, within earnings in equity interests in the condensed consolidated statements of income.

As of June 30, 2011, the difference between the Company’s carrying value of its investment in Alibaba Group and its proportionate share of the net assets of Alibaba Group is summarized as follows (in thousands):

 

Carrying value of investment in Alibaba Group

   $ 2,360,748   

Proportionate share of Alibaba Group stockholders’ equity

     1,704,545   
  

 

 

 

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

   $ 656,203   
  

 

 

 

 

(*) 

The excess carrying value has been primarily assigned to goodwill.

The amortizable intangible assets included in the excess carrying value have useful lives not exceeding seven years and a weighted average useful life of approximately five years. Goodwill is not deductible for tax purposes.

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

 

     Three Months Ended      Six Months Ended  
     March 31,
2010
     March 31,
2011
     March 31,
2010
    March 31,
2011
 

Operating data(1):

          

Revenue

   $ 281,955       $ 490,933       $ 555,767      $ 1,035,447   

Gross profit

   $ 207,189       $ 324,342       $ 420,074      $ 687,309   

Income (loss) from operations(2)

   $ 35,548       $ 47,159       $ (133,574   $ 73,251   

Net income (loss)

   $ 45,013       $ 51,629       $ (100,212   $ 96,634   

Net income (loss) attributable to Alibaba Group

   $ 32,060       $ 29,623       $ (124,636   $ 61,943   
                   September 30,
2010
    March 31,
2011
 

Balance sheet data(1):

          

Current assets

         $ 4,399,571      $ 3,137,104   

Long-term assets

         $ 2,436,976      $ 2,632,775   

Current liabilities

         $ 2,660,043      $ 1,325,758   

Long-term liabilities

         $ 58,679      $ 109,813   

Non-voting participating redeemable securities

         $ 860      $ 2,341   

Noncontrolling interests

         $ 338,419      $ 358,450   

 

(1) 

To expedite obtaining an essential regulatory license, the ownership of Alibaba Group’s online payment business, Alipay.com Co., Ltd. (“Alipay”), was restructured so that 100 percent of its outstanding shares are held by a Chinese domestic company, which is majority owned by Alibaba Group’s chief executive officer, and certain control agreements were terminated which resulted in the deconsolidation of Alipay in the first quarter of 2011. Accordingly, the Alibaba Group consolidated financial statements as of and for the quarter ended March 31, 2011, do not include the results of Alipay, nor do they include the net assets of Alipay. The consolidated current assets and current liabilities of Alibaba Group as of September 30, 2010, both include $1.6 billion of cash collected from purchasers and to be remitted to sellers. These amounts are no longer included in the consolidated balance sheet as of March 31, 2011. The impact of the deconsolidation of Alipay was not material to the Company’s financial statements. See Note 16 — “Subsequent Events” for additional information.

(2) 

The loss from operations of $134 million for the six months ended March 31, 2010 is primarily due to Alibaba Group’s impairment loss of $192 million on goodwill related to the business that Yahoo! contributed to Alibaba Group in 2005. This impairment does not impact Yahoo!’s earnings in equity interests as Yahoo!’s investment balance related to this contributed business was carried over at cost and therefore Yahoo! has no basis in the impaired goodwill.

 

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The Company also has commercial arrangements with Alibaba Group to provide technical, development, and advertising services. For the three and six months ended June 30, 2010 and 2011, these transactions were not material.

Equity Investment in Yahoo Japan. The investment in Yahoo Japan Corporation (“Yahoo Japan”) is accounted for using the equity method and the total investment, including net tangible assets, identifiable intangible assets and goodwill, is classified as part of investments in equity interests balance on the Company’s condensed consolidated balance sheets. The Company records its share of the results of Yahoo Japan, and any related amortization expense, one quarter in arrears within earnings in equity interests in the condensed consolidated statements of income.

The Company makes adjustments to the earnings in equity interests line in the consolidated statements of income for any differences between U.S. GAAP and accounting principles generally accepted in Japan (“Japanese GAAP”), the standards by which Yahoo Japan’s financial statements are prepared.

During the three and six months ended June 30, 2011, the Company recorded $7 million and $33 million, respectively, in U.S. GAAP adjustments to Yahoo Japan’s net income to reflect the Company’s 35 percent share of non-cash losses related to impairments of assets held by Yahoo Japan. The $7 million recorded during the three months ended June 30, 2011 relates to the Company’s share of a non-cash loss related to an impairment of assets held by Yahoo Japan. The $33 million recorded during the six months ended June 30, 2011 includes a $26 million, net of tax, U.S. GAAP adjustment to Yahoo Japan’s net income in the first quarter of 2011 to reflect the Company’s share of an other-than-temporary impairment of a cost method investment of Yahoo Japan that resulted primarily from reductions in the projected operating results of the Yahoo Japan investee.

The fair value of the Company’s ownership interest in the common stock of Yahoo Japan, based on the quoted stock price, was approximately $7 billion as of June 30, 2011.

During the three and six months ended June 30, 2010 and 2011, the Company received cash dividends from Yahoo Japan in the amounts of $61 million and $75 million, net of taxes, respectively, which were recorded as reductions to the Company’s investment in Yahoo Japan.

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

 

     Three Months Ended      Six Months Ended  
     March 31,
2010
     March 31,
2011
     March 31,
2010
     March 31,
2011
 
     (in thousands)  

Operating data:

  

Revenue

   $ 896,822       $ 1,006,327       $ 1,790,717       $ 2,000,158   

Gross profit

   $ 720,102       $ 831,503       $ 1,454,038       $ 1,655,768   

Income from operations

   $ 426,552       $ 496,915       $ 832,212       $ 995,186   

Net income

   $ 258,877       $ 289,109       $ 492,805       $ 515,884   

Net income attributable to Yahoo Japan

   $ 257,379       $ 287,577       $ 489,625       $ 512,283   
                   September 30,
2010
     March 31,
2011
 
                   (in thousands)  

Balance sheet data:

        

Current assets

         $ 2,332,325       $ 3,074,077   

Long-term assets

         $ 2,679,566       $ 2,655,185   

Current liabilities

         $ 938,985       $ 1,052,464   

Long-term liabilities

         $ 30,132       $ 33,596   

Noncontrolling interests

         $ 28,774       $ 26,190   

Under technology and trademark license and other commercial arrangements with Yahoo Japan, the Company records revenue from Yahoo Japan based on a percentage of revenue earned by Yahoo Japan. The Company recorded revenue from Yahoo Japan of approximately $76 million and $68 million for the three months ended June 30, 2010 and 2011, respectively, and revenue of approximately of $150 million and $137 million for the six months ended June 30, 2010 and 2011, respectively. As of December 31, 2010 and June 30, 2011, the Company had net receivable balances from Yahoo Japan of approximately $40 million and $42 million, respectively.

Note 5 GOODWILL

The Company’s goodwill balance was $3.7 billion as of December 31, 2010, of which $2.7 billion was recorded in the Americas segment, $0.6 billion in the EMEA (Europe, Middle East, and Africa) segment, and $0.4 billion in the Asia Pacific segment. As of June 30, 2011, the Company’s goodwill balance was $3.8 billion, of which $2.7 billion was recorded in the Americas segment, $0.6 billion in the EMEA

 

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segment, and $0.5 billion in the Asia Pacific segment. The change in the carrying amount of goodwill of $99 million reflected on our condensed consolidated balance sheets during the six months ended June 30, 2011 was primarily due to the addition of $30 million and $22 million related to acquisitions in the Americas and Asia Pacific segments, respectively, and the effect of foreign currency translation adjustments of $47 million.

Note 6 INTANGIBLE ASSETS, NET

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

 

     December 31, 2010      June 30, 2011  
     Net      Gross Carrying
Amount
     Accumulated
Amortization(*)
    Net  

Customer and advertiser related relationships

   $ 62,104       $ 144,588       $ (78,505   $ 66,083   

Developed technology and patents

     167,897         354,062         (210,475     143,587   

Trade names, trademarks, and domain names

     25,869         71,085         (44,890     26,195   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total intangible assets, net

   $ 255,870       $ 569,735       $ (333,870   $ 235,865   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(*)

Foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities, totaled approximately $20 million as of June 30, 2011.

For the three months ended June 30, 2010 and 2011, the Company recognized amortization expense for intangible assets of $32 million and $29 million, respectively, including $25 million in cost of revenue for the three months ended June 30, 2010 and $21 million in cost of revenue for the three months ended June 30, 2011. For the six months ended June 30, 2010 and 2011, the Company recognized amortization expense for intangible assets of $68 million and $59 million, respectively, including $52 million and $42 million in cost of revenue for the six months ended June 30, 2010 and 2011, respectively. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2011 and each of the succeeding years is as follows: six months ending December 31, 2011: $57 million; 2012: $86 million; 2013: $45 million; 2014: $25 million; 2015: $6 million; and 2016: $1 million.

Note 7 OTHER INCOME (EXPENSE), NET

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
     June 30,
2011
    June 30,
2010
     June 30,
2011
 

Interest and investment income

   $ 5,837       $ 5,084      $ 12,180       $ 10,444   

Gain on sale of Zimbra, Inc.

     —           —          66,130         —     

Other

     6,751         (10,750     20,606         (11,083
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other income (expense), net

   $ 12,588       $ (5,666   $ 98,916       $ (639
  

 

 

    

 

 

   

 

 

    

 

 

 

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

In February 2010, the Company sold Zimbra, Inc. for net proceeds of $100 million and recorded a pre-tax gain of $66 million.

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

Note 8 COMPREHENSIVE INCOME

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2011
    June 30,
2010
    June 30,
2011
 

Net income

   $ 216,143      $ 238,502      $ 528,422      $ 463,334   

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

     4,702        (1,703     5,748        (224

Foreign currency translation adjustments

     (111,471     42,460        (170,701     171,845   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income

     (106,769     40,757        (164,953     171,621   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     109,374        279,259        363,469        634,955   

Comprehensive income attributable to noncontrolling interests

     (2,822     (1,530     (4,910     (3,370
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Yahoo! Inc.

   $ 106,552      $ 277,729      $ 358,559      $ 631,585   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

     December 31,
2010
     June 30,
2011
 

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

   $ 8,734       $ 8,510   

Foreign currency translation, net of tax

     495,520         667,365   
  

 

 

    

 

 

 

Accumulated other comprehensive income

   $ 504,254       $ 675,875   
  

 

 

    

 

 

 

Note 9 INVESTMENTS

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

 

     December 31, 2010  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 1,353,064       $ 1,513       $ (514 )   $ 1,354,063   

Municipal bonds

     6,609         8         —          6,617   

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

     740,043         1,608         (76 )     741,575   

Corporate equity securities

     2,597         —           (1,128 )     1,469   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 2,102,313       $ 3,129       $ (1,718 )   $ 2,103,724   
  

 

 

    

 

 

    

 

 

   

 

 

 
     June 30, 2011  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 882,534       $ 1,540       $ (90   $ 883,984   

Municipal bonds

     3,191         —           —          3,191   

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

     785,696         1,383         (63     787,016   

Corporate equity securities

     2,761         —           (1,404     1,357   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 1,674,182       $ 2,923       $ (1,557   $ 1,675,548   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31,
2010
     June 30,
2011
 

Reported as:

     

Short-term marketable debt securities

   $ 1,357,661       $ 972,635   

Long-term marketable debt securities

     744,594         701,556   

Other assets

     1,469         1,357   
  

 

 

    

 

 

 

Total

   $ 2,103,724       $ 1,675,548   
  

 

 

    

 

 

 

Available-for-sale securities included in cash and cash equivalents on the condensed consolidated balance sheets are not included in the table above as the gross unrealized gains and losses were immaterial for both 2010 and the six months ended June 30, 2011 as the carrying value approximates fair value because of the short maturity of those instruments.

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

 

     December 31,
2010
     June 30,
2011
 

Due within one year

   $ 1,357,661       $ 972,635   

Due after one year through five years

     744,594         701,556   
  

 

 

    

 

 

 

Total available-for-sale marketable debt securities

   $ 2,102,255       $ 1,674,191   
  

 

 

    

 

 

 

 

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

 

     December 31, 2010  
     Less than 12 Months     12 Months or Greater     Total  
     Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

Government and agency securities

   $ 539,287       $ (514   $ —         $ —        $ 539,287       $ (514

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

     153,209         (75     6,006         (1     159,215         (76

Corporate equity securities

     —           —          1,469         (1,128     1,469         (1,128
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 692,496       $ (589   $ 7,475       $ (1,129   $ 699,971       $ (1,718
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     June 30, 2011  
     Less than 12 Months     12 Months or Greater     Total  
     Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

Government and agency securities

   $ 111,714       $ (90   $ —         $ —        $ 111,714       $ (90

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

     136,950         (63     —           —          136,950         (63

Corporate equity securities

     —           —          1,357         (1,404     1,357         (1,404
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 248,664       $ (153   $ 1,357       $ (1,404   $ 250,021       $ (1,557
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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

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

Basis of Fair Value Measurement

 

Level 1

   Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2

   Inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3

   Unobservable inputs reflecting the Company’s own assumptions incorporated in valuation techniques used to determine fair value. These assumptions are required to be consistent with market participant assumptions that are reasonably available.

 

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The following table sets forth the financial assets, measured at fair value, by level within the fair value hierarchy as of December 31, 2010 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  

Assets

   Level 1      Level 2      Total  

Money market funds(1)

   $ 291,268       $ —         $ 291,268   

Available-for-sale securities:

        

Government and agency securities(1)

     —           1,401,991         1,401,991   

Municipal bonds(1)

     —           26,269         26,269   

Commercial paper and bank certificates of deposit(1)

     —           218,485         218,485   

Corporate debt securities(1)

     —           576,378         576,378   
  

 

 

    

 

 

    

 

 

 

Available-for-sale securities at fair value

   $ 291,268       $ 2,223,123       $ 2,514,391   

Corporate equity securities(2)

     1,469         —           1,469   
  

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 292,737       $ 2,223,123       $ 2,515,860   
  

 

 

    

 

 

    

 

 

 

 

(1) 

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

(2) 

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

The amount of cash and cash equivalents as of December 31, 2010 includes $1.1 billion in cash deposited with commercial banks, of which $425 million are time deposits.

The following table sets forth the financial assets, measured at fair value, by level within the fair value hierarchy as of June 30, 2011 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  

Assets

   Level 1      Level 2      Total  

Money market funds(1)

   $ 455,472       $ —         $ 455,472   

Available-for-sale securities:

        

Government and agency securities(1)

     —           966,801         966,801   

Municipal bonds(1)

     —           3,191         3,191   

Commercial paper and bank certificates of deposit(1)

     —           247,665         247,665   

Corporate debt securities(1)

     —           577,371         577,371   
  

 

 

    

 

 

    

 

 

 

Available-for-sale securities at fair value

   $ 455,472       $ 1,795,028       $ 2,250,500   

Corporate equity securities(2)

     1,357         —           1,357   
  

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 456,829       $ 1,795,028       $ 2,251,857   
  

 

 

    

 

 

    

 

 

 

 

 

(1) 

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

(2) 

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

The amount of cash and cash equivalents as of June 30, 2011 includes $1.0 billion in cash deposited with commercial banks, of which $442 million are time deposits.

The fair values of the Company’s Level 1 financial assets are based on quoted market prices of the identical underlying security. The fair values of the Company’s Level 2 financial assets are obtained from readily-available pricing sources for the identical underlying security that may not be actively traded. The Company utilizes a pricing service to assist in obtaining fair value pricing for the majority of this investment portfolio. The Company conducts reviews on a quarterly basis to verify pricing, assess liquidity, and determine if significant inputs have changed that would impact the fair value hierarchy disclosure. During the six months ended June 30, 2011, the Company did not make significant transfers between Level 1 and Level 2 assets. As of December 31, 2010 and June 30, 2011, the Company did not have any significant Level 3 financial assets.

 

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Note 10 STOCKHOLDERS’ EQUITY AND EMPLOYEE BENEFITS

Employee Stock Purchase Plan. As of June 30, 2011, there was $30 million of unamortized stock-based compensation cost related to the Company’s Employee Stock Purchase Plan which will be recognized over a weighted average period of 1.0 year.

Stock Options. The Company’s 1995 Stock Plan, the Directors’ Plan, and other stock-based award plans assumed through acquisitions are collectively referred to as the “Plans.” Stock option activity under the Company’s Plans for the six months ended June 30, 2011 is summarized as follows (in thousands, except per share amounts):

 

     Shares     Weighted Average
Exercise Price per
Share
 

Outstanding at December 31, 2010

     80,976      $ 22.02   

Options granted

     6,473      $ 16.39   

Options assumed

     14      $ 5.25   

Options exercised(*)

     (4,380   $ 10.85   

Options expired

     (6,658   $ 28.82   

Options cancelled/forfeited

     (3,797   $ 15.60   
  

 

 

   

Outstanding at June 30, 2011

     72,628      $ 21.90   
  

 

 

   

 

(*) 

The Company issued new shares to satisfy stock option exercises.

As of June 30, 2011, there was $99 million of unrecognized stock-based compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of 2.4 years.

The Company determines the grant-date fair value of stock options, including the options granted under the Company’s Employee Stock Purchase Plan, using a Black-Scholes model. The following weighted average assumptions were used in determining the fair value of option grants using the Black-Scholes option pricing model:

 

     Stock Options     Purchase Plan (*)  
     Three Months Ended     Three Months Ended  
     June 30,
2010
    June 30,
2011
    June 30,
2010
    June 30,
2011
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate

     2.2     1.6     2.3     1.4

Expected volatility

     36.7     34.8     68.1     36.1

Expected life (in years)

     4.50        3.94        0.36        0.98   
     Stock Options     Purchase Plan (*)  
     Six Months Ended     Six Months Ended  
     June 30,
2010
    June 30,
2011
    June 30,
2010
    June 30,
2011
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate

     2.2     1.6     2.3     1.4

Expected volatility

     34.0     34.7     68.9     36.1

Expected life (in years)

     4.50        4.09        0.44        1.03   

 

 

(*) 

Assumptions for the Employee Stock Purchase Plan relate to the annual average of the enrollment periods. Enrollment is currently permitted in May and November of each year.

Restricted Stock. Restricted stock awards and restricted stock units activity for the six months ended June 30, 2011 is summarized as follows (in thousands, except per share amounts):

 

     Shares     Weighted Average
Grant Date
Fair Value
Per Share
 

Awarded and unvested at December 31, 2010(*)

     31,395      $ 17.99   

Granted(*)

     15,724      $ 16.47   

Assumed

     210      $ 16.61   

Vested

     (5,709   $ 17.55   

Forfeited

     (6,458   $ 16.04   
  

 

 

   

Awarded and unvested at June 30, 2011(*)

     35,162      $ 17.73   
  

 

 

   

 

(*) 

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

As of June 30, 2011, there was $308 million of unrecognized stock-based compensation cost related to unvested restricted stock awards and restricted stock units, which is expected to be recognized over a weighted average period of 2.6 years.

 

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Table of Contents

During the six months ended June 30, 2010 and June 30, 2011, 6.8 million shares and 5.7 million shares, respectively, that were subject to previously granted restricted stock awards and restricted stock units vested. A majority of these vested restricted stock awards and restricted stock units were net share settled. During the six months ended June 30, 2010 and June 30, 2011, the Company withheld 2.5 million and 2.0 million shares, respectively, based upon the Company’s closing stock price on the vesting date to settle the employees’ minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities.

Total payments for the employees’ tax obligations to the relevant taxing authorities were $41 million and $34 million for the six months ended June 30, 2010 and June 30, 2011, respectively, and are reflected as a financing activity within the condensed consolidated statements of cash flows. The payments were used for tax withholdings related to the net share settlements of restricted stock units and tax withholdings related to reacquisitions of shares of restricted stock awards. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.

Performance-Based Executive Incentive Restricted Stock Units.

In February 2009 and February 2010, the Compensation Committee approved long-term performance-based incentive equity awards to Ms. Bartz and other senior officers, including three-year annual financial performance restricted stock units which generally are scheduled to vest on the third anniversary of the grant date based on the Company’s attainment of certain annual financial performance targets in each of the three years as well as the executive’s continued employment through that vesting date. The number of shares which ultimately vest will range from 0 percent to 200 percent of the target amount stated in each executive’s award agreement based on the performance of the Company relative to the applicable performance targets. The annual financial performance targets are established at the beginning of each fiscal year and, accordingly, the portion of the award subject to each annual target is treated as a separate annual grant for accounting purposes. The financial performance targets for the 2011 tranches of these awards were established in February 2011. The amount of stock-based compensation recorded for these restricted stock units will vary depending on the Company’s attainment of the financial performance targets and each executive’s completion of the service period. The fair values of the 2011 tranches of the February 2009 and February 2010 annual financial performance restricted stock unit grants are $2 million and $3 million, respectively, and are being recognized as stock-based compensation expense over one-year and two-year service periods, respectively.

In February 2011, the Compensation Committee approved a long-term performance-based incentive equity award to Ms. Bartz and other senior officers in the form of restricted stock units that generally are scheduled to vest on the third anniversary of the grant date based on the Company’s attainment of certain financial performance targets for 2011 as well as the executive’s continued employment through that vesting date. The number of shares which ultimately vest will range from 0 percent to 200 percent of the target amount stated in each executive’s award agreement based on the performance of the Company relative to the performance targets. The financial performance targets were established in February 2011. The amount of stock-based compensation recorded for these restricted stock units will vary depending on the Company’s attainment of the financial performance targets and each executive’s completion of the service period. The fair value of these restricted stock unit grants is $32 million and is being recognized as stock-based compensation expense over a three-year service period.

Stock Repurchases. In June 2010, the Board authorized a stock repurchase program allowing the Company to repurchase up to $3.0 billion of its outstanding shares of common stock from time to time. The repurchase program expires in June 2013. Repurchases under this program may take place in the open market or in privately negotiated transactions, including derivative transactions, and may be made under a Rule 10b5-1 plan. During the six months ended June 30, 2011, the Company repurchased approximately 38.6 million shares of its common stock under this stock repurchase program at an average price of $15.79 per share for a total of $609 million. During the six months ended June 30, 2010, the Company repurchased approximately 56.7 million shares of its common stock at an average price of $15.55 per share for a total of $881 million. Such repurchases were made under the Company’s previous stock repurchase program approved by the Board of Directors in October 2006, which was exhausted during the third quarter of 2010. See Note 16 — “Subsequent Events” for information regarding share repurchase activity subsequent to June 30, 2011.

Note 11 COMMITMENTS AND CONTINGENCIES

Lease Commitments. The Company leases office space and data centers under operating lease and capital lease agreements with original lease periods of up to 13 years, expiring between 2011 and 2022.

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

 

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A summary of gross and net lease commitments as of June 30, 2011 is as follows (in millions):

 

     Gross Operating
Lease
Commitments
     Sublease
Income
    Net Operating
Lease
Commitments
 

Six months ending December 31, 2011

   $ 86       $ (6   $ 80   

Years ending December 31,

       

2012

     150         (10     140   

2013

     126         (10     116   

2014

     97         (9     88   

2015

     75         (6     69   

2016

     39         (1     38   

Due after 5 years

     58         —          58   
  

 

 

    

 

 

   

 

 

 

Total gross and net lease commitments

   $ 631       $ (42   $ 589   
  

 

 

    

 

 

   

 

 

 

 

     Capital Lease
Commitment
 

Six months ending December 31, 2011

   $ 4   

Years ending December 31,

  

2012

     7   

2013

     8   

2014

     8   

2015

     8   

2016

     8   

Due after 5 years

     23   
  

 

 

 

Gross lease commitment

   $ 66   
  

 

 

 

Less: interest

     (26
  

 

 

 

Net lease commitment

   $ 40   
  

 

 

 

Affiliate Commitments. In connection with contracts to provide advertising services to Affiliates, the Company is obligated to make payments, which represent traffic acquisition costs (“TAC”), to its Affiliates. As of June 30, 2011, these commitments totaled $121 million, of which $44 million will be payable in the remainder of 2011, $74 million will be payable in 2012, and $3 million will be payable in 2013.

Intellectual Property Rights. The Company is committed to make certain payments under various intellectual property arrangements of up to $35 million through 2023.

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

As of June 30, 2011, 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. In addition, the Company identified no variable interests currently held in entities for which it is the primary beneficiary.

 

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See Note 15 — “Search Agreement with Microsoft Corporation” for a description of the Company’s Search and Advertising Services and Sales Agreement (the “Search Agreement”) and License Agreement with Microsoft Corporation (“Microsoft”).

Contingencies. From time to time, third parties assert patent infringement claims against Yahoo!. Currently, the Company is engaged in lawsuits regarding patent issues and has been notified of other potential patent disputes. In addition, from time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights, trade secrets, and other intellectual property rights, claims related to employment matters, and a variety of other claims, including claims alleging defamation, invasion of privacy, or similar claims arising in connection with the Company’s e-mail, message boards, photo and video sites, auction sites, shopping services, and other communications and community features.

On July 12, 2001, the first of several purported securities class action lawsuits was filed in the U.S. District Court for the Southern District of New York against certain underwriters involved in Overture Services Inc.’s (“Overture”) IPO, Overture, and certain of Overture’s former officers and directors. The court consolidated the cases against Overture. Plaintiffs allege, among other things, violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 (the “Exchange Act”) involving undisclosed compensation to the underwriters, and improper practices by the underwriters, and seek unspecified damages. Similar complaints were filed in the same court against numerous public companies that conducted IPOs of their common stock since the mid-1990s. All of these lawsuits were consolidated. On October 5, 2009, the court granted class certification and granted final approval of a stipulated global settlement and plan of allocation. On October 6, 2010, various individuals objecting to the settlement filed opening appeal briefs with the U.S. Court of Appeals for the Second Circuit, and in early February 2011 Yahoo! and other appellees filed reply briefs in support of the settlement.

On June 14, 2007, a stockholder derivative action was filed in the U.S. District Court for the Central District of California by Jill Watkins against members of the Board and selected officers. The complaint filed by the plaintiff alleged breaches of fiduciary duties and corporate waste, similar to the allegations in a former class action relating to stock price declines during the period April 2004 to July 2006, and alleged violation of Section 10(b) of the Exchange Act. On July 16, 2009, the plaintiff Watkins voluntarily dismissed the action against all defendants without prejudice. On July 17, 2009, plaintiff Miguel Leyte-Vidal, who had substituted in as plaintiff prior to the dismissal of the federal Watkins action, re-filed a stockholder derivative action in Santa Clara County Superior Court against members of the Board and selected officers. The Santa Clara County Superior Court derivative action purports to assert causes of action on behalf of the Company for violation of specified provisions of the California Corporations Code, for breaches of fiduciary duty regarding financial accounting and insider selling and for unjust enrichment. On April 15, 2011, Yahoo! demurred to plaintiff’s second amended complaint, and the court heard oral argument on July 8, 2011. On July 11, 2011, the court granted Yahoo!’s demurrer to plaintiff’s second amended complaint with leave to amend. On July 18, 2011, plaintiff filed a third amended complaint. On August 5, 2011, Yahoo! demurred to the third amended complaint.

Since May 31, 2011, eight stockholder derivative lawsuits have been filed in State or Federal court in California purportedly on behalf of Yahoo! stockholders against certain officers and directors of the Company and third parties alleging breaches of fiduciary duties, corporate waste, mismanagement, abuse of control, unjust enrichment, misappropriation of corporate assets, or contribution and seeking to recover damages, equitable or injunctive relief, disgorgement, and corporate governance changes in connection with Alibaba Group’s restructuring of its payment processing subsidiary Alipay and related disclosures. The following actions were filed in Santa Clara County Superior Court: Cinotto v. Bartz, et al., (May 31, 2011); Lassoff v. Bartz, et al., (June 9, 2011); Zucker v. Bartz, et al., (July 6, 2011); and Koo v. Bartz, et al., (July 18, 2011). On June 24, 2011, the Santa Clara County Superior Court consolidated the then-pending actions (Cinotto and Lasoff) under the caption In re Yahoo! Inc. Derivative Shareholder Litigation and sought the assistance of counsel to provide notice of subsequent cases that might properly be consolidated. In addition, the following actions were filed in the United States District Court for the Northern District of California: Salzman v. Bartz, et al., (July 1, 2011); Oh v. Bartz, et al., (July 5, 2011); Tawila v. Bartz, et al., (July 6, 2011); and Iron Workers Mid-South Pension Fund v. Bartz, et al., (July 6, 2011).

On June 6, 2011, a purported stockholder class action, Bonato v. Bartz, et al., was filed in the United States District Court for the Northern District of California against the Company and certain officers and directors for alleged violations of the Exchange Act. Plaintiff seeks to represent a class of persons who purchased or otherwise acquired the Company’s common stock between April 19, 2011 and May 13, 2011, and alleges that during that class period, defendants issued false or misleading statements regarding the Company’s business and financial results and failed to disclose that Alibaba Group transferred ownership of its payments processing subsidiary Alipay at less than market value. The complaint purports to assert claims for relief for violation of Section 10(b) and 20(a) of the Exchange Act and for violation of Rule 10b-5 thereunder, and seeks unspecified damages, injunctive and equitable relief, fees and costs.

With respect to the legal proceedings and claims described above, the Company has determined, based on current knowledge, that the amount or range of reasonably possible losses, including reasonably possible losses in excess of amounts already accrued, is not reasonably estimable with respect to certain matters and that the aggregate amount or range of such losses that are estimable would not have a material adverse effect on the Company’s financial position, results of operations or cash flows. Amounts accrued as of December 31, 2010 and June 30, 2011 were not material. The ultimate outcome of legal proceedings involves judgments, estimates and inherent uncertainties, and cannot be predicted with certainty. In the event of a determination adverse to Yahoo!, its subsidiaries, directors, or officers in these matters, however, the Company may incur substantial monetary liability, and be required to change its business practices. Either of these possibilities could have a material adverse effect on the Company’s financial position, results of operations, or cash flows. The Company may also incur substantial expenses in defending against these claims.

 

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Table of Contents

Note 12 SEGMENTS

The Company manages its business geographically. The primary areas of measurement and decision-making are Americas, EMEA (Europe, Middle East, and Africa), and Asia Pacific. Management relies on an internal reporting process that provides revenue ex-TAC, which is defined as revenue less TAC, and direct costs excluding TAC by segment, and consolidated income from operations for making decisions related to the evaluation of the financial performance of, and allocating resources to, the Company’s segments. Prior period presentations have been updated to conform to the current profitability measures being used by the Company’s management team to evaluate the financial performance of the Company’s segments.

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

 

     Three Months Ended      Six Months Ended  
     June 30,
2010
     June 30,
2011
     June 30,
2010
     June 30,
2011
 

Revenue by segment:

           

Americas

   $ 1,133,216       $ 808,038       $ 2,288,228       $ 1,626,969   

EMEA

     140,513         162,601         282,338         316,651   

Asia Pacific

     327,650         258,385         627,773         499,761   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Revenue

   $ 1,601,379       $ 1,229,024       $ 3,198,339       $ 2,443,381   
  

 

 

    

 

 

    

 

 

    

 

 

 

TAC by segment:

           

Americas

   $ 282,072       $ 39,404       $ 563,818       $ 77,545   

EMEA

     50,054         57,648         103,474         115,160   

Asia Pacific

     141,124         55,844         272,488         110,222   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total TAC

   $ 473,250       $ 152,896       $ 939,780       $ 302,927   
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenue ex-TAC by segment:

           

Americas

   $ 851,144       $ 768,634       $ 1,724,410       $ 1,549,424   

EMEA

     90,459         104,953         178,864         201,491   

Asia Pacific

     186,526         202,541         355,285         389,539   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Revenue ex-TAC

   $ 1,128,129       $ 1,076,128       $ 2,258,559       $ 2,140,454   
  

 

 

    

 

 

    

 

 

    

 

 

 

Direct costs by segment(1):

           

Americas

     145,333         132,866         290,237         268,940   

EMEA

     30,375         34,090         61,148         64,677   

Asia Pacific

     35,641         48,506         70,108         93,091   

Global operating costs(2)(3)

     515,789         449,113         1,017,613         906,885   

Restructuring charges, net

     10,052         237         14,464         10,812   

Depreciation and amortization

     157,970         161,373         323,216         321,811   

Stock-based compensation expense

     57,597         59,048         118,380         93,598   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 175,372       $ 190,895       $ 363,393       $ 380,640   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Direct costs for each segment include cost of revenue (excluding TAC) and other operating expenses that are directly attributable to the segment such as employee compensation expense (excluding stock-based compensation expense), local sales and marketing expenses, and facilities expenses. Beginning in the fourth quarter of 2010, the Company no longer includes TAC in segment direct costs. For comparison purposes, prior period amounts have been revised to conform to the current presentation.

(2) 

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

(3) 

The net cost reimbursements from Microsoft are primarily included in global operating costs.

 

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Table of Contents
     Three Months Ended      Six Months Ended  
     June 30,
2010
     June 30,
2011
     June 30,
2010
     June 30,
2011
 

Capital expenditures, net:

           

Americas

   $ 147,551       $ 119,167       $ 239,350       $ 246,537   

EMEA

     23,560         13,963         35,131         27,222   

Asia Pacific

     19,159         38,387         28,330         65,307   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capital expenditures, net

   $ 190,270       $ 171,517       $ 302,811       $ 339,066   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31,
2010
     June 30,
2011
 

Property and equipment, net:

     

Americas

   $ 1,475,021       $ 1,504,106   

EMEA

     63,820         82,301   

Asia Pacific

     114,581         154,340   
  

 

 

    

 

 

 

Total property and equipment, net

   $ 1,653,422       $ 1,740,747   
  

 

 

    

 

 

 

See Note 14 —“Restructuring Charges, Net” for additional information regarding segments.

Enterprise Wide Disclosures:

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

 

     Three Months Ended      Six Months Ended  
     June 30,
2010
     June 30,
2011
     June 30,
2010
     June 30,
2011
 

Display

   $ 514,119       $ 523,537       $ 1,005,160       $ 1,046,160   

Search

     842,040         466,674         1,683,254         921,795   

Other

     245,220         238,813         509,925         475,426   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,601,379       $ 1,229,024       $ 3,198,339       $ 2,443,381   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended      Six Months Ended  
     June 30,
2010
     June 30,
2011
     June 30,
2010
     June 30,
2011
 

Revenue:

           

U.S.

   $ 1,091,727       $ 759,042       $ 2,212,391       $ 1,538,011   

International

     509,652         469,982         985,948         905,370   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,601,379       $ 1,229,024       $ 3,198,339       $ 2,443,381   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31,
2010
     June 30,
2011
 

Property and equipment, net:

     

U.S

   $ 1,471,536       $ 1,500,928   

International

     181,886         239,819   
  

 

 

    

 

 

 

Total property and equipment, net

   $ 1,653,422       $ 1,740,747   
  

 

 

    

 

 

 

Note 13 INCOME TAXES

The Company’s effective tax rate is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. Historically, the Company’s provision for income taxes has differed from the tax computed at the U.S. federal statutory income tax rate due to state taxes, the effect of non-U.S. operations, non-deductible stock-based compensation expense and adjustments to unrecognized tax benefits.

The effective tax rate reported for the three months ended June 30, 2011 was 30 percent compared to 36 percent for the same period in 2010. The rate for the second quarter of 2011 was lower than in 2010 primarily due to a shift of the geographic mix of earnings for 2011 and a lower effective state tax rate resulting from a change in the apportionment rules in California effective in 2011.

 

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Table of Contents

The effective tax rate reported for the six months ended June 30, 2011 was 28 percent compared to 26 percent for the same period in 2010. The rates in both periods were lower than the U.S. federal statutory rate primarily due to reductions of tax reserves that were recorded as tax audits were favorably settled and the shift of the geographic mix of earnings. During the six months ended June 30, 2010, the Company also recorded the benefit of a capital loss carryover that was used to offset a capital gain. While the discrete adjustments had a greater effect in the six months ended June 30, 2010 than in the six months ended June 30, 2011, the annual effective tax rate for 2011 is projected to be lower than in 2010 as a result of the geographic mix in earnings and the lower effective blended state tax rate.

The Company is in various stages of examination and appeal in connection with all of its tax audits worldwide, which generally span tax years 2005 through 2009. It is difficult to determine when these examinations will be settled or what their final outcomes will be. The Company believes that it has adequately provided for any reasonably foreseeable adjustment and that any settlement will not have a material adverse effect on its consolidated financial position or results of operations.

The Company’s gross amount of unrecognized tax benefits as of June 30, 2011 is $526 million, of which $405 million is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of June 30, 2011 decreased by $71 million from the recorded balance as of December 31, 2010 due to favorable settlements of tax audits in the first quarter of 2011. Since there can be no assurance as to the outcome of tax audits currently in progress, it is reasonably possible that over the next twelve-month period the Company may experience an increase or decrease in its unrecognized tax benefits. It is not possible to determine either the magnitude or the range of any increase or decrease at this time.

Note 14 RESTRUCTURING CHARGES, NET

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
     June 30,
2011
    June 30,
2010
     June 30,
2011
 

Employee severance pay and related costs

   $ 692       $ (424   $ 950       $ 8,911   

Non-cancelable lease, contract termination, and other charges

     9,360         1,187        13,514         3,179   
  

 

 

    

 

 

   

 

 

    

 

 

 

Sub-total before reversal of stock-based compensation expense

     10,052         763        14,464         12,090   

Reversal of stock-based compensation expense for forfeitures

     —           (526     —           (1,278
  

 

 

    

 

 

   

 

 

    

 

 

 

Restructuring charges, net

   $ 10,052       $ 237      $ 14,464       $ 10,812   
  

 

 

    

 

 

   

 

 

    

 

 

 

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

Q4’08 Restructuring Plan. During the fourth quarter of 2008, the Company implemented certain cost reduction initiatives, including a workforce reduction and consolidation of certain real estate facilities. During the three and six months ended June 30, 2010, the Company incurred total pre-tax cash charges of approximately $10 million and $14 million, respectively, in facility and other related costs related to the Q4’08 restructuring plan. Net charges under the Q4’08 restructuring plan relating to the Americas segment were $9 million and $14 million for the three and six months ended June 30, 2010, respectively. Net charges under the Q4’08 restructuring plan relating to the EMEA segment were $1 million and $0 (which is net of a $1 million credit in the first quarter of 2010) for the three and six months ended June 30, 2010, respectively. During the three and six months ended June 30, 2011, the Company incurred total pre-tax cash charges of approximately $1 million and $3 million, respectively, in facility and other related costs related to the Q4’08 restructuring plan, the majority of which related to the Americas segment.

Q4’09 Restructuring Charges. During the fourth quarter of 2009, the Company decided to close one of its EMEA facilities and began implementation of a workforce realignment at the facility to focus resources on its strategic initiatives. The Company exited the facility in the third quarter of 2010. In connection with the strategic realignment efforts, a U.S. executive of one of the Company’s acquired businesses departed. During the three and six months ended June 30, 2010, the Company incurred total pre-tax charges of less than $1 million in severance and other related costs related to the Q4’09 restructuring charges, consisting of charges primarily related to the EMEA segment. During the three months ended June 30, 2011, the Company did not incur any charges related to the Q4’09 restructuring charges. During the six months ended June 30, 2011, the Company recorded a reversal of $1 million for adjustments to original estimates in severance and other related costs related to the Q4’09 restructuring charges, entirely related to the EMEA segment.

Q4’10 Restructuring Plan. During the fourth quarter of 2010, the Company began implementation of a worldwide workforce reduction to align resources with its product strategy. During the three months ended June 30, 2011, the Company recorded a net reversal of $1 million for adjustments to original estimates in severance and other related costs related to the Q4’10 restructuring plan, the majority of which related to the Americas segment. During the six months ended June 30, 2011, the Company incurred total pre-tax cash charges of $2 million in severance and other related costs related to the Q4’10 restructuring plan, consisting of $1 million in charges related to the Americas segment and $1 million related to the EMEA segment. The pre-tax cash charges were offset by a $1 million reversal for adjustments to original estimates related to the Americas segment, resulting in a $1 million net charge in the six months ended June 30, 2011.

 

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Table of Contents

Q1’11 Restructuring Plan. During the first quarter of 2011, the Company began implementation of a workforce realignment to further reduce its cost structure. During the three months ended June 30, 2011, the Company did not record any charges related to the Q1’11 restructuring plan. During the six months ended June 30, 2011, the Company incurred total pre-tax cash charges of $9 million in severance and other related costs related to the Q1’11 restructuring plan. The pre-tax cash charges were offset by a $1 million credit related to non-cash stock-based compensation expense reversals for unvested stock awards that were forfeited. Of the $8 million in restructuring charges, net recorded in the six months ended June 30, 2011, $7 million related to the Americas segment and $1 million related to the EMEA segment.

Restructuring Accruals. The $52 million restructuring liability as of June 30, 2011 consists of $12 million for employee severance pay expenses, which the Company expects to substantially pay out by the end of the first quarter of 2012, and $40 million related to non-cancelable lease costs, which the Company expects to pay over the terms of the related obligations (which extend to the second quarter of 2017).

The Company’s restructuring accrual activity for the six months ended June 30, 2011 is summarized as follows (in thousands):

 

     Q4’08
Restructuring
Plan
    Q4’09
Restructuring
Charges
    Q4’10
Restructuring
Plan
    Q1’11
Restructuring
Plan
    Total  

Balance as of January 1, 2011

   $ 49,484      $ 4,286      $ 33,332      $ —        $ 87,102   

Employee severance pay and related costs

     8        109        3,698        9,647        13,462   

Reversals of stock-based compensation expense

     —          (46     (586     (646     (1,278

Non-cancelable lease, contract termination, and other charges

     3,536        18        —          —          3,554   

Reversals of previous charges

     (317     (1,664     (2,230     (715     (4,926
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges, net for the quarter ended June 30, 2011

   $ 3,227      $ (1,583   $ 882      $ 8,286      $ 10,812   

Cash paid

     (12,484     (1,494     (27,014     (6,625     (47,617

Non-cash reversals (accelerations) of stock-based compensation expense

     —          46        586        646        1,278   

Non-cash adjustments

     (98     (1,255     739        937        323   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2011

   $ 40,129      $ —        $ 8,525      $ 3,244      $ 51,898   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

     December 31,
2010
     June 30,
2011
 

Americas

   $ 68,268       $ 41,397   

EMEA

     16,895         9,946   

Asia Pacific

     1,939         555   
  

 

 

    

 

 

 

Total restructuring accruals

   $ 87,102       $ 51,898   
  

 

 

    

 

 

 

Note 15 SEARCH AGREEMENT WITH MICROSOFT CORPORATION

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

During the first five years of the term of the Search Agreement, in the transitioned markets the Company is entitled to receive 88 percent of the revenue generated from Microsoft’s services on Yahoo! Properties (the “Revenue Share Rate”) and the Company is also entitled to receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue is deducted. For new Affiliates during the term of the Search Agreement, and for all Affiliates after the first five years of such term, the Company will receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue and certain Microsoft costs are deducted. On the fifth anniversary of the date of implementation of the Search Agreement, Microsoft will have the option to terminate the Company’s sales exclusivity for premium search advertisers. If Microsoft exercises its option, the Revenue Share Rate will increase to 93 percent for the remainder of the term of the Search Agreement, unless the Company exercises its option to retain the Company’s sales exclusivity, in which case the Revenue Share Rate would be reduced to 83 percent

 

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for the remainder of the term. If Microsoft does not exercise such option, the Revenue Share Rate will be 90 percent for the remainder of the term of the Search Agreement. In the transitioned markets, the Company reports as revenue the 88 percent revenue share as the Company is not the primary obligor in the arrangement with the advertisers and publishers. The underlying search advertising services are provided by Microsoft. As of December 31, 2010, the Company had collected a total amount of $93 million on behalf of Microsoft and affiliates, which is included in cash and cash equivalents as of December 31, 2010, with a corresponding liability in accrued expenses and other current liabilities. The Company remitted the $93 million to Microsoft in the first quarter of 2011. The Company’s uncollected 88 percent share in connection with the Search Agreement was $172 million, which is included in accounts receivable, net, as of December 31, 2010. As of June 30, 2011, the Company had no restricted cash related to amounts collected on behalf of Microsoft and affiliates that the Company would have been required to remit to Microsoft in the third quarter of 2011. The Company’s uncollected 88 percent revenue share in connection with the Search Agreement was $186 million, which is included in accounts receivable, net, as of June 30, 2011.

The global transition of the algorithmic and paid search platforms to Microsoft’s platform and the migration of the paid search advertisers and publishers to Microsoft’s platform are being done on a market by market basis and are expected to continue through the first half of 2013. The algorithmic and paid search transition to the Microsoft platform was completed in the U.S. and Canada in the fourth quarter of 2010, and the Company plans to complete the transition of algorithmic search in other markets in 2011. The transition of paid search in other markets is expected to resume in the second half of 2011 and to continue through the first half of 2013.

Under the Search Agreement, for each market, Microsoft generally guarantees Yahoo!’s revenue per search (“RPS Guarantee”) on Yahoo! Properties only for 18 months after the transition of paid search services to Microsoft’s platform in that market. For example, because the transition of paid search was completed in the U.S. and Canada in the fourth quarter of 2010, the RPS Guarantee with respect to the U.S. and Canada markets terminates on March 31, 2012. The RPS Guarantee is calculated based on the difference in revenue per search between the pre-transition and post-transition periods. The Company records the RPS Guarantee as search revenue in the quarter the amount becomes fixed, which would typically be the quarter in which the associated shortfall in revenue per search occurred.

Microsoft has agreed to reimburse the Company for certain transition costs up to an aggregate total of $150 million during the first three years of the Search Agreement. Through the second quarter of 2011, the Company has incurred transition costs of $146 million reimbursable by Microsoft under the Search Agreement. The Company’s results for the three and six months ended June 30, 2010 reflect transition cost reimbursements from Microsoft under the Search Agreement, which were equal to the transition costs of $18 million and $42 million, respectively, incurred by Yahoo! related to the Search Agreement in the three and six months ended June 30, 2010. During the six months ended June 30, 2010, the Company also recorded $43 million for transition costs incurred in 2009. The 2009 transition cost reimbursements were recorded in the first quarter of 2010 after regulatory clearance in the U.S. and Europe was received, implementation of the Search Agreement commenced, and Microsoft became obligated to make such payments. During the three and six months ended June 30, 2011, the Company recorded transition cost reimbursements from Microsoft under the Search Agreement, which were equal to the transition costs of $12 million and $23 million, respectively, incurred by Yahoo! in those periods.

From February 23, 2010 until the applicable services are fully transitioned to Microsoft in all markets, Microsoft will also reimburse the Company for the costs of operating algorithmic and paid search services subject to specified exclusions and limitations. The Company’s results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $86 million and $121 million, respectively, for the three and six months ended June 30, 2010 and $55 million and $111 million, respectively, for the three and six months ended June 30, 2011. Search operating cost reimbursements began during the quarter ended March 31, 2010 and will, subject to specified exclusions and limitations, continue until the Company has fully transitioned to Microsoft’s platform.

In addition to the reimbursements for transition and search operating costs, during the first quarter of 2010, the Company recorded reimbursements of $15 million for employee retention costs incurred in the first quarter of 2010 and reimbursements of $5 million for employee retention costs incurred in 2009. These employee retention cost reimbursements are separate from and in addition to the $150 million of transition cost reimbursement payments and search operating cost reimbursements.

Reimbursement receivables are recorded as the reimbursable costs are incurred and are applied against the operating expense categories in which the costs were incurred. Of the total amounts incurred in the fourth quarter of 2010, the total reimbursements not yet received from Microsoft of $64 million were classified as part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets as of December 31, 2010. Of the total amounts incurred in the second quarter of 2011, the total reimbursements not yet received from Microsoft of $28 million were classified as part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets as of June 30, 2011.

 

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Note 16 SUBSEQUENT EVENTS

Stock Repurchase Transactions. From July 1, 2011 through August 8, 2011, the Company repurchased approximately 24.5 million shares of its common stock at an average price of $14.63 per share, for a total of $358 million.

Agreement on Alipay. On July 29, 2011, the Company entered into a Framework Agreement (the “Framework Agreement”), by and among Yahoo!, Alibaba Group, Softbank Corp., a Japanese corporation (“Softbank”), Alipay, APN Ltd., a company organized under the laws of the Cayman Islands (“IPCo”), Zhejiang Alibaba E-Commerce Co., Ltd., a limited liability company organized under the laws of the People’s Republic of China (“HoldCo”), Jack Ma Yun, Joseph C. Tsai and certain security holders of Alipay or HoldCo as joinder parties.

Alipay, formerly a subsidiary of Alibaba Group, is a subsidiary of HoldCo, which is majority owned by Mr. Ma. IPCo is a special purpose entity formed in connection with the Framework Agreement which at the time of consummation of the transactions under the Framework Agreement will be owned by Mr. Ma and Mr. Tsai.

Pursuant to the terms of the Framework Agreement and subject to the closing of the transactions contemplated thereby, the parties have agreed, among other things, that:

(1) Upon a Liquidity Event (as defined below), HoldCo will pay to Alibaba Group 37.5 percent of the equity value of Alipay (the “Liquidity Event Payment”), less $500 million (i.e., the principal amount of the IPCo Promissory Note as described below). The Liquidity Event Payment plus $500 million must in the aggregate not be less than $2 billion and may not exceed $6 billion, subject to certain increases and additional payments if no Liquidity Event has occurred by the sixth anniversary of the consummation of the transactions (the “closing”). “Liquidity Event” means the earlier to occur of (a) a qualified initial public offering of Alipay, (b) a transfer of 37.5 percent or more of the securities of Alipay; or (c) a sale of all or substantially all of the assets of Alipay. If a Liquidity Event has not occurred by the tenth anniversary of the consummation of the transactions under the Framework Agreement, Alibaba Group will have the right to cause HoldCo to effect a Liquidity Event, provided that the equity value or enterprise value of Alipay at such time exceeds $1 billion, and in such case, the $2 billion minimum amount described above will not apply to a Liquidity Event effected by means of a qualified initial public offering, a sale of all of the securities of Alipay, or a sale of all or substantially all of the assets of Alipay.

(2) Alibaba Group will receive payment processing services on preferential terms from Alipay and its subsidiaries in accordance with a long-term agreement. The fees to be paid by Alibaba Group and its subsidiaries to Alipay for the services provided under such agreement will take into account Alibaba Group and its subsidiaries’ status as large volume customers and will be approved on an annual basis by the directors of Alibaba Group designated by Yahoo! and Softbank.

(3) Alibaba Group will license to Alipay certain intellectual property and technology and perform certain software technology services for Alipay and in return Alipay will pay to Alibaba Group a royalty and software technology services fee, which will consist of an expense reimbursement and a 49.9 percent share of the consolidated pre-tax income of Alipay and its subsidiaries. This percentage will decrease upon certain dilutive equity issuances by Alipay and HoldCo; provided, however, such percentage will not be reduced below 30 percent. This agreement will terminate upon the earlier to occur of (a) such time as it may be required to be terminated by applicable regulatory authorities in connection with a qualified initial public offering by Alipay and (b) the date the Liquidity Event Payment, the IPCo Promissory Note and certain related payments have been paid in full.

(4) IPCo will issue to Alibaba Group a non-interest bearing promissory note in the principal amount of $500 million with a seven year maturity (the “IPCo Promissory Note”).

(5) The IPCo Promissory Note, the Liquidity Event Payment and certain other payments will be secured by a pledge of 50,000,000 ordinary shares of Alibaba Group which will be contributed to IPCo by Mr. Ma and Mr. Tsai, as well as certain other collateral which may be pledged in the future.

(6) Yahoo!, Softbank, Alibaba Group, HoldCo, Mr. Ma, Mr. Tsai will enter into an agreement pursuant to which (a) the Alibaba Group board of directors will ratify the actions taken by Alibaba Group in connection with the restructuring of the ownership of Alipay and the termination of certain control agreements which resulted in the deconsolidation of Alipay; and (b) the Company, Softbank and Alibaba Group will release claims against Alibaba Group, Alipay, HoldCo, Mr. Ma, Mr. Tsai and certain of their related parties (including Alibaba Group’s directors in their capacity as such) from any and all claims and liabilities, subject to certain limitations, arising out of or based upon such actions.

The closing of the transactions under the Framework Agreement is subject to certain closing conditions, including PRC regulatory approvals. The parties expect the closing to occur by the end of 2011. Following closing, the Company will account for any impact of the Framework Agreement on the Company’s financial statements.

 

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

Forward-Looking Statements

In addition to current and historical information, this Quarterly Report on Form 10-Q (“Report”) contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future operations, prospects, potential products, services, developments, and business strategies. These statements can, in some cases, be identified by the use of terms such as “may,” “will,” “should,” “could,” “would,” “intend,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” or “continue” or the negative of such terms or other comparable terminology. This Report includes, among others, forward-looking statements regarding our:

 

   

expectations about revenue, including display, search, and other revenue;

 

   

expectations about growth in users;

 

   

expectations about cost of revenue and operating expenses;

 

   

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

 

   

anticipated capital expenditures;

 

   

expectations about the implementation and the financial and operational impacts of our Search Agreement with Microsoft;

 

   

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

 

   

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

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

Overview

Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo!,” the “Company,” “we,” or “us”), is a premier digital media company that delivers personalized digital content and experiences, across devices and around the globe, to vast audiences. We provide engaging and innovative canvases for advertisers to connect with their target audiences using our unique blend of Science + Art + Scale. Through our proprietary technology and insights, we deliver unique content and experiences for our audience and create powerful opportunities for our advertisers to connect with their target audiences, in context and at scale. To users, we provide online properties and services (“Yahoo! Properties”). To advertisers, we provide a range of marketing services designed to reach and connect with users of our Yahoo! Properties, as well as with Internet users beyond Yahoo! Properties, through a distribution network of third-party entities (our “Affiliates”) that have integrated our advertising offerings into their Websites or other offerings (those Websites and offerings, “Affiliate sites”). We believe that our marketing services enable advertisers to deliver highly relevant marketing messages to their target audiences.

Our offerings to users on Yahoo! Properties currently fall into three categories: Communications and Communities; Search and Marketplaces; and Media. The majority of what we offer is available in more than 25 languages and in more than 50 countries, regions, and territories. We have properties tailored to users in specific international markets including Yahoo! Homepage and social networking Websites such as Meme and Wretch. We manage and measure our business geographically, principally in the Americas, EMEA (Europe, Middle East, and Africa), and Asia Pacific.

Second Quarter Highlights

 

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

Operating Highlights

   2010      2011        2010      2011     
     (In thousands)  

Revenue

   $ 1,601,379       $ 1,229,024       $ (372,355   $ 3,198,339       $ 2,443,381       $ (754,958

Income from operations

   $ 175,372       $ 190,895       $ 15,523      $ 363,393       $ 380,640       $ 17,247   

 

     Six Months Ended
June 30,
   Dollar
Change
 

Cash Flow Results

   2010     2011   
     (In thousands)  

Net cash provided by operating activities

   $ 490,564      $ 538,989         $ 48,425   

Net cash provided by (used in) investing activities

   $ 253,213      $ (11,790      $ (265,003

Net cash used in financing activities

   $ (775,242   $ (515,379      $ 259,863   

 

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Our revenue decreased 23 percent and 24 percent for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010. This can be attributed to a slight increase in our display revenue, offset by a decrease in our search revenue. The increase in income from operations of $16 million and $17 million for the three and six months ended June 30, 2011, respectively, reflects a decrease in revenue, offset by a decrease in operating expenses of $76 million and $132 million for the three and six months ended June 30, 2011, respectively, compared to the same periods in 2010.

Cash generated by operating activities is a measure of the cash productivity of our business model. Our operating activities in the six months ended June 30, 2011 generated adequate cash to meet our operating needs. Cash used by investing activities in the six months ended June 30, 2011 included net proceeds from sales, maturities, and purchases of marketable debt securities of $416 million offset by $77 million used for acquisitions, net of cash acquired, net capital expenditures of $339 million, and $11 million for the purchase of intangible assets. Cash used in financing activities included $609 million used in the direct repurchase of common stock and $34 million used for tax withholding payments related to the net share settlements of restricted stock units and tax withholding related reacquisition of shares of restricted stock, offset by $99 million in proceeds from employee option exercises and employee stock purchases.

Search Agreement with Microsoft Corporation

Under the Search Agreement, for each market, Microsoft generally guarantees Yahoo!’s revenue per search (“RPS Guarantee”) on Yahoo! Properties only, for 18 months after the transition of paid search services to Microsoft’s platform in that market. For example, because the transition of paid search was completed in the U.S. and Canada in the fourth quarter of 2010, the RPS Guarantee with respect to the U.S. and Canada markets terminates on March 31, 2012. The RPS Guarantee is calculated based on the difference in revenue per search between the pre-transition and post-transition periods. We record the RPS Guarantee as search revenue in the quarter the amount becomes fixed, which would typically be the quarter in which the associated shortfall in revenue per search occurred.

Under the Search Agreement, Microsoft has agreed to reimburse us for certain transition costs up to an aggregate total of $150 million during the first three years of the Search Agreement. Through the second quarter of 2011, we have incurred transition costs of $146 million reimbursable by Microsoft under the Search Agreement. We expect transition costs of approximately $10 million to be reflected in our cost structure in the third quarter of 2011. Our results for the three and six months ended June 30, 2011 reflect transition cost reimbursements from Microsoft under the Search Agreement, which were equal to the transition costs of $12 million and $23 million, respectively, incurred by Yahoo! in those periods. During the three and six months ended June 30, 2010, we recorded transition cost reimbursements from Microsoft under the Search Agreement, which were equal to the transition costs of $18 million and $42 million, respectively, incurred by Yahoo! in those periods. During the six months ended June 30, 2010, we also recorded $43 million for transition costs incurred in 2009. The 2009 transition cost reimbursements were recorded in the first quarter of 2010 after regulatory clearance in the U.S. and Europe was received, implementation of the Search Agreement commenced, and Microsoft became obligated to make such payments.

From February 23, 2010 until the applicable services are fully transitioned to Microsoft in all markets, Microsoft will also reimburse us for the costs of operating algorithmic and paid search services subject to specified exclusions and limitations. Our results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $55 million and $111 million, respectively, for the three and six months ended June 30, 2011 and $86 million and $121 million, respectively, for the same periods of 2010. The global transition of the algorithmic and paid search platforms to Microsoft’s platform and the migration of the paid search advertisers and publishers to Microsoft’s platform are being done on a market by market basis and are expected to continue through the first half of 2013. The algorithmic and paid search transition to the Microsoft platform was completed in the U.S. and Canada in the fourth quarter of 2010, and we plan to complete the transition of algorithmic search in other markets in 2011. The transition of paid search in other markets is expected to resume in the second half of 2011 and to continue through the first half of 2013. Search operating cost reimbursements are expected to decline as we fully transition all markets and the underlying expenses are no longer incurred under our cost structure following completion of the transition.

In addition to the reimbursements for transition and search operating costs, during the first quarter of 2010, we recorded reimbursements of $15 million for employee retention costs incurred in the first quarter of 2010 and reimbursements of $5 million for employee retention costs incurred in 2009. These employee retention cost reimbursements are separate from and in addition to the $150 million of transition cost reimbursement payments and search operating cost reimbursements.

We record receivables for the reimbursements as costs are incurred and apply them against the operating expense categories in which the costs were incurred. Of the total amounts incurred in the second quarter of 2011, the total reimbursements not yet received from Microsoft of $28 million were classified as part of prepaid expenses and other current assets on our condensed consolidated balance sheets as of June 30, 2011. The $28 million of unpaid reimbursements will be received during the third quarter of 2011.

During the first five years of the Search Agreement, in transitioned markets we are entitled to receive 88 percent of the revenue generated from Microsoft’s services on Yahoo! Properties and we are also entitled to receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue and certain Microsoft costs are deducted. In the transitioned markets, for search revenue generated from Microsoft’s services on Yahoo! Properties and Affiliate sites, we report as revenue the 88 percent revenue share, as we are not the primary obligor in the arrangement with the advertisers.

 

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As a result of the required change in revenue presentation and the revenue share with Microsoft, our revenue and traffic acquisition costs for the third quarter of 2011 are expected to be lower than these amounts would otherwise have been by approximately $210 million and $175 million, respectively.

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

Results of Operations

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

 

     Three Months Ended June 30,     Percent
Change
    Six Months Ended June 30,     Percent
Change
 
     2010      (*)     2011      (*)       2010      (*)     2011      (*)    

Display

   $ 514,119         32   $ 523,537         43     2   $ 1,005,160         31   $ 1,046,160         43     4

Search

     842,040         53     466,674         38     (45 )%      1,683,254         53     921,795         38     (45 )% 

Other

     245,220         15     238,813         19     (3 )%      509,925         16     475,426         19     (7 )% 
  

 

 

    

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

    

 

 

   

Total revenue

   $ 1,601,379         100   $ 1,229,024         100     (23 )%    $ 3,198,339         100   $ 2,443,381         100     (24 )% 
  

 

 

    

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

    

 

 

   

 

(*) 

Percent of total revenue.

We currently generate revenue principally from display advertising on Yahoo! Properties and from search advertising on Yahoo! Properties and Affiliate sites.

We earn revenue from guaranteed or “premium” display advertising by delivering advertisements according to advertisers’ specified criteria, such as number of impressions during a fixed period on a specific site. Also, we earn revenue from non-guaranteed or “non-premium” display advertising by delivering advertisements for advertisers purchasing inventory on a preemptible basis, which means that the advertisement may or may not appear, inventory is not reserved and position placement is not assured. Generally, we make our non-guaranteed display inventory available through our Right Media Exchange.

To assist us in evaluating display advertising and search advertising, beginning in the fourth quarter of 2010, we began reporting the number of Web pages viewed by users (“Page Views”) separately for display and search. “Search Page Views” is defined as the number of Web pages viewed by users on Yahoo! Properties and Affiliate sites resulting from search queries, and “revenue per Search Page View” is defined as search revenue divided by our Search Page Views. “Display Page Views” is defined as the total number of Page Views on Yahoo! Properties less the number of Search Page Views on Yahoo! Properties, and “revenue per Display Page View” is defined as display revenue divided by our Display Page Views. While we also receive display revenue for content match links (advertising in the form of contextually relevant links to advertisers’ Websites) on Yahoo! Properties and Affiliate sites and for display advertising on Affiliate sites, we do not include that revenue or those Page Views in our discussion or calculation of Display Page Views or revenue per Display Page View because the net revenue and related volume metrics associated with them are not currently material to display revenue.

We periodically review and refine our methodology for monitoring, gathering, and counting Page Views to more accurately reflect the total number of Web pages viewed by users on Yahoo! Properties. Based on this process, from time to time, we update our methodology to exclude from the count of Page Views interactions with our servers that we determine or believe are not the result of user visits to Yahoo! Properties.

Display Revenue. Display revenue for the three and six months ended June 30, 2011 increased by 2 percent and 4 percent, respectively, compared to the same periods in 2010. Our year-over-year growth can be attributed to increased volume of ad impressions in our EMEA and Asia Pacific segments as well as favorable effects of foreign currency exchange rate fluctuations, offset by a decline in our Americas display revenue. For the three and six months ended June 30, 2011, Americas display revenue declined as compared to the same periods of 2010 primarily due to changes being made to our U.S. sales force during the second quarter of 2011. Without the sales force operating at full capacity, ad inventory typically sold by a sales agent at a guaranteed or premium basis was instead sold at non-premium prices through our Right Media Exchange. For both the three and six months ended June 30, 2011, Display Page Views decreased 2 percent, and revenue per Display Page View increased 6 percent and 8 percent, respectively, compared to the same periods in 2010 due to the net increase in display revenue as discussed above.

We expect display revenue to increase for the third quarter of 2011 compared to the same period of 2010, although we expect the impact from the changes in our sales organization will continue to temper the growth of our display revenue.

Search Revenue. Search revenue for both the three and six months ended June 30, 2011 decreased by 45 percent, compared to the same periods in 2010. Search revenue decreased primarily due to the required change in revenue presentation which began in the fourth quarter of 2010, the associated revenue share with Microsoft for transitioned markets, and the loss of an affiliate in the Asia Pacific region. For the three and six months ended June 30, 2011, Search Page Views increased 2 percent and 1 percent, respectively. For both the three and six months ended June 30, 2011, revenue per Search Page View decreased 46 percent, compared to the same periods in 2010. The decline in revenue per Search Page View for the three and six months ended June 30, 2011 compared to the same periods in 2010 was attributable to the declines in search revenue over the two periods as discussed above.

 

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We expect search revenue for the third quarter of 2011 to decrease compared to the same period of 2010. We expect this decrease will be attributable to several factors associated with the transition of algorithmic and paid search results to Microsoft’s platform in the transitioned markets, including the required change in revenue presentation for transitioned markets from a gross to a net basis and the revenue share with Microsoft in transitioned markets as well as the loss of an Affiliate in the Asia Pacific segment in the fourth quarter of 2010.

Other Revenue. Other revenue includes listings-based services revenue, transaction revenue and fees revenue. Other revenue for the three and six months ended June 30, 2011 decreased by 3 percent and 7 percent, respectively, compared to the same periods in 2010. The decreases are attributable to changes in certain of our broadband access partnerships and to the divestiture of certain business lines throughout 2010. In addition, revenue from other premium services declined year-over-year as we continue to outsource various offerings.

We expect other revenue to decline for the third quarter of 2011, compared to the same period of 2010. The divestitures and outsourcing of non-core businesses and offerings, as well as declining broadband deferred revenue amortization, are among the factors expected to contribute to the decrease in other revenue.

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

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

 

     Three Months Ended June 30,     Dollar
Change
    Percent
Change
 
     2010      (*)     2011      (*)      

Cost of revenue

   $ 682,722         43   $ 371,155         30   $ (311,567     (46 )% 

Sales and marketing

   $ 331,468         21   $ 280,312         23   $ (51,156     (15 )% 

Product development

   $ 268,552         17   $ 246,513         20   $ (22,039     (8 )% 

General and administrative

   $ 125,333         8   $ 131,330         11   $ 5,997        5

Amortization of intangibles

   $ 7,880         0   $ 8,582         1   $ 702        9

Restructuring charges, net

   $ 10,052         1   $ 237         0   $ (9,815     (98 )% 

 

     Six Months Ended June 30,     Dollar
Change
    Percent
Change
 
     2010      (*)     2011      (*)      

Cost of revenue

   $ 1,389,104         43   $ 748,617         31   $ (640,487     (46 )% 

Sales and marketing

   $ 645,006         20   $ 542,546         22   $ (102,460     (16 )% 

Product development

   $ 534,629         17   $ 489,580         20   $ (45,049     (8 )% 

General and administrative

   $ 235,761         7   $ 254,554         10   $ 18,793        8

Amortization of intangibles

   $ 15,982         0   $ 16,632         1   $ 650        4

Restructuring charges, net

   $ 14,464         0   $ 10,812         0   $ (3,652     (25 )% 

 

(*) 

Percent of total revenue.

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

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010      2011     2010      2011  

Cost of revenue

   $ 580       $ 875      $ 1,591       $ 1,523   

Sales and marketing

     21,540         19,373        35,218         26,070   

Product development

     26,132         25,531        58,505         43,203   

General and administrative

     9,345         13,269        23,066         23,368   

Restructuring expense reversals, net

     —           (526     —           (1,278
  

 

 

    

 

 

   

 

 

    

 

 

 

Total stock-based compensation expense

   $ 57,597       $ 58,522      $ 118,380       $ 92,886   
  

 

 

    

 

 

   

 

 

    

 

 

 

For additional information about stock-based compensation, see Note 10 — “Stockholders’ Equity and Employee Benefits” in the Notes to the condensed consolidated financial statements included elsewhere in this Report as well as “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2010 under the caption Management's Discussion and Analysis of Financial Condition and Results of Operations.

 

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Traffic Acquisition Costs. TAC consists of payments made to third-party entities that have integrated our advertising offerings into their Websites or other offerings and payments made to companies that direct consumer and business traffic to Yahoo! Properties. We enter into agreements of varying duration that involve TAC. There are generally three economic structures of the Affiliate agreements: fixed payments based on a guaranteed minimum amount of traffic delivered, which often carry reciprocal performance guarantees from the Affiliate; variable payments based on a percentage of our revenue or based on a certain metric, such as number of searches or paid clicks; or a combination of the two. We expense TAC under two different methods. Agreements with fixed payments are expensed ratably over the term the fixed payment covers, and agreements based on a percentage of revenue, number of paid introductions, number of searches, or other metrics are expensed based on the volume of the underlying activity or revenue multiplied by the agreed-upon price or rate.

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

The changes in operating costs and expenses for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 are comprised of the following (in thousands):

 

     Compensation     Information
Technology
    Depreciation  and
Amortization
    TAC     Facilities     Other     Total  

Cost of revenue

   $ (1,077   $ 4,583      $ (995   $ (320,353   $ (149   $ 6,424      $ (311,567

Sales and marketing

     (20,373     (217     (138     —          (2,417     (28,011     (51,156

Product development

     (24,531     (839     4,861        —          147        (1,677     (22,039

General and administrative

     4,779        112        (1,027     —          6,695        (4,562     5,997   

Amortization of intangibles

     —          —          702        —          —          —          702   

Restructuring charges, net

     —          —          —          —          —          (9,815     (9,815
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (41,202   $ 3,639      $ 3,403      $ (320,353   $ 4,276      $ (37,641   $ (387,878
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The changes in operating costs and expenses for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 are comprised of the following (in thousands):

 

     Compensation     Information
Technology
    Depreciation  and
Amortization
    TAC     Facilities     Other     Total  

Cost of revenue

   $ (7,926   $ 5,971      $ (6,179   $ (636,852   $ (319   $ 4,818      $ (640,487

Sales and marketing

     (45,708     (467     (1,084     —          (2,358     (52,843     (102,460

Product development

     (48,016     (1,997     7,419        —          (12     (2,443     (45,049

General and administrative

     4,056        (99     (2,212     —          6,652        10,396        18,793   

Amortization of intangibles

     —          —          650        —          —          —          650   

Restructuring charges, net

     —          —          —          —          —          (3,652     (3,652
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (97,594   $ 3,408      $ (1,406   $ (636,852   $ 3,963      $ (43,724   $ (772,205
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Compensation Expense. Total compensation expense decreased $41 million and $98 million for the three and six months ended June 30, 2011, respectively, as compared to the same periods in 2010. Excluding the impact of Microsoft reimbursements, compensation expense for the three and six months ended June 30, 2011 decreased $57 million and $135 million, respectively, compared to the same periods of 2010, primarily due to decreased stock-based compensation expense, lower salaries and wages from decreased headcount across all functions, and the capitalization of otherwise expensed compensation costs associated with increased efforts in the development of our technology platform and specific products. The decrease in stock-based compensation expense is primarily due to higher employee forfeitures of stock-based awards and reduced headcount in the six months ended June 30, 2011, compared to the same period of 2010. Capitalized internal use software and Website development costs have increased as we continue to invest in improving our technology platforms. The decline in compensation expense was offset by decreased Microsoft reimbursements of $16 million and $37 million, respectively, during the three and six months ended June 30, 2011, compared to the same periods of 2010. The decrease in Microsoft reimbursements for the three months ended June 30, 2011 was due to the transition of paid search to Microsoft platforms. Microsoft reimbursements decreased $36 million in the six months ended June 30, 2011 compared to the same period in 2010 due to the impact of 2009 transition cost reimbursements being recorded in the first quarter of 2010.

 

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Information Technology. Information technology expense increased $4 million and $3 million for the three and six months ended June 30, 2011, respectively, as compared to the same periods in 2010. Excluding the impact of Microsoft reimbursements, information technology expense for the three and six months ended June 30, 2011 increased $4 million and $12 million, respectively, compared to the same periods of 2010, due to increased data center operating costs. The increase for the six months ended June 30, 2011 was offset by increased reimbursements from Microsoft of $9 million during the six months ended June 30, 2011, compared to the same period of 2010. Reimbursements from Microsoft remained flat for the three months ended June 30, 2011 compared to the same period of 2010. The increase in Microsoft reimbursements for the six months ended June 30, 2011 was due to the inclusion of six months of expenses in 2011 compared to the inclusion of four months of expenses in the same period of 2010.

Depreciation and Amortization. Depreciation and amortization expense increased $3 million for the three months ended June 30, 2011 and decreased $1 million for the six months ended June 30, 2011, as compared to the same periods in 2010. Excluding the impact of Microsoft reimbursements, depreciation and amortization expense was flat for both the three and six months ended June 30, 2011, compared to the same periods of 2010. The increase for the three months ended June 30, 2011 was due to a decrease in reimbursements from Microsoft of $3 million compared to the same period of 2010. The decrease for the six months ended June 30, 2011 was due to an increase in reimbursements from Microsoft of $2 million, compared to the same periods of 2010. The increase in Microsoft reimbursements for the six months ended June 30, 2011 was due to the inclusion of six months of expenses in 2011 compared to the inclusion of four months of expenses in the same period of 2010.

TAC. TAC decreased $320 million and $637 million for the three and six months ended June 30, 2011, respectively, as compared to the same periods in 2010. The decrease for the three and six months ended June 30, 2011, compared to the same periods of 2010 was primarily due to the change in the recording of TAC in the fourth quarter of 2010 due to the Search Agreement with Microsoft as we no longer incur TAC for transitioned markets. We now receive an 88 percent revenue share in the transitioned markets as Microsoft is the primary obligor to the advertisers. In addition, the decrease in TAC year-over-year was due to the loss of an affiliate in the Asia Pacific region during late 2010.

Facilities and Other Expenses. Facilities and other expenses decreased $33 million and $40 million for the three and six months ended June 30, 2011, compared to the same periods in 2010. Excluding the impact of Microsoft reimbursements, facilities and other expenses decreased $47 million and $68 million, primarily due to decreases in marketing-related expenses of $25 million and $46 million for the three and six months ended June 30, 2011. Marketing-related expenses decreased during the three and six months ended June 30, 2011 compared to the same periods of 2010 due to the launch of various 2010 marketing campaigns, including our global branding campaign, for which there were no similar campaigns in the three and six months ended June 30, 2011. The decline in facilities and other expenses was offset by decreased Microsoft reimbursements of $13 million and $28 million during the three and six months ended June 30, 2011, compared to the same periods of 2010. The decrease in Microsoft reimbursements for the three months ended June 30, 2011 was due to the transition of paid search to Microsoft platforms. Microsoft reimbursements decreased $7 million in the six months ended June 30, 2011 compared to the same period in 2010 due to the impact of 2009 transition cost reimbursements being recorded in the first quarter of 2010.

We currently expect our operating costs to decrease for the third quarter of 2011, compared to the same period of 2010, primarily due to lower workforce expenses driven by restructuring activities and higher marketing expenses in 2010 than 2011 as we continue our efforts to drive efficiencies and align our spending with our strategic priorities.

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2010
     June 30,
2011
    June 30,
2010
     June 30,
2011
 

Employee severance pay and related costs

   $ 692       $ (424   $ 950       $ 8,911   

Non-cancelable lease, contract termination, and other charges

     9,360         1,187        13,514         3,179   
  

 

 

    

 

 

   

 

 

    

 

 

 

Sub-total before reversal of stock-based compensation expense

     10,052         763        14,464         12,090   

Reversals of stock-based compensation expense for forfeitures

     —           (526     —           (1,278
  

 

 

    

 

 

   

 

 

    

 

 

 

Restructuring charges, net

   $ 10,052       $ 237      $ 14,464       $ 10,812   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Q4’08 Restructuring Plan. During the fourth quarter of 2008, we implemented certain cost reduction initiatives, including a workforce reduction and consolidation of certain real estate facilities. During the three and six months ended June 30, 2010, we incurred total pre-tax cash charges of approximately $10 million and $14 million, respectively, in facility and other related costs related to the Q4’08 restructuring plan. Net charges under the Q4’08 restructuring plan relating to the Americas segment were $9 million and $14 million for the three and six months ended June 30, 2010, respectively. Net charges under the Q4’08 restructuring plan relating to the EMEA segment were $1 million and $0 (which is net of a $1 million credit in the first quarter of 2010) for the three and six months ended June 30, 2010, respectively. During the three and six months ended June 30, 2011, we incurred total pre-tax cash charges of approximately $1 million and $3 million, respectively, in facility and other related costs related to the Q4’08 restructuring plan, the majority of which related to the Americas segment. As of June 30, 2011, the aggregate outstanding restructuring liability related to the Q4’08 restructuring plan was $40 million, most of which relates to non-cancelable lease costs that we expect to pay over the lease terms of the related obligations, which end by the second quarter of 2017.

Q4’09 Restructuring Charges. During the fourth quarter of 2009, we decided to close one of our EMEA facilities and began implementation of a workforce realignment at the facility to focus resources on our strategic initiatives. We exited the facility in the third quarter of 2010. In connection with the strategic realignment efforts, a U.S. executive of one of our acquired businesses departed. During the three and six months ended June 30, 2010, we incurred total pre-tax charges of less than $1 million in severance and other related costs related to the Q4’09 restructuring charges, consisting of charges primarily related to the EMEA segment. During the three months ended June 30, 2011, we did not incur any charges related to the Q4’09 restructuring charges. During the six months ended June 30, 2011, we recorded a reversal of $1 million for adjustments to original estimates in severance and other related costs related to the Q4’09 restructuring charges, entirely related to the EMEA segment. As of June 30, 2011, there was no remaining restructuring liability related to the Q4’09 restructuring charges.

Q4’10 Restructuring Plan. During the fourth quarter of 2010, we began implementation of a worldwide workforce reduction to align resources with our product strategy. During the three months ended June 30, 2011, we recorded a net reversal of $1 million for adjustments to original estimates in severance and other related costs related to the Q4’10 restructuring plan, the majority of which related to the Americas segment. During the six months ended June 30, 2011, we incurred total pre-tax cash charges of $2 million in severance and other related costs related to the Q4’10 restructuring plan, consisting of $1 million in charges related to the Americas segment and $1 million related to the EMEA segment. The pre-tax cash charges were offset by a $1 million reversal for adjustments to original estimates related to the Americas segment, resulting in a $1 million net charge in the six months ended June 30, 2011. As of June 30, 2011, the aggregate outstanding restructuring liability related to the Q4’10 restructuring plan was $9 million, which we expect to substantially pay by the first quarter of 2012.

Q1’11 Restructuring Plan. During the first quarter of 2011, we began implementation of a workforce realignment to further reduce our cost structure. During the three months ended June 30, 2011, we did not record any charges related to the Q1’11 restructuring plan. During the six months ended June 30, 2011, we incurred total pre-tax cash charges of $9 million in severance and other costs related to the Q1’11 restructuring plan. The pre-tax cash charges were offset by a $1 million credit related to non-cash stock-based compensation expense reversals for unvested stock awards that were forfeited. Of the $8 million in restructuring charges, net recorded in the six months ended June 30, 2011, $7 million related to the Americas segment and $1 million related to the EMEA segment. As of June 30, 2011, the aggregate outstanding restructuring liability related to the Q1’11 restructuring plan was $3 million, which we expect to substantially pay by the first quarter of 2012.

In addition to the charges described above, we currently expect to incur future charges of approximately $13 million to $18 million primarily related to non-cancelable operating costs and accretion related to exited facilities identified as part of the Q4’08 restructuring plan. Of the total future charges, $12 million to $17 million relates to the Americas segment, $1 million relates to the EMEA segment, and no charges relate to the Asia Pacific segment. The future charges are expected to be recorded through 2017. See Note 14 — “Restructuring charges, net” in the Notes to the condensed consolidated financial statements for additional information.

 

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

 

     Three Months Ended
June 30,
    Dollar
Change
    Six Months Ended
June 30,
    Dollar
Change
 
     2010      2011       2010      2011    

Interest and investment income

   $ 5,837       $ 5,084      $ (753   $ 12,180       $ 10,444      $ (1,736

Gain on sale of Zimbra, Inc.

     —           —          —          66,130         —          (66,130

Other

     6,751         (10,750     (17,501     20,606         (11,083     (31,689
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total other income (expense), net

   $ 12,588       $ (5,666   $ (18,254   $ 98,916       $ (639   $ (99,555
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

In February 2010, we sold Zimbra, Inc. for net proceeds of $100 million and recorded a pre-tax gain of $66 million.

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

Other income (expense), net may fluctuate in future periods due to realized gains and losses on investments, other than temporary impairments of investments, changes in our average investment balances, and changes in interest and foreign currency exchange rates.

Income Taxes. Our effective tax rate is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. Historically, our provision for income taxes has differed from the tax computed at the U.S. federal statutory income tax rate due to state taxes, the effect of non-U.S. operations, non-deductible stock-based compensation expense, and adjustments to unrecognized tax benefits.

The effective tax rate reported for the three months ended June 30, 2011 was 30 percent compared to 36 percent for the same period in 2010. The rate for the second quarter of 2011 was lower than in 2010 primarily due to a shift of the geographic mix of earnings for 2011 and a lower effective state tax rate resulting from a change in the apportionment rules in California effective in 2011.

The effective tax rate reported for the six months ended June 30, 2011 was 28 percent compared to 26 percent for the same period in 2010. The rates in both periods were lower than the U.S. federal statutory rate primarily due to reductions of tax reserves that were recorded as tax audits were favorably settled and the shift of the geographic mix of earnings. During the six months ended June 30, 2010, we also recorded the benefit of a capital loss carryover that was used to offset a capital gain. While the discrete adjustments had a greater effect in the six months ended June 30, 2010 than in the six months ended June 30, 2011, the annual effective tax rate for 2011 is projected to be lower than in 2010 as a result of the geographic mix in earnings and the lower effective blended state tax rate.

We are in various stages of examination and appeal in connection with all of our tax audits worldwide, which generally span tax years 2005 through 2009. It is difficult to determine when these examinations will be settled or what their final outcomes will be. We believe that we have adequately provided for any reasonably foreseeable adjustment and that any settlement will not have a material adverse effect on our consolidated financial position or results of operations.

Our gross amount of unrecognized tax benefits as of June 30, 2011 is $526 million, of which, $405 million is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of June 30, 2011 decreased by $71 million from the recorded balance as of December 31, 2010 due to favorable settlements of tax audits in the first quarter of 2011. Since there can be no assurance as to the outcome of tax audits currently in progress, it is reasonably possible that over the next twelve-month period we may experience an increase or decrease in its unrecognized tax benefits. It is not possible to determine either the magnitude or the range of any increase or decrease at this time.

Earnings in Equity Interests. Earnings in equity interests for the three and six months ended June 30, 2011 was $109 million and $191 million, respectively, compared to $97 million and $184 million for the same periods in 2010. The increases for the three and six months ended June 30, 2011 were due primarily to Yahoo Japan’s continued improvement in financial performance, offset by non-cash losses related to impairments of assets held by Yahoo Japan. See Note 4 — “Investments in Equity Interests” in the Notes to the condensed consolidated financial statements for additional information.

Noncontrolling Interests. Noncontrolling interests represent the noncontrolling holders’ percentage share of income or losses from the subsidiaries in which we hold a majority, but less than 100 percent, ownership interest and the results of which are consolidated in our condensed consolidated financial statements.

 

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Business Segment Results

We manage our business geographically. The primary areas of measurement and decision-making are Americas, EMEA (Europe, Middle East, and Africa), and Asia Pacific. Management relies on an internal reporting process that provides revenue ex-TAC, which is defined as revenue less TAC, and direct costs excluding TAC by segment, and consolidated income from operations for making decisions related to the evaluation of the financial performance of, and allocating resources to, our segments. Prior period presentations have been updated to conform to the current profitability measures being used by our management team to evaluate the financial performance of our segments.

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

 

     Three Months Ended      Percent
Change
    Six Months Ended      Percent
Change
 
     June 30,
2010
     June 30,
2011
       June 30,
2010
     June 30,
2011
    

Revenue by segment:

                

Americas

   $ 1,133,216       $ 808,038         (29 %)    $ 2,288,228       $ 1,626,969         (29 %) 

EMEA

     140,513         162,601         16     282,338         316,651         12

Asia Pacific

     327,650         258,385         (21 %)      627,773         499,761         (20 %) 
  

 

 

    

 

 

      

 

 

    

 

 

    

Total revenue

   $ 1,601,379       $ 1,229,024         (23 %)    $ 3,198,339       $ 2,443,381         (24 %) 
  

 

 

    

 

 

      

 

 

    

 

 

    

TAC by segment:

                

Americas

   $ 282,072       $ 39,404         (86 %)    $ 563,818       $ 77,545         (86 %) 

EMEA

     50,054         57,648         15     103,474         115,160         11

Asia Pacific

     141,124         55,844         (60 %)      272,488         110,222         (60 %) 
  

 

 

    

 

 

      

 

 

    

 

 

    

Total TAC

   $ 473,250       $ 152,896         (68 %)    $ 939,780       $ 302,927         (68 %) 
  

 

 

    

 

 

      

 

 

    

 

 

    

Revenue ex-TAC by segment:

                

Americas

   $ 851,144       $ 768,634         (10 %)    $ 1,724,410       $ 1,549,424         (10 %) 

EMEA

     90,459         104,953         16     178,864         201,491         13

Asia Pacific

     186,526         202,541         9     355,285         389,539         10
  

 

 

    

 

 

      

 

 

    

 

 

    

Total revenue ex-TAC

   $ 1,128,129       $ 1,076,128         (5 %)    $ 2,258,559       $ 2,140,454         (5 %) 
  

 

 

    

 

 

      

 

 

    

 

 

    

Direct costs by segment(1):

                

Americas

     145,333         132,866         (9 %)      290,237         268,940         (7 %) 

EMEA

     30,375         34,090         12     61,148         64,677         6

Asia Pacific

     35,641         48,506         36     70,108         93,091         33

Global operating costs(2) (3)

     515,789         449,113         (13 %)      1,017,613         906,885         (11 %) 

Restructuring charges, net

     10,052         237         (98 %)      14,464         10,812         (25 %) 

Depreciation and amortization

     157,970         161,373         2     323,216         321,811         0

Stock-based compensation expense

     57,597         59,048         3     118,380         93,598         (21 %) 
  

 

 

    

 

 

      

 

 

    

 

 

    

Income from operations

   $ 175,372       $ 190,895         9   $ 363,393       $ 380,640         5
  

 

 

    

 

 

      

 

 

    

 

 

    

 

(1) 

Direct costs for each segment include cost of revenue (excluding TAC) and other operating expenses that are directly attributable to the segment such as employee compensation expense (excluding stock-based compensation expense), local sales and marketing expenses, and facilities expenses. Beginning in the fourth quarter of 2010, we no longer include TAC in segment direct costs. For comparison purposes, prior period amounts have been revised to conform to the current presentation.

(2) 

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

(3) 

The net cost reimbursements from Microsoft are primarily included in global operating costs.

 

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Americas. Americas revenue ex-TAC for the three and six months ended June 30, 2011 decreased $83 million, or 10 percent, and $175 million, or 10 percent, respectively, as compared to the same periods in 2010. For the three months ended June 30, 2011, our year-over-year decrease in Americas revenue ex-TAC was primarily due to declines across various revenue streams, primarily in our search advertising business and display advertising business. For the three months ended June 30, 2011, search revenue ex-TAC decreased year-over-year due to the revenue share with Microsoft associated with the Search Agreement. For the three months ended June 30, 2011, our year-over-year display revenue ex-TAC declined slightly due to a decrease in display revenue primarily related to changes being made to our sales force as noted in Results of Operations above, offset by a decrease in display TAC. The year-over-year decline in display TAC was primarily due to changes in our partner mix. For the six months ended June 30, 2011, our year-over-year decrease was a result of a decline in our search advertising business and other revenue, partially offset by an increase in our display advertising business. For the six months ended June 30, 2011, search revenue ex-TAC decreased year-over-year due to the revenue share with Microsoft associated with the Search Agreement. For the six months ended June 30, 2011, the increase in year-over-year display revenue ex-TAC was due to a decline in display TAC, partially offset by a decline in display revenue primarily related to changes being made to our sales force as noted in Results of Operations above. The year-over-year decline in display TAC was primarily due to changes in our partner mix. For the three and six months ended June 30, 2011 direct costs attributable to the Americas segment decreased $12 million, or 9 percent, and $21 million, or 7 percent, respectively, compared to the same periods in 2010. The year-over-year decreases in direct costs were primarily due to lower compensation costs driven by lower headcount and lower data center operating costs, offset by higher content costs.

Revenue ex-TAC in the Americas accounted for approximately 71 percent and 72 percent of total revenue ex-TAC in the three and six months ended June 30, 2011, respectively, compared to 75 percent and 76 percent for the three and six months ended June 30, 2010, respectively.

EMEA. EMEA revenue ex-TAC for the three and six months ended June 30, 2011 increased $14 million, or 16 percent, and $23 million, or 13 percent, respectively, as compared to the same periods in 2010. The increases in EMEA revenue ex-TAC were primarily driven by increases in our display advertising business and the favorable effects of foreign currency exchange rate fluctuations. For the three and six months ended June 30, 2011, direct costs attributable to the EMEA segment increased $4 million, or 12 percent, and $4 million, or 6 percent, respectively, compared to the same periods in 2010. The increases are primarily due to higher compensation costs driven by higher average headcount, the effects of foreign currency exchange rate fluctuations, and content costs.

Revenue ex-TAC in EMEA accounted for approximately 10 percent of total revenue ex-TAC for both the three and six months ended June 30, 2011, respectively, compared to 8 percent for both the three and six months ended June 30, 2010.

Asia Pacific. Asia Pacific revenue ex-TAC for the three and six months ended June 30, 2011 increased $16 million, or 9 percent, and $34 million, or 10 percent, respectively, as compared to the same periods in 2010. The increases in Asia Pacific revenue ex-TAC were primarily driven by an increase in our display advertising business and the favorable effects of foreign currency exchange rate fluctuations, offset by the loss of an Affiliate in the Asia Pacific region in late 2010. For the three and six months ended June 30, 2011, direct costs attributable to the Asia Pacific segment increased $13 million, or 36 percent, and $23 million, or 33 percent, respectively, compared to the same periods in 2010. The increases are primarily due to higher compensation costs driven by higher average headcount, the effects of foreign currency exchange rate fluctuations, and increased data center operating costs.

Revenue ex-TAC in Asia Pacific accounted for approximately 19 percent and 18 percent of total revenue ex-TAC for the three and six months ended June 30, 2011, respectively, compared to 17 percent and 16 percent for the three and six months ended June 30, 2010, respectively.

Our international operations expose us to foreign currency exchange rate fluctuations. Revenue ex-TAC and related expenses generated from our international subsidiaries are generally denominated in the currencies of the local countries. Primary currencies include Australian dollars, British pounds, Euros, Japanese yen, Korean won, and Taiwan dollars. The statements of income of our international operations are translated into U.S. dollars at exchange rates indicative of market rates during each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency-denominated transactions results in reduced consolidated revenue ex-TAC and operating expenses. Conversely, our consolidated revenue ex-TAC and operating expenses will increase if the U.S. dollar weakens against foreign currencies. Using the foreign currency exchange rates from the three and six months ended June 30, 2010, revenue ex-TAC for the Americas segment for the three and six months ended June 30, 2011 would have been lower than we reported by $2 million and $4 million, respectively, revenue ex-TAC for the EMEA segment would have been lower than we reported by $8 million and $7 million, respectively, and revenue ex-TAC for the Asia Pacific segment would have been lower than we reported by $17 million and $30 million, respectively. Using the foreign currency exchange rates from the three and six months ended June 30, 2010, direct costs for the Americas segment for both the three and six months ended June 30, 2011 would have been lower than we reported by $1 million, direct costs for the EMEA segment would have been lower than we reported by $3 million and $2 million, respectively, and direct costs for the Asia Pacific segment would have been lower than we reported by $4 million and $8 million, respectively.

 

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Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Our estimates form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

An accounting policy is considered to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimate that are reasonably likely to occur, could materially impact the condensed consolidated financial statements. We believe that our critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the condensed consolidated financial statements.

For a discussion of our critical accounting policies and estimates, see “Critical Accounting Policies and Estimates” included in our Annual Report on Form 10-K for the year ended December 31, 2010 under the caption Management's Discussion and Analysis of Financial Condition and Results of Operations. We have made no significant changes to our critical accounting policies and estimates from those described in our Annual Report on Form 10-K for the year ended December 31, 2010.

Liquidity and Capital Resources

 

     As of
December 31,
2010
    As of
June 30,
2011
 
     (Dollars in thousands)  

Cash and cash equivalents

   $ 1,526,427      $ 1,580,837   

Short-term marketable debt securities

     1,357,661        972,635   

Long-term marketable debt securities

     744,594        701,556   
  

 

 

   

 

 

 

Total cash, cash equivalents, and marketable debt securities

   $ 3,628,682      $ 3,255,028   
  

 

 

   

 

 

 

Percentage of total assets

     24     22
  

 

 

   

 

 

 

 

     Six Months Ended
June 30,
 

Cash Flow Highlights

   2010     2011  
     (In thousands)  

Net cash provided by operating activities

   $ 490,564      $ 538,989   

Net cash provided by (used in) investing activities

   $ 253,213      $ (11,790

Net cash used in financing activities

   $ (775,242   $ (515,379

Our operating activities for the six months ended June 30, 2011 generated adequate cash to meet our operating needs. As of June 30, 2011, we had cash, cash equivalents, and marketable debt securities totaling $3.3 billion, compared to $3.6 billion at December 31, 2010. During the six months ended June 30, 2011, we repurchased 38.6 million shares of our outstanding common stock for $609 million.

During the six months ended June 30, 2011, we generated $539 million of cash from operating activities, net proceeds from sales, maturities and purchases of marketable debt securities of $416 million, and $99 million from the issuance of common stock as a result of the exercise of employee stock options and employee stock purchases. This was offset by a net $339 million in capital expenditures, $34 million in tax withholding payments related to net share settlements of restricted stock units and tax withholding-related reacquisitions of shares of restricted stock, $609 million used in the direct repurchase of common stock and a net $77 million for acquisitions. During the six months ended June 30, 2010, we generated $491 million of cash from operating activities, net proceeds from sales, maturities, and purchases of marketable debt securities of $600 million, $100 million of proceeds from the sale of a divested business, and $84 million from the issuance of common stock as a result of the exercise of employee stock options and employee stock purchases. This was offset by a net $303 million in capital expenditures, a net $112 million for acquisitions, $881 million used in the direct repurchase of common stock, and $41 million in tax withholding payments related to net share settlements of restricted stock units and tax withholding-related reacquisitions of shares of restricted stock.

 

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We have accrued U.S. federal income taxes on the earnings of our foreign subsidiaries except to the extent the earnings are considered indefinitely reinvested outside the U.S. As of June 30, 2011, approximately $2.9 billion of earnings held by our foreign subsidiaries and a corporate joint venture are designated as indefinitely reinvested outside the U.S. Our foreign subsidiaries held $1.1 billion of our total $3.3 billion of cash, cash equivalents, and marketable debt securities as of June 30, 2011. If required for our operations in the U.S., most of the cash held abroad could be repatriated to the U.S. but, under current law, would be subject to U.S. federal income taxes (subject to an adjustment for foreign tax credits). Currently, we do not anticipate a need to repatriate these funds for use in our U.S. operations.

We expect to continue to generate positive cash flows from operations for the third quarter of 2011. We use cash generated by operations as our primary source of liquidity, since we believe that internally generated cash flows are sufficient to support our business operations and capital expenditures. We believe that existing cash, cash equivalents, and investments in marketable debt securities, together with any cash generated from operations, will be sufficient to meet normal operating requirements including capital expenditures for the next twelve months. However, we may sell additional debt securities or obtain credit facilities to further enhance our liquidity position.

See Note 9 — “Investments” in the Notes to the condensed consolidated financial statements for additional information.

Cash flow changes

Cash provided by operating activities is driven by our net income, adjusted for non-cash items, working capital changes, and non-operating gains from sales of investments. Non-cash adjustments include depreciation, amortization of intangible assets, stock-based compensation expense, non-cash restructuring charges, tax benefits from stock-based awards, excess tax benefits from stock-based awards, deferred income taxes, and earnings in equity interests. Cash provided by operating activities was higher than net income in the six months ended June 30, 2011 due to changes in working capital.

During the six months ended June 30, 2011, cash used in investing activities was primarily attributable to cash used for net capital expenditures and net acquisitions, offset by net proceeds from the sales and maturities of marketable debt securities. In the six months ended June 30, 2011, we received net proceeds from sales, maturities, and purchases of marketable debt securities of $416 million, which was offset by the investment of $339 million in net capital expenditures, $77 million for net acquisitions, and $11 million to purchase intangible assets. During the six months ended June 30, 2010, cash provided by investing activities was primarily attributable to net proceeds from the sales and maturities of marketable debt securities and proceeds from the sale of a divested business. In the six months ended June 30, 2010, we received net proceeds from sales, maturities, and purchases of marketable debt securities of $600 million and $100 million from the sale of a business, which was offset by the investment of $303 million in net capital expenditures, $112 million for net acquisitions, $19 million for other investing activities, and $13 million to purchase intangible assets.

Cash used in financing activities is driven by stock repurchases offset by employee stock option exercises and employee stock purchases. Our cash proceeds from employee stock option exercises and employee stock purchases were $99 million for the six months ended June 30, 2011, compared to $84 million for the same period of 2010. During the six months ended June 30, 2011, we used $609 million in the direct repurchase of 38.6 million shares of common stock at an average price of $15.79 per share. We used $34 million for tax withholding payments related to net share settlements of restricted stock units and tax withholding related reacquisitions of shares of restricted stock. During the six months ended June 30, 2010, we used $881 million in the direct repurchase of 56.7 million shares of common stock at an average price of $15.55 per share. We used $41 million for tax withholding payments related to net share settlements of restricted stock units and tax withholding related reacquisitions of shares of restricted stock.

Capital expenditures

Capital expenditures have generally comprised purchases of computer hardware, software, server equipment, furniture and fixtures, and real estate. Capital expenditures, net were $339 million for the six months ended June 30, 2011, compared to $303 million in the same period of 2010. Our capital expenditures for the year ended December 31, 2011 are expected to be lower compared to the same period of 2010 due in part to higher infrastructure costs in 2010 in connection with our initiatives to build out our owned and operated data centers.

Contractual obligations and commitments

Leases. We have entered into various non-cancelable operating and capital lease agreements for office space and data centers globally for original lease periods up to 13 years, expiring between 2011 and 2022.

 

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

A summary of lease commitments as of June 30, 2011 is as follows (in millions):

 

     Gross Operating
Lease Commitments
     Capital Lease
Commitment
 

Six months ending December 31, 2011

   $ 86       $ 4   

Years ending December 31,

     

2012

     150         7   

2013

     126         8   

2014

     97         8   

2015

     75         8   

2016

     39         8   

Due after 5 years

     58         23   
  

 

 

    

 

 

 

Total gross lease commitments

   $ 631       $ 66   
  

 

 

    

 

 

 

Less: interest

     —           (26
  

 

 

    

 

 

 

Net lease commitments

   $ 631       $ 40   
  

 

 

    

 

 

 

Affiliate Commitments. In connection with contracts to provide advertising services to Affiliates, we are obligated to make payments, which represent traffic acquisition costs, to our Affiliates. As of June 30, 2011, these commitments totaled $121 million, of which $44 million will be payable in the remainder of 2011, $74 million will be payable in 2012, and $3 million will be payable in 2013.

Intellectual Property Rights. We are committed to make certain payments under various intellectual property arrangements of up to $35 million through 2023.

Income Taxes. As of June 30, 2011, unrecognized tax benefits of $405 million, including interest and penalties, are recorded on our condensed consolidated balance sheets. As of June 30, 2011, the settlement period for our income tax liabilities cannot be determined.

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

As of June 30, 2011, we 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. In addition, as of June 30, 2011, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures, or capital resources.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to the impact of interest rate changes, foreign currency exchange rate fluctuations, and changes in the market values of our investments.

Interest Rate Risk. Our exposure to market rate risk for changes in interest rates relates primarily to our cash and marketable debt securities portfolio. We invest excess cash in money market funds, time deposits, and liquid debt instruments of the U.S. and foreign governments and their agencies, U.S. municipalities, and high-credit corporate issuers which are classified as marketable debt securities and cash equivalents.

Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates. A hypothetical 100 basis point increase in interest rates would result in an approximate $10 million and $14 million decrease in the fair value of our available-for-sale debt securities as of June 30, 2011 and December 31, 2010, respectively.

Foreign Currency Risk. Revenue and related expenses generated from our international subsidiaries are generally denominated in the currencies of the local countries. Primary currencies include Australian dollars, British pounds, Euros, Japanese yen, Korean won, and Taiwan dollars. The statements of income of our international operations are translated into U.S. dollars at exchange rates indicative of market rates during each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency-denominated transactions results in reduced revenue, operating expenses, and net income. Conversely, our revenue, operating expenses, and net income will increase if the U.S. dollar weakens against foreign currencies. Using the foreign currency exchange rates from the three and six months ended June 30, 2010, revenue for the Americas segment for the three and six months ended June 30, 2011 would have been lower than we reported by $3 million and $5 million, respectively, revenue for the EMEA segment would have been lower than we reported by $13 million and $11 million, respectively, and revenue for the Asia Pacific segment would have been lower than we reported by $20 million and $35 million, respectively. Using the foreign currency exchange rates from the three and six months ended June 30, 2010, direct costs for the Americas segment for both the three and six months ended June 30, 2011 would have been lower than we reported by $1 million, direct costs for the EMEA segment would have been lower than we reported by $3 million and $2 million, respectively, and direct costs for the Asia Pacific segment would have been lower than we reported by $4 million and $8 million, respectively.

As mentioned above, we are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries and our investments in equity interests into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries’ financial statements into U.S. dollars results in a gain or loss which is recorded as a component of accumulated other comprehensive income which is part of stockholders’ equity. In addition, we have certain assets and liabilities that are denominated in currencies other than the respective entity’s functional currency. Changes in the functional currency value of these assets and liabilities create fluctuations that will lead to a gain or loss. We record these foreign currency transaction gains and losses, realized and unrealized, in other income, net on the condensed consolidated statements of income. During both the three and six months ended June 30, 2011, we recorded realized and unrealized foreign currency transaction gains of $1 million. During the three and six months ended June 30, 2010, we recorded realized and unrealized foreign currency transaction gains of $8 million and $13 million, respectively.

Investment Risk. We are exposed to investment risk as it relates to changes in the market value of our investments. We have investments in marketable debt securities.

Our cash and marketable debt securities investment policy and strategy attempts primarily to preserve capital and meet liquidity requirements. A large portion of our cash is managed by external managers within the guidelines of our investment policy. We protect and preserve invested funds by limiting default, market, and reinvestment risk. To achieve this objective, we maintain our portfolio of cash and cash equivalents and short-term and long-term investments in a variety of liquid fixed income securities, including both government and corporate obligations and money market funds. As of June 30, 2011 and 2010, net unrealized gains and losses on these investments were not material.

 

Item 4. Controls and Procedures

Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this Report. Based on such evaluation, the Company’s principal executive officer and principal financial officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.

 

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Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

For a description of our material legal proceedings, see the section captioned “Contingencies” included in Note 11 — “Commitments and Contingencies” in the Notes to the condensed consolidated financial statements, which is incorporated by reference herein.

 

Item 1A. Risk Factors

We have updated the risk factors previously disclosed in Part I, Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2010, which was filed with the Securities and Exchange Commission on February 28, 2011, as set forth below. Other than the addition of the risk factors concerning Alipay and legal proceedings, we do not believe any of the changes constitute material changes from the risk factors previously disclosed in the Annual Report on Form 10-K for the year ended December 31, 2010.

We face significant competition for users, advertisers, publishers, developers, and distributors.

We face significant competition from integrated online media companies as well as from social networking sites, traditional print and broadcast media, general purpose and vertical search engines and various e-commerce sites. In a number of international markets, especially those in Asia, Europe, the Middle East and Latin America, we face substantial competition from local Internet service providers and other portals that offer search, communications, and other commercial services.

Several of our competitors offer an integrated variety of Internet products, advertising services, technologies, online services and content in a manner similar to Yahoo!. Among other areas, we compete against these companies to attract and retain users, advertisers, developers, and third-party Website publishers as participants in our Affiliate network, and to obtain agreements with third parties to promote or distribute our services.

In addition, several competitors offer products and services that directly compete for users with our offerings, including consumer e-mail, local search, instant messaging, photos, maps, video sharing, content channels, mobile applications, and shopping. Similarly, the advertising networks operated by our competitors offer services that directly compete with our offerings for advertisers, including advertising exchanges, ad serving technologies and sponsored search offerings. We also compete with traditional print and broadcast media companies to attract advertising dollars, both domestically and internationally. We further compete for users, advertisers and developers with social media and networking sites as well as the wide variety of other providers of online services. Social networking sites in particular are attracting a substantial and increasing share of users and users’ online time, which could enable them to attract an increasing share of online advertising dollars.

Some of our existing competitors and possible entrants may have greater brand recognition for certain products and services, more expertise in a particular segment of the market, and greater operational, strategic, technological, financial, personnel, or other resources than we do. Many of our competitors have access to considerable financial and technical resources with which to compete aggressively, including by funding future growth and expansion and investing in acquisitions and research and development. Further, emerging start-ups may be able to innovate and provide new products and services faster than we can. In addition, competitors may consolidate with each other or collaborate, and new competitors may enter the market. Some of our competitors in international markets have a substantial competitive advantage over us because they have dominant market share in their territories, are owned by local telecommunications providers, have greater brand recognition, are focused on a single market, are more familiar with local tastes and preferences, or have greater regulatory and operational flexibility due to the fact that we are subject to both U.S. and foreign regulatory requirements.

If our competitors are more successful than we are in developing and deploying compelling products or in attracting and retaining users, advertisers, publishers, developers, or distributors, our revenue and growth rates could decline.

 

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The majority of our revenue is derived from display and search, and the reduction in spending by or loss of current or potential advertisers would cause our revenue and operating results to decline.

For the three months ended June 30, 2011, 81 percent of our total revenue came from display and search. Our ability to continue to retain and grow display and search revenue depends upon:

 

   

maintaining and growing our user base;

 

   

maintaining and growing our popularity as an Internet destination site;

 

   

maintaining and expanding our advertiser base on the Internet and mobile devices;

 

   

broadening our relationships with advertisers to small- and medium-sized businesses;

 

   

the successful implementation of changes and improvements to our advertising management platforms and acceptance of our advertising management platforms by advertisers, Website publishers, and online advertising networks;

 

   

the successful implementation of changes in our sales force, sales development teams, and sales strategy;

 

   

the effective monetization of search queries;

 

   

continuing to innovate and improve users’ search experiences;

 

   

maintaining and expanding our Affiliate program for search and display advertising services; and

 

   

deriving better demographic and other information about our users to enable us to offer better experiences to both our users and advertisers.

In most cases, our agreements with advertisers have a term of one year or less, and may be terminated at any time by the advertiser or by us. Search marketing agreements often have payments dependent upon usage or click-through levels. Accordingly, it is difficult to forecast display and search revenue accurately. In addition, our expense levels are based in part on expectations of future revenue, including occasional guaranteed minimum payments to our Affiliates in connection with search and/or display advertising, and are fixed over the short-term in some categories. The state of the global economy and availability of capital has impacted and could further impact the advertising spending patterns of existing and potential advertisers. Any reduction in spending by, or loss of, existing or potential advertisers would negatively impact our revenue and operating results. Further, we may be unable to adjust our expenses and capital expenditures quickly enough to compensate for any unexpected revenue shortfall.

Adverse general economic conditions have caused and could cause decreases or delays in display and search services spending by our advertisers and could harm our ability to generate display and search revenue and our results of operations.

Display and search expenditures tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Since we derive most of our revenue from display and search, adverse economic conditions have caused, and a continuation of adverse economic conditions could cause, additional decreases in or delays in advertising spending, a reduction in our display and search revenue and a negative impact on our short-term ability to grow our revenue. Further, any decreased collectability of accounts receivable or early termination of agreements, whether resulting from customer bankruptcies or otherwise due to the current economic conditions, could negatively impact our results of operations.

If we do not manage our operating expenses effectively, our profitability could decline.

We have implemented cost reduction initiatives to better align our operating expenses with our revenue, including reducing our headcount, outsourcing some administrative functions, consolidating space and terminating leases or entering into subleases. We plan to continue to manage costs to better and more efficiently manage our business. However, our operating expenses might also increase, from their reduced levels, as we expand our operations in areas of desired growth, continue to develop and extend the Yahoo! brand, fund product development, and acquire and integrate complementary businesses and technologies. Our operating costs might also increase if we do not effectively manage costs as we transition markets under the Search Agreement and reimbursements from Microsoft under the Search Agreement decline or cease. In addition, weak economic conditions or other factors could cause our business to contract, requiring us to implement additional cost cutting measures. If our expenses increase at a greater pace than our revenue, or if we fail to implement additional cost cutting if required in a timely manner, our profitability will decline.

 

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Transition, implementation and execution risks associated with our Search Agreement with Microsoft may adversely affect our business and operating results.

Under our Search Agreement with Microsoft, Microsoft is the exclusive algorithmic and paid search services provider on Yahoo! Properties and non-exclusive provider of such services on Affiliate sites for the transitioned markets. The parties commenced implementation of the Search Agreement on February 23, 2010. The global transition of the algorithmic and paid search platforms to Microsoft’s platform and the migration of the paid search advertisers and publishers to Microsoft’s platform are being done on a market by market basis and are expected to continue through the first half of 2013. The transition process is complex and requires the expenditure of significant time and resources by us. The algorithmic and paid search transition to the Microsoft platform was completed in the U.S. and Canada in the fourth quarter of 2010, and we plan to complete the transition of algorithmic search in other markets in 2011. The transition of paid search in other markets is expected to resume in the second half of 2011 and to continue through the first half of 2013. Delays or difficulties in, or disruptions and inconveniences caused by, the transition process could result in the loss of advertisers, publishers, Affiliates, and employees, as well as delays in recognizing or reductions in the anticipated benefits of the transaction, any of which could negatively impact our business and operating results.

If Microsoft fails to perform as required under the Search Agreement for any reason or suffers service level interruptions or other performance issues (including if Microsoft is unable to effectively monetize search queries in markets where paid search has transitioned under the Search Agreement), or if advertisers, Affiliates, or users are less satisfied than expected with the services provided or results obtained after transition or during the period prior to transition of search to Microsoft in their respective markets, we may not realize the anticipated benefits of the Search Agreement, we may lose advertisers, publishers and Affiliates, we may lose exclusivity with certain publishers, and our search revenue or our profitability could decline. In addition, to the extent the RPS Guarantee payments we receive do not fully offset any shortfall relating to revenue per search in transitioned markets or if our revenue per search upon expiration of the RPS Guarantee payments is lower than the guarantee levels, our search revenue or our profitability could decline.

If we are unable to provide innovative search experiences and other services that generate significant traffic to our Websites, our business could be harmed, causing our revenue to decline.

Internet search is characterized by rapidly changing technology, significant competition, evolving industry standards, and frequent product and service enhancements. We must continually invest in improving our users’ search experience—presenting users with a search experience that is responsive to their needs and preferences—in order to continue to attract, retain, and expand our user base and paid search advertiser base.

We currently deploy our own technology to provide search results on our network, except in markets where we have transitioned to Microsoft’s platform. Even after we complete the transition to Microsoft’s platform in all markets, we will need to continue to invest and innovate to improve our users’ search experience.

We also generate revenue through other online services, such as Yahoo! Mail. If we are unable to provide innovative search and other services which generate significant traffic to our Websites, our business could be harmed, causing our revenue to decline.

If we are unable to license or acquire compelling content and services at reasonable cost or if we do not develop or commission compelling content of our own, the number of users of our services may not grow as anticipated, or may decline, or users’ level of engagement with our services may decline, all or any of which could harm our operating results.

Our future success depends in part on our ability to aggregate compelling content and deliver that content through our online properties. We license from third parties much of the content and services on our online properties, such as news items, stock quotes, weather reports, music videos, music radio, and maps. We believe that users will increasingly demand high-quality content and services, including music videos, film clips, news footage, and special productions. Such content and services may require us to make substantial payments to third parties from whom we license or acquire such content or services. Our ability to maintain and build relationships with such third-party providers is critical to our success. In addition, as new methods for accessing the Internet become available, including through alternative devices, we may need to enter into amended agreements with existing third-party providers to cover the new devices. We may be unable to enter into new, or preserve existing, relationships with the third-parties whose content or services we seek to obtain. In addition, as competition for compelling content increases both domestically and internationally, our third-party providers may increase the prices at which they offer their content and services to us, and potential providers may not offer their content or services to us at all, or may offer them on terms that are not agreeable to us. An increase in the prices charged to us by third-party providers could harm our operating results and financial condition. Further, many of our content and services licenses with third parties are non-exclusive. Accordingly, other media providers may be able to offer similar or identical content. This increases the importance of our ability to deliver compelling editorial content and personalization of this content for users in order to differentiate Yahoo! from other businesses. If we are unable to license or acquire compelling content at reasonable prices, if other companies distribute content or services that are similar to or the same as that provided by us, or if we do not develop compelling editorial content or personalization services, the number of users of our services may not grow as anticipated, or may decline, which could harm our operating results.

 

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We rely on the value of our brands, and a failure to maintain or enhance the Yahoo! brands in a cost-effective manner could harm our operating results.

We believe that maintaining and enhancing our brands is an important aspect of our efforts to attract and expand our user, advertiser, and Affiliate base. We also believe that the importance of brand recognition will increase due to the relatively low barriers to entry in the Internet market. We have spent considerable money and resources to date on the establishment and maintenance of our brands, and we anticipate continuing to spend and devote resources to, advertising, marketing, and other brand-building efforts to preserve and enhance consumer awareness of our brands. Our brands may be negatively impacted by a number of factors, including among other issues: service outages; product malfunctions; data privacy and security issues; exploitation of our trademarks by others without permission; and poor presentation or integration of our search marketing offerings by Affiliates on their sites or in their software and services.