Quarterly Report on 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, 2012

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 31, 2012

Common Stock, $0.001 par value   1,184,617,827

 

 

 


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, 2011 and 2012      3   
 

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2011 and 2012

     4   
  Condensed Consolidated Balance Sheets as of December 31, 2011 and June 30, 2012      5   
  Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2012      6   
  Notes to Condensed Consolidated Financial Statements      7   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      26   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      37   

Item 4.

  Controls and Procedures      38   

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      52   

Item 3.

  Defaults Upon Senior Securities      52   

Item 4.

  Mine Safety Disclosures      52   

Item 5.

  Other Information      52   

Item 6.

  Exhibits      52   
  Signatures      53   

 

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Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Statements of Income

 

     Three Months Ended     Six Months Ended  
     June 30,
2011
    June 30,
2012
    June 30,
2011
    June 30,
2012
 
     (Unaudited, in thousands except per share amounts)  

Revenue

   $ 1,229,024      $ 1,217,794      $ 2,443,381      $ 2,439,027   

Operating expenses:

        

Cost of revenue — Traffic acquisition costs

     152,896        137,025        302,927        281,116   

Cost of revenue — Other

     231,388        278,453        481,014        532,432   

Sales and marketing

     280,159        272,910        542,308        558,178   

Product development

     233,045        199,628        454,328        428,106   

General and administrative

     131,822        136,117        254,720        260,388   

Amortization of intangibles

     8,582        9,756        16,632        19,809   

Restructuring charges, net

     237        129,092        10,812        134,809   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     1,038,129        1,162,981        2,062,741        2,214,838   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     190,895        54,813        380,640        224,189   

Other (expense) income, net

     (5,666     20,175        (639     22,453   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes and earnings in equity interests

     185,229        74,988        380,001        246,642   

Provision for income taxes

     (55,629     (26,523     (107,749     (82,942

Earnings in equity interests

     108,902        179,991        191,082        352,234   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     238,502        228,456        463,334        515,934   

Less: net income attributable to noncontrolling interests

     (1,530     (1,825     (3,370     (2,960
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc.

   $ 236,972      $ 226,631      $ 459,964      $ 512,974   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.18      $ 0.19      $ 0.35      $ 0.42   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.18      $ 0.18      $ 0.35      $ 0.42   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — basic

     1,299,947        1,213,320        1,304,505        1,214,551   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — diluted

     1,308,359        1,221,719        1,314,272        1,224,102   
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation expense by function:

        

Cost of revenue — Other

   $ 875      $ 2,614      $ 1,523      $ 5,508   

Sales and marketing

   $ 19,373      $ 18,981      $ 26,070      $ 40,078   

Product development

   $ 25,531      $ 17,808      $ 43,203      $ 37,279   

General and administrative

   $ 13,269      $ 10,168      $ 23,368      $ 22,672   

Restructuring expense reversals

   $ (526   $ (3,429   $ (1,278   $ (3,429

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

 

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YAHOO! INC.

Condensed Consolidated Statements of Comprehensive Income

 

     Three Months Ended     Six Months Ended  
     June 30,
2011
    June 30,
2012
    June 30,
2011
    June 30,
2012
 
     (Unaudited, in thousands)  

Net Income

   $ 238,502      $ 228,456      $ 463,334      $ 515,934   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income:

        

Unrealized gains (losses) on available-for-sale securities, net of taxes of $(1,002) and $106 for the three months ended June 30, 2011 and 2012, respectively, and $(803) and $206 for the six months ended June 30, 2011 and 2012, respectively

     (1,466     6,143        2,772        5,680   

Reclassification adjustment for realized (gains) losses included in net income, net of taxes of $158 and $(932) for the three months ended June 30, 2011 and 2012, respectively, and $1,813 and $(5,356) for the six months ended June 30, 2011 and 2012, respectively

     (237     1,630        (2,996     9,358   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized gains (losses) on available-for-sale securities, net of taxes

     (1,703     7,773        (224     15,038   

Foreign currency translation adjustment

     42,460        (231,371     171,845        (221,137
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income, net of tax

     40,757        (223,598     171,621        (206,099
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     279,259        4,858        634,955        309,835   

Less: comprehensive income attributable to noncontrolling interests

     (1,530     (1,825     (3,370     (2,960
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Yahoo! Inc.

   $ 277,729      $ 3,033      $ 631,585      $ 306,875   
  

 

 

   

 

 

   

 

 

   

 

 

 

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,
2011
    June 30,
2012
 
     (Unaudited, in thousands
except par values)
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 1,562,390      $ 1,539,269   

Short-term marketable debt securities

     493,189        371,204   

Accounts receivable, net

     1,037,474        1,040,893   

Prepaid expenses and other current assets

     359,483        318,932   
  

 

 

   

 

 

 

Total current assets

     3,452,536        3,270,298   

Long-term marketable debt securities

     474,338        490,570   

Property and equipment, net

     1,730,888        1,663,665   

Goodwill

     3,900,752        3,887,360   

Intangible assets, net

     254,600        196,729   

Other long-term assets

     220,628        209,669   

Investments in equity interests

     4,749,044        4,939,938   
  

 

 

   

 

 

 

Total assets

   $ 14,782,786      $ 14,658,229   
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Current liabilities:

    

Accounts payable

   $ 166,595      $ 132,105   

Accrued expenses and other current liabilities

     846,044        768,080   

Deferred revenue

     194,722        176,960   
  

 

 

   

 

 

 

Total current liabilities

     1,207,361        1,077,145   

Long-term deferred revenue

     43,639        38,757   

Capital lease and other long-term liabilities

     134,905        130,149   

Deferred and other long-term tax liabilities, net

     815,534        895,941   
  

 

 

   

 

 

 

Total liabilities

     2,201,439        2,141,992   

Commitments and contingencies (Note 11)

     —          —     

Yahoo! Inc. stockholders’ equity:

    

Common stock, $0.001 par value; 5,000,000 shares authorized; 1,244,956 shares issued and 1,217,481 shares outstanding as of December 31, 2011 and 1,255,870 shares issued and 1,194,147 shares outstanding as of June 30, 2012

     1,242        1,253   

Additional paid-in capital

     9,825,899        9,976,949   

Treasury stock at cost, 27,475 shares as of December 31, 2011 and 61,723 shares as of June 30, 2012

     (416,237     (942,244

Retained earnings

     2,432,294        2,945,269   

Accumulated other comprehensive income

     697,869        491,770   
  

 

 

   

 

 

 

Total Yahoo! Inc. stockholders’ equity

     12,541,067        12,472,997   

Noncontrolling interests

     40,280        43,240   
  

 

 

   

 

 

 

Total equity

     12,581,347        12,516,237   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 14,782,786      $ 14,658,229   
  

 

 

   

 

 

 

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,
2011
    June 30,
2012
 
     (Unaudited, in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 463,334      $ 515,934   

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

    

Depreciation

     275,901        254,539   

Amortization of intangible assets

     58,993        60,209   

Stock-based compensation expense, net

     92,886        102,108   

Noncash restructuring charges, net

     —          38,638   

Tax benefits from stock-based awards

     12,483        (3,935

Excess tax benefits from stock-based awards

     (30,225     (16,770

Deferred income taxes

     45,831        (18,474

Earnings in equity interests

     (191,082     (352,234

Dividends received from equity investee

     75,391        83,648   

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

     22,792        (24,507

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

    

Accounts receivable, net

     86,692        (9,908

Prepaid expenses and other

     53,293        16,563   

Accounts payable

     (10,821     (35,714

Accrued expenses and other liabilities

     (386,044     (15,755

Deferred revenue

     (33,118     (22,329
  

 

 

   

 

 

 

Net cash provided by operating activities

     536,306        572,013   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Acquisition of property and equipment, net

     (339,064     (215,922

Purchases of marketable debt securities

     (1,124,596     (645,266

Proceeds from sales of marketable debt securities

     882,229        548,439   

Proceeds from maturities of marketable debt securities

     657,916        198,498   

Proceeds from the sale of investments

     —          26,132   

Acquisitions, net of cash acquired

     (68,812     —     

Purchases of intangible assets

     (10,960     (3,088

Other investing activities, net

     149        (9,421
  

 

 

   

 

 

 

Net cash used in investing activities

     (3,138     (100,628
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from issuance of common stock, net

     98,547        77,871   

Repurchases of common stock

     (609,019     (526,007

Excess tax benefits from stock-based awards

     30,225        16,770   

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

     (33,669     (38,494

Other financing activities, net

     (7,521     (2,222
  

 

 

   

 

 

 

Net cash used in financing activities

     (521,437     (472,082
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     42,679        (22,424

Net change in cash and cash equivalents

     54,410        (23,121

Cash and cash equivalents at beginning of period

     1,526,427        1,562,390   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 1,580,837      $ 1,539,269   
  

 

 

   

 

 

 

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 focused on creating deeply personal digital experiences that keep more than half a billion people connected to what matters most to them, across devices and around the globe. Yahoo!’s unique combination of Science + Art + Scale connects advertisers to the consumers who build their businesses. The Company provides online properties and services (“Yahoo! Properties”) to users as well as a range of marketing services designed to reach and connect with those users on Yahoo! Properties and through a distribution network of third-party entities (“Affiliates”). These Affiliates integrate the Company’s advertising offerings into their Websites or other offerings (those Websites and other 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. To conform to the current period presentation, the Company corrected the classification of $13 million and $35 million of costs principally included in product development expenses to cost of revenue—other for the three and six months ended June 30, 2011, respectively.

The accompanying unaudited condensed consolidated interim financial statements reflect all adjustments, consisting of only normal recurring items, which, in the opinion of management, are necessary for a fair statement of the results of operations for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full year or for any future 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, 2011. 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, 2011 was derived from the Company’s audited financial statements for the year ended December 31, 2011, 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.

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

Basic and diluted net income attributable to Yahoo! common stockholders per share is computed using the weighted average number of common shares outstanding during the period, excluding net income attributable to participating securities (restricted stock awards granted under the Company’s 1995 Stock Plan and restricted stock units granted under the 1996 Directors’ Stock Plan (the “Directors’ Plan”)). Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares are calculated using the treasury stock method and consist of unvested restricted stock and shares underlying unvested restricted stock units, the incremental common shares issuable upon the exercise of stock options, and shares to be purchased under the 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 47 million and 48 million shares of common stock for the three and six months ended June 30, 2012, respectively, and 59 million shares of common stock for both the three and six months ended June 30, 2011 were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive.

 

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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,
2011
    June 30,
2012
    June 30,
2011
    June 30,
2012
 

Basic:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 236,972      $ 226,631      $ 459,964      $ 512,974   

Less: Net income allocated to participating securities

     (3     (3     (8     (12
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 236,969      $ 226,628      $ 459,956      $ 512,962   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average common shares

     1,299,947        1,213,320        1,304,505        1,214,551   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.18      $ 0.19      $ 0.35      $ 0.42   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 236,972      $ 226,631      $ 459,964      $ 512,974   

Less: Net income allocated to participating securities

     (3     (3     (8     (12

Less: Effect of dilutive securities issued by equity investees

     (654     (1,246     (1,302     (2,512
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 236,315      $ 225,382      $ 458,654      $ 510,450   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic calculation

     1,299,947        1,213,320        1,304,505        1,214,551   

Weighted average effect of Yahoo! Inc. dilutive securities:

        

Restricted stock and restricted stock units

     5,391        6,756        6,485        7,871   

Stock options and employee stock purchase plan

     3,021        1,643        3,282        1,680   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted calculation

     1,308,359        1,221,719        1,314,272        1,224,102   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.18      $ 0.18      $ 0.35      $ 0.42   
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 3 ACQUISITIONS

During the six months ended June 30, 2011, the Company acquired three companies in transactions that 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 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.

The Company did not make any acquisitions during the six months ended June 30, 2012.

Note 4 INVESTMENTS IN EQUITY INTERESTS

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

 

     December 31,
2011
     June 30,
2012
     Percent
Ownership of
Common Stock as of

June 30, 2012
 

Alibaba Group

   $ 2,521,825       $ 2,754,578         42

Yahoo Japan

     2,219,946         2,175,135         35

Other

     7,273         10,225         26
  

 

 

    

 

 

    

Total

   $ 4,749,044       $ 4,939,938      
  

 

 

    

 

 

    

 

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Equity Investment in Alibaba Group. The investment in Alibaba Group Holding Limited (“Alibaba Group”) is being accounted for using the equity method, and the total investment, including net tangible assets, identifiable intangible assets and goodwill, is classified as part of the investments in equity interests balance 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, 2012, 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

   $ 2,754,578   

Proportionate share of Alibaba Group stockholders’ equity

     2,099,467   
  

 

 

 

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

   $ 655,111   
  

 

 

 

 

(*) 

The excess carrying value has been primarily assigned to goodwill.

The amortizable intangible assets included in the excess carrying value had original useful lives not exceeding seven years and an original 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,
2011
     March 31,
2012
     March 31,
2011
     March 31,
2012
 

Operating data:

           

Revenue

   $ 490,933       $ 805,900       $ 1,035,447       $ 1,828,707   

Gross profit

   $ 324,342       $ 530,537       $ 687,309       $ 1,227,376   

Income from operations

   $ 47,159       $ 213,262       $ 73,251       $ 489,921   

Net income

   $ 51,629       $ 235,208       $ 96,634       $ 488,773   

Net income attributable to Alibaba Group

   $ 29,623       $ 220,483       $ 61,943       $ 457,395   
                    September 30,
2011
     March 31,
2012
 

Balance sheet data:

           

Current assets

         $ 3,491,753       $ 4,491,012   

Long-term assets

         $ 2,993,329       $ 3,004,320   

Current liabilities

         $ 1,562,840       $ 1,861,959   

Long-term liabilities

         $ 134,160       $ 166,155   

Non-voting participating redeemable securities

         $ 1,415       $ 4,704   

Noncontrolling interests

         $ 406,805       $ 459,900   

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, 2011 and 2012, these transactions were not material.

Framework Agreement with Alibaba Group regarding Alipay. Alibaba Group restructured the ownership of Alipay.com Co., Ltd. (“Alipay”) and deconsolidated Alipay in the first quarter of 2011. The impact of the deconsolidation of Alipay was not material to the Company’s financial statements. On July 29, 2011, the Company entered into a Framework Agreement (the “Framework Agreement”), with 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. The Framework Agreement establishes the ongoing financial and other arrangements between Alibaba Group and Alipay.

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 was owned by Mr. Ma and Mr. Tsai. The transactions under the Framework Agreement closed on December 14, 2011 (“the closing”).

Pursuant to the terms of the Framework Agreement 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

 

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certain increases and additional payments if no Liquidity Event has occurred by the sixth anniversary of 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 closing, 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. Upon payment in full of the Liquidity Event Payment, Alibaba Group will transfer to Alipay certain assets used in the Alipay business that were retained by Alibaba Group.

(2) Alibaba Group and Alipay have entered into a long-term agreement pursuant to which Alibaba Group will receive payment processing services on preferential terms from Alipay and its subsidiaries. The fees to be paid by Alibaba Group and its subsidiaries to Alipay for the services provided under such agreement 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 has licensed to Alipay certain intellectual property and technology and performs certain software technology services for Alipay and in return Alipay pays to Alibaba Group a royalty and software technology services fee, which consists 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 constituting a Liquidity Event and (b) the date the Liquidity Event Payment, the IPCo Promissory Note (as defined below) and certain related payments have been paid in full. Upon termination of this agreement, the intellectual property and technology licensed under the agreement will be transferred to Alipay.

(4) IPCo has issued 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 are secured by a pledge of 50,000,000 ordinary shares of Alibaba Group which have been 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 and Mr. Tsai have entered into an agreement pursuant to which (a) the Alibaba Group board of directors ratified 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 released 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 royalty and software technology services fee and the payment processing services fees discussed above approximate the estimated fair values of such services and are recognized in Alibaba Group’s financial statements as income or expense, as applicable, as the services are rendered. Yahoo! will record its share, if any, of the results of these transactions as they are recorded by Alibaba within Yahoo!’s earnings in equity interests in the consolidated statements of income.

Alibaba Group will recognize the Liquidity Event Payment, the payment of the IPCo Promissory Note, and any impact from the transfer of assets, described above, if and when such payments or transfers occur. Yahoo! will record its share, if any, of the results of these transactions as they are recorded by Alibaba Group within Yahoo!’s earnings in equity interests in the consolidated statements of income.

Share Repurchase and Preference Share Sale Agreement with Alibaba Group. On May 20, 2012, Yahoo! entered into a Share Repurchase and Preference Share Sale Agreement (the “Repurchase Agreement”) with Alibaba Group and Yahoo! Hong Kong Holdings Limited, a Hong Kong corporation and wholly-owned subsidiary of Yahoo! Inc. (“YHK”). For the purposes of the discussion of the Repurchase Agreement in this Note 4, “Yahoo!” collectively refers to Yahoo! Inc. and YHK.

Pursuant to the terms of the Repurchase Agreement, the parties have agreed, among other things, that:

(1) Of the 1,046.6 million ordinary shares of Alibaba Group (“Shares”) owned by Yahoo!, Alibaba Group will initially repurchase from Yahoo! between 261.5 million and 523 million Shares depending on the amount of financing raised by Alibaba Group to make the repurchase (the “Initial Repurchase”). Yahoo! will sell 261.5 million Shares to Alibaba Group if Alibaba Group completes a sale of Shares meeting certain requirements (a “Qualified Resale”) with gross proceeds of at least $1 billion and 523 million Shares if Alibaba Group completes a Qualified Resale with gross proceeds of at least $2 billion, with any repurchase over 261.5 million Shares subject to Alibaba Group obtaining sufficient additional financing to complete the repurchase. Yahoo! will sell the repurchased Shares to Alibaba Group at a per share price equal to the greater of $13.50 and the price per share at which Alibaba Group raises equity financing, subject to discounts depending on such price. If Alibaba Group does not complete a Qualified Resale

 

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with gross proceeds of at least $1 billion, Yahoo! may require Alibaba Group to repurchase 261.5 million Shares for $13.50 per Share. Alibaba Group may elect to deliver up to $800 million of the consideration for the Initial Repurchase in the form of preference shares rather than cash. If issued to Yahoo!, the preference shares will yield semi-annual dividends at a rate per annum of up to 10 percent, with at least 3 percent payable in cash and the remainder accruing and resulting in an increase to the liquidation preference. The dividend rate is subject to certain adjustments. Until the preference shares have been redeemed, Alibaba Group will not pay dividends on its Shares.

(2) at the time Alibaba Group completes an initial public offering meeting certain specified criteria (a “Qualified IPO”), Yahoo! will sell, at Alibaba Group’s election, (either directly to Alibaba Group or in the Qualified IPO) up to 261.5 million Shares;

(3) upon the consummation of the Initial Repurchase or upon certain terminations of the Repurchase Agreement, the Company and Alibaba Group will enter into an amendment of the existing Technology and Intellectual Property License Agreement by and between Yahoo! and Alibaba Group (the “TIPLA”), pursuant to which Alibaba Group will make an initial payment to the Company of $550 million in satisfaction of certain future royalty payments under the existing TIPLA and will thereafter continue making royalty payments until the earlier of the fourth anniversary of the effective date of the amendment and a Qualified IPO; and

(4) upon the consummation of the Initial Repurchase, the parties will terminate certain existing contractual limitations on Yahoo!’s ability to compete in the People’s Republic of China.

The closing of the Initial Repurchase is subject to customary closing conditions and is expected to occur within six months of May 20, 2012, the date of signing of the Repurchase Agreement.

Equity Investment in Yahoo Japan. The investment in Yahoo Japan Corporation (“Yahoo Japan”) is being accounted for using the equity method and the total investment, including net tangible assets, identifiable intangible assets and goodwill, is classified as part of the 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.

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

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 $6.5 billion as of June 30, 2012.

During the three and six months ended June 30, 2011 and 2012, the Company received cash dividends from Yahoo Japan in the amount of $75 million and $84 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. 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,
2011
     March 31,
2012
     March 31,
2011
     March 31,
2012
 
     (in thousands)  

Operating data:

           

Revenue

   $ 1,006,327       $ 1,069,974       $ 2,000,158       $ 2,139,301   

Gross profit

   $ 831,503       $ 919,132       $ 1,655,768       $ 1,816,840   

Income from operations

   $ 496,915       $ 585,443       $ 995,186       $ 1,127,941   

Net income

   $ 289,109       $ 348,093       $ 515,884       $ 650,697   

Net income attributable to Yahoo Japan

   $ 287,577       $ 346,899       $ 512,283       $ 648,092   

 

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      September 30,
2011
     March 31,
2012
 
     (in thousands)  

Balance sheet data:

     

Current assets

   $ 3,622,833       $ 5,527,311   

Long-term assets

   $ 2,907,062       $ 1,242,815   

Current liabilities

   $ 1,117,773       $ 1,135,395   

Long-term liabilities

   $ 36,009       $ 45,027   

Noncontrolling interests

   $ 31,102       $ 28,244   

Under technology and trademark license and other commercial arrangements with Yahoo Japan, the Company records revenue from Yahoo Japan based on a percentage of advertising revenue earned by Yahoo Japan. The Company recorded revenue from Yahoo Japan of approximately $68 million and $66 million for the three months ended June 30, 2011 and 2012, respectively, and revenue of approximately of $137 million and $136 million for the six months ended June 30, 2011 and 2012, respectively. As of both December 31, 2011 and June 30, 2012, the Company had net receivable balances from Yahoo Japan of approximately $42 million.

Note 5 GOODWILL

The Company’s goodwill balance was $3.9 billion as of December 31, 2011 and June 30, 2012, of which $2.9 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. The change in the carrying amount of goodwill of $13 million reflected on the Company’s condensed consolidated balance sheets during the six months ended June 30, 2012 was primarily due to foreign exchange losses of $16 million.

Note 6 INTANGIBLE ASSETS, NET

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

 

     December 31, 2011      June 30, 2012  
     Net      Gross Carrying
Amount
     Accumulated
Amortization(*)
    Net  

Customer and advertiser related relationships

   $ 93,683       $ 166,589       $ (89,577   $ 77,012   

Developed technology and patents

     137,668         298,089         (198,583     99,506   

Trade names, trademarks, and domain names

     23,249         50,982         (30,771     20,211   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total intangible assets, net

   $ 254,600       $ 515,660       $ (318,931   $ 196,729   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(*)

Cumulative foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities, totaled approximately $18 million as of June 30, 2012.

The Company recognized amortization expense for intangible assets of $29 million for both the three months ended June 30, 2011 and 2012, including $21 million and $19 million, respectively, in cost of revenue - other. For the six months ended June 30, 2011 and 2012, the Company recognized amortization expense for intangible assets of $59 million and $60 million, respectively, including $42 million and $40 million in cost of revenue - other, respectively. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2012 and each of the succeeding years is as follows: six months ending December 31, 2012: $45 million; 2013: $62 million; 2014: $43 million; 2015: $22 million; 2016: $5 million; and 2017: $5 million.

Note 7 OTHER (EXPENSE) INCOME, NET

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

 

     Three Months Ended      Six Months Ended  
     June 30,
2011
    June 30,
2012
     June 30,
2011
    June 30,
2012
 

Interest and investment income

   $ 5,084      $ 3,584       $ 10,444      $ 9,280   

Other

     (10,750     16,591         (11,083     13,173   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total other (expense) income, net

   $ (5,666   $ 20,175       $ (639   $ 22,453   
  

 

 

   

 

 

    

 

 

   

 

 

 

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

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.

 

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Note 8 ACCUMULATED OTHER COMPREHENSIVE INCOME

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

 

     December 31,
2011
    June 30,
2012
 

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

   $ (7,538   $ 7,500   

Foreign currency translation, net of tax

     705,407        484,270   
  

 

 

   

 

 

 

Accumulated other comprehensive income

   $ 697,869      $ 491,770   
  

 

 

   

 

 

 

Note 9 INVESTMENTS

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

 

     December 31, 2011  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 599,582       $ 1,054       $ (172   $ 600,464   

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

     366,264         1,025         (226     367,063   

Corporate equity securities

     2,761         —           (1,978     783   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 968,607       $ 2,079       $ (2,376   $ 968,310   
  

 

 

    

 

 

    

 

 

   

 

 

 
      June 30, 2012  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 402,791       $ 586       $ (54   $ 403,323   

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

     458,008         721         (278     458,451   

Corporate equity securities

     230         9         —          239   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 861,029       $ 1,316       $ (332   $ 862,013   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31,
2011
     June 30,
2012
 

Reported as:

     

Short-term marketable debt securities

   $ 493,189       $ 371,204   

Long-term marketable debt securities

     474,338         490,570   

Other assets

     783         239   
  

 

 

    

 

 

 

Total

   $ 968,310       $ 862,013   
  

 

 

    

 

 

 

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 as of December 31, 2011 and June 30, 2012 as the carrying value approximates fair value because of the short maturity of those instruments. Realized gains and losses from sales of marketable securities were not material for the six months ended June 30, 2011 and 2012.

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

 

     December 31,
2011
     June 30,
2012
 

Due within one year

   $ 493,189       $ 371,204   

Due after one year through five years

     474,338         490,570   
  

 

 

    

 

 

 

Total available-for-sale marketable debt securities

   $ 967,527       $ 861,774   
  

 

 

    

 

 

 

 

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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, 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

   $ 138,755       $ (172   $ —         $ —        $ 138,755       $ (172

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

     123,574         (226     —           —          123,574         (226

Corporate equity securities

     —           —          783         (1,978     783         (1,978
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investments in available-for-sale securities

   $ 262,329       $ (398   $ 783       $ (1,978   $ 263,112       $ (2,376
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
      June 30, 2012  
      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

   $ 145,069       $ (54   $ —         $ —        $ 145,069       $ (54

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

     193,133         (278     —           —          193,133         (278
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investments in available-for-sale securities

   $ 338,202       $ (332   $ —         $ —        $ 338,202       $ (332
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The Company’s investment portfolio consists of liquid high-quality fixed income government, agency, 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 following table sets forth the financial assets and liabilities, measured at fair value, by level within the fair value hierarchy as of December 31, 2011 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  

Assets

   Level 1      Level 2     Total  

Money market funds(1)

   $ 418,338       $ —        $ 418,338   

Available-for-sale securities:

       

Government and agency securities(1)

     —           617,316        617,316   

Commercial paper and bank certificates of deposit(1)

     —           47,904        47,904   

Corporate debt securities(1)

     —           318,805        318,805   
  

 

 

    

 

 

   

 

 

 

Available-for-sale securities at fair value

   $ 418,338       $ 984,025      $ 1,402,363   

Corporate equity securities(2)

     783         —          783   

Liabilities

       

Foreign currency derivative contract(3)

     —           (2,817     (2,817
  

 

 

    

 

 

   

 

 

 

Total assets and liabilities at fair value

   $ 419,121       $ 981,208      $ 1,400,329   
  

 

 

    

 

 

   

 

 

 

 

(1) 

The money market funds, government and agency securities, 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.

(3) 

Foreign currency derivative contracts are classified as part of either other current assets or other current liabilities in the condensed consolidated balance sheets.

The amount of cash and cash equivalents as of December 31, 2011 includes $1.1 billion in cash deposited with commercial banks, of which $217 million are time deposits.

 

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The following table sets forth the financial assets and liabilities, measured at fair value, by level within the fair value hierarchy as of June 30, 2012 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  

Assets

   Level 1      Level 2     Total  

Money market funds(1)

   $ 498,749       $ —        $ 498,749   

Available-for-sale securities:

       

Government and agency securities(1)

     —           450,043        450,043   

Commercial paper and bank certificates of deposit(1)

     —           58,192        58,192   

Corporate debt securities(1)

     —           400,260        400,260   
  

 

 

    

 

 

   

 

 

 

Available-for-sale securities at fair value

   $ 498,749       $ 908,495      $ 1,407,244   

Corporate equity securities(2)

     239         —          239   

Liabilities

       

Foreign currency derivative contract(3)

     —           (3,037     (3,037
  

 

 

    

 

 

   

 

 

 

Total assets and liabilities at fair value

   $ 498,988       $ 905,458      $ 1,404,446   
  

 

 

    

 

 

   

 

 

 

 

(1) 

The money market funds, government and agency securities, 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.

(3) 

Foreign currency derivative contracts are classified as part of either other current assets or other current liabilities in the condensed consolidated balance sheets.

The amount of cash and cash equivalents as of June 30, 2012 includes $1.0 billion in cash deposited with commercial banks, of which $249 million are time deposits.

The fair values of the Company’s Level 1 financial assets and liabilities are based on quoted market prices of the identical underlying security. The fair values of the Company’s Level 2 financial assets and liabilities 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, 2012, the Company did not make any transfers between Level 1 and Level 2 assets or liabilities. As of December 31, 2011 and June 30, 2012, the Company did not have any significant Level 3 financial assets or liabilities.

Note 10 STOCKHOLDERS’ EQUITY AND EMPLOYEE BENEFITS

Employee Stock Purchase Plan. As of June 30, 2012, there was $39 million of unamortized stock-based compensation expense related to the Company’s Employee Stock Purchase Plan which will be recognized over a weighted average period of 1.4 years.

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, 2012 is summarized as follows (in thousands, except per share amounts):

 

     Shares     Weighted Average
Exercise Price per
Share
 

Outstanding at December 31, 2011

     62,439      $ 21.94   

Options granted

     8,291      $ 14.86   

Options exercised(*)

     (2,767   $ 11.40   

Options expired

     (6,238   $ 29.23   

Options cancelled/forfeited

     (6,458   $ 14.84   
  

 

 

   

Outstanding at June 30, 2012

     55,267      $ 21.41   
  

 

 

   

 

(*) 

The Company issued new shares to satisfy stock option exercises.

As of June 30, 2012, there was $58 million of unrecognized stock-based compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of 2.0 years.

 

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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,
2011
    June 30,
2012
    June 30,
2011
    June 30,
2012
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate

     1.6     0.8     1.4     1.1

Expected volatility

     34.8     32.3     36.1     34.0

Expected life (in years)

     3.94        4.00        0.98        1.36   
     Stock Options     Purchase Plan (*)  
     Six Months Ended     Six Months Ended  
     June 30,
2011
    June 30,
2012
    June 30,
2011
    June 30,
2012
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate

     1.6     0.7     1.4     1.2

Expected volatility

     34.7     32.3     36.1     34.1

Expected life (in years)

     4.09        4.04        1.03        1.25   

 

(*) 

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 awards and restricted stock units activity for the six months ended June 30, 2012 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, 2011(*)

     38,775      $ 17.28   

Granted(*)

     13,314      $ 14.97   

Vested

     (7,180   $ 16.03   

Forfeited

     (12,866   $ 15.35   
  

 

 

   

Awarded and unvested at June 30, 2012(*)

     32,043      $ 17.38   
  

 

 

   

 

(*) 

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

As of June 30, 2012, there was $291 million of unrecognized stock-based compensation expense related to unvested restricted stock awards and restricted stock units, which is expected to be recognized over a weighted average period of 2.4 years.

During the six months ended June 30, 2011 and June 30, 2012, 5.7 million shares and 7.2 million shares, respectively, that were subject to previously granted restricted stock awards and restricted stock units vested. These vested restricted stock awards and restricted stock units were net share settled. During the six months ended June 30, 2011 and June 30, 2012, the Company withheld 2.0 million shares and 2.5 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 $34 million and $38 million for the six months ended June 30, 2011 and June 30, 2012, 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 withholding related to the reacquisition 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.

Former CEO Inducement and Make-Up Equity. On January 27, 2012, Mr. Scott Thompson, former Chief Executive Officer, was granted an award of restricted stock units under the 1995 Stock Plan with an aggregate value of $6.5 million on the date of grant (the “Thompson Make-Whole RSUs”). On February 10, 2012, Mr. Thompson received a make-whole cash bonus of $1.5 million (the “Make-Whole Cash Bonus”). The Thompson Make-Whole RSUs and the Make-Whole Cash Bonus compensated Mr. Thompson for the forfeiture of the value of his cash bonus and equity awards from his previous employer. The Thompson Make-Whole RSUs vested as to a number of stock units with a grant date value of $5.5 million on March 15, 2012 and the remaining stock units were forfeited upon Mr. Thompson’s resignation as Yahoo!’s Chief Executive Officer and President effective May 12, 2012.

 

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The Company recorded total stock-based compensation expense reversals of less than $1 million for the three months ended June 30, 2012 and total stock-based compensation expense of $6 million for the six months ended June 30, 2012 in connection with the equity grants made to Mr. Thompson pursuant to the terms of his employment letter agreement with the Company.

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. That repurchase program expires in June 2013. In May 2012, the Company announced authorization of a stock repurchase program allowing the Company to repurchase up to an additional $5.0 billion of its outstanding shares of common stock from time to time. The aggregate amount available under the two repurchase programs was approximately $5,079 million at June 30, 2012. Repurchases under the repurchase programs 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, 2012, the Company repurchased approximately 34 million shares of its common stock under the stock repurchase program announced in June 2010 at an average price of $15.36 per share for a total of $526 million.

Note 11 COMMITMENTS AND CONTINGENCIES

Lease Commitments. The Company leases office space and data centers under operating and capital lease agreements with original lease periods of up to 13 years, which expire between 2012 and 2022.

A summary of gross and net lease commitments as of June 30, 2012 is as follows (in millions):

 

     Gross  Operating
Lease
Commitments
     Sublease
Income
    Net Operating
Lease
Commitments
 

Six months ending December 31, 2012

   $ 77       $ (6   $ 71   

Years ending December 31,

       

2013

     136         (13     123   

2014

     106         (11     95   

2015

     81         (7     74   

2016

     45         (1     44   

2017

     31         —          31   

Due after 5 years

     38         —          38   
  

 

 

    

 

 

   

 

 

 

Total gross and net lease commitments

   $ 514       $ (38   $ 476   
  

 

 

    

 

 

   

 

 

 

 

     Capital Lease
Commitment
 

Six months ending December 31, 2012

   $ 4   

Years ending December 31,

  

2013

     9   

2014

     8   

2015

     8   

2016

     8   

2017

     9   

Due after 5 years

     14   
  

 

 

 

Gross lease commitment

   $ 60   
  

 

 

 

Less: interest

     (21
  

 

 

 

Net lease commitment

   $ 39   
  

 

 

 

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, 2012, these commitments totaled $113 million, of which $40 million will be payable in the remainder of 2012, and $73 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 $32 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

 

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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 the Company’s condensed consolidated financial statements.

As of June 30, 2012, 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.

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 June 14, 2007, a stockholder derivative action was filed in the United States 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 Securities Exchange Act of 1934, as amended (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 September 19, 2011, the Court sustained Yahoo!’s demurrer to plaintiff’s third amended complaint without leave to amend. On December 21, 2011, plaintiff filed a notice of appeal.

Since May 31, 2011, several related stockholder derivative suits were filed in the Santa Clara County Superior Court (“California Derivative Litigation”) and the United States District Court for the Northern District of California (“Federal Derivative Litigation”) purportedly on behalf of the Company against certain officers and directors of the Company and third parties. The California Derivative Litigation was filed by plaintiffs Cinotto, Lassoff, Zucker, and Koo, and consolidated under the caption In re Yahoo! Inc. Derivative Shareholder Litigation on June 24, 2011 and September 12, 2011. The Federal Derivative Litigation was filed by plaintiffs Salzman, Tawila, and Iron Workers Mid-South Pension Fund and consolidated under the caption In re Yahoo! Inc. Shareholder Derivative Litigation on October 3, 2011. The plaintiffs allege breaches of fiduciary duties, corporate waste, mismanagement, abuse of control, unjust enrichment, misappropriation of corporate assets, or contribution and seek damages, equitable relief, disgorgement and corporate governance changes in connection with Alibaba Group’s restructuring of its subsidiary Alipay and related disclosures. On June 7, 2012, the courts approved stipulations staying the California Derivative Litigation pending resolution of the Federal Derivative Litigation, and deferring the Federal Derivative Litigation pending a ruling on the motion to dismiss filed by the defendants in the related stockholder class actions, which are discussed below.

Since June 6, 2011, two purported stockholder class actions were filed in the United States District Court for the Northern District of California against the Company and certain officers and directors by plaintiffs Bonato and the Twin Cities Pipe Trades Pension Trust. In October 2011, the District Court consolidated the two actions under the caption In re Yahoo! Inc. Securities Litigation and appointed the Pension Trust Fund for Operating Engineers as lead plaintiff. In a consolidated amended complaint filed December 15, 2011, the lead plaintiff purports to represent a class of investors who purchased the Company’s common stock between April 19, 2011 and July 29, 2011, and alleges that during that class period, defendants issued statements that were materially false or misleading because they did not disclose information relating to Alibaba Group’s restructuring of Alipay. 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. On June 22, 2012, the court held a hearing on defendants’ motion to dismiss the consolidated amended complaint.

 

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On December 1, 2011 and December 7, 2011, purported class action complaints were filed in the Delaware Chancery Court by M & C Partners, III and Louisiana Municipal Police Employees’ Retirement System, respectively, against the Company and the members of the Company’s Board of Directors at that time. On December 14, 2011, the Delaware Chancery Court consolidated the two actions under the caption In re Yahoo! Shareholders Litig. and appointed lead plaintiffs. On December 29, 2011, the lead plaintiffs filed a consolidated amended class action complaint purportedly on behalf of all of the Company’s stockholders alleging that the Board of Directors breached its fiduciary duties by failing to maximize the Company’s value in connection with the strategic review process. Plaintiffs seek injunctive relief, rescission, fees and costs. The Company and the members of the Company’s Board of Directors at that time answered the amended class action complaint on January 18, 2012. On July 6, 2012, the lead plaintiffs filed a motion for an award of attorneys’ fees and expenses alleging that their claims had become moot as a result of events occurring after the filing of the amended class action complaint. On July 25, 2012, the Court dismissed the plaintiffs’ claims while retaining jurisdiction to decide plaintiffs’ motion for fees and expenses.

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 consolidated financial position, results of operations or cash flows. Amounts accrued as of December 31, 2011 and June 30, 2012 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 events could have a material adverse effect on the Company’s financial position, results of operations, or cash flows. The Company may also incur substantial legal fees, which are expensed as incurred, in defending against these claims.

Note 12 SEGMENTS

The Company continues to manage its business geographically. The primary areas of measurement and decision-making are currently Americas, EMEA, and Asia Pacific. Management relies on an internal reporting process that provides revenue ex-TAC, which is defined as revenue less TAC, 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.

 

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

 

     Three Months Ended      Six Months Ended  
     June 30,
2011
     June 30,
2012
     June 30,
2011
     June 30,
2012
 

Revenue by segment:

           

Americas

   $ 808,038       $ 821,751       $ 1,626,969       $ 1,657,784   

EMEA

     162,601         128,099         316,651         262,061   

Asia Pacific

     258,385         267,944         499,761         519,182   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Revenue

   $ 1,229,024       $ 1,217,794       $ 2,443,381       $ 2,439,027   
  

 

 

    

 

 

    

 

 

    

 

 

 

TAC by segment:

           

Americas

   $ 39,404       $ 45,910       $ 77,545       $ 88,865   

EMEA

     57,648         34,187         115,160         79,849   

Asia Pacific

     55,844         56,928         110,222         112,402   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total TAC

   $ 152,896       $ 137,025       $ 302,927       $ 281,116   
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenue ex-TAC by segment:

           

Americas

   $ 768,634       $ 775,841       $ 1,549,424       $ 1,568,919   

EMEA

     104,953         93,912         201,491         182,212   

Asia Pacific

     202,541         211,016         389,539         406,780   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total Revenue ex-TAC

   $ 1,076,128       $ 1,080,769       $ 2,140,454       $ 2,157,911   
  

 

 

    

 

 

    

 

 

    

 

 

 

Direct costs by segment(1):

           

Americas

     171,042         181,510         333,940         360,735   

EMEA

     42,768         41,277         81,374         81,498   

Asia Pacific

     57,728         56,248         109,050         107,739   

Global operating costs(2)(3)

     393,037         410,519         808,663         832,417   

Restructuring charges, net

     237         129,092         10,812         134,809   

Depreciation and amortization

     161,373         157,739         321,811         310,987   

Stock-based compensation expense

     59,048         49,571         94,164         105,537   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from operations

   $ 190,895       $ 54,813       $ 380,640       $ 224,189   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Direct costs for each segment include cost of revenue—other as well as 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 2012, marketing and customer advocacy costs are managed locally and included as direct costs for each segment. Prior period amounts have been revised to conform to the current presentation.

(2) 

Global operating costs include product development, service engineering and operations, general and administrative, and other corporate expenses that are managed on a global basis and that are not directly attributable to any segment. Prior to 2012, marketing and customer advocacy costs were managed on a global basis and included as global operating costs. Prior period amounts have been revised to conform to the current presentation.

(3) 

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

 

     Three Months Ended      Six Months Ended  
     June 30,
2011
     June 30,
2012
     June 30,
2011
     June 30,
2012
 

Capital expenditures, net:

           

Americas

   $ 119,167       $ 96,443       $ 246,537       $ 179,327   

EMEA

     13,962         4,078         27,221         13,361   

Asia Pacific

     38,386         5,610         65,306         23,234   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capital expenditures, net

   $ 171,515       $ 106,131       $ 339,064       $ 215,922   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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     December 31,
2011
     June 30,
2012
 

Property and equipment, net:

     

Americas

   $ 1,489,096       $ 1,455,477   

EMEA

     79,955         56,571   

Asia Pacific

     161,837         151,617   
  

 

 

    

 

 

 

Total property and equipment, net

   $ 1,730,888       $ 1,663,665   
  

 

 

    

 

 

 

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,
2011
     June 30,
2012
     June 30,
2011
     June 30,
2012
 

Display

   $ 523,537       $ 534,972       $ 1,046,160       $ 1,046,189   

Search

     466,674         460,969         921,795         931,366   

Other

     238,813         221,853         475,426         461,472   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,229,024       $ 1,217,794       $ 2,443,381       $ 2,439,027   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended      Six Months Ended  
     June 30,
2011
     June 30,
2012
     June 30,
2011
     June 30,
2012
 

Revenue:

           

U.S.

   $ 759,042       $ 779,321       $ 1,538,011       $ 1,578,971   

International

     469,982         438,473         905,370         860,056   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,229,024       $ 1,217,794       $ 2,443,381       $ 2,439,027   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31,
2011
     June 30,
2012
 

Property and equipment, net:

     

U.S

   $ 1,486,596       $ 1,453,274   

International

     244,292         210,391   
  

 

 

    

 

 

 

Total property and equipment, net

   $ 1,730,888       $ 1,663,665   
  

 

 

    

 

 

 

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, 2012 was 35 percent compared to 30 percent for the same period in 2011. The effective tax rate for the three months ended June 30, 2012 was higher than in 2011 primarily due to the expiration of the U.S. federal research and development tax credit and to more earnings expected to be realized in countries that have higher statutory tax rates.

The effective tax rate reported for the six months ended June 30, 2012 was 34 percent compared to 28 percent for the same period in 2011. The rates in both periods were lower than the U.S. federal statutory rate primarily due to tax reserve reductions attributed to favorably settled tax audits and to a shift of the geographic mix of earnings. The effective tax rate for the six months ended June 30, 2012 was higher than in 2011 primarily due to the expiration of the U.S. federal research and development tax credit and to more earnings expected to be realized in countries that have higher statutory tax rates.

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 2011. 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, results of operations, or cash flows.

 

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The Company’s gross amount of unrecognized tax benefits as of June 30, 2012 is $521 million, of which $410 million is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of June 30, 2012 decreased by $12 million from the recorded balance as of December 31, 2011. While it is difficult to determine when these examinations will be settled or their final outcomes, certain audits in various jurisdictions related to multinational income tax issues are expected to be resolved in the foreseeable future. As a result, it is reasonably possible that the unrecognized tax benefits could be reduced by up to approximately $100 million in the next twelve months.

Note 14 RESTRUCTURING CHARGES, NET

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2011
    June 30,
2012
    June 30,
2011
    June 30,
2012
 

Employee severance pay and related costs

   $ (424   $ 91,736      $ 8,911      $ 94,727   

Non-cancelable lease, contract termination, and other charges

     1,187        2,147        3,179        4,873   

Other non-cash charges

     —          38,638        —          38,638   
  

 

 

   

 

 

   

 

 

   

 

 

 

Sub-total before reversal of stock-based compensation expense

     763        132,521        12,090        138,238   

Reversal of stock-based compensation expense for forfeitures

     (526     (3,429     (1,278     (3,429
  

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges, net

   $ 237      $ 129,092      $ 10,812      $ 134,809   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

2011 and Prior Restructuring Plans. Prior to and into 2011, the Company implemented workforce reductions, a strategic realignment, and consolidation of certain real estate facilities and data centers to reduce its cost structure, align resources with its product strategy, and improve efficiency. During the three and six months ended June 30, 2011, the Company incurred total pre-tax cash charges of $1 million and $12 million, respectively, in severance, facility, and other related costs. 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 for both the three and six months ended June 30, 2011. Of the $11 million in restructuring charges, net recorded in the six months ended June 30, 2011, $10 million related to the Americas segment and $1 million related to the EMEA segment.

During the three and six months ended June 30, 2012, the Company incurred total pre-tax cash charges of $2 million and $8 million, respectively, in severance, facility, and other related costs, the majority of which related to the Americas segment.

Q2’12 Restructuring Plan. During the second quarter of 2012, the Company began implementing a plan to reduce its worldwide workforce by approximately 2,000 employees and to consolidate certain real estate and data center facilities (the “Q2’12 Restructuring Plan”). During the three months ended June 30, 2012, the Company incurred total pre-tax cash charges of $91 million in severance related costs and $39 million in non-cash facility and other asset impairment charges. The total pre-tax charges were offset by a $3 million credit related to non-cash stock-based compensation expense reversals for unvested stock awards that were forfeited. Of the $127 million in restructuring charges, net, recorded in the three months ended June 30, 2012, $86 million related to the Americas segment, $35 million related to the EMEA segment, and $6 million related to the Asia Pacific segment. See Management Changes in Note 16 — “Subsequent Events” for further information.

Restructuring Accruals. The $103 million restructuring liability as of June 30, 2012 consists of $71 million for employee severance pay expenses, which the Company expects to pay out by the fourth quarter of 2013, and $32 million for non-cancelable lease costs that the Company expects to pay over the terms of the related obligations, which extend to the second quarter of 2017.

 

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The Company’s restructuring accrual activity for the six months ended June 30, 2012 is summarized as follows (in thousands):

 

     2011 and Prior
Restructuring
Plans
    Q2’12
Restructuring
Plan
    Total  

Balance as of January 1, 2012

   $ 49,127      $ —        $ 49,127   
  

 

 

   

 

 

   

 

 

 

Employee severance pay and related costs

     5,208        91,066        96,274   

Non-cash reversals of stock-based compensation expense

     —          (3,429     (3,429

Non-cancelable lease, contract termination, and other charges

     4,369        617        4,986   

Other non-cash charges

     —          38,638        38,638   

Reversals of previous charges

     (1,660     —          (1,660
  

 

 

   

 

 

   

 

 

 

Restructuring charges, net for the six months ended June 30, 2012

   $ 7,917      $ 126,892      $ 134,809   
  

 

 

   

 

 

   

 

 

 

Cash paid

     (20,761     (21,292     (42,053

Non-cash reversals of stock-based compensation expense

     —          3,429        3,429   

Other non-cash charges

     (232     (38,440     (38,672

Foreign currency

     (255     (3,843     (4,098
  

 

 

   

 

 

   

 

 

 

Payments/reductions, net for the six months ended June 30, 2012

   $ (21,248   $ (60,146   $ (81,394
  

 

 

   

 

 

   

 

 

 

Balance as of June 30, 2012

   $ 35,796      $ 66,746      $ 102,542   
  

 

 

   

 

 

   

 

 

 

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

 

     December 31,
2011
     June 30,
2012
 

Americas

   $ 41,199       $ 80,100   

EMEA

     6,948         18,132   

Asia Pacific

     980         4,310   
  

 

 

    

 

 

 

Total restructuring accruals

   $ 49,127       $ 102,542   
  

 

 

    

 

 

 

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. 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 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, 2011 and June 30, 2012, the Company had collected a total amount of $66 million and $48 million, respectively, on behalf of Microsoft and Affiliates, which was included in cash and cash equivalents with a corresponding liability in accrued expenses and other current liabilities. The Company’s uncollected 88 percent share in connection with the Search Agreement

 

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was $203 million and $215 million as of December 31, 2011 and June 30, 2012, respectively, which is included in accounts receivable, net.

The Company completed the transition of its algorithmic and paid search platforms to the Microsoft platform in the U.S. and Canada in the fourth quarter of 2010. In 2011, the Company completed the transition of algorithmic search in all other markets and the transition of paid search in India. In the second quarter of 2012, the Company completed the transition of paid search in certain EMEA markets including the United Kingdom, France, and Germany. The market-by-market transition of the Company’s paid search platform to Microsoft’s platform and the migration of paid search advertisers and publishers to Microsoft’s platform are expected to continue through 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. In the fourth quarter of 2011, Microsoft agreed to extend the RPS Guarantee in the U.S. and Canada through March 2013. 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.

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 $55 million and $111 million for the three and six months ended June 30, 2011, and $17 million and $34 million for the three and six months ended June 30, 2012, respectively. 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.

The Company’s results for the three and six months ended June 30, 2011 reflect transition cost reimbursements from Microsoft under the Search Agreement that were equal to the transition costs of $12 million and $23 million, respectively, incurred by Yahoo! related to the Search Agreement in the three and six months ended June 30, 2011. During the third quarter of 2011, the Company’s cumulative transition costs exceeded Microsoft’s $150 million reimbursement cap under the Search Agreement. Transition costs the Company incurs in excess of the $150 million reimbursement cap are not subject to reimbursement.

Reimbursement receivables are recorded as the reimbursable costs are incurred and are applied against the operating expense categories in which the costs were incurred. As of December 31, 2011, a total of $238 million of reimbursable expenses related to 2011 had been incurred by the Company related to the Search Agreement. Of that amount, $16 million had not been received from Microsoft and was classified as part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets as of December 31, 2011. For the second quarter of 2012, a total of $17 million of search operating cost reimbursements had been incurred by the Company related to the Search Agreement. Of that amount, $6 million had not been received from Microsoft and was classified as part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets as of June 30, 2012.

Note 16 SUBSEQUENT EVENTS

Management Changes. On July 16, 2012, the Company entered into an employment offer letter (the “Agreement”) with respect to the appointment of Marissa A. Mayer as the Company’s Chief Executive Officer and President, effective July 17, 2012. The Agreement has no specified term, and Ms. Mayer’s employment with the Company will be on an at-will basis

This Agreement provides that Ms. Mayer will receive an annual base salary of $1 million, subject to annual review. She is also eligible for an annual bonus under the Company’s Executive Incentive Plan with a target amount of 200 percent of base salary. The actual amount of the annual bonus will be determined by the Compensation and Leadership Development Committee of the Board (the “Compensation Committee”) based upon two criteria: (i) the Company’s financial performance and, (ii) if applicable under the Company’s bonus plan for that year, Ms. Mayer’s performance. The 2012 bonus will be prorated based on her period of employment in 2012.

2012 Annual Equity Awards (Vesting Over Three Years). Ms. Mayer will receive an equity award for 2012 that will vest over three years. A total of $6 million of this equity award was granted as restricted stock units on July 26, 2012 and will vest over three years. A total of $6 million will be granted in the form of a performance-based stock option that is expected to be granted in November 2012. The stock option will be subject to both time-based and performance-based vesting requirements over the next two and a half years. The Compensation Committee will establish the performance vesting criteria after consulting Ms. Mayer.

After 2012, Ms. Mayer will be eligible to receive annual equity grants when such grants are made to senior executives. Subject to the Compensation Committee’s discretion, the Company contemplates that the target value of such awards will not be less than the target value of her 2012 annual grant.

One-Time Retention Award (Vesting Over Five Years). Ms. Mayer will receive a one-time retention equity award that will vest over five years. A total of $15 million of this equity award was granted as restricted stock units on July 26, 2012 and will vest over five years. A total of $15 million of this equity award will be granted in the form of a performance-based stock option that is expected

 

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to be granted in November 2012. The stock option will be subject to both time-based and performance-based vesting requirements over the next four and a half years. The Compensation Committee will establish the performance vesting criteria after consulting Ms. Mayer.

Make-Whole Restricted Stock Units (Vesting Over 29 Months). To partially compensate Ms. Mayer for forfeiture of compensation from her previous employer, on July 26, 2012 she was granted restricted stock units with a grant-date value of $14 million (the “Make-Whole RSUs”).The Make-Whole RSUs are scheduled to vest on the following schedule, based on grant date values: $4 million in 2012, $7 million in 2013, and $3 million in 2014.

Ms. Mayer is engaging in a review of the Company’s business strategy to enhance long term shareholder value. As part of that review, Ms. Mayer intends to review with the Board of Directors, among other things, the Company’s growth and acquisition strategy, the restructuring plan the Company began implementing in the second quarter of 2012, and the Company’s cash position and planned capital allocation strategy. This review process may lead to a reevaluation of, or changes to, the Company’s current plans, including its restructuring plan, its share repurchase program, and its previously announced plans for returning to shareholders substantially all of the after tax cash proceeds of the initial share repurchase by Alibaba Group under the Repurchase Agreement described in Note 4 — “Investments in Equity Interests.”

Stock Repurchase Transactions. From July 1, 2012 through August 9, 2012, the Company repurchased approximately 12.2 million shares of its common stock at an average price of $15.62 per share, for a total of $190 million. Of such repurchases, $79 million was under the June 2010 repurchase program and $111 million was under the May 2012 repurchase program.

Forward Contract. On August 7, 2012, the Company entered into a new forward contract with a notional value equivalent of approximately $400 million, which will mature on March 28, 2013.

 

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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 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;

 

   

projections and estimates with respect to our restructuring activities and changes to our organizational structure; 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 focused on creating deeply personal digital experiences that keep more than half a billion people connected to what matters most to them, across devices and around the globe. Our unique combination of Science + Art + Scale connects advertisers to the consumers who build their businesses. We provide online properties and services (“Yahoo! Properties”) to users as well as a range of marketing services designed to reach and connect with those users on Yahoo! Properties and through a distribution network of third-party entities (“Affiliates”). These Affiliates integrate our advertising offerings into their Websites or other offerings (those Websites and other offerings, “Affiliate sites”).

New Chief Executive Officer and Review of Business Strategy

On July 17, 2012, Marissa A. Mayer became our Chief Executive Officer and a member of our Board of Directors. Ms. Mayer is engaging in a review of the Company’s business strategy to enhance long term shareholder value. As part of that review, Ms. Mayer intends to review with the Board of Directors, among other things, the Company’s growth and acquisition strategy, the restructuring plan we began implementing in the second quarter of 2012, and the Company’s cash position and planned capital allocation strategy. This review process may lead to a reevaluation of, or changes to, our current plans, including our restructuring plan, our share repurchase program, and our previously announced plans for returning to shareholders substantially all of the after tax cash proceeds of the initial share repurchase by Alibaba Group under the Repurchase Agreement described below.

Agreement with Alibaba Group to Repurchase Yahoo! Stake

On May 20, 2012, we entered into a Share Repurchase and Preference Share Sale Agreement (the “Repurchase Agreement”) with Alibaba Group Holding Limited (“Alibaba Group”) and Yahoo! Hong Kong Holdings Limited, a Hong Kong corporation and wholly-owned subsidiary of Yahoo!, to sell to Alibaba Group up to one-half of our stake, or approximately 20 percent of Alibaba Group’s fully-diluted ordinary shares (“Shares”), at a minimum price of $13.50 per Share, payable in a combination of cash and up to $800 million of Alibaba preference shares. We expect this initial repurchase will occur within six months of May 20, 2012, the date of signing of the Repurchase Agreement.

In addition to the initial repurchase described above, at the time of an initial public offering of Alibaba Group meeting certain specified criteria (“Qualified IPO”), we will sell, at Alibaba Group’s election, (either directly to Alibaba Group or in the Qualified IPO) up to 261.5 million Shares.

See Note 4 — “Investments in Equity Interests” in the Notes to the condensed consolidated financial statements for additional information.

 

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Second Quarter Highlights

 

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

Operating Highlights

   2011      2012        2011      2012     
     (In thousands)  

Revenue

   $ 1,229,024       $ 1,217,794       $ (11,230   $ 2,443,381       $ 2,439,027       $ (4,354

Income from operations

   $ 190,895       $ 54,813       $ (136,082   $ 380,640       $ 224,189       $ (156,451

 

     Six Months Ended     Dollar
Change
 
     June 30,    

Cash Flow Results

   2011     2012    
     (In thousands)  

Net cash provided by operating activities

   $ 536,306      $ 572,013      $ 35,707   

Net cash used in investing activities

   $ (3,138   $ (100,628   $ (97,490

Net cash used in financing activities

   $ (521,437   $ (472,082   $ 49,355   

Our revenue decreased 1 percent and was flat for the three and six months ended June 30, 2012, respectively, compared to the same periods in 2011. This can be attributed primarily to decrease in other revenue. The decrease in income from operations of $136 million and $156 million for the three and six months ended June 30, 2012, respectively, reflects a decrease in revenue and an increase in operating expenses compared to the same periods in 2011. The increase in operating expenses is primarily attributable to increases in restructuring charges of $129 million and $124 million for the three and six months ended June 30, 2012, respectively.

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, 2012 generated adequate cash to meet our operating needs. Cash used by investing activities in the six months ended June 30, 2012 included net proceeds from sales, maturities, and purchases of marketable debt securities of $102 million offset by net capital expenditures of $216 million. Cash used in financing activities included $526 million used in the direct repurchase of common stock and $38 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 $78 million in proceeds from employee option exercises and employee stock purchases.

During the second quarter of 2012, we began implementing a plan to reduce our worldwide workforce by approximately 2,000 employees and to consolidate certain real estate and data center facilities (the “Q2’12 Restructuring Plan”). During the three months ended June 30, 2012, we incurred total pre-tax cash charges of $91 million in severance related costs and $39 million in non-cash facility and other asset impairment charges. The total pre-tax charges were offset by a $3 million credit related to non-cash stock-based compensation expense reversals for unvested stock awards that were forfeited.

Search Agreement with Microsoft Corporation

On December 4, 2009, we entered into a Search and Advertising Services and Sales Agreement (the “Search Agreement”) with Microsoft Corporation (“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. We also entered into a License Agreement with Microsoft pursuant to which Microsoft acquired an exclusive 10-year license to our core search technology that it will be able to integrate into its existing Web search platforms.

During the first five years of the Search Agreement, in the transitioned markets, we are entitled to receive 88 percent of the revenue generated from Microsoft’s services on Yahoo! Properties. 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. 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 and publishers.

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. In the fourth quarter of 2011, Microsoft agreed to extend the RPS Guarantee in the U.S. and Canada through March 2013. 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 is typically the quarter in which the associated shortfall in revenue per search occurred.

Under the Search Agreement, Microsoft 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. Our results for the three and six months ended June 30, 2011 reflect transition cost reimbursements from Microsoft under the Search Agreement that were equal to transition costs of $12 million and $23 million, respectively, incurred by Yahoo! related to the Search Agreement in the those periods. During the third quarter of 2011, our

 

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cumulative transition costs exceeded Microsoft’s $150 million reimbursement cap under the Search Agreement. Transition costs we incur in excess of the $150 million reimbursement cap are not subject to reimbursement.

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. The Company’s results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $55 million and $111 million for the three and six months ended June 30, 2011, and $17 million and $34 million for the three and six months ended June 30, 2012, respectively. 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. Search operating cost reimbursements are expected to decline as we fully transition all markets and, in the long term, the underlying expenses are not expected to be incurred under our cost structure.

We completed the transition of our algorithmic and paid search platforms to the Microsoft platform in the U.S. and Canada in the fourth quarter of 2010. In 2011, we completed the transition of algorithmic search in all other markets and the transition of paid search in India. In the second quarter of 2012, we completed the transition of paid search in certain EMEA (Europe, Middle East, and Africa) markets including the United Kingdom, France, and Germany. The market-by-market transition of our paid search platform to Microsoft’s platform and the migration of paid search advertisers and publishers to Microsoft’s platform are expected to continue through 2013.

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 during the year ended December 31, 2011, total reimbursements of $16 million not yet received from Microsoft were classified as part of prepaid expenses and other current assets on our condensed consolidated balance sheets as of December 31, 2011. For the second quarter of 2012, a total of $17 million of search operating cost reimbursements had been incurred by us related to the Search Agreement. Of that amount, $6 million had not been received from Microsoft and was classified as part of prepaid expenses and other current assets on our condensed consolidated balance sheets as of June 30, 2012.

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 were as follows (dollars in thousands):

 

     Three Months Ended June 30,     Percent
Change
    Six Months Ended June 30,     Percent
Change
 
     2011      (*)     2012      (*)       2011      (*)     2012      (*)    

Display

   $ 523,537         43   $ 534,972         44     2   $ 1,046,160         43   $ 1,046,189         43     0

Search

     466,674         38     460,969         38     (1 )%      921,795         38     931,366         38     1

Other

     238,813         19     221,853         18     (7 )%      475,426         19     461,472         19     (3 )% 
  

 

 

    

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

    

 

 

   

Total revenue

   $ 1,229,024         100   $ 1,217,794         100     (1 )%    $ 2,443,381         100   $ 2,439,027         100     0
  

 

 

    

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

    

 

 

   

 

(*) 

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.

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 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 months ended June 30, 2012 increased by 2 percent compared to the same period in 2011. Display revenue for the six months ended June 30, 2012 was flat compared to the same period in 2011. For the three months ended June 30, 2012, our year-over-year growth can be attributed to increased display revenue in the Asia Pacific region due

 

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to guaranteed display revenue growth in certain markets, offset by a decline in display revenue for the EMEA region due to continued weakness in the macroeconomic climate. For the three and six months ended June 30, 2012, Display Page Views decreased 4 percent and 5 percent, respectively, and revenue per Display Page View increased 6 percent and 5 percent, respectively, compared to the same periods in 2011 due to the increase in display revenue as discussed above.

Search Revenue. Search revenue for the three and six months ended June 30, 2012 decreased by 1 percent and increased by 1 percent, respectively, compared to the same periods in 2011. For the three months ended June 30, 2012, search revenue declined due to decreased Affiliate search revenue in the EMEA region as well as the required change in revenue presentation associated with the transition of paid search in certain markets to Microsoft’s search platform. This decline was offset by increased search revenue in the Americas regions due to an increase in sponsored search on Yahoo! Properties. For the six months ended June 30, 2012, the increase in search revenue is primarily attributable to an increase in sponsored search on Yahoo! Properties offset by declines in search revenue in the EMEA region as discussed above. For the three and six months ended June 30, 2012, Search Page Views decreased 25 percent and 17 percent, respectively. For the three and six months ended June 30, 2012, revenue per Search Page View increased 31 percent and 22 percent, respectively, compared to the same periods in 2011, due to the factors discussed above.

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, 2012 decreased by 7 percent and 3 percent, respectively, compared to the same periods in 2011. The decreases, for the three and six months ended June 30, 2012, are primarily attributable to a decline in revenue from certain of our broadband access partnerships in the Americas region. This decline is partially offset by an increase in the Americas region due to a new partner as well as an increase in royalty revenue.

Costs and Expenses. Operating costs and expenses consist of cost of revenue — traffic acquisition costs (“TAC”), cost of revenue — other, sales and marketing, product development, general and administrative, amortization of intangible assets, and restructuring charges, net. Cost of revenue — other consists of 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
 
     2011      (1)     2012      (1)      

Cost of revenue — TAC

   $ 152,896         12   $ 137,025         11   $ (15,871     (10 )% 

Cost of revenue — Other

   $ 231,388         19   $ 278,453         23   $ 47,065        20

Sales and marketing

   $ 280,159         23   $ 272,910         22   $ (7,249     (3 )% 

Product development

   $ 233,045         19   $ 199,628         16   $ (33,417     (14 )% 

General and administrative

   $ 131,822         11   $ 136,117         11   $ 4,295        3

Amortization of intangibles

   $ 8,582         1   $ 9,756         1   $ 1,174        14

Restructuring charges, net

   $ 237         0   $ 129,092         11   $ 128,855        N/M  (2) 

 

     Six Months Ended June 30,     Dollar
Change
    Percent
Change
 
     2011      (1)     2012      (1)      

Cost of revenue — TAC

   $ 302,927         12   $ 281,116         12   $ (21,811     (7 )% 

Cost of revenue — Other

   $ 481,014         20   $ 532,432         22   $ 51,418        11

Sales and marketing

   $ 542,308         22   $ 558,178         23   $ 15,870        3

Product development

   $ 454,328         19   $ 428,106         18   $ (26,222     (6 )% 

General and administrative

   $ 254,720         10   $ 260,388         11   $ 5,668        2

Amortization of intangibles

   $ 16,632         1   $ 19,809         1   $ 3,177        19

Restructuring charges, net

   $ 10,812         0   $ 134,809         6   $ 123,997        N/M  (2) 

 

(1) 

Percent of total revenue.

(2) 

N/M = not meaningful.

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

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2012     2011     2012  

Cost of revenue — Other

   $ 875      $ 2,614      $ 1,523      $ 5,508   

Sales and marketing

     19,373        18,981        26,070        40,078   

Product development

     25,531        17,808        43,203        37,279   

General and administrative

     13,269        10,168        23,368        22,672   

Restructuring expense reversals, net

     (526     (3,429     (1,278     (3,429
  

 

 

   

 

 

   

 

 

   

 

 

 

Total stock-based compensation expense

   $ 58,522      $ 46,142      $ 92,886      $ 102,108   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2011 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Traffic Acquisition Costs for Non-transitioned Search Markets and All Markets for Display. TAC consist 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 two 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, or variable payments based on a percentage of our revenue or based on a certain metric, such as number of searches or paid clicks. 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 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, 2012 compared to the three months ended June 30, 2011 are comprised of the following (in thousands):

 

     Compensation     Information
Technology
    Depreciation  and
Amortization
    TAC     Facilities     Other     Total  

Cost of revenue — TAC

   $ —        $ —        $ —        $ (15,871   $ —        $ —        $ (15,871

Cost of revenue — Other

     6,846        25,392        4,950        —          312        9,565        47,065   

Sales and marketing

     14,937        64        (336     —          665        (22,579     (7,249

Product development

     (13,684     (5,821     (5,143     —          (5,056     (3,713     (33,417

General and administrative

     (5,095     533        (1,967     —          2,594        8,230        4,295   

Amortization of intangibles

     —          —          1,174        —          —          —          1,174   

Restructuring charges, net

     —          —          —          —          —          128,855        128,855   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 3,004      $ 20,168      $ (1,322   $ (15,871   $ (1,485   $ 120,358      $ 124,852   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The changes in operating costs and expenses for the six months ended June 30, 2012 compared to the six months ended June 30, 2011 are comprised of the following (in thousands):

 

     Compensation     Information
Technology
    Depreciation  and
Amortization
    TAC     Facilities     Other     Total  

Cost of revenue — TAC

   $ —        $ —        $ —        $ (21,811   $ —        $ —        $ (21,811

Cost of revenue — Other

     12,158        37,075        (287     —          962        1,510        51,418   

Sales and marketing

     47,504        (150     (839     —          980        (31,625     15,870   

Product development

     (5,401     (5,302     (5,267     —          (6,624     (3,628     (26,222

General and administrative

     (9,174     1,377        (5,297     —          4,367        14,395        5,668   

Amortization of intangibles

     —          —          3,177        —          —          —          3,177   

Restructuring charges, net

     —          —          —          —          —          123,997        123,997   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 45,087      $ 33,000      $ (8,513   $ (21,811   $ (315   $ 104,649      $ 152,097   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Compensation Expense. Total compensation expense increased $3 million and $45 million for the three and six months ended June 30, 2012, respectively, as compared to the same periods in 2011. For the three months ended June 30, 2012, the increase is primarily attributable to higher salaries and sales commissions in sales and marketing due to increased headcount in the sales function. This is offset by a decrease in stock based compensation expense due to cancellations related to the Q2’12 Restructuring Plan (defined below) and lower Employee Stock Purchase Plan expense due to lower estimated contributions. For the six months ended June 30, 2012, the increase is primarily attributable to higher stock based compensation expense and higher salaries and sales commissions in sales and marketing due to increased headcount in the sales function. The increase in stock-based compensation expense, which is driven by the impact of awards granted in the second half of 2011, is offset by lower Employee Stock Purchase Plan expense due to lower estimated contributions. Excluding the impact of Microsoft reimbursements, compensation expense for the three and six months ended June 30, 2012 decreased $10 million and increased $20 million, respectively, compared to the same periods of 2011. Microsoft reimbursements decreased $13 million and $25 million, respectively, during the three and six months ended June 30, 2012, compared to the same periods of 2011. The decrease in Microsoft reimbursements for the three and six months ended June 30, 2012 was due to the transition of paid search to the Microsoft platform.

 

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Information Technology. Information technology expense increased $20 million and $33 million for the three and six months ended June 30, 2012, respectively, as compared to the same periods in 2011. The increase in information technology expense for the three and six months ended June 30, 2012 was primarily attributable to decreased Microsoft reimbursements of $17 million and $34 million, respectively, compared to the same periods of 2011. Excluding the impact of Microsoft reimbursements, information technology expense for the three and six months ended June 30, 2012 increased $3 million and decreased $1 million, respectively, compared to the same periods of 2011. The decrease in Microsoft reimbursements for the three and six months ended June 30, 2012 was due to the transition of paid search to the Microsoft platform.

Depreciation and Amortization. Depreciation and amortization expense decreased $1 million and $9 million for the three and six months ended June 30, 2012, respectively, as compared to the same periods in 2011. The decline for the three and six months ended June 30, 2012 is primarily attributable to a decrease in depreciation expense for fully depreciated assets acquired in prior years. This decline was partially offset by increased amortization of intangibles related to the acquisition of interclick in the fourth quarter of 2011. Excluding the impact of Microsoft reimbursements, depreciation and amortization expense for the three and six months ended June 30, 2012 decreased $5 million and $20 million, respectively, compared to the same periods of 2011. Microsoft reimbursements decreased $4 million and $11 million, respectively, during the three and six months ended June 30, 2012, compared to the same periods of 2011. The decrease in Microsoft reimbursements for the three and six months ended June 30, 2012 was due to the transition of paid search to Microsoft platforms.

TAC. TAC decreased $16 million and $22 million for the three and six months ended June 30, 2012, respectively, as compared to the same periods in 2011. For the three and six months ended June 30, 2012, the decrease in TAC is primarily attributable to the loss of Affiliates in the EMEA region as well as the change in the recording of TAC associated with the transition of paid search in certain markets to Microsoft’s search platform. This decline is offset by an increase in the Americas region due to the inclusion of interclick display TAC.

Facilities and Other Expenses. Facilities and other expenses increased $119 million and $104 million for the three and six months ended June 30, 2012, compared to the same periods in 2011. Excluding the impact of Microsoft reimbursements, facilities and other expenses for the three and six months ended June 30, 2012 increased $115 million and $98 million, respectively, primarily due to increases in restructuring charges of $129 million and $124 million for the three and six months ended June 30, 2012, respectively. These increases were offset by decreased marketing expenses of $17 million and $22 million for the three and six months ended June 30, 2012, respectively. The increase in facilities and other expenses was due to decreased Microsoft reimbursements of $4 million and $6 million during the three and six months ended June 30, 2012, respectively, compared to the same periods of 2011. The decrease in Microsoft reimbursements for the three and six months ended June 30, 2012 was due to the transition of paid search to the Microsoft platform.

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2011
    June 30,
2012
    June 30,
2011
    June 30,
2012
 

Employee severance pay and related costs

   $ (424   $ 91,736      $ 8,911      $ 94,727   

Non-cancelable lease, contract termination, and other charges

     1,187        2,147        3,179        4,873   

Other non-cash charges

     —          38,638        —          38,638   
  

 

 

   

 

 

   

 

 

   

 

 

 

Sub-total before reversal of stock-based compensation expense

     763        132,521        12,090        138,238   

Reversal of stock-based compensation expense for forfeitures

     (526     (3,429     (1,278     (3,429
  

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges, net

   $ 237      $ 129,092      $ 10,812      $ 134,809   
  

 

 

   

 

 

   

 

 

   

 

 

 

2011 and Prior Restructuring Plans. Prior to and into 2011, we implemented workforce reductions, a strategic realignment, and consolidation of certain real estate facilities and data centers. The restructuring plans were to reduce our cost structure, align resources with our product strategy and improve efficiency. During the three and six months ended June 30, 2011, we incurred total pre-tax cash charges of $1 million and $12 million, respectively, in severance, facility, and other related costs. 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 for both the three and six months ended June 30, 2011. Of the $11 million in restructuring charges, net recorded in the six months ended June 30, 2011, $10 million related to the Americas segment and $1 million related to the EMEA segment.

During the three and six months ended June 30, 2012, we incurred total pre-tax cash charges of $2 million and $8 million, respectively, in severance, facility, and other related costs, the majority of which related to the Americas segment.

 

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As of June 30, 2012, the aggregate outstanding restructuring liability related to the 2011 and prior restructuring plans was approximately $36 million, most of which relate to non-cancelable lease costs that we expect to pay over the terms of the related obligations, which extend to second quarter of 2017.

Q2’12 Restructuring Plan. During the second quarter of 2012, we began implementing the Q2’12 Restructuring Plan. During the three months ended June 30, 2012, we incurred total pre-tax cash charges of $91 million in severance related costs and $39 million in non-cash facility and other asset impairment charges. The total pre-tax charges were offset by a $3 million credit related to non-cash stock-based compensation expense reversals for unvested stock awards that were forfeited. Of the $127 million in restructuring charges, net recorded in the three months ended June 30, 2012, $86 million related to the Americas segment, $35 million related to the EMEA segment, and $6 million related to the Asia Pacific segment. As of June 30, 2012, the aggregate outstanding restructuring liability related to the Q2’12 Restructuring Plan was $67 million, most of which relate to severance and other related costs that we expect to be substantially paid by the fourth quarter of 2013.

See Note 14 — “Restructuring charges, net” in the Notes to the condensed consolidated financial statements for additional information.

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, 2012 was 35 percent compared to 30 percent for the same period in 2011. The effective tax rate for the three months ended June 30, 2012 was higher than in 2011 primarily due to the expiration of the U.S. federal research and development tax credit and to more earnings expected to be realized in countries that have higher statutory tax rates.

The effective tax rate reported for the six months ended June 30, 2012 was 34 percent compared to 28 percent for the same period in 2011. The rates in both periods were lower than the U.S. federal statutory rate primarily due to tax reserve reductions attributed to favorably settled tax audits and to a shift of the geographic mix of earnings. The effective tax rate for the six months ended June 30, 2012 was higher than in 2011 primarily due to the expiration of the U.S. federal research and development tax credit and to more earnings expected to be realized in countries that have higher statutory tax rates

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 2011. 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, results of operations, or cashflows.

Our gross amount of unrecognized tax benefits as of June 30, 2012 is $521 million, of which $410 million is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of June 30, 2012 decreased by $12 million from the recorded balance as of December 31, 2011. While it is difficult to determine when these examinations will be settled or their final outcomes, certain audits in various jurisdictions related to multinational income tax issues are expected to be resolved in the foreseeable future. As a result, it is reasonably possible that the unrecognized tax benefits could be reduced by up to approximately $100 million in the next twelve months.

Earnings in Equity Interests. Earnings in equity interests for the three and six months ended June 30, 2012 was $180 million and $352 million, respectively, compared to $109 million and $191 million for the same periods in 2011. The increases for the three and six months ended June 30, 2012 were primarily due to improved financial performance for Alibaba Group. 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.

Business Segment Results

We continue to manage our business geographically. The primary areas of measurement and decision-making are currently Americas, EMEA, and Asia Pacific. Management relies on an internal reporting process that provides revenue ex-TAC, which is defined as revenue less TAC, 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.

 

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

 

     Three Months Ended            Six Months Ended         
     June 30,
2011
     June 30,
2012
     Percent
Change
    June 30,
2011
     June 30,
2012
     Percent
Change
 

Revenue by segment:

                

Americas

   $ 808,038       $ 821,751         2   $ 1,626,969       $ 1,657,784         2

EMEA

     162,601         128,099         (21 )%      316,651         262,061         (17 )% 

Asia Pacific

     258,385         267,944         4     499,761         519,182         4
  

 

 

    

 

 

      

 

 

    

 

 

    

Total revenue

   $ 1,229,024       $ 1,217,794         (1 )%    $ 2,443,381       $ 2,439,027         0
  

 

 

    

 

 

      

 

 

    

 

 

    

TAC by segment:

                

Americas

   $ 39,404       $ 45,910         17   $ 77,545       $ 88,865         15

EMEA

     57,648         34,187         (41 )%      115,160         79,849         (31 )% 

Asia Pacific

     55,844         56,928         2     110,222         112,402         2
  

 

 

    

 

 

      

 

 

    

 

 

    

Total TAC

   $ 152,896       $ 137,025         (10 )%    $ 302,927       $ 281,116         (7 )% 
  

 

 

    

 

 

      

 

 

    

 

 

    

Revenue ex-TAC by segment:

                

Americas

   $ 768,634       $ 775,841         1   $ 1,549,424       $ 1,568,919         1

EMEA

     104,953         93,912         (11 )%      201,491         182,212         (10 )% 

Asia Pacific

     202,541         211,016         4     389,539         406,780         4
  

 

 

    

 

 

      

 

 

    

 

 

    

Total revenue ex-TAC

   $ 1,076,128       $ 1,080,769         0   $ 2,140,454       $ 2,157,911         1
  

 

 

    

 

 

      

 

 

    

 

 

    

Direct costs by segment(1):

                

Americas

     171,042         181,510         6     333,940         360,735         8

EMEA

     42,768         41,277         (3 )%      81,374         81,498         0

Asia Pacific

     57,728         56,248         (3 )%      109,050         107,739         (1 )% 

Global operating costs(2)(3)

     393,037         410,519         4     808,663         832,417         3

Restructuring charges, net

     237         129,092         N/M (4)      10,812         134,809         N/M (4) 

Depreciation and amortization

     161,373         157,739         (2 )%      321,811         310,987         (3 )% 

Stock-based compensation expense

     59,048         49,571         (16 )%      94,164         105,537         12
  

 

 

    

 

 

      

 

 

    

 

 

    

Income from operations

   $ 190,895       $ 54,813         (71 )%    $ 380,640       $ 224,189         (41 )% 
  

 

 

    

 

 

      

 

 

    

 

 

    

 

(1) 

Direct costs for each segment include cost of revenue—other as well as 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 2012, marketing and customer advocacy costs are managed locally and included as direct costs for each segment. Prior period amounts have been revised to conform to the current presentation.

(2) 

Global operating costs include product development, service engineering and operations, general and administrative, and other corporate expenses that are managed on a global basis and that are not directly attributable to any particular segment. Prior to 2012, marketing and customer advocacy costs were managed on a global basis and included as global operating costs. Prior period amounts have been revised to conform to the current presentation.

(3) 

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

(4) 

N/M = not meaningful.

Americas. Americas revenue ex-TAC for the three and six months ended June 30, 2012 increased $7 million, or 1 percent, and $19 million, or 1 percent, respectively, as compared to the same periods in 2011. For the three and six months ended June 30, 2012, our year over year increase in Americas revenue ex-TAC was primarily attributable to increases in search revenue ex-TAC offset by decreases in other revenue ex-TAC. Search revenue ex-TAC increased due to increases in sponsored search on Yahoo! Properties. Other revenue ex-TAC decreased primarily due to a decline in revenue from certain of our broadband access partnerships. For the three and six months ended June 30, 2012 direct costs attributable to the Americas segment increased $10 million, or 6 percent, and $27 million, or 8 percent, respectively, compared to the same periods in 2011. For the three and six months ended June 30, 2012, the year-over-year increases in direct costs were primarily due to higher compensation costs and higher content costs offset by lower marketing expenses.

Revenue ex-TAC in the Americas accounted for approximately 72 percent and 73 percent of total revenue ex-TAC in the three and six months ended June 30, 2012, respectively, compared to 71 percent and 72 percent for the three and six months ended June 30, 2011, respectively.

 

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EMEA. EMEA revenue ex-TAC for the three and six months ended June 30, 2012 decreased $11 million, or 11 percent, and $19 million, or 10 percent, respectively, as compared to the same periods in 2011. For the three and six months end June 30, 2012, the year-over-year declines in EMEA revenue ex-TAC were primarily related to decreased search revenue ex-TAC. Search revenue ex-TAC declined due to loss of Affiliates in the region and traffic quality initiatives conducted by Yahoo! For the three months ended June 30, 2012, direct costs attributable to the EMEA segment decreased $1 million, or 3 percent compared to the same period in 2011. For the three months ended June 30, 2012, the decline was primarily due to decreased marketing expenses in the region. For the six months ended June 30, 2012, direct costs attributable to the EMEA segment were flat compared to the same period in 2011.

Revenue ex-TAC in EMEA accounted for approximately 9 percent and 8 percent of total revenue ex-TAC for the three and six months ended June 30, 2012, respectively, compared to 10 percent and 9 percent for the three and six months ended June 30, 2011, respectively.

Asia Pacific. Asia Pacific revenue ex-TAC for the three and six months ended June 30, 2012 increased $8 million, or 4 percent, and $17 million, or 4 percent, respectively, as compared to the same periods in 2011. For the three and six months ended June 30, 2012, the increases in Asia Pacific revenue ex-TAC were driven by increased display and other revenue ex-TAC. Display revenue ex-TAC increased due to an increase in guaranteed display revenue in certain markets. Other revenue ex-TAC increased due to increased listings revenue. For the three and six months ended June 30, 2012, direct costs attributable to the Asia Pacific segment decreased $1 million, or 3 percent, and $1 million, or 1 percent, respectively, compared to the same periods in 2011. For the three and six months ended June 30, 2012, the year-over-year decreases were primarily due to decreased marketing expenses offset by higher compensation and bandwidth costs.

Revenue ex-TAC in Asia Pacific accounted for approximately 20 percent and 19 percent of total revenue ex-TAC for the three and six months ended June 30, 2012, respectively, compared to 19 percent and 18 percent for the three and six months ended June 30, 2011, 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, 2011, revenue ex-TAC for the Americas segment for the three and six months ended June 30, 2012 would have been higher than we reported by $3 million and $4 million, respectively, revenue ex-TAC for the EMEA segment would have been higher than we reported by $5 million and $7 million, respectively, and revenue ex-TAC for the Asia Pacific segment would have been higher than we reported by $3 million and $1 million, respectively. Using the foreign currency exchange rates from the three and six months ended June 30, 2011, direct costs for the Americas segment for the three and six months ended June 30, 2012 would have been higher than we reported by $1 million and $2 million, respectively, direct costs for the EMEA segment would have been higher than we reported by $2 million and $3 million, respectively, and direct costs for the Asia Pacific segment would have been higher than we reported by $1 million for both periods.

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, 2011 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, 2011.

 

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Liquidity and Capital Resources

 

     December 31,
2011
    June 30,
2012
 
     (Dollars in thousands)  

Cash and cash equivalents

   $ 1,562,390      $ 1,539,269   

Short-term marketable debt securities

     493,189        371,204   

Long-term marketable debt securities

     474,338        490,570   
  

 

 

   

 

 

 

Total cash, cash equivalents, and marketable debt securities

   $ 2,529,917      $ 2,401,043   
  

 

 

   

 

 

 

Percentage of total assets

     17     16
  

 

 

   

 

 

 

 

     Six Months Ended
June 30,
 

Cash Flow Highlights

   2011     2012  
     (In thousands)  

Net cash provided by operating activities

   $ 536,306      $ 572,013   

Net cash used in investing activities

   $ (3,138   $ (100,628

Net cash used in financing activities

   $ (521,437   $ (472,082

Our operating activities for the six months ended June 30, 2012 generated adequate cash to meet our operating needs. As of June 30, 2012, we had cash, cash equivalents, and marketable debt securities totaling $2.4 billion, compared to $2.5 billion at December 31, 2011. During the six months ended June 30, 2012, we repurchased approximately 34 million shares of our outstanding common stock for $526 million.

During the six months ended June 30, 2012, we generated $572 million of cash from operating activities, net proceeds from sales, maturities and purchases of marketable debt securities of $102 million, and $78 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 $216 million in capital expenditures, $38 million in tax withholding payments related to net share settlements of restricted stock units, and $526 million used in the direct repurchase of common stock. During the six months ended June 30, 2011, we generated $536 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, a net $69 million for acquisitions, $609 million used in the direct repurchase of common stock, and $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.

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, 2012, approximately $3.5 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 $1.2 billion of our total $2.4 billion of cash, cash equivalents, and marketable debt securities as of June 30, 2012. 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 2012. 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, 2012 due to changes in working capital.

During the six months ended June 30, 2012, cash used in investing activities was primarily attributable to capital expenditures, offset by net proceeds from the sales and maturities of marketable debt securities and $26 million of proceeds from the sale of investments. In the six months ended June 30, 2012, we received net proceeds from sales, maturities, and purchases of marketable

 

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debt securities of $102 million, which was offset by the investment of $216 million in net capital expenditures. 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, $69 million for net acquisitions, and $11 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 $78 million for the six months ended June 30, 2012, compared to $99 million for the same period of 2011. During the six months ended June 30, 2012, we used $526 million in the direct repurchase of approximately 34 million shares of common stock at an average price of $15.36 per share. We used $38 million for tax withholding payments related to net share settlements of restricted stock units. During the six months ended June 30, 2011, we used $609 million in the direct repurchase of approximately 39 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.

Capital expenditures

Capital expenditures have generally been comprised of purchases of computer hardware, software, server equipment, furniture and fixtures, and real estate. Capital expenditures, net were $216 million for the six months ended June 30, 2012, compared to $339 million in the same period of 2011.

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 2012 and 2022.

A summary of lease commitments as of June 30, 2012 is as follows (in millions):

 

     Gross Operating
Lease Commitments
     Capital Lease
Commitment
 

Six months ending December 31, 2012

   $ 77       $ 4   

Years ending December 31,

     

2013

     136         9   

2014

     106         8   

2015

     81         8   

2016

     45         8   

2017

     31         9   

Due after 5 years

     38         14   
  

 

 

    

 

 

 

Total gross lease commitments

   $ 514       $ 60   
  

 

 

    

 

 

 

Less: interest

     —           (21
  

 

 

    

 

 

 

Net lease commitments

   $ 514       $ 39   
  

 

 

    

 

 

 

Affiliate Commitments. In connection with contracts to provide advertising services to Affiliates, we are obligated to make payments, which represent TAC, to our Affiliates. As of June 30, 2012, these commitments totaled $113 million, of which $40 million will be payable in the remainder of 2012 and $73 million will be payable in 2013.

Intellectual Property Rights. We are committed to make certain payments under various intellectual property arrangements of up to $32 million through 2023.

Income Taxes. As of June 30, 2012, unrecognized tax benefits of $410 million, including interest and penalties, are recorded on our condensed consolidated balance sheets. As of June 30, 2012, the settlement period for our income tax liabilities cannot be determined.

Other Commitments and Off-Balance Sheet Arrangements. 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

 

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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, 2012, 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, 2012, 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.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to financial market risks, including changes in currency exchange rates and interest rates and changes in the market values of our investments.

Interest Rate Exposure

Our exposure to market 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 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 that have declined in market value due to changes in interest rates. A hypothetical 100 basis point increase in interest rates would result in a $7 million and $9 million decrease in the fair value of our available-for-sale debt securities as of December 31, 2011 and June 30, 2012, respectively.

Foreign Currency Exposure

Our foreign currency exposure continues to increase as we grow internationally. The objective of our foreign exchange risk management program is to identify material foreign currency exposures and identify methods to manage these exposures to minimize the potential effects of currency fluctuations on our reported condensed consolidated cash flows and results of operations. We categorize our foreign currency exposure by three categories: 1) economic, 2) transaction, and 3) translation.

Economic Exposure. We transact business in various foreign currencies and have significant international revenue, as well as costs denominated in foreign currencies. This exposes us to the risk of fluctuations in foreign currency exchange rates. Our objective is to identify material foreign currency exposures and to manage these exposures to minimize the potential effects of currency fluctuations on our reported consolidated cash flow and results of operations.

Transaction Exposure. Our exposure to foreign currency transaction gains and losses is the result of assets and liabilities (including intercompany transactions) that are denominated in currencies other than the relevant entity’s functional currency. In certain circumstances, changes in the functional currency value of these assets and liabilities create fluctuations in our reported condensed consolidated financial position, cash flows and results of operations. We may enter into derivative instruments, such as foreign currency forward contracts or other instruments to minimize the impact of the short-term foreign currency fluctuations on such assets and liabilities. The gains and losses on the forward contracts may not offset any or more than a portion of the transaction gains and losses on certain foreign currency receivables, investments and payables recognized in earnings. Transaction gains and losses on these foreign exchange contracts are recognized each period in other income, net included on the condensed consolidated statements of income. Our net realized and unrealized foreign currency transaction gains were $5 million and $4 million for the three and six months ended June 30, 2012. Our net realized and unrealized foreign currency transaction gains were immaterial for both the three and six months ended June 30, 2011. As of June 30, 2012, we had an outstanding forward contract with a notional value equivalent of approximately $100 million, which matured on July 31, 2012. On July 31, 2012, we entered into a new forward contract with a notional value equivalent of approximately $75 million, which will mature on October 31, 2012. On August 7, 2012, we entered into a new forward contract with a notional value equivalent of approximately $400 million, which will mature on March 28, 2013.

Translation Exposure. 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.

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

 

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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 and operating expenses. Conversely, our consolidated revenue 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, 2011, revenue ex-TAC for the Americas segment for the three and six months ended June 30, 2012 would have been higher than we reported by $3 million and $4 million, respectively, revenue ex-TAC for the EMEA segment would have been higher than we reported by $5 million and $7 million, respectively, and revenue ex-TAC for the Asia Pacific segment would have been higher than we reported by $3 million and $1 million, respectively. Using the foreign currency exchange rates from the three and six months ended June 30, 2011, direct costs for the Americas segment for the three and six months ended June 30, 2012 would have been higher than we reported by $1 million and $2 million, respectively, direct costs for the EMEA segment would have been higher than we reported by $2 million and $3 million, respectively, and direct costs for the Asia Pacific segment would have been higher than we reported by $1 million for both periods.

Investment Exposure

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 and equity instruments of public and private companies.

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 2012, 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 and Exchange Act of 1934, as amended (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.

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, 2011, which was filed with the Securities and Exchange Commission on February 29, 2012, as set forth below. Other than the addition of risks and uncertainties pertaining to the Repurchase Agreement with Alibaba Group, 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, 2011.

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!. We compete against these and other 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. We also compete with social media and networking sites which are attracting a substantial and increasing share of users and users’ online time, and may continue to attract an increasing share of online advertising dollars.

In addition, several competitors offer products and services that directly compete for users with our offerings, including consumer e-mail, local search, instant messaging, daily deals, photos, maps, video sharing, content channels, mobile applications, and shopping. Similarly, the advertising networks operated by our competitors or by other participants in the display marketplace offer services that directly compete with our offerings for advertisers, including advertising exchanges, ad networks, demand side platforms, ad serving technologies and sponsored search offerings. We also compete with traditional print and broadcast media companies to attract domestic and international advertising spending. 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, technologies, 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 may be 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.

The majority of our revenue is derived from display and search advertising, 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, 2012, 82 percent of our total revenue came from display and search advertising. 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 PCs and mobile devices;

 

   

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

 

   

successfully implementing changes and improvements to our advertising management platforms and obtaining the acceptance of our advertising management platforms by advertisers, Website publishers, and online advertising networks;

 

   

successfully acquiring, investing in, and implementing new technologies and strategic partnerships;

 

   

successfully implementing changes in our sales force, sales development teams, and sales strategy;

 

   

continuing to innovate and improve the monetization capabilities of our display advertising products;

 

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effectively monetizing 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 spending by our advertisers and could harm our ability to generate revenue and our results of operations.

Advertising expenditures tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Since we derive most of our revenue from advertising, adverse economic conditions have caused, and a continuation of adverse economic conditions could cause, additional decreases or delays in advertising spending, a reduction in our advertising 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, build data centers or acquire real property, 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.

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 transition process is complex and requires the expenditure of significant time and resources by us. We have completed the transition of our algorithmic search platform to the Microsoft platform in all markets, and have completed transition of paid search in several markets. The market-by-market transition of our paid search platform to Microsoft’s platform and the migration of paid search advertisers and publishers to Microsoft’s platform are expected to continue through 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 the 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. 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. Notwithstanding any RPS Guarantee payments that we may receive, our competitors may increase revenue, profitability and market share at a higher rate than us.

 

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If we are unable to provide innovative search experiences and other products and 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 paid search results on our network, except in markets where we have transitioned those services 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 products and services, such as Yahoo! Mail. If we are unable to provide innovative search and other products and services which generate significant traffic to our Websites, our business could be harmed, causing our revenue to decline.

Changes to our management, organizational structure and strategic business plan may cause uncertainty regarding the future of our business, and may adversely impact employee hiring and retention, our stock price, and our revenue, operating results, and financial condition.

In April 2012, we announced changes to our management and organizational structure, as well as a related reduction in our workforce. The implementation of these changes to our management and organizational structure, as well as our recent appointment of a new Chief Executive Officer and the potential for additional changes to our management, organizational structure, and strategic business plan, may cause speculation and uncertainty regarding our future business strategy and direction. These changes may cause or result in:

 

   

disruption of our business or distraction of our employees and management;

 

   

difficulty in recruiting, hiring, motivating, and retaining talented and skilled personnel;

 

   

stock price volatility; and

 

   

difficulty in negotiating, maintaining, or consummating business or strategic relationships or transactions.

If we are unable to mitigate these or other potential risks, our revenue, operating results, and financial condition may be adversely impacted.

If we are unable to recruit and retain key personnel, we may not be able to execute our business plan.

Our business is dependent on our ability to recruit, hire, motivate, and retain talented, highly skilled personnel. Achieving this objective may be difficult due to many factors, including the intense competition for such highly skilled personnel in the San Francisco Bay Area and other metropolitan areas where our offices and the offices of several of our competitors are located; fluctuations in global economic and industry conditions; changes in our management, leadership or strategic business plan; the recent reduction in our workforce; competitors’ hiring practices; and the effectiveness of our compensation programs. If we do not succeed in recruiting, retaining, and motivating our key employees and in attracting new key personnel, we may be unable to meet our business plan and as a result, our revenue and profitability may 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 certain portions of 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.

Further, while we attempt to ensure that the quality of our brands is maintained by our licensees, our licensees might take actions that could impair the value of our brands, our proprietary rights, or the reputation of our products and media properties. If we are unable to maintain or enhance customer awareness of, and trust in, our brands in a cost-effective manner, or if we incur excessive expenses in these efforts, our business, operating results and financial condition could be harmed.

Our intellectual property rights are valuable, and any failure or inability to sufficiently protect them could harm our business and our operating results.

We create, own, and maintain a wide array of intellectual property assets, including copyrights, patents, trademarks, trade dress, trade secrets, and rights to certain domain names, which we believe are collectively among our most valuable assets. We seek to protect our intellectual property assets through patent, copyright, trade secret, trademark, and other laws of the U.S. and other countries of the world, and through contractual provisions. However, the efforts we have taken to protect our intellectual property and proprietary rights might not be sufficient or effective at stopping unauthorized use of those rights. Protection of the distinctive elements of Yahoo! might not always be available under copyright law or trademark law, or we might not discover or determine the full extent of any unauthorized use of our copyrights and trademarks in order to protect our rights. In addition, effective trademark, patent, copyright, and trade secret protection might not be available or cost-effective in every country in which our products and media properties are distributed or made available through the Internet. Changes in patent law, such as changes in the law regarding patentable subject matter, could also impact our ability to obtain patent protection for our inn