UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

Commission file number 0-28018

 

 

 

 

YAHOO! INC.

(Exact name of Registrant as specified in its charter)

 

 

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 o

 

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

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

 

 

 

YAHOO! INC.

 

Table of Contents

 

 

 

YAHOO! INC.

 

Condensed Consolidated Statements of Income

 

 

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

YAHOO! INC.

 

Condensed Consolidated Balance Sheets

 

 

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

YAHOO! INC.

 

Condensed Consolidated Statements of Cash Flows

 

 

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

 

YAHOO! INC.

 

Condensed Consolidated Statements of Cash Flows — (Continued)

 

Supplemental cash flow disclosures:

 

During the three months ended March 31, 2008, the holders of the Company’s zero coupon senior convertible notes (the “Notes”) converted $167 million of the Notes into 8.1 million shares of Yahoo! common stock. See Note 9 — “Long-Term Debt” and Note 17 — “Subsequent Events” for additional information.

 

 

See Note 3 — “Acquisitions” for additional information.

 

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

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

 

The Company.  Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo!” or the “Company”), is a leading global Internet brand and one of the most trafficked Internet destinations worldwide. Yahoo! is focused on powering its communities of users, advertisers, publishers, and developers by creating indispensable experiences built on trust. To users, Yahoo! provides owned and operated online properties and services (“Yahoo! Properties,” “Offerings,” or “Owned and Operated sites”). Yahoo! also extends its marketing platform and access to Internet users beyond Yahoo! Properties through its distribution network of third-party entities (referred to as “Affiliates”) who have integrated the Company’s advertising offerings into their Websites (referred to as “Affiliate sites”) or their other offerings. To advertisers and publishers, Yahoo! provides a range of marketing solutions and tools that enable businesses to reach users who visit Yahoo! Properties and its Affiliate sites. Publishers, such as eBay Inc., WebMD, Cars.com, Forbes.com, and the Newspaper Consortium (the Company’s strategic partnership with a consortium of more than 20 leading United States (“U.S.”) newspaper publishing companies), are a subset of its Affiliates and are primarily Websites and search engines that attract users by providing content of interest, presented on Web pages that have space for advertisements. To developers, Yahoo! provides an innovative and easily accessible array of Web Services and Application Programming Interfaces (“APIs”), technical resources, tools, and channels to market.

 

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 closing date of the acquisition. Certain prior period amounts have been reclassified to conform to the current period presentation.

 

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

 

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

 

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The condensed consolidated balance sheet as of December 31, 2007 was derived from the Company’s audited financial statements for the year ended December 31, 2007, but does not include all disclosures required by GAAP. However, the Company believes the disclosures are adequate to make the information presented not misleading.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Recent Accounting Pronouncements

 

In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), which delays the effective date of Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”) for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. The Company is currently evaluating the impact of adopting FSP FAS 157-2 for non-financial assets and non-financial liabilities on its consolidated financial position, cash flows, and results of operations.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”) and SFAS No. 160, “Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB 51” (“SFAS 160”), which will change the accounting for and reporting of business combination transactions and noncontrolling interests in consolidated financial statements. SFAS 141R and SFAS 160 will be effective for the Company on January 1, 2009. The Company is currently evaluating the impact of adopting SFAS 141R and SFAS 160 on its consolidated financial position, cash flows, and results of operations.

 

 

Basic net income per share is computed using the weighted average number of common shares outstanding during the period, excluding any unvested restricted stock that is subject to repurchase. Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of unvested restricted stock and restricted stock units, collectively referred to as “restricted stock awards” (using the treasury stock method), the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s Notes (using the if-converted method). Potentially dilutive securities representing approximately 132 million and 136 million shares of common stock for the three months ended March 31, 2007 and 2008, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive. Potentially dilutive securities for the three months ended March 31, 2007 and 2008 consist of outstanding stock options, shares to be issued under the employee stock purchase plan, and restricted stock awards. The Company also takes into account the effect on consolidated net income per share of potentially dilutive securities of entities in which the Company holds equity interests that are accounted for using the equity method.

 

See Note 9 — “Long-Term Debt” for additional information related to the Company’s Notes.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

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

 

 

 

Transactions completed in 2007

 

Right Media.  On July 11, 2007, the Company acquired Right Media Inc. (“Right Media”), an online advertising exchange. The Company believes the acquisition of Right Media is an integral piece of the Company’s strategy to build the industry’s leading advertising and publishing network and is a key step in executing the Company’s long-term strategy to change how online advertisers and publishers connect to their audiences in one open advertising community. The purchase price exceeded the fair value of net tangible and intangible assets acquired from Right Media and as a result, the Company recorded goodwill in connection with this transaction. Under the terms of the agreement, the Company acquired all of the remaining equity interests (including all outstanding options and restricted stock units) in Right Media not already owned by the Company. Right Media stockholders were paid in approximately equal parts cash and shares of Yahoo! common stock (approximately 8 million shares) and outstanding Right Media options and restricted stock units were assumed. Assumed Right Media options and restricted stock units are exercisable for, or will settle in, shares of Yahoo! common stock. The acquisition followed the Company’s 20 percent investment in Right Media in October 2006.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The total purchase price of $526 million consisted of $246 million in cash consideration, $237 million in equity consideration, $40 million for the initial 20 percent investment, and $3 million of direct transaction costs. The $246 million of total cash consideration less cash acquired of $16 million resulted in a net cash outlay of $230 million. In connection with the acquisition, the Company issued stock-based awards valued at $177 million which will be recognized as stock-based compensation expense as the awards vest over a period of up to four years.

 

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

 

 

The amortizable intangible assets have useful lives not exceeding seven years and a weighted average useful life of six years. No amounts have been allocated to in-process research and development and $440 million has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes. The goodwill recorded in connection with this acquisition is included in the U.S. segment. The Company may make additional adjustments to the purchase price allocation related to goodwill and tangible assets acquired.

 

Zimbra.  On October 4, 2007, the Company acquired Zimbra, Inc. (“Zimbra”), a provider of e-mail and collaboration software. The Company believes the acquisition of Zimbra will further strengthen its position in Web mail and expand the Company’s presence in universities, small and medium-sized businesses, and service provider partners. The purchase price exceeded the fair value of net tangible and intangible assets acquired from Zimbra and as a result, the Company recorded goodwill in connection with this transaction. Under the terms of the agreement, the Company acquired all of the equity interests (including all outstanding options and restricted stock units) in Zimbra. Zimbra stockholders were paid in cash. Outstanding Zimbra options and restricted stock units were assumed and are exercisable for, or will settle in, shares of Yahoo! common stock.

 

The total purchase price of $302 million consisted of $290 million in cash consideration, $11 million in equity assumed, and $1 million of direct transaction costs. The $290 million of total cash consideration less cash acquired of $11 million resulted in a net cash outlay of $279 million. In connection with the acquisition, the Company issued stock-based awards valued at $38 million which is being recognized as stock-based compensation expense as the awards vest over a period of up to four years.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

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

 

 

The amortizable intangible assets have useful lives not exceeding seven years and a weighted average useful life of four years. No amounts have been allocated to in-process research and development and $245 million has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes. The goodwill recorded in connection with this acquisition is included in the U.S. segment. The Company may make additional adjustments to the purchase price allocation related to goodwill and tangible assets acquired.

 

BlueLithium.  On October 15, 2007, the Company acquired BlueLithium, Inc. (“BlueLithium”), an online global ad network. The Company believes that BlueLithium complements the Company’s leading advertising tools and capabilities. The purchase price exceeded the fair value of the net tangible and intangible assets acquired from BlueLithium and as a result, the Company recorded goodwill in connection with this transaction. Under the terms of the agreement, the Company acquired all of the equity interests (including all outstanding options and restricted stock units) in BlueLithium. BlueLithium stockholders were paid in cash. Outstanding BlueLithium options and restricted stock units were assumed and will be exercisable for, or will settle in, shares of Yahoo! common stock.

 

The total purchase price of $255 million consisted of $245 million in cash consideration, $8 million in equity assumed and $2 million of direct transaction costs. The $245 million of total cash consideration less cash acquired of $10 million resulted in a net cash outlay of $235 million. In connection with the acquisition, the Company issued stock-based awards valued at $47 million which is being recognized as stock-based compensation expense as the awards vest over a period of up to four years.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

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

 

 

The amortizable intangible assets have useful lives not exceeding six years and a weighted average useful life of five years. $225 million has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes. The goodwill recorded in connection with this acquisition is included in the U.S. ($143 million) and International ($82 million) segments. The Company may make additional adjustments to the purchase price allocation related to goodwill and tangible assets acquired.

 

Other Acquisitions — Business Combinations.  During the year ended December 31, 2007, the Company acquired two other companies which were accounted for as business combinations. The total purchase price for these two acquisitions was $108 million and consisted of $106 million in cash consideration and $2 million of direct transaction costs. The total cash consideration of $106 million less cash acquired of $5 million resulted in net cash outlay of $101 million. Of the purchase price, $74 million was allocated to goodwill, $33 million to amortizable intangible assets, $5 million to tangible assets, $5 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.

 

Other Acquisitions — Asset Acquisitions.  During the year ended December 31, 2007, the Company acquired five companies which were accounted for as asset acquisitions. The total purchase price for these acquisitions was $61 million and consisted of $23 million in cash consideration, $35 million in equity consideration, $2 million of assumed liabilities, and $1 million of direct transaction costs. The total cash consideration of $23 million less cash acquired of $3 million resulted in a net cash outlay of $20 million. For accounting purposes, approximately $85 million was allocated to amortizable intangible assets, $29 million to net assumed liabilities, primarily deferred income tax liabilities, $2 million to tangible assets, and $3 million to cash acquired. In connection with these acquisitions, the Company also issued stock-based awards valued at $19 million that will be recognized as stock-based compensation expense over the next three years.

 

Transactions completed in 2008

 

Maven.  On February 11, 2008, the Company acquired Maven Networks, Inc. (“Maven”), a leading online video platform provider. The Company believes that Maven will assist the Company in expanding state-of-the-art consumer video and advertising experiences on Yahoo! and the Company’s network of leading premium video publishers across the Web. The purchase price exceeded the fair value of the net tangible and intangible assets acquired from Maven and as a result, the Company recorded goodwill in connection with this transaction. Under

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

the terms of the agreement, the Company acquired all of the equity interests (including all outstanding options and restricted stock units) in Maven. Maven stockholders were paid in cash. Outstanding unvested Maven options and restricted stock units were assumed and will be exercisable for, or will settle in, shares of Yahoo! common stock.

 

The total purchase price of $143 million consisted of $141 million in cash consideration and $2 million of direct transaction costs. In connection with the acquisition, the Company issued stock-based awards valued at $21 million which is being recognized as stock-based compensation expense as the awards vest over a period of up to four years.

 

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

 

 

The amortizable intangible assets have useful lives not exceeding six years and a weighted average useful life of five years. No amounts have been allocated to in-process research and development and $88 million has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not deductible for tax purposes. The goodwill recorded in connection with this acquisition is included in the U.S. segment. The Company may make additional adjustments to the purchase price allocation related to goodwill and tangible assets acquired.

 

During the three months ended March 31, 2008, the Company also completed immaterial asset acquisitions that did not qualify as business combinations.

 

The results of operations for Right Media, Zimbra, BlueLithium, and certain other business combinations have been included in the Company’s condensed consolidated statements of operations since the completion of the acquisitions in 2007. The following unaudited pro forma financial information presents the combined results of the Company and the 2007 acquisitions as if the acquisitions had occurred at the beginning of 2007 (in thousands, except per share amounts):

 

 

The above unaudited pro forma financial information includes adjustments for interest income on cash disbursed for the acquisitions, amortization of identifiable intangible assets, stock-based compensation expense, and related tax effects. Pro forma disclosures for the Company’s 2008 business combinations were not significant.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

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

 

 

Equity Investment in Alibaba Group.  As of March 31, 2008, the Company’s ownership interest in Alibaba Group Holding Limited (“Alibaba Group”) was 44 percent compared to 43 percent as of December 31, 2007. The 1 percent increase in ownership interest is due to a net increase in ownership interest resulting from the exchange of certain Alibaba Group shares previously held by employees for shares in Alibaba.com Limited, the business-to-business e-commerce subsidiary of Alibaba Group (“Alibaba.com”), as further described below, offset by a decrease in ownership interest resulting from the exercise of Alibaba Group’s employee stock options.

 

In the initial public offering (“IPO”) of Alibaba.com, Alibaba Group sold an approximate 27 percent interest in Alibaba.com through the issuance of new Alibaba.com shares, the sale of previously held shares in Alibaba.com, and the exchange of certain Alibaba Group shares previously held by Alibaba Group employees for shares in Alibaba.com, resulting in a gain on disposal of interests in Alibaba.com. Accordingly, in the first quarter of 2008, the Company recorded a net non-cash gain of $401 million, net of tax, within earnings in equity interests.

 

As of March 31, 2008, the difference between the Company’s carrying value of its 44 percent investment in Alibaba Group and its proportionate share of the net assets is summarized as follows (in thousands):

 

 

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

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The following table presents Alibaba Group’s financial information, as derived from the Alibaba Group condensed consolidated financial statements, which includes summary operating information for the three months ended December 31, 2006 and 2007 and summary balance sheet information as of September 30, 2007 and December 31, 2007 (in thousands):

 

 

 

 

The Company also has commercial arrangements with Alibaba Group to provide technical, development, and advertising services. For the three months ended March 31, 2007 and 2008, these transactions were not material.

 

Equity Investment in Alibaba.com Limited.  As part of the November 6, 2007 IPO on the Hong Kong Stock Exchange of Alibaba.com, the Company purchased an approximate 1 percent direct interest in Alibaba.com for a total purchase price of approximately $101 million, including $1 million of transaction costs. The investment in Alibaba.com is being accounted for using the equity method due to the Company’s investment in Alibaba Group, which has a controlling interest in Alibaba.com. The total investment is classified as part of the investment in equity interests balance in the condensed consolidated balance sheet. The Company records its share of the results of Alibaba.com one quarter in arrears within earnings in equity interests in the condensed consolidated statements of income. As of March 31, 2008, the difference between the Company’s carrying value of its investment in Alibaba.com of $102 million and its proportionate share of the net assets of Alibaba.com is $96 million. This excess carrying value has been primarily assigned to goodwill and amortizable intangible assets. The fair value of the Company’s approximate 1 percent ownership in Alibaba.com, based upon the quoted stock price as of March 31, 2008 was approximately $119 million. The differences between generally accepted accounting principles in the U.S. and International Financial Reporting Standards did not materially impact the amounts reflected in the Company’s condensed consolidated financial statements.

 

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 is classified as a part of the investments in equity interests balance on the condensed consolidated balance sheets. The fair value of the Company’s approximate 33 percent ownership interest in Yahoo! Japan, based upon the quoted stock price as of March 31, 2008 was approximately $11 billion.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

On September 1, 2007, the Company commenced a commercial arrangement with Yahoo! Japan in which the Company provides advertising and search marketing services to Yahoo! Japan for a service fee and exited the pre-existing Affiliate arrangement. The Company no longer recognizes marketing services revenue and traffic acquisition costs (“TAC”) for the delivery of sponsored search results and payments to Affiliates in Japan as Yahoo! Japan is responsible for the fulfillment of all advertiser and Affiliate services. Under this arrangement, the Company records marketing services revenue from Yahoo! Japan for the provision of search marketing services based on a percentage of advertising revenues earned by Yahoo! Japan for the delivery of sponsored search results. These arrangements resulted in a net cost of approximately $78 million for the three months ended March 31, 2007 and revenues of approximately $73 million for the three months ended March 31, 2008. As of December 31, 2007 and March 31, 2008, the Company had a net receivable balance from Yahoo! Japan of approximately $62 million and $22 million, respectively.

 

The following table presents Yahoo! Japan’s condensed financial information, as derived from the Yahoo! Japan financial statements for the three months ended December 31, 2006 and 2007, respectively, and as of September 30, 2007 and December 31, 2007, respectively (in thousands):

 

 

 

 

The differences between generally accepted accounting principles in the U.S. and Japan did not materially impact the amounts reflected in the Company’s condensed consolidated financial statements.

 

 

The changes in the carrying amount of goodwill for the three months ended March 31, 2008 are as follows (in thousands):

 

 

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

 

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

 

 

 

For the three months ended March 31, 2007 and 2008, the Company recognized amortization expense for intangible assets of $56 million and $70 million, respectively, including $29 million in cost of revenues for the three months ended March 31, 2007 and $46 million in cost of revenues for the three months ended March 31, 2008. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2008 and each of the succeeding years is as follows: nine months ending December 31, 2008: $200 million; 2009: $159 million; 2010: $128 million; 2011: $81 million; 2012: $53 million; 2013: $21 million; and cumulatively thereafter: $10 million.

 

During the three months ended March 31, 2007 and 2008, the Company acquired $7 million and $9 million, respectively, of patents and intellectual property rights, included in the “Developed and acquired technology and intellectual property rights” category of the intangible assets balances as of March 31, 2007 and 2008, respectively.

 

 

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

 

 

Investment gains (losses), net includes realized investment gains and realized investment losses related to declines in values of investments in publicly traded and privately held companies judged to be other than temporary.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

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

 

 

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

 

 

 

In April 2003, the Company issued $750 million of the Notes due April 1, 2008, resulting in net proceeds to the Company of approximately $733 million after transaction fees of $17 million, which had been deferred and were included on the condensed consolidated balance sheets in prepaid expense and other current assets. As of March 31, 2008, the transaction fees were fully amortized. The Notes were issued at par and bear no interest. The Notes were convertible into Yahoo! common stock at a conversion price of $20.50 per share, which would result in the issuance of an aggregate of approximately 37 million shares, subject to adjustment upon the occurrence of specified events. Each $1,000 principal amount of the Notes would initially be convertible into 48.78 shares of Yahoo! common stock.

 

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

 

Each $1,000 principal amount of the Notes was convertible on or prior to April 1, 2008 if the market price of the Company’s common stock reaches a specified threshold ($22.55) for a defined period of time or specified corporate transactions occur. As of March 31, 2008, the market price condition for convertibility of the Notes was satisfied with respect to the fiscal quarters beginning on January 1, 2008 and April 1, 2008. On or before April 1, 2008, the holders of the Notes were able to convert their Notes into shares of Yahoo! common stock at the rate of 48.78 shares of Yahoo! common stock for each Note. The Company would be required to pay the outstanding principal amount of any Notes not converted by the holders on or before April 1, 2008 in cash.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

As of March 31, 2008, $167 million of the Notes were converted and 8.1 million shares of Yahoo! common stock were issued to the holders of the Notes. The $583 million remaining debt outstanding as of March 31, 2008 was classified as long-term debt as the debt was converted into issued common stock of the Company in April 2008. Since the quarter beginning April 1, 2007, the Notes had been classified as short-term debt as the Company would have had to settle the Notes in cash at maturity, unless conversion was requested by the holders of the Notes.

 

As of March 31, 2008, the fair value of the Notes was approximately $0.8 billion based on quoted market prices. The shares issuable upon conversion of the Notes have been included in the computation of diluted net income per share since the Notes were issued.

 

See Note 17 — “Subsequent Events” for additional information.

 

 

Stock Options.  The Company’s Amended and Restated 1995 Stock 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 and the Amended and Restated 1996 Directors’ Stock Plan for the three months ended March 31, 2008 is summarized as follows (in thousands, except per share amounts):

 

 

 

 

As of March 31, 2008, there was $393 million of unrecognized stock-based compensation cost related to unvested stock options which is expected to be recognized over a weighted average period of 2.95 years.

 

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

 

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Restricted stock awards and restricted stock units activity for the three months ended March 31, 2008 is summarized as follows (in thousands, except per share amounts):

 

 

During the three months ended March 31, 2008, 5.3 million previously granted restricted stock awards and restricted stock units vested. A majority of these vested restricted stock awards and restricted stock units were net share settled such that the Company withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. The total shares withheld of approximately 1.8 million was based on the value of the restricted stock awards on their vesting date as determined by the Company’s closing stock price. Total payments for the employees’ tax obligations to the relevant taxing authorities were $52 million for the three months ended March 31, 2008 and are reflected as a financing activity within the condensed consolidated statements of cash flows. Upon the vesting of shares of certain restricted stock awards, 605,000 shares were reacquired by the Company to satisfy the tax withholding obligations and $18 million was recorded as treasury stock. Payments of $34 million related to net share settlements of restricted stock units had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued as a result of the vesting and were recorded as a reduction of additional paid-in-capital.

 

As of March 31, 2008, there was $370 million of unrecognized stock-based compensation cost related to unvested restricted stock awards and restricted stock units which is expected to be recognized over a weighted average period of 2.32 years.

 

The excess tax benefits from stock-based awards of $52 million as reported on the condensed consolidated statement of cash flows in financing activities for the three months ended March 31, 2007 represents the reduction, in income taxes otherwise payable during the period, attributable to the gross tax benefits in excess of the expected tax benefits for options exercised in current and prior periods. The reduction in income taxes otherwise payable during the three months ended March 31, 2008 is attributable entirely to the exercise of stock options for which deferred income tax assets were recorded in prior periods. The income tax benefit of such stock option exercises was recorded as a reduction to deferred income tax assets and is reflected in the deferred income taxes line of the cash flows from operating activities section of the condensed consolidated statement of cash flows.

 

Executive Retention Compensation Arrangement.  During 2006, the Compensation Committee of the Company’s Board of Directors approved a three year performance and retention compensation arrangement with Terry Semel, the Company’s then Chief Executive Officer (“CEO”). Under this arrangement, for each of the years 2006 to 2008, as the CEO, Mr. Semel was eligible to receive a discretionary annual bonus payable in the form of a fully vested non-qualified stock option for up to 1 million shares with an exercise price equal to the closing trading price of the Company’s common stock on the date of the grant.

 

On June 18, 2007, the executive retention arrangement was terminated due to Mr. Semel’s resignation as the CEO of the Company. During the second quarter of 2007, $16 million of stock-based compensation expense recorded through March 31, 2007 under this arrangement was reversed due to the forfeitures of equity awards. No similar arrangement exists for the current CEO.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

In October 2006, the Company’s Board of Directors authorized a new stock repurchase program allowing it to repurchase up to $3.0 billion of its outstanding shares of common stock from time to time over the next five years, depending on market conditions, share price, and other factors. Repurchases 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.

 

In the three months ended March 31, 2008, the Company repurchased 3.4 million shares of common stock directly at an average price of $23.39 per share. Total cash consideration for the repurchased stock was $79 million.

 

Upon the vesting of certain restricted stock awards during the three months ended March 31, 2008, 605,000 shares of such vested stock were reacquired by the Company to satisfy tax withholding obligations. These repurchased shares were recorded as $18 million of treasury stock and accordingly reduced the number of common shares outstanding by 605,000.

 

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

 

 

Operating Lease Commitments.  The Company leases office space and data centers under operating lease agreements with original lease periods of up to 23 years, expiring between 2008 and 2027.

 

A summary of gross and net lease commitments as of March 31, 2008 follows (in millions):

 

 

Affiliate Commitments.  In connection with contracts to provide advertising services to Affiliates, the Company is obligated to make payments, which represent TAC, to its Affiliates. As of March 31, 2008, these commitments totaled $275 million, of which $71 million will be payable in the remainder of 2008, $111 million will be payable in 2009, and $93 million will be payable in 2010.

 

Intellectual Property Rights.  In connection with the licensing of certain intellectual property, the Company is obligated to invest up to $84 million through July 2008. To the extent the licensed intellectual property will benefit future periods, the Company will capitalize such payments and amortize them over the useful life of the related intellectual property.

 

Other Commitments.  In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of agreements, services to be provided by the Company, or from intellectual property claims made by third parties. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as

 

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Notes to Condensed Consolidated Financial Statements — (Continued)

 

directors or officers. The Company has also agreed to indemnify certain former officers, directors, and employees of acquired companies in connection with the acquisition of such companies. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers, and former directors and officers of acquired companies, in certain circumstances. It is not possible to determine the aggregate maximum potential loss under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements may not be subject to maximum loss clauses. Historically, the Company has not incurred material costs as a result of obligations under these agreements and it has not accrued any liabilities related to such indemnification obligations in its condensed consolidated financial statements.

 

As of March 31, 2008, 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.

 

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, auction sites, shopping services, and other communications and community features.

 

On May 24, 2001, Arista Records, Inc., Bad Boy Records, BMG Music d/b/a The RCA Records Label, Capitol Records, Inc., Virgin Records America, Inc., Sony Music Entertainment, Inc., UMG Recordings, Inc., Interscope Records, Motown Record Company, L.P., and Zomba Recording Corporation filed a lawsuit alleging copyright infringement against LAUNCH Media, Inc. (“LAUNCH”) in the United States District Court for the Southern District of New York. The plaintiffs alleged, among other things, that the consumer-influenced portion of LAUNCH’s LAUNCHcast service is “interactive” within the meaning of Section 114 of the Copyright Act and therefore does not qualify for the compulsory license provided for by the Copyright Act. The complaint sought declaratory and injunctive relief and damages for the alleged infringement. After the lawsuit was commenced, Yahoo! entered into an agreement to acquire LAUNCH, which closed in August 2001, and since that time LAUNCH has been a wholly owned subsidiary of Yahoo!. Because LAUNCH settled the LAUNCH litigation as to all other plaintiffs, BMG Music d/b/a/The RCA Records Label was the sole remaining plaintiff in this proceeding. On April 27, 2007, after a two week jury trial, the jury returned a unanimous verdict in favor of LAUNCH finding no liability. The plaintiff has filed a notice of appeal to the United States Court of Appeals for the Second Circuit.

 

On July 12, 2001, the first of several purported securities class action lawsuits was filed in the U.S. District Court, Southern District of New York against certain underwriters involved in Overture Services Inc.’s (“Overture”) IPO, Overture, and certain of Overture’s current and former officers and directors. The Court consolidated the cases against Overture. Plaintiffs allege, among other things, violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 involving undisclosed compensation to the underwriters, and improper practices by the underwriters, and seek unspecified damages. Similar complaints were filed in the same court against numerous public companies that conducted IPOs of their common stock since the mid-1990s. All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin. On April 19, 2002, plaintiffs filed an amended complaint. On July 15, 2002, the issuers filed an omnibus motion to dismiss for failure to comply with applicable pleading standards. On October 8, 2002, the Court entered an Order of Dismissal as to all of the individual defendants in the Overture IPO litigation, without prejudice. On February 19, 2003, the Court denied the motion to dismiss the claims against certain defendants, including Overture. In June 2004, a stipulation of settlement and

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

release of claims against the issuer defendants, including Overture, was submitted to the Court for approval. While the partial settlement was pending approval, the plaintiffs continued to litigate against the underwriter defendants. The district court directed that the litigation proceed within a number of “focus cases” rather than in all of the 310 cases that had been consolidated. Overture’s case is not one of these focus cases. On October 13, 2004, the district court certified these focus cases as class actions. The underwriter defendants appealed that ruling, and on December 5, 2006, the Court of Appeals for the Second Circuit overturned the district court’s class certification decision. Since class certification, which was a condition of the settlement, was not met, the parties stipulated to terminate the settlement. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon this stipulation. Plaintiffs amended complaints in the six cases. On March 26, 2008, the district court denied the motions to dismiss except as to Section 11 claims raised by some plaintiffs who sold their securities for a price in excess of the initial offering price and those who purchased outside the previously certified class period. Initial briefing on the class certification motion was completed in April 2008. The Company intends to defend the case vigorously.

 

In May 2007, two purported class actions were commenced by plaintiffs Ellen Brodsky and Manifred Hacker, asserting claims arising under the federal securities laws against the Company and certain individual defendants. These actions were ordered consolidated in the U.S. District Court for the Central District of California and, on December 21, 2007, a Consolidated Amended Complaint was filed against Yahoo! and certain individual defendants, including current and former officers and a former director and officer. Plaintiffs purport to represent a class of persons who purchased the Company’s common stock between April 8, 2004 and July 18, 2006. Plaintiffs allege that defendants engaged in a scheme to inflate the Company’s share price by making false and misleading statements regarding the Company’s operations, financial results, and future business prospects in violation of Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. Plaintiffs also allege that the individual defendants engaged in insider trading in violation of Section 20(A) of the Securities Exchange Act, and as control persons are subject to liability under Section 20(A) of the Securities Exchange Act. The Consolidated Amended Complaint seeks compensatory damages, injunctive relief, disgorgement of alleged insider trading proceeds, and other equitable relief. On March 10, 2008, the Court granted defendants’ motion to transfer the action to the U.S. District Court for the Northern District of California.

 

On May 15, 2007, a stockholder derivative complaint was filed in the California Superior Court, Santa Clara County, by Greg Brockwell against members of the Company’s Board of Directors and selected officers. Brockwell seeks to prosecute the action on behalf of the Company, which is named as a “nominal defendant,” and to obtain relief on behalf of the Company. The complaint alleges breaches of state law, including breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of the California Corporations Code between April 2004 and the present. The derivative complaint alleges facts substantially similar to the Consolidated Amended Complaint in the federal class action litigation, and seeks, on behalf of the Company, treble damages under California law, equitable and injunctive relief, restitution, and reimbursement of costs. Discovery has been initiated, and a status conference is set for May 16, 2008. On June 14, 2007, a second stockholder derivative action was filed in the U.S. District Court for the Central District of California by Jill Watkins against members of the Board of Directors and selected officers. The complaint filed by Plaintiff Watkins is substantially similar to the complaint filed by Plaintiff Brockwell, with the addition of a claim for relief for alleged violation of Section 10(b) of the Securities Exchange Act of 1934. The federal derivative plaintiff (Watkins) has agreed to coordinate her action with the consolidated federal class action litigation. On April 15, 2008, defendants filed a motion to transfer the Watkins federal derivative action to accompany the previously transferred Consolidated Amended Complaint in the Brodsky federal class action litigation. On April 21, 2008, defendants also opposed plaintiff’s motion to further amend the complaint to assert allegations relating to Microsoft Corporation’s February 1, 2008 unsolicited proposal to acquire Yahoo! Inc. On April 29, 2008, the Watkins action was transferred to the U.S. District Court for the Northern District of California, and a motion to amend the complaint was denied by the transferring court.

 

Since February 1, 2008, five separate stockholder lawsuits were filed in the California Superior Court, Santa Clara County, against Yahoo! Inc., members of the Board of Directors and selected former officers by

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

plaintiffs Edward Fritsche, the Thomas Stone Trust, Tom Turberg, Congregation Beth Aaron, and the Louisiana Municipal Police Employees’ Retirement System (the “California Lawsuits”). The California Lawsuits were consolidated, and on March 12, 2008, a Consolidated Amended Class Action and Derivative Complaint was filed, captioned, In re Yahoo! Inc. Shareholder Litigation, in Santa Clara County Superior Court. The Consolidated Amended Class and Derivative Complaint alleges that the Yahoo! Board of Directors breached fiduciary duties in connection with Microsoft Corporation’s unsolicited proposal to acquire Yahoo!. The Consolidated Amended Class and Derivative Complaint seeks declaratory and injunctive relief, as well as an award of plaintiffs’ attorneys’ fees and costs. On March 28, 2008, the Santa Clara County Superior Court granted defendants’ motion to stay the Consolidated Amended Class Action and Derivative Complaint pending resolution of similar proceedings pending in Delaware Court of Chancery described below.

 

Since February 11, 2008, five separate stockholder lawsuits were filed in Delaware Court of Chancery against Yahoo! Inc. and members of the Board of Directors by plaintiffs The Wayne County Employees’ Retirement System, Ronald Dicke, and The Police and Fire Retirement System of the City of Detroit along with The General Retirement System of the City of Detroit, Plumbers and Pipefitters Local Union No. 630 Pension-Annuity Trust Fund and Vernon A. Mercier (the “Delaware Lawsuits”). Two of the Delaware Lawsuits (by plaintiff Wayne County and by plaintiff Plumbers and Pipefitters Local Union) were voluntarily dismissed. All of the remaining Delaware Lawsuits were consolidated (lead plaintiff is the Police and Fire Retirement System of the City of Detroit) and lead counsel was appointed. The plaintiffs in the Delaware Lawsuits purport to assert class claims on behalf of all Yahoo! stockholders, except defendants and their affiliates and generally allege that defendants breached fiduciary duties by rejecting Microsoft’s February 1, 2008 unsolicited proposal to acquire Yahoo! Inc. without fully informing themselves whether Microsoft would offer additional consideration and alleging that defendants are not acting in the best interests of stockholders and are seeking to entrench themselves through a series of defensive initiatives. The complaints in the Delaware Court of Chancery seek unspecified damages, declaratory relief and injunctive relief, as well as an award of plaintiffs’ attorneys’ fees and costs. Pursuant to a case management order, defendants are responding to expedited discovery. On March 24, 2008, the Court denied plaintiff’s motion to set an expedited trial date in May 2008.

 

The Company may incur substantial expenses in defending against such claims, and it is not presently possible to accurately forecast their outcome. The Company does not believe, based on current knowledge, that any of the foregoing legal proceedings or claims are likely to have a material adverse effect on its financial position, results of operations, or cash flows. In the event of a determination adverse to Yahoo!, its subsidiaries, directors, or officers, the Company may incur substantial monetary liability, and be required to change its business practices. Either of these could have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

 

Change in Control Severance Plans.  On February 12, 2008, the Compensation Committee of the Board of Directors of the Company approved two change in control severance plans (the “Severance Plans”) that, together, cover all full-time employees of the Company, including the Company’s Chief Executive Officer, Chief Financial Officer, and the executive officers currently employed by the Company. The Severance Plans are designed to help retain the employees, help maintain a stable work environment and provide certain economic benefits to the employees in the event their employment is terminated. Benefits under the Severance Plans generally include (1) continuation of the employee’s annual base salary, as severance pay for a designated number of months following the employee’s severance date; (2) reimbursement for outplacement services; (3) continued medical group health and dental plan coverage for the period the employee receives severance pay; and (4) accelerated vesting of all stock options, restricted stock units, and any other equity-based awards previously granted or assumed by the Company and outstanding as of the severance date.

 

 

The Company manages its business geographically. The primary areas of measurement and decision-making are the U.S. and International. Management relies on an internal management reporting process that provides

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

revenue and segment operating income before depreciation, amortization, and stock-based compensation expense for making financial decisions and allocating resources. Segment operating income before depreciation, amortization, and stock-based compensation expense includes income from operations before depreciation, amortization, and stock-based compensation expense. Management believes that segment operating income before depreciation, amortization, and stock-based compensation expense is an appropriate measure of evaluating the operational performance of the Company’s segments. However, this measure should be considered in addition to, not as a substitute for, or superior to, income from operations or other measures of financial performance prepared in accordance with GAAP.

 

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

 

 

 

Revenue is attributed to individual countries according to the international online property that generated the revenue. No single foreign country accounted for more than 10 percent of revenues in the three months ended March 31, 2007 and 2008.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

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

 

 

 

The effective tax rate for the three months ended March 31, 2008 was 39.5 percent, compared to 45.2 percent for the same period in 2007. The effective tax rate of 39.5 percent for the three months ended March 31, 2008 differs from the statutory rate of 35.0 percent primarily due to state taxes, the effect of non-U.S. operations, and non-deductible stock-based compensation expense. The effective tax rate for the three months ended March 31, 2008 was lower than the rate for the same period in 2007 primarily due to the effect of items recorded in the quarter ended March 31, 2008 related to non-U.S. operations.

 

In the quarter ended March 31, 2008, the Company recorded a deferred tax liability of $276 million related to its investment in the Alibaba Group. The deferred tax liability resulted primarily from the non-cash gain recorded in the quarter in connection with the IPO of Alibaba.com. See Note 4 — “Investments in Equity Interests” for additional information.

 

During the three months ended March 31, 2008, the Company recorded an increase in its total unrecognized tax benefits of approximately $5 million bringing the balance to $691 million. Over the next twelve months, the Company’s existing tax positions are expected to generate an increase in total unrecognized tax benefits.

 

The Company’s federal income tax returns for the years ended December 31, 2003 and December 31, 2004 are under examination by the Internal Revenue Service.

 

 

The Company’s marketable debt and equity securities are classified as available-for-sale and are reported at fair value, with unrealized gains and losses, net of tax, recorded in accumulated other comprehensive income (loss). Realized gains or losses and declines in value judged to be other than temporary, if any, on available-for-sale securities are reported in other income, net. The Company evaluates the investments periodically for possible other-than-temporary impairment and reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and the Company’s ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in market value. The Company records impairment charges equal to the amount that the carrying value of its available-for-sale securities exceeds the estimated fair market value of the securities as of the evaluation date, if appropriate. The fair value for securities is determined based on quoted market prices as of the valuation date. In computing realized gains and losses on available-for-sale securities, the Company determines cost based on amounts paid, including direct costs such as commissions, to acquire the security using the specific identification method.

 

All highly liquid investments with an original maturity of three months or less are considered cash equivalents. Investments with effective maturities of less than 12 months from the balance sheet date are classified as current

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

assets. Investments with effective maturities greater than 12 months from the balance sheet date are classified as long-term assets.

 

Effective January 1, 2008, the Company adopted SFAS 157 for financial assets and liabilities. SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements by establishing a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS 157 are described below:

 

Basis of Fair Value Measurement

 

 

The following table set forth the financial assets, measured at fair value, by level within the fair value hierarchy as of March 31, 2008 (in thousands):

 

 

 

The amount of cash and cash equivalents as of March 31, 2008 includes $750 million in cash.

 

The fair value of the Company’s Level 1 financial assets are based on quoted market prices of the identical underlying security. The fair value of the Company’s Level 2 financial assets are obtained from readily-available pricing sources for the identical underlying security that may not be actively traded. As of March 31, 2008, the Company did not have any significant Level 3 financial assets or liabilities.

 

YAHOO! INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The Company has investments in equity interests that are accounted for using the equity method and are classified as part of the investment in equity interests balance in the condensed consolidated balance sheet. See Note 4 — “Investments in Equity Interests” for additional information.

 

See Note 9 — “Long-Term Debt” for fair value disclosures related to the Company’s Notes.

 

 

During the three months ended March 31, 2008, the Company implemented a strategic workforce realignment to more appropriately allocate resources to the Company’s key strategic initiatives. The strategic realignment involves investing resources in some areas, reducing resources in others, and eliminating some areas of the Company’s business that do not support the Company’s strategic priorities.

 

As of March 31, 2008, the Company incurred total pre-tax cash charges of approximately $29 million in severance pay expenses and related cash expenses in connection with the workforce realignment. The pre-tax cash charges were offset by a $12 million credit related to non-cash stock-based compensation expense reversals for forfeited unvested awards, resulting in a net estimated total strategic workforce realignment pre-tax expense of approximately $17 million. Of the $17 million strategic workforce realignment pre-tax expense, $13 million was related to the U.S. segment and $4 million was related to the International segment. As of March 31, 2008, the remaining accrual related to the strategic workforce realignment was approximately $15 million, which the Company expects to be substantially paid by the end of the second quarter of 2008.

 

Note 17     SUBSEQUENT EVENTS

 

Long-Term Debt.  In April 2008, the $583 million of long-term debt outstanding as of March 31, 2008 was converted by the holders of the Notes and 28.4 million shares of Yahoo! common stock were issued.

 

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:

 

 

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

 

Overview

 

We are a leading global Internet brand and one of the most trafficked Internet destinations worldwide. We are focused on powering our communities of users, advertisers, publishers, and developers by creating indispensable experiences built on trust. We seek to provide Internet services that are essential and relevant to these communities of users, advertisers, publishers, and developers. Publishers, such as eBay Inc., WebMD, Cars.com, Forbes.com, and the Newspaper Consortium (our strategic partnership with a consortium of more than 20 leading United States (“U.S.”) newspaper publishing companies), are a subset of our Affiliates and are primarily Websites and search engines that attract users by providing content of interest, presented on Web pages that have space for advertisements.

 

To users, we provide owned and operated online properties and services (“Yahoo! Properties” or “Offerings” or “Owned and Operated sites”). We also extend our marketing platform and access to Internet users beyond Yahoo! Properties through our distribution network of third-party entities (referred to as “Affiliates”) who have integrated our advertising offerings into their Websites (referred to as “Affiliate sites”) or their other offerings.

 

We focus on expanding our communities of users and deepening their engagement on Yahoo! Properties to enhance the value of our users to advertisers and publishers and thereby increase the spending of advertisers and publishers with us. We believe that we can expand our communities of users by offering compelling Internet services and effectively integrating search, community, personalization, and content to create a powerful user experience. We leverage our user relationships and the social community the users create to enhance our online advertising potential, as well as our fee-based services.

To advertisers and publishers, we provide a range of marketing solutions and tools that enable businesses to reach users who visit Yahoo! Properties and our Affiliate sites.

 

To developers, we provide an innovative and easily accessible array of Web Services and Application Programming Interfaces (“APIs”), technical resources, tools, and channels to market.

 

We generate revenues by providing marketing services to advertisers across a majority of Yahoo! Properties and Affiliate sites. Additionally, although many of our user services are free, we do charge for a range of premium services that we offer. We classify these revenues as either marketing services or fees revenues. The majority of our offerings are available globally in more than 20 languages. We manage and measure our business geographically. Our principal geographies are the United States and International.

 

As used below, “Page Views” is defined as our internal estimate of the total number of Web pages viewed by users on Owned and Operated sites. “Searches” is defined as online search queries that may yield Internet search results ranked and sorted based on relevance to the user’s search query. “Sponsored search results” are a subset of the overall search results and provide links to paying advertisers’ Web pages. A “click-through” occurs when a user clicks on an advertisers’ language.

 

First Quarter Highlights

 

 

Our revenue growth for the three months ended March 31, 2008, compared to the prior year, can be attributed to growth in our marketing services business. Marketing services and fees revenues experienced 7 percent and 21 percent year over year growth, respectively.

 

Our revenues for the three months ended March 31, 2008 increased 9 percent year over year to approximately $1.8 billion, with fee paying users up 5 percent year over year, and Page Views up 19 percent year over year. Operating income for the three months ended March 31, 2008 declined by $48 million. The decline reflects year over year increases in operating expenses of $153 million offset by the impact of additional margin related to year over year revenue growth.

 

We believe the searches, Page Views, click-throughs, and the related marketing services and fees revenues that we generate correlate to the number and activity level of users across our offerings on Yahoo! Properties and the activity level on our Affiliate sites. By providing a platform for our users that brings together our search technology, content, and community while allowing for personalization and integration across devices, we seek to become more essential to, increase our share of, and deepen the engagement of, our users with our products and services. We believe this deeper engagement of new and existing users and our enhanced algorithmic search technology, coupled with the growth of the Internet as an advertising medium may enable us to increase our revenues during 2008.

 

During the three months ended March 31, 2008, we implemented a strategic workforce realignment to more appropriately allocate resources to our key strategic initiatives. As of March 31, 2008, we incurred a net estimated total strategic workforce realignment pre-tax expense of $17 million.

Net cash provided by operating activities includes a $350 million one-time payment related to a commercial arrangement entered into with AT&T Inc.

 

Results of Operations

 

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

 

 

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

 

 

(*) Percent of total revenues.

 

We currently generate marketing services revenues principally from display advertising on Owned and Operated sites and from sponsored search results generated from searches on Owned and Operated and Affiliate sites. In addition, we receive revenues for Content Match links (advertising on Yahoo! Properties and Affiliate sites which include contextually relevant advertiser links to their respective Websites) on Owned and Operated and Affiliate sites and display advertising on Affiliate sites. The net revenues and related volume metrics from Content Match links and display advertising on Affiliate sites are not currently material and are excluded from the discussion and calculation of average revenue per Page View on Owned and Operated sites and average revenue per search on Affiliate sites that follows.

Marketing Services Revenues from Owned and Operated Sites.  Marketing services revenues from Owned and Operated sites for the three months ended March 31, 2008 increased by $146 million, or 18 percent, as compared to the same period in 2007. Factors leading to growth in overall marketing services revenues included an increase in user activity levels on Yahoo! Properties, which contributed to a higher volume of searches, Page Views, click-throughs, and ad impression displays. Also, our growing audience of users makes Yahoo! Properties more attractive to advertisers and increases their spending on marketing services. We expect marketing services revenues from our Owned and Operated sites to continue growing at a rate faster than total revenues.

 

We periodically review and refine our methodology for monitoring, gathering, and counting Page Views to more accurately reflect the total number of Web pages viewed by users on Yahoo! Properties. Based on this process, from time to time we update our methodology to exclude from the count of Page Views interactions with our servers that we determine or believe are not the result of user visits to our Owned and Operated sites. Using our updated methodology, for the three months ended March 31, 2008 as compared to the same period in 2007, Page Views increased 19 percent and revenue per Page View decreased 1 percent.

 

Underlying our marketing services revenues from Owned and Operated sites for the three months ended March 31, 2008 is growth in Display and Search advertising. During the three months ended March 31, 2008, revenues from display advertising on Owned and Operated sites grew 17 percent, as compared to the same period in 2007. During the three months ended March 31, 2008, revenues from search advertising on Owned and Operated sites grew 21 percent, as compared to the same period in 2007.

 

We believe our growing number of users, advertisers, publishers, and inventory, both on and off our network, over recent years has been driving the increases in our marketing services revenues. We also believe our expanding offerings, including our enhanced algorithmic search technology, contribute to our growing number of users. As our user base increases, we process a higher number of searches and generate a higher number of Page Views. We also believe that our growing audience of users make Yahoo! Properties more attractive to advertisers and increases their spending on marketing services. Further, we believe the growth in users on Yahoo! Properties and on the Internet overall reflects the increasing acceptance, importance, and dependence of users on the Internet. As a result of this growth in the online audience, we believe advertisers are shifting a greater percentage of their spending from traditional media to the Internet to reach this growing audience.

 

Marketing Services Revenues from Affiliate sites.  Marketing services revenues from Affiliate sites for the three months ended March 31, 2008 decreased $42 million, or 7 percent, as compared to the same period in 2007. As more inventory becomes available on the Web, it has, and will continue to make, the Affiliate business more competitive; consequently, our portion of revenue share from Affiliate sites is declining. We expect this trend to continue in 2008. However, we also expect to experience some favorable impact from our off-network display initiatives. While this display business is still relatively small, we expect continued growth as our major partnerships gain momentum. The sale of Overture Japan to Yahoo! Japan in the third quarter of 2007 negatively impacted the Affiliate revenues during the three months ended March 31, 2008 by approximately $120 million on a year over year basis.

 

The number of searches on Affiliate sites increased by approximately 18 percent in the three months ended March 31, 2008, as compared to the same period in 2007. The increase in the volume of searches is primarily attributed to the net increase in the number of Affiliates, as well as increases in searches per Affiliate.

 

The average revenue per search on our Affiliate sites decreased by 23 percent in the three months ended March 31, 2008, as compared to the same period in 2007, primarily as a result of a change in traffic mix, as well as due to traffic quality initiatives, and the impact of the aforementioned sale of Overture Japan to Yahoo! Japan.

 

Fees Revenues.  Fees revenues for the three months ended March 31, 2008 increased $42 million, or 21 percent, as compared to the same period in 2007. The year over year growth is associated with an increase in the number of paying users for our fee-based services, which numbered 17.4 million as of March 31, 2008, compared to 16.5 million as of March 31, 2007, an increase of 5 percent. As we renew contracts with broadband partners and our relationships move from being fee paying user based to an advertising revenue sharing model, our number of fee paying users will decrease. Adjusting the number of fee paying users as of March 31, 2007 to remove the impact of renewed broadband relationships, our fee paying users would have been 15.3 million, compared to 17.4 million as

of March 31, 2008, an increase of 14 percent. Our increased base of paying users grew across most of our Offerings. Our fee-based services include Internet broadband services, sports, music, games, personals, and premium mail offerings, as well as our services for small businesses. Average monthly revenues per paying user remained consistent at approximately $3 for both the three months ended March 31, 2008 and 2007, respectively. Recently, we have been working with our broadband Internet access partners (“partners”) to renew and extend our relationships. As we renew these access relationships, we are seeking to add new opportunities to improve on our historic strengths in portal, search, and mail. The market has moved to an environment in which advertising revenue sharing is the prevailing model. We are evolving our partnerships accordingly and our partners are re-signing with us due to the strategic importance of our relationships and the products we offer. This will result in a reduction in fees revenues associated with these partnerships, but is expected to be offset by increased marketing services revenues associated with the display advertising and sponsored search revenue share arrangements.

 

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

 

 

 

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