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Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

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

For the quarterly period ended June 30, 2014

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  x    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  x    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   x    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  x

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

 

Class

 

Outstanding at July 31, 2014

Common Stock, $0.001 par value   994,603,788

 

 

 


Table of Contents

YAHOO! INC.

Table of Contents

 

PART I   FINANCIAL INFORMATION      3   
Item 1.  

Condensed Consolidated Financial Statements (unaudited):

     3   
 

Condensed Consolidated Balance Sheets as of December 31, 2013 and June 30, 2014 (unaudited)

     3   
 

Condensed Consolidated Statements of Income for the three and six months ended June 30, 2013 and 2014 (unaudited)

     4   
 

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2013 and 2014 (unaudited)

     5   
 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2014 (unaudited)

     6   
  Notes to Condensed Consolidated Financial Statements (unaudited)      8   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      31   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      48   
Item 4.   Controls and Procedures      50   
PART II   OTHER INFORMATION      51   
Item 1.   Legal Proceedings      51   
Item 1A.   Risk Factors      51   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      65   
Item 3.   Defaults Upon Senior Securities      65   
Item 4.   Mine Safety Disclosures      65   
Item 5.   Other Information      65   
Item 6.   Exhibits      65   
  Signatures      66   

 

2


Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Balance Sheets

 

     December 31,
2013
    June 30,
2014
 
     (Unaudited, in thousands
except par values)
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 2,077,590      $ 1,114,586   

Short-term marketable securities

     1,330,304        1,629,869   

Accounts receivable, net

     979,559        824,472   

Prepaid expenses and other current assets

     638,404        588,822   
  

 

 

   

 

 

 

Total current assets

     5,025,857        4,157,749   

Long-term marketable securities

     1,589,500        1,566,120   

Property and equipment, net

     1,488,518        1,470,272   

Goodwill

     4,679,648        4,693,656   

Intangible assets, net

     417,808        364,332   

Other long-term assets

     177,281        175,872   

Investments in equity interests

     3,426,347        4,028,812   
  

 

 

   

 

 

 

Total assets

   $ 16,804,959      $ 16,456,813   
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Current liabilities:

    

Accounts payable

   $ 138,031      $ 121,933   

Accrued expenses and other current liabilities

     907,782        784,345   

Deferred revenue

     294,499        287,508   
  

 

 

   

 

 

 

Total current liabilities

     1,340,312        1,193,786   

Convertible notes

     1,110,585        1,140,112   

Long-term deferred revenue

     258,904        186,348   

Capital lease and other long-term liabilities

     116,605        153,511   

Deferred and other long-term tax liabilities

     847,956        1,052,541   
  

 

 

   

 

 

 

Total liabilities

     3,674,362        3,726,298   

Commitments and contingencies (Note 12)

     —         —    

Yahoo! Inc. stockholders’ equity:

    

Common stock, $0.001 par value; 5,000,000 shares authorized; 1,019,812 shares issued and 1,014,338 shares outstanding as of December 31, 2013 and 1,033,635 shares issued and 995,681 shares outstanding as of June 30, 2014

     1,015        1,029   

Additional paid-in capital

     8,688,304        8,986,410   

Treasury stock at cost, 5,474 shares as of December 31, 2013 and 37,954 shares as of June 30, 2014

     (200,228     (1,367,492

Retained earnings

     4,267,429        4,848,714   

Accumulated other comprehensive income

     318,389        223,327   
  

 

 

   

 

 

 

Total Yahoo! Inc. stockholders’ equity

     13,074,909        12,691,988   

Noncontrolling interests

     55,688        38,527   
  

 

 

   

 

 

 

Total equity

     13,130,597        12,730,515   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 16,804,959      $ 16,456,813   
  

 

 

   

 

 

 

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

 

3


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Income

 

     Three Months Ended     Six Months Ended  
     June 30,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 
     (Unaudited, in thousands except per share amounts)  

Revenue

   $ 1,135,244      $ 1,084,191      $ 2,275,612      $ 2,216,921   

Operating expenses:

        

Cost of revenue — traffic acquisition costs

     64,316        43,826        130,384        89,735   

Cost of revenue — other

     271,262        271,148        549,269        551,992   

Sales and marketing

     279,738        292,817        536,757        622,663   

Product development

     246,198        303,659        465,778        585,291   

General and administrative

     135,039        128,019        268,460        264,512   

Amortization of intangibles

     8,084        15,164        15,449        33,504   

Gains on sales of patents

     (9,950 )     (61,500     (9,950     (61,500

Restructuring charges (reversals), net

     3,578        52,621        (3,484     62,108   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     998,265        1,045,754        1,952,663        2,148,305   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     136,979        38,437        322,949        68,616   

Other income (expense), net

     23,606        (13,589     40,678        (27,042
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes and earnings in equity interests

     160,585        24,848        363,627        41,574   

Provision for income taxes

     (50,267     (8,143     (80,003     (12,360

Earnings in equity interests

     224,690        255,852        442,278        557,254   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     335,008        272,557        725,902        586,468   

Net income attributable to noncontrolling interests

     (3,858     (2,850     (4,467     (5,183
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc.

   $ 331,150      $ 269,707      $ 721,435      $ 581,285   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.31      $ 0.27      $ 0.66      $ 0.58   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.30      $ 0.26      $ 0.65      $ 0.55   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — basic

     1,079,389        999,765        1,086,780        1,004,828   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — diluted

     1,094,694        1,014,692        1,101,395        1,023,056   
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation expense by function:

        

Cost of revenue — other

   $ 3,029      $ 3,209      $ 6,607      $ 25,896   

Sales and marketing

   $ 23,775      $ 33,380      $ 39,820      $ 86,018   

Product development

   $ 20,537      $ 39,507      $ 28,800      $ 53,434   

General and administrative

   $ 20,795      $ 26,349      $ 37,514      $ 46,278   

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

 

4


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Comprehensive Income

 

     Three Months Ended     Six Months Ended  
     June 30,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 
     (Unaudited, in thousands)  

Net income

   $ 335,008      $ 272,557      $ 725,902      $ 586,468   
  

 

 

   

 

 

   

 

 

   

 

 

 

Available-for-sale securities:

        

Unrealized gains (losses) on available-for-sale securities, net of taxes of $2,862 and $(3,238) for the three months ended June 30, 2013 and 2014, respectively, and $3,017 and $(4,136) for the six months ended June 30, 2013 and 2014, respectively

     3,031        9,788        4,069        16,516   

Reclassification adjustment for realized (gains) losses on available-for-sale securities included in net income, net of taxes of $150 and $65 for the three months ended June 30, 2013 and 2014, respectively, and $173 and $73 for the six months ended June 30, 2013 and 2014, respectively

     (251     (109     (290     (121
  

 

 

   

 

 

   

 

 

   

 

 

 

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

     2,780        9,679        3,779        16,395   
  

 

 

   

 

 

   

 

 

   

 

 

 

Foreign currency translation adjustments (“CTA”):

        

Foreign CTA gains (losses), net of taxes of $185 and $(230) for the three months ended June 30, 2013 and 2014, respectively, and $347 and $6 for the six months ended June 30, 2013 and 2014, respectively

     (243,854     63,939        (525,359     (82,918

Net investment hedge CTA gains (losses), net of taxes of ($60,665) and $7,130 for the three months ended June 30, 2013 and 2014, respectively, and ($161,961) and $15,562 for the six months ended June 30, 2013 and 2014, respectively

     101,023        (11,862     269,737        (25,911
  

 

 

   

 

 

   

 

 

   

 

 

 

Net foreign CTA gains (losses), net of tax

     (142,831     52,077        (255,622     (108,829
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flow hedges:

        

Unrealized gains (losses) on cash flow hedges, net of taxes of ($364) and $127 for the three months ended June 30, 2013 and 2014, respectively, and ($364) and $431 for the six months ended June 30, 2013 and 2014, respectively

     11        (1,383     11        (1,889

Reclassification adjustment for realized (gains) losses on cash flow hedges included in net income, net of taxes of $135 and $231 for the three months ended June 30, 2013 and 2014, respectively, and $135 and $504 for the six months ended June 30, 2013 and 2014, respectively

     23        (285     23        (739
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized gains (losses) on cash flow hedges, net of tax

     34        (1,668     34        (2,628
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     (140,017     60,088        (251,809     (95,062
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     194,991        332,645        474,093        491,406   

Less: comprehensive income attributable to noncontrolling interests

     (3,858     (2,850     (4,467     (5,183
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Yahoo! Inc.

   $ 191,133      $ 329,795      $ 469,626      $ 486,223   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

5


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

 

     Six Months Ended  
     June 30,
2013
    June 30,
2014
 
     (Unaudited, in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 725,902      $ 586,468   

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

    

Depreciation

     285,290        239,631   

Amortization of intangible assets

     37,477        64,763   

Accretion of convertible notes discount

     —         29,526   

Stock-based compensation expense

     112,741        211,626   

Non-cash restructuring charges (reversals)

     547        (7,031

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

     13,175        18,667   

Gains on sales of patents

     (9,950     (61,500

Earnings in equity interests

     (442,278     (557,254

Dividend income related to Alibaba Group Preference Shares

     (35,726     —    

Tax benefits from stock-based awards

     9,725        76,828   

Excess tax benefits from stock-based awards

     (18,513     (79,100

Deferred income taxes

     (27,997     14,185   

Dividends received from equity investees

     135,058        83,685   

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

    

Accounts receivable

     58,510        154,129   

Prepaid expenses and other

     (28,723     13,592   

Accounts payable

     (59,754     (10,075

Accrued expenses and other liabilities

     (130,656     (202,142

Deferred revenue

     (75,318     (79,523
  

 

 

   

 

 

 

Net cash provided by operating activities

     549,510        496,475   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Acquisition of property and equipment , net

     (151,657     (192,013

Purchases of marketable securities

     (2,244,302     (1,363,836

Proceeds from sales of marketable securities

     1,458,593        380,954   

Proceeds from maturities of marketable securities

     462,406        690,018   

Proceeds related to the redemption of Alibaba Group Preference Shares

     800,000        —    

Acquisitions, net of cash acquired

     (1,024,157     (21,661

Purchases of intangible assets

     (2,052     (2,174

Proceeds from settlement of derivative hedge contracts

     5,511        173,258   

Payments for settlement of derivative hedge contracts

     (7,720     (4,616

Payment for equity investment

     —         (10,399

Proceeds from sales of patents

     —         1,500   

Other investing activities, net

     (930     (640
  

 

 

   

 

 

 

Net cash used in investing activities

     (704,308     (349,609
  

 

 

   

 

 

 

 

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

 

6


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows (continued)

 

     Six Months Ended  
     June 30,
2013
    June 30,
2014
 
     (Unaudited, in thousands)  

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from issuance of common stock, net

     123,092        163,737   

Repurchases of common stock

     (1,427,825     (1,168,206

Excess tax benefits from stock-based awards

     18,513        79,100   

Tax withholdings related to net share settlements of restricted stock units

     (51,137     (159,581

Distributions to noncontrolling interests

     —         (22,344

Other financing activities, net

     (2,778     (6,130
  

 

 

   

 

 

 

Net cash used in financing activities

     (1,340,135     (1,113,424
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (30,622     3,554   

Net change in cash and cash equivalents

     (1,525,555     (963,004

Cash and cash equivalents at beginning of period

     2,667,778        2,077,590   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 1,142,223      $ 1,114,586   
  

 

 

   

 

 

 

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

 

7


Table of Contents

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 making the world’s daily habits inspiring and entertaining. By creating highly personalized experiences for its users, the Company keeps people connected to what matters most to them, across devices and around the world. The Company creates value for advertisers by connecting them with the audiences that build their businesses. For advertisers, the opportunity to be a part of users’ daily habits across products and platforms is a powerful tool to engage audiences and build brand loyalty. Advertisers can build their businesses by advertising to targeted audiences on the Company’s online properties and services (“Yahoo Properties”) or through a distribution network of third-party entities (“Affiliates”) who integrate the Company’s advertising offerings into their Websites or other offerings (“Affiliate sites” and, together with Yahoo Properties, the “Yahoo Network”). The Company manages and measures its business geographically, principally in the Americas, EMEA (Europe, Middle East, and Africa) and Asia Pacific.

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

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

The preparation of consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States (“U.S.”) requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses and the related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to revenue, the useful lives of long-lived assets including property and equipment and intangible assets, investment fair values, stock-based compensation, goodwill, income taxes, contingencies, and restructuring charges. When these carrying values are not readily available from other sources, 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. 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, 2013. 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, 2013 was derived from the Company’s audited financial statements for the year ended December 31, 2013, but does not include all disclosures required by U.S. GAAP. However, the Company believes the disclosures are adequate to make the information presented not misleading.

Recent Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-08, “Reporting of Discontinued Operations and Disclosures of Disposals of Components of an Entity,” which provides a narrower definition of discontinued operations than under existing U.S. GAAP. ASU 2014-08 requires that only a disposal of a component of an entity, or a group of components of an entity, that represents a strategic shift that has, or will have, a major effect on the reporting entity’s operations and financial results should be reported in the financial statements as discontinued operations. ASU 2014-08 also provides guidance on the financial statement presentations and disclosures of discontinued operations. The amendments in ASU 2014-08 are effective for all disposals of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015, with early application permitted. The Company does not anticipate that this adoption will have a significant impact on its financial position, results of operations, or cash flows.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition” and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, with early application not permitted. The Company is currently evaluating the effects, if any, that the adoption of this guidance will have on the Company’s financial position, results of operations and cash flows.

 

8


Table of Contents

Note 2 INVESTMENTS AND FAIR VALUE MEASUREMENTS

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

 

     December 31, 2013  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 538,397       $ 65       $ (101   $ 538,361   

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

     2,380,134         2,525         (1,216     2,381,443   

Corporate equity securities

     230         153         —         383   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 2,918,761       $ 2,743       $ (1,317   $ 2,920,187   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     June 30, 2014  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 572,678       $ 447       $ (84   $ 573,041   

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

     2,620,760         2,722         (534     2,622,948   

Corporate equity securities

     230         189         —         419   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 3,193,668       $ 3,358       $ (618   $ 3,196,408   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31,
2013
     June 30,
2014
 

Reported as:

     

Short-term marketable securities

   $ 1,330,304       $ 1,629,869   

Long-term marketable securities

     1,589,500         1,566,120   

Other assets

     383         419   
  

 

 

    

 

 

 

Total

   $ 2,920,187       $ 3,196,408   
  

 

 

    

 

 

 

Short-term, highly liquid investments of $1.5 billion and $374 million as of December 31, 2013 and June 30, 2014, respectively, 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 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 three and six months ended June 30, 2013 and 2014.

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

 

     December 31,
2013
     June 30,
2014
 

Due within one year

   $ 1,330,304       $ 1,629,869   

Due after one year through five years

     1,589,500         1,566,120   
  

 

 

    

 

 

 

Total available-for-sale marketable securities

   $ 2,919,804       $ 3,195,989   
  

 

 

    

 

 

 

 

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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, 2013  
     Less than 12 Months     12 Months or Longer     Total  
     Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

Government and agency securities

   $ 263,514       $ (101   $  —        $  —        $ 263,514       $ (101

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

     696,950         (1,214     3,833         (2 )     700,783         (1,216
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investments in available-for-sale securities

   $ 960,464       $ (1,315   $ 3,833       $ (2 )   $ 964,297       $ (1,317
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     June 30, 2014  
     Less than 12 Months     12 Months or Longer     Total  
     Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

Government and agency securities

   $ 111,788       $ (84   $  —        $ —       $ 111,788       $ (84

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

     589,718         (496     12,834         (38     602,552         (534
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investments in available-for-sale securities

   $ 701,506       $ (580   $ 12,834      $ (38   $ 714,340       $ (618
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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 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 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 the securities in an unrealized loss position. 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, 2013 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  

Assets

   Level 1      Level 2     Total  

Money market funds(1)

   $ 936,438       $ —       $ 936,438   

Available-for-sale securities:

       

Government and agency securities(1)

     —          876,197        876,197   

Commercial paper and bank certificates of deposit(1)

     —          472,080        472,080   

Corporate debt securities(1)

     —          2,059,159        2,059,159   

Time deposits(1)

     —          84,443        84,443   

Corporate equity securities(2)

     383         —         383   

Foreign currency derivative contracts(3)

     —          214,041        214,041   
  

 

 

    

 

 

   

 

 

 

Financial assets at fair value

   $ 936,821       $ 3,705,920      $ 4,642,741   

Liabilities

                   

Foreign currency derivative contracts(3)

     —          (1,401     (1,401
  

 

 

    

 

 

   

 

 

 

Total financial assets and liabilities at fair value

   $ 936,821       $ 3,704,519      $ 4,641,340   
  

 

 

    

 

 

   

 

 

 

 

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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, 2014 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  

Assets

   Level 1      Level 2     Total  

Money market funds(1)

   $ 373,308       $ —       $ 373,308   

Available-for-sale securities:

       

Government and agency securities(1)

     —          647,767        647,767   

Commercial paper and bank certificates of deposit(1)

     —          351,504        351,504   

Corporate debt securities(1)

     —          2,271,444        2,271,444   

Time deposits(1)

     —          77,782        77,782   

Corporate equity securities(2)

     419         —         419   

Foreign currency derivative contracts(3)

     —          22,709        22,709   
  

 

 

    

 

 

   

 

 

 

Financial assets at fair value

   $ 373,727       $ 3,371,206      $ 3,744,933   

Liabilities

                   

Foreign currency derivative contracts(3)

     —          (24,063     (24,063
  

 

 

    

 

 

   

 

 

 

Total financial assets and liabilities at fair value

   $ 373,727       $ 3,347,143      $ 3,720,870   
  

 

 

    

 

 

   

 

 

 

 

(1)

The money market funds, government and agency securities, commercial paper and bank certificates of deposit, corporate debt securities, and time deposits are classified as part of either cash and cash equivalents or investments in marketable 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 current or noncurrent assets or liabilities in the condensed consolidated balance sheets. The notional amounts of the foreign currency derivative contracts were $1.8 billion, including contracts designated as net investment hedges of $1.3 billion, as of December 31, 2013, and $3.1 billion, including contracts designated as net investment hedges of $2.6 billion, as of June 30, 2014.

The amount of cash and cash equivalents as of December 31, 2013 and June 30, 2014 included $569 million and $589 million, respectively, in cash 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 using quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in markets that are not active; and inputs other than quoted prices (e.g., interest rates and yield curves). The Company utilizes a pricing service to assist in obtaining fair value pricing for the majority of the investment portfolio.

Activity between Levels of the Fair Value Hierarchy

During the year ended December 31, 2013 and the six months ended June 30, 2014, the Company did not make any transfers between Level 1 and Level 2 assets or liabilities.

Convertible Senior Notes

In 2013, the Company issued $1.4375 billion aggregate principal amount of 0.00% Convertible Senior Notes due 2018 (the “Notes”). The Notes are carried at their original issuance value, net of unamortized debt discount, and are not marked to market each period. The approximate estimated fair value of the Notes as of both December 31, 2013 and June 30, 2014 was $1.1 billion. The estimated fair value of the Notes was determined on the basis of quoted market prices observable in the market and is considered Level 2 in the fair value hierarchy. See Note 11—“Convertible Notes” for additional information related to the Notes.

 

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Note 3 CONSOLIDATED FINANCIAL STATEMENT DETAILS

Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income were as follows (in thousands):

 

     December 31,
2013
     June 30,
2014
 

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

   $ 15,101       $ 31,496   

Unrealized gains (losses) on cash flow hedges, net of tax

     1,412         (1,216

Foreign currency translation, net of tax

     301,876         193,047   
  

 

 

    

 

 

 

Accumulated other comprehensive income

   $ 318,389       $ 223,327   
  

 

 

    

 

 

 

Noncontrolling Interests

Noncontrolling interests were as follows (in thousands):

 

     December 31,
2013
     June 30,
2014
 

Beginning balance of noncontrolling interests

   $ 45,403       $ 55,688   

Distributions to noncontrolling interests

     —          (22,344

Net income attributable to noncontrolling interests

     10,285         5,183   
  

 

 

    

 

 

 

Ending balance of noncontrolling interests

   $ 55,688       $ 38,527   
  

 

 

    

 

 

 

Other Income (Expense), Net

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 

Interest, dividend, and investment income

   $ 21,934      $ 5,596      $ 47,852      $ 11,033   

Interest expense

     (2,217     (17,088     (4,490     (34,169

Other income (expense), net

     3,889        (2,097     (2,684     (3,906
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense), net

   $ 23,606      $ (13,589   $ 40,678      $ (27,042
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest, dividend and investment income consists of income earned from cash in bank accounts, investments made in marketable securities and money market funds, and dividend income on the Alibaba Group Preference Shares.

Interest expense is related to the Notes and capital lease obligations for buildings and data centers.

Other income (expense), net consists of gains and losses from sales or impairments of marketable securities and/or investments in privately-held companies, foreign exchange gains and losses due to re-measurement of monetary assets and liabilities denominated in non-functional currencies, and unrealized and realized foreign currency transaction gains and losses, including gains and losses related to balance sheet hedges.

 

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Reclassifications Out of Accumulated Other Comprehensive Income

Reclassifications out of accumulated other comprehensive income for the three months ended June 30, 2013 and June 30, 2014 were as follows (in thousands):

 

    Three Months Ended
June 30, 2013
    Three Months Ended
June 30, 2014
     
    Amount
Reclassified from
Accumulated
Other
Comprehensive
Income
    Amount
Reclassified from
Accumulated
Other
Comprehensive
Income
    Affected Line Item in the
Statement of Income

Realized losses (gains) on cash flow hedges, net of tax

  $ 23      $ (285   Revenue

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

    (251     (109   Other income, net
 

 

 

   

 

 

   

Total reclassifications for the period

  $ (228   $ (394  
 

 

 

   

 

 

   
Reclassifications out of accumulated other comprehensive income for the six months ended June 30, 2013 and June 30, 2014 were as follows (in thousands):
    Six Months Ended
June 30, 2013
    Six Months Ended
June 30, 2014
     
    Amount
Reclassified from
Accumulated
Other
Comprehensive
Income
    Amount
Reclassified from
Accumulated
Other
Comprehensive
Income
    Affected Line Item in the
Statement of Income

Realized losses (gains) on cash flow hedges, net of tax

  $ 23      $ (739   Revenue

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

    (290     (121   Other income, net
 

 

 

   

 

 

   

Total reclassifications for the period

  $ (267   $ (860  
 

 

 

   

 

 

   

Note 4 ACQUISITIONS AND DISPOSITIONS

Transactions completed in 2013

Tumblr. On June 19, 2013, the Company completed the acquisition of Tumblr, Inc. (“Tumblr”), a blog-hosting Website that allows users to post their own content as well as follow or re-blog posts made by other users. The acquisition of Tumblr brought a community of new users to the Yahoo Network.

The purchase price exceeded the fair value of the net tangible and identifiable intangible assets acquired 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 vested options) in Tumblr. Tumblr stockholders and vested optionholders were paid in cash, outstanding Tumblr unvested options and restricted stock units were assumed and converted into equivalent awards covering Yahoo common stock, and a portion of the Tumblr shares held by its founder were exchanged for Yahoo common stock.

The total purchase price of approximately $990 million consisted mainly of cash consideration. The allocation of the purchase price of the assets acquired and liabilities assumed based on their fair values was as follows (in thousands):

 

Cash and marketable securities acquired

   $ 16,587   

Other tangible assets acquired

     76,566   

Amortizable intangible assets:

  

Developed technology

     23,700   

Customer contracts and related relationships

     182,400   

Trade name

     56,500   

Goodwill

     748,979   
  

 

 

 

Total assets acquired

     1,104,732   

Liabilities assumed

     (114,521
  

 

 

 

Total

   $ 990,211   
  

 

 

 

 

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In connection with the acquisition, the Company is recognizing stock-based compensation expense of $70 million over a period of up to four years. This amount is comprised of assumed unvested stock options and restricted stock units (which had an aggregate fair value of $29 million at the acquisition date), and Yahoo common stock issued to Tumblr’s founder (which had a fair value of $41 million at the acquisition date). The Yahoo common stock issued to Tumblr’s founder is subject to holdback and will be released over four years provided he remains an employee of the Company. In addition, the transaction resulted in cash consideration of $40 million to be paid to Tumblr’s founder over four years, also provided that he remains an employee of the Company. Such cash payments are being recognized as compensation expense over the four-year service period.

The amortizable intangible assets have useful lives not exceeding six years and a weighted average useful life of six years. No amounts have been allocated to in-process research and development and $749 million has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired and is not deductible for tax purposes. This acquisition brings a community of new users to the Yahoo Network by deploying Yahoo’s personalization technology and search infrastructure to deliver relevant content to the Tumblr user base.

Other Acquisitions — Business Combinations. During the six months ended June 30, 2013, the Company acquired nine other companies, which were accounted for as business combinations. The total aggregate purchase price for these other acquisitions was $54 million. The total cash consideration of $54 million less cash acquired of $1 million resulted in a net cash outlay of $53 million. The purchase price allocated to the assets acquired and liabilities assumed based on their relative fair values was $36 million allocated to goodwill, $18 million to amortizable intangible assets, $4 million to other tangible assets, $1 million to cash acquired, and $5 million to assumed liabilities.

The Company’s business combinations completed during the six months ended June 30, 2013 did not have a material impact on the Company’s condensed consolidated revenue or net income, and therefore pro forma disclosures have not been presented.

Transactions completed in 2014

Other Acquisitions — Business Combinations. During the six months ended June 30, 2014, the Company acquired five companies, all of which were accounted for as business combinations. The total purchase price for these acquisitions was $23 million less cash acquired of $1 million, which resulted in a net cash outlay of $22 million. The preliminary purchase price allocation of the assets acquired and liabilities assumed based on their estimated fair values was $16 million allocated to goodwill, $9 million to amortizable intangible assets, $1 million to cash acquired, and $3 million to assumed liabilities.

The Company’s business combinations completed during the six months ended June 30, 2014 did not have a material impact on the Company’s condensed consolidated revenue or net income, and therefore pro forma disclosures have not been presented.

Patent Sale and License Agreement

During the second quarter of 2014, the Company entered into a patent sale and license agreement for total cash consideration of $460 million. The total consideration was allocated based on the estimated relative fair value of each of the elements of the agreement: $61 million was allocated to the sale of patents (“Sold Patents”), $135 million to the license to existing patents (“Existing Patents”) and $264 million to the license of patents developed or acquired in the next five years (“Capture Period Patents”). The Company recorded $60 million as a gain on the Sold Patents during the second quarter of 2014 and will recognize the remaining $1 million gain on the Sold Patents in the third quarter of 2014 when payment is due. The amounts allocated to the license of the Existing Patents will be recorded as revenue over the four year payment period under the license when payments are due. The amounts allocated to the Capture Period Patents will be recorded as revenue over the five year capture period.

Note 5 GOODWILL

The Company’s goodwill balance was $4.7 billion as of December 31, 2013 and June 30, 2014, of which $3.8 billion was recorded in the Americas segment, $0.6 billion was recorded in the EMEA (Europe, Middle East and Africa) segment, and $0.3 billion was recorded in the Asia Pacific segment. The increase in the carrying amount of goodwill of $14 million during the six months ended June 30, 2014 was primarily due to foreign currency translation gains of $7 million, additions to goodwill of $16 million related to acquisitions, and $9 million related to adjustments made to prior year acquisitions.

 

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Note 6 INTANGIBLE ASSETS, NET

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

 

     December 31, 2013      June 30, 2014  
     Net      Gross Carrying
Amount
     Accumulated
Amortization(*)
    Net  

Customer, affiliate, and advertiser related relationships

   $ 205,818       $ 263,772       $ (85,242   $ 178,530   

Developed technology and patents

     140,499         247,775         (127,863     119,912   

Trade names, trademarks, and domain names

     71,491         105,978         (40,088     65,890   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total intangible assets

   $ 417,808       $ 617,525       $ (253,193   $ 364,332   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(*) 

Cumulative foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities increased total intangible assets by approximately $19 million as of June 30, 2014.

For the three months ended June 30, 2013 and 2014, the Company recognized amortization expense for intangible assets of $19 million and $30 million, respectively, including $11 million and $15 million in cost of revenue—other for the three months ended June 30, 2013 and 2014, respectively. For the six months ended June 30, 2013 and 2014, the Company recognized amortization expense for intangible assets of $37 million and $65 million, respectively, including $22 million and $31 million in cost of revenue—other for the six months ended June 30, 2013 and 2014, respectively. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2014 and each of the succeeding years is as follows: six months ending December 31, 2014: $56 million; 2015: $93 million; 2016: $68 million; 2017: $60 million; and thereafter $70 million.

Note 7 BASIC AND DILUTED NET INCOME ATTRIBUTABLE TO YAHOO! INC. COMMON STOCKHOLDERS PER SHARE

Basic and diluted net income attributable to Yahoo! Inc. 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 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 10 million and 17 million shares of common stock for the three and six months ended June 30, 2013, respectively, and 7 million and 4 million shares of common stock for the three and six months ended June 30, 2014, respectively, 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,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 

Basic:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 331,150      $ 269,707      $ 721,435      $ 581,285   

Less: Net income allocated to participating securities

     (7     (2     (18     (5
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 331,143      $ 269,705      $ 721,417      $ 581,280   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average common shares

     1,079,389        999,765        1,086,780        1,004,828   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.31      $ 0.27      $ 0.66      $ 0.58   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 331,150      $ 269,707      $ 721,435      $ 581,285   

Less: Net income allocated to participating securities

     (7     (2     (18     (5

Less: Effect of dilutive securities issued by equity investees

     (3,619     (9,421     (5,738     (21,786
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 327,524      $ 260,284      $ 715,679      $ 559,494   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic calculation

     1,079,389        999,765        1,086,780        1,004,828   

Weighted average effect of Yahoo! Inc. dilutive securities:

        

Restricted stock units

     12,140        10,855        11,784        13,262   

Stock options and employee stock purchase plan

     3,165        4,072        2,831        4,966   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted calculation

     1,094,694        1,014,692        1,101,395        1,023,056   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 0.30      $ 0.26      $ 0.65      $ 0.55   
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 8 INVESTMENTS IN EQUITY INTERESTS

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

 

     December 31,
2013
     Percent
Ownership
    June 30,
2014
     Percent
Ownership
 

Alibaba Group

   $ 1,018,126         24   $ 1,572,080         24

Yahoo Japan

     2,399,590         35     2,437,767         36

Other

     8,631         19     18,965         17
  

 

 

      

 

 

    

Total

   $ 3,426,347         $ 4,028,812      
  

 

 

      

 

 

    

 

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’s accounting policy is to record its share of the results of Alibaba Group, and any related amortization expense and related tax impact, one quarter in arrears within earnings in equity interests in the condensed consolidated statements of income. As of June 30, 2014, the excess of carrying value of the Company’s investment in Alibaba Group and the Company’s proportionate share of the net assets of Alibaba Group is largely attributable to goodwill.

Initial Repurchase by Alibaba Group. On September 18, 2012 (the “Repurchase Closing Date”), Alibaba Group repurchased 523 million of the 1,047 million ordinary shares of Alibaba Group (“Alibaba Shares”) owned by the Company (the “Initial Repurchase”). The Initial Repurchase was made pursuant to the terms of the Share Repurchase and Preference Share Sale Agreement entered into by Yahoo! Inc., Alibaba Group and Yahoo! Hong Kong Holdings Limited, a Hong Kong corporation and wholly-owned subsidiary of Yahoo! Inc. (“YHK”), on May 20, 2012 (as amended on September 11, 2012, October 14, 2013 and July 14, 2014, the

 

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“Repurchase Agreement”). Yahoo received $13.54 per Alibaba Share, or approximately $7.1 billion in total consideration, for the 523 million Alibaba Shares sold to Alibaba Group. Approximately $6.3 billion of the consideration was received in cash and $800 million was received in Alibaba Group Preference Shares, which Alibaba Group redeemed on May 16, 2013. During the six months ended June 30, 2013, the Company received cash dividends from Alibaba Group of $58 million related to the Alibaba Group Preference Shares. The Initial Repurchase resulted in a pre-tax gain of approximately $4.6 billion for the year ended December 31, 2012.

The Repurchase Agreement initially provided that at the time Alibaba Group completes an initial public offering meeting certain specified criteria (a “Qualified IPO”), Yahoo and YHK would sell, at Alibaba Group’s election (either directly to Alibaba Group or in the Qualified IPO), up to 261.5 million of their remaining Alibaba Shares. This amount was subsequently reduced to 140 million. If Alibaba Shares are sold back to Alibaba Group, the purchase price per share will be equal to the per share price in the Qualified IPO less specified fees and underwriter discounts.

On the Repurchase Closing Date, the Company and Alibaba Group entered into an amendment of their existing Technology and Intellectual Property License Agreement (the “TIPLA”) pursuant to which Alibaba Group made an initial payment to the Company of $550 million in satisfaction of certain future royalty payments under the existing TIPLA. The Company is currently recognizing this revenue over the four-year term of the TIPLA, which ends on September 18, 2016. In the event of a Qualified IPO prior to September 18, 2015, the TIPLA terminates on September 18, 2015. In that event, the Company will recognize the remaining initial TIPLA payment revenue through September 18, 2015. For both the three months ended June 30, 2013 and 2014, the Company recognized approximately $34 million of this revenue. For both the six months ended June 30, 2013 and 2014, the Company recognized approximately $69 million of this revenue. Alibaba Group will continue making royalty payments until the earlier of the fourth anniversary of the effective date of the amendment and a Qualified IPO. The royalty revenue recognized was approximately $21 million and $28 million for the three months ended June 30, 2013 and 2014, respectively, and approximately $56 million and $63 million for the six months ended June 30, 2013 and 2014, respectively.

The following table presents Alibaba Group’s U.S. GAAP financial information, as derived from the Alibaba Group financial statements (in thousands):

 

     Three Months Ended      Six Months Ended  
     March 31,
2013
     March 31,
2014
     March 31,
2013
     March 31,
2014
 

Operating data:

           

Revenue

   $ 1,381,644       $ 1,966,303       $ 3,222,093       $ 5,024,031   

Gross profit(*)

   $ 1,018,916       $ 1,399,105       $ 2,396,787       $ 3,776,532   

Income from operations(*)

   $ 709,083       $ 890,830       $ 1,512,170       $ 2,326,517   

Net income

   $ 679,537       $ 925,568       $ 1,329,514       $ 2,289,329   

Net income attributable to ordinary shareholders of Alibaba Group

   $ 668,676       $ 906,299       $ 1,310,849       $ 2,255,231   

 

     September 30,
2013
     March 31,
2014
 

Balance sheet data:

     

Current assets

   $ 7,994,731       $ 11,025,969   

Long-term assets

   $ 5,959,835       $ 7,105,867   

Current liabilities

   $ 4,838,510       $ 6,076,625   

Long-term liabilities

   $ 5,319,113       $ 5,420,426   

Convertible preferred shares

   $ 1,688,889       $ 1,690,642   

Noncontrolling interests

   $ 92,127       $ 175,115   

 

(*) 

Certain prior period amounts have been reclassified to conform to the current period presentation with no effect on previously reported net income or stockholders’ equity.

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.

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

 

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The fair value of the Company’s ownership interest in the common stock of Yahoo Japan, based on the quoted stock price, was approximately $9 billion as of June 30, 2014.

During the three and six months ended June 30, 2013 and 2014, the Company received cash dividends from Yahoo Japan in the amount of $77 million and $84 million, net of withholding taxes, respectively, which were recorded as reductions to the Company’s investment in Yahoo Japan.

During the six months ended June 30, 2014, the Company sold data center assets and assigned a data center lease to Yahoo Japan for cash proceeds of $11 million and recorded a net gain of approximately $5 million within general and administrative operating expenses.

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

 

     Three Months Ended      Six Months Ended  
     March 31,
2013
     March 31,
2014
     March 31,
2013
     March 31,
2014
 
     (in thousands)  

Operating data:

           

Revenue

   $ 1,121,453       $ 1,055,064       $ 2,278,643       $ 2,086,720   

Gross profit

   $ 934,003       $ 861,258       $ 1,915,065       $ 1,705,184   

Income from operations

   $ 551,488       $ 477,945       $ 1,165,980       $ 967,387   

Net income

   $ 348,297       $ 314,029       $ 691,711       $ 621,141   

Net income attributable to Yahoo Japan

   $ 346,163       $ 311,182       $ 686,713       $ 615,527   

 

     September 30,
2013
     March 31,
2014
 
     (In thousands)  

Balance sheet data:

     

Current assets

   $ 6,318,156       $ 6,533,053   

Long-term assets

   $ 1,728,912       $ 1,746,621   

Current liabilities

   $ 1,992,508       $ 2,115,259   

Long-term liabilities

   $ 56,762       $ 55,830   

Noncontrolling interests

   $ 74,754       $ 77,329   

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 $63 million and $64 million for the three months ended June 30, 2013 and 2014, respectively, and approximately $134 million and $132 million for the six months ended June 30, 2013 and 2014, respectively. As of December 31, 2013 and June 30, 2014, the Company had net receivable balances from Yahoo Japan of approximately $42 million and $44 million, respectively.

Note 9 DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments, primarily forward contracts and option contracts, to mitigate risk associated with adverse movements in foreign currency exchange rates.

The Company records all derivatives in the condensed consolidated balance sheets at fair value with assets included in prepaid expenses and other current assets or other long-term assets and liabilities included in accrued expenses and other current liabilities or capital lease and other long-term liabilities. The Company’s accounting treatment for these instruments is based on whether or not the instruments are designated as a hedging instrument. The effective portions of net investment hedges are recorded in other comprehensive income as a part of the cumulative translation adjustment. The effective portions of cash flow hedges are recorded in accumulated other comprehensive income until the hedged item is recognized in revenue on the condensed consolidated statements of income when the underlying hedged revenue is recognized. Any ineffective portions of net investment hedges and cash flow hedges are recorded in other income, net on the Company’s condensed consolidated statements of income. For balance sheet hedges, changes in the fair value are recorded in other income, net on the Company’s condensed consolidated statements of income.

The Company enters into master netting arrangements, which are designed to reduce credit risk by permitting net settlement of transactions with the same counterparty. The Company presents its derivative assets and liabilities at their gross fair values on the condensed consolidated balance sheets. However, under the master netting arrangements with the respective counterparties of the foreign exchange contracts, subject to applicable requirements, the Company is allowed to net settle transactions. The Company is not required to pledge, and is not entitled to receive, cash collateral related to these derivative transactions.

 

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Designated as Hedging Instruments

Net Investment Hedges. The Company hedges, on an after-tax basis, a portion of its net investment in Yahoo Japan with forward contracts and option contracts to reduce the risk that its investment in Yahoo Japan will be adversely affected by foreign currency exchange rate fluctuations. The total of the after-tax net investment hedge was less than the Yahoo Japan investment balance as of both December 31, 2013 and June 30, 2014. As such, the net investment hedge was considered to be effective.

Cash Flow Hedges. The Company entered into foreign currency forward contracts designated as cash flow hedges of varying maturities through December 31, 2014. The cash flow hedges were considered to be effective as of December 31, 2013 and June 30, 2014. The Company expects all of the forward contracts designated as cash flow hedges to be reclassified to revenue within fiscal year 2014, as it expects to recognize the hedged forecasted revenue related to these contracts by December 31, 2014.

Not Designated as Hedging Instruments

Balance Sheet Hedges. The Company hedges certain of its net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that its earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These derivative instruments hedge assets and liabilities, including intercompany transactions, which are denominated in foreign currencies.

Notional amounts of the Company’s outstanding forward contracts as of December 31, 2013 and June 30, 2014 (in millions) were as follows:

 

     December 31,
2013
     June 30,
2014
 

Derivatives designated as hedging instruments:

     

Net investment hedges

   $ 1,341       $ 2,553   

Cash flow hedges

   $ 56       $ 143   

Derivatives not designated as hedging instruments:

     

Balance sheet hedges

   $ 393       $ 408   

Foreign currency forward contracts activity for the six months ended June 30, 2013 was as follows (in millions):

 

     Beginning
Fair Value
    Settlement      Gain (Loss)
Recorded in
Other Income,
Net
     Gain (Loss)
Recorded in
Other
Comprehensive
Income
    Gain
(Loss)
Recorded
in
Revenue
     Ending Fair
Value
 

Derivatives designated as hedging instruments:

               

Net investment hedges

   $ 3      $  —         $ —         $ 432 (*)    $ —         $ 435   

Derivatives not designated as hedging instruments:

               

Balance sheet hedges

     (5     2         4        —         —          1   

 

(*) 

This amount does not reflect the tax impact of $162 million recorded during the six months ended June 30, 2013. The $273 million after tax impact of the gain recorded under other comprehensive income was included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets as of June 30, 2013.

 

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Foreign currency forward contracts activity for the six months ended June 30, 2014 was as follows (in millions):

 

     Beginning
Fair Value
     Settlement     Gain (Loss)
Recorded in
Other Income,
Net
    Gain (Loss)
Recorded in
Other
Comprehensive
Income
    Gain
(Loss)
Recorded
in
Revenue
     Ending Fair
Value
 

Derivatives designated as hedging instruments:

              

Net investment hedges

   $ 209       $ (170   $ —        $ (41 )(1)    $ —         $ (2

Cash flow hedges

     4         (2     (1 )     (4 )(2)      2        (1 )

Derivatives not designated as hedging instruments:

              

Balance sheet hedges

     —          3        (1 )     —         —          2   

 

(1) 

This amount does not reflect the tax impact of $15 million recorded during the six months ended June 30, 2014. The $26 million after tax impact of the loss recorded within other comprehensive income was included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets as of June 30, 2014.

(2) 

This amount does not reflect the tax impact of $1 million recorded during the six months ended June 30, 2014. The $3 million after tax impact of the loss was included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets as of June 30, 2014.

Foreign currency forward contracts balance sheet location and ending fair value was as follows (in millions):

 

     Balance Sheet
Location
   December 31,
2013
    June 30,
2014
 

Derivatives designated as hedging instruments:

       

Net investment hedges

   Asset    $ 209      $ 19   
   Liability    $ —       $ (21

Cash flow hedges

   Asset    $ 4      $ —    
   Liability    $ —       $ (1

Derivatives not designated as hedging instruments:

       

Balance sheet hedges

   Asset    $ 1      $ 3   
   Liability    $ (1   $ (1

Note 10 CREDIT AGREEMENT

The Company’s credit agreement (the “Credit Agreement”) with Citibank, N.A. terminates on October 9, 2014. The Credit Agreement, as amended, provides for a $750 million unsecured revolving credit facility, subject to increase of up to $250 million in accordance with its terms. As of June 30, 2014, the Company was in compliance with the financial covenants in the Credit Agreement and no amounts were outstanding.

Note 11 CONVERTIBLE NOTES

0.00% Convertible Senior Notes

As of June 30, 2014, the Company had $1.4 billion principal amount of Notes outstanding. The Notes are senior unsecured obligations of Yahoo, the Notes do not bear regular interest, and the principal amount of the Notes does not accrete. The Notes mature on December 1, 2018, unless previously purchased or converted in accordance with their terms prior to such date. The Company may not redeem Notes prior to maturity. However, holders of the Notes may convert them at certain times and upon the occurrence of certain events in the future, as outlined in the indenture governing the Notes (the “Indenture”). Holders of the Notes who convert in connection with a “make-whole fundamental change,” as defined in the Indenture, may require Yahoo to purchase for cash all or any portion of their Notes at a purchase price equal to 100 percent of the principal amount, plus accrued and unpaid special interest as defined in the Indenture, if any. The Notes are convertible, subject to certain conditions, into shares of Yahoo common stock at an initial conversion rate of 18.7161 shares per $1,000 principal amount of Notes (which is equivalent to an initial conversion price of approximately $53.43 per share), subject to adjustment upon the occurrence of certain events. Upon conversion of the Notes, holders will receive cash, shares of Yahoo’s common stock, or a combination thereof, at Yahoo’s election. The Company’s intent is to settle

 

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the principal amount of the Notes in cash upon conversion. If the conversion value exceeds the principal amount, the Company would deliver shares of its common stock in respect to the remainder of its conversion obligation in excess of the aggregate principal amount (conversion spread). As of June 30, 2014, none of the conditions allowing holders of the Notes to convert had been met.

The Notes consist of the following (in thousands):

 

     December 31,
2013
    June 30,
2014
 

Liability component:

    

Principal

   $ 1,437,500      $ 1,437,500   

Less: note discount

     (326,915     (297,388
  

 

 

   

 

 

 

Net carrying amount

   $ 1,110,585      $ 1,140,112   
  

 

 

   

 

 

 

Equity component (*)

   $ 305,569      $ 305,569   
  

 

 

   

 

 

 

 

(*)

Recorded on the condensed consolidated balance sheets within additional paid-in capital.

The following table sets forth total interest expense recognized related to the Notes for the three and six months ended June 30, 2013 and 2014 (in thousands):

 

     Three Months Ended      Six Months Ended  
     June 30,
2013
     June 30,
2014
     June 30,
2013
     June 30,
2014
 

Accretion of convertible note discount

   $ —         $ 14,860       $ —         $ 29,526   
  

 

 

    

 

 

    

 

 

    

 

 

 

The fair value of the Notes, which was determined based on inputs that are observable in the market (Level 2), and the carrying value of debt instruments (carrying value excludes the equity component of the Notes classified in equity) was as follows (in thousands):

 

     December 31, 2013      June 30, 2014  
      Fair Value      Carrying Value      Fair Value      Carrying Value  

Convertible senior notes

   $ 1,111,473       $ 1,110,585       $ 1,146,539       $ 1,140,112   

Note 12 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 12 years which expire between 2014 and 2025.

A summary of gross and net lease commitments as of June 30, 2014 was as follows (in millions):

 

     Gross Operating
Lease
Commitments
     Sublease
Income
    Net Operating
Lease
Commitments
 

Six months ending December 31, 2014

   $ 71       $ (6   $ 65   

Years ending December 31,

       

2015

     120         (9     111   

2016

     86         (2     84   

2017

     64         —         64   

2018

     41         —         41   

2019

     32         —         32   

Due after 5 years

     108         —         108   
  

 

 

    

 

 

   

 

 

 

Total gross and net lease commitments

   $ 522       $ (17   $ 505   
  

 

 

    

 

 

   

 

 

 

 

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     Capital Lease
Commitment
 

Six months ending December 31, 2014

   $ 7   

Years ending December 31,

  

2015

     12   

2016

     9   

2017

     9   

2018

     9   

2019

     4   

Due after 5 years

      
  

 

 

 

Gross lease commitment

   $ 50   

Less: interest

     (12
  

 

 

 

Net lease commitment included in capital lease and other long-term liabilities

   $ 38   
  

 

 

 

Affiliate Commitments. The Company is obligated to make payments, which represent traffic acquisition costs (“TAC”), to its Affiliates. As of June 30, 2014, these commitments totaled $184 million, of which $62 million will be payable in the remainder of 2014, $122 million will be payable in 2015, and $1 million will be payable in 2016.

Intellectual Property Rights. The Company is committed to make certain payments under various intellectual property arrangements of up to $21 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, lease, or assignment of assets, or the sale of a subsidiary, matters related to the Company’s conduct of the business and tax matters prior to the sale, lease or assignment. In addition, the Company has entered into indemnification agreements with its directors and certain of its officers that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The Company has also agreed to indemnify certain former officers, directors, and employees of acquired companies in connection with the acquisition of such companies. The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its current and former 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 material liabilities related to such indemnification obligations in the Company’s condensed consolidated financial statements.

As of June 30, 2014, 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, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, the Company is not exposed to any financing, liquidity, market, or credit risk that could arise if the Company had such relationships. In addition, the Company identified no variable interests currently held in entities for which it is the primary beneficiary.

See Note 17 — “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”).

Legal Contingencies

Intellectual Property and General Matters. From time to time, third parties assert patent infringement claims against the Company. 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.

Stockholder and Securities Matters. Since May 31, 2011, several related stockholder derivative suits were filed in the Santa Clara County Superior Court (“California Derivative Litigation”) and the U.S. 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

 

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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.com Co., Ltd. (“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. On December 16, 2013, the U.S. District Court for the Northern District of California granted the Company’s motion to stay the Federal Derivative Litigation pending resolution of the appeal filed by the plaintiffs in the related stockholder class actions.

Since June 6, 2011, two purported stockholder class actions were filed in the U.S. District Court for the Northern District of California against the Company and certain officers and directors of the Company 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 Securities Exchange Act of 1934, as amended, and for violation of Rule 10b-5 thereunder, and seeks unspecified damages, injunctive and equitable relief, fees, and costs. On August 10, 2012, the court granted defendants’ motion to dismiss the consolidated amended complaint. Plaintiffs have appealed.

On July 30, 2013, a stockholder derivative action captioned Zucker v. Loeb, et al. was filed in the Supreme Court of New York for the County of New York against current and former members of the Company’s board of directors (the “Board”), Third Point LLC, and entities related to Third Point LLC. The complaint filed by the plaintiff asserts claims for alleged breach of fiduciary duty, waste, and unjust enrichment in connection with the Company’s repurchase of 40 million shares of Company common stock beneficially owned by Third Point LLC. The complaint seeks a judgment declaring that the defendants breached their fiduciary duties, an award of restitution, and corporate governance changes. The Company filed a motion to dismiss the action. While the motion was pending, on June 13, 2014, the plaintiff dismissed the action without prejudice.

On March 14, 2014, a stockholder derivative action captioned Hughes Trust v. de Castro, et al. was filed in the Delaware Court of Chancery purportedly on behalf of Yahoo against current and former members of the Board and our former chief operating officer, Henrique de Castro. The plaintiff alleges that the directors who approved Mr. de Castro’s employment agreement in 2012 wasted corporate assets and breached their fiduciary duties by failing to adequately inform themselves about how much compensation Mr. de Castro would be entitled to receive. The plaintiff further alleges that the directors failed to provide adequate disclosure regarding Mr. de Castro’s compensation. The plaintiff asserts a claim against Mr. de Castro for unjust enrichment. Plaintiff seeks unspecified damages and restitution in favor of Yahoo, an order directing Yahoo to reform its corporate governance and internal procedures, and attorneys’ fees and costs. The Company intends to file a motion to dismiss the action.

Mexico Matter. On November 16, 2011, plaintiffs Worldwide Directories, S.A. de C.V. (“WWD”), and Ideas Interactivas, S.A. de C.V. (“Ideas”) filed an action in the 49th Civil Court of Mexico against the Company, Yahoo! de Mexico, S.A. de C.V. (“Yahoo! Mexico”), Yahoo International Subsidiary Holdings, Inc., and Yahoo Hispanic Americas LLC. The complaint alleged claims of breach of contract, breach of promise, and lost profits in connection with various commercial contracts entered into among the parties between 2002 and 2004, relating to a business listings service, and alleged total damages of approximately $2.75 billion. On December 7, 2011, Yahoo! Mexico filed a counterclaim against WWD for payments of approximately $2.6 million owed to Yahoo! Mexico for services rendered. On April 10, 2012, plaintiffs withdrew their claim filed against Yahoo International Subsidiary Holdings, Inc. and Yahoo Hispanic Americas LLC.

On November 28, 2012, the 49th Civil Court of Mexico entered a non-final judgment against the Company and Yahoo! Mexico in the amount of USD $2.75 billion and a non-final judgment in favor of Yahoo! Mexico on its counterclaim against WWD in the amount of $2.6 million. The judgment against the Company and Yahoo! Mexico purported to leave open for determination in future proceedings certain other alleged damages that were not quantified in the judgment. The judgment was issued by a law clerk to the trial court judge who presided over the entire case during the trial court proceedings but stepped down from his position shortly before the judgment was entered.

On December 12, 2012 and December 13, 2012, respectively, Yahoo! Mexico and the Company appealed the judgment to a three-magistrate panel of the Superior Court of Justice for the Federal District (the “Superior Court”). On May 15, 2013, the Superior Court reversed the judgment, overturned all monetary awards against the Company and reduced the monetary award against Yahoo! Mexico to $172,500. The Superior Court affirmed the award of $2.6 million in favor of Yahoo! Mexico on its counterclaim.

 

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Plaintiffs have appealed the Superior Court’s decision to the Mexican Federal Civil Collegiate Court for the First Circuit (“Civil Collegiate Court”). The Company has appealed the Superior Court’s decision not to award it statutory costs in the underlying proceeding. Yahoo! Mexico has appealed the Superior Court’s award of $172,500, the Superior Court’s decision not to award it additional moneys beyond the $2.6 million award on its counterclaims, and the Superior Court’s decision not to award it statutory costs. In the pending appeals, review is limited to whether the Superior Court’s decision is unconstitutional, unlawful, or both.

The Company believes the plaintiffs’ claims are without legal or factual merit. First, the plaintiffs’ claims are based on agreements that were either terminated by agreement with releases or had expired or terminated in accordance with their terms, a non-binding letter of intent pursuant to which no definitive agreements were ever entered into by the parties, and correspondence that did not constitute agreements. Second, the loss of profits of the type claimed by plaintiffs are not awardable under Mexico law because they were not a direct and immediate consequence of a breach of contract. Of the $2.75 billion in total damages alleged by plaintiffs, more than $2.4 billion were for loss of profits. Third, the plaintiffs’ alleged damages and loss of profits were further precluded by the agreements at issue through, among other things, contractual and legal limitations of liability. Fourth, the plaintiffs’ pleadings in the complaint, as well as documentary evidence filed by the plaintiffs in support of their allegations, were generally deficient to support or establish plaintiffs’ claims. Fifth, the decision failed to consider substantially all of the defenses asserted by the Company and Yahoo! Mexico. Finally, the Company believes that the law clerk who entered the judgment lacked the requisite authority to issue the judgment.

The Company has not recorded an accrual for the judgment, which was reversed, as explained above. The Company cannot assure the ultimate outcome of the pending or further appeals.

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 described above. The Company has also determined, based on current knowledge, that the aggregate amount or range of losses that are estimable with respect to the Company’s legal proceedings, including the matters described above other than the Mexico matter, 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, 2013 and June 30, 2014 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, 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 13 STOCKHOLDERS’ EQUITY AND EMPLOYEE BENEFITS

Employee Stock Purchase Plan. As of June 30, 2014, there was $2 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 0.1 years.

Stock Options. The Company’s Stock Plan, the Directors’ Plan, and stock-based awards assumed through acquisitions (including stock-based commitments related to continued service of acquired employees, such as the holdback by Yahoo of shares of Yahoo common stock issued to Tumblr’s founder in connection with the Company’s acquisition of Tumblr in June 2013) are collectively referred to as the “Plans.” Stock option activity under the Company’s Plans for the six months ended June 30, 2014 is summarized as follows (in thousands, except per share amounts):

 

     Shares     Weighted Average
Exercise Price Per
Share
 

Outstanding at December 31, 2013(1)

     20,968      $ 20.43   

Options granted(2)

     20      $ 35.52   

Options assumed in acquisitions

     —        $ —     

Options exercised(3)

     (5,364   $ 20.86   

Options expired

     (748   $ 21.56   

Options cancelled/forfeited

     (1,990   $ 18.63   
  

 

 

   

Outstanding at June 30, 2014(1)

     12,886      $ 20.49   
  

 

 

   

 

(1)

Includes shares subject to performance-based stock options for which performance goals had not been set as of the date shown.

(2)

Excludes tranches of previously granted performance-based stock options for which performance goals were set during the six months ended June 30, 2014.

(3)

The Company generally issues new shares to satisfy stock option exercises.

As of June 30, 2014, there was $26 million of unamortized stock-based compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of 0.8 years.

 

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

 

     Stock Options     Purchase Plan(*)  
     Three Months Ended     Three Months Ended  
     June 30,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate

     0.5     1.4     0.1     0.1

Expected volatility

     31.5     38.6     29.4     39.1

Expected life (in years)

     3.25        4.00        0.24        0.24   

 

     Stock Options     Purchase Plan(*)  
     Six Months Ended     Six Months Ended  
     June 30,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate

     0.5     1.5     0.1     0.1

Expected volatility

     31.2     37.4     29.4     38.9

Expected life (in years)

     3.63        4.00        0.24        0.24   

 

(*)

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

Restricted Stock and Restricted Stock Units. Restricted stock and restricted stock unit activity under the Plans for the six months ended June 30, 2014 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, 2013(1)

     49,584      $ 24.20   

Granted(2)

     9,977      $ 37.82   

Assumed in acquisitions

     277      $ 40.85   

Vested

     (11,403   $ 20.05   

Forfeited

     (3,634   $ 22.27   
  

 

 

   

Awarded and unvested at June 30, 2014(1)

     44,801      $ 28.54   
  

 

 

   

 

(1)

Includes the maximum number of shares issuable under the Company’s performance-based restricted stock unit awards (including future-year tranches for which performance goals had not been set) as of the date shown.

(2)

Includes the maximum number of shares issuable under the performance-based restricted stock unit awards granted during the six months ended June 30, 2014 (including future-year tranches for which performance goals had not been set during the period); excludes tranches of previously granted performance-based restricted stock units for which performance goals were set during the six months ended June 30, 2014.

As of June 30, 2014, there was $736 million of unamortized 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 2.6 years.

During the six months ended June 30, 2013 and 2014, 6.5 million shares and 11.4 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, 2013 and 2014, the Company withheld 2.4 million shares and 4.2 million shares, respectively, based upon the Company’s closing stock price on the vesting date, to satisfy the Company’s tax withholding obligation relating to 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 $51 million and $160 million, respectively, for the six months ended June 30, 2013 and 2014, 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. 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.

 

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Table of Contents

Performance-Based Executive Incentive Equity Awards.

Performance Options. The financial performance stock options awarded by the Company in November 2012 to Ms. Mayer and Mr. Goldman include multiple performance periods. The number of stock options that ultimately vest for each performance period will range from 0 percent to 100 percent of the target amount for such period stated in each executive’s award agreement based on the Company’s performance relative to goals. The financial performance goals are established at the beginning of each performance period and the portion (or “tranche”) of the award related to each performance period is treated as a separate grant for accounting purposes. In February 2014, the Compensation and Leadership Development Committee of the Board (the “Compensation Committee”) established performance goals under these stock options for the 2014 performance year. The 2014 financial performance metrics (and their weightings) under the performance stock options are GAAP revenue (70 percent) and adjusted EBITDA (30 percent). The grant date fair value of the 2014 tranche of the November 2012 financial performance stock options was $38 million, and is being recognized over the twelve-month service period. The Company began recording stock-based compensation expense for this tranche in February 2014, when the financial performance goals were established.

Performance RSUs. In February 2014, the Compensation Committee approved additional annual financial performance-based restricted stock unit (“RSU”) awards to Ms. Mayer and other senior officers, and established the 2014 annual performance goals for these awards as well as for the similar performance-based RSUs granted in February 2013. The 2013 and 2014 performance-based RSU awards are generally eligible to vest in equal annual target amounts over four years (three years for Ms. Mayer) based on the Company’s attainment of annual financial performance goals as well as the executive’s continued employment through each vesting date. The number of shares that ultimately vest each year will range from 0 percent to 200 percent of the annual target amount, based on the Company’s performance. Annual financial performance metrics and goals are established for these RSU awards at the beginning of each year and the tranche of each RSU award related to that year’s performance goal is treated as a separate annual grant for accounting purposes. The 2014 financial performance metrics (and their weightings) established for the performance RSUs are: GAAP revenue (70 percent) and adjusted EBITDA (30 percent). The grant date fair value of the first tranche of the February 2014 performance RSUs was $9 million, and the grant date fair value of the second tranche of the February 2013 performance RSUs was $17 million. These values are being recognized over the tranches’ twelve-month service periods. The Company began recording stock-based compensation expense for these tranches in February 2014, when the financial performance goals were established.

Stock Repurchases. In May 2012, the Board authorized a stock repurchase program allowing the Company to repurchase up to $5 billion of its outstanding shares of common stock from time to time. That repurchase program was exhausted during the first quarter of 2014. In November 2013, the Board authorized an additional stock repurchase program with an authorized level of $5 billion. The November 2013 program, according to its terms, will expire in December 2016. The aggregate amount remaining under the November 2013 repurchase authorization was approximately $3.9 billion at June 30, 2014. Repurchases under the repurchase programs may take place in the open market or in privately negotiated transactions, including structured and derivative transactions such as accelerated share repurchase transactions, and may be made under a Rule 10b5-1 plan. During the six months ended June 30, 2014, the Company repurchased approximately 33 million shares of its common stock under its stock repurchase programs at an average price of $35.93 per share for a total of $1.2 billion.

Note 14 RESTRUCTURING CHARGES (REVERSALS), NET

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 

Employee severance pay and related costs

   $ 242      $ 82      $ 6,718      $ 3,673   

Non-cancelable lease, contract termination, and other charges

     6,810        61,906        11,202        68,438   

Other non-cash (credits) charges, net

     —         (7,031     538        (7,031

Changes in estimates and reversals of previous charges

     (3,474     (2,336     (21,942     (2,972
  

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges (reversals), net

   $ 3,578      $ 52,621      $ (3,484   $ 62,108   
  

 

 

   

 

 

   

 

 

   

 

 

 

The Company has previously implemented various restructuring plans to reduce its cost structure, align resources with its product strategy and improve efficiency, which have resulted in workforce reductions and the consolidation of certain real estate facilities and data centers. For the three months ended June 30, 2013, the Company recorded $3 million related to the EMEA segment and $1 million related the Asia Pacific segment. For the three months ended June 30, 2014, the Company recorded $50 million related to the Americas segment and $3 million related to the EMEA segment. For the six months ended June 30, 2013, the Company recorded a credit of $3 million related to the Americas segment, a credit of $1 million related to the EMEA segment and a $1 million debit related the Asia Pacific segment. For the six months ended June 30, 2014, the Company recorded $55 million related to the Americas segment and $7 million related to the EMEA segment. The amounts recorded during the three and six months ended June 30, 2014 were primarily related to the consolidation of a data center as the Company ceased use of that facility pursuant to a restructuring plan initiated by the Company in 2011.

 

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The Company’s restructuring accrual activity for the six months ended June 30, 2014 is summarized as follows (in thousands):

 

Accrual balance as of December 31, 2013

   $ 30,096   

Restructuring charges

     62,108   

Cash paid

     (20,140

Foreign currency translation and other adjustments

     6,987   
  

 

 

 

Accrual balance as of June 30, 2014

   $ 79,051   
  

 

 

 

The $79 million restructuring liability as of June 30, 2014 consists of $2 million for employee severance expenses, which the Company expects to pay out by the end of the third quarter of 2014, and $77 million related to non-cancelable lease costs, which the Company expects to pay over the terms of the related obligations through the fourth quarter of 2021, less estimated sublease income.

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

 

     December 31,
2013
     June 30,
2014
 

Americas

   $ 18,078       $ 70,481   

EMEA

     11,284         8,125   

Asia Pacific

     734         445   
  

 

 

    

 

 

 

Total restructuring accruals

   $ 30,096       $ 79,051   
  

 

 

    

 

 

 

Note 15 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, non-deductible acquisition-related costs and adjustments to unrecognized tax benefits.

The effective tax rate reported for the three months ended June 30, 2014 was 33 percent compared to 31 percent for the same period in 2013. The effective tax rate reported for the six months ended June 30, 2014 was 30 percent compared to 22 percent for the same period in 2013. The effective tax rate for the three months ended June 30, 2014 was lower than the U.S. federal statutory rate primarily due to the tax benefit from a $15 million capital loss recognized during the quarter. The effective tax rate for the three months ended June 30, 2013 was lower than the U.S. federal statutory rate primarily due to an $11 million tax benefit recorded during the quarter ended June 30, 2013 relating to the resolution of certain tax matters associated with a one-time foreign earnings distribution made during the quarter ended September 30, 2012. The tax rates for the six months ended June 30, 2014 and 2013 were lower than the U.S. federal statutory rate also due to the reductions of tax reserves that were recorded based on new information received during interactions with tax authorities. The income tax expense reported for the three and six months ended June 30, 2014 does not include any benefit from the federal research and development tax credit as that provision expired on December 31, 2013.

As of June 30, 2014, the Company does not anticipate repatriating its undistributed foreign earnings of approximately $2.9 billion. Those earnings are principally related to its equity method investment in Yahoo Japan. If those earnings were to be repatriated in the future, the Company may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits). It is not practicable to determine the income tax liability that might be incurred if these earnings were to be repatriated.

The Company is in various stages of examination and appeal in connection with its taxes both in the U.S. and in foreign jurisdictions. Those audits generally span tax years 2005 through 2012. The IRS Appeals division is currently finalizing the Company’s protest of the 2007 and 2008 audit results, while the 2009 and 2010 U.S. federal income tax returns are currently under examination. The Company has protested the proposed California Franchise Tax Board’s adjustments to the 2005 and 2006 returns, but no conclusions have been reached to date. The 2007 and 2008 California tax returns are currently under examination.

The Company’s gross amount of unrecognized tax benefits as of June 30, 2014 was $685 million, of which $596 million is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of June 30, 2014 decreased by $11 million from the recorded balance as of December 31, 2013. While it is difficult to determine when the 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 Company’s unrecognized tax benefits could be reduced by up to approximately $70 million in the next twelve months. 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 the Company’s consolidated financial position, results of operations, or cash flows.

 

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Table of Contents

The Company may have additional tax liabilities in China related to the sale to Alibaba Group of 523 million Alibaba Shares that took place during the year ended December 31, 2012. Any taxes assessed and paid in China are expected to be ultimately offset and recovered in the U.S.

During the year ended December 31, 2012, tax authorities from the Brazilian State of Sao Paulo assessed certain indirect taxes against the Company’s Brazilian subsidiary, Yahoo! do Brasil Internet Ltda., related to online advertising services. The assessment totaling approximately $85 million is for calendar years 2008 and 2009. The Company currently believes the assessment is without merit. The Company believes the risk of loss is remote and has not recorded an accrual for the assessment.

Note 16 SEGMENTS

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

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

 

     Three Months Ended      Six Months Ended  
     June 30,
2013
     June 30,
2014
     June 30,
2013
    June 30,
2014
 

Revenue by segment:

          

Americas

   $ 828,537       $ 805,535       $ 1,670,732      $ 1,672,463   

EMEA

     97,387         97,847         192,211        189,417   

Asia Pacific

     209,320         180,809         412,669        355,041   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total Revenue

   $ 1,135,244       $ 1,084,191       $ 2,275,612      $ 2,216,921   
  

 

 

    

 

 

    

 

 

   

 

 

 

TAC by segment:

          

Americas

   $ 37,120       $ 30,296       $ 74,642      $ 64,390   

EMEA

     11,372         10,212         22,908        19,405   

Asia Pacific

     15,824         3,318         32,834        5,940   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total TAC

   $ 64,316       $ 43,826       $ 130,384      $ 89,735   
  

 

 

    

 

 

    

 

 

   

 

 

 

Revenue ex-TAC by segment:

          

Americas

   $ 791,417       $ 775,239       $ 1,596,090      $ 1,608,073   

EMEA

     86,015         87,635         169,303        170,012   

Asia Pacific

     193,496         177,491         379,835        349,101   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total Revenue ex-TAC

   $ 1,070,928       $ 1,040,365       $ 2,145,228      $ 2,127,186   
  

 

 

    

 

 

    

 

 

   

 

 

 

Direct costs by segment(1):

          

Americas

     186,019         180,713         362,412        360,119   

EMEA

     41,913         38,536         80,458        78,266   

Asia Pacific

     49,432         45,249         104,387        89,583   

Global operating costs(2)(3)

     424,382         435,504         843,184        952,474   

Depreciation and amortization

     160,489         146,860         322,581        304,394   

Stock-based compensation expense

     68,136         102,445         112,741        211,626   

Restructuring charges (reversals), net

     3,578         52,621         (3,484     62,108   
  

 

 

    

 

 

    

 

 

   

 

 

 

Income from operations

   $ 136,979       $ 38,437       $ 322,949      $ 68,616   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(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.

(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.

(3) 

The net cost reimbursements from Microsoft pursuant to the Search Agreement are primarily included in global operating costs.

 

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Table of Contents
     Three Months Ended      Six Months Ended  
     June 30,
2013
     June 30,
2014
     June 30,
2013
     June 30,
2014
 

Capital expenditures, net:

           

Americas

   $ 75,061       $ 100,340       $ 140,477       $ 164,317   

EMEA

     2,757         3,274         5,664         19,036   

Asia Pacific

     4,258         3,744         5,516         8,660   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capital expenditures, net

   $ 82,076       $ 107,358       $ 151,657       $ 192,013   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31,
2013
     June 30,
2014
 

Property and equipment, net:

     

Americas:

     

U.S.

   $ 1,346,889       $ 1,335,592   

Other

     1,183         828   
  

 

 

    

 

 

 

Total Americas

   $ 1,348,072       $ 1,336,420   
  

 

 

    

 

 

 

EMEA

     44,976         51,404   

Asia Pacific

     95,470         82,448   
  

 

 

    

 

 

 

Total property and equipment, net

   $ 1,488,518       $ 1,470,272   
  

 

 

    

 

 

 

See Note 14 —“Restructuring Charges (Reversals), 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,
2013
     June 30,
2014
     June 30,
2013
     June 30,
2014
 

Display

   $ 471,742       $ 436,053       $ 926,813       $ 889,277   

Search

     418,202         428,418         842,889         873,185   

Other

     245,300         219,720         505,910         454,459   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,135,244       $ 1,084,191       $ 2,275,612       $ 2,216,921   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended      Six Months Ended  
     June 30,
2013
     June 30,
2014
     June 30,
2013
     June 30,
2014
 

Revenue:

           

U.S.

   $ 784,726       $ 771,959       $ 1,589,479       $ 1,605,616   

International

     350,518         312,232         686,133         611,305   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,135,244       $ 1,084,191       $ 2,275,612       $ 2,216,921   
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenue is attributed to individual countries according to the online property that generated the revenue. No single foreign country accounted for more than 10 percent of the Company’s revenue for the three or six months ended June 30, 2013 and 2014.

Note 17 SEARCH AGREEMENT WITH MICROSOFT CORPORATION

By the end of 2013, the Company had substantially completed the transition of paid search to the Microsoft platform. In the transitioned markets, the Company reports as revenue the 88 percent revenue share it receives from Microsoft under the Search Agreement 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. Approximately 29 percent of the Company’s revenue for both the three and six months ended June 30, 2013, and approximately 36 percent of the Company’s revenue for both the three and six months ended June 30, 2014, was attributable to the Search Agreement.

Under the Search Agreement, Microsoft continues to be obligated to guarantee Yahoo’s revenue per search (“RPS Guarantee”) on Yahoo Properties in Taiwan and Hong Kong for 18 months after the transition of paid search services to Microsoft’s platform in those markets, which was completed during the fourth quarter of 2013.

 

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Table of Contents

The Company’s results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $18 million and $31 million for the three and six months ended June 30, 2013, respectively, and nil and less than $1 million for the three and six months ended June 30, 2014, respectively. As of December 31, 2013 and June 30, 2014, the Company had collected total amounts of $21 million and $17 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 on the condensed consolidated balance sheets. The Company’s uncollected 88 percent share in connection with the Search Agreement was $305 million and $278 million as of December 31, 2013 and June 30, 2014, respectively, which was included in accounts receivable, net on the condensed consolidated balance sheets. The total reimbursements not yet received from Microsoft of $5 million were classified as part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheet as of December 31, 2013. There were no amounts classified as a part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheet as of June 30, 2014 related to reimbursements not yet received from Microsoft.

Note 18 SUBSEQUENT EVENTS

Stock Repurchase Transactions. From July 1, 2014 through August 7, 2014, the Company repurchased approximately 4 million shares of its common stock at an average price of $34.81 per share, for a total of $149 million.

 

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Table of Contents
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,” 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 changes in our earnings in equity interests;

 

 

expectations about changes in operating expenses;

 

 

anticipated capital expenditures;

 

 

expectations about our share repurchase activity;

 

 

expectations about 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, intangible assets, and technologies;

 

 

expectations about the growth of, and the opportunities for monetization in, the mobile industry;

 

 

projections and estimates with respect to our restructuring activities and changes to our organizational structure;

 

 

expectations about the amount of unrecognized tax benefits, the outcome of tax assessment appeals, the adequacy of our existing tax reserves, future tax expenditures, and tax rates;

 

 

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

 

 

expectations regarding the outcome of legal proceedings in which we are involved, including the outcome of our efforts to sustain the reversal of judgment entered against us and one of our subsidiaries in a proceeding in Mexico.

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. You are urged to carefully review the disclosures made concerning risks and uncertainties that may affect our business or operating results, which 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 or revise any of our forward-looking statements after the date of this Report to reflect new information, actual results or future events or circumstances.

Overview

Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo,” the “Company,” “we,” or “us”) is focused on making the world’s daily habits inspiring and entertaining. By creating highly personalized experiences for our users, we keep people connected to what matters most to them, across devices and around the world. We create value for advertisers by connecting them with the audiences that build their businesses. For advertisers, the opportunity to be a part of users’ daily habits across products and platforms is a powerful tool to engage audiences and build brand loyalty. Advertisers can build their businesses by advertising to targeted audiences on our online properties and services (“Yahoo Properties”) or through a distribution network of third-party entities (“Affiliates”) who integrate our advertising offerings into their Websites or other offerings (“Affiliate sites”). Our revenue is generated principally from display and search advertising.

We continue to manage and measure our business geographically, principally in the Americas, EMEA (Europe, Middle East, and Africa), and Asia Pacific.

 

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In the following Management’s Discussion and Analysis, we provide information regarding the following areas:

 

 

Key Financial Metrics;

 

 

Non-GAAP Financial Measures;

 

 

Significant Transactions;

 

 

Results of Operations;

 

 

Liquidity and Capital Resources;

 

 

Critical Accounting Policies and Estimates; and

 

 

Recent Accounting Pronouncements.

Key Financial Metrics

The key financial metrics we use are as follows: revenue; revenue less traffic acquisition costs (“TAC”), or revenue ex-TAC; income from operations; adjusted EBITDA; net income attributable to Yahoo! Inc.; net cash provided by operating activities; and free cash flow. Revenue ex-TAC, adjusted EBITDA, and free cash flow are financial measures that are not defined in accordance with generally accepted accounting principles (“GAAP”) in the United States (“U.S.”). We use these non-GAAP financial measures for internal managerial purposes and to facilitate period-to-period comparisons. See “Non-GAAP Financial Measures” below for a description of each of these non-GAAP financial measures.

 

     Three Months Ended June 30,      Six Months Ended June 30,  
     2013      2014      2013     2014  
     (dollars in thousands)  

Revenue

   $ 1,135,244       $ 1,084,191       $ 2,275,612      $ 2,216,921   

Revenue ex-TAC

   $ 1,070,928       $ 1,040,365       $ 2,145,228      $ 2,127,186   

Income from operations(*)

   $ 136,979       $ 38,437       $ 322,949      $ 68,616   

Adjusted EBITDA

   $ 369,182       $ 340,363       $ 754,787      $ 646,744   

Net income attributable to Yahoo! Inc.

   $ 331,150       $ 269,707       $ 721,435      $ 581,285   

Net cash provided by operating activities

   $ 330,828       $ 357,414       $ 549,510      $ 496,475   

Free cash flow

   $ 131,400       $ 185,915       $ 281,308      $ 299,877   

(*)    Includes:

          

Stock-based compensation expense

   $ 68,136       $ 102,445       $ 112,741      $ 211,626   

Restructuring charges (reversals), net

   $ 3,578       $ 52,621       $ (3,484   $ 62,108   

Revenue ex-TAC (a Non-GAAP Financial Measure)

 

     Three Months Ended June 30,      Percent
Change
    Six Months Ended June 30,      Percent
Change
 
   2013      2014            2013      2014         
     (dollars in thousands)  

Revenue

   $ 1,135,244       $ 1,084,191         (4 )%    $ 2,275,612       $ 2,216,921         (3 )% 

Less: TAC

     64,316         43,826         (32 )%      130,384         89,735         (31 )% 
  

 

 

    

 

 

      

 

 

    

 

 

    

Revenue ex-TAC

   $ 1,070,928       $ 1,040,365         (3 )%    $ 2,145,228       $ 2,127,186         (1 )% 
  

 

 

    

 

 

      

 

 

    

 

 

    

For the three and six months ended June 30, 2014, revenue ex-TAC decreased $31 million, or 3 percent, and $18 million, or 1 percent, respectively, compared to the same periods of 2013, due to a decline in display and other revenue ex-TAC, partially offset by an increase in search revenue ex-TAC. The decline in TAC for both the three and six months ended June 30, 2014 was primarily driven by the impact of the transition of search to the Microsoft platform, which was substantially completed by the end of 2013.

 

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Adjusted EBITDA (a Non-GAAP Financial Measure)

 

     Three Months Ended June 30,     Percent
Change
    Six Months Ended June 30,     Percent
Change
 
   2013     2014           2013     2014        
     (dollars in thousands)  

Net income attributable to Yahoo! Inc.

   $ 331,150      $ 269,707        (19 )%    $ 721,435      $ 581,285        (19 )% 

Depreciation and amortization

     160,489        146,860        (8 )%      322,581        304,394        (6 )% 

Stock-based compensation expense

     68,136        102,445        50     112,741        211,626        88

Restructuring charges (reversals), net

     3,578        52,621        N/M        (3,484     62,108        N/M   

Other income (expense), net

     (23,606     13,589        (158 )%      (40,678     27,042        (166 )% 

Provision for income taxes

     50,267        8,143        (84 )%      80,003        12,360        (85 )% 

Earnings in equity interests

     (224,690     (255,852     14     (442,278     (557,254     26

Net income attributable to noncontrolling interests

     3,858        2,850        (26 )%      4,467        5,183        16
  

 

 

   

 

 

     

 

 

   

 

 

   

Adjusted EBITDA

   $ 369,182      $ 340,363        (8 )%    $ 754,787      $ 646,744        (14 )% 
  

 

 

   

 

 

     

 

 

   

 

 

   

Percentage of revenue ex-TAC(1)(2)

     34     33       35     30  
  

 

 

   

 

 

     

 

 

   

 

 

   

 

N/M = Not meaningful.

(1) 

Revenue ex-TAC is calculated as GAAP revenue less TAC.

(2) 

Net income attributable to Yahoo! Inc. as a percentage of GAAP revenue for the three and six months ended June 30, 2014 was 25 percent and 26 percent, respectively. Net income attributable to Yahoo! Inc. as a percentage of GAAP revenue for the three and six months ended June 30, 2013 was 29 percent and 32 percent, respectively.

For the three months ended June 30, 2014, adjusted EBITDA decreased $29 million, or 8 percent, compared to the same period of 2013, mainly due to a decline in revenue ex-TAC. During the three months ended June 30, 2013 and 2014, adjusted EBITDA included benefits of $10 million and $62 million, respectively, from patent sales. For the six months ended June 30, 2014, adjusted EBITDA decreased $108 million, or 14 percent, compared to the same periods of 2013, mainly due to an increase in global operating costs. During the six months ended June 30, 2013 and 2014, adjusted EBITDA included benefits of $10 million and $62 million, respectively, from patent sales.

Free Cash Flow (a Non-GAAP Financial Measure)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2013     2014     2013     2014  
     (dollars in thousands)  

Net cash provided by operating activities:

   $ 330,828      $ 357,414      $ 549,510      $ 496,475   

Acquisition of property and equipment, net

     (82,076     (107,358     (151,657     (192,013

Dividends received from equity investees

     (123,058     (83,685     (135,058     (83,685

Excess tax benefits from stock-based awards

     5,706        19,544        18,513        79,100   
  

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow

   $ 131,400      $ 185,915      $ 281,308      $ 299,877   
  

 

 

   

 

 

   

 

 

   

 

 

 

For the three and six months ended June 30, 2014, free cash flow increased $55 million, or 41 percent, and $19 million, or 7 percent, respectively, compared to the same periods of 2013, primarily due to improvements in working capital.

Non-GAAP Financial Measures

Revenue ex-TAC

Revenue ex-TAC is a non-GAAP financial measure defined as GAAP revenue less TAC. TAC consists of payments made to Affiliates that have integrated our advertising offerings into their sites and payments made to companies that direct consumer and business traffic to Yahoo Properties.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure defined as net income attributable to Yahoo! Inc. before taxes, depreciation, amortization of intangible assets, stock-based compensation expense, other income, net (which includes interest), earnings in equity interests, net income attributable to noncontrolling interests, and certain gains, losses, and expenses that we do not believe are indicative of our ongoing results.

 

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Free Cash Flow

Free cash flow is a non-GAAP financial measure defined as net cash provided by operating activities (adjusted to include excess tax benefits from stock-based awards), less acquisition of property and equipment, net, and dividends received from equity investees.

For additional information about these non-GAAP financial measures, see “Non-GAAP Financial Measures” included in our Annual Report on Form 10-K for the year ended December 31, 2013 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Significant Transactions

Alibaba Group Holding Limited Initial Public Offering

The Company, Yahoo! Hong Kong Holdings Limited and Alibaba Group Holding Limited (“Alibaba Group”) entered into a Third Amendment to the Share Repurchase and Preference Share Sale Agreement, dated as of July 14, 2014. The amendment reduced the maximum number of ordinary shares of Alibaba Group (“Alibaba Shares”) that we are required to sell in connection with an initial public offering by Alibaba Group meeting certain specified criteria (a “Qualified IPO”) from 208 million to 140 million.

On May 6, 2014, Alibaba Group filed a registration statement with the Securities and Exchange Commission regarding its Qualified IPO. If Yahoo sells the 140 million Alibaba Shares that it is currently obligated to sell in connection with the completion of such offering, we will no longer account for our remaining investment in Alibaba Group using the equity method and as a result will no longer record our proportionate share of Alibaba Group’s financial results in our consolidated financial statements. This would materially reduce our reported net income. Also, in the event of a Qualified IPO prior to September 18, 2015, the TIPLA terminates on September 18, 2015. In that event, we will recognize the remaining initial TIPLA payment revenue through September 18, 2015.

Patent Sale and License Agreement

During the second quarter of 2014, we entered into a patent sale and license agreement for total cash consideration of $460 million. The total consideration was allocated based on the estimated relative fair value of each of the elements of the agreement: $61 million was allocated to the sale of patents (“Sold Patents”), $135 million to the license to existing patents (“Existing Patents”) and $264 million to the license of patents developed or acquired in the next five years (“Capture Period Patents”). We recorded $60 million as a gain on the Sold Patents during the second quarter of 2014 and will recognize the remaining $1 million gain on the Sold Patents in the third quarter of 2014 when payment is due. The amounts allocated to the license of the Existing Patents will be recorded as revenue over the four year payment period under the license when payments are due. The amounts allocated to the Capture Period Patents will be recorded as revenue over the five year capture period.

See “Operating Costs and Expenses—Gains on Sales of Patents” for additional information on gains recorded for the three and six months ended June 30, 2014.

Search Agreement with Microsoft Corporation

By the end of 2013, we had substantially completed the transition of paid search to the Microsoft Corporation (“Microsoft”) platform. For search revenue generated from Microsoft’s services on Yahoo Properties and Affiliate sites, we report as revenue our 88 percent revenue share, as we are not the primary obligor in the arrangement with the advertisers and publishers. The underlying search advertising services are provided by Microsoft. Revenue under our Search and Advertising Services and Sales Agreement with Microsoft (the “Search Agreement”) represented approximately 29 percent of our revenue for both the three and six months ended June 30, 2013 and approximately 36 percent of our revenue for both the three and six months ended June 30, 2014.

Our results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $18 million and $31 million for the three and six months ended June 30, 2013, respectively, and less than $1 million for both the three and six months ended June 30, 2014.

See Note 17 — “Search Agreement with Microsoft Corporation” in the Notes to our condensed consolidated financial statements for additional information.

 

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Results of Operations

 

     Three Months Ended June 30,     Percent
Change
    Six Months Ended June 30,     Percent
Change
 
   2013     2014           2013     2014        
     (dollars in thousands)  

Revenue for groups of similar services:

            

Display

            

Yahoo Properties

   $ 425,278      $ 387,965        (9 )%    $ 830,403      $ 796,158        (4 )% 

Affiliate sites

     46,464        48,088        3     96,410        93,119        (3 )% 
  

 

 

   

 

 

     

 

 

   

 

 

   

Total Display revenue

   $ 471,742      $ 436,053        (8 )%    $ 926,813      $ 889,277        (4 )% 
  

 

 

   

 

 

     

 

 

   

 

 

   

Search

            

Yahoo Properties

   $ 329,369      $ 360,041        9   $ 649,546      $ 731,785        13

Affiliate sites

     88,833        68,377        (23 )%      193,343        141,400        (27 )% 
  

 

 

   

 

 

     

 

 

   

 

 

   

Total Search revenue

     418,202        428,418        2     842,889        873,185        4
  

 

 

   

 

 

     

 

 

   

 

 

   

Other

     245,300        219,720        (10 )%      505,910        454,459        (10 )% 
  

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

   $ 1,135,244      $ 1,084,191        (4 )%    $ 2,275,612      $ 2,216,921        (3 )% 

Cost of revenue — traffic acquisition costs

     64,316        43,826        (32 )%      130,384        89,735        (31 )% 

Cost of revenue — other

     271,262        271,148        —         549,269        551,992        —    

Sales and marketing

     279,738        292,817        5     536,757        622,663        16

Product development

     246,198        303,659        23     465,778        585,291        26

General and administrative

     135,039        128,019        (5 )%      268,460        264,512        (1 )% 

Amortization of intangibles

     8,084        15,164        88     15,449        33,504        117

Gains on sales of patents

     (9,950     (61,500     N/M        (9,950     (61,500     N/M   

Restructuring charges (reversals), net

     3,578        52,621        N/M        (3,484     62,108        N/M   
  

 

 

   

 

 

     

 

 

   

 

 

   

Total operating expenses

   $ 998,265      $ 1,045,754        5   $ 1,952,663      $ 2,148,305        10
  

 

 

   

 

 

     

 

 

   

 

 

   

Income from operations

   $ 136,979      $ 38,437        (72 )%    $ 322,949      $ 68,616        (79 )% 
  

 

 

   

 

 

     

 

 

   

 

 

   

Includes:

            

Stock-based compensation expense

   $ 68,136      $ 102,445        50   $ 112,741      $ 211,626        88

N/M = Not meaningful.

 

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The following table sets forth selected information concerning our results of operations as a percentage of revenue for the period indicated:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
   2013     2014     2013     2014  

Revenue for groups of similar services:

        

Display:

        

Yahoo Properties

     38     36     37     36

Affiliate sites

     4     4     4     4
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Display revenue

     42     40     41     40
  

 

 

   

 

 

   

 

 

   

 

 

 

Search:

        

Yahoo Properties

     29     33     29     33

Affiliate sites

     8     7     8     6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Search revenue

     37     40     37     39
  

 

 

   

 

 

   

 

 

   

 

 

 

Other

     21     20     22     21
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     100     100     100     100

Cost of revenue — traffic acquisition costs

     6     4     6     4

Cost of revenue — other

     24     25     24     25

Sales and marketing

     24     27     23     28

Product development

     22     28     20     26

General and administrative

     12     12     12     12

Amortization of intangibles

     1     1     1     2

Gains on sales of patents

     (1 )%      (6 )%      —         (3 )% 

Restructuring charges (reversals), net

     —         5     —         3
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     88     96     86     97
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     12     4     14     3
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Management Reporting

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

 

     Three Months Ended      Percent
Change
    Six Months Ended      Percent
Change
 
     June 30,
2013
     June 30,
2014
           June 30,
2013
    June 30,
2014
        
     (dollars in thousands)  

Revenue by segment:

               

Americas

   $ 828,537       $ 805,535         (3 )%    $ 1,670,732      $ 1,672,463         —    

EMEA

     97,387         97,847         —         192,211        189,417         (1 )% 

Asia Pacific

     209,320         180,809         (14 )%      412,669        355,041         (14 )% 
  

 

 

    

 

 

      

 

 

   

 

 

    

Total revenue

   $ 1,135,244       $ 1,084,191         (4 )%    $ 2,275,612      $ 2,216,921         (3 )% 
  

 

 

    

 

 

      

 

 

   

 

 

    

TAC by segment:

               

Americas

   $ 37,120       $ 30,296         (18 )%    $ 74,642      $ 64,390         (14 )% 

EMEA

     11,372         10,212         (10 )%      22,908        19,405         (15 )% 

Asia Pacific

     15,824         3,318         (79 )%      32,834        5,940         (82 )% 
  

 

 

    

 

 

      

 

 

   

 

 

    

Total TAC

   $ 64,316       $ 43,826         (32 )%    $ 130,384      $ 89,735         (31 )% 
  

 

 

    

 

 

      

 

 

   

 

 

    

Revenue ex-TAC by segment:

               

Americas

   $ 791,417       $ 775,239         (2 )%    $ 1,596,090      $ 1,608,073         1

EMEA

     86,015         87,635         2     169,303        170,012         —    

Asia Pacific

     193,496         177,491         (8 )%      379,835        349,101         (8 )% 
  

 

 

    

 

 

      

 

 

   

 

 

    

Total revenue ex-TAC

   $ 1,070,928       $ 1,040,365         (3 )%    $ 2,145,228      $ 2,127,186         (1 )% 
  

 

 

    

 

 

      

 

 

   

 

 

    

Direct costs by segment(1):

               

Americas

     186,019         180,713         (3 )%      362,412        360,119         (1 )% 

EMEA

     41,913         38,536         (8 )%      80,458        78,266         (3 )% 

Asia Pacific

     49,432         45,249         (8 )%      104,387        89,583         (14 )% 

Global operating costs(2)(3)

     424,382         435,504         3     843,184        952,474         13

Depreciation and amortization

     160,489         146,860         (8 )%      322,581        304,394         (6 )% 

Stock-based compensation expense

     68,136         102,445         50     112,741        211,626         88

Restructuring charges (reversals), net

     3,578         52,621         N/M        (3,484     62,108         N/M   
  

 

 

    

 

 

      

 

 

   

 

 

    

Income from operations

   $ 136,979       $ 38,437         (72 )%    $ 322,949      $ 68,616         (79 )% 
  

 

 

    

 

 

      

 

 

   

 

 

    

 

(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.

(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.

(3) 

The net cost reimbursements from Microsoft pursuant to the Search Agreement are primarily included in global operating costs.

Revenue

We generate revenue principally from display and search advertising on Yahoo Properties and Affiliate sites with the majority of our revenue coming from advertising on Yahoo Properties. Our margins on revenue from Yahoo Properties advertising are higher than our margins on revenue from display and search advertising on Affiliate sites, as we pay TAC to our Affiliates. Additionally, we generate revenue from other sources including listings-based services, facilitating commercial transactions, royalties, and consumer and business fee-based services.

With the significant platform shift to mobile devices, including smartphones and tablets, we have increased our strategic focus on mobile products and mobile ad formats. We have hired engineering and technical talent to help us accelerate our efforts in mobile development, and introduced new mobile apps and refreshed the user experience on mobile across a number of Yahoo Properties, including News, Sports (including Fantasy Sports), Mail, and Finance. We are seeing an increase in the number of our daily and monthly mobile users as a result of these product improvements. During the quarter ended June 30, 2014, we reached more than 450 million monthly mobile users. The monetization of these mobile products is driven primarily through advertisements and we are committed to continuing to develop and deliver innovative ad formats on mobile.

 

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For additional information about how we generate and recognize revenue, see “Results of Operations—RevenueDisplay Revenue,” “Search Revenue,” and “—Other Revenue” included in our Annual Report on Form 10-K for the year ended December 31, 2013 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Display Revenue

Display revenue for the three and six months ended June 30, 2014 decreased $36 million, or 8 percent, and $38 million, or 4 percent, respectively, as compared to the same periods of 2013. The decline in display revenue was attributable to a decline in the percentage of Ads Sold on a premium basis notwithstanding an overall increase in the total number of Ads Sold.

The decline for the three months ended June 30, 2014 was primarily attributable to a decline in advertising revenue on Yahoo Properties in the Americas, EMEA, and Asia Pacific regions of $23 million, $3 million, and $11 million, respectively.

The decline for the six months ended June 30, 2014 was primarily attributable to a decline in advertising revenue on Yahoo Properties in the Americas, EMEA, and Asia Pacific regions of $7 million, $7 million, and $20 million, respectively, and a decline in advertising revenue on Affiliate sites in the Americas and EMEA regions of $7 million and $3 million, respectively, partially offset by an increase in advertising revenue on Affiliate sites in the Asia Pacific region of $7 million.

Search Revenue

Search revenue for the three and six months ended June 30, 2014 increased $10 million, or 2 percent, and $30 million, or 4 percent, respectively, as compared to the same periods of 2013. The growth in search revenue was primarily attributable to click yield improvements resulting from an increase in contribution of higher monetizing clicks from the Americas region and Yahoo Properties, partially offset by the impact of the Microsoft transition in the Asia Pacific region. Additionally, for the three months ended June 30, 2014, search revenue increased as compared to the three months ended June 30, 2013, even with the expiration of the RPS Guarantee in the U.S.

The increase in search revenue for the three months ended June 30, 2014 was primarily attributable to an increase in advertising revenue on Yahoo Properties in the Americas, EMEA, and Asia Pacific regions of $18 million, $9 million, and $4 million, respectively, partially offset by a decline in advertising revenue on Affiliate sites in the Asia Pacific region of $21 million.

The increase in search revenue for the six months ended June 30, 2014 was primarily attributable to an increase in advertising revenue on Yahoo Properties in the Americas, EMEA, and Asia Pacific regions of $60 million, $16 million, and $6 million, respectively, partially offset by a decline in advertising revenue on Affiliate sites in the Americas and Asia Pacific regions of $9 million and $44 million, respectively.

Other Revenue

Other revenue for the three and six months ended June 30, 2014 decreased $26 million, or 10 percent, and $51 million, or 10 percent, respectively, as compared to the same periods of 2013. The decrease for the three months ended June 30, 2014 was primarily due to a decline in listings-based revenue in the Americas and EMEA regions of $18 million and $4 million, respectively, and a decline in fees revenue in the Asia Pacific region of $3 million. The decrease for the six months ended June 30, 2014 was primarily attributable to a decline in listings-based revenue in the Americas, EMEA and Asia Pacific regions of $30 million, $8 million, and $3 million, respectively, and a decline in fees revenue in the Americas and Asia Pacific regions of $6 million and $3 million, respectively.

As a result of the patent sale and license agreement entered into during the three months ended June 30, 2014, beginning in the third quarter of 2014, we expect to recognize approximately $135 million of other revenue over four years related to the Existing Patents and $264 million of other revenue over five years related to the Capture Period Patents.

Display and Search Metrics

We present information below regarding the number of “Ads Sold” and “Price-per-Ad” for display and the number of “Paid Clicks” and “Price-per-Click” for search. This information is derived from internal data.

“Ads Sold” consist of display ad impressions for paying advertisers on Yahoo Properties. “Price-per-Ad” is defined as display revenue from Yahoo Properties divided by our total number of Ads Sold. Our price and volume metrics for display are based on display revenue, which we report on a gross basis (before TAC), and include data for graphical, sponsorship, and native ad units on Yahoo Properties (including mobile). Our price and volume metrics for display exclude both the number of Ads Sold and the related revenue for certain regions and acquired companies where historical data was not retained in a manner that would support period-to-period comparison on these metrics. The countries and regions included in our display metrics are: the U.S., the United Kingdom, France, Germany, Spain, Italy, Taiwan, Hong Kong, Southeast Asia, and India. Tumblr, Inc. (“Tumblr”) data in our display metrics is limited to our new native ad units from and after the first quarter of 2014.

 

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“Paid Clicks” are defined as clicks by end-users on sponsored search listings (excluding native ad units) on Yahoo Properties and Affiliate sites. Advertisers generally pay for sponsored search listings on a per-click basis. “Search click-driven revenue” is gross search revenue (before TAC), excluding the RPS Guarantee. “Price-per-Click” is defined as search click-driven revenue divided by our total number of Paid Clicks.

We periodically review, refine and update our methodologies for monitoring, gathering, and counting number of Ads Sold and Paid Clicks and for calculating search click-driven revenue, Price-per-Click, and Price-per-Ad. Prior period amounts have been updated to conform to the current presentation.

Display Metrics

For the three and six months ended June 30, 2014, number of Ads Sold increased 24 percent and 16 percent, respectively, and Price-per-Ad decreased 24 percent and 15 percent, respectively, as compared to the same periods of 2013. The increase in number of Ads Sold for the three and six months ended June 30, 2014 was attributable to an increase in native ad units sold, partially offset by a decline in premium ad units sold. Native ad units represented approximately 40 percent and 31 percent of total Ads Sold for the three and six months ended June 30, 2014, respectively. The decrease in Price-per-Ad for the three and six months ended June 30, 2014 was due to a mix shift toward lower monetizing native ad units in the Americas region, partially offset by an increase in Price-per-Ad in the Asia Pacific region.

Search Metrics

For the three and six months ended June 30, 2014, Paid Clicks increased 3 percent and 5 percent, respectively, and Price-per-Click increased 15 percent and 12 percent, respectively, as compared to the same periods of 2013. The increase in Paid Clicks for the three and six months ended June 30, 2014 was attributable to an increase in Paid Clicks on Yahoo Properties primarily in the Americas region, partially offset by a decline in Paid Clicks on Affiliate sites primarily in the Asia Pacific region driven by the transition of paid search to Microsoft. Paid Clicks for the six months ended June 30, 2014 were also impacted by a decline in Paid Clicks on Affiliate sites in the Americas region. The increase in Price-per-Click for the three and six months ended June 30, 2014 was primarily due to improved traffic quality in the Asia Pacific region resulting in higher Price-per-Click and an increase in Price-per-Click in the EMEA region resulting from mobile traffic on Yahoo Properties. Improvements in the search metrics resulted in year-over-year growth in search click-driven revenue for the three and six months ended June 30, 2014 of 19 percent and 17 percent, respectively.

Revenue ex-TAC by Segment

Americas

Americas revenue ex-TAC for the three and six months ended June 30, 2014 decreased $16 million, or 2 percent, and increased $12 million, or 1 percent, respectively, as compared to the same periods of 2013. The decrease in Americas revenue ex-TAC for the three months ended June 30, 2014 was attributable to declines in display revenue ex-TAC of $19 million and other revenue ex-TAC of $17 million, partially offset by an increase in search revenue ex-TAC of $19 million. The decline in display revenue ex-TAC was due to a decline in premium ads sold on Yahoo Properties, partially offset by an increase in native advertising. The decline in other revenue ex-TAC was primarily attributable to a decline in listings-based revenue. Search revenue ex-TAC increased 6 percent year-over-year as Paid Clicks increased 15 percent and Price-per-Click increased 4 percent in the Americas region. The increase in search revenue ex-TAC was attributable to an increase in search revenue on Yahoo Properties driven by higher revenue-per-search from a change in the design of the search results page and an increase in search advertising from mobile devices. Additionally, search revenue ex-TAC increased even with the expiration of the RPS Guarantee in the U.S.

The increase in Americas revenue ex-TAC for the six months ended June 30, 2014 was attributable to an increase in search revenue ex-TAC of $55 million, partially offset by declines in other revenue ex-TAC of $40 million and display revenue ex-TAC of $3 million. Search revenue ex-TAC increased 9 percent year-over-year as Paid Clicks increased 12 percent and Price-per-Click increased 3 percent in the Americas region. The increase in search revenue ex-TAC was attributable to an increase in search revenue on Yahoo Properties driven by higher revenue-per-search from a change in the design of the search results page and an increase in search advertising from mobile devices. This revenue increase was partially offset by a decline in Affiliate search revenue in the region. The decline in other revenue ex-TAC was primarily attributable to a decline in listings and fees-based revenue. The decline in display revenue ex-TAC was due to a decline in premium ads sold on Yahoo Properties, partially offset by an increase in native advertising.

Revenue ex-TAC in the Americas accounted for approximately 75 percent and 76 percent of total revenue ex-TAC for the three and six months ended June 30, 2014, respectively, compared to 74 percent for both the three and six months ended June 30, 2013.

EMEA

EMEA revenue ex-TAC for the three and six months ended June 30, 2014 increased $2 million, or 2 percent, and $1 million, or essentially flat, respectively, as compared to the same periods of 2013. The increase in EMEA revenue ex-TAC for the three months ended June 30, 2014 was primarily attributable to an increase in search revenue ex-TAC of $10 million, partially offset by declines in display and other revenue ex-TAC of $4 million and $4 million, respectively. The increase in EMEA revenue ex-TAC for the six

 

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months ended June 30, 2014 was primarily attributable to an increase in search revenue ex-TAC of $18 million, partially offset by declines in display and other revenue ex-TAC of $8 million and $9 million, respectively. Search revenue ex-TAC in the EMEA region increased 45 percent and 39 percent for the three and six months ended June 30, 2014, respectively, as compared to the same periods of 2013, as Paid Clicks increased 27 percent and 28 percent, respectively, and Price-per-Click increased 11 percent and 9 percent, respectively, in the region. The increase in search revenue ex-TAC for the three and six months ended June 30, 2014 was due to an increase in search advertising on Yahoo Properties driven by distribution deals that contributed to improved revenue-per-search. The decline in display revenue ex-TAC for the three and six months ended June 30, 2014 was due to a decline in Ads Sold on Yahoo Properties, primarily Homepage. The decline in other revenue ex-TAC for the three and six months ended June 30, 2014 was primarily attributable to a decline in listings-based revenue.

Revenue ex-TAC in EMEA accounted for approximately 8 percent of total revenue ex-TAC for both the three and six months ended June 30, 2014 and 2013.

Asia Pacific

Asia Pacific revenue ex-TAC for the three and six months ended June 30, 2014 decreased $16 million, or 8 percent, and $31 million, or 8 percent, respectively, as compared to the same periods of 2013. The decline for the three months ended June 30, 2014 was attributable to declines in display, search and other revenue ex-TAC of $6 million, $5 million, and $5 million, respectively. The decline for the six months ended June 30, 2014 was attributable to declines in display, search, and other revenue ex-TAC of $12 million, $13 million, and $6 million, respectively. The decline in display revenue ex-TAC for the three and six months ended June 30, 2014 was primarily attributable to a decline in premium advertising due to a decline in supply, and a decline in content match. The decline in search revenue ex-TAC for the three and six months ended June 30, 2014 was primarily attributable to the revenue share with Microsoft associated with the Search Agreement. The decline in other revenue ex-TAC for the three and six months ended June 30, 2014 was primarily due to a decline in listings-based and fees revenue. Revenue ex-TAC in the Asia Pacific region was also impacted by unfavorable foreign exchange fluctuations of $6 million and $19 million for the three and six months ended June 30, 2014, respectively.

Revenue ex-TAC in Asia Pacific accounted for approximately 17 percent and 16 percent of total revenue ex-TAC for the three and six months ended June 30, 2014, respectively, compared to 18 percent for both the three and six months ended June 30, 2013.

Direct Costs by Segment

Americas

For the three and six months ended June 30, 2014, direct costs attributable to the Americas segment decreased $5 million, or 3 percent, and $2 million, or 1 percent, respectively, as compared to the same periods of 2013. For the three months ended June 30, 2014, the decrease in direct costs was primarily due to a year-over-year decline in compensation costs of $8 million and travel and entertainment expense of $2 million. This decrease was partially offset by higher bandwidth and other cost of revenue, outside service provider expenses, and marketing expenses of $5 million. For the six months ended June 30, 2014, the decrease in direct costs was primarily due to declines in compensation costs of $11 million. This decline was partially offset by an increase in marketing expenses of $7 million and outside service provider expenses of $3 million.

Direct costs attributable to the Americas segment represented approximately 23 percent and 22 percent of Americas revenue ex-TAC for the three and six months ended June 30, 2014, respectively, compared to 24 percent and 23 percent for the three and six months ended June 30, 2013, respectively.

EMEA

For the three and six months ended June 30, 2014, direct costs attributable to the EMEA segment decreased $3 million, or 8 percent, and $2 million, or 3 percent, respectively, compared to the same periods of 2013. For the three months ended June 30, 2014, the decrease was due to declines in compensation costs and content costs of $3 million. For the six months ended June 30, 2014, the decrease was due to declines in content costs and bandwidth and other cost of revenue of $2 million.

Direct costs attributable to the EMEA segment represented approximately 44 percent and 46 percent of EMEA revenue ex-TAC for the three and six months ended June 30, 2014, respectively, compared to 49 percent and 48 percent for the three and six months ended June 30, 2013, respectively.

Asia Pacific

For the three and six months ended June 30, 2014, direct costs attributable to the Asia Pacific segment decreased $4 million, or 8 percent, and $15 million, or 14 percent, respectively, as compared to the same periods of 2013. For the three months ended June 30, 2014, the decrease was primarily attributable to declines in compensation costs, bandwidth and other cost of revenue, and outside service provider expenses of $4 million. For the six months ended June 30, 2014, the decrease was primarily attributable to declines in compensation costs of $6 million, bandwidth and other cost of revenue of $3 million, outside service provider expenses of $2 million, and content and other costs of $4 million.

 

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Direct costs attributable to the Asia Pacific segment represented approximately 25 percent and 26 percent of Asia Pacific revenue ex-TAC for the three and six months ended June 30, 2014, respectively, compared to 26 percent and 27 percent for the three and six months ended June 30, 2013, respectively.

Operating Costs and Expenses

Traffic Acquisition Costs

TAC consists of payments made to third-party entities that have integrated our advertising offerings into their Websites or other offerings and payments made to companies that direct consumer and business traffic to Yahoo Properties. We enter into agreements of varying durations 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.

TAC for the three and six months ended June 30, 2014 decreased $20 million, or 32 percent, and $41 million, or 31 percent, respectively, as compared to the same periods of 2013. The decrease for the three months ended June 30, 2014, compared to 2013, was primarily attributable to declines in the Asia Pacific and Americas regions of $13 million and $7 million, respectively. The decrease for the six months ended June 30, 2014, compared to 2013, was primarily attributable to declines in the Asia Pacific, Americas, and EMEA regions of $27 million, $10 million and $4 million, respectively. The decline for both the three and six months ended June 30, 2014 was primarily due to the required change in revenue presentation for transitioned markets from a gross (before TAC) basis to a net (after TAC) basis in the Asia Pacific region and declines in display TAC in the Americas region.

TAC represented approximately 4 percent of GAAP revenue for both the three and six months ended June 30, 2014, compared to 6 percent for both the three and six months ended June 30, 2013.

Cost of Revenue—Other

Cost of revenue—other consists of bandwidth costs, content costs, and other expenses associated with the production and usage of Yahoo Properties, including amortization of developed technology and patents. Cost of revenue—other also includes costs for Yahoo’s technology platforms and infrastructure, including depreciation expense and other operating costs, directly related to revenue generating activities.

Cost of revenue—other was relatively flat for the three and six months ended June 30, 2014, as compared to the same periods of 2013. The three months ended June 30, 2014, compared to 2013, reflected a decline in depreciation and amortization of $15 million offset by an increase in bandwidth costs of $15 million. The six months ended June 30, 2014, compared to 2013, reflected increases in bandwidth costs of $20 million and stock-based compensation expense of $19 million, partially offset by a decline in depreciation and amortization of $30 million and a decline in rich media ad serving costs and maintenance contracts of $7 million.

Cost of revenue—other represented approximately 25 percent of GAAP revenue for both the three and six months ended June 30, 2014, respectively, compared to 24 percent for both the three and six months ended June 30, 2013.

Sales and Marketing

Sales and marketing expenses consist primarily of advertising and other marketing-related expenses, compensation-related expenses (including stock-based compensation expense), sales commissions, and travel costs.

Sales and marketing expenses for the three and six months ended June 30, 2014 increased $13 million, or 5 percent, and $86 million, or 16 percent, respectively, as compared to the same periods of 2013. For the three months ended June 30, 2014, compensation costs increased $11 million and stock-based compensation expense increased $10 million. This was partially offset by a decline in depreciation and amortization expense of $5 million and a decline in travel and entertainment expense of $3 million. For the six months ended June 30, 2014, compensation costs increased $47 million, stock-based compensation expense increased $46 million, and facilities and equipment expense increased $5 million. This was partially offset by a decline in depreciation and amortization expense of $5 million and a decline in travel and entertainment expense of $5 million. The increase in compensation costs for both the three and six months ended June 30, 2014 was primarily attributable to a 3 percent increase in headcount year-over-year, including incremental headcount in connection with our acquisition of Tumblr in June 2013. The increase in compensation costs for the three months ended June 30, 2014 was also attributable to increases in incentive compensation, benefits, and sales commissions. The increase in compensation costs for the six months ended June 30, 2014 was also attributable to merit-based increases in salaries, as well as increases in incentive compensation, benefits, and sales commissions. The increase in stock-based compensation expense for both the three and six months ended June 30, 2014 was attributable to an increase in the number of awards granted at a higher fair value.

 

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Sales and marketing expenses represented approximately 27 percent and 28 percent of GAAP revenue for the three and six months ended June 30, 2014, respectively, compared to 24 percent and 23 percent for the three and six months ended June 30, 2013, respectively. The increase in this percentage was primarily driven by increases in compensation costs and stock-based compensation expense as discussed above.

Product Development

Product development expenses consist primarily of compensation-related expenses (including stock-based compensation expense) incurred for the development of, enhancements to and maintenance of Yahoo Properties, classification and organization of listings within Yahoo Properties, research and development, and Yahoo’s technology platforms and infrastructure. Depreciation expense and other operating costs are also included in product development.

Product development expenses for the three and six months ended June 30, 2014 increased $57 million, or 23 percent, and $120 million, or 26 percent, respectively, as compared to the same periods of 2013. For the three months ended June 30, 2014, the increase was primarily attributable to increases in compensation costs of $31 million, and stock-based compensation expense of $19 million, a decrease in capitalized labor projects resulting in an increase in expense of $17 million, partially offset by a decline in facilities and equipment expense of $6 million, depreciation and amortization of $5 million, and travel and entertainment expense of $4 million. For the six months ended June 30, 2014, the increase was primarily attributable to increases in compensation costs of $88 million, stock-based compensation expense of $25 million, a decrease in capitalized labor projects resulting in an increase in expense of $25 million, and an increase in telephone expenses of $7 million, partially offset by a decline in depreciation and amortization of $29 million, and travel and entertainment expense of $5 million. The increase in compensation costs for both the three and six months ended June 30, 2014 was primarily attributable to an 8 percent increase in headcount year-over-year, including incremental headcount for mobile and search, as well as incremental headcount in connection with our acquisition of Tumblr in June 2013. The increase in compensation costs for the three months ended June 30, 2014 was also attributable to increases in compensation costs due to a shift in location of employees, increases in benefits, and increases in incentive compensation. The increase in compensation costs for the six months ended June 30, 2014 was also attributable to increases in compensation costs due to merit-based increases in salaries, as well as increases in costs from a shift in location of employees, increases in benefits, and increases in incentive compensation. The increase in stock-based compensation expense for both the three and six months ended June 30, 2014 was attributable to an increase in the number of awards granted at a higher fair value and an increase in expense related to equity assumed from acquisitions.

Product development expenses represented approximately 28 percent and 26 percent of GAAP revenue for the three and six months ended June 30, 2014, respectively, compared to 22 percent and 20 percent for the three and six months ended June 30, 2013, respectively. The increase in this percentage was primarily driven by increases in compensation costs, stock-based compensation expense, and a decline in capitalizable projects as discussed above and reflected increased investments in product development.

General and Administrative

General and administrative expenses consist primarily of compensation-related expenses (including stock-based compensation expense) related to other corporate departments and fees for professional services.

General and administrative expenses for the three and six months ended June 30, 2014 decreased $7 million, or 5 percent, and $4 million, or 1 percent, respectively, as compared to the same periods of 2013. For the three months ended June 30, 2014, the decline was due to a decrease in outside service provider expense of $5 million, as well as benefits related to net gains on disposal of assets and business tax refunds received of $12 million. This was partially offset by an increase in stock-based compensation expense of $6 million and facilities and equipment expense of $4 million. For the six months ended June 30, 2014, the decline was due to a decrease in outside service provider expense of $11 million, as well as benefits related to net gains on disposal of assets and business tax refunds received of $13 million. This was partially offset by an increase in stock-based compensation expense of $9 million, other compensation costs of $6 million, and facilities and equipment expense of $7 million. The increase in stock-based compensation expense for both the three and six months ended June 30, 2014 was attributable to an increase in the number of awards granted at a higher fair value. The increase in compensation costs for the six months ended June 30, 2014 was attributable to a 4 percent increase in headcount year-over-year.

General and administrative expenses represented approximately 12 percent of GAAP revenue for both the three and six months ended June 30, 2014 and 2013.

Amortization of Intangibles

We have purchased, and expect to continue purchasing, assets and/or businesses, which may include the purchase of intangible assets. Intangible assets include customer, affiliate, and advertiser-related relationships and tradenames, trademarks and domain names. Amortization of developed technology and patents is included in the cost of revenue—other and not in amortization of intangibles.

Amortization of intangibles for the three and six months ended June 30, 2014 increased $7 million, or 88 percent, and $18 million, or 117 percent, respectively, as compared to the same periods of 2013. For the three and six months ended June 30, 2014, the increase in amortization of intangibles was primarily driven by amortization of intangible assets related to Tumblr, which we acquired in the second quarter of 2013.

 

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Amortization of intangibles represented approximately 1 percent and 2 percent of GAAP revenue for the three and six months ended June 30, 2014, respectively, compared to 1 percent for both the three and six months ended June 30, 2013.

Gains on Sales of Patents

For the three and six months ended June 30, 2014 and June 30, 2013, we sold certain patents and recorded gains on sales of patents of approximately $62 million and $10 million, respectively. See “Significant Transactions—Patent Sale” for additional information on the patents sold during the three and six months ended June 30, 2014.

Restructuring Charges (Reversals), Net

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 

Employee severance pay and related costs

   $ 242      $ 82      $ 6,718      $ 3,673   

Non-cancelable lease, contract termination, and other charges

     6,810        61,906        11,202        68,438   

Other non-cash (credits) charges, net

     —         (7,031     538        (7,031

Changes in estimates and reversals of previous charges

     (3,474     (2,336     (21,942     (2,972
  

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges (reversals), net

   $ 3,578      $ 52,621      $ (3,484   $ 62,108   
  

 

 

   

 

 

   

 

 

   

 

 

 

We have previously implemented various restructuring plans to reduce our cost structure, align resources with our product strategy and improve efficiency, which have resulted in workforce reductions and the consolidation of certain real estate facilities and data centers. For the three months ended June 30, 2013, we recorded $3 million related to the EMEA segment and $1 million related the Asia Pacific segment. For the three months ended June 30, 2014, we recorded $50 million related to the Americas segment and $3 million related to the EMEA segment. For the six months ended June 30, 2013, we recorded a credit of $3 million related to the Americas segment, a credit of $1 million related to the EMEA segment and a $1 million debit related the Asia Pacific segment. For the six months ended June 30, 2014, we recorded $55 million related to the Americas segment and $7 million related to the EMEA segment. The amounts recorded during the three and six months ended June 30, 2014 were primarily related to the consolidation of a data center as we ceased use of that facility pursuant to a restructuring plan we initiated in 2011.

Our restructuring accrual activity for the six months ended June 30, 2014 is summarized as follows (in thousands):

 

Accrual balance as of December 31, 2013

   $ 30,096   

Restructuring charges

     62,108   

Cash paid

     (20,140

Foreign currency translation and other adjustments

     6,987   
  

 

 

 

Accrual balance as of June 30, 2014

   $ 79,051   
  

 

 

 

The $79 million restructuring liability as of June 30, 2014 consists of $2 million for employee severance expenses, which we expect to pay out by the end of the third quarter of 2014, and $77 million related to non-cancelable lease costs, which we expect to pay over the terms of the related obligations through the fourth quarter of 2021, less estimated sublease income.

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

 

     December 31,
2013
     June 30,
2014
 

Americas

   $ 18,078       $ 70,481   

EMEA

     11,284         8,125   

Asia Pacific

     734         445   
  

 

 

    

 

 

 

Total restructuring accruals

   $ 30,096       $ 79,051   
  

 

 

    

 

 

 

 

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Other Income (Expense), Net

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

 

     Three Months Ended     Six Months Ended  
     June 30,
2013
    June 30,
2014
    June 30,
2013
    June 30,
2014
 

Interest, dividend, and investment income

   $ 21,934      $ 5,596      $ 47,852      $ 11,033   

Interest expense, net

     (2,217     (17,088     (4,490     (34,169

Other income (expense), net

     3,889        (2,097     (2,684     (3,906
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense), net

   $ 23,606      $ (13,589   $ 40,678      $ (27,042
  

 

 

   

 

 

   

 

 

   

 

 

 

For the three and six months ended June 30, 2014, interest, dividend and investment income decreased $16 million and $37 million, respectively, primarily due to dividend income on the Alibaba Group Preference Shares received during the three and six months ended June 30, 2013 for which there was no similar income for the three and six months ended June 30, 2014.

Interest expense increased $15 million and $30 million for the three and six months ended June 30, 2014, respectively, compared to the same periods of 2013, due to the accreted non-cash interest expense related to the 0.00% Convertible Senior Notes due 2018 that we issued in November 2013.

For the three and six months ended June 30, 2014, other income (expense), net decreased $6 million and $1 million, respectively, primarily due to unrealized and realized foreign exchange currency transaction losses.

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, non-deductible acquisition-related costs and adjustments to unrecognized tax benefits.

The effective tax rate reported for the three months ended June 30, 2014 was 33 percent compared to 31 percent for the same period in 2013. The effective tax rate reported for the six months ended June 30, 2014 was 30 percent compared to 22 percent for the same period in 2013. The effective tax rate for the three months ended June 30, 2014 was lower than the U.S. federal statutory rate primarily due to the tax benefit from a $15 million capital loss recognized during the quarter. The effective tax rate for the three months ended June 30, 2013 was lower than the U.S. federal statutory rate primarily due to an $11 million tax benefit recorded during the quarter ended June 30, 2013 relating to the resolution of certain tax matters associated with a one-time foreign earnings distribution made during the quarter ended September 30, 2012. The tax rates for the six months ended June 30, 2014 and 2013 were lower than the U.S. federal statutory rate also due to the reductions of tax reserves that were recorded based on new information received during interactions with tax authorities. The income tax expense reported for the three and six months ended June 30, 2014 does not include any benefit from the federal research and development tax credit as that provision expired on December 31, 2013.

As of June 30, 2014, we do not anticipate repatriating our undistributed foreign earnings of approximately $2.9 billion. Those earnings are principally related to our equity method investment in Yahoo Japan. If those earnings were to be repatriated in the future, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits). It is not practicable to determine the income tax liability that might be incurred if these earnings were to be repatriated.

We are in various stages of examination and appeal in connection with our taxes both in the U.S. and in foreign jurisdictions. Those audits generally span tax years 2005 through 2012. The IRS Appeals division is currently finalizing our protest of the 2007 and 2008 audit results, while the 2009 and 2010 U.S. federal income tax returns are currently under examination. We have protested the proposed California Franchise Tax Board’s adjustments to the 2005 and 2006 returns, but no conclusions have been reached to date. The 2007 and 2008 California tax returns are currently under examination.

Our gross amount of unrecognized tax benefits as of June 30, 2014 was $685 million, of which $596 million is recorded on our condensed consolidated balance sheets. The gross unrecognized tax benefits as of June 30, 2014 decreased by $11 million from the recorded balance as of December 31, 2013. While it is difficult to determine when the 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 our unrecognized tax benefits could be reduced by up to approximately $70 million in the next twelve months. 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 cash flows.

We may have additional tax liabilities in China related to the sale to Alibaba Group of 523 million shares of Alibaba Group that took place during the year ended December 31, 2012. Any taxes assessed and paid in China are expected to be ultimately offset and recovered in the U.S.

 

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During the year ended December 31, 2012, tax authorities from the Brazilian State of Sao Paulo assessed certain indirect taxes against our Brazilian subsidiary, Yahoo! do Brasil Internet Ltda., related to online advertising services. The assessment totaling approximately $85 million is for calendar years 2008 and 2009. We currently believe the assessment is without merit. We believe the risk of loss is remote and have not recorded an accrual for the assessment.

Earnings in Equity Interests

Earnings in equity interests for the three and six months ended June 30, 2014 was $256 million and $557 million, respectively, compared to $225 million and $442 million, respectively, in the same periods of 2013. The increases for the three and six months ended June 30, 2014 were due primarily to improved financial performance for Alibaba Group, partially offset by a decline in earnings in equity interests from Yahoo Japan year-over-year. We record earnings in equity interests one quarter in arrears. See “Significant Transactions—Alibaba Group Holding Limited Initial Public Offering” above and Note 8 — “Investments in Equity Interests” in the Notes to our 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.

Liquidity and Capital Resources

 

     December 31,
2013
    June 30,
2014
 
     (Dollars in thousands)  

Cash and cash equivalents

   $ 2,077,590      $ 1,114,586   

Short-term marketable securities

     1,330,304        1,629,869   

Long-term marketable securities

     1,589,500        1,566,120   
  

 

 

   

 

 

 

Total cash, cash equivalents, and marketable securities

   $ 4,997,394      $ 4,310,575   
  

 

 

   

 

 

 

Percentage of total assets

     30     26
  

 

 

   

 

 

 

 

     Six Months Ended
June 30,
 

Cash Flow Highlights

   2013     2014  
     (In thousands)  

Net cash provided by operating activities

   $ 549,510      $ 496,475   

Net cash used in investing activities

   $ (704,308   $ (349,609

Net cash used in financing activities

   $ (1,340,135   $ (1,113,424

Our operating activities for the six months ended June 30, 2014 generated adequate cash to meet our operating needs.

As of June 30, 2014, we had cash, cash equivalents, and marketable securities totaling $4.3 billion compared to $5 billion at December 31, 2013. During the six months ended June 30, 2014, we repurchased 33 million shares of our outstanding common stock for $1.2 billion. This was partially offset by net proceeds of $169 million from settlement of derivative hedge contracts and dividends received from Yahoo Japan of $84 million.

Our foreign subsidiaries held $556 million of our total $4.3 billion of cash and cash equivalents, and marketable securities as of June 30, 2014. The cumulative earnings remaining in our consolidated foreign subsidiaries, if repatriated to the U.S., under current law, would be subject to U.S. income taxes with an adjustment for foreign tax credits. For the earnings that are considered indefinitely reinvested outside the U.S., we do not anticipate a need to repatriate these earnings for use in our U.S. operations.

Our credit agreement (the “Credit Agreement”) with Citibank, N.A. terminates on October 9, 2014. As of June 30, 2014, we were in compliance with the financial covenants in the Credit Agreement and no amounts were outstanding. See Note 10 — “Credit Agreement” in the Notes to our condensed consolidated financial statements for additional information regarding our Credit Agreement.

We currently hedge a portion of our net investment in Yahoo Japan with forward and option contracts to reduce the risk that our investment in Yahoo Japan will be adversely affected by foreign currency translation exchange rate fluctuations. The forward contracts are required to be settled in cash and the amount of cash payment we receive or could be required to pay upon settlement could be material. The amount of cash paid or received on the option contracts would only be required if the exchange rate is outside a predetermined range.

 

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We expect to continue to evaluate possible acquisitions of, or strategic investments in, businesses, products, and technologies that are complementary to our business, which acquisitions and investments may require the use of cash.

We expect to generate positive cash flows from operations in the third quarter of 2014. 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 securities, together with any cash generated from operations, and borrowings under the Credit Agreement, will be sufficient to meet normal operating requirements including capital expenditures for the next twelve months, as well as additional stock repurchases we expect to make under our stock repurchase program.

On May 6, 2014, Alibaba Group filed a registration statement with the Securities and Exchange Commission regarding its initial public offering. If Yahoo sells the 140 million Alibaba Shares that it is currently obligated to sell in connection with the completion of the Qualified IPO, we will receive substantial cash proceeds. As previously announced, we expect to return to our stockholders at least half of the after-tax proceeds we receive from the sale of the Alibaba Shares in the Qualified IPO.

Cash Flow Changes

Net cash provided by operating activities. For the six months ended June 30, 2014, operating activities provided $496 million in cash. Net income for the six months ended June 30, 2014 was $586 million, which was adjusted for the following increases related to non-cash items: depreciation, amortization of intangibles and accretion of convertible notes discount of $334 million, stock-based compensation expense of $212 million, tax benefits from stock-based awards of $77 million, deferred income taxes of $14 million, and losses from sales of investments, assets and other of $19 million, offset by reductions related to the following non-cash items: earnings in equity interests of $558 million, excess tax benefits from stock-based awards of $79 million, restructuring reversals of $7 million, and gains on sales of patents of $62 million. Additionally, we received dividends of $84 million from Yahoo Japan and working capital sources of cash of $168 million, which were partially offset by working capital uses of cash of $292 million.

For the six months ended June 30, 2013, operating activities provided $550 million in cash. Net income for the six months ended June 30, 2013 was $726 million, which was adjusted for the following increases related to non-cash items: depreciation and amortization of intangibles of $323 million, stock-based compensation expense of $113 million, tax benefits from stock-based awards of $10 million, and losses from sales of investments, assets and other of $13 million, offset by reductions related to the following non-cash items: earnings in equity interests of $442 million, excess tax benefits from stock-based awards of $19 million, deferred income taxes of $28 million, dividend income related to Alibaba Group Preference Shares of $36 million, and gains on sales of patents of $10 million. Additionally, we received dividends of $135 million from equity investees and working capital sources of cash of $59 million, which were partially offset by working capital uses of cash of $294 million.

Net cash used in investing activities. In the six months ended June 30, 2014, the $350 million used in investing activities was due to net purchases of marketable securities of $293 million, $192 million used for capital expenditures, $22 million used for acquisitions, $10 million used for additional equity investments, $5 million used to settle derivative hedge contracts, and $3 million used for the purchase of intangibles and other activities, partially offset by $173 million in proceeds received from settlement of derivative hedge contracts and $2 million in proceeds from sales of patents. In the six months ended June 30, 2013, the $704 million used in investing activities was due to net purchases of marketable securities of $323 million, $152 million used for capital expenditures, $1,024 million used for acquisitions, $8 million used to settle derivative hedge contracts, and $3 million used for the purchase of intangibles and other activities, partially offset by $800 million received from the redemption of the Alibaba Group Preference Shares and $6 million in proceeds from settlement of derivative hedge contracts.

Net cash used in financing activities. In the six months ended June 30, 2014, the $1,113 million used in financing activities was due to $1,168 million used for the repurchase of 33 million shares of common stock at an average price of $35.93 per share, $22 million used for distributions to noncontrolling interests, and $166 million used for tax withholding payments related to net share settlements of restricted stock units and other financing activities. This use of cash was partially offset by $164 million in cash proceeds received from employee stock option exercises and employee stock purchases made through our employee stock purchase plan, and an excess tax benefit from stock-based awards of $79 million. In the six months ended June 30, 2013, the $1,340 million used in financing activities was due to $1,428 million used for the repurchase of 63 million shares of common stock at an average price of $22.51 per share and $54 million used for tax withholding payments related to net share settlements of restricted stock units and other financing activities. This use of cash was partially offset by $123 million in cash proceeds received from employee stock option exercises and employee stock purchases made through our employee stock purchase plan, and an excess tax benefit from stock-based awards of $19 million.

Capital Expenditures, Net

Capital expenditures are generally comprised of purchases of computer hardware, software, server equipment, furniture and fixtures, real estate, and capitalized software and labor. Capital expenditures, net of disposals, were $192 million for the six months ended June 30, 2014 compared to $152 million in the same period of 2013. The increase in capital expenditures was primarily due to incremental investment in hardware to support Company initiatives and facilities expansions, partially offset by a decline in capitalizable software projects.

 

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We expect capital expenditures to increase in the second half of 2014 from the amount recorded during the six months ended June 30, 2014, as a result of increased investment initiatives.

Stock Repurchases

During the six months ended June 30, 2014, we repurchased approximately 33 million shares of our common stock at an average price of $35.93 per share for a total of $1.2 billion. The following table provides the remaining authorization and repurchases by program:

 

     May 2012
Program
    November 2013
Program
    Total  
     (Dollars in millions)  

Remaining authorization as of December 31, 2013

   $ 93      $ 5,000      $ 5,093   

Total repurchases in the first quarter

     (93     (357     (450

Total repurchases in the second quarter

     —         (719     (719
  

 

 

   

 

 

   

 

 

 

Remaining authorization as of June 30, 2014

   $
 

  
 
 
  $ 3,924      $ 3,924   
  

 

 

   

 

 

   

 

 

 

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 12 years, expiring between 2014 and 2025.

A summary of lease commitments as of June 30, 2014 is as follows (in millions):

 

     Gross Operating
Lease Commitments
     Capital Lease
Commitment
 

Six months ending December 31, 2014

   $ 71       $ 7   

Years ending December 31,

     

2015

     120         12   

2016

     86         9   

2017

     64         9   

2018

     41         9   

2019

     32         4   

Due after 5 years

     108         —     
  

 

 

    

 

 

 

Total gross lease commitments

   $ 522       $ 50   
  

 

 

    

 

 

 

Less: interest

     —           (12
  

 

 

    

 

 

 

Net lease commitments

   $ 522       $ 38   
  

 

 

    

 

 

 

Affiliate Commitments. We are obligated to make payments, which represent TAC, to our Affiliates. As of June 30, 2014, these commitments totaled $184 million, of which $62 million will be payable in the remainder of 2014, $121 million will be payable in 2015, and $1 million will be payable in 2016.

Intellectual Property Rights. We are committed to make certain payments under various intellectual property arrangements of up to $21 million through 2023.

Income Taxes. As of June 30, 2014, unrecognized tax benefits of $671 million, including interest and penalties, are recorded on our condensed consolidated balance sheets. Of this amount, we currently expect approximately $2 million to be paid by us in cash in the next 12 months for settlements of tax audits. The settlement period for the remaining balance 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 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 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, lease, or assignment 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 current and former 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

 

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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, 2014, 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. Accordingly we are not exposed to any financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships. In addition, we identified no variable interests currently held in entities for which we are the primary beneficiary. In addition, as of June 30, 2014, 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.

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.

Goodwill. For the Europe reporting unit, the percentage by which the estimated fair value exceeded the carrying value as of October 31, 2013 was 20 percent and the amount of goodwill allocated to the Europe reporting unit was $466 million. 

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, 2013 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, 2013.

Recent Accounting Pronouncements

See Note 1—“The Company and Summary of Significant Accounting Policies” in the Notes to our condensed consolidated financial statements.

 

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. We may use derivative financial instruments to mitigate certain risks in accordance with our investment and foreign exchange policies.

We enter into master netting arrangements, which are designed to reduce credit risk by permitting net settlement of transactions with the same counterparty. We present our derivative assets and liabilities at their gross fair values on the condensed consolidated balance sheets.

Interest Rate Exposure

Our exposure to market risk for changes in interest rates impacts our costs associated with hedging, and primarily relates to our cash and marketable 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 securities and cash equivalents.

In November 2013, we issued $1.4375 billion of 0.00% Convertible Senior Notes due 2018 (the “Notes”). We carry the Notes at face value less unamortized discount on our condensed consolidated balance sheet. The fair value of the Notes changes when the market price of our stock fluctuates.

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

 

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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 $15 million and $17 million decrease in the fair value of our available-for-sale securities as of December 31, 2013 and June 30, 2014, respectively.

Foreign Currency Exposure

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. All counterparties to our derivative contracts are major financial institutions. See Note 9 — “Derivative Financial Instruments” in the Notes to our condensed consolidated financial statements for additional information on our hedging programs.

We transact business in various foreign currencies and have international revenue, as well as costs denominated in foreign currencies. This exposes us to the risk of fluctuations in foreign currency exchange rates.

Net realized and unrealized foreign currency transaction gains were immaterial for the three months ended June 30, 2013. Net realized and unrealized foreign currency transaction losses were $7 million for the six months ended June 30, 2013. Net realized and unrealized foreign currency transaction losses were $5 million and $7 million for the three and six months ended June 30, 2014, respectively.

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.

A Value-at-Risk (“VaR”) sensitivity analysis was performed on all of our foreign currency derivative positions as of June 30, 2014 and December 31, 2013 to assess the potential impact of fluctuations in exchange rates. The VaR model uses a Monte Carlo simulation to generate thousands of random price paths assuming normal market conditions. The VaR is the maximum expected one day loss in fair value, for a given statistical confidence level, to our foreign currency derivative positions due to adverse movements in rates. The VaR model is used as a risk management tool and is not intended to represent either actual or forecasted losses. Based on the results of the model using a 99 percent confidence interval, we estimate the maximum one-day loss in the net investment hedge portfolio was $8 million and $12 million at June 30, 2014 and December 31, 2013, respectively. The maximum one-day loss in the cash flow hedge portfolio was $1 million and less than $1 million at June 30, 2014 and December 31, 2013, respectively. The maximum one-day loss in the balance sheet hedge portfolio was $1 million and $2 million at June 30, 2014 and December 31, 2013, respectively. Actual future gains and losses associated with our derivative positions may differ materially from the sensitivity analysis performed as of June 30, 2014 due to the inherent limitations associated with predicting the timing and amount of changes in foreign currency exchange rates and our actual exposures and positions. In addition, the VaR sensitivity analysis may not reflect the complex market reactions that may arise from the market shifts modeled within this VaR sensitivity analysis.

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, 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 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, 2013, revenue ex-TAC for the Americas segment for the three and six months ended June 30, 2014 would have been higher than we reported by $3 million and $6 million, respectively; revenue ex-TAC for the EMEA segment would have been lower than we reported by $6 million and $8 million, respectively; and revenue ex-TAC for the Asia Pacific segment would have been higher than we reported by $6 million and $19 million, respectively. Using the foreign currency exchange rates from the three and six months ended June 30, 2013, direct costs for the Americas segment for the three and six months ended June 30, 2014 would have been higher than we reported by $1 million and $3 million, respectively; direct costs for the EMEA segment would have been lower than we reported by $2 million and $4 million, respectively; and direct costs for the Asia Pacific segment would have been higher than we reported by $2 million and $5 million, respectively.

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 securities and equity instruments of public and private companies.

Our cash and marketable 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

 

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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 December 31, 2013, net unrealized gains and losses on these investments were not material. As of June 30, 2014, net unrealized gains on these investments were $3 million.

 

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 12 — “Commitments and Contingencies” in the Notes to our 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, 2013, which was filed with the Securities and Exchange Commission on February 28, 2014 (“2013 Annual Report”), as set forth below. We do not believe any of the changes constitute material changes from the risk factors previously disclosed in our 2013 Annual Report, as updated in our subsequent Quarterly Reports on Form 10-Q.

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

We face significant competition from online media companies, social media and networking sites, traditional print and broadcast media, 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 increasingly used to communicate and share information, and which are attracting a substantial and increasing share of users, users’ online time, and online advertising dollars.

A key element of our strategy is focusing on mobile products and mobile advertising formats, as well as increasing our revenue from mobile. A number of our competitors have devoted significant resources to the development of products and services for mobile devices. Several of our competitors have mobile revenue significantly greater than ours. If we are unable to develop products for mobile devices that users find engaging and that help us grow our mobile revenue, our competitive position, our financial condition and operating results could be harmed.

In addition, a number of competitors offer products and services that directly compete for users with our offerings, including e-mail, search, sports, news and finance. Similarly, the advertising networks operated by our competitors or by other participants in the display marketplace offer advertising exchanges, ad networks, demand side platforms, ad serving technologies, sponsored search offerings, and other services that directly compete for advertisers with our 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 particular market segments, 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 or collaborate with each other, 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, have greater local 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.

We generate the majority of our revenue 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 both the three and six months ended June 30, 2014, 80 percent of our total revenue came from display and search advertising. Our ability to retain and grow display and search revenue depends upon:

 

 

maintaining and growing our user base and popularity as an Internet destination site;

 

 

maintaining the popularity of our existing products and introducing engaging new products and making our new and existing products popular and distributable on mobile and other alternative devices and platforms;

 

   

maintaining and expanding our advertiser base on PCs and mobile devices;

 

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

 

 

successfully implementing innovative changes and improvements to our advertising management platforms and formats and obtaining the acceptance of our new advertising management platforms and formats 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 and mobile products;

 

 

effectively monetizing mobile and other 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, growth rate of the online advertising market, and availability of capital has impacted and could further impact the advertising spending patterns of our 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.

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

We plan to continue to manage costs to better and more efficiently manage our business. However, our operating expenses might increase as we expand our operations in areas of desired growth, continue to develop and extend the Yahoo brand, fund product development, build or expand data centers, acquire additional office space, and continue to make talent acquisitions and to acquire and integrate complementary businesses and technologies. If our expenses increase at a greater pace than our revenue, or if we fail to effectively manage costs, our profitability will decline.

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. Even though we have substantially completed the transition to Microsoft’s platform, we still need to continue to invest and innovate to improve our users’ search experience to continue to attract, retain, and expand our user base and paid search advertiser base. We also need to continue to invest in and innovate on the mobile search experience. Pursuant to the Search Agreement with Microsoft, we are also dependent on Microsoft to continue to invest and innovate to maintain and improve its algorithmic and paid search services.

We also generate revenue through other online products and services, such as Yahoo Mail, and continue to innovate the products and services that we offer. The research and development of new, technologically advanced products is a complex process that requires significant levels of innovation and investment, as well as accurate anticipation of technology, market and consumer trends. If we are unable to provide innovative products and services which gain user acceptance and generate significant traffic to our Websites, our business could be harmed, causing our revenue to decline.

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. Approximately 31 percent, 36 percent and 36 percent of our revenue for 2013 and the three months and six months ended June 30, 2014, respectively, were attributable to the Search Agreement. Our business and operating results would be adversely affected by a significant decline in or loss of this revenue.

 

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Implementation of our Search Agreement with Microsoft commenced on February 23, 2010. We have completed the transition of our algorithmic search platform to the Microsoft platform and have substantially completed transition of paid search.

Pursuant to the Search Agreement with Microsoft, to maintain and grow search revenue, we are dependent on Microsoft continuing to invest and innovate to maintain and improve its algorithmic and paid search services and to be competitive with other search providers. If Microsoft fails to do this, our revenue and profitability could decline and our ability to maintain and expand our relationships with Affiliates for search and paid search advertising could be negatively impacted. Further, our competitors may continue to increase revenue, profitability, and market share at a higher rate than we do.

As mobile advertising continues to evolve and people increasingly access our products via mobile devices rather than PCs, our financial results may be adversely impacted if our mobile offerings are not widely adopted by users, advertisers and device manufacturers or if we do not generate adequate revenue from our mobile offerings.

The number of people who access the Internet through mobile devices rather than a PC, including mobile telephones, smartphones and tablets, is increasing and will likely continue to increase dramatically. Over 450 million of our monthly users are now joining us on mobile. In addition, search queries are increasingly being undertaken through mobile devices. We expect our ability to grow advertising revenue will become increasingly dependent on our ability to generate revenue from ads displayed on mobile devices.

A key element of our strategy is focusing on mobile devices and we expect to continue to devote significant resources to the creation and support of developing new and innovative mobile products and services. However, if our new mobile products and services, including new forms of Internet advertising for mobile devices, are not more attractive and successful in attracting and retaining users, advertisers and device manufacturers than those of our competitors and fail to generate and grow revenue, our operating and financial results will be adversely impacted.

To the extent that an access provider or device manufacturer enters into a distribution arrangement with one of our competitors, or as our competitors design, develop, or acquire control of alternative devices or their operating systems, we face an increased risk that our users will favor the services or properties of that competitor. We are dependent on the interoperability of our products and services with mobile operating systems we do not control. The manufacturer or access provider might promote a competitor’s services or might impair users’ access to our services by blocking access through their devices or by not making our services or apps available in a readily-discoverable manner on their devices. If distributors impair access to or refuse to distribute our services or apps, then our user engagement and revenue could 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, video, and maps. We believe that users will increasingly demand high-quality content and services. We may need 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 users increasingly access the Internet via mobile and other 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, because many of our content and services licenses with third parties are non-exclusive, 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 cost, 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 or commission compelling editorial content or personalization services, 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.

 

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Acquisitions and strategic investments could result in adverse impacts on our operations and in unanticipated liabilities.

We have acquired, and have made strategic investments in, a number of companies (including through joint ventures) in the past, and we expect to make additional acquisitions and strategic investments in the future. Such transactions may result in dilutive issuances of our equity securities, use of our cash resources, and incurrence of debt and amortization expenses related to intangible assets. Our acquisitions and strategic investments to date were accompanied by a number of risks, including:

 

 

the difficulty of assimilating the operations and personnel of acquired companies into our operations;

 

 

the potential disruption of our ongoing business and distraction of management;

 

 

the incurrence of additional operating losses and operating expenses of the businesses we acquired or in which we invested;

 

 

the difficulty of integrating acquired technology and rights into our services and unanticipated expenses related to such integration;

 

 

the failure to successfully further develop an acquired business or technology and any resulting impairment of amounts currently capitalized as intangible assets;

 

 

the failure of strategic investments to perform as expected or to meet financial projections;

 

 

the potential for patent and trademark infringement and data privacy and security claims against the acquired companies, or companies in which we have invested;

 

 

litigation or other claims in connection with acquisitions, acquired companies, or companies in which we have invested;

 

 

the impairment or loss of relationships with customers and partners of the companies we acquired or in which we invested or with our customers and partners as a result of the integration of acquired operations;

 

 

the impairment of relationships with, or failure to retain, employees of acquired companies or our existing employees as a result of integration of new personnel;

 

 

our lack of, or limitations on our, control over the operations of our joint venture companies;

 

 

the difficulty of integrating operations, systems, and controls as a result of cultural, regulatory, systems, and operational differences;

 

 

in the case of foreign acquisitions and investments, the impact of particular economic, tax, currency, political, legal and regulatory risks associated with specific countries; and

 

 

the impact of known potential liabilities or liabilities that may be unknown, including as a result of inadequate internal controls, associated with the companies we acquired or in which we invested.

We are likely to experience similar risks in connection with our future acquisitions and strategic investments. Our failure to be successful in addressing these risks or other problems encountered in connection with our past or future acquisitions and strategic investments could cause us to fail to realize the anticipated benefits of such acquisitions or investments, incur unanticipated liabilities, and harm our business generally.

We may be required to record a significant charge to earnings if our goodwill, amortizable intangible assets, investments in equity interests, including investments held by our equity method investees, or other investments become impaired.

We are required under generally accepted accounting principles to test goodwill for impairment at least annually and to review our amortizable intangible assets and investments in equity interests, including investments held by our equity method investees, for impairment when events or changes in circumstance indicate the carrying value may not be recoverable. Factors that could lead to impairment of goodwill and amortizable intangible assets (including goodwill or assets acquired via acquisitions) include significant adverse changes in the business climate and actual or projected operating results (affecting our company as a whole or affecting any particular reporting unit) and declines in the financial condition of our business. Factors that could lead to impairment of investments in equity interests include a prolonged period of decline in the stock price or operating performance of, or an announcement of adverse changes or events by, the companies in which we invested or the investments held by those companies. Factors that could lead to an impairment of U.S. government securities, which constitute a significant portion of our assets, include any downgrade of U.S. government debt or concern about the creditworthiness of the U.S. government. We have recorded and may be required in the future

 

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to record additional charges to earnings if our goodwill, amortizable intangible assets, investments in equity interests, including investments held by our equity investees, or other investments become impaired. Any such charge would adversely impact our financial results.

Fluctuations in foreign currency exchange rates may adversely affect our operating results and financial condition.

Revenue generated and expenses incurred by our international subsidiaries and equity method investees are often denominated in the currencies of the local countries. As a result, our consolidated U.S. dollar financial statements are subject to fluctuations due to changes in exchange rates as the financial results of our international subsidiaries and equity method investees are translated from local currencies into U.S. dollars. Our financial results are also subject to changes in exchange rates that impact the settlement of transactions in non-local currencies. The carrying values of our equity investments in our equity investees are also subject to fluctuations in the exchange rates of foreign currencies.

We use derivative instruments, such as foreign currency forward contracts, to partially offset certain exposures to fluctuations in foreign currency exchange rates. The use of such instruments may not offset any, or more than a portion, of the adverse financial effects of unfavorable movements in foreign currency exchange rates. Any losses on these instruments that we experience may adversely impact our financial results, cash flows and financial condition. Further, we hedge a portion of our net investment in Yahoo Japan with currency forward contracts. If the Japanese yen appreciated at maturity beyond the forward contract execution rates, we would be required to settle the contract by making a cash payment which could be material and could adversely impact our cash flows and financial condition. See Part I, Item 3—“Quantitative and Qualitative Disclosures About Market Risk” of this Report.

Our business depends on a strong brand, and failing to maintain or enhance the Yahoo brands in a cost-effective manner could harm our operating results.

Maintaining and enhancing our brands is an important aspect of our efforts to attract and expand our user, advertiser, and Affiliate base. We believe that the importance of brand recognition will increase due to the relatively low barriers to entry in certain portions of the Internet market. Maintaining and enhancing our brands will depend largely on our ability to provide high-quality, innovative products and services, which we might not do successfully. We have spent and expect to spend considerable money and resources on the establishment and maintenance of our brands, as well as 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 such as service outages, product malfunctions, data protection 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 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.

We are regularly involved in claims, suits, government investigations, and other proceedings that may result in adverse outcomes.

We are regularly involved in claims, suits, government investigations, and proceedings arising from the ordinary course of our business, including actions with respect to intellectual property claims, privacy, consumer protection, information security, data protection or law enforcement matters, tax matters, labor and employment claims, commercial claims, as well as actions involving content generated by our users, stockholder derivative actions, purported class action lawsuits, and other matters. Such claims, suits, government investigations, and proceedings are inherently uncertain and their results cannot be predicted with certainty. Regardless of the outcome, such legal proceedings can have an adverse impact on us because of legal costs, diversion of management and other personnel, and other factors. In addition, it is possible that a resolution of one or more such proceedings could result in reputational harm, liability, penalties, or sanctions, as well as judgments, consent decrees, or orders preventing us from offering certain features, functionalities, products, or services, or requiring a change in our business practices, products or technologies, which could in the future materially and adversely affect our business, operating results, and financial condition. See Note 12—“Commitments and Contingencies” in the Notes to our condensed consolidated financial statements.

On May 15, 2013, the Superior Court of Justice for the Federal District of Mexico reversed a judgment of U.S. $2.75 billion that had been entered against us and our subsidiary, Yahoo! Mexico, in a lawsuit brought by plaintiffs Worldwide Directories S.A. de C.V. and Ideas Interactivas, S.A. de C.V. The plaintiffs have appealed. We believe the plaintiffs’ claims are without legal or factual merit. We do not believe that it is probable the judgment will be reinstated on appeal, however we cannot predict the timing of a decision or assure the ultimate outcome of the pending or further appeals. If we are ultimately required to pay all or a significant portion of the judgment, together with any potential additional damages, interests and costs, it would have a material adverse effect on our financial condition, results of operations and cash flows. We will also be required to record an accrual for the judgment if we should determine in the future that it is probable that we will be required to pay the judgment.

 

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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 copyrights, patents, trademarks, trade dress, trade secrets, rights to domain names and other intellectual property assets 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 innovations. In particular, recent amendments to the U.S. patent law may affect our ability to protect our innovations and defend against claims of patent infringement. Further, given the costs of obtaining patent protection, we might choose not to protect (or not to protect in some jurisdictions) certain innovations that later turn out to be important. There is also a risk that the scope of protection under our patents may not be sufficient in some cases or that existing patents may be deemed invalid or unenforceable. To help maintain our trade secrets, we have entered into confidentiality agreements with most of our employees and contractors, and confidentiality agreements with many of the parties with whom we conduct business, in order to limit access to and disclosure of our proprietary information. If these confidentiality agreements are breached it could compromise our trade secrets and cause us to lose any competitive advantage provided by those trade secrets.

If we are unable to protect our proprietary rights from unauthorized use, the value of our intellectual property assets may be reduced. In addition, protecting our intellectual property and other proprietary rights is expensive and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and consequently harm our operating results.

We are, and may in the future be, subject to intellectual property infringement or other third-party claims, which are costly to defend, could result in significant damage awards, and could limit our ability to provide certain content or use certain technologies in the future.

Internet, technology, media, and patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing or purchasing search, indexing, electronic commerce, and other Internet-related technologies, as well as a variety of online business models and methods.

We believe that these parties will continue to take steps such as seeking patent protection to protect these technologies. In addition, patent holding companies may continue to seek to monetize patents they have purchased or otherwise obtained. As a result, disputes regarding the ownership of technologies and rights associated with online businesses are likely to continue to arise in the future. From time to time, parties assert patent infringement claims against us. Currently, we are engaged in a number of lawsuits regarding patent issues and have been notified of a number of other potential disputes.

In addition to patent claims, third parties have asserted, and are likely in the future to assert, claims against us alleging infringement of copyrights, trademark rights, trade secret rights or other proprietary rights, or alleging unfair competition, violation of federal or state statutes or other claims, including alleged violation of international statutory and common law. In addition, third parties have made, and may continue to make, infringement and related claims against us over the display of content or search results triggered by search terms, including the display of advertising, that include trademark terms.

As we expand our business and develop new technologies, products and services, we may become increasingly subject to intellectual property infringement and other claims, including those that may arise under international laws. In the event that there is a determination that we have infringed third-party proprietary rights such as patents, copyrights, trademark rights, trade secret rights, or other third-party rights such as publicity and privacy rights, we could incur substantial monetary liability, or be required to enter into costly royalty or licensing agreements or be prevented from using such rights, which could require us to change our business practices in the future, hinder us from offering certain features, functionalities, products or services, require us to develop non-infringing products or technologies, and limit our ability to compete effectively. We may also incur substantial expenses in defending against third-party claims regardless of the merit of such claims. In addition, many of our agreements with our customers or Affiliates require us to indemnify them for some types of third-party intellectual property infringement claims, which could increase our costs in defending such claims and our damages. Furthermore, such customers and Affiliates may discontinue the use of our products, services, and technologies either as a result of injunctions or otherwise. The occurrence of any of these results could harm our brands or have an adverse effect on our business, financial position, operating results, and cash flows.

 

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A variety of new and existing U.S. and foreign government laws and regulations could subject us to claims, judgments, monetary liabilities and other remedies, and to limitations on our business practices.

We are subject to numerous U.S. and foreign laws and regulations covering a wide variety of subject matters. New laws and regulations, changes in existing laws and regulations or the interpretation of them, our introduction of new products, or an extension of our business into new areas, could increase our future compliance costs, make our products and services less attractive to our users, or cause us to change or limit our business practices. We may incur substantial expenses to comply with laws and regulations or defend against a claim that we have not complied with them. Further, any failure on our part to comply with any relevant laws or regulations may subject us to significant civil or criminal liabilities, penalties, and negative publicity.

The application of existing domestic and international laws and regulations to us relating to issues such as user privacy and data protection, security, defamation, pricing, advertising, taxation, gambling, sweepstakes, promotions, billing, real estate, consumer protection, accessibility, content regulation, quality of services, law enforcement demands, telecommunications, mobile, television, and intellectual property ownership and infringement in many instances is unclear or unsettled. Further, the application to us or our subsidiaries of existing laws regulating or requiring licenses for certain businesses of our advertisers can be unclear. U.S. export control laws and regulations also impose requirements and restrictions on exports to certain nations and persons and on our business. Internationally, we may also be subject to laws regulating our activities in foreign countries and to foreign laws and regulations that are inconsistent from country to country.

The Digital Millennium Copyright Act (“DMCA”) is intended, in part, to limit the liability of eligible online service providers for caching, hosting, listing or linking to, third-party Websites or user content that include materials that give rise to copyright infringement. Portions of the Communications Decency Act (“CDA”) are intended to provide statutory protections to online service providers who distribute third-party content. We rely on the protections provided by both the DMCA and the CDA in conducting our business, and may be adversely impacted by future legislation and future judicial decisions altering these safe harbors or if international jurisdictions refuse to apply similar protections.

The Children’s Online Privacy Protection Act and rule, as amended in December 2012 (“COPPA”), impose restrictions on the ability of online services to collect some types of information from children under the age of 13. In addition, Providing Resources, Officers, and Technology to Eradicate Cyber Threats to Our Children Act of 2008 (“PROTECT”) requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances. COPPA and PROTECT currently impose restrictions and requirements on our business, and other federal, state or international laws and legislative efforts designed to protect children on the Internet may impose additional requirements on us.

Changes in regulations or user concerns regarding privacy and protection of user data, or any failure to comply with such laws, could adversely affect our business.

Federal, state, and international laws and regulations govern the collection, use, retention, disclosure, sharing and security of data that we receive from and about our users. The use of consumer data by online service providers and advertising networks is a topic of active interest among federal, state, and international regulatory bodies, and the regulatory environment is unsettled. Many states have passed laws requiring notification to users where there is a security breach for personal data, such as California’s Information Practices Act. We face similar risks in international markets where our products and services are offered. Any failure, or perceived failure, by us to comply with or make effective modifications to our policies, or to comply with any federal, state, or international privacy, data-retention or data-protection-related laws, regulations, orders or industry self-regulatory principles could result in proceedings or actions against us by governmental entities or others, a loss of user confidence, damage to the Yahoo brands, and a loss of users, advertising partners, or Affiliates, any of which could potentially have an adverse effect on our business.

In addition, various federal, state and foreign legislative or regulatory bodies may enact new or additional laws and regulations concerning privacy, data-retention and data-protection issues, including laws or regulations mandating disclosure to domestic or international law enforcement bodies, which could adversely impact our business, our brand or our reputation with users. For example, some countries are considering laws mandating that user data regarding users in their country be maintained in their country. Having to maintain local data centers in individual countries could increase our operating costs significantly. The interpretation and application of privacy, data protection and data retention laws and regulations are often uncertain and in flux in the U.S. and internationally. These laws may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices, complicating long-range business planning decisions. If privacy, data protection or data retention laws are interpreted and applied in a manner that is inconsistent with our current policies and practices we may be fined or ordered to change our business practices in a manner that adversely impacts our operating results. Complying with these varying international requirements could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business and operating results.

 

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If our security measures are breached, our products and services may be perceived as not being secure, users and customers may curtail or stop using our products and services, and we may incur significant legal and financial exposure.

Our products and services involve the storage and transmission of Yahoo’s users’ and customers’ personal and proprietary information in our facilities and on our equipment, networks and corporate systems. Security breaches expose us to a risk of loss of this information, litigation, remediation costs, increased costs for security measures, loss of revenue, damage to our reputation, and potential liability. Security breaches or unauthorized access have resulted in and may in the future result in a combination of significant legal and financial exposure, increased remediation and other costs, damage to our reputation and a loss of confidence in the security of our products, services and networks that could have an adverse effect on our business. We take steps to prevent unauthorized access to our corporate systems, however, because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently or may be designed to remain dormant until a triggering event, we may be unable to anticipate these techniques or implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose users and customers.

Interruptions, delays, or failures in the provision of our services could damage our reputation and harm our operating results.

Delays or disruptions to our service, or the loss or compromise of data, could result from a variety of causes, including the following:

 

 

Our operations are susceptible to outages and interruptions due to fire, flood, earthquake, tsunami, other natural disasters, power loss, equipment or telecommunications failures, cyber attacks, terrorist attacks, political or social unrest, and other events over which we have little or no control. We do not have multiple site capacity for all of our services and some of our systems are not fully redundant in the event of delays or disruptions to service, so some data or systems may not be fully recoverable after such events.

 

 

The systems through which we provide our products and services are highly technical, complex, and interdependent. Design errors might exist in these systems, or might be introduced when we make modifications, which might cause service malfunctions or require services to be taken offline while corrective responses are developed.

 

 

Despite our implementation of network security measures, our servers are vulnerable to computer viruses, malware, worms, hacking, physical and electronic break-ins, router disruption, sabotage or espionage, and other disruptions from unauthorized access and tampering, as well as coordinated denial-of-service attacks. We may not be in a position to promptly address attacks or to implement adequate preventative measures if we are unable to immediately detect such attacks. Such events could result in large expenditures to investigate or remediate, to recover data, to repair or replace networks or information systems, including changes to security measures, to deploy additional personnel, to defend litigation or to protect against similar future events, and may cause damage to our reputation or loss of revenue.

 

 

We rely on third-party providers over which we have little or no control for our principal Internet connections and co-location of a significant portion of our data servers, as well as for our payment processing capabilities and key components or features of certain of our products and services. Any disruption of the services they provide us or any failure of these third-party providers to handle higher volumes of use could, in turn, cause delays or disruptions in our services and loss of revenue. In addition, if our agreements with these third-party providers are terminated for any reason, we might not have a readily available alternative.

Prolonged delays or disruptions to our service could result in a loss of users, damage to our brands, legal costs or liability, and harm to our operating results.

Our international operations expose us to additional risks that could harm our business, operating results, and financial condition.

In addition to uncertainty about our ability to continue to generate revenue from our foreign operations and expand our international market position, there are additional risks inherent in doing business internationally (including through our international joint ventures), including:

 

 

tariffs, trade barriers, customs classifications and changes in trade regulations;

 

 

difficulties in developing, staffing, and simultaneously managing a large number of varying foreign operations as a result of distance, language, and cultural differences;

 

 

stringent local labor laws and regulations;

 

 

longer payment cycles;

 

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credit risk and higher levels of payment fraud;

 

 

profit repatriation restrictions and foreign currency exchange restrictions;

 

 

political or social unrest, economic instability, repression, or human rights issues;

 

 

geopolitical events, including natural disasters, acts of war and terrorism;

 

 

import or export regulations;

 

 

compliance with U.S. laws such as the Foreign Corrupt Practices Act, and local laws prohibiting bribery and corrupt payments to government officials;

 

 

antitrust and competition regulations;

 

 

potentially adverse tax developments;

 

 

seasonal volatility in business activity and local economic conditions;

 

 

economic uncertainties relating to volatility in emerging markets and global economic uncertainty;

 

 

laws, regulations, licensing requirements, and business practices that favor local competitors or prohibit foreign ownership or investments;

 

 

different, uncertain or more stringent user protection, content, data protection, privacy, intellectual property and other laws; and

 

 

risks related to other government regulation, required compliance with local laws or lack of legal precedent.

We are subject to numerous and sometimes conflicting U.S. and foreign laws and regulations which increase our cost of doing business. Violations of these complex laws and regulations that apply to our international operations could result in damage awards, fines, criminal actions, sanctions, or penalties against us, our officers or our employees, prohibitions on the conduct of our business and our ability to offer products and services, and damage to our reputation. Although we have implemented policies and procedures designed to promote compliance with these laws, there can be no assurance that our employees, contractors, or agents will not violate our policies. These risks inherent in our international operations and expansion increase our costs of doing business internationally and could result in harm to our business, operating results, and financial condition.

We may be subject to legal liability associated with providing online services or content.

We host and provide a wide variety of services and technology products that enable and encourage individuals and businesses to exchange information; upload or otherwise generate photos, videos, text, and other content; advertise products and services; conduct business; and engage in various online activities both domestically and internationally. The law relating to the liability of providers of online services and products for activities of their users is currently unsettled both within the U.S. and internationally. As a publisher and producer of original content, we may be subject to claims such as copyright, libel, defamation or improper use of publicity rights, as well as other infringement claims such as plagiarism. Claims have been threatened and brought against us for defamation, negligence, breaches of contract, plagiarism, copyright and trademark infringement, unfair competition, unlawful activity, tort, including personal injury, fraud, or other theories based on the nature and content of information which we publish or to which we provide links or that may be posted online or generated by us or by third parties, including our users. In addition, we have been and may again in the future be subject to domestic or international actions alleging that certain content we have generated or third-party content that we have made available within our services violates laws in domestic and international jurisdictions. We arrange for the distribution of third-party advertisements to third-party publishers and advertising networks, and we offer third-party products, services, or content, such as stock quotes and trading information, under the Yahoo brand or via distribution on Yahoo Properties. We may be subject to claims concerning these products, services, or content by virtue of our involvement in marketing, branding, broadcasting, or providing access to them, even if we do not ourselves host, operate, provide, or provide access to these products, services, or content. While our agreements with respect to these products, services, and content may provide that we will be indemnified against such liabilities, the ability to receive such indemnification may be disputed, could result in substantial costs to enforce or defend, and depends on the financial resources of the other party to the agreement, and any amounts received might not be adequate to cover our liabilities or the costs associated with defense of such proceedings. Defense of any such actions could be costly and involve significant time and attention of our management and other resources, may result in monetary liabilities or penalties, and may require us to change our business in an adverse manner.

 

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It is also possible that if any information provided directly by us contains errors or is otherwise wrongfully provided to users, third parties could make claims against us. For example, we offer Web-based e-mail services, which expose us to potential risks, such as liabilities or claims, by our users and third parties, resulting from unsolicited e-mail, lost or misdirected messages, illegal or fraudulent use of e-mail, alleged violations of policies, property interests, or privacy protections, including civil or criminal laws, or interruptions or delays in e-mail service. We may also face purported consumer class actions or state actions relating to our online services, including our fee-based services (particularly in connection with any decision to discontinue a fee-based service). In addition, our customers, third parties, or government entities may assert claims or actions against us if our online services or technologies are used to spread or facilitate malicious or harmful code or applications.

Investigating and defending these types of claims are expensive, even if the claims are without merit or do not ultimately result in liability, and could subject us to significant monetary liability or cause a change in business practices that could negatively impact our ability to compete.

If we are unable to recruit, hire, motivate, 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 are located; fluctuations in global economic and industry conditions; competitors’ hiring practices; and the effectiveness of our compensation programs. If we do not succeed in retaining and motivating our existing 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.

Certain of our metrics are subject to inherent challenges in measurement, and real or perceived inaccuracies in such metrics may harm our reputation and negatively affect our business.

We present key metrics such as number of users, number of Ads Sold, number of Paid Clicks, Price-per-Click and Price-per-Ad that are calculated using internal company data. We periodically review, refine, and update our methodologies for monitoring, gathering, and calculating these metrics. Based on this process, from time to time we update our methodologies.

While our metrics are based on what we believe to be reasonable measurements and methodologies, there are inherent challenges in deriving our metrics across large online and mobile populations around the world. In addition, our user metrics may differ from estimates published by third parties or from similar metrics of our competitors due to differences in methodology.

If advertisers or publishers do not perceive our metrics to be accurate, or if we discover material inaccuracies in our metrics, it could negatively affect our reputation, business and financial results.

Any failure to scale and adapt our existing technology architecture to manage expansion of user-facing services and to respond to rapid technological change could adversely affect our business.

As some of the most visited sites on the Internet, Yahoo Properties deliver a significant number of products, services, page views, and advertising impressions to users around the world. We expect our products and services to continue to expand and change significantly and rapidly in the future to accommodate new technologies, new devices, new Internet advertising solutions, and new means of content delivery.

In addition, widespread adoption of new Internet, networking or telecommunications technologies, or other technological changes, could require substantial expenditures to modify or adapt our services or infrastructure. The technology architectures and platforms utilized for our services are highly complex and may not provide satisfactory security features or support in the future, as usage increases and products and services expand, change, and become more complex. In the future, we may make additional changes to our existing, or move to completely new, architectures, platforms and systems, such as the changes we have made in response to the increased use of tablets and smartphones. Such changes may be technologically challenging to develop and implement, may take time to test and deploy, may cause us to incur substantial costs or data loss, and may cause changes, delays or interruptions in service. These changes, delays, or interruptions in our service may cause our users, Affiliates and other advertising platform participants to become dissatisfied with our service or to move to competing providers or seek remedial actions or compensation. Further, to the extent that demands for our services increase, we will need to expand our infrastructure, including the capacity of our hardware servers and the sophistication of our software. This expansion is likely to be expensive and complex and require additional technical expertise. As we acquire users who rely upon us for a wide variety of services, it becomes more technologically complex and costly to retrieve, store, and integrate data that will enable us to track each user’s preferences. Any difficulties experienced in adapting our architectures, platforms and infrastructure to accommodate increased traffic, to store user data, and track user preferences, together with the associated costs and potential loss of traffic, could harm our operating results, cash flows from operations, and financial condition.

 

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We rely on third parties to provide the technologies necessary to deliver content, advertising, and services to our users, and any change in the licensing terms, costs, availability, or acceptance of these formats and technologies could adversely affect our business.

We rely on third parties to provide the technologies that we use to deliver content, advertising, and services to our users. There can be no assurance that these providers will continue to license their technologies or intellectual property to us on reasonable terms, or at all. Providers may change the fees they charge users or otherwise change their business model in a manner that slows the widespread acceptance of their technologies. In order for our services to be successful, there must be a large base of users of the technologies necessary to deliver our content, advertising, and services. We have limited or no control over the availability or acceptance of those technologies, and any change in the licensing terms, costs, availability, or user acceptance of these technologies could adversely affect our business.

Our business depends on continued and unimpeded access to the Internet by us and our users. Internet access providers may be able to block, degrade, or charge for access to certain of our products and services, which could lead to additional expenses and the loss of users and advertisers.

Our products and services depend on the ability of our users to access the Internet, and certain of our products require significant bandwidth to work effectively. Currently, this access is provided by companies that have significant market power in the broadband and internet access marketplace, including incumbent telephone companies, cable companies, mobile communications companies, and government-owned service providers. Some of these providers have taken, or have stated that they may take, measures that could degrade, disrupt, or increase the cost of user access to certain of our products by restricting or prohibiting the use of their infrastructure to support or facilitate our offerings, or by charging increased fees to us or our users to provide our offerings. Such interference could result in a loss of existing users and advertisers, and increased costs, and could impair our ability to attract new users and advertisers, thereby harming our revenues and growth.

If we are unable to attract, sustain, and renew distribution arrangements on favorable terms, our revenue may decline.

We enter into distribution arrangements with third parties such as operators of third-party Websites, online networks, software companies, electronics companies, computer manufacturers, Internet service providers and others to promote or supply our services to their users. For example:

 

 

We maintain search and display advertising relationships with Affiliate sites, which integrate our advertising offerings into their Websites.

 

 

We enter into distribution alliances with Internet service providers (including providers of cable and broadband Internet access) and software distributors to promote our services to their users.

 

 

We enter into agreements with mobile phone, tablet, television, and other device manufacturers, electronics companies and carriers to promote our software and services on their devices.

In some markets, we depend on a limited number of distribution arrangements for a significant percentage of our user activity. A failure by our distributors to attract or retain their user bases would negatively impact our user activity and, in turn, reduce our revenue. In some cases, device manufacturers may be unwilling to pay fees to Yahoo in order to distribute Yahoo services or may be unwilling to distribute Yahoo services.

In the future, as new methods for accessing the Internet and our services become available, including through alternative devices, we may need to enter into amended distribution agreements with existing access providers, distributors, and manufacturers to cover the new devices and new arrangements. We face a risk that existing and potential new access providers, distributors, and manufacturers may decide not to offer distribution of our services on reasonable terms, or at all.

Distribution agreements often involve revenue sharing. Over time competition to enter into distribution arrangements may cause our traffic acquisition costs to increase. In some cases, we guarantee distributors a minimum level of revenue and, as a result, run a risk that the distributors’ performance (in terms of ad impressions, toolbar installations, etc.) might not be sufficient to otherwise earn their minimum payments. In other cases, we agree that if the distributor does not realize specified minimum revenue we will adjust the distributor’s revenue-share percentage or provide make-whole arrangements.

Some of our distribution agreements are not exclusive, have a short term, are terminable at will, or are subject to early termination provisions. The loss of distributors, increased distribution costs, or the renewal of distribution agreements on significantly less favorable terms may cause our revenue to decline.

 

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Technologies, tools, software, and applications could block our advertisements, impair our ability to deliver interest-based advertising, or shift the location in which advertising appears, which could harm our operating results.

Technologies, tools, software, and applications (including new and enhanced Web browsers) have been developed and are likely to continue to be developed that can block or allow users to opt out of display, search, and interest-based advertising and content, delete or block the cookies used to deliver such advertising, or shift the location in which advertising appears on pages so that our advertisements do not show up in the most monetizable places on our pages or are obscured. Most of our revenue is derived from fees paid by advertisers in connection with the display of graphical and non-graphical advertisements or clicks on search advertisements on Web pages. As a result, the adoption of such technologies, tools, software, and applications could reduce the number of display and search advertisements that we are able to deliver and/or our ability to deliver interest-based advertising and this, in turn, could reduce our advertising revenue and operating results.

Any failure to manage expansion and changes to our business could adversely affect our operating results.

If we are unable to effectively manage a large and geographically dispersed group of employees or to anticipate our future growth and personnel needs, our business may be adversely affected. As we expand our business, we must also expand and adapt our operational infrastructure. Our business relies on data systems, billing systems, and financial reporting and control systems, among others. All of these systems have become increasingly complex in the recent past due to the growing complexity of our business, acquisitions of new businesses with different systems, and increased regulation over controls and procedures. To manage our business in a cost-effective manner, we will need to continue to upgrade and improve our data systems, billing systems, and other operational and financial systems, procedures, and controls. In some cases, we are outsourcing administrative functions to lower-cost providers. These upgrades, improvements and outsourcing changes will require a dedication of resources and in some cases are likely to be complex. If we are unable to adapt our systems and put adequate controls in place in a timely manner, our business may be adversely affected. In particular, sustained failures of our billing systems to accommodate increasing numbers of transactions, to accurately bill users and advertisers, or to accurately compensate Affiliates could adversely affect the viability of our business model.

Proprietary document formats may limit the effectiveness of our search technology by preventing our technology from accessing the content of documents in such formats, which could limit the effectiveness of our products and services.

A large amount of information on the Internet is provided in proprietary document formats. These proprietary document formats may limit the effectiveness of search technology by preventing the technology from accessing the content of such documents. The providers of the software applications used to create these documents could engineer the document format to prevent or interfere with the process of indexing the document contents with search technology. This would mean that the document contents would not be included in search results even if the contents were directly relevant to a search. The software providers may also seek to require us to pay them royalties in exchange for giving us the ability to search documents in their format. If the search platform technology we employ is unable to index proprietary format Web documents as effectively as our competitors’ technology, usage of our search services might decline, which could cause our revenue to fall.

We have dedicated resources to provide a variety of premium enhancements to our products and services, which might not prove to be successful in generating significant revenue for us.

We offer fee-based enhancements for many of our free services. The development cycles for these technologies are long and generally require investment by us. We have invested and will continue to invest in premium products and services. Some of these premium products and services might not generate anticipated revenue or might not meet anticipated user adoption rates. We have previously discontinued some non-profitable premium services and may discontinue others. General economic conditions as well as the rapidly evolving competitive landscape may affect users’ willingness to pay for such premium services. If we cannot generate revenue from our premium services that are greater than the cost of providing such services, our operating results could be harmed.

We may have exposure to additional tax liabilities which could negatively impact our income tax provision, net income, and cash flow.

We are subject to income taxes and other taxes in both the U.S. and the foreign jurisdictions in which we currently operate or have historically operated. The determination of our worldwide provision for income taxes and current and deferred tax assets and liabilities requires judgment and estimation. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. As a U.S. multinational corporation, we are subject to changing tax laws both within and outside of the U.S. We cannot predict the form or timing of potential legislative changes, but any newly enacted tax law could have a material adverse impact on our tax expense and cash flow. For example, several jurisdictions have sought to increase revenues by imposing new taxes on internet advertising or increasing general business taxes.

We earn a material amount of our income from outside the U.S. As of June 30, 2014, we had undistributed foreign earnings of approximately $2.9 billion, principally related to our equity method investment in Yahoo Japan. While we do not currently anticipate repatriating these earnings, any repatriation of funds in foreign jurisdictions to the U.S. could result in higher effective tax rates for us and subject us to significant additional U.S. income tax liabilities.

 

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We are subject to regular review and audit by both domestic and foreign tax authorities as well as subject to the prospective and retrospective effects of changing tax regulations and legislation. Although we believe our tax estimates are reasonable, the ultimate tax outcome may materially differ from the tax amounts recorded in our condensed consolidated financial statements and may materially affect our income tax provision, net income, or cash flows in the period or periods for which such determination and settlement is made.

Adverse macroeconomic conditions 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 macroeconomic conditions have caused, and future adverse macroeconomic conditions could cause, decreases or delays in advertising spending and negatively impact our advertising revenue and 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 adverse macroeconomic conditions, could negatively impact our results of operations.

Our stock price has been volatile historically and may continue to be volatile regardless of our operating performance.

The trading price of our common stock has been and may continue to be subject to broad fluctuations. During the three months ended June 30, 2014, the closing sale price of our common stock on the NASDAQ Global Select Market ranged from $32.87 to $36.94 per share and the closing sale price on July 31, 2014 was $35.81 per share. Our stock price may fluctuate in response to a number of events and factors, such as variations in quarterly operating results or announcements of technological innovations, significant transactions, or new features, products or services by us or our competitors; changes in financial estimates and recommendations by securities analysts; the operating and stock price performance of, or other developments involving, other companies that investors may deem comparable to us; trends in our industry; general economic conditions; and the current and anticipated future operating performance and market equity valuation of Alibaba Group (including speculation regarding its initial public offering) and Yahoo Japan Corporation in which we have equity investments, including changes in equity valuation due to fluctuations in foreign currency exchange rates.

In addition, the stock market in general, and the market prices for companies in our industry, have experienced volatility that often has been unrelated to operating performance. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance. A decrease in the market price of our common stock would likely adversely impact the trading price of the Notes we issued in November 2013. Volatility or a lack of positive performance in our stock price may also adversely affect our ability to retain key employees who have been granted stock options or other stock-based awards. A sustained decline in our stock price and market capitalization could lead to an impairment charge to our long-lived assets.

Delaware statutes and certain provisions in our charter documents could make it more difficult for a third-party to acquire us.

Our Board has the authority to issue up to 10 million shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of our common stock may be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock may have the effect of delaying, deterring or preventing a change in control of Yahoo without further action by the stockholders and may adversely affect the voting and other rights of the holders of our common stock.

Some provisions of our charter documents, including provisions eliminating the ability of stockholders to take action by written consent and limiting the ability of stockholders to raise matters at a meeting of stockholders without giving advance notice, may have the effect of delaying or preventing changes in control or changes in our management, which could have an adverse effect on the market price of our stock and the value of the $1.4375 billion aggregate principal amount of the Notes we issued in November 2013. In addition, our charter documents do not permit cumulative voting, which may make it more difficult for a third-party to gain control of our Board. Further, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit us from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, even if such combination is favored by a majority of stockholders, unless the business combination is approved in a prescribed manner. The application of Section 203 also could have the effect of delaying or preventing a change in control of us.

Any of these provisions could, under certain circumstances, depress the market price of our common stock and the Notes.

 

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Risks Relating to the Notes

The conditional conversion feature of the Notes, if triggered, may adversely affect our financial condition and operating results.

In the event the conditional conversion feature of the Notes is triggered, holders of Notes will be entitled to convert the Notes at any time during specified periods at their option. If one or more holders elect to convert their Notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share), we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity. In addition, even if holders do not elect to convert their Notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the Notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.

We may not have the ability to raise the funds necessary to settle conversions of the Notes in cash or to repurchase the Notes upon a fundamental change, and our future debt may contain limitations on our ability to pay cash upon conversion or repurchase of the Notes.

Holders of the Notes will have the right to require us to repurchase all or a portion of their Notes upon the occurrence of a fundamental change at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid special interest, if any. We may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of Notes surrendered therefore, or pay cash with respect to Notes being converted if we elect not to issue shares, which could harm our reputation and affect the trading price of our common stock.

The note hedge and warrant transactions may affect the value of the Notes and our common stock.

In connection with the pricing of the Notes, we entered into note hedge transactions with the option counterparties. The note hedge transactions are generally expected to reduce the potential dilution upon conversion of the Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Notes, as the case may be. We also entered into warrant transactions with the option counterparties. However, the warrant transactions could separately have a dilutive effect to the extent that the market price per share of our common stock exceeds the applicable strike price of the warrants.

In connection with establishing their initial hedge of the note hedge and warrant transactions, the option counterparties or their respective affiliates have purchased shares of our common stock and/or entered into various derivative transactions with respect to our common stock concurrently with or shortly after the pricing of the Notes. In addition, the option counterparties or their respective affiliates may modify their hedge positions by entering into or unwinding various derivatives with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions prior to the maturity of the Notes (and are likely to do so during any observation period related to a conversion of Notes or following any repurchase of Notes by us on any fundamental repurchase date or otherwise). This activity could cause or avoid an increase or a decrease in the market price of our common stock or the Notes.

Any adverse change in the rating of the Notes may cause their trading price to decline.

While we did not seek a rating on the Notes, one rating service has rated the Notes. If that rating service announces its intention to put the Notes on credit watch or lowers its rating on the Notes below any rating initially assigned to the Notes, the trading price of the Notes could decline.

The accounting method for convertible debt securities that may be settled in cash, such as the Notes, could have a material effect on our reported financial results.

In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement), which has subsequently been codified as Accounting Standards Codification (“ASC”) 470-20, Debt with Conversion and Other Options, which we refer to as ASC 470-20. Under ASC 470-20, an entity must separately account for the liability and equity components of the convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the Notes is that the equity component is required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet, and the value of the equity component would be treated as debt discount for purposes of accounting for the debt component of the Notes. As a result, we will be required to record a greater amount of non-cash interest expense in current periods presented as a result of the amortization of the discounted carrying value of the Notes to their face amount over the term of the Notes. We will report lower net income in our financial results because ASC 470-20 will require interest to include the current period’s amortization of the debt discount, which could adversely affect our reported or future financial results, the trading price of our common stock and the trading price of the Notes.

 

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In addition, under certain circumstances, convertible debt instruments (such as the Notes) that may be settled entirely or partly in cash are currently accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of the Notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of the Notes exceeds their principal amount. Under the treasury stock method, for diluted earnings per share purposes, the transaction is accounted for as if the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, are issued. We cannot be sure that the accounting standards in the future will continue to permit the use of the treasury stock method. If we are unable to use the treasury stock method in accounting for the shares issuable upon conversion of the Notes, then our diluted earnings per share would be adversely affected.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Repurchases of Equity Securities

Share repurchase activity during the three months ended June 30, 2014 was as follows:

 

Period

   Total
Number
of Shares
Purchased (*)
     Average
Price Paid
per Share
     Total
Number of
Shares
Purchased
as Part of a
Publicly
Announced
Program
     Approximate Dollar
Value of Shares
that May Yet be
Purchased Under
the Program
(in 000s) (*)
 

April 1 — April 30, 2014

     6,723,455       $ 35.36         6,723,455       $ 4,405,765   

May 1 — May 31, 2014

     9,392,496       $ 34.70         9,392,496       $ 4,079,865   

June 1 — June 30, 2014

     4,454,449       $ 34.79         4,454,449       $ 3,924,904   
  

 

 

       

 

 

    

Total

     20,570,400       $ 34.94         20,570,400      
  

 

 

       

 

 

    

 

(*) 

The share repurchases in the three months ended June 30, 2014 were made under our stock repurchase program announced in November 2013, which authorizes the repurchase of up to $5 billion of our outstanding shares of common stock. This program, according to its terms, will expire in December 2016. Repurchases under this program may take place in open market or privately negotiated transactions, including derivative transactions, and may be made under a Rule 10b5-1 plan.

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

None.

 

Item 6. Exhibits

The exhibits listed in the Index to Exhibits (following the signatures page of this Report) are filed with, or incorporated by reference in, this Report.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

        YAHOO! INC.
Dated: August 7, 2014     By:    /s/    MARISSA A. MAYER
     

Marissa A. Mayer

Chief Executive Officer

(Principal Executive Officer)

   

Dated: August 7, 2014

    By:    /S/    KEN GOLDMAN
     

Ken Goldman

Chief Financial Officer

(Principal Financial Officer)

 

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YAHOO! INC.

Index to Exhibits

 

Exhibit

Number

 

Description

  2.4   Third Amendment to Share Repurchase and Preference Share Sale Agreement, by and among Alibaba Group Holding Limited, Yahoo! Inc., and Yahoo! Hong Kong Holdings Limited, dated as of July 14, 2014 (previously filed as Exhibit 2.4 to the Registrant’s Current Report on Form 8-K filed July 15, 2014 and incorporated herein by reference).
  3.1(A)   Amended and Restated Certificate of Incorporation of the Registrant (previously filed as Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q filed July 28, 2000 and incorporated herein by reference).
  3.1(B)   Certificate of Designation, Preferences and Rights of Series A Junior Participating Preferred Stock of the Registrant (included as Exhibit A within the Amended and Restated Rights Agreement, dated as of April 1, 2005, by and between the Registrant and Equiserve Trust Company, N.A., as rights agent (previously filed as Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed April 4, 2005 and incorporated herein by reference)).
  3.2   Amended and Restated Bylaws of the Registrant (previously filed as Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed June 27, 2014 and incorporated herein by reference).
10.2(A)+   Yahoo! Inc. Stock Plan, as amended and restated on April 8, 2014 (and effective June 25, 2014) (previously referred to as the “1995 Stock Plan” and filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed June 27, 2014 and incorporated herein by reference).
10.15(D)   Second Amendment to the Alipay Framework Agreement, dated as of May 3, 2014, by and among the Registrant, Alibaba Group Holding Limited, Softbank Corp., Alipay.com Co., Ltd., APN Ltd., Zhejiang Alibaba E-Commerce Co., Ltd., Jack Ma Yun, Joseph C. Tsai and certain joinder parties (previously filed as Exhibit 10.15(D) to the Registrant’s Quarterly Report filed May 8, 2014 and incorporated herein by reference).
10.17(K)+   Letter Amendment, dated April 14, 2014, to Performance Stock Option Agreement (Retention Grant), between the Registrant and Marissa A. Mayer (previously filed as Exhibit 10.17(K) to the Registrant’s Quarterly Report filed May 8, 2014 and incorporated herein by reference).
10.17(L)+   Letter Amendment, dated April 14, 2014, to Performance Stock Option Agreement (2012 Annual Grant), between the Registrant and Marissa A. Mayer (previously filed as Exhibit 10.17(L) to the Registrant’s Quarterly Report filed May 8, 2014 and incorporated herein by reference).
10.18(C)+   Letter Amendment, dated April 14, 2014, to Performance Stock Option Agreement, between the Registrant and Ken Goldman (previously filed as Exhibit 10.18(C) to the Registrant’s Quarterly Report filed May 8, 2014 and incorporated herein by reference).
31.1*   Certificate of Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 7, 2014.
31.2*   Certificate of Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated August 7, 2014.
32**   Certificate of Chief Executive Officer and Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14(b) and 15d-14(b) and 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated August 7, 2014.
101.INS*   XBRL Instance
101.SCH*   XBRL Taxonomy Extension Schema
101.CAL*   XBRL Taxonomy Extension Calculation
101.DEF*   XBRL Taxonomy Extension Definition
101.LAB*   XBRL Taxonomy Extension Labels
101.PRE*   XBRL Taxonomy Extension Presentation

 

* Filed herewith.
** Furnished herewith.
+ Indicates a management contract or compensatory plan or arrangement.

 

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