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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