XMEX:YHOO Yahoo! Inc Quarterly Report 10-Q Filing - 6/30/2012

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

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

For the quarterly period ended June 30, 2012

Or

 

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

For the transition period from              to             

Commission file number 000-28018

 

 

Yahoo! Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware		77-0398689
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

701 First Avenue

Sunnyvale, California 94089

(Address of principal executive offices, including zip code)

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

 

 

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

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

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

 

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

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

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

 

Class		Outstanding at July 31, 2012
Common Stock, $0.001 par value		1,184,617,827

 

 

 

---

Table of Contents

YAHOO! INC.

Table of Contents

 

PART I		FINANCIAL INFORMATION			3
Item 1.		Condensed Consolidated Financial Statements (unaudited)			3
		Condensed Consolidated Statements of Income for the three and six months ended June 30, 2011 and 2012			3
		Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2011 and 2012			4
		Condensed Consolidated Balance Sheets as of December 31, 2011 and June 30, 2012			5
		Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2012			6
		Notes to Condensed Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			37
Item 4.		Controls and Procedures			38
PART II		OTHER INFORMATION			39
Item 1.		Legal Proceedings			39
Item 1A.		Risk Factors			39
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			52
Item 3.		Defaults Upon Senior Securities			52
Item 4.		Mine Safety Disclosures			52
Item 5.		Other Information			52
Item 6.		Exhibits			52
		Signatures			53

 

2

---

Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1.

Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Statements of Income

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
		(Unaudited, in thousands except per share amounts)
Revenue		$	1,229,024			$	1,217,794			$	2,443,381			$	2,439,027
Operating expenses:
Cost of revenue — Traffic acquisition costs			152,896				137,025				302,927				281,116
Cost of revenue — Other			231,388				278,453				481,014				532,432
Sales and marketing			280,159				272,910				542,308				558,178
Product development			233,045				199,628				454,328				428,106
General and administrative			131,822				136,117				254,720				260,388
Amortization of intangibles			8,582				9,756				16,632				19,809
Restructuring charges, net			237				129,092				10,812				134,809
Total operating expenses			1,038,129				1,162,981				2,062,741				2,214,838
Income from operations			190,895				54,813				380,640				224,189
Other (expense) income, net			(5,666	)			20,175				(639	)			22,453
Income before income taxes and earnings in equity interests			185,229				74,988				380,001				246,642
Provision for income taxes			(55,629	)			(26,523	)			(107,749	)			(82,942	)
Earnings in equity interests			108,902				179,991				191,082				352,234
Net income			238,502				228,456				463,334				515,934
Less: net income attributable to noncontrolling interests			(1,530	)			(1,825	)			(3,370	)			(2,960	)
Net income attributable to Yahoo! Inc.		$	236,972			$	226,631			$	459,964			$	512,974
Net income attributable to Yahoo! Inc. common stockholders per share — basic		$	0.18			$	0.19			$	0.35			$	0.42
Net income attributable to Yahoo! Inc. common stockholders per share — diluted		$	0.18			$	0.18			$	0.35			$	0.42
Shares used in per share calculation — basic			1,299,947				1,213,320				1,304,505				1,214,551
Shares used in per share calculation — diluted			1,308,359				1,221,719				1,314,272				1,224,102
Stock-based compensation expense by function:
Cost of revenue — Other		$	875			$	2,614			$	1,523			$	5,508
Sales and marketing		$	19,373			$	18,981			$	26,070			$	40,078
Product development		$	25,531			$	17,808			$	43,203			$	37,279
General and administrative		$	13,269			$	10,168			$	23,368			$	22,672
Restructuring expense reversals		$	(526	)		$	(3,429	)		$	(1,278	)		$	(3,429	)

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

 

3

---

Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Comprehensive Income

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
		(Unaudited, in thousands)
Net Income		$	238,502			$	228,456			$	463,334			$	515,934
Other comprehensive income:
Unrealized gains (losses) on available-for-sale securities, net of taxes of $(1,002) and $106 for the three months ended June 30, 2011 and 2012, respectively, and $(803) and $206 for the six months ended June 30, 2011 and 2012, respectively			(1,466	)			6,143				2,772				5,680
Reclassification adjustment for realized (gains) losses included in net income, net of taxes of $158 and $(932) for the three months ended June 30, 2011 and 2012, respectively, and $1,813 and $(5,356) for the six months ended June 30, 2011 and 2012, respectively			(237	)			1,630				(2,996	)			9,358
Net change in unrealized gains (losses) on available-for-sale securities, net of taxes			(1,703	)			7,773				(224	)			15,038
Foreign currency translation adjustment			42,460				(231,371	)			171,845				(221,137	)
Total other comprehensive income, net of tax			40,757				(223,598	)			171,621				(206,099	)
Comprehensive income			279,259				4,858				634,955				309,835
Less: comprehensive income attributable to noncontrolling interests			(1,530	)			(1,825	)			(3,370	)			(2,960	)
Comprehensive income attributable to Yahoo! Inc.		$	277,729			$	3,033			$	631,585			$	306,875

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

 

4

---

Table of Contents

YAHOO! INC.

Condensed Consolidated Balance Sheets

 

		December 31, 2011				June 30, 2012
		(Unaudited, in thousands except par values)
ASSETS
Current assets:
Cash and cash equivalents		$	1,562,390			$	1,539,269
Short-term marketable debt securities			493,189				371,204
Accounts receivable, net			1,037,474				1,040,893
Prepaid expenses and other current assets			359,483				318,932
Total current assets			3,452,536				3,270,298
Long-term marketable debt securities			474,338				490,570
Property and equipment, net			1,730,888				1,663,665
Goodwill			3,900,752				3,887,360
Intangible assets, net			254,600				196,729
Other long-term assets			220,628				209,669
Investments in equity interests			4,749,044				4,939,938
Total assets		$	14,782,786			$	14,658,229
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable		$	166,595			$	132,105
Accrued expenses and other current liabilities			846,044				768,080
Deferred revenue			194,722				176,960
Total current liabilities			1,207,361				1,077,145
Long-term deferred revenue			43,639				38,757
Capital lease and other long-term liabilities			134,905				130,149
Deferred and other long-term tax liabilities, net			815,534				895,941
Total liabilities			2,201,439				2,141,992
Commitments and contingencies (Note 11)			—				—
Yahoo! Inc. stockholders’ equity:
Common stock, $0.001 par value; 5,000,000 shares authorized; 1,244,956 shares issued and 1,217,481 shares outstanding as of December 31, 2011 and 1,255,870 shares issued and 1,194,147 shares outstanding as of June 30, 2012			1,242				1,253
Additional paid-in capital			9,825,899				9,976,949
Treasury stock at cost, 27,475 shares as of December 31, 2011 and 61,723 shares as of June 30, 2012			(416,237	)			(942,244	)
Retained earnings			2,432,294				2,945,269
Accumulated other comprehensive income			697,869				491,770
Total Yahoo! Inc. stockholders’ equity			12,541,067				12,472,997
Noncontrolling interests			40,280				43,240
Total equity			12,581,347				12,516,237
Total liabilities and equity		$	14,782,786			$	14,658,229

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

 

5

---

Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

 

		Six Months Ended
		June 30, 2011				June 30, 2012
		(Unaudited, in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	463,334			$	515,934
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			275,901				254,539
Amortization of intangible assets			58,993				60,209
Stock-based compensation expense, net			92,886				102,108
Noncash restructuring charges, net			—				38,638
Tax benefits from stock-based awards			12,483				(3,935	)
Excess tax benefits from stock-based awards			(30,225	)			(16,770	)
Deferred income taxes			45,831				(18,474	)
Earnings in equity interests			(191,082	)			(352,234	)
Dividends received from equity investee			75,391				83,648
Gain from sales of investments, assets, and other, net			22,792				(24,507	)
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable, net			86,692				(9,908	)
Prepaid expenses and other			53,293				16,563
Accounts payable			(10,821	)			(35,714	)
Accrued expenses and other liabilities			(386,044	)			(15,755	)
Deferred revenue			(33,118	)			(22,329	)
Net cash provided by operating activities			536,306				572,013
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment, net			(339,064	)			(215,922	)
Purchases of marketable debt securities			(1,124,596	)			(645,266	)
Proceeds from sales of marketable debt securities			882,229				548,439
Proceeds from maturities of marketable debt securities			657,916				198,498
Proceeds from the sale of investments			—				26,132
Acquisitions, net of cash acquired			(68,812	)			—
Purchases of intangible assets			(10,960	)			(3,088	)
Other investing activities, net			149				(9,421	)
Net cash used in investing activities			(3,138	)			(100,628	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net			98,547				77,871
Repurchases of common stock			(609,019	)			(526,007	)
Excess tax benefits from stock-based awards			30,225				16,770
Tax withholdings related to net share settlements of restricted stock awards and restricted stock units			(33,669	)			(38,494	)
Other financing activities, net			(7,521	)			(2,222	)
Net cash used in financing activities			(521,437	)			(472,082	)
Effect of exchange rate changes on cash and cash equivalents			42,679				(22,424	)
Net change in cash and cash equivalents			54,410				(23,121	)
Cash and cash equivalents at beginning of period			1,526,427				1,562,390
Cash and cash equivalents at end of period		$	1,580,837			$	1,539,269

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

 

6

---

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

Basis of Presentation. The condensed consolidated financial statements include the accounts of Yahoo! Inc. and its majority-owned or otherwise controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in entities in which the Company can exercise significant influence, but does not own a majority equity interest or otherwise control, are accounted for using the equity method and are included as investments in equity interests on the condensed consolidated balance sheets. The Company has included the results of operations of acquired companies from the date of the acquisition. Certain prior period amounts have been reclassified to conform to the current period presentation. To conform to the current period presentation, the Company corrected the classification of $13 million and $35 million of costs principally included in product development expenses to cost of revenue—other for the three and six months ended June 30, 2011, respectively.

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

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

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. The condensed consolidated balance sheet as of December 31, 2011 was derived from the Company’s audited financial statements for the year ended December 31, 2011, but does not include all disclosures required by U.S. GAAP. However, the Company believes the disclosures are adequate to make the information presented not misleading.

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

Basic and diluted net income attributable to Yahoo! common stockholders per share is computed using the weighted average number of common shares outstanding during the period, excluding net income attributable to participating securities (restricted stock awards granted under the Company’s 1995 Stock Plan and restricted stock units granted under the 1996 Directors’ Stock Plan (the “Directors’ Plan”)). Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares are calculated using the treasury stock method and consist of unvested restricted stock and shares underlying unvested restricted stock units, the incremental common shares issuable upon the exercise of stock options, and shares to be purchased under the 1996 Employee Stock Purchase Plan (the “Employee Stock Purchase Plan”). The Company calculates potential tax windfalls and shortfalls by including the impact of pro forma deferred tax assets.

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

Potentially dilutive securities representing approximately 47 million and 48 million shares of common stock for the three and six months ended June 30, 2012, respectively, and 59 million shares of common stock for both the three and six months ended June 30, 2011 were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive.

 

7

---

Table of Contents

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

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Basic:
Numerator:
Net income attributable to Yahoo! Inc.		$	236,972			$	226,631			$	459,964			$	512,974
Less: Net income allocated to participating securities			(3	)			(3	)			(8	)			(12	)
Net income attributable to Yahoo! Inc. common stockholders — basic		$	236,969			$	226,628			$	459,956			$	512,962
Denominator:
Weighted average common shares			1,299,947				1,213,320				1,304,505				1,214,551
Net income attributable to Yahoo! Inc. common stockholders per share — basic		$	0.18			$	0.19			$	0.35			$	0.42
Diluted:
Numerator:
Net income attributable to Yahoo! Inc.		$	236,972			$	226,631			$	459,964			$	512,974
Less: Net income allocated to participating securities			(3	)			(3	)			(8	)			(12	)
Less: Effect of dilutive securities issued by equity investees			(654	)			(1,246	)			(1,302	)			(2,512	)
Net income attributable to Yahoo! Inc. common stockholders — diluted		$	236,315			$	225,382			$	458,654			$	510,450
Denominator:
Denominator for basic calculation			1,299,947				1,213,320				1,304,505				1,214,551
Weighted average effect of Yahoo! Inc. dilutive securities:
Restricted stock and restricted stock units			5,391				6,756				6,485				7,871
Stock options and employee stock purchase plan			3,021				1,643				3,282				1,680
Denominator for diluted calculation			1,308,359				1,221,719				1,314,272				1,224,102
Net income attributable to Yahoo! Inc. common stockholders per share — diluted		$	0.18			$	0.18			$	0.35			$	0.42

Note 3 ACQUISITIONS

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

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

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

Note 4 INVESTMENTS IN EQUITY INTERESTS

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

 

		December 31, 2011				June 30, 2012				Percent Ownership of Common Stock as of June 30, 2012
Alibaba Group		$	2,521,825			$	2,754,578				42	%
Yahoo Japan			2,219,946				2,175,135				35	%
Other			7,273				10,225				26	%
Total		$	4,749,044			$	4,939,938

 

8

---

Table of Contents

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

As of June 30, 2012, the difference between the Company’s carrying value of its investment in Alibaba Group and its proportionate share of the net assets of Alibaba Group is summarized as follows (in thousands):

 

Carrying value of investment in Alibaba Group		$	2,754,578
Proportionate share of Alibaba Group stockholders’ equity			2,099,467
Excess of carrying value of investment over proportionate share of Alibaba Group’s stockholders’ equity(*)		$	655,111

 

(*)	The excess carrying value has been primarily assigned to goodwill.

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

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

 

		Three Months Ended								Six Months Ended
		March 31, 2011				March 31, 2012				March 31, 2011				March 31, 2012
Operating data:
Revenue		$	490,933			$	805,900			$	1,035,447			$	1,828,707
Gross profit		$	324,342			$	530,537			$	687,309			$	1,227,376
Income from operations		$	47,159			$	213,262			$	73,251			$	489,921
Net income		$	51,629			$	235,208			$	96,634			$	488,773
Net income attributable to Alibaba Group		$	29,623			$	220,483			$	61,943			$	457,395
										September 30, 2011				March 31, 2012
Balance sheet data:
Current assets										$	3,491,753			$	4,491,012
Long-term assets										$	2,993,329			$	3,004,320
Current liabilities										$	1,562,840			$	1,861,959
Long-term liabilities										$	134,160			$	166,155
Non-voting participating redeemable securities										$	1,415			$	4,704
Noncontrolling interests										$	406,805			$	459,900

The Company also has commercial arrangements with Alibaba Group to provide technical, development, and advertising services. For the three and six months ended June 30, 2011 and 2012, these transactions were not material.

Framework Agreement with Alibaba Group regarding Alipay. Alibaba Group restructured the ownership of Alipay.com Co., Ltd. (“Alipay”) and deconsolidated Alipay in the first quarter of 2011. The impact of the deconsolidation of Alipay was not material to the Company’s financial statements. On July 29, 2011, the Company entered into a Framework Agreement (the “Framework Agreement”), with Alibaba Group, Softbank Corp., a Japanese corporation, (“Softbank”), Alipay, APN Ltd., a company organized under the laws of the Cayman Islands (“IPCo”), Zhejiang Alibaba E-Commerce Co., Ltd., a limited liability company organized under the laws of the People’s Republic of China (“HoldCo”), Jack Ma Yun, Joseph C. Tsai and certain security holders of Alipay or HoldCo as joinder parties. The Framework Agreement establishes the ongoing financial and other arrangements between Alibaba Group and Alipay.

Alipay, formerly a subsidiary of Alibaba Group, is a subsidiary of HoldCo, which is majority owned by Mr. Ma. IPCo is a special purpose entity formed in connection with the Framework Agreement, which at the time of consummation of the transactions under the Framework Agreement was owned by Mr. Ma and Mr. Tsai. The transactions under the Framework Agreement closed on December 14, 2011 (“the closing”).

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

(1) Upon a Liquidity Event (as defined below), HoldCo will pay to Alibaba Group 37.5 percent of the equity value of Alipay (the “Liquidity Event Payment”), less $500 million (i.e., the principal amount of the IPCo Promissory Note as described below). The Liquidity Event Payment plus $500 million must in the aggregate not be less than $2 billion and may not exceed $6 billion, subject to

 

9

---

Table of Contents

certain increases and additional payments if no Liquidity Event has occurred by the sixth anniversary of the closing. “Liquidity Event” means the earlier to occur of (a) a qualified initial public offering of Alipay, (b) a transfer of 37.5 percent or more of the securities of Alipay; or (c) a sale of all or substantially all of the assets of Alipay. If a Liquidity Event has not occurred by the tenth anniversary of the closing, Alibaba Group will have the right to cause HoldCo to effect a Liquidity Event, provided that the equity value or enterprise value of Alipay at such time exceeds $1 billion, and in such case, the $2 billion minimum amount described above will not apply to a Liquidity Event effected by means of a qualified initial public offering, a sale of all of the securities of Alipay, or a sale of all or substantially all of the assets of Alipay. Upon payment in full of the Liquidity Event Payment, Alibaba Group will transfer to Alipay certain assets used in the Alipay business that were retained by Alibaba Group.

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

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

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

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

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

The royalty and software technology services fee and the payment processing services fees discussed above approximate the estimated fair values of such services and are recognized in Alibaba Group’s financial statements as income or expense, as applicable, as the services are rendered. Yahoo! will record its share, if any, of the results of these transactions as they are recorded by Alibaba within Yahoo!’s earnings in equity interests in the consolidated statements of income.

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

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

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

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

 

10

---

Table of Contents

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

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

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

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

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

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

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

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

The fair value of the Company’s ownership interest in the common stock of Yahoo Japan, based on the quoted stock price, was approximately $6.5 billion as of June 30, 2012.

During the three and six months ended June 30, 2011 and 2012, the Company received cash dividends from Yahoo Japan in the amount of $75 million and $84 million, net of taxes, respectively, which were recorded as reductions to the Company’s investment in Yahoo Japan.

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

 

		Three Months Ended								Six Months Ended
		March 31, 2011				March 31, 2012				March 31, 2011				March 31, 2012
		(in thousands)
Operating data:
Revenue		$	1,006,327			$	1,069,974			$	2,000,158			$	2,139,301
Gross profit		$	831,503			$	919,132			$	1,655,768			$	1,816,840
Income from operations		$	496,915			$	585,443			$	995,186			$	1,127,941
Net income		$	289,109			$	348,093			$	515,884			$	650,697
Net income attributable to Yahoo Japan		$	287,577			$	346,899			$	512,283			$	648,092

 

11

---

Table of Contents

		September 30, 2011				March 31, 2012
		(in thousands)
Balance sheet data:
Current assets		$	3,622,833			$	5,527,311
Long-term assets		$	2,907,062			$	1,242,815
Current liabilities		$	1,117,773			$	1,135,395
Long-term liabilities		$	36,009			$	45,027
Noncontrolling interests		$	31,102			$	28,244

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

Note 5 GOODWILL

The Company’s goodwill balance was $3.9 billion as of December 31, 2011 and June 30, 2012, of which $2.9 billion was recorded in the Americas segment, $0.6 billion in the EMEA (Europe, Middle East, and Africa) segment, and $0.4 billion in the Asia Pacific segment. The change in the carrying amount of goodwill of $13 million reflected on the Company’s condensed consolidated balance sheets during the six months ended June 30, 2012 was primarily due to foreign exchange losses of $16 million.

Note 6 INTANGIBLE ASSETS, NET

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

 

		December 31, 2011				June 30, 2012
		Net				Gross Carrying Amount				Accumulated Amortization(*)				Net
Customer and advertiser related relationships		$	93,683			$	166,589			$	(89,577	)		$	77,012
Developed technology and patents			137,668				298,089				(198,583	)			99,506
Trade names, trademarks, and domain names			23,249				50,982				(30,771	)			20,211
Total intangible assets, net		$	254,600			$	515,660			$	(318,931	)		$	196,729

 

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

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

Note 7 OTHER (EXPENSE) INCOME, NET

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

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Interest and investment income		$	5,084			$	3,584			$	10,444			$	9,280
Other			(10,750	)			16,591				(11,083	)			13,173
Total other (expense) income, net		$	(5,666	)		$	20,175			$	(639	)		$	22,453

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

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

 

12

---

Table of Contents

Note 8 ACCUMULATED OTHER COMPREHENSIVE INCOME

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

 

		December 31, 2011				June 30, 2012
Unrealized (losses) gains on available-for-sale securities, net of tax		$	(7,538	)		$	7,500
Foreign currency translation, net of tax			705,407				484,270
Accumulated other comprehensive income		$	697,869			$	491,770

Note 9 INVESTMENTS

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

 

		December 31, 2011
		Gross Amortized Costs				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Government and agency securities		$	599,582			$	1,054			$	(172	)		$	600,464
Corporate debt securities, commercial paper, and bank certificates of deposit			366,264				1,025				(226	)			367,063
Corporate equity securities			2,761				—				(1,978	)			783
Total investments in available-for-sale securities		$	968,607			$	2,079			$	(2,376	)		$	968,310
		June 30, 2012
		Gross Amortized Costs				Gross Unrealized Gains				Gross Unrealized Losses				Estimated Fair Value
Government and agency securities		$	402,791			$	586			$	(54	)		$	403,323
Corporate debt securities, commercial paper, and bank certificates of deposit			458,008				721				(278	)			458,451
Corporate equity securities			230				9				—				239
Total investments in available-for-sale securities		$	861,029			$	1,316			$	(332	)		$	862,013

 

		December 31, 2011				June 30, 2012
Reported as:
Short-term marketable debt securities		$	493,189			$	371,204
Long-term marketable debt securities			474,338				490,570
Other assets			783				239
Total		$	968,310			$	862,013

Available-for-sale securities included in cash and cash equivalents on the condensed consolidated balance sheets are not included in the table above as the gross unrealized gains and losses were immaterial as of December 31, 2011 and June 30, 2012 as the carrying value approximates fair value because of the short maturity of those instruments. Realized gains and losses from sales of marketable securities were not material for the six months ended June 30, 2011 and 2012.

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

 

		December 31, 2011				June 30, 2012
Due within one year		$	493,189			$	371,204
Due after one year through five years			474,338				490,570
Total available-for-sale marketable debt securities		$	967,527			$	861,774

 

13

---

Table of Contents

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

 

		December 31, 2011
		Less than 12 Months								12 Months or Greater								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
Government and agency securities		$	138,755			$	(172	)		$	—			$	—			$	138,755			$	(172	)
Corporate debt securities, commercial paper, and bank certificates of deposit			123,574				(226	)			—				—				123,574				(226	)
Corporate equity securities			—				—				783				(1,978	)			783				(1,978	)
Total investments in available-for-sale securities		$	262,329			$	(398	)		$	783			$	(1,978	)		$	263,112			$	(2,376	)
		June 30, 2012
		Less than 12 Months								12 Months or Greater								Total
		Fair Value				Unrealized Loss				Fair Value				Unrealized Loss				Fair Value				Unrealized Loss
Government and agency securities		$	145,069			$	(54	)		$	—			$	—			$	145,069			$	(54	)
Corporate debt securities, commercial paper, and bank certificates of deposit			193,133				(278	)			—				—				193,133				(278	)
Total investments in available-for-sale securities		$	338,202			$	(332	)		$	—			$	—			$	338,202			$	(332	)

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

The following table sets forth the financial assets and liabilities, measured at fair value, by level within the fair value hierarchy as of December 31, 2011 (in thousands):

 

		Fair Value Measurements at Reporting Date Using
Assets		Level 1				Level 2				Total
Money market funds(1)		$	418,338			$	—			$	418,338
Available-for-sale securities:
Government and agency securities(1)			—				617,316				617,316
Commercial paper and bank certificates of deposit(1)			—				47,904				47,904
Corporate debt securities(1)			—				318,805				318,805
Available-for-sale securities at fair value		$	418,338			$	984,025			$	1,402,363
Corporate equity securities(2)			783				—				783
Liabilities
Foreign currency derivative contract(3)			—				(2,817	)			(2,817	)
Total assets and liabilities at fair value		$	419,121			$	981,208			$	1,400,329

 

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

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

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

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

 

14

---

Table of Contents

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

 

		Fair Value Measurements at Reporting Date Using
Assets		Level 1				Level 2				Total
Money market funds(1)		$	498,749			$	—			$	498,749
Available-for-sale securities:
Government and agency securities(1)			—				450,043				450,043
Commercial paper and bank certificates of deposit(1)			—				58,192				58,192
Corporate debt securities(1)			—				400,260				400,260
Available-for-sale securities at fair value		$	498,749			$	908,495			$	1,407,244
Corporate equity securities(2)			239				—				239
Liabilities
Foreign currency derivative contract(3)			—				(3,037	)			(3,037	)
Total assets and liabilities at fair value		$	498,988			$	905,458			$	1,404,446

 

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

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

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

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

The fair values of the Company’s Level 1 financial assets and liabilities are based on quoted market prices of the identical underlying security. The fair values of the Company’s Level 2 financial assets and liabilities are obtained from readily-available pricing sources for the identical underlying security that may not be actively traded. The Company utilizes a pricing service to assist in obtaining fair value pricing for the majority of this investment portfolio. The Company conducts reviews on a quarterly basis to verify pricing, assess liquidity, and determine if significant inputs have changed that would impact the fair value hierarchy disclosure. During the six months ended June 30, 2012, the Company did not make any transfers between Level 1 and Level 2 assets or liabilities. As of December 31, 2011 and June 30, 2012, the Company did not have any significant Level 3 financial assets or liabilities.

Note 10 STOCKHOLDERS’ EQUITY AND EMPLOYEE BENEFITS

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

Stock Options. The Company’s 1995 Stock Plan, the Directors’ Plan, and other stock-based award plans assumed through acquisitions are collectively referred to as the “Plans.” Stock option activity under the Company’s Plans for the six months ended June 30, 2012 is summarized as follows (in thousands, except per share amounts):

 

		Shares				Weighted Average Exercise Price per Share
Outstanding at December 31, 2011			62,439			$	21.94
Options granted			8,291			$	14.86
Options exercised(*)			(2,767	)		$	11.40
Options expired			(6,238	)		$	29.23
Options cancelled/forfeited			(6,458	)		$	14.84
Outstanding at June 30, 2012			55,267			$	21.41

 

(*)	The Company issued new shares to satisfy stock option exercises.

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

 

15

---

Table of Contents

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

 

		Stock Options								Purchase Plan (*)
		Three Months Ended								Three Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Expected dividend yield			0.0	%			0.0	%			0.0	%			0.0	%
Risk-free interest rate			1.6	%			0.8	%			1.4	%			1.1	%
Expected volatility			34.8	%			32.3	%			36.1	%			34.0	%
Expected life (in years)			3.94				4.00				0.98				1.36
		Stock Options								Purchase Plan (*)
		Six Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Expected dividend yield			0.0	%			0.0	%			0.0	%			0.0	%
Risk-free interest rate			1.6	%			0.7	%			1.4	%			1.2	%
Expected volatility			34.7	%			32.3	%			36.1	%			34.1	%
Expected life (in years)			4.09				4.04				1.03				1.25

 

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

Restricted stock awards and restricted stock units activity for the six months ended June 30, 2012 is summarized as follows (in thousands, except per share amounts):

 

		Shares				Weighted Average Grant Date Fair Value Per Share
Awarded and unvested at December 31, 2011(*)			38,775			$	17.28
Granted(*)			13,314			$	14.97
Vested			(7,180	)		$	16.03
Forfeited			(12,866	)		$	15.35
Awarded and unvested at June 30, 2012(*)			32,043			$	17.38

 

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

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

During the six months ended June 30, 2011 and June 30, 2012, 5.7 million shares and 7.2 million shares, respectively, that were subject to previously granted restricted stock awards and restricted stock units vested. These vested restricted stock awards and restricted stock units were net share settled. During the six months ended June 30, 2011 and June 30, 2012, the Company withheld 2.0 million shares and 2.5 million shares, respectively, based upon the Company’s closing stock price on the vesting date to settle the employees’ minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities.

Total payments for the employees’ tax obligations to the relevant taxing authorities were $34 million and $38 million for the six months ended June 30, 2011 and June 30, 2012, respectively, and are reflected as a financing activity within the condensed consolidated statements of cash flows. The payments were used for tax withholdings related to the net share settlements of restricted stock units and tax withholding related to the reacquisition of shares of restricted stock awards. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.

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

 

16

---

Table of Contents

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

Stock Repurchases. In June 2010, the Board authorized a stock repurchase program allowing the Company to repurchase up to $3.0 billion of its outstanding shares of common stock from time to time. That repurchase program expires in June 2013. In May 2012, the Company announced authorization of a stock repurchase program allowing the Company to repurchase up to an additional $5.0 billion of its outstanding shares of common stock from time to time. The aggregate amount available under the two repurchase programs was approximately $5,079 million at June 30, 2012. Repurchases under the repurchase programs may take place in the open market or in privately negotiated transactions, including derivative transactions, and may be made under a Rule 10b5-1 plan. During the six months ended June 30, 2012, the Company repurchased approximately 34 million shares of its common stock under the stock repurchase program announced in June 2010 at an average price of $15.36 per share for a total of $526 million.

Note 11 COMMITMENTS AND CONTINGENCIES

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

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

 

		Gross  Operating Lease Commitments				Sublease Income				Net Operating Lease Commitments
Six months ending December 31, 2012		$	77			$	(6	)		$	71
Years ending December 31,
2013			136				(13	)			123
2014			106				(11	)			95
2015			81				(7	)			74
2016			45				(1	)			44
2017			31				—				31
Due after 5 years			38				—				38
Total gross and net lease commitments		$	514			$	(38	)		$	476

 

		Capital Lease Commitment
Six months ending December 31, 2012		$	4
Years ending December 31,
2013			9
2014			8
2015			8
2016			8
2017			9
Due after 5 years			14
Gross lease commitment		$	60
Less: interest			(21	)
Net lease commitment		$	39

Affiliate Commitments. In connection with contracts to provide advertising services to Affiliates, the Company is obligated to make payments, which represent traffic acquisition costs (“TAC”), to its Affiliates. As of June 30, 2012, these commitments totaled $113 million, of which $40 million will be payable in the remainder of 2012, and $73 million will be payable in 2013.

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

Other Commitments. In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, joint ventures and business partners, purchasers of assets or subsidiaries and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of agreements or representations and warranties made by the Company, services to be provided by the Company, intellectual property infringement claims made by third parties or, with respect to the sale of assets or a subsidiary, matters related to the Company’s conduct of the business and tax matters prior to the sale. In addition, the Company has entered into indemnification agreements with its directors and certain of its

 

17

---

Table of Contents

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

As of June 30, 2012, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, the Company is not exposed to any financing, liquidity, market, or credit risk that could arise if the Company had engaged in such relationships. In addition, the Company identified no variable interests currently held in entities for which it is the primary beneficiary.

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

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

On June 14, 2007, a stockholder derivative action was filed in the United States District Court for the Central District of California by Jill Watkins against members of the Board and selected officers. The complaint filed by the plaintiff alleged breaches of fiduciary duties and corporate waste, similar to the allegations in a former class action relating to stock price declines during the period April 2004 to July 2006, and alleged violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). On July 16, 2009, the plaintiff Watkins voluntarily dismissed the action against all defendants without prejudice. On July 17, 2009, plaintiff Miguel Leyte-Vidal, who had substituted in as plaintiff prior to the dismissal of the federal Watkins action, re-filed a stockholder derivative action in Santa Clara County Superior Court against members of the Board and selected officers. The Santa Clara County Superior Court derivative action purports to assert causes of action on behalf of the Company for violation of specified provisions of the California Corporations Code, for breaches of fiduciary duty regarding financial accounting and insider selling and for unjust enrichment. On September 19, 2011, the Court sustained Yahoo!’s demurrer to plaintiff’s third amended complaint without leave to amend. On December 21, 2011, plaintiff filed a notice of appeal.

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

Since June 6, 2011, two purported stockholder class actions were filed in the United States District Court for the Northern District of California against the Company and certain officers and directors by plaintiffs Bonato and the Twin Cities Pipe Trades Pension Trust. In October 2011, the District Court consolidated the two actions under the caption In re Yahoo! Inc. Securities Litigation and appointed the Pension Trust Fund for Operating Engineers as lead plaintiff. In a consolidated amended complaint filed December 15, 2011, the lead plaintiff purports to represent a class of investors who purchased the Company’s common stock between April 19, 2011 and July 29, 2011, and alleges that during that class period, defendants issued statements that were materially false or misleading because they did not disclose information relating to Alibaba Group’s restructuring of Alipay. The complaint purports to assert claims for relief for violation of Section 10(b) and 20(a) of the Exchange Act and for violation of Rule 10b-5 thereunder, and seeks unspecified damages, injunctive and equitable relief, fees and costs. On June 22, 2012, the court held a hearing on defendants’ motion to dismiss the consolidated amended complaint.

 

18

---

Table of Contents

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

With respect to the legal proceedings and claims described above, the Company has determined, based on current knowledge, that the amount or range of reasonably possible losses, including reasonably possible losses in excess of amounts already accrued, is not reasonably estimable with respect to certain matters and that the aggregate amount or range of such losses that are estimable would not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. Amounts accrued as of December 31, 2011 and June 30, 2012 were not material. The ultimate outcome of legal proceedings involves judgments, estimates and inherent uncertainties, and cannot be predicted with certainty. In the event of a determination adverse to Yahoo!, its subsidiaries, directors, or officers in these matters, however, the Company may incur substantial monetary liability, and be required to change its business practices. Either of these events could have a material adverse effect on the Company’s financial position, results of operations, or cash flows. The Company may also incur substantial legal fees, which are expensed as incurred, in defending against these claims.

Note 12 SEGMENTS

The Company continues to manage its business geographically. The primary areas of measurement and decision-making are currently Americas, EMEA, and Asia Pacific. Management relies on an internal reporting process that provides revenue ex-TAC, which is defined as revenue less TAC, direct costs excluding TAC by segment, and consolidated income from operations for making decisions related to the evaluation of the financial performance of, and allocating resources to, the Company’s segments.

 

19

---

Table of Contents

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

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Revenue by segment:
Americas		$	808,038			$	821,751			$	1,626,969			$	1,657,784
EMEA			162,601				128,099				316,651				262,061
Asia Pacific			258,385				267,944				499,761				519,182
Total Revenue		$	1,229,024			$	1,217,794			$	2,443,381			$	2,439,027
TAC by segment:
Americas		$	39,404			$	45,910			$	77,545			$	88,865
EMEA			57,648				34,187				115,160				79,849
Asia Pacific			55,844				56,928				110,222				112,402
Total TAC		$	152,896			$	137,025			$	302,927			$	281,116
Revenue ex-TAC by segment:
Americas		$	768,634			$	775,841			$	1,549,424			$	1,568,919
EMEA			104,953				93,912				201,491				182,212
Asia Pacific			202,541				211,016				389,539				406,780
Total Revenue ex-TAC		$	1,076,128			$	1,080,769			$	2,140,454			$	2,157,911
Direct costs by segment(1):
Americas			171,042				181,510				333,940				360,735
EMEA			42,768				41,277				81,374				81,498
Asia Pacific			57,728				56,248				109,050				107,739
Global operating costs(2)(3)			393,037				410,519				808,663				832,417
Restructuring charges, net			237				129,092				10,812				134,809
Depreciation and amortization			161,373				157,739				321,811				310,987
Stock-based compensation expense			59,048				49,571				94,164				105,537
Income from operations		$	190,895			$	54,813			$	380,640			$	224,189

 

(1)

Direct costs for each segment include cost of revenue—other as well as other operating expenses that are directly attributable to the segment such as employee compensation expense (excluding stock-based compensation expense), local sales and marketing expenses, and facilities expenses. Beginning in 2012, marketing and customer advocacy costs are managed locally and included as direct costs for each segment. Prior period amounts have been revised to conform to the current presentation.

(2)

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

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

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Capital expenditures, net:
Americas		$	119,167			$	96,443			$	246,537			$	179,327
EMEA			13,962				4,078				27,221				13,361
Asia Pacific			38,386				5,610				65,306				23,234
Total capital expenditures, net		$	171,515			$	106,131			$	339,064			$	215,922

 

20

---

Table of Contents

		December 31, 2011				June 30, 2012
Property and equipment, net:
Americas		$	1,489,096			$	1,455,477
EMEA			79,955				56,571
Asia Pacific			161,837				151,617
Total property and equipment, net		$	1,730,888			$	1,663,665

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

Enterprise Wide Disclosures:

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

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Display		$	523,537			$	534,972			$	1,046,160			$	1,046,189
Search			466,674				460,969				921,795				931,366
Other			238,813				221,853				475,426				461,472
Total revenue		$	1,229,024			$	1,217,794			$	2,443,381			$	2,439,027

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Revenue:
U.S.		$	759,042			$	779,321			$	1,538,011			$	1,578,971
International			469,982				438,473				905,370				860,056
Total revenue		$	1,229,024			$	1,217,794			$	2,443,381			$	2,439,027

 

		December 31, 2011				June 30, 2012
Property and equipment, net:
U.S		$	1,486,596			$	1,453,274
International			244,292				210,391
Total property and equipment, net		$	1,730,888			$	1,663,665

Note 13 INCOME TAXES

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

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

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

The Company is in various stages of examination and appeal in connection with all of its tax audits worldwide, which generally span tax years 2005 through 2011. The Company believes that it has adequately provided for any reasonably foreseeable adjustment and that any settlement will not have a material adverse effect on its consolidated financial position, results of operations, or cash flows.

 

21

---

Table of Contents

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

Note 14 RESTRUCTURING CHARGES, NET

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

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Employee severance pay and related costs		$	(424	)		$	91,736			$	8,911			$	94,727
Non-cancelable lease, contract termination, and other charges			1,187				2,147				3,179				4,873
Other non-cash charges			—				38,638				—				38,638
Sub-total before reversal of stock-based compensation expense			763				132,521				12,090				138,238
Reversal of stock-based compensation expense for forfeitures			(526	)			(3,429	)			(1,278	)			(3,429	)
Restructuring charges, net		$	237			$	129,092			$	10,812			$	134,809

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

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

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

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

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

 

22

---

Table of Contents

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

 

		2011 and Prior Restructuring Plans				Q2’12 Restructuring Plan				Total
Balance as of January 1, 2012		$	49,127			$	—			$	49,127
Employee severance pay and related costs			5,208				91,066				96,274
Non-cash reversals of stock-based compensation expense			—				(3,429	)			(3,429	)
Non-cancelable lease, contract termination, and other charges			4,369				617				4,986
Other non-cash charges			—				38,638				38,638
Reversals of previous charges			(1,660	)			—				(1,660	)
Restructuring charges, net for the six months ended June 30, 2012		$	7,917			$	126,892			$	134,809
Cash paid			(20,761	)			(21,292	)			(42,053	)
Non-cash reversals of stock-based compensation expense			—				3,429				3,429
Other non-cash charges			(232	)			(38,440	)			(38,672	)
Foreign currency			(255	)			(3,843	)			(4,098	)
Payments/reductions, net for the six months ended June 30, 2012		$	(21,248	)		$	(60,146	)		$	(81,394	)
Balance as of June 30, 2012		$	35,796			$	66,746			$	102,542

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

 

		December 31, 2011				June 30, 2012
Americas		$	41,199			$	80,100
EMEA			6,948				18,132
Asia Pacific			980				4,310
Total restructuring accruals		$	49,127			$	102,542

Note 15 SEARCH AGREEMENT WITH MICROSOFT CORPORATION

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

During the first five years of the term of the Search Agreement, in the transitioned markets, the Company is entitled to receive 88 percent of the revenue generated from Microsoft’s services on Yahoo! Properties (the “Revenue Share Rate”) and the Company is also entitled to receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue. For new Affiliates during the term of the Search Agreement, and for all Affiliates after the first five years of such term, the Company will receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue and certain Microsoft costs are deducted. On the fifth anniversary of the date of implementation of the Search Agreement, Microsoft will have the option to terminate the Company’s sales exclusivity for premium search advertisers. If Microsoft exercises its option, the Revenue Share Rate will increase to 93 percent for the remainder of the term of the Search Agreement, unless the Company exercises its option to retain the Company’s sales exclusivity, in which case the Revenue Share Rate would be reduced to 83 percent for the remainder of the term. If Microsoft does not exercise such option, the Revenue Share Rate will be 90 percent for the remainder of the term of the Search Agreement. In the transitioned markets, the Company reports as revenue the 88 percent revenue share as the Company is not the primary obligor in the arrangement with the advertisers and publishers. The underlying search advertising services are provided by Microsoft.

As of December 31, 2011 and June 30, 2012, the Company had collected a total amount of $66 million and $48 million, respectively, on behalf of Microsoft and Affiliates, which was included in cash and cash equivalents with a corresponding liability in accrued expenses and other current liabilities. The Company’s uncollected 88 percent share in connection with the Search Agreement

 

23

---

Table of Contents

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

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

Under the Search Agreement, for each market, Microsoft generally guarantees Yahoo!’s revenue per search (“RPS Guarantee”) on Yahoo! Properties only for 18 months after the transition of paid search services to Microsoft’s platform in that market. In the fourth quarter of 2011, Microsoft agreed to extend the RPS Guarantee in the U.S. and Canada through March 2013. The RPS Guarantee is calculated based on the difference in revenue per search between the pre-transition and post-transition periods. The Company records the RPS Guarantee as search revenue in the quarter the amount becomes fixed, which would typically be the quarter in which the associated shortfall in revenue per search occurred.

From February 23, 2010 until the applicable services are fully transitioned to Microsoft in all markets, Microsoft will also reimburse the Company for the costs of operating algorithmic and paid search services subject to specified exclusions and limitations. The Company’s results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $55 million and $111 million for the three and six months ended June 30, 2011, and $17 million and $34 million for the three and six months ended June 30, 2012, respectively. Search operating cost reimbursements began during the quarter ended March 31, 2010 and will, subject to specified exclusions and limitations, continue until the Company has fully transitioned to Microsoft’s platform.

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

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

Note 16 SUBSEQUENT EVENTS

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

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

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

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

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

 

24

---

Table of Contents

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

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

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

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

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

 

25

---

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” or the negative of such terms or other comparable terminology. This Report includes, among others, forward-looking statements regarding our:

 

•

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

 

•

expectations about growth in users;

 

•

expectations about operating expenses;

 

•

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

 

•

anticipated capital expenditures;

 

•

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

 

•

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

 

•

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

 

•

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

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

Overview

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

New Chief Executive Officer and Review of Business Strategy

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

Agreement with Alibaba Group to Repurchase Yahoo! Stake

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

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

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

 

26

---

Table of Contents

Second Quarter Highlights

 

		Three Months Ended								Dollar Change				Six Months Ended								Dollar Change
		June 30,												June 30,
Operating Highlights		2011				2012								2011				2012
		(In thousands)
Revenue		$	1,229,024			$	1,217,794			$	(11,230	)		$	2,443,381			$	2,439,027			$	(4,354	)
Income from operations		$	190,895			$	54,813			$	(136,082	)		$	380,640			$	224,189			$	(156,451	)

 

		Six Months Ended								Dollar Change
		June 30,
Cash Flow Results		2011				2012
		(In thousands)
Net cash provided by operating activities		$	536,306			$	572,013			$	35,707
Net cash used in investing activities		$	(3,138	)		$	(100,628	)		$	(97,490	)
Net cash used in financing activities		$	(521,437	)		$	(472,082	)		$	49,355

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

Cash generated by operating activities is a measure of the cash productivity of our business model. Our operating activities in the six months ended June 30, 2012 generated adequate cash to meet our operating needs. Cash used by investing activities in the six months ended June 30, 2012 included net proceeds from sales, maturities, and purchases of marketable debt securities of $102 million offset by net capital expenditures of $216 million. Cash used in financing activities included $526 million used in the direct repurchase of common stock and $38 million used for tax withholding payments related to the net share settlements of restricted stock units and tax withholding related reacquisition of shares of restricted stock, offset by $78 million in proceeds from employee option exercises and employee stock purchases.

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

Search Agreement with Microsoft Corporation

On December 4, 2009, we entered into a Search and Advertising Services and Sales Agreement (the “Search Agreement”) with Microsoft Corporation (“Microsoft”), which provides for Microsoft to be the exclusive algorithmic and paid search services provider on Yahoo! Properties and non-exclusive provider of such services on Affiliate sites. We also entered into a License Agreement with Microsoft pursuant to which Microsoft acquired an exclusive 10-year license to our core search technology that it will be able to integrate into its existing Web search platforms.

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

Under the Search Agreement, for each market, Microsoft generally guarantees Yahoo!’s revenue per search (“RPS Guarantee”) on Yahoo! Properties only for 18 months after the transition of paid search services to Microsoft’s platform in that market. In the fourth quarter of 2011, Microsoft agreed to extend the RPS Guarantee in the U.S. and Canada through March 2013. The RPS Guarantee is calculated based on the difference in revenue per search between the pre-transition and post-transition periods. We record the RPS Guarantee as search revenue in the quarter the amount becomes fixed, which is typically the quarter in which the associated shortfall in revenue per search occurred.

Under the Search Agreement, Microsoft agreed to reimburse us for certain transition costs up to an aggregate total of $150 million during the first three years of the Search Agreement. Our results for the three and six months ended June 30, 2011 reflect transition cost reimbursements from Microsoft under the Search Agreement that were equal to transition costs of $12 million and $23 million, respectively, incurred by Yahoo! related to the Search Agreement in the those periods. During the third quarter of 2011, our

 

27

---

Table of Contents

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

From February 23, 2010 until the applicable services are fully transitioned to Microsoft in all markets, Microsoft will also reimburse us for the costs of operating algorithmic and paid search services subject to specified exclusions and limitations. The Company’s results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $55 million and $111 million for the three and six months ended June 30, 2011, and $17 million and $34 million for the three and six months ended June 30, 2012, respectively. The global transition of the algorithmic and paid search platforms to Microsoft’s platform and the migration of the paid search advertisers and publishers to Microsoft’s platform are being done on a market by market basis. Search operating cost reimbursements are expected to decline as we fully transition all markets and, in the long term, the underlying expenses are not expected to be incurred under our cost structure.

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

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

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

Results of Operations

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

 

		Three Months Ended June 30,																Percent Change				Six Months Ended June 30,																Percent Change
		2011				(*)				2012				(*)								2011				(*)				2012				(*)
Display		$	523,537				43	%		$	534,972				44	%			2	%		$	1,046,160				43	%		$	1,046,189				43	%			0	%
Search			466,674				38	%			460,969				38	%			(1	)%			921,795				38	%			931,366				38	%			1	%
Other			238,813				19	%			221,853				18	%			(7	)%			475,426				19	%			461,472				19	%			(3	)%
Total revenue		$	1,229,024				100	%		$	1,217,794				100	%			(1	)%		$	2,443,381				100	%		$	2,439,027				100	%			0	%

 

(*)	Percent of total revenue.

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

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

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

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

 

28

---

Table of Contents

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

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

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

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

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

 

		Three Months Ended June 30,																Dollar Change				Percent Change
		2011				(1)				2012				(1)
Cost of revenue — TAC		$	152,896				12	%		$	137,025				11	%		$	(15,871	)			(10	)%
Cost of revenue — Other		$	231,388				19	%		$	278,453				23	%		$	47,065				20	%
Sales and marketing		$	280,159				23	%		$	272,910				22	%		$	(7,249	)			(3	)%
Product development		$	233,045				19	%		$	199,628				16	%		$	(33,417	)			(14	)%
General and administrative		$	131,822				11	%		$	136,117				11	%		$	4,295				3	%
Amortization of intangibles		$	8,582				1	%		$	9,756				1	%		$	1,174				14	%
Restructuring charges, net		$	237				0	%		$	129,092				11	%		$	128,855				N/M	(2)

 

		Six Months Ended June 30,																Dollar Change				Percent Change
		2011				(1)				2012				(1)
Cost of revenue — TAC		$	302,927				12	%		$	281,116				12	%		$	(21,811	)			(7	)%
Cost of revenue — Other		$	481,014				20	%		$	532,432				22	%		$	51,418				11	%
Sales and marketing		$	542,308				22	%		$	558,178				23	%		$	15,870				3	%
Product development		$	454,328				19	%		$	428,106				18	%		$	(26,222	)			(6	)%
General and administrative		$	254,720				10	%		$	260,388				11	%		$	5,668				2	%
Amortization of intangibles		$	16,632				1	%		$	19,809				1	%		$	3,177				19	%
Restructuring charges, net		$	10,812				0	%		$	134,809				6	%		$	123,997				N/M	(2)

 

(1)	Percent of total revenue.

(2)	N/M = not meaningful.

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

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2012				2011				2012
Cost of revenue — Other		$	875			$	2,614			$	1,523			$	5,508
Sales and marketing			19,373				18,981				26,070				40,078
Product development			25,531				17,808				43,203				37,279
General and administrative			13,269				10,168				23,368				22,672
Restructuring expense reversals, net			(526	)			(3,429	)			(1,278	)			(3,429	)
Total stock-based compensation expense		$	58,522			$	46,142			$	92,886			$	102,108

For additional information about stock-based compensation, see Note 10 — “Stockholders’ Equity and Employee Benefits” in the Notes to the condensed consolidated financial statements included elsewhere in this Report as well as “Critical Accounting

 

29

---

Table of Contents

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

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

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

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

 

		Compensation				Information Technology				Depreciation  and Amortization				TAC				Facilities				Other				Total
Cost of revenue — TAC		$	—			$	—			$	—			$	(15,871	)		$	—			$	—			$	(15,871	)
Cost of revenue — Other			6,846				25,392				4,950				—				312				9,565				47,065
Sales and marketing			14,937				64				(336	)			—				665				(22,579	)			(7,249	)
Product development			(13,684	)			(5,821	)			(5,143	)			—				(5,056	)			(3,713	)			(33,417	)
General and administrative			(5,095	)			533				(1,967	)			—				2,594				8,230				4,295
Amortization of intangibles			—				—				1,174				—				—				—				1,174
Restructuring charges, net			—				—				—				—				—				128,855				128,855
Total		$	3,004			$	20,168			$	(1,322	)		$	(15,871	)		$	(1,485	)		$	120,358			$	124,852

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

 

		Compensation				Information Technology				Depreciation  and Amortization				TAC				Facilities				Other				Total
Cost of revenue — TAC		$	—			$	—			$	—			$	(21,811	)		$	—			$	—			$	(21,811	)
Cost of revenue — Other			12,158				37,075				(287	)			—				962				1,510				51,418
Sales and marketing			47,504				(150	)			(839	)			—				980				(31,625	)			15,870
Product development			(5,401	)			(5,302	)			(5,267	)			—				(6,624	)			(3,628	)			(26,222	)
General and administrative			(9,174	)			1,377				(5,297	)			—				4,367				14,395				5,668
Amortization of intangibles			—				—				3,177				—				—				—				3,177
Restructuring charges, net			—				—				—				—				—				123,997				123,997
Total		$	45,087			$	33,000			$	(8,513	)		$	(21,811	)		$	(315	)		$	104,649			$	152,097

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

 

30

---

Table of Contents

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

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

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

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

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

 

		Three Months Ended								Six Months Ended
		June 30, 2011				June 30, 2012				June 30, 2011				June 30, 2012
Employee severance pay and related costs		$	(424	)		$	91,736			$	8,911			$	94,727
Non-cancelable lease, contract termination, and other charges			1,187				2,147				3,179				4,873
Other non-cash charges			—				38,638				—				38,638
Sub-total before reversal of stock-based compensation expense			763				132,521				12,090				138,238
Reversal of stock-based compensation expense for forfeitures			(526	)			(3,429	)			(1,278	)			(3,429	)
Restructuring charges, net		$	237			$	129,092			$	10,812			$	134,809

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

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

 

31

---

Table of Contents

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

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

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

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

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

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

We are in various stages of examination and appeal in connection with all of our tax audits worldwide, which generally span tax years 2005 through 2011. We believe that we have adequately provided for any reasonably foreseeable adjustment and that any settlement will not have a material adverse effect on our consolidated financial position, results of operations, or cashflows.

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

Earnings in Equity Interests. Earnings in equity interests for the three and six months ended June 30, 2012 was $180 million and $352 million, respectively, compared to $109 million and $191 million for the same periods in 2011. The increases for the three and six months ended June 30, 2012 were primarily due to improved financial performance for Alibaba Group. See Note 4 — “Investments in Equity Interests” in the Notes to the condensed consolidated financial statements for additional information.

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

Business Segment Results

We continue to manage our business geographically. The primary areas of measurement and decision-making are currently Americas, EMEA, and Asia Pacific. Management relies on an internal reporting process that provides revenue ex-TAC, which is defined as revenue less TAC, direct costs excluding TAC by segment, and consolidated income from operations for making decisions related to the evaluation of the financial performance of, and allocating resources to, our segments.

 

32

---

Table of Contents

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

 

		Three Months Ended												Six Months Ended
		June 30, 2011				June 30, 2012				Percent Change				June 30, 2011				June 30, 2012				Percent Change
Revenue by segment:
Americas		$	808,038			$	821,751				2	%		$	1,626,969			$	1,657,784				2	%
EMEA			162,601				128,099				(21	)%			316,651				262,061				(17	)%
Asia Pacific			258,385				267,944				4	%			499,761				519,182				4	%
Total revenue		$	1,229,024			$	1,217,794				(1	)%		$	2,443,381			$	2,439,027				0	%
TAC by segment:
Americas		$	39,404			$	45,910				17	%		$	77,545			$	88,865				15	%
EMEA			57,648				34,187				(41	)%			115,160				79,849				(31	)%
Asia Pacific			55,844				56,928				2	%			110,222				112,402				2	%
Total TAC		$	152,896			$	137,025				(10	)%		$	302,927			$	281,116				(7	)%
Revenue ex-TAC by segment:
Americas		$	768,634			$	775,841				1	%		$	1,549,424			$	1,568,919				1	%
EMEA			104,953				93,912				(11	)%			201,491				182,212				(10	)%
Asia Pacific			202,541				211,016				4	%			389,539				406,780				4	%
Total revenue ex-TAC		$	1,076,128			$	1,080,769				0	%		$	2,140,454			$	2,157,911				1	%
Direct costs by segment(1):
Americas			171,042				181,510				6	%			333,940				360,735				8	%
EMEA			42,768				41,277				(3	)%			81,374				81,498				0	%
Asia Pacific			57,728				56,248				(3	)%			109,050				107,739				(1	)%
Global operating costs(2)(3)			393,037				410,519				4	%			808,663				832,417				3	%
Restructuring charges, net			237				129,092				N/M	(4)			10,812				134,809				N/M	(4)
Depreciation and amortization			161,373				157,739				(2	)%			321,811				310,987				(3	)%
Stock-based compensation expense			59,048				49,571				(16	)%			94,164				105,537				12	%
Income from operations		$	190,895			$	54,813				(71	)%		$	380,640			$	224,189				(41	)%

 

(1)

Direct costs for each segment include cost of revenue—other as well as other operating expenses that are directly attributable to the segment such as employee compensation expense (excluding stock-based compensation expense), local sales and marketing expenses, and facilities expenses. Beginning in 2012, marketing and customer advocacy costs are managed locally and included as direct costs for each segment. Prior period amounts have been revised to conform to the current presentation.

(2)

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

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

(4)	N/M = not meaningful.

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

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

 

33

---

Table of Contents

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

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

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

Revenue ex-TAC in Asia Pacific accounted for approximately 20 percent and 19 percent of total revenue ex-TAC for the three and six months ended June 30, 2012, respectively, compared to 19 percent and 18 percent for the three and six months ended June 30, 2011, respectively.

Our international operations expose us to foreign currency exchange rate fluctuations. Revenue ex-TAC and related expenses generated from our international subsidiaries are generally denominated in the currencies of the local countries. Primary currencies include Australian dollars, British pounds, Euros, Japanese yen, Korean won, and Taiwan dollars. The statements of income of our international operations are translated into U.S. dollars at exchange rates indicative of market rates during each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency-denominated transactions results in reduced consolidated revenue ex-TAC and operating expenses. Conversely, our consolidated revenue ex-TAC and operating expenses will increase if the U.S. dollar weakens against foreign currencies. Using the foreign currency exchange rates from the three and six months ended June 30, 2011, revenue ex-TAC for the Americas segment for the three and six months ended June 30, 2012 would have been higher than we reported by $3 million and $4 million, respectively, revenue ex-TAC for the EMEA segment would have been higher than we reported by $5 million and $7 million, respectively, and revenue ex-TAC for the Asia Pacific segment would have been higher than we reported by $3 million and $1 million, respectively. Using the foreign currency exchange rates from the three and six months ended June 30, 2011, direct costs for the Americas segment for the three and six months ended June 30, 2012 would have been higher than we reported by $1 million and $2 million, respectively, direct costs for the EMEA segment would have been higher than we reported by $2 million and $3 million, respectively, and direct costs for the Asia Pacific segment would have been higher than we reported by $1 million for both periods.

Critical Accounting Policies and Estimates

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

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

For a discussion of our critical accounting policies and estimates, see “Critical Accounting Policies and Estimates” included in our Annual Report on Form 10-K for the year ended December 31, 2011 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have made no significant changes to our critical accounting policies and estimates from those described in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

34

---

Table of Contents

Liquidity and Capital Resources

 

		December 31, 2011				June 30, 2012
		(Dollars in thousands)
Cash and cash equivalents		$	1,562,390			$	1,539,269
Short-term marketable debt securities			493,189				371,204
Long-term marketable debt securities			474,338				490,570
Total cash, cash equivalents, and marketable debt securities		$	2,529,917			$	2,401,043
Percentage of total assets			17	%			16	%

 

		Six Months Ended June 30,
Cash Flow Highlights		2011				2012
		(In thousands)
Net cash provided by operating activities		$	536,306			$	572,013
Net cash used in investing activities		$	(3,138	)		$	(100,628	)
Net cash used in financing activities		$	(521,437	)		$	(472,082	)

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

During the six months ended June 30, 2012, we generated $572 million of cash from operating activities, net proceeds from sales, maturities and purchases of marketable debt securities of $102 million, and $78 million from the issuance of common stock as a result of the exercise of employee stock options and employee stock purchases. This was offset by a net $216 million in capital expenditures, $38 million in tax withholding payments related to net share settlements of restricted stock units, and $526 million used in the direct repurchase of common stock. During the six months ended June 30, 2011, we generated $536 million of cash from operating activities, net proceeds from sales, maturities, and purchases of marketable debt securities of $416 million, and $99 million from the issuance of common stock as a result of the exercise of employee stock options and employee stock purchases. This was offset by a net $339 million in capital expenditures, a net $69 million for acquisitions, $609 million used in the direct repurchase of common stock, and $34 million in tax withholding payments related to net share settlements of restricted stock units and tax withholding-related reacquisitions of shares of restricted stock.

We have accrued U.S. federal income taxes on the earnings of our foreign subsidiaries except to the extent the earnings are considered indefinitely reinvested outside the U.S. As of June 30, 2012, approximately $3.5 billion of earnings held by our foreign subsidiaries and a corporate joint venture are designated as indefinitely reinvested outside the U.S. Our foreign subsidiaries held $1.2 billion of our total $2.4 billion of cash, cash equivalents, and marketable debt securities as of June 30, 2012. If required for our operations in the U.S., most of the cash held abroad could be repatriated to the U.S. but, under current law, would be subject to U.S. federal income taxes (subject to an adjustment for foreign tax credits). Currently, we do not anticipate a need to repatriate these funds for use in our U.S. operations.

We expect to continue to generate positive cash flows from operations for the third quarter of 2012. We use cash generated by operations as our primary source of liquidity, since we believe that internally generated cash flows are sufficient to support our business operations and capital expenditures. We believe that existing cash, cash equivalents, and investments in marketable debt securities, together with any cash generated from operations, will be sufficient to meet normal operating requirements including capital expenditures for the next twelve months. However, we may sell additional debt securities or obtain credit facilities to further enhance our liquidity position.

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

Cash flow changes

Cash provided by operating activities is driven by our net income, adjusted for non-cash items, working capital changes, and non-operating gains from sales of investments. Non-cash adjustments include depreciation, amortization of intangible assets, stock-based compensation expense, non-cash restructuring charges, tax benefits from stock-based awards, excess tax benefits from stock-based awards, deferred income taxes, and earnings in equity interests. Cash provided by operating activities was higher than net income in the six months ended June 30, 2012 due to changes in working capital.

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

 

35

---

Table of Contents

debt securities of $102 million, which was offset by the investment of $216 million in net capital expenditures. During the six months ended June 30, 2011, cash used in investing activities was primarily attributable to cash used for net capital expenditures and net acquisitions, offset by net proceeds from the sales and maturities of marketable debt securities. In the six months ended June 30, 2011, we received net proceeds from sales, maturities, and purchases of marketable debt securities of $416 million, which was offset by the investment of $339 million in net capital expenditures, $69 million for net acquisitions, and $11 million to purchase intangible assets.

Cash used in financing activities is driven by stock repurchases offset by employee stock option exercises and employee stock purchases. Our cash proceeds from employee stock option exercises and employee stock purchases were $78 million for the six months ended June 30, 2012, compared to $99 million for the same period of 2011. During the six months ended June 30, 2012, we used $526 million in the direct repurchase of approximately 34 million shares of common stock at an average price of $15.36 per share. We used $38 million for tax withholding payments related to net share settlements of restricted stock units. During the six months ended June 30, 2011, we used $609 million in the direct repurchase of approximately 39 million shares of common stock at an average price of $15.79 per share. We used $34 million for tax withholding payments related to net share settlements of restricted stock units and tax withholding related reacquisitions of shares of restricted stock.

Capital expenditures

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

Contractual obligations and commitments

Leases. We have entered into various non-cancelable operating and capital lease agreements for office space and data centers globally for original lease periods up to 13 years, expiring between 2012 and 2022.

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

 

		Gross Operating Lease Commitments				Capital Lease Commitment
Six months ending December 31, 2012		$	77			$	4
Years ending December 31,
2013			136				9
2014			106				8
2015			81				8
2016			45				8
2017			31				9
Due after 5 years			38				14
Total gross lease commitments		$	514			$	60
Less: interest			—				(21	)
Net lease commitments		$	514			$	39

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

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

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

Other Commitments and Off-Balance Sheet Arrangements. In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, joint venture and business partners, purchasers of assets or subsidiaries and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements or representations and warranties made by us, services to be provided by us, intellectual property infringement claims made by third parties or, with respect to the sale of assets or a subsidiary, matters related to our conduct of the business and tax matters prior to the sale. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. We have also agreed to indemnify certain former officers, directors, and employees of acquired companies in connection with the acquisition of such companies. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers and former directors and officers of acquired companies, in certain

 

36

---

Table of Contents

circumstances. It is not possible to determine the aggregate maximum potential loss under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements might not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements and we have not accrued any liabilities related to such indemnification obligations in our condensed consolidated financial statements.

As of June 30, 2012, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, as of June 30, 2012, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures, or capital resources.

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

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

Interest Rate Exposure

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

Investments in fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. A hypothetical 100 basis point increase in interest rates would result in a $7 million and $9 million decrease in the fair value of our available-for-sale debt securities as of December 31, 2011 and June 30, 2012, respectively.

Foreign Currency Exposure

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

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

Transaction Exposure. Our exposure to foreign currency transaction gains and losses is the result of assets and liabilities (including intercompany transactions) that are denominated in currencies other than the relevant entity’s functional currency. In certain circumstances, changes in the functional currency value of these assets and liabilities create fluctuations in our reported condensed consolidated financial position, cash flows and results of operations. We may enter into derivative instruments, such as foreign currency forward contracts or other instruments to minimize the impact of the short-term foreign currency fluctuations on such assets and liabilities. The gains and losses on the forward contracts may not offset any or more than a portion of the transaction gains and losses on certain foreign currency receivables, investments and payables recognized in earnings. Transaction gains and losses on these foreign exchange contracts are recognized each period in other income, net included on the condensed consolidated statements of income. Our net realized and unrealized foreign currency transaction gains were $5 million and $4 million for the three and six months ended June