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YHOO > SEC Filings for YHOO > Form 10-Q on 7-May-2013All Recent SEC Filings

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Form 10-Q for YAHOO INC


7-May-2013

Quarterly Report


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 changes in our earnings in equity interests;

expectations about operating expenses;

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, intangible assets, and technologies;

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

expectations about the impact of the closure of our Korea business;

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

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

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

These statements involve certain known and unknown risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. 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 making the world's daily habits inspiring and entertaining. By creating highly personalized experiences for our users, we keep people connected to what matters most to them, across devices and around the world. In turn, we create value for advertisers by connecting them with the audiences that build their businesses. Advertisers can build their businesses through advertising to targeted audiences on our online properties and services ("Yahoo! Properties"), or through our distribution network of third-party entities ("Affiliates") who integrate our advertising offerings into their Websites or other offerings (those Websites and other offerings, "Affiliate sites").

Our offerings to users on Yahoo! Properties currently fall into four categories:
Yahoo.com; Communications; User-Generated Content; and Mobile & Emerging Products. We manage and measure our business geographically, principally in the Americas, EMEA (Europe, Middle East, and Africa), and Asia Pacific.

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

Key Financial Metrics;

Non-GAAP Financial Measures;

Significant Transactions;

Results of Operations;

Liquidity and Capital Resources; and

Critical Accounting Policies and Estimates.


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Key Financial Metrics

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

                                                  Three Months Ended March 31,
                                                     2012                2013
                                                     (dollars in thousands)

    Revenue                                     $     1,221,233       $ 1,140,368
    Revenue ex-TAC                              $     1,077,142       $ 1,074,300
    Income from operations(*)                   $       169,376       $   185,970
    Adjusted EBITDA                             $       384,307       $   385,605
    Net income attributable to Yahoo! Inc.      $       286,343       $   390,285
    Net cash provided by operating activities   $       297,453       $   218,682
    Free cash flow                              $       195,823       $   149,908

    (*)  Includes:

    Stock-based compensation expense            $        55,966       $    44,605
    Restructuring charges (reversals), net      $         5,717       $    (7,062 )

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

                                                                   2012-2013
                              Three Months Ended March 31,         % Change
                                 2012                2013
                                 (dollars in thousands)

           Revenue          $     1,221,233       $ 1,140,368              (7 )%
           Less: TAC                144,091            66,068             (54 )%

           Revenue ex-TAC   $     1,077,142       $ 1,074,300              -

For the three months ended March 31, 2013, revenue ex-TAC was flat compared to the same period of 2012, due to an increase in search and other revenue ex-TAC offset by a decline in display revenue ex-TAC.

Adjusted EBITDA (a Non-GAAP Financial Measure)



                                                                                         2012-2013
                                                  Three Months Ended March 31,           % Change
                                                     2012                2013
                                                     (dollars in thousands)

Net income attributable to Yahoo! Inc.          $      286,343        $   390,285                36 %
Depreciation and amortization                          153,248            162,092                 6 %
Stock-based compensation expense                        55,966             44,605               (20 )%
Restructuring charges (reversals), net                   5,717             (7,062 )             N/M
Other income, net                                       (2,278 )          (17,072 )             N/M
Provision for income taxes                              56,419             29,736               (47 )%
Earnings in equity interests                          (172,243 )         (217,588 )              26 %
Net income attributable to noncontrolling
interests                                                1,135                609               (46 )%

Adjusted EBITDA                                 $      384,307        $   385,605                -

Percentage of Revenue ex-TAC(1)(2)                          36 %               36 %

N/M = Not Meaningful


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(1) Revenue ex-TAC is calculated as revenue less TAC.

(2) Net income attributable to Yahoo! Inc. as a percentage of GAAP revenue for the three months ended March 31, 2012 and 2013 was 23 percent and 34 percent, respectively.

For the three months ended March 31, 2013, adjusted EBITDA was flat compared to 2012, mainly due to flat revenue ex-TAC.

Free Cash Flow (a Non-GAAP Financial Measure)



                                                   Three Months Ended March 31,
                                                      2012                 2013
                                                      (dollars in thousands)

   Net cash provided by operating activities     $       297,453        $  218,682
   Acquisition of property and equipment, net           (109,791 )         (69,581 )
   Dividends received from equity investees                   -            (12,000 )
   Excess tax benefits from stock-based awards             8,161            12,807

   Free cash flow                                $       195,823        $  149,908

For the three months ended March 31, 2013, free cash flow decreased $46 million, or 23 percent compared to 2012. The decrease was primarily attributable to a decline in net cash provided by operating activities which was partially offset by a decline in capital expenditures year-over-year.

Non-GAAP Financial Measures

Revenue ex-TAC

Revenue ex-TAC is a non-GAAP financial measure defined as GAAP revenue less TAC. TAC consists of payments made to Affiliates that have integrated our advertising offerings into their sites and payments made to companies that direct consumer and business traffic to Yahoo! Properties. Based on the terms of the Search Agreement with Microsoft described under "Significant Transactions" below, Microsoft retains a revenue share of 12 percent of the net (after TAC) search revenue generated on Yahoo! Properties and Affiliate sites in transitioned markets. We report the net revenue we receive under the Search Agreement as revenue and no longer present the associated TAC. Accordingly, for transitioned markets we report GAAP revenue associated with the Search Agreement on a net (after TAC) basis rather than a gross basis. For markets that have not yet transitioned, revenue continues to be recorded on a gross (before TAC) basis, and TAC is recorded as a part of operating expenses.

Adjusted EBITDA

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

Free Cash Flow

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

For additional information about these non-GAAP financial measures, see "Non-GAAP Financial Measures" included in our Annual Report on Form 10-K for the year ended December 31, 2012 under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations."

Significant Transactions

Initial Repurchase of Alibaba Group Holding Limited Ordinary Shares

See Note 8-"Investments in Equity Interests" in the Notes to our condensed consolidated financial statements for information regarding the repurchase by Alibaba Group Holding Limited ("Alibaba Group") of 523 million of the 1,047 million ordinary shares of Alibaba Group (the "Shares") owned by us (the "Initial Repurchase").


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In September 2012, we received net cash proceeds after the payment of taxes and fees from the Initial Repurchase and the $550 million TIPLA payment of approximately $4.3 billion. We intend to return $3.65 billion of the after-tax proceeds to shareholders. This amount includes approximately $2.9 billion we returned to shareholders through share repurchases from May 20, 2012, the date we announced the Repurchase Agreement, through March 31, 2013.

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. The global transition of our algorithmic and paid search platforms to Microsoft's platform and the migration of paid search advertisers and publishers to Microsoft's platform are being done on a market-by-market basis.

During the first five years of the Search Agreement, in 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. The underlying search advertising services are provided by Microsoft. For new Affiliates during the term of the Search Agreement, and for all Affiliates after the first five years of such term, we 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 February 23, 2015 (the fifth anniversary of the date that implementation of the Search Agreement commenced), Microsoft will have the option to terminate our 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 we exercise our option to retain our 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. The term of the Search Agreement is 10 years from February 23, 2010, subject to earlier termination as provided in the Search Agreement.

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. The RPS Guarantee is calculated based on the difference in revenue per search between the pre-transition and post-transition periods and certain other factors. 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. 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 in the U.S. and Canada expired on March 31, 2013. On April 30, 2013, Microsoft extended the RPS Guarantee in the U.S. for an additional 12 months commencing April 1, 2013. We are currently unable to estimate what impact, if any, the extension of the RPS Guarantee will have on our future financial results.

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 2012, we completed the transition of paid search in most of the EMEA markets as well as six markets in Latin America. We are continuing to work with Microsoft on transitioning paid search in the remaining markets. The market-by-market transition of our paid search platform to Microsoft's platform and the migration of paid search advertisers and publishers to Microsoft's platform are expected to continue through 2013, and possibly into 2014.

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. Our results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $17 million and $13 million for the three months ended March 31, 2012 and 2013, respectively. 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 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, 2012 and the three months ended March 31, 2013, the total reimbursements not yet received from Microsoft of $5 million and $4 million, were classified as part of prepaid expenses and other current assets on our condensed consolidated balance sheets as of December 31, 2012 and March 31, 2013, respectively.

See Note 16 - "Search Agreement with Microsoft Corporation" in the Notes to our condensed consolidated financial statements for additional information.


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Results of Operations



                                                                                       2012-2013
                                                 Three Months Ended March 31,          % Change
                                                    2012                2013
                                                    (dollars in thousands)
Revenue for groups of similar services:
Display                                        $       511,217       $   455,071              (11 )%
Search                                                 470,397           424,687              (10 )%
Other                                                  239,619           260,610                9 %

Total revenue                                  $     1,221,233       $ 1,140,368               (7 )%
Cost of revenue - traffic acquisition costs    $       144,091       $    66,068              (54 )%
Cost of revenue - other                                253,980           278,007                9 %
Sales and marketing                                    285,267           257,019              (10 )%
Product development                                    228,478           219,580               (4 )%
General and administrative                             124,271           133,421                7 %
Amortization of intangibles                             10,053             7,365              (27 )%
Restructuring charges (reversals), net                   5,717           (7,062)               N/ M

Total operating expenses                       $     1,051,857       $   954,398               (9 )%

Income from operations                         $       169,376       $   185,970               10 %

Includes:
Stock-based compensation expense               $        55,966       $    44,605              (20 )%

N/M = Not Meaningful

Management Reporting

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

                                                                         2012-2013
                                    Three Months Ended March 31,         % Change
                                       2012                2013
                                       (dollars in thousands)
     Revenue by segment:
     Americas                     $       836,033       $   842,195               1 %
     EMEA                                 133,962            94,824             (29 )%
     Asia Pacific                         251,238           203,349             (19 )%

     Total revenue                $     1,221,233       $ 1,140,368              (7 )%


     TAC by segment:
     Americas                     $        42,955       $    37,522             (13 )%
     EMEA                                  45,662            11,536             (75 )%
     Asia Pacific                          55,474            17,010             (69 )%

     Total TAC                    $       144,091       $    66,068             (54 )%

     Revenue ex-TAC by segment:
     Americas                     $       793,078       $   804,673               1 %
     EMEA                                  88,300            83,288              (6 )%
     Asia Pacific                         195,764           186,339              (5 )%

     Total revenue ex-TAC         $     1,077,142       $ 1,074,300              -


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                                                                                          2012-2013
                                                   Three Months Ended March 31,           % Change
                                                     2012                 2013
                                                      (dollars in thousands)
Direct costs by segment(1):
Americas                                               179,225              170,124               (5 )%
EMEA                                                    40,221               38,428               (4 )%
Asia Pacific                                            51,491               55,014                7 %
Global operating costs(2)(3)                           421,898              425,129                1 %
Depreciation and amortization                          153,248              162,092                6 %
Stock-based compensation expense                        55,966               44,605              (20 )%
Restructuring charges (reversals), net                   5,717               (7,062 )             N/ M

Income from operations                          $      169,376       $      185,970               10 %

N/M = Not Meaningful

(1) Direct costs for each segment include cost of revenue - other, as well as other operating expenses that are directly attributable to the segment such as employee compensation expense (excluding stock-based compensation expense), local sales and marketing expenses, and facilities expenses.

(2) Global operating costs include product development, service engineering and operations, general and administrative, and other corporate expenses that are managed on a global basis and that are not directly attributable to any particular segment.

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

Revenue

We generate revenue principally from display and search advertising on Yahoo! Properties and Affiliate sites. The majority of our revenue comes from display and search advertising on Yahoo! Properties, and our margins on revenue from Yahoo! Properties advertising is higher than our margins on revenue from display and search advertising on Affiliate sites, as we pay traffic acquisition costs to our Affiliates. Additionally, we generate revenue from other sources including listings-based services, facilitating commercial transactions, royalties, and consumer and business fee-based services.

We are increasing our strategic focus on the mobile industry due to a shift in Internet access by users and have hired engineering and technical talent to help us accelerate our efforts in mobile development. At present, our display and search revenue from mobile are not material.

For additional information about how we generate and recognize revenue, see "Results of Operations-Revenue" included in our Annual Report on Form 10-K for the year ended December 31, 2012 under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations."

Display and Search Metrics

We present information below regarding the "Number of Ads Sold" and "Price-per-Ad" for display and the number of "Paid Clicks" and "Price-per-Click" for search. This information is derived from internal data. We periodically review and refine our methodologies for monitoring, gathering, and counting Number of Ads Sold and Paid Clicks. Based on this process, from time to time, we update such methodologies.

Due to the closure of the Korea business in the fourth quarter of 2012, "Number of Ads Sold," "Paid Clicks," "Price-per-Ad," and "Price-per-Click," as presented below, exclude the Korea market for all periods presented.

"Number of Ads Sold" is defined as the total number of ads displayed, or impressions, for paying advertisers on Yahoo! Properties. "Price-per-Ad" is defined as display revenue from Yahoo! Properties divided by our Number of Ads Sold. Our price and volume metrics for display are based on display revenue which we report on a gross basis (before TAC). Our price and volume metrics for display exclude both the Number of Ads Sold and the related revenue for certain regions where we did not retain historical information in a manner that would support period-to-period comparison on these metrics. The countries and regions included in our display metrics are: the United States, the United Kingdom, France, Germany, Spain, Italy, Taiwan, Hong Kong, Southeast Asia (excluding Korea as discussed above), and India.

"Paid Clicks" are defined as the total number of times an end-user clicks on a sponsored listing on Yahoo! Properties and Affiliate sites for which an advertiser pays on a per click basis. "Price-per-Click" is defined as search revenue divided by our Paid Clicks. Although Paid Clicks and Price-per-Click are predominantly search metrics, we include Paid Clicks and the related revenue from

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