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YHOO > SEC Filings for YHOO > Form 10-K on 28-Feb-2014All Recent SEC Filings

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Form 10-K for YAHOO INC


28-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

In addition to current and historical information, this Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our future operations, prospects, potential products, services, developments, and business strategies. These statements can, in some cases, be identified by the use of terms such as "may," "will," "should," "could," "would," "intend," "expect," "plan," "anticipate," "believe," "estimate," "predict," "project," "potential," or "continue," the negative of such terms, or other comparable terminology. This Annual Report on Form 10-K includes, among others, forward-looking statements regarding our:

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

expectations about growth in users;

expectations about changes in our earnings in equity interests;

expectations about changes in operating expenses;

anticipated capital expenditures;

expectations about our share repurchase activity;

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

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

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

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

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

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

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

These statements involve certain known and unknown risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. You are urged to carefully review the disclosures made concerning risks and uncertainties that may affect our business or operating results, which include, among others, those listed in Part 1, Item 1A "Risk Factors" of this Annual Report on Form 10-K. We do not intend, and undertake no obligation, to update or revise any of our forward-looking statements after the date of this Annual Report on Form 10-K to reflect new information, actual results or future events or circumstances.

Overview

Yahoo! Inc., together with its consolidated subsidiaries ("Yahoo," the "Company," "we," or "us") is a global technology company focused on making the world's daily habits inspiring and entertaining. Our mission is driven by our commitment to creating highly personalized experiences that reach our users wherever they might be-on their mobile phone, tablet or desktop. Our more than 800 million monthly users connect to the things that matter most to them with beautiful, engaging experiences across Search, Communications, Digital Magazines and Video-some of which will be powered by Flickr and Tumblr.


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We create value for advertisers with a streamlined, simplified advertising technology stack that leverages Yahoo's data, reach and analytics to connect advertisers with their target audiences. For advertisers, the opportunity to be a part of users' daily habits across products and platforms is a powerful tool to engage audiences and build brand loyalty.

Advertisers can build their businesses through advertising to targeted audiences on our online properties and services ("Yahoo Properties") or through a distribution network of third party entities ("Affiliates") who integrate our advertising offerings into their Websites or other offerings ("Affiliate sites"; together with Yahoo Properties, the "Yahoo Network"). Our revenue is generated principally from display and search advertising.

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

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

Key Financial Metrics;

Non-GAAP Financial Measures;

Significant Transactions;

Results of Operations;

Liquidity and Capital Resources;

Critical Accounting Policies and Estimates; and

Recent Accounting Pronouncements.

Key Financial Metrics

The key financial metrics we use are as follows: revenue; revenue less traffic acquisition costs ("TAC"), or revenue ex-TAC; income from operations; adjusted EBITDA; net income attributable to Yahoo! Inc.; net cash provided by (used in) 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, and limitations specific to, each of these non-GAAP financial measures.

                                                                  Years Ended December 31,
                                                          2011             2012              2013
                                                                   (dollars in thousands)
Revenue                                                $ 4,984,199      $ 4,986,566       $ 4,680,380
Revenue ex-TAC                                         $ 4,380,828      $ 4,467,660       $ 4,425,938
Income from operations(1)                              $   800,341      $   566,368       $   589,926
Adjusted EBITDA                                        $ 1,654,583      $ 1,698,727       $ 1,564,245
Net income attributable to Yahoo! Inc                  $ 1,048,827      $ 3,945,479       $ 1,366,281
Net cash provided by (used in) operating activities    $ 1,323,806      $  (281,554 )     $ 1,195,247
Free cash flow(2)                                      $   725,801      $  (834,865 )     $   786,465

(1)    Includes:

Stock-based compensation expense                       $   203,958      $   224,365       $   278,220
Restructuring charges, net                             $    24,420      $   236,170       $     3,766

(2) Excluding the impact of the cash taxes paid of $2.3 billion related to the Initial Repurchase described under "Significant Transactions" below, free cash flow for the year ended December 31, 2012 would have been $1.4 billion.


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Revenue ex-TAC (a non-GAAP financial measure)

                            Years Ended December 31,                2011-2012       2012-2013
                      2011            2012            2013          % Change        % Change
                             (dollars in thousands)
  Revenue          $ 4,984,199     $ 4,986,566     $ 4,680,380               -              (6 )%
  Less: TAC            603,371         518,906         254,442           (14)%             (51 )%

  Revenue ex-TAC   $ 4,380,828     $ 4,467,660     $ 4,425,938              2%              (1 )%

For the year ended December 31, 2013, revenue ex-TAC decreased $42 million, or 1 percent, due to a decrease in display revenue ex-TAC partially offset by an increase in search revenue ex-TAC and other revenue ex-TAC.

For the year ended December 31, 2012, revenue ex-TAC increased $87 million, or 2 percent, due to an increase in search revenue ex-TAC partially offset by a decline in display revenue ex-TAC.

Adjusted EBITDA (a non-GAAP financial measure)



                                             Years Ended December 31,                   2011-2012        2012-2013
                                     2011              2012             2013            % Change         % Change
                                              (dollars in thousands)
Net income attributable to
Yahoo! Inc.                       $ 1,048,827      $  3,945,479      $ 1,366,281               N/M            (65)%
Costs associated with the Korea
business and its closure                   -             99,485               -               100%           (100)%
Deal-related costs related to
the sale of Alibaba Group
shares                                     -              6,500               -               100%           (100)%
Depreciation and amortization         625,864           649,267          628,778                4%             (3)%
Stock-based compensation
expense                               203,958           224,365          278,220               10%              24%
Goodwill impairment charge                 -                 -            63,555                 -             100%
Restructuring charges, net, as
adjusted(1)                            24,420           152,742            3,766               N/M            (98)%
Other income, net                     (27,175 )      (4,647,839 )        (43,357 )             N/M              N/M
Provision for income taxes            241,767         1,940,043          153,392               N/M              N/M
Earnings in equity interests         (476,920 )        (676,438 )       (896,675 )             42%              33%
Net income attributable to
noncontrolling interests               13,842             5,123           10,285             (63)%             101%

Adjusted EBITDA                   $ 1,654,583      $  1,698,727      $ 1,564,245                3%             (8)%

Percentage of revenue
ex-TAC(2)(3)                              38%               38%              35%

N/M = Not Meaningful

(1) For the year ended December 31, 2012, this amount excludes the restructuring charges of $83 million related to the Korea business and its closure, which charges are included in costs associated with the Korea business and its closure.

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

(3) Net income attributable to Yahoo! Inc. as a percentage of GAAP revenue in 2011, 2012, and 2013 was 21 percent, 79 percent, and 29 percent, respectively.

For the year ended December 31, 2013, adjusted EBITDA decreased $134 million, or 8 percent, compared to 2012, mainly due to a decline in revenue ex-TAC and an increase in global operating costs.


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For the year ended December 31, 2012, adjusted EBITDA increased $44 million, or 3 percent, compared to 2011. Excluding the impact of the Initial Repurchase described under "Significant Transactions" below, such increase was primarily attributable to increased revenue in the Americas region and a decline in TAC in the EMEA region.

Free Cash Flow (a non-GAAP financial measure)



                                                            Years Ended December 31,
                                                    2011              2012             2013
                                                             (dollars in thousands)
Net cash provided by (used in) operating
activities                                       $ 1,323,806       $ (281,554 )     $ 1,195,247
Acquisition of property and equipment, net          (593,294 )       (505,507 )        (338,131 )
Dividends received from equity investees             (75,391 )        (83,648 )        (135,058 )
Excess tax benefits from stock-based awards           70,680           35,844            64,407

Free cash flow(*)                                $   725,801       $ (834,865 )     $   786,465

(*) Excluding the impact of the cash taxes paid of $2.3 billion related to the Initial Repurchase described under "Significant Transactions" below, free cash flow for the year ended December 31, 2012 would have been $1.4 billion.

For the year ended December 31, 2013, free cash flow increased $1.6 billion, compared to 2012. Excluding the impact of the cash taxes paid in 2012 of $2.3 billion related to the Initial Repurchase described under "Significant Transactions" below, free cash flow decreased $645 million in 2013, compared to 2012. The decline was primarily due to an upfront payment of $550 million we received in 2012 from Alibaba Group Holding Limited (the "Alibaba Group") in satisfaction of certain future royalty payments under the existing technology and intellectual property license agreement with Alibaba Group (the "TIPLA"), for which there were no similar payments in 2013. This was partially offset by a decrease in capital expenditures.

For the year ended December 31, 2012, free cash flow decreased $1.6 billion, compared to 2011. Excluding the impact of the cash taxes paid of $2.3 billion related to the Initial Repurchase described under "Significant Transactions" below, free cash flow increased $705 million primarily due to the upfront payment of $550 million from Alibaba Group in 2012 described above.

Non-GAAP Financial Measures

Revenue ex-TAC. Revenue ex-TAC is a non-GAAP financial measure defined as GAAP revenue less traffic acquisition costs ("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 had not yet transitioned, revenue continued to be recorded on a gross (before TAC) basis, and TAC is recorded as a part of operating expenses.

We present revenue ex-TAC to provide investors a metric used by us for evaluation and decision-making purposes during the Microsoft transition and to provide investors with comparable revenue numbers when comparing periods preceding, during and following the transition period. A limitation of revenue ex-TAC is that it is a measure which we have defined for internal and investor purposes that may be unique to us, and therefore it may not enhance the comparability of our results to other companies in our industry who have similar business


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arrangements but address the impact of TAC differently. Management compensates for these limitations by also relying on the comparable GAAP financial measures of revenue and total operating expenses, which include TAC in non-transitioned markets.

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.

We present adjusted EBITDA because the exclusion of certain gains, losses, and expenses facilitates comparisons of the operating performance of our Company on a period to period basis. Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation or as a substitute for results reported under GAAP. These limitations include: adjusted EBITDA does not reflect tax payments and such payments reflect a reduction in cash available to us; adjusted EBITDA does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses; adjusted EBITDA does not include stock-based compensation expense related to our workforce; adjusted EBITDA also excludes 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, and these items may represent a reduction or increase in cash available to us. Adjusted EBITDA is a measure that may be unique to us, and therefore it may not enhance the comparability of our results to other companies in our industry. Management compensates for these limitations by also relying on the comparable GAAP financial measure of net income attributable to Yahoo! Inc., which includes taxes, depreciation, amortization, stock-based compensation expense, other income, net (which includes interest), earnings in equity interests, net income attributable to noncontrolling interests and the other gains, losses and expenses that are excluded from adjusted EBITDA.

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

We consider free cash flow to be a liquidity measure which provides useful information to management and investors about the amount of cash generated by the business after the acquisition of property and equipment, which can then be used for strategic opportunities including, among others, investing in our business, making strategic acquisitions, strengthening the balance sheet, and repurchasing stock. A limitation of free cash flow is that it does not represent the total increase or decrease in the cash balance for the period. Management compensates for the limitation of free cash flow by also relying on the net change in cash and cash equivalents as presented in our consolidated statements of cash flows prepared in accordance with GAAP which incorporates all cash movements during the period.

Significant Transactions

Acquisition of Tumblr

On June 19, 2013, we completed the acquisition of Tumblr, Inc. ("Tumblr"), a blog-hosting Website that allows users to post their own content as well as follow or re-blog posts made by other users. The acquisition of Tumblr brings a community of new users to the Yahoo Network. The total purchase price of approximately $990 million consisted mainly of cash consideration. See Note 4-"Acquisitions" in the Notes to our consolidated financial statements for additional information.

Initial Repurchase of Alibaba Group Holding Limited Ordinary Shares

See Note 8-"Investments in Equity Interests" in the Notes to our consolidated financial statements for information regarding the repurchase by Alibaba Group of 523 million of the 1,047 million ordinary shares of


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Alibaba Group (the "Shares") we owned at the time (the "Initial Repurchase") pursuant to the terms of a Share Repurchase and Preference Share Sale Agreement (as amended on September 11, 2012 and October 14, 2013, the "Repurchase Agreement").

In September 2012, we received net cash proceeds of approximately $4.3 billion after the payment of taxes and fees from the Initial Repurchase, which included the $550 million TIPLA payment. We returned $3.65 billion of these after-tax proceeds to shareholders.

In connection with the Initial Repurchase, we also received $800 million in Alibaba Group Preference Shares. On May 16, 2013, we received $846 million in cash from Alibaba Group to redeem the Alibaba Group Preference Shares. The cash received represented the redemption value, which included the stated value of $800 million plus accrued dividends of $46 million.

The Company, Yahoo! Hong Kong Holdings Limited ("YHK") and Alibaba Group entered into a Second Amendment to the Share Repurchase and Preference Share Sale Agreement, dated as of October 14, 2013. The amendment reduced the maximum number of Shares of Alibaba Group that we are required to sell in connection with an initial public offering of Alibaba Group meeting certain specified criteria (a "Qualified IPO") from 261.5 million Shares to 208.0 million Shares.

Convertible Senior Notes

In 2013, we completed the offering of $1.4375 billion aggregate principal amount of our 0.00% Convertible Senior Notes due in 2018 (the "Notes"). The Notes were sold in a private placement under a purchase agreement, dated November 20, 2013, that we entered into with J.P. Morgan Securities LLC and Goldman, Sachs & Co., as representatives of the several initial purchasers named therein (collectively, the "Initial Purchasers"), for resale to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the "Securities Act"). In connection with the issuance of the Notes, we entered into note hedge transactions with the Initial Purchasers (in such capacity, the "Option Counterparties") to reduce the potential dilution with respect to our common stock upon conversion of the Notes or offset any cash payment we would be required to make in excess of the principal amount of converted Notes. For the year ended December 31, 2013, we used $206 million to pay the cost of the privately negotiated note hedge transactions. Separately, we entered into privately negotiated warrant transactions with the Option Counterparties giving them the right to purchase Yahoo common stock from us. The warrant transactions will have a dilutive effect with respect to our common stock to the extent that the market price per share of our common stock exceeds the $71.24 strike price of the warrants on or prior to the expiration date of the warrants. For the year ended December 31, 2013, we received $125 million from the issuance of warrants.

Concurrent with the offering, we also used approximately $87.5 million of the net proceeds from the sale of the Notes to repurchase approximately 2.5 million shares of our common stock. We expect to use the remainder of the net proceeds from the sale of the Notes for general corporate purposes, including, but not limited to, acquisitions or other strategic transactions, additional repurchases of common stock and working capital. For additional information see "Item 5-Recent Sales of Unregistered Securities" and Note 11-"Convertible Notes" in the Notes to our consolidated financial statements.

Search Agreement with Microsoft Corporation

On December 4, 2009, we entered into a Search and Advertising Services and Sales Agreement, as amended, (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


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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 were to be 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. Under the Search Agreement, Yahoo is the exclusive worldwide relationship sales force for both companies' premium search advertisers. 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. Revenue under the Search Agreement represented approximately 20 percent, 25 percent, and 31 percent of our revenue for the years ended December 31, 2011, 2012 and, 2013, respectively.

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 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, and in the second quarter of 2013, Microsoft extended the RPS Guarantee in the U.S. through March 2014. In June 2013, Microsoft and we agreed upon the RPS Guarantee payment amounts to be paid to us for the quarters ended December 31, 2012, March 31, 2013 and June 30, 2013. We also agreed to fixed quarterly payments in lieu of the RPS Guarantee in the U.S. for the quarters ending September 30, 2013, December 31, 2013 and March 31, 2014. In addition, we agreed to waive our right to receive any future RPS Guarantee payments in all other . . .

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