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 a leading global Internet brand and one of the most trafficked Internet destinations worldwide.  Yahoo! seeks to provide Internet services that are essential and relevant to users and businesses through the provision of online properties (collectively referred to as the “Yahoo! Properties”) to Internet users and a range of tools and marketing solutions for businesses to market to that community of users.

 

Basis of Presentation.   The condensed consolidated financial statements include the accounts of Yahoo! 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 closing date of the acquisition.

 

Certain prior period amounts have been reclassified to conform to the current period presentation.  The Company has changed the classification of amortization expense related to developed technology and patents in the condensed consolidated statements of operations.  Amortization expense of $14 million for the three months ended March 31, 2005, was previously included as part of operating expenses and has been reclassified to cost of revenues.  Amortization expense included in cost of revenues for the three months ended March 31, 2006 was $26 million.

 

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 period.

 

The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities.  On an on-going basis, the Company evaluates its estimates, including those related to uncollectible receivables, the useful lives of long-lived assets including property and equipment, investment fair values, goodwill and other intangible assets, investments in equity interests, income taxes, and contingencies.  In addition, the Company uses assumptions when employing the Black-Scholes option valuation model to calculate the fair value of stock options granted.  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, 2005.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations.  The December 31, 2005 condensed consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.  However, the Company believes the disclosures are adequate to make the information presented not misleading.

 

Recent Accounting Pronouncement

 

Stock-Based Compensation .  Effective January 1, 2006 the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share Based Payment” (“SFAS 123R”), and the Company’s condensed consolidated financial statements as of and for the three months ended March 31, 2006 reflect the impact of SFAS 123R.  For the three months ended March 31, 2006, the Company recorded stock-based compensation expense of $109 million which reduced gross profit by $2 million, income from operations by $109 million, and net income by $71 million.  The impact on basic and diluted net income per share for the three months ended March 31, 2006 was $0.05 and $0.04 respectively.  The Company also capitalized $2 million of stock-based compensation expense in the three months ended March 31, 2006 which is now part of property and equipment, net on the condensed consolidated balance sheet.  For the three months ended March 31, 2005, the Company recognized $9 million of stock-based compensation expense under the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”).  In addition, prior to the adoption of SFAS 123R, the Company presented tax benefits from stock-based compensation as cash flow from operating activities.  Upon the adoption of SFAS 123R,

 

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the benefit of tax deductions related to stock-based compensation in excess of the grant date fair value of the related stock-based awards are now classified as cash flows from financing activities.  See Note 10—“Stock-Based Compensation” for further information.

 

Note 2 BASIC AND DILUTED NET INCOME PER SHARE

 

Basic net income per share is computed using the weighted average number of common shares outstanding during the period, excluding any unvested restricted stock that is subject to repurchase.  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 consist of unvested restricted stock and restricted stock units, collectively referred to as “restricted stock awards” (using the treasury stock method), the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s zero coupon senior convertible notes (using the if-converted method).  For the three months ended March 31, 2005 and 2006, approximately 61 million and 83 million options to purchase common stock, respectively were excluded from the calculation, as they were anti-dilutive.  See Note 9—“Long-Term Debt” for additional information related to the Company’s zero coupon senior convertible notes.  

 

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

 

		Three Months Ended
		March 31, 2005			March 31, 2006
Numerator:
Net income		$	204,560		$	159,859
Denominator:
Weighted average common shares		1,387,051			1,422,786
Weighted average unvested restricted stock subject to repurchase		(2,093		)	(4,869		)
Denominator for basic calculation		1,384,958			1,417,917
Weighted average effect of dilutive securities:
Employee stock options		54,910			37,351
Convertible notes		36,585			36,585
Restricted stock awards		1,358			1,454
Denominator for diluted calculation		1,477,811			1,493,307
Net income per share – basic		$	0.15		$	0.11
Net income per share – diluted		$	0.14		$	0.11

 

Note 3 ACQUISITIONS

 

Transactions completed in 2005

 

Verdisoft Corporation.   On February 11, 2005, the Company acquired Verdisoft Corporation (“Verdisoft”), a software development company.  The acquisition of Verdisoft enhanced the Company’s platform for delivering content and services to mobile devices as part of the Company’s strategy to provide users with seamless access to its network.  The transaction was treated as an asset acquisition for accounting purposes and therefore no goodwill was recorded.  The purchase price was $58 million and consisted of $54 million in cash consideration, $3 million related to stock options exchanged and $1 million of direct transaction costs.  In connection with the acquisition, the Company also issued approximately 1 million shares of restricted stock valued at $35 million that will be recognized as expense over three years as the Company’s right to repurchase these shares lapses on the third anniversary of the date of grant.  For accounting purposes,  $93 million was allocated to amortizable intangible assets, $37 million to liabilities, primarily deferred income tax liabilities, and $2 million to deferred stock-based compensation (which has been netted against additional paid in-capital upon the adoption of SFAS 123R).  The amortizable intangible assets have useful lives not exceeding four years and a weighted average useful life of approximately 3 years.

 

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Yahoo! Europe and Yahoo! Korea.    In November 1996, the Company entered into joint ventures with  SOFTBANK Corp., including its consolidated affiliates (“SOFTBANK”) whereby separate companies were formed in the United Kingdom, France and Germany, (collectively “Yahoo! Europe”) which established and managed local versions of Yahoo! in those countries.  In August 1997, the Company entered into a similar joint venture with SOFTBANK in Korea.  Prior to November 2005, the Company had a majority share of approximately 70 percent in each of the Yahoo! Europe entities and 67 percent in Yahoo! Korea and therefore the results of these entities were included in the Company’s consolidated financial statements, with minority interests separately presented on the consolidated statements of operations and consolidated balance sheets.  On November 23, 2005, the Company purchased SOFTBANK’s remaining shares in the joint ventures giving the Company 100 percent ownership in these entities.

 

The total purchase price of $501 million consisted of $500 million in cash consideration and direct transaction costs of $1 million.

 

The allocation of the purchase price to the assets acquired and liabilities assumed based on their fair values was as follows (in thousands):

 

Net tangible assets acquired		$	52,484
Amortizable intangible assets:
Customer contracts and related relationships		30,561
Developed technology and patents		6,570
Trade name, trademark and domain name		50,121
Goodwill		387,771
Total assets acquired		527,507
Deferred income taxes		(26,633		)
Total		$	500,874

 

The amortizable intangible assets have useful lives not exceeding five years and a weighted average life of approximately 4 years.  No amount has been allocated to in-process research and development and $388 million has been allocated to goodwill.  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.

 

Other Acquisitions—Business Combinations .   During the year ended December 31, 2005, the Company acquired four other companies which were accounted for as business combinations.  The total purchase price for these four acquisitions was $79 million and consisted of $73 million in cash consideration, $3 million related to stock options exchanged and $3 million of direct transaction costs.  The total cash consideration of $73 million less cash acquired of $3 million resulted in net cash outlay of $70 million.  Of the purchase price, $58 million was allocated to goodwill, $32 million to amortizable intangible assets and $11 million to net assumed liabilities.  Approximately $1 million was allocated to in-process research and development and expensed in the condensed consolidated statements of operations.  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 purchase price allocations for these acquisitions are preliminary and subject to revision as more detailed analyses are completed and additional information on the fair value of assets and liabilities becomes available.  Any change in the fair value of the net assets of the acquired companies will change the amount of the purchase price allocable to goodwill.

 

During 2005, the Company also made a strategic investment in Alibaba.com Corporation (“Alibaba”)—see Note 4—“Investments in Equity Interests” and completed immaterial asset acquisitions that did not qualify as business combinations.

 

Transactions completed in 2006

 

Seven Networks Limited .  On January 29, 2006, the Company and Seven Network Limited (“Seven”), a leading Australian media company, completed a strategic partnership in which the Company contributed its Australian Internet business, Yahoo! Australia and New Zealand (“Yahoo! Australia”), and Seven contributed its online assets, television and magazine content, an option to purchase its 33 percent ownership interest in mobile solutions provider m.Net Corporation Ltd, and cash of AUD $10 million.  The Company believes this strategic partnership and the contribution of the respective businesses with their rich media and entertainment content will create a comprehensive and engaging online experience for local users and advertisers.  The Company obtained a 50 percent equity ownership interest in the newly formed entity, which operates as “Yahoo!7.”  Pursuant to a shareholders agreement and a power of attorney granted by Seven to vote certain of its shares, the Company has the right to vote 50.1 percent of the outstanding voting interests in Yahoo!7 and control over the day-to-day operations and therefore consolidates Yahoo!7, which includes the operations of Yahoo! Australia.  For accounting purposes, Yahoo! is considered to have acquired the assets contributed by Seven in exchange for 50 percent of the

 

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ownership of Yahoo! Australia.  Accordingly, the Company will account for this transaction in accordance with SFAS No. 141 “Business Combinations.”  The total estimated purchase price was $34 million including direct transaction costs of $2 million.

 

The preliminary allocation of the purchase price of the Company's share of the assets acquired and liabilities assumed based on their fair values was as follows (in thousands):

 

Cash acquired		$	3,763
Other tangible assets acquired		2,400
Amortizable intangible assets:
Customer contracts, related relationships and developed technology and patents		18,600
Goodwill		15,034
Total assets acquired		39,797
Deferred income taxes		(5,580		)
Total		$	34,217

 

The amortizable intangible assets have useful lives not exceeding seven years and a weighted average useful life of seven years.  No amounts have been allocated to in-process research and development and approximately $15 million has been allocated to goodwill.  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 preliminary allocation of the purchase price is subject to revision as more detailed analyses are completed and additional information on the fair value of assets and liabilities becomes available.  Any change in the fair value of the net assets acquired will change the amount of the purchase price allocable to goodwill.

 

As a result of this transaction, the Company’s ownership in Yahoo! Australia, which is now part of Yahoo!7, decreased to 50 percent.  The Company effectively recognized a non-cash gain of approximately $30 million representing the difference between the fair value of Yahoo! Australia and its carrying value adjusted for the Company’s continued ownership in Yahoo!7.  This non-cash gain was treated as a capital transaction and recorded as additional paid-in capital because of certain future events that could affect actual realization of the gain.  The Company also recorded a minority interest of $8 million related to its reduced ownership of Yahoo! Australia and Seven’s retained interest in their contributed assets.